enforcement actions, with respect to depository institutions with more than $10 billion in consolidated assets. The federal bank regulators will examine and enforce compliance with the CFPB’s rules for institutions with $10 billion or fewer assets. The CFPB will also have new authority, among other things, to declare acts “unfair, deceptive or abusive” and to require certain consumer disclosures. The Act limits federal pre-emption of state consumer protection laws, and allows state enforcement of federal consumer protection rules.

Debit Card Interchange Fees.

The Dodd-Frank Act provides for a set of new rules requiring that interchange transaction fees for electric debit transactions be “reasonable” and proportional to certain costs associated with processing the transactions. The FRB has established standards for assessing whether interchange fees are reasonable and proportional.

Derivatives.

The Dodd-Frank Act requires a new regulatory system for the U.S. market for swaps and other over-the counter derivatives, which includes strict capital and margin requirements, central clearing of standardized over-the-counter derivatives, and heightened supervision of over-the-counter derivatives dealers and major market participants. These rules could increase the costs and collateral required to utilize derivatives that we could find useful to reduce our interest rate and other risks.

Other Legislative and Regulatory Changes

Various legislative and regulatory proposals regarding substantial changes in banking, and the regulation of banks, thrifts and other financial institutions, compensation, and the regulation of financial markets and their participants and financial instruments, and the regulators of all of these, as well as the taxation of these entities, are being considered by the executive branch of the federal government, Congress and various state governments, including Alabama.Certain of these proposals, if adopted, could significantly change the regulation or operations of banks and the financial services industry. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of the nation’s financial institutions.

ITEM 1A. RISK1A.RISK FACTORS

Any of the following risks could harm our business, results of operations and financial condition and an investment in our stock. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.

There can be no assurance that recent legislation and administrative actions will improve the long term stability of the U.S. financial system.

Numerous actions by the U.S. Congress, the Federal Reserve, the Treasury, the FDIC, the SEC and other governmental authorities have been taken to address the liquidity and credit crisis that commenced in 2007. These measures include various laws regulations and other actions, including, but not limited to, those described under “Supervision and Regulation.”

We cannot predict the actual effects of the Dodd-Frank Act and the numerous rules already thereunder that have been adopted, proposed or which are required to be adopted but that have not been proposed or adopted yet, or various governmental, regulatory, and fiscal and monetary initiatives, studies and rulemakings which have been and may be enacted, adopted or proposed will have on the financial markets, our competitors, counterparties and customers and on us. The terms and costs of these activities, or the failure of these actions to continue to stabilize the financial markets, asset prices, market liquidity or a worsening of current financial market and economic conditions could materially and adversely affect our business, financial condition, results of operations, and the trading prices of our common stock.

Difficult market conditions have adversely affected our industry.

We are exposed to downturns in the U.S. economy, although the local markets in which we operate in East Alabama have not been as adversely affected as various other areas of the country. Although declines in the housing market appear to be stabilizing over the past year, the declines in home prices and high levels of foreclosures, unemployment and under-employment since 2007, have negatively affected the credit performance of mortgage loans and resulted in significant write-downs of asset values by various financial institutions, including government-sponsored entities as well as major commercial and investment banks. This market turmoil and the tightening of available credit have led to increased levels of commercial and consumer delinquencies, reduced consumer confidence, increased market volatility and reductions in business activity, although signs of stabilization and some recovery are beginning to evolve. Failures have increased among financial services companies, and various companies, weakened by market conditions, have merged with other institutions. We believe the following, among other things, may affect us in 2012:2013:

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine investment and banking transactions, as well as the quality and values of our investments in equity securities and obligations of other financial institutions, could be adversely affected by the actions, financial condition, and profitability of such other financial institutions with which we deal, including, without limitation, the FHLB and our correspondent banks. At December 31, 2011,2012, the amortized cost of the Bank’s investments in FHLB common stock and individual issuer trust preferred securities of financial institutions and pooled trust preferred securities of other financial institutions was approximately $4.4 million, $1.9$2.3 million and $0.2$0.7 million, respectively. In 2009, Silverton Bank, N.A., one of our correspondent banks, failed, which had a material adverse effect on our 2009 results of operations. Financial services institutions are interrelated as a result of shared credits, trading, clearing, counterparty and other relationships. As a result, defaults by, or even rumors or questions about, one or more financial institutions, or the financial services industry generally, have led to market-wide liquidity problems, losses of depositor, creditor or counterparty confidence in certain institutions and could lead to losses or defaults by other institutions, and in some cases, failure of such institutions. Any losses, defaults by, or failures of, the institutions we do business with could adversely affect our holdings of the debt of and equity in, such other institutions, our participation interests in loans originated by other institutions, and our business, including our liquidity, financial condition and earnings.

Nonperforming and similar assets take significant time to resolve and may adversely affect our results of operations and financial condition.

At December 31, 2011,2012, our nonaccrual loans totaled $10.4$10.5 million, or 2.8%2.65% of total loans. In addition, we had approximately $7.9$4.9 million of other real estate owned (“OREO”) at December 31, 2011.2012. Our non-performing assets may adversely affect our net income in various ways. We do not record interest income on nonaccrual loans or OREO and these assets require higher loan administration and other costs, thereby adversely affecting our income. Decreases in the value of these assets, or the underlying collateral, or in the related borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires commitments of time from management, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience increases in nonperforming loans in the future.

Our allowance for loan losses may prove inadequate or we may be negatively affected by credit risk exposures.

Our business depends on the creditworthiness of our customers. We periodically review our allowance for loan losses for adequacy considering economic conditions and trends, collateral values and credit quality indicators, including past charge-off experience and levels of past due loans and nonperforming assets. We cannot be certain that our allowance for loan losses will be adequate over time to cover credit losses in our portfolio because of unanticipated adverse changes in the economy, market conditions or events adversely affecting specific customers, industries or markets. If the credit quality of our customer base materially decreases, if the risk profile of a market, industry or group of customers changes materially or weaknesses in the real estate markets persist or worsen, borrower payment behaviors change, or if our allowance for loan losses is not adequate, our business, financial condition, including our liquidity and capital, and results of operations could be materially adversely affected.

Weaknesses in the real estate markets, including the secondary market for residential mortgage loans, may continue to adversely affect us.

The Lee County Association of Realtors (“LCAR”) reported that the average median residential home price in Lee County, Alabama for the quarter ended December 31, 2011 was $139,461, a decrease of 24.2% from the same quarter a year earlier. The number of homes sold during the quarter ended December 31, 2011 increased by 30.8% from the same quarter a year ago. LCAR also reported that residential inventory at December 31, 2011 was 1,047 homes, a decrease of 16.1% from a year earlier. The effects of ongoingproposed CFPB changes to mortgage market challenges,rules, the effectual mortgage servicing enforcement actions, reviews and settlements, proposed changes in the securitization rules under the Dodd-Frank Act and under the treatment of mortgages sold and servicing under the Basel III regulatory capital proposals, combined with the ongoing correction in residential real estate market pricescontinuing conservatorships of Fannie Mae and Freddie Mac, the levels of risky assets at the FHA and its relatively low reserves for losses, current levels of home sales and the risks of interest rates increasing from historically low levels, could result in furtherhave serious adverse effects on the mortgage markets and our mortgage operations. Such effects could include, among other things, price reductions in single family home values, further adversely affecting the liquidity and value of collateral securing commercial loans for residential acquisition, construction and development, as well as residential mortgage loans that we hold, mortgage loan originations and gains on sale of mortgage loans.

Declining real estate prices and higher interest rates charged on mortgage loans have caused higher delinquencies and losses on certain mortgage loans, generally, particularly second lien mortgages and home equity lines of credit.

Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of most mortgage loans other than conforming Fannie Mae, Freddie Mac, and VHAFHA loans. These trends could continue. Continued declinesDeclines in real estate values, or low home sales volumes, and financial stress on

borrowers as a result of job losses or reduced incomes, interest rate increases, generally, including resets on adjustable rate mortgage loans or other factors could have further adverse effects on borrowers thatand changes in mortgage loan rules, could result in fewer mortgage originations, higher delinquencies and greater charge-offs in future periods, as well as increased regulation capital requirement which would adversely affect our financial condition, including capital and liquidity, orand our results of operations. In the event our allowance for loan losses is insufficient to cover such losses, if any, our earnings, capital and liquidity could be adversely affected. Fannie Mae and Freddie Mac, the largest purchasers of residential mortgage loans remain in federal conservatorship and the timing and effects of their resolution cannot be predicted.

Weaknesses in real estate markets may adversely affect the length of time and costs required to manage and dispose of, and the values realized from the sale of our OREO. We have no control over the sale of other real estate owned where the FDIC has the controlling interest as a result of the FDIC receivership of Silverton Bank.

Our concentration of commercial real estate loans could result in further increased loan losses, and adversely affect our business, earnings, and financial condition.

Commercial real estate or CRE is cyclical and poses risks of possible loss due to concentration levels and risks of the assets being financed, which include loans for the acquisition and development of land and residential construction. We had 53.955.1 % of our portfolio in CRE loans, as defined by the Federal Reserve, at year-end 20112012 compared to 56.453.9 % at year-end 2010.2011. The banking regulators continue to give CRE lending greater scrutiny, and require banks with higher levels of CRE loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as higher levels of allowances for possible losses and capital levels as a result of CRE lending growth and exposures. Continued low demand for CRE, reduced availability of, and higher costs for, CRE lending could adversely affect our CRE loans and sales of our OREO, and therefore our earnings and financial condition, including our capital and liquidity.

We may be contractually obligated to repurchase mortgage loans we sold to third parties on terms unfavorable to us.

As a routine part of its business, the Company originates mortgage loans that it subsequently sells in the secondary market, including to governmental agencies and government sponsored utilitiesentities, such as Fannie Mae. In connection with the sale of these loans, the Company makes customary representations and warranties, the breach of which could result in the Company being required to repurchase the loan or loans. Furthermore, the amount paid may be greater than the fair value of the loan or loans at the time of the repurchase. Requests for mortgage loan repurchases have increased, generally in recent years, although we have received no such requests in 2012. Such requests, if these increased, could require the establishment of reserves for possible repurchases and adversely affect our results of operation and financial condition.

Servicing requirements may change and require us to incur additional costs and risks.

On February 9, 2012, the DOJ and various state attorneys general announced a $25 billion agreement with the nation’s five largest mortgage servicers to address mortgage loan servicing and foreclosure abuses. While we were not a party to the settlement or a subject of the joint governmental investigation, we cannot be assured that the settlement may ultimately affect mortgage servicing standards generally, which could increase compliance and other costs of servicing residential mortgage loans. This could reduce our income from servicing these types of loans and make it more difficult and costly to timely realize the value of collateral securing such loans upon a borrower default.

Costs of insuring our deposits remain high.

FDIC insurance premiums increased substantially beginning in 20092009. The Dodd-Frank Act and we expect to pay significantly higherFDIC regulations have changed the basis on which FDIC insurance premiums are assessed, increased minimum DIF reserves levels and guarantee fees inmandated restoration of the future. Market developments have significantly depletedDIF, which was drawn down during the FDIC’s DIFcredit crisis. Although our FDIC premiums will vary based on our risk as calculated by the FDIC for deposit insurance purposes, we expect that we and reduced the FDIC’s ratio of reserves to insured deposits. The FDIC has also requiredgenerally all FDIC-insured institutions will continue to prepay their estimated quarterly risk-based assessmentspay FDIC insurance premiums at higher than pre-crisis levels for the fourth quarter of 2009 and for all of 2010, 2011 and 2012, which we paid on December 30, 2009, and has implemented a new risk-based assessment system upon all liabilities (not just insured deposits) and increased the DIF’s designated reserve ratio, as described more fully underforeseeable future. See “Supervision and Regulation – FDIC Insurance Assessments.Assessments.”

We have experienced high levels of market volatility.

The capital and credit markets have experienced volatility and disruption since 2007. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial condition or performance. Although market disruptions and volatility appear more stable currently,

there can be no assurance that we will not experience future market conditions and volatility, which may have material adverse effects on our ability to access capital and on our business, financial condition (including liquidity) and results of operations.

Our ability to realize our deferred tax assets may be further reduced in the future if our estimates of future taxable income from our operations and tax planning strategies do not support this amount, and the amount of net operating loss carry-forwards realizable for income tax purposes may be reduced under Section 382 of the Internal Revenue Code by sales of our capital securities.

We are allowed to carry-back losses for five years for Federal income tax purposes as otherwise permitted generally under the Worker, Homeownership, and Business Assistance Act of 2009 which was signed into law on November 6, 2009. As of December 31, 2011,2012, we had net deferred tax assets of $2.4 million after we recorded $0.5 million of valuation allowance based on management’s estimation of the likelihood of those deferred tax assets being realized.$1.2 million. These and future deferred tax assets may be further reduced in the future if our estimates of future taxable income from our operations and tax planning strategies do not support the amount of the deferred tax asset. The amount of net operating loss carry-forwards realizable for income tax purposes potentially could be further reduced under Section 382 of the Internal Revenue Code by a significant offering and/or other sales of our capital securities. The Basel III regulatory capital proposals could reduce the regulatory capital benefits of deferred tax assets, also.

Our future success is dependent on our ability to compete effectively in highly competitive markets.

The East Alabama banking markets in which we do business are highly competitive and our future growth and success will depend on our ability to compete effectively in these markets. We compete for loans, deposits and other financial services in our markets with other local, regional and national commercial banks, thrifts, credit unions, mortgage lenders, and securities and insurance brokerage firms. Many of our competitors offer products and services different from us, and have substantially greater resources, name recognition and market presence than we do, which benefits them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we are able to and have broader and more diverse customer and geographic bases to draw upon. The Dodd-Frank Act allows others to branch into our markets more easily from other states. Failures of other banks with offices in our markets could also lead to the entrance of new, stronger competitors in our markets.

Our success depends on local economic conditions where we operate.

Our success depends on the general economic conditions in the geographic markets we serve in Alabama. The local economic conditions in our markets have a significant effect on our commercial, real estate and construction loans, the ability of borrowers to repay these loans and the value of the collateral securing these loans. Adverse changes in the economic conditions of the Southeastern United States in general, or in one or more of our local markets could negatively affect our results of operations and our profitability.

Our cost of funds may increase as a result of general economic conditions, interest rates, inflation and competitive pressures.

The Federal Reserve has taken aggressive actions to reduce interest rates generally, and the federal government continues large deficit spending. Our cost of funds may increase as a result of general economic conditions, interest rates and competitive pressures, and potential inflation resulting from government deficit spending.spending and monetary policies. Traditionally, we have obtained funds principally through local deposits and borrowings from other institutional lenders. Generally, we believe local deposits are a cheaper and more stable source of funds than borrowings because interest rates paid for local deposits are typically lower than interest rates charged for borrowings from other institutional lenders. Increases in interest rates could also change consumers to shift their funds to more interest bearing instruments and to increase the competition for funds. See “Fiscal and Monetary Policy”.

The Federal Reserve has acknowledged the possibility of further recession and deflation. Should this occur, the financial services industry and our business could be adversely affected.

The recovery of the U.S. economy continues to progress slowly; consumer confidence remains low, national unemployment remains high at 8.57.9 % for December 2011,in early 2013, and despite recent improvements, the housing market remains an important downside risk, and prices and sales volumes may continue at current low levels or fall further.levels. Given the concerns about the U.S. economy and the costs of complying with new healthcare laws, U.S. employers continue to approach hiring with caution, and as a result unemployment may continue at high levels. Monetary and fiscal policy measures, including the two-year extension of the existing federal personal income tax rates through 2012,changes at the beginning of 2013, may adversely affect the recovery, return unemployment to lower levels, and promote long-term

stability in the financial markets. Any shift from fiscal stimulus efforts to fiscal restraint, including the effect of federal budget sequestration that may occur due to the lack of a budget agreement in early 2013, and higher income and other taxes to reduce government deficits could adversely affect the economy and cause instability in the financial markets. Various governments in Europe have announced budget reductions and/or austerity measures as a means to limit fiscal budget deficits as a result of the economic crisis. Additionally, many state and local governments in the U.S. have also implemented budget reductions. Such economic factors could affect us in a variety of substantial and unpredictable ways, as well as affect our borrowers’ ability and willingness to meet their repayment obligations. These factors could have a material adverse effect on our results of operation and financial condition, liquidity and earnings.

Our profitability and liquidity may be affected by changes in interest rates and interest rate levels, the shape of the yield curve and economic conditions.

Our profitability depends upon net interest income, which is the difference between interest earned on assets, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Net interest income will be adversely affected if market interest rates change such thatwhere the interest we pay on deposits and borrowings increases faster than the interest earned on loans and investments. Interest rates, and consequently our results of operations, are affected by general economic conditions (domestic and foreign) and fiscal and monetary policies, as well as expectations of these rates and policies.policies and the shape of the yield curve. Decreases in interest rates generally increase the market values of fixed-rate, interest-bearing investments and loans held, and increase the values of loan sales and mortgage loan activities. However, the production of mortgages and other loans and the value of collateral securing our loans, are dependent on demand within the markets we serve, as well as interest rates. The levels of sales, as well as the values of real estate in our markets, have declined.declined and values, while stabilizing to increasing, generally remain below the levels of several years ago. Declining interest rates reflect efforts by the Federal Reserve to stimulate the economy, but such efforts may not be effective, and otherwise adversely affect our net interest margin and thus may negatively affect our results of operations and financial condition, liquidity and earnings.

Increases in interest rates generally decrease the market values of fixed-rate, interest-bearing investments and loans held and the production of mortgage and other loans and the value of collateral securing our loans, and therefore may adversely affect our liquidity and earnings, to the extent not offset by potential increases in our net interest margin.

Liquidity risks could affect operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the repayment or sale of loans and other sources could have a substantial negative effect on our liquidity. Our funding sources include federal funds purchased securities sold under repurchase agreements, core and non-core deposits, and short- and long-term debt. We are also members of the FHLB and the Federal Reserve Bank of Atlanta, where we can obtain advances collateralized with eligible assets. We maintain a portfolio of securities that can be used as a source of liquidity. There are other sources of liquidity available to the Company or the Bank should they be needed, including our ability to acquire additional non-core deposits. We may be able, depending upon market conditions, to issue and sell debt securities, and preferred or common securities in public or private transactions. Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Our ability to borrow or obtain funding, if needed, could also be impaired by factors that are not specific to us, such as further disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets, as well as the financial condition, liquidity and profitability of the financial institutions we deal with.

We are subject to extensive regulation that could limit or restrict our activities and adversely affect our earnings.

We and our subsidiaries are regulated by several regulators, including the Federal Reserve, the Alabama Superintendent, the SEC and the FDIC. Our success is affected by state and federal regulations affecting banks and bank holding companies, and the securities markets, and our costs of compliance could adversely affect our earnings. Banking regulations are primarily intended to protect depositors, not shareholders. The financial services industry also is subject to frequent legislative and regulatory changes and proposed changes, and a large number of required Dodd-Frank Act rules have yet to be proposed or finalized, and the effects of whichall these cannot be predicted. Federal bank regulatory agencies and the Treasury, as well as the Congress and the President, are evaluating the regulation of banks, other financial services providers and the financial markets and such changes, if any, could require us to maintain more capital and liquidity, and restrict our activities, which could adversely affect our growth, profitability and financial condition.

Changes in accounting and tax rules applicable to banks could adversely affect our financial conditions and results of operations.

From time to time, the Financial Accounting Standards Board (the “FASB”) and the SEC change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in us restating prior period financial statements.statements.FASB has proposed for comment significant changes to the manner in which banks’ allowance for loan losses would be calculated.

We are subject to internal control reporting requirements that increase compliance costs and failure to comply timely could adversely affect our reputation and the value of our securities.

We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the SEC, the Public Company Accounting Oversight Board and Nasdaq. In particular, we are required to report on internal controls as part of our annual report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act. We expect to continue to spend significant amounts of time and money on compliance with these rules. Our failure to comply with these internal control rules may materially adversely affect our reputation, ability to obtain the necessary certifications to financial statements, and the value of our securities.

We are required to maintain capital to meet regulatory requirements, and if we fail to maintain sufficient capital, our financial condition, liquidity and results of operations would be adversely affected.

We and the Bank must meet regulatory capital requirements and maintain sufficient liquidity, including liquidity at the Company, as well as the Bank. If we fail to meet these capital and other regulatory requirements, including more rigorous requirements arising from our regulators implementation of Basel III, our financial condition, liquidity and results of operations would be materially and adversely affected. Our failure to remain “well capitalized” and “well managed” for bank regulatory purposes could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance, our ability to raise brokered deposits, our ability to pay dividends on common stock, our ability to make acquisitions, and we would no longer meet the requirements for becoming a financial holding company.

The Dodd-Frank Act restricts our future issuance of trust preferred securities and cumulative preferred securities as eligible Tier 1 risk-based capital for purposes of the regulatory capital guidelines for bank holding companies.

Under the Dodd-Frank Act, banks and thrift holding companies with assets of less than $15 billion as of December 31, 2009 will be permitted to include trust preferred securities that were issued before May 19, 2010 as Tier 1 capital, only bank holding companies with assets of less than $500 million will be permitted to continue to issue trust preferred securities and have them count as Tier 1 capital. Accordingly, should we determine it is advisable, or should our regulators require us, based upon new capital or liquidity regulations or otherwise, to raise additional Tier 1 risk-based capital, we would not be able to issue additional trust preferred securities, and would instead have to issue preferred stock or common equity. To the extent we issue new equity, it could result in dilution to our shareholders. To the extent we issue preferred stock, dividends on the preferred stock, unlike distributions paid on trust preferred securities, would not be tax deductible.

We may need to raise additional capital in the future, but that capital may not be available when it is needed or on favorable terms.

We anticipate that our current capital resources will satisfy our capital requirements for the foreseeable future under currently effective rules. We may, however, need to raise additional capital to support our growth or currently unanticipated losses, or to meet the needs of our communities, resulting from failures or cutbacks by our competitors, and new capital rules being considered, including Basel III. Our ability to raise additional capital, if needed, will depend, among other things, on conditions in the capital markets at that time, which are currently disrupted and limited by events outside our control, and on our financial performance. If we cannot raise additional capital on acceptable terms when needed, our ability to further expand our operations through internal growth and acquisitions could be limited.

Future acquisitions and expansion activities may disrupt our business, dilute shareholder value and adversely affect our operating results.

We regularly evaluate potential acquisitions and expansion opportunities. To the extent that we grow through acquisitions, we cannot assure you that we will be able to adequately or profitably manage this growth. Acquiring other banks, branches, or businesses, as well as other geographic and product expansion activities, involve various risks including:

We may engage in FDIC-assisted transactions, which could present additional risks to our business.

We may have opportunities to acquire the assets and liabilities of failed banks in FDIC-assisted transactions, which present the risks of acquisitions, although generally, as well as some risks specific to these transactions. Although these FDIC-assisted transactions typically provide for FDIC assistance to an acquirorterms to mitigate certain of the buyer’s risks, whichsuch as purchasing only certain assets and assuming specified liabilities of the failed bank. These transactions may also include loss-sharing,loss sharing, where the FDIC absorbs mostspecified losses on certain covered assets and provides some indemnity, we would beindemnities to the buyer. However these transaction are generally subject to many of the same risks we would face in acquiring another bank in a negotiated transaction, without FDIC assistance, including risks associated with pricing such transactions, the risks of loss of deposits and maintaining customer relationships and failure to realize the anticipated acquisition benefits in the amounts and within the timeframes we expect. In addition, because these acquisitions provide for limited diligence and negotiation of terms, these transactions may require additional resources and time, servicing acquired problem loans and costsincluding those related to integration of personnel and operating systems, the establishment of processes to service acquired assets, require usassets. We may need to raiseobtain additional capital to support such an acquisition, which may be dilutive to our existing shareholders. If we are unable to manage these risks, FDIC-assisted acquisitions could have a material adverse effect on our business, financial condition and results of operations.

Attractive acquisition opportunities may not be available to us in the future.

While we seek continued organic growth, we also may consider the acquisition of other businesses. We expect that other banking and financial companies, many of which have significantly greater resources, will compete with us to acquire financial services businesses. This competition could increase prices for potential acquisitions that we believe are attractive. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests, and regulatory approvals could contain conditions that reduce the anticipated benefits of any transaction. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. Any acquisition could be dilutive to our earnings and shareholders’ equity per share of our common stock.

Technological changes affect our business, and we may have fewer resources than many competitors to invest in technological improvements.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to serving clients better, the effective use of technology may increase efficiency and may enable financial institutions to reduce costs. Our future success will depend, in part, upon our ability to use technology to provide products and services that provide convenience to customers and to create additional efficiencies in operations. We may need to make significant additional capital investments in technology in the future, and we may not be able to effectively implement new technology-driven products and services. Many competitors have substantially greater resources to invest in technological improvements.

Our information systems may experience aan interruption or security breach.

We rely heavily on communications and information systems, including those provided by third-party service providers, to conduct our business. Any failure, interruption, or security breach of these systems could result in failures or disruptions which could affect our customers’ privacy and our customer relationships, generally. While we have policies and procedures designed to prevent or limit the effect of the possible failure interruption, “cyber-attack”, or security breaches will not occur or, if they do occur, that they will be adequately addressed. In addition to the immediate costs of any failure, interruption or security breach, including those at our third-party service providers, these events could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

Severe weather, natural disasters, acts of war or terrorism or other external events could have significant effects on our business.

Severe weather and natural disasters, including hurricanes and tornados, acts of war or terrorism or other external events could have a significant effect on our ability to conduct business. Such events could affect the stability of our deposit base; impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

Our ability to continue to pay dividends to shareholders in the future is subject to profitability, capital, liquidity and regulatory requirements and these limitations may prevent us from paying dividends in the future.

Cash available to pay dividends to our shareholders is derived primarily from dividends paid to the Company by the Bank. The ability of the Bank to pay dividends, as well as our ability to pay dividends to our shareholders, will continue to be subject to and limited by the results of operations of our subsidiaries and our need to maintain appropriate liquidity and capital at all levels of our business consistent with regulatory requirements and the needs of our businesses.See“Supervision “Supervision and Regulation”.

A limited trading market exists for our common shares, which could lead to price volatility.

Your ability to sell or purchase common shares depends upon the existence of an active trading market for our common stock. Although our common stock is quoted on the Nasdaq Global Market, the volume of trades on any given day has been limited historically. As a result, you may be unable to sell or purchase shares of our common stock at the volume, price and time that you desire. Additionally, a fair valuation of the purchase or sales price of our common stock also depends upon an active trading market, and thus the price you receive for a thinly-traded stock such as common stock, may not reflect its true value. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market.

ITEM 1B. UNRESOLVED1B.UNRESOLVED STAFF COMMENTS

None.

ITEM 2. DESCRIPTION2.DESCRIPTION OF PROPERTY

The Bank conducts its business from its main office and ten full-service branches. The Bank also operates loan production offices in Montgomery and Phenix City, Alabama. The bank owns its main office building, which is located in downtown Auburn, Alabama, and has approximately 16,150 square feet of space. The original building was constructed in 1964, and an addition was completed in 1981. Portions of the building have been renovated to accommodate growth and changes in the Bank’s operational structure and to adapt to technological changes. The main office building has paved parking for 84 vehicles. The main office offers the full line of the Bank’s services and has two ATMs, including one walk-up ATM and one drive-through ATM. The Bank leasescompleted construction on a drive-innew drive-through facility located directly acrosson the street from its main office.office campus in October 2012. This drive-indrive-through facility has five drive-through lanes, including an ATM, and a walk-up teller window.

The Bank also owns a commercial office building, the AuburnBank Center (the “Center”), which is located next to the Bank’s main office. The Center has approximately 23,000 square feet of space and the Bank occupies approximately 80% of the building’s leasable square footage. The remaining leasable space is rented to outside third parties. The Bank’s mortgage division, data processing activities, as well as other operations, are located in the Center. In total, the main office and Center parking lots provide parking for approximately 196 vehicles.

The Bank’s Auburn Kroger branch was opened in August 1988 and is located in the Kroger supermarket in the Corner Village Shopping Center in Auburn, Alabama. The bank leases approximately 500 square feet of space for this branch. In September 2008, the Bank entered into a new lease agreement with the Kroger Corporation for five years with options for two 5-year extensions. This branch offers the full line of the Bank’s deposit and other services including an ATM, except safe deposit boxes.

The Opelika branch is located in Opelika, Alabama. This branch, built in 1991, is owned by the Bank and has approximately 4,000 square feet of space. This branch offers the full line of the Bank’s services and has drive-through windows and an ATM. This branch offers parking for approximately 36 vehicles.

The Bank’s Phenix City branch was opened in August 1998 in the Wal-Mart shopping center in Phenix City, Alabama, about 35 miles southeast of Auburn, Alabama. The bank leases approximately 500 square feet of space in the Wal-Mart. In September 2010, the Bank entered into a new three-year lease agreement. This branch offers the full line of the Bank’s deposit and other services including an ATM, except safe deposit boxes.

The Bank’s Hurtsboro branch was opened in June 1999. This branch is located in Hurtsboro, Alabama, about 35 miles south of Auburn, Alabama. The Bank owns this branch, which has approximately 1,000 square feet of space. The Bank leases the land for this branch from a third party. In June 2009, the Bank exercised its option to extend the lease for another five years. This branch offers the full line of the Bank’s services including safe deposit boxes, a drive-through window and an ATM. This branch offers parking for approximately 12 vehicles, including a handicapped ramp.

The Bank’s Auburn Wal-Mart Supercenter branch was opened in September 2000 inside the Wal-Mart shopping center on the south side of Auburn, Alabama. The lease is for approximately 700 square feet of space in the Wal-Mart. In September 2010, the Bank exercised its option to extend the lease for another five years. This branch offers the full line of the Bank’s deposit and other services, including an ATM, except safe deposit boxes.

The Bank’s Notasulga branch was opened in August 2001. This branch is located in Notasulga, Alabama, about 15 miles south of Auburn, Alabama. This branch is owned by the Bank and has approximately 1,344 square feet of space. The Bank leased the land for this branch from a third party. In May 2009,2012, the Bank’s land lease renewed for another three year term.Thisterm. This branch offers the full line of the Bank’s services including safe deposit boxes and a drive-through window. This branch offers parking for approximately 11 vehicles, including a handicapped ramp.

In July 2002, the Bank’s Opelika Wal-Mart Supercenter branch was opened inside the Wal-Mart shopping center in Opelika, Alabama. In July 2007,June 2012, the Bank exercised its option to extend the lease for another five years. The lease is for approximately 700 square feet of space in the Wal-Mart. This branch offers the full line of the Bank’s deposits and other services including an ATM, except safe deposit boxes.

In November 2002, the Bank opened a loan production office in Phenix City, Alabama, about 35 miles south of Auburn, Alabama. In November 2011, the Bank renewed its lease for another year.

In July 2007, the Bank opened a new branch located in the Kroger supermarket in the TigerTown retail center in Opelika, Alabama. The Bank entered into a lease agreement with the Kroger Corporation for five years with options for two 5-year extensions. In July 2012, the Bank exercised its option to extend the lease for another five years. The Branch offers the full line of bank deposit and other services including an ATM, except for safe deposit boxes.

In February 2009, the Bank opened a branch located on Bent Creek Road in Auburn, Alabama. This branch is owned by the Bank and has approximately 4,000 square feet of space. This branch offers the full line of the Bank’s services and has drive-through windows and a drive-up ATM. This branch offers parking for approximately 29 vehicles.

In September 2011, the Bank opened a loan production office in Montgomery, Alabama, about 50 miles west of Auburn, Alabama. The Bank’s lease agreement will expire in two years.

In December 2011, the Bank opened a branch located on Fob James Drive in Valley, Alabama, about 30 miles northeast of Auburn, Alabama. This branch is owned by the Bank and has approximately 5,000 square feet of space. This branch offers the full line of the Bank’s services and has drive-through windows and a drive-up ATM. This branch offers parking for approximately 35 vehicles. Prior to December 2011, the Bank leased office space for a loan production office in Valley, Alabama. The loan production office was originally opened in September 2004.

In addition, the Bank owns a commercial office building, the AuburnBank Center (the “Center”), which is located next to the Bank’s main office. The Center has approximately 23,000 square feet of space and the Bank occupies approximately 80% of the building’s leasable square footage. The remaining leasable space is rented to outside third parties. The Bank’s mortgage division, data processing activities, as well as other operations, are located in the Center. The parking lot provides parking for approximately 120 vehicles.

The Bank also owns several parcels of land adjoining the main office and the Center. In 2012, the Bank plans to remove any unoccupied buildings located on these tracts in order to consolidate its main campus and build a new drive-through facility to replace the location it currently leases.

The Company owns a commercial office building (the “Hudson Building”) located across the street from the main office in downtown Auburn. The Hudson Building has two floors and a basement which contain approximately 14,500 square feet of leasable space. This building is rented by unaffiliated third-party tenants.

ITEM 3

LEGAL PROCEEDINGS

In the normal course of its business, the Company and the Bank from time to time are involved in legal proceedings. The Company’s management believe there are no pending or threatened legal proceedings that, upon resolution, are expected to have a material adverse effect upon the Company’s or the Bank’s financial condition or results of operations.

Not applicable.

PART II

The Company’s Common Stock is listed on the Nasdaq Global Market, under the symbol “AUBN”. As of March 9, 2012,15, 2013, there were approximately 3,642,7383,642,928 shares of the Company’s Common Stock issued and outstanding, which were held by approximately 416432 shareholders of record. The following table sets forth, for the indicated periods, the high and low closing sale prices for the Company’s Common Stock as reported on the Nasdaq Global Market, and the cash dividends declared to shareholders during the indicated periods.

The Company has paid cash dividends on its capital stock since 1985. Prior to this time, the Bank paid cash dividends since its organization in 1907, except during the Depression years of 1932 and 1933. Holders of Common Stock are entitled to receive such dividends as may be declared by the Company’s Board of Directors. The amount and frequency of cash dividends will be determined in the judgment of the Board based upon a number of factors, including the Company’s earnings, financial condition, capital requirements and other relevant factors. The Board currently intends to continue its present dividend policies.

Federal Reserve policy could restrict future dividends on our Common Stock, depending on our earnings and capital position and likely needs. See “SUPERVISION AND REGULATION – Payment of Dividends” and “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — CAPITAL ADEQUACY.”

The amount of dividends payable by the Bank is limited by law and regulation. The need to maintain adequate capital in the Bank also limits dividends that may be paid to the Company.

Performance Graph

The following performance graph compares the cumulative, total return on the Company’s Common Stock from December 31, 20062007 to December 31, 2011,2012, with that of the Nasdaq Composite Index and SNL Southeast Bank Index (assuming a $100 investment on December 31, 2006)2007). Cumulative total return represents the change in stock price and the amount of dividends received over the indicated period, assuming the reinvestment of dividends.

ISSUER PURCHASES OF EQUITY SECURITIES

Securities Authorized for Issuance Under Equity Compensation Plans

See the information included under Part III, Item 12, which is incorporated in response to this item by reference.

See Table 2 “Selected Financial Data” and general discussion in Item 7, “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”.

ITEM 7.

ITEM 7.

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

The following is a discussion of our financial condition at December 31, 20112012 and 20102011 and our results of operations for the years ended December 31, 2012, 2011, 2010, and 2009.2010. The purpose of this discussion is to provide information about our financial condition and results of operations which is not otherwise apparent from the consolidated financial statements. The following discussion and analysis should be read along with our consolidated financial statements and the related notes included elsewhere herein. In addition, this discussion and analysis contains forward-looking statements, so you should refer to Item 1A, “Risk Factors” and “Special Cautionary Notice Regarding Forward-Looking Statements”.

Certain amounts reported in prior periods have been reclassified to conform to the current-period presentation. These reclassifications had no effect on the Company’s previously reported stockholders’ equity or net earnings during the periods involved.

OVERVIEW

The Company was incorporated in 1990 under the laws of the State of Delaware and became a bank holding company after it acquired its Alabama predecessor, which was a bank holding company established in 1984. The Bank, the Company’s principal subsidiary, is an Alabama state-chartered bank that is a member of the Federal Reserve System and has operated continuously since 1907. Both the Company and the Bank are headquartered in Auburn, Alabama. The Bank conducts its business primarily in East Alabama, including Lee County and surrounding areas. The Bank operates full-service branches in Auburn, Opelika, Hurtsboro, Notasulga and Valley, Alabama. In-store branches are located in the Auburn and Opelika Kroger stores, as well as Wal-Mart SuperCenter stores in Auburn, Opelika and Phenix City, Alabama. Loan production offices are located in Montgomery and Phenix City, Alabama.

Summary of Results of Operations

Financial Summary

The Company’s net earnings were $6.8 million, or $1.86 per share, for the full year 2012, compared to $5.5 million, or $1.52 per share, for the full year 2011, compared to $5.3 million, or $1.47 per share, for the full year 2010.2011.

Tax-equivalent net interest income increased 1%8% in 20112012 from 20102011 as improvement in the Company’s net interest margin offset a decrease in average total interest earning assets in 20112012 compared to 2010.2011. Average total interest earning assets decreased 2%1% in 20112012 when compared to 20102011 as cash proceeds from securities sold, called, and matured in 20112012 were used to reduce the level of wholesale funding (such as brokered certificates of deposit and Federal Home Loan BankFHLB advances) on our balance sheet. The decline in the average balance of the securities portfolio in 2012 was largely offset by growth in the loan portfolio. Average loans decreased slightlywere $391.3 million in 20112012, an increase of 5%, compared to 20102011. Average loans increased in 2012 compared to 2011 due to weakincreased loan demand and a challenging economic environment. Average loans were $373.9an expanded market presence in Valley, Alabama.

The provision for loan losses was $3.8 million for 2012, compared to $2.5 million in 2011, a decrease of 1%,2011. The increase in the provision for loan losses was primarily due to an increase in net charge-offs and loan portfolio growth. Net charge-offs were $4.0 million for 2012, compared to 2010.

$3.2 million in 2011. This increase was primarily due to an increase in net charge-offs in the commercial real estate portfolio of $2.7 million, which was partially offset by declines in net charge-offs of $1.6 million and $0.4 million, respectively, in the construction and land development and commercial and industrial portfolios. In both 2012 and 2011, net charge-offs were affected by a few individually significant charge-offs. In 2012, the Company charged off $3.1 million related to three borrowing relationships. In 2011, the Company charged off $2.5 million related to three borrowing relationships. Overall, the Company’s net charge-off ratio was 0.86%,1.03% in 2012, compared to 0.64%0.86% in 2010. The provision for loan losses was $2.5 million for 2011, compared to $3.6 million in 2010. Despite the increase in net charge-offs during 2011, the provision for loan losses decreased during 2011 primarily due to the reduced level of allowance for loan losses related to the construction and land development loan portfolio segment. The decline in the allowance for loan losses was due to declines in total construction and land development loans outstanding as well as a decline in adversely risk-graded construction and land development loans.2011.

Noninterest income was $10.5 million in 2012, compared to $5.2 million in 2011, compared to $6.7 million in 2010.2011. The decreaseincrease in noninterest income was primarily due to a decreasean increase in mortgage lending income of $0.6 million, a decrease in net securities gains of $0.5$1.5 million and an increase in losses related toa $3.3 million gain on sale of three affordable housing investments of $0.3 million.in January 2012.

Noninterest expense was $19.4 million in 2012, compared to $16.4 million in 2011, compared to $15.92011. On January 19, 2012, the Company restructured its balance sheet by paying off $38.0 million in 2010.of FHLB advances with a weighted average interest rate of 4.26% and a weighted average duration of 2.6 years. The increase in total noninterest expense in 2012 was primarily due to prepayment penalties of $3.7 million incurred on the repayment of the FHLB advances, compared to none in 2011. Other changes impacting noninterest expense were an increase in salaries and benefits expense of $0.8$0.5 million, an increase in other noninterest expense of $0.7 million, and an increasea decrease in net expenses related to OREOother real estate owned of $0.6 million. These increases were partially offset by a decrease in FDIC and other regulatory assessments of $0.3 million and a decrease in prepayment penalties on long-term debt of $0.7$1.7 million.

Income tax expense for 20112012 was $0.1$1.4 million, compared to $0.8$0.1 million in 2010.2011. The Company’s effective income tax rate was 17.34% in 2012, compared to 1.02% in 2011, compared to 12.99% in 2010.2011. The decreaseincrease in the Company’s effective tax rate during 2011 compared to 2010 was due to a decline46% increase in the level of earnings before taxes and an increasea decrease in federal tax credits related to the Company’s investments in affordable housing limited partnerships, which increasedwere sold in 2011.January 2012. The impact of these changes on the Company’s effective tax rate for the full year 2012 was partially reduced by the reversal of a previously established deferred tax asset valuation allowance of $0.5 million related to capital loss carry-forwards.

In 2011,2012, the Company paid cash dividends of $2.9$3.0 million, or $0.80$0.82 per share. The Company remains well capitalized under current regulatory guidelines with a total risk-based capital ratio of 16.66%17.46%, a tier one risk-based capital ratio of 15.40%16.20%, and a tier one leverage capital ratio of 8.82%9.58% at December 31, 2011.2012.

CRITICAL ACCOUNTING POLICIES

The accounting and financial reporting policies of the Company conform with U.S. generally accepted accounting principles, or GAAP, and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses, our assessment of other-than-temporary impairment, recurring and non-recurring fair value measurements, valuation of OREO, and the valuation of deferred tax assets, were critical to the determination of our financial position and results of operations. Other policies also require subjective judgment and assumptions and may accordingly impact our financial position and results of operations.

Allowance for Loan Losses

The Company assesses the adequacy of its allowance for loan losses prior to the end of each calendar quarter. The level of the allowance is based upon management’s evaluation of the loan portfolios,portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect thea borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, industry and peer bank loan loss rates and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loan lossesLoans are charged off, in whole or in part, when management believes that the full collectability of the loan is unlikely. A loan may be partially charged-off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, is deemed to be uncollectible.

The Company deems loans 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. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.

An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan. The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs.

The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.

In assessing the adequacy of the allowance, the Company also considers the results of its ongoing internal and independent loan review process.processes. The Company’s loan review process assists in determining whether there are loans in the portfolio whose credit quality has weakened over time and evaluating the risk characteristics of the entire loan portfolio. The Company’s

loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their examination process. The Company incorporates loan review results in the determination of whether or not it is probable that weit will be able to collect all amounts due according to the contractual terms of a loan.

As part of the Company’s quarterly assessment of the allowance, management divides the loan portfolio into five segments: commercial and industrial, loans, construction and land development, loans, commercial real estate, residential real estate, and consumer installment loans. The Company analyzes each segment and estimates an allowance allocation for each loan segment.

The allocation of the allowance for loan losses begins with a process of estimating the probable losses inherent for these types of loans. The estimates for these loans are established by category and based on the Company’s internal system of credit risk ratings and historical loss data. The estimated loan loss allocation rate for the Company’s internal system of credit risk grades is based on its experience with similarly graded loans. For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups. At December 31, 20112012 and 2010,2011, and for the years then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors. The allocation for qualitative and environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies or procedures and other influencing factors. These qualitative and environmental factors are considered for each of the five loan segments and the allowance allocation, as determined by the processes noted above, is increased or decreased based on the incremental assessment of these factors.

The Company constantlyregularly re-evaluates its practices in determining the allowance for loan losses. During the fourth quarter of 2011, the Company’s management decided to eliminate a previously unallocated component of the allowance. As a result, the Company had no unallocated amount included in the allowance at December 31, 2011, compared to an unallocated amount of $0.1 million, or 1.4% of the total allowance, at December 31, 2010.

During 2010, the Company implemented certain refinements to its allowance for loan losses methodology, specifically the way that historical loss factors are calculated. Prior to September 30, 2010, the Company calculated average losses by loan segment using a rolling 12 quarter historical period. In order to better capture the effect of current economic conditions on the Company’s loan loss experience, the Company calculated average losses by loan segment using a rolling 6 quarter historical period beginning with the quarter ended September 30, 2010. Correspondingly, the Company reduced the level of adjustments made to historical losses for “qualitative and environmental factors” since the updated historical losses arewere more representative of current economic conditions.conditions as of the applicable balance sheet date.

Assessment for Other-Than-Temporary Impairment of Securities

On a quarterly basis, management makes an assessment to determine whether there have been events or economic circumstances to indicate that a security on which there is an unrealized loss is other-than-temporarily impaired. For equity securities with an unrealized loss, the Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; and recent events specific to the issuer or industry. Equity securities for which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses).

For debt securities with an unrealized loss, an other-than-temporary impairment write-down is triggered when (1) the Company has the intent to sell thea debt security, (2) it is more likely than not that the entityCompany will be required to sell the debt security before recovery of its amortized cost basis, or (3) the entityCompany does not expect to recover the entire amortized cost basis of the debt security. If the Company has the intent to sell a debt security or if it is more likely than not that that it will be required to sell the debt security before recovery, the other-than-temporary write-down is equal to the entire difference between the debt security’s amortized cost and its fair value. If the Company does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery, the other-than-temporary impairment write-down is separated into the amount that is credit related (credit loss component) and the amount due to all

other factors. The credit loss component is recognized in earnings as a realized loss in securities gains (losses), and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income, net of applicable taxes.

The Company assesses impairment for pooled trust preferred securities using a cash flow model. The key assumptions include default probabilities of the underlying collateral and recoveries on collateral defaults. These assumptions may have a significant effect on the determination of the present value of expected future cash flows and the resulting amount of other-than-temporary impairment. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Fair Value Determination

GAAP requires management to value and present at fair valuedisclose certain of the Company’s assets and liabilities at fair value, including investments classified as available-for-sale and derivatives. FASB ASC 820,Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value under GAAPin accordance with U.S. generally accepted accounting principles and expands disclosures about fair value measurements. For more information regarding fair value measurements and disclosures, please refer to Note 17, Fair Value, Disclosures, of the consolidated financial statements that accompany this report.

Fair values are based on active market prices of identical assets or liabilities when available. Comparable assets or liabilities or a composite of comparable assets in active markets are used when identical assets or liabilities do not have readily available active market pricing. However, some of the Company’s transactionsassets or liabilities lack an available or comparable trading market characterized by frequent transactions between a willing buyerbuyers and seller.sellers. In these cases, such values arefair value is estimated using pricing models that use discounted cash flows and other pricing techniques. Pricing models and their underlying assumptions are based upon management’s best estimates for appropriate discount rates, default rates, prepayments, market volatility and other factors, taking into account current observable market data and experience.

These assumptions may have a significant effect on the reported fair values of assets and liabilities and the related income and expense. As such, the use of different models and assumptions, as well as changes in market conditions, could result in materially different net earnings and retained earnings results.

Other Real Estate Owned

OREOOther real estate owned (“OREO”), consists of properties obtained through foreclosure or in satisfaction of loans and is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other noninterest expense along with holding costs. Any gains or losses on disposal realized at the time of disposalOREO are also reflected in noninterest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility, as experienced during 2011 and 2010.volatility. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO.

Deferred Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the we will realize the benefits of these deductible differences at December 31, 2011.2012. The amount of the deferred tax assets considered realizable, however, could be reduced in the near term if estimates of future taxable income during the future periods are reduced.

Average Balance Sheet and Interest Rates

(a) Tax-equivalent. See “Table 1 - Explanation of Non-GAAP Financial Measures”.

RESULTS OF OPERATIONS

Net Interest Income and Margin

2012 vs. 2011 comparison

Net interest income (tax-equivalent) was $22.5 million in 2012, compared to $20.9 million in 2011, as net interest margin improvement offset a decline in average interest-earning assets of 1%. Net interest margin (tax-equivalent) was 3.21% in 2012, compared to 2.95% in 2011. The improved net interest margin reflected management’s efforts to increase earnings by shifting the Company’s asset mix through loan growth, focusing on deposit pricing, and repaying higher-cost wholesale funding sources. The cost of total interest-bearing liabilities decreased 45 basis points in 2012 from 2011 to 1.42%. The net decrease was largely the result of the continued shift in our deposit mix, as we increased our lower-cost noninterest-bearing demand deposits, interest bearing demand deposits (NOW accounts), and savings and money market accounts and concurrently reduced balances of higher-cost certificates of deposit and other higher-cost time deposits and long-term debt (i.e. wholesale funding).

The tax-equivalent yield on total interest-earning assets decreased by 19 basis points in 2012 from 2011 to 4.38%. This decrease was primarily driven by a 51 basis point reduction in the tax-equivalent yield on total securities to 3.14% as reinvestment yields in the securities portfolio declined due to the continued low interest rate environment. Also, loan pricing for creditworthy borrowers continues to be competitive in our markets and has limited the Company’s ability to increase yields on new and renewed loans.

The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations. The Company’s net interest margin could experience pressure due to lower reinvestment yields in the securities portfolio given the current interest rate environment, increased pricing competition for quality loan opportunities, and fewer opportunities to further reduce our cost of funds due to the already low level of deposit rates currently.

2011 vs. 2010 comparison

Tax-equivalentNet interest income (tax-equivalent) was $20.9 million in 2011, compared to $20.7 million in 2010, as net interest income increased 1%margin improvement offset a decline in average interest-earning assets of 2%. Net interest margin (tax-equivalent) was 2.95% in 2011, compared to 2.86% in 2010. The improved net interest margin reflected management’s efforts to increase earnings by focusing on deposit pricing and repaying higher-cost wholesale funding sources. The cost of total interest-

bearing liabilities decreased 43 basis points in 2011 from 2010 to 1.87%. The net decrease was largely the result of the continued shift in our deposit mix, as improvement in the Company’s netwe increased our lower-cost noninterest-bearing demand deposits, interest margin offset a decrease in total interest earning assets.bearing demand deposits (NOW accounts), and savings and money market accounts and concurrently reduced balances of higher-cost certificates of deposit and other higher-cost time deposits and long-term debt (i.e. wholesale funding).

The tax-equivalent yield on total interest earninginterest-earning assets decreased by 30 basis points in 2011 from 2010 to 4.57%. This decrease was primarily due todriven by a decline of 64 basis points in the yield on taxable securities to 2.69%.

The cost of total interest-bearing liabilities decreased 43 basis points in 2011 from 2010, to 1.87%. This decrease was primarily due to a 4044 basis point decreasereduction in the cost of total interest-bearing deposits to 1.54%.

2010 vs. 2009 comparison

Tax-equivalent net interest income increased 1% in 2010 from 2009 as improvement in the Company’s net interest margin offset the decrease in total interest earning assets.

The tax-equivalent yield on total interest earning assets decreased 36 basis pointssecurities to 3.65% as reinvestment yields in 2010 from 2009 to 4.87%. The decrease was mainlythe securities portfolio declined due to a decline of 104 basis points in the yield on taxable securities to 3.33%.

The cost of total interest-bearing liabilities decreased 48 basis points in 2010 from 2009, to 2.30%. This decrease was primarily due to a 60 basis point decrease in the cost of total interest-bearing deposits to 1.94%.low interest rate environment.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that, in management’s evaluation, should be adequate to provide coverage for the probable losses on outstanding loans. The provision for loan losses amounted to $3.8 million, $2.5 million, $3.6 million, and $5.3$3.6 million for the years ended December 31, 2012, 2011, and 2010, and 2009, respectively.

The provision for loan losses decreasedincreased in 2012 compared to 2011 due to an increase in net charge-offs and loan portfolio growth. Net charge-offs were $4.0 million for 2012, compared to $3.2 million in 2011. This increase was primarily due to an increase in net charge-offs in the commercial real estate loan portfolio of $2.7 million, which was partially offset by declines in net charge-offs of $1.6 million and $0.4 million, respectively, in the construction and land development and commercial and industrial loan portfolios.

The provision for losses declined in 2011 compared to 2010 due to a decline in the level of allowance for loan losses related to the construction and land development portfolio segment. The decline in the allowance for loan losses was due to declines in total construction and development loans outstanding as well as a decline in adversely risk-graded construction and land development loans. The provision for losses declined in 2010 when compared to 2009 due to a decline in net charge-offs and nonperforming loan inflows. Also, the provision for loan losses in 2009 was impacted by $2.8 million in impairments related to the deterioration of two construction and land development loans.

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover probable losses in the loan portfolio. The Company’s allowance for loan losses to total loans decreased to 1.69% at December 31, 2012 from 1.87% at December 31, 2011 from 2.05% at December 31, 2010.2011. Based upon our evaluation of the loan portfolio, management believes the allowance for loan losses toshould be adequate to absorb our estimate of probable losses existing in the loan portfolio at December 31, 2011.2012. While our policies and procedures used to estimate the allowance for loan losses, as well as the resultant provision for loan losses charged to operations, are believed adequate by management and are reviewed from time to time by our regulators, they are necessarilybased on estimates and judgment and are therefore approximate and imprecise. There exist factorsFactors beyond our control, such as conditions in the local and national economy, a local real estate market or particular industry conditions exist which may negatively impact,and materially affect our asset quality and the adequacy of our allowance for loan losses and, thus, the resulting provision for loan losses.

Noninterest Income

The Company’s income from mortgage lending is primarily attributable to the (1) origination and sale of new mortgage loans and (2) servicing of mortgage loans. Origination income, net, is comprised of gains or losses from the sale of the mortgage loans originated, origination fees, underwriting fees and other fees associated with the origination of loans, which are netted against the commission expense associated with these originations. The Company’s normal practice is to originate mortgage loans for sale in the secondary market and to either releasesell or retain the associated mortgage servicing rights (“MSRs”) when the loan is sold.

MSRs are recognized based on the fair value of the servicing right on the date the corresponding mortgage loan is sold. Subsequent to the date of transfer, the Company has elected to measure its MSRs under the amortization method. Servicing fee income is reported net of any related amortization expense.

MSRs are also evaluated for impairment periodically. Impairment is determined by grouping MSRs by common predominant characteristics, such as interest rate and loan type. If the aggregate carrying amount of a particular group of MSRs exceeds the group’s aggregate fair value, a valuation reserve for that group is established. The valuation reserve is adjusted as the fair value changes. An increase in mortgage interest rates typically results in an increase in the fair value of the MSRs while a decrease in mortgage interest rates typically results in a decrease in the fair value of MSRs. Despite an increase in the balance of loans serviced by the Company in 2011, the fair value of the Company’s MSRs decreased due to a decline in mortgage interest rates. As a result, the Company established a valuation reserve of $117,000 at December 31, 2011, compared to none at December 31, 2010.

The following table presents a breakdown of the Company’s mortgage lending income for 2012, 2011, 2010 and 2009.2010.

2012 vs. 2011 comparison

Service charges on deposit accounts were $1.1 million in 2012, compared to $1.2 million in 2011. The decrease is primarily due to a decline in insufficient funds charges, reflecting changes in customer behavior and spending patterns.

Mortgage lending income was $3.4 million in 2012, compared to $1.9 million in 2011. A increase in the level of mortgage refinance activity during 2012 when compared to the levels experienced during 2011 contributed to the increase in mortgage lending income. The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to origination and sale of new mortgage loans.

The Company recognized a gain on sale of $3.3 million related to the sale of its interests in three affordable housing limited partnerships in January 2012. Accordingly, the Company did not receive any federal tax credits related to affordable housing partnership investments in 2012. Prior to the sale of these interests, the Company accrued its pro-rata share of partnership losses in noninterest income. In 2011, the Company accrued approximately $0.6 million related to affordable housing investment losses.

The net gain on securities was $0.7 million in 2012, compared to a net gain of $0.9 million in 2011. Gross realized gains of $1.0 million in 2012 were reduced by gross realized losses of $0.2 million and other-than-temporary impairment charges of $0.1 million related to trust preferred securities. Gross realized gains of $1.7 million in 2011 were reduced by gross realized losses of $0.5 million and $0.3 million in other-than-temporary impairment charges related to trust preferred securities.

2011 vs. 2010 comparison

Service charges on deposit accounts were $1.2 million in 2011, compared to $1.3 million in 2010. The decrease is primarily due to a decline in insufficient funds charges, reflecting changes in customer behavior and spending patterns.

Mortgage lending income was $1.9 million in 2011, compared to $2.5 million in 2010. A decline in the level of mortgage refinance activity during 2011 when compared to the levels experienced during 2010 contributed to the decrease in mortgage lending income. The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to origination and sale of new mortgage loans.

Losses related to affordable housing partnership investments were $0.6 million in 2011, compared to $0.3 million in 2010. The increase in losses on affordable housing partnership investments was primarily due to the Company’s increased total investment in these projects in 2011. While the losses incurred by the partnerships are recognized in pre-tax earnings, these investments are designed to generate a return primarily through the realization of federal tax credits. As a result, these investments have significantly reduced the Company’s income tax expense during 2011 when compared to 2010. In January of 2012, the Company sold its interests in three affordable housing partnership investments. The Company will recognize a pre-tax gain on sale of $3.2 million related to these investments in 2012. Accordingly, the Company expects it will not incur any losses related to affordable housing partnership investments subsequent to the sale. In addition, the Company does not expect to receive any federal tax credits related to affordable housing partnership investments in 2012.

The net gain on securities was $0.9 million in 2011, compared to a net gain of $1.4 million in 2010. Gross realized gains of $1.7 million in 2011 were reduced by gross realized losses of $0.5 million and other-than-temporary impairment charges of $0.3 million related to trust preferred securities. Gross realized gains of $3.5 million in 2010 were primarily reduced by approximately $2.0 million in other-than-temporary impairment charges related to trust preferred securities and corporate debt securities.

2010 vs. 2009 comparison

Service charges on deposit accounts were $1.3 million in 2010, compared to $1.2 million in 2009. The increase was primarily due to increased insufficient funds charges, reflecting changes in customer behavior and spending patterns.

Mortgage lending income was $2.5 million in 2010, compared to $3.3 million in 2009. A significant decline in the level of mortgage refinance activity during 2010 when compared to the record levels experienced during 2009 contributed to the decrease in mortgage lending income. The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to origination and sale of new mortgage loans.

Losses related to affordable housing partnership investments were $0.3 million in 2010, compared to $0.2 million in 2009. The increase in losses on affordable housing partnership investments was primarily due to the Company’s increased total investment in these projects. While the losses incurred by the partnerships are recognized in pre-tax earnings, these investments are designed to generate a return primarily through the realization of federal tax credits.

The net gain on securities was $1.4 million in 2010, compared to a net loss of $3.7 million in 2009. Gross realized gains of $3.5 million in 2010 were offset by gross realized losses of $2.1 million. Gross realized losses in 2010 primarily related to other-than-temporary impairment charges for trust preferred securities and corporate debt securities. Gross realized losses of $6.6 million in 2009 primarily related to other-than-temporary impairment charges for trust preferred securities and an investment in the common stock of Silverton Financial Services, Inc. These losses were offset by gross realized gains of $2.9 million during the same period.

Noninterest Expense

2012 vs. 2011 comparison

Salaries and benefits expense was $8.7 million in 2012, compared to $8.2 million in 2011. The increase in 2012 when compared to 2011 reflected routine increases coupled with an increase in the number of full-time equivalent employees due to the opening of a new branch during December 2011 in Valley, Alabama.

FDIC and other regulatory assessments expense was $0.7 million in 2012, compared to $0.8 million in 2011. The decrease in 2012 when compared to 2011 was primarily due to the FDIC redefining the deposit insurance assessment base effective April 1, 2011. As a result, most FDIC insured institutions with less than $10 billion in assets experienced a reduction in their FDIC deposit insurance assessments.

Other real estate owned expense, net was $0.3 million in 2012, compared to $2.0 million in 2011. The decrease was primarily due to a decline in realized holding losses or write-downs on the valuations of certain OREO properties. Despite the improvement in net expenses related to OREO, these properties could also be subject to future valuation adjustments as a result of updated appraisal information and further deterioration in real estate values, thus causing additional fluctuations in other real estate owned expense, net. Also, the Company will continue to incur expenses associated with maintenance costs and property taxes associated with these assets.

On January 19, 2012, the Company restructured its balance sheet by paying off $38.0 million of FHLB advances with a weighted average interest rate of 4.26% and a weighted average duration of 2.6 years. In connection with repaying the FHLB advances, the Company incurred a $3.7 million prepayment penalty in 2012, compared to none in 2011.

2011 vs. 2010 comparison

Salaries and benefits expense was $8.2 million in 2011, compared to $7.4 million in 2010. The increase in 2011 when compared to 2010 was primarily due to increased costs related to salaries, bonus compensation, and group medical insurance. No cash bonuses were accrued for Company or Bank officers in 2010.

FDIC and other regulatory assessments expense was $0.8 million in 2011, compared to $1.1 million in 2010. The decrease in 2011 when compared to 2010 was primarily due to the FDIC redefining the deposit insurance assessment base effective April 1, 2011. Most FDIC insured institutions with less than $10 billion in assets experienced a reduction in their FDIC deposit insurance assessments during 2011.

Other real estate owned expense, net was $2.0 million in 2011, compared to $1.4 million in 2010. Approximately $2.0 million and $1.3 million of other real estate owned expense, net, in 2011 and 2010, respectively, related to realized holding losses or write-downs due to reduced valuations of certain OREO properties. These properties could also be subject to future valuation adjustments as a result of updated appraisal information and further deterioration in real estate values, thus causing additional fluctuations in other real estate owned expense, net. Also, the Company will continue to incur expenses associated with maintenance costs and property taxes associated with these assets. In 2011, rental income on OREO properties largely offset these costs.

The Company incurred no prepayment penalties on long-term debt in 2011, compared to $0.7 million in 2010. In 2010, the Company repaid $10.0 million of securities sold under agreements to repurchase prior to their maturity that had been included in long-term debt. In January 2012, the Company repaid $38.0 million of FHLB advances with a weighted average rate of 4.26% and a weighted average duration of 2.6 years. Accordingly, the Company will incur approximately $3.7 million in prepayment penalties on long-term debt in 2012 related to the repayment of these FHLB advances.

2010 vs. 2009 comparison

Salaries and benefits expense was $7.4 million in 2010, compared to $7.1 million in 2009. The increase in 2010 when compared to 2009 was primarily due to increased salaries expense and group medical insurance costs. No cash bonuses were accrued for Company or Bank officers in 2010 or 2009.

FDIC and other regulatory assessments expense was $1.1 million in 2010, compared to $1.3 million in 2009. The decrease in 2010 when compared to 2009 was primarily due to the impact of the $0.4 million special assessment from the FDIC included in FDIC and other regulatory assessments expense in 2009.

Other real estate owned expense, net increased by $1.3 million in 2010 when compared to 2009. The increase was primarily due to write-downs of the carrying value of certain foreclosed properties due to deterioration in real estate values.

Prepayment penalties on long-term debt were approximately $0.7 million during 2010 compared to nil during 2009. As part of its strategy to reduce wholesale funding and interest expense, the Company repaid $10.0 million of securities sold under agreements to repurchase prior to their maturity that had been included in long-term debt during 2010.

Income Tax Expense

2012 vs. 2011 comparison

Income tax expense for 2012 was $1.4 million, compared to $0.1 million in 2011. The Company’s effective income tax rate was 17.34% in 2012, compared to 1.02% in 2011. The increase in the Company’s effective tax rate was due to a 46% increase in the level of earnings before taxes and a decrease in federal tax credits related to the Company’s investments in affordable housing limited partnerships, which were sold in January 2012. The impact of these changes on the Company’s effective tax rate for the full year 2012 was partially reduced by the reversal of a previously established deferred tax asset valuation allowance of $0.5 million related to capital loss carry-forwards. Excluding the reversal of the valuation allowance, the Company’s effective tax rate for 2012 would have been approximately 23.51%.

2011 vs. 2010 comparison

In 2011, the Company recorded income tax expense of $0.1 million, compared to $0.8 million in 2010. The effective income tax rate was 1.02% in 2011, compared to 12.99% in 2010. The decrease in income tax expense and the effective

tax rate from 2010 to 2011 was primarily due to a decrease in the level of earnings before taxes and an increase in federal tax credits related to the Company’s increased investments in affordable housing limited partnerships in 2011. In January of 2012, the Company sold its interests in three affordable housing partnership investments. Accordingly, the Company expects that income tax expense will increase in 2012 when compared to 2011 since the Company currently does not expect to receive any federal tax credits related to affordable housing partnership investments in 2012.

2010 vs. 2009 comparison

In 2010, the Company recorded income tax expense of $0.8 million, compared to an income tax benefit of $0.3 million in 2009. This change was primarily due to an increase in the level of earnings before taxes. The effective income tax rate was 12.99% in 2010, compared to an effective income tax benefit rate of 16.47% in 2009. The increase in the effective tax rate from 2009 to 2010 was primarily due to a 198% increase in earnings before taxes. Also reflected in the Company’s effective income tax benefit rate for 2009 was a change in valuation allowance of $0.5 million related to nondeductible capital losses and an income tax benefit of $0.3 million related to the correction of an accounting error in prior periods. Information concerning the correction of an accounting error is included in Note 1 to the Consolidated Financial Statements.

BALANCE SHEET ANALYSIS

Securities

Securities available-for-sale were $299.6$259.5 million and $315.2$299.6 million as of December 31, 20112012 and 2010,2011, respectively. The decrease from December 31, 2010in securities available-for-sale of $40.1 million, or 13%, was primarily reflectsdue to management’s decisionefforts to utilize a portionlimit the reinvestment of the cash proceeds from sales, calls, and maturities of securities sold, called,available-for-sale while long-term interest rates are at historically low levels by growing the loan portfolio and matured during 2011 to reduce the level ofrepaying wholesale funding (such as brokered certificates of deposit andborrowings (e.g. FHLB advances) on our balance sheet.. Unrealized net gains on securities available-for-sale were $6.7$8.2 million as ofat December 31, 20112012 compared to unrealized net lossesgains of $3.5$6.7 million as ofat December 31, 2010.2011. The changeincrease in net unrealized gains (losses) of $10.2 million from December 31, 2010on securities available-for-sale was primarily due to changesa decline in long-term interest rates and athe narrowing of credit spreads on securities of U.S. states and political subdivisions during 2011.spreads. The average tax-equivalent yields earned on total securities were 3.14% in 2012 and 3.65% in 2011 and 4.09% in 2010.2011.

The following table shows the carrying value and weighted average yield of securities available-for-sale as of December 31, 20112012 according to contractual maturity. Actual maturities may differ from contractual maturities of residential mortgage-backed securities (“RMBS”) because the mortgages underlying the securities may be called or prepaid with or without penalty.

Total loans, net of unearned income, were $370.3$398.2 million as of December 31, 2011, a decrease2012, an increase of $3.9$27.9 million, or 1%8%, from $374.2$370.3 million at December 31, 2010.2011. Loan growth was primarily driven by an increase in commercial real estate loans of $21.2 million from December 31, 2011. The loan portfolio decreased slightlymajority of the increase in 2011 as newcommercial real estate was due to an increase in multi-family residential and shopping center loans were unable to offset the impact of pay-downs, charge-offs, foreclosures$13.5 million and other problem loan resolutions. In particular, construction and land development loans decreased by $8.0$6.7 million, or 17%, in 2011.respectively. Four loan categories represented the majority of the loan portfolio as December 31, 2011:2012: commercial real estate mortgage loans (44%(46%), residential real estate mortgage loans (27%), commercial and industrial loans (15%) and construction and land development loans (11%(9%).

Within its residential real estate mortgage portfolio, the Company had junior lien mortgages of approximately $23.9$15.8 million, or 6%4%, and $24.3$15.1 million, or 6%4%, of total loans, net of unearned income at December 31, 20112012 and 2010,2011, respectively. For residential real estate mortgage loans with a consumer purpose, approximately $1.8$1.3 million and $4.1$1.8 million required interest-only payments at December 31, 20112012 and 2010,2011, respectively. The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high-risk consumer mortgage products.

Purchased loan participations included in the Company’s loan portfolio were approximately $3.8$3.1 million and $7.2$3.8 million as of December 31, 20112012 and 2010,2011, respectively. All purchased loan participations are underwritten by the Company independent of the selling bank. In addition, all loans, including purchased participations, are evaluated for collectability during the course of the Company’s normal loan review procedures. If the Company deems a participation loan impaired, it applies the same accounting policies and procedures as described in “CRITICAL ACCOUNTING POLICIES.”

The average yield earned on loans and loans held for sale was 5.54% in 2012 and 5.67% in 2011 and 5.73% in 2010.2011.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the impacteffects of recessionarycurrent economic conditions on our borrowers’ cash flows, real estate market sales volumes, valuations, and availability and cost of financing for properties, real estate industry concentrations, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations.

The Company attempts to reduce these economic and credit risks by adhering to loan to value (“LTV”) guidelines for collateralized loans, investigating the creditworthiness of borrowers and monitoring borrowers’ financial position. Also, we establish and periodically review our lending policies and procedures. Banking regulations limit oura bank’s credit exposure by prohibiting unsecured loan relationships that exceed 10% of theour Bank’s capital accounts of the Bank;accounts; or 20% of the capital accounts, if loans in excess of 10% are fully secured, which would approximate $14.6secured. Under these regulations, we are prohibited from having unsecured loan relationships in excess of approximately $15.4 million. Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $13.2$13.8 million. Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit. At December 31, 2011,2012, the Company had no loan relationships exceeding these limits.

We periodically analyze our commercial loan portfolio to determine if a concentration of credit risk exists in any one or more industries. We use classification systems broadly accepted by the financial services industry classification systems in order to classify borrowers into various industry classifications. Loan concentrations to borrowers in the following industriesclasses exceeded 25% of the Bank’s total risk-based capital at December 31, 20112012 (and related balances at December 31, 2010)2011).