Botetourt Bankshares (BORT) 10-Q 2010 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d) of

the Securities Exchange Act of 1934

for the quarterly period ended June 30, 2010

Commission File No. – 000-49787

BOTETOURT BANKSHARES, INC.

(Exact name of the registrant as specified in its charter)

Virginia	54-1867438
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

19747 Main Street, Buchanan, VA 24066

(Address of principal executive offices)

(540) 591-5000

(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

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

The number of shares outstanding of the Registrant’s Common Stock, $1 Par Value, as of August 10, 2010 was 1,247,994.

Botetourt Bankshares, Inc.

Form 10-Q

Index

Part I Financial Information
Item 1.	Financial Statements
The consolidated financial statements of Botetourt Bankshares, Inc. (the “Company”) are set forth in the following pages.
Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009		2
Consolidated Statements of Operations for the Six and Three Months Ended June 30, 2010 and 2009		3
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009		4
Notes to Consolidated Financial Statements		5-14
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15-19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19
Item 4.	Controls and Procedures	19
Part II Other Information
Item 1.	Legal Proceedings	20
Item 1A.	Risk Factors	20
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20
Item 3.	Defaults Upon Senior Securities	20
Item 4	(Removed and Reserved)	20
Item 5.	Other Information	20
Item 6.	Exhibits	20
Signatures		21
Certifications		22-24

Part I. Financial Information

Item 1. Financial Statements

Botetourt Bankshares, Inc.

Consolidated Balance Sheets

June 30, 2010 and December 31, 2009

	(Unaudited) June 30, 2010			(Audited) December 31, 2009
Assets
Cash and due from banks	$	7,494,006		$	7,507,950
Interest-bearing deposits with banks		15,444,515			2,044,636
Federal funds sold		3,220,000			7,272,000
Investment securities available for sale		14,667,382			16,090,402
Investment securities held to maturity (fair value approximates $100,000 at June 30, 2010 and $99,800 at December 31, 2009)		100,000			100,000
Restricted equity securities		581,000			581,000
Loans, net of allowance for loan losses of $3,442,753 at June 30, 2010 and $3,947,025 at December 31, 2009		259,858,214			259,998,540
Property and equipment, net		7,813,729			8,058,292
Accrued income		1,226,140			1,253,125
Foreclosed assets		2,463,250			1,322,340
Other assets		4,136,422			4,306,288
Total assets	$	317,004,658		$	308,534,573
Liabilities and stockholders’ equity
Liabilities
Noninterest-bearing deposits	$	33,307,336		$	30,706,483
Interest-bearing deposits		254,795,792			249,133,352
Total deposits		288,103,128			279,839,835
Accrued interest payable		577,609			685,138
Other liabilities		1,295,123			1,403,272
Total liabilities		289,975,860			281,928,245
Commitments and contingencies		—			—
Stockholders’ equity
Common stock, $1.00 par value, 2,500,000 shares authorized, 1,247,994 and 1,246,062 issued and outstanding at June 30, 2010 and December 31, 2009		1,247,994			1,246,062
Additional paid-in capital		1,658,600			1,630,586
Retained earnings		24,581,185			24,208,695
Accumulated other comprehensive loss		(458,981	)		(479,015	)
Total stockholders’ equity		27,028,798			26,606,328
Total liabilities and stockholders’ equity	$	317,004,658		$	308,534,573

See Notes to Consolidated Financial Statements

2

Botetourt Bankshares, Inc.

Consolidated Statements of Operations

For the Six and Three Months ended June 30, 2010 and 2009 (Unaudited)

	Six Months Ended June 30,				Three Months Ended June 30,
	2010		2009		2010		2009
Interest income
Loans and fees on loans	$	7,840,864	$	8,009,753	$	3,871,138	$	3,943,087
Federal funds sold		4,665		2,769		2,615		1,770
Investment securities:
Taxable		187,417		210,325		94,009		114,783
Exempt from federal income tax		115,670		146,668		57,663		69,841
Dividend income		870		656		786		84
Deposits with banks		5,018		1,492		3,563		1,378
Total interest income		8,154,504		8,371,663		4,029,774		4,130,943
Interest expense
Deposits		2,652,272		3,465,194		1,281,660		1,733,714
Federal funds purchased		—		1,495		—		3
Total interest expense		2,652,272		3,466,689		1,281,660		1,733,717
Net interest income		5,502,232		4,904,974		2,748,114		2,397,226
Provision for loan losses		1,225,000		785,000		655,000		310,000
Net interest income after provision for loan losses		4,277,232		4,119,974		2,093,114		2,087,226
Noninterest income
Service charges on deposit accounts		318,176		393,004		153,190		196,459
Mortgage origination fees		85,623		114,688		51,093		57,317
Net realized gain on sale of AFS securities		1,075		8,000		—		8,000
Other income		566,108		489,638		285,175		246,936
Total noninterest income		970,982		1,005,330		489,458		508,712
Noninterest expense
Salaries and employee benefits		2,327,706		2,267,271		1,150,225		1,109,491
Occupancy and equipment expense		482,230		507,749		244,207		264,062
Foreclosed assets, net		79,209		83,283		32,881		10,507
Other expense		1,565,799		1,618,429		804,292		1,040,317
Total noninterest expense		4,454,944		4,476,732		2,231,605		2,424,377
Income before income taxes		793,270		648,572		350,967		171,561
Income tax expense		221,333		170,782		95,181		35,099
Net income	$	571,937	$	477,790	$	255,786	$	136,462
Basic earnings per share	$	0.46	$	0.38	$	0.21	$	0.11
Diluted earnings per share	$	0.46	$	0.38	$	0.21	$	0.11
Dividends declared per share	$	0.16	$	0.28	$	0.08	$	0.14
Basic weighted average shares outstanding		1,247,082		1,245,300		1,247,570		1,245,300
Diluted weighted average shares outstanding		1,247,082		1,245,300		1,247,570		1,245,300

See Notes to Consolidated Financial Statements

3

Botetourt Bankshares, Inc.

Consolidated Statements of Cash Flows

For the Six Months ended June 30, 2010 and 2009 (Unaudited)

	Six Months Ended June 30,
	2010			2009
Cash flows from operating activities
Net income	$	571,937		$	477,790
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		338,064			333,135
Net amortization of securities premiums/(accretion) discounts		(2,488	)		1,859
Provision for loan losses		1,225,000			785,000
Deferred income taxes		(55,536	)		(37,596	)
Net realized losses on sales of assets		14,680			10,702
Write down of other real estate owned		42,700			45,000
Changes in assets and liabilities:
Accrued income		26,985			20,715
Other assets		154,314			(237,018	)
Accrued interest payable		(107,529	)		(15,545	)
Other liabilities		(118,469	)		98,923
Net cash provided by operating activities		2,089,658			1,482,965
Cash flows from investing activities
Net (increase) decrease in federal funds sold		4,052,000			(6,183,000	)
Purchases of investment securities – available for sale		(4,879,138	)		(6,658,755	)
Purchases of restricted equity securities		—			(30,100	)
Maturity of investment securities – held to maturity		—			950,000
Maturity of investment securities – available for sale		6,120,000			5,443,000
Sale of investment securities – available for sale		216,075			505,000
Net increase in interest-bearing deposits with banks		(13,399,879	)		(345,554	)
Net increase in loans		(2,899,384	)		(6,676,597	)
Purchases of properties and equipment		(42,973	)		(57,670	)
Proceeds from sales of properties and equipment		20,500			6,750
Proceeds from sales of foreclosed assets		615,405			600,000
Net cash used in investing activities		(10,197,394	)		(12,446,926	)
Cash flows from financing activities
Net increase in noninterest-bearing deposits		2,600,853			1,003,465
Net increase in interest-bearing deposits		5,662,440			11,206,726
Net decrease in federal funds purchased		—			(1,113,000	)
Dividends paid		(199,447	)		(348,684	)
Common stock issued		29,946			—
Net cash provided by financing activities		8,093,792			10,748,507
Net decrease in cash and due from banks		(13,944	)		(215,454	)
Cash and due from banks, beginning		7,507,950			8,621,683
Cash and due from banks, ending	$	7,494,006		$	8,406,229
Supplemental disclosures of cash flow information:
Interest paid	$	2,759,801		$	3,482,234
Income taxes paid	$	260,000		$	65,000
Supplemental schedule of noncash investing activities:
Other real estate acquired in settlement of loans	$	1,814,710		$	605,000
Loans originated to finance the sale of other real estate owned	$	463,500		$	—

See Notes to Consolidated Financial Statements

4

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements

June 30, 2010 (Unaudited)

Note 1. Organization and Basis of Presentation

Organization

Botetourt Bankshares, Inc., (the Company) was incorporated as a Virginia corporation on January 17, 1997 and is the holding company for Bank of Botetourt (the Bank). The Bank was acquired by the Company on September 30, 1997. Bank of Botetourt was founded in 1899 and currently serves Botetourt, Roanoke, Rockbridge, and Franklin Counties, Virginia and surrounding areas through ten banking offices. As an FDIC-insured, state-chartered bank, the Bank is subject to regulation by the Commonwealth of Virginia’s Bureau of Financial Institutions and the Federal Deposit Insurance Corporation. The Company is subject to supervision by the Federal Reserve.

The consolidated financial statements as of June 30, 2010 and for the periods ended June 30, 2010 and 2009 included herein, have been prepared by Botetourt Bankshares, Inc., without audit pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s consolidated financial position, results of operations, and cash flows for such interim periods. Management believes that all interim period adjustments are of a normal recurring nature. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto as of December 31, 2009, included in the Company’s Form 10-K for the fiscal year ended December 31, 2009. The balance sheet as of December 31, 2009 was extracted from the Form 10-K for the year ended December 31, 2009.

Interim financial performance is not necessarily indicative of performance for the full year.

The accounting and reporting policies of the Company and its subsidiaries follow generally accepted accounting principles and general practices within the financial services industry.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Subsequent Events

In accordance with accounting guidance, the Company evaluated events and transactions for potential recognition or disclosure in our financial statements through the date the financial statements were issued.

Note 2. Cash and Cash Equivalents

For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption “cash and due from banks.” As a condition of our correspondent bank agreement, the Bank is also required to maintain a target balance. The target balance as of June 30, 2010 was $3,550,000.

5

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements

June 30, 2010 (Unaudited)

Note 3. Allowance for Loan Losses

The following is an analysis of the allowance for loan losses for the six months ended June 30:

	2010			2009
Balance, beginning	$	3,947,025		$	3,780,725
Provision charged to expense		1,225,000			785,000
Recoveries of amounts charged off		40,000			41,834
Amounts charged off		(1,769,273	)		(997,865	)
Balance, ending	$	3,442,752		$	3,609,694

The following is a summary of information pertaining to impaired and nonperforming loans:

	June 30, 2010		December 31, 2009
Impaired loans without a valuation allowance	$	12,743,204	$	12,056,395
Impaired loans with a valuation allowance		4,567,501		6,526,126
Total impaired loans	$	17,310,705	$	18,582,521
Valuation allowance related to impaired loans	$	647,594	$	1,484,740
Nonaccrual loans	$	9,579,150	$	10,558,464
Loans past due ninety days or more still accruing		1,254,048		1,666,758
Total nonperforming loans	$	10,833,198	$	12,225,222

Note 4. Earnings Per Share

Basic earnings per share is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if option contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The following is a reconciliation of basic and diluted earnings per share for the six months ended June 30:

	2010			2009
	Shares	Per Share		Shares	Per Share
Basic earnings per share	1,247,082	$	0.46	1,245,300	$	0.38
Effect of dilutive options	—		—	—		—
Diluted earnings per share	1,247,082	$	0.46	1,245,300	$	0.38

The following is a reconciliation of basic and diluted earnings per share for the three months ended June 30:

	2010			2009
	Shares	Per Share		Shares	Per Share
Basic earnings per share	1,247,570	$	0.21	1,245,300	$	0.11
Effect of dilutive options	—		—	—		—
Diluted earnings per share	1,247,570	$	0.21	1,245,300	$	0.11

The number of shares for basic and diluted earnings per share were the same for the six months ended and three months ended June 30, 2010, as the Company has no potentially dilutive securities outstanding.

6

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 5. Comprehensive Income

A summary of comprehensive income is as follows:

	Six Months Ended June 30,
	2010			2009
Net income	$	571,937		$	477,790
Other comprehensive income:
Net change in unrealized appreciation on investment securities available for sale, net of taxes $(10,686) in 2010 and $22,583 in 2009		20,744			(43,840	)
Reclassified securities gains realized, net of taxes $365 in 2010 and $2,720 in 2009		(710	)		(5,280	)
Total comprehensive income	$	591,971		$	428,670

Note 6. Commitments and Contingencies

Financial Instruments with Off-Balance-Sheet Risk

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

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments. A summary of the Bank’s commitments at June 30, 2010 and December 31, 2009 is as follows:

	2010		2009
Commitments to extend credit	$	40,911,000	$	37,478,000
Standby letters of credit		3,173,000		3,782,000

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

7

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 7. Investment Securities

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The carrying amount of securities and their approximate fair values at June 30, 2010 and December 31, 2009 are as follows:

	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
June 30, 2010
Available for sale:
Government-sponsored enterprises	$	7,391,739	$	30,033	$	7,015	$	7,414,757
State and municipal securities		7,060,687		158,312		9,458		7,209,541
Corporate securities		1		43,083		—		43,084
	$	14,452,427	$	231,428	$	16,473	$	14,667,382
Held to maturity:
State and municipal securities	$	100,000		—		—	$	100,000
	$	100,000	$	—	$	—	$	100,000
December 31, 2009
Available for sale:
U.S. Treasury securities	$	499,360	$	3,922	$	—	$	503,282
Government-sponsored enterprises		8,505,929		34,700		85,592		8,455,037
State and municipal securities		6,900,512		196,409		10,261		7,086,660
Corporate securities		1		45,422		—		45,423
	$	15,905,802	$	280,453	$	95,853	$	16,090,402
Held to maturity:
State and municipal securities	$	100,000		—		200	$	99,800
	$	100,000	$	—	$	200	$	99,800

Government-sponsored enterprises, commonly referred to as U.S. Agencies, include investments in Federal Farm Credit Banks, Federal Home Loan Banks, and Federal National Mortgage Association bonds.

Investment securities with amortized cost of approximately $1,500,000 were pledged as collateral on public deposits and for other purposes as required or permitted by law at June 30, 2010 and $500,000 at December 31, 2009.

Gains and losses on the sale of investment securities are recorded on the trade date and are determined using the specific identification method. Proceeds on the sale of investment securities amounted to $216,075 for the six months ended June 30, 2010 and $505,000 for the six months ended June 30, 2009. Gross realized gains amounted to $1,075 for the period ended June 30, 2010 and $8,000 for the period ended June 30, 2009.

The scheduled maturities of securities available for sale and securities held to maturity at June 30, 2010 are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	614,425	$	622,604	$	100,000	$	100,000
Due after one year through five years		5,474,218		5,581,137		—		—
Due after five years through ten years		7,503,249		7,557,137		—		—
Due after ten years		860,535		906,504		—		—
	$	14,452,427	$	14,667,382	$	100,000	$	100,000

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Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 7. Investment Securities, continued

The following tables detail unrealized losses and related fair values in the Bank’s investment securities portfolio. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2010 and December 31, 2009.

	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
June 30, 2010
Government-sponsored enterprises	$	1,992,985	$	7,015	$	—	$	—	$	1,992,985	$	7,015
State and municipal securities		1,134,484		9,458		—		—		1,134,484		9,458
Total temporarily impaired securities	$	3,127,469	$	16,473	$	—	$	—	$	3,127,469	$	16,473
	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
December 31, 2009
Government-sponsored enterprises	$	3,920,367	$	85,592	$	—	$	—	$	3,920,367	$	85,592
State and municipal securities		621,206		10,128		94,667		333		715,873		10,461
Total temporarily impaired securities	$	4,541,573	$	95,720	$	94,667	$	333	$	4,636,240	$	96,053

Management considers the nature of the investment, the underlying causes of the decline in market value, the magnitude and duration of the decline in market value and other evidence, on a security by security basis, in determining if the decline in market value is other than temporary. The Company believes that gross unrealized losses as of June 30, 2010 and December 31, 2009, which are comprised of 8 and 14 investment securities respectively, represent a temporary impairment given the credit ratings on these investment securities and the short duration of the unrealized loss. The gross unrealized losses reported relate to investment securities issued by Government-sponsored enterprises and various state and municipal securities. Total gross unrealized losses, which represent 0.11% of the amortized cost basis of the Company’s total investment securities, resulted from changes in interest rates due to market conditions and not due to the credit quality of the investment securities.

Restricted equity securities, which are carried at cost, consist of investments in stock of the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corp., which are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow from it. The Bank is required to hold that stock so long as it borrows from the FHLB. Both the Bank’s stock in CBB Financial Corp. and the FHLB are restricted in the fact that the stock may only be repurchased by the issuer. Management also considers these investments when testing for impairment. On a quarterly basis, management reviews both institutions’ capital adequacy to ensure they meet regulatory minimum requirements. Bank management does not believe any unrealized losses associated with investments in these institutions to be anything other than temporary.

Note 8. Benefit Plans

Stock-Based Compensation

The Company adopted the 2009 Incentive Stock Plan (“2009 Incentive Plan”) that provides for restricted stock grants and options up to 50,000 shares for key employees of the Company, to be issued at no less than the current market price at the time of the grant or option. The maximum number of shares with respect to which awards may be granted in any calendar year is 15,000 shares. The plan expires May 13, 2019 unless all shares are granted prior to the expiration date. No restricted stock grants or options have been granted under this plan.

9

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 8. Benefit Plans, continued

Defined Benefit Pension Plan

The Company has a qualified noncontributory, Defined Benefit Pension Plan which covers substantially all of its employees. For additional information related to this plan, refer to the Company’s Form 10-K for the year ended December 31, 2009.

The components of net periodic benefit cost related to the Defined Benefit Pension Plan for the six and three months ended are as follows:

	Pension Benefits Six Months Ended June 30,						Pension Benefits Three Months Ended June 30,
	2010			2009			2010			2009
Service cost	$	115,580		$	109,814		$	57,790		$	54,907
Interest cost		130,716			128,840			65,358			64,420
Expected return on plan assets		(153,954	)		(101,586	)		(76,977	)		(50,793	)
Amortization of net obligation at transition		—			—			—			—
Amortization of prior service cost		766			766			383			383
Amortization of net loss		8,296			40,966			4,148			20,483
Net periodic benefit cost	$	101,404		$	178,800		$	50,702		$	89,400

Employer Contributions

The Company previously disclosed in its consolidated financial statements for the year ended December 31, 2009, that a $250,000 contribution was paid during the first quarter of 2010. No additional contributions are expected by December 31, 2010.

Note 9. Fair Value

Generally accepted accounting principles (“GAAP”) provides a framework for measuring and disclosing fair value and requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

Assets Recorded at Fair Value on a Recurring Basis

There were no significant transfers to or from Levels 1 and 2 during the reporting period ended June 30, 2010. The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.

(In Thousands)
June 30, 2010	Total		Level 1		Level 2		Level 3
Investment securities available for sale:
Government-sponsored enterprises	$	7,415	$	—	$	7,415	$	—
State and municipal securities		7,209		—		7,209		—
Corporate securities		43		43		—		—
Total assets at fair value	$	14,667	$	43	$	14,624	$	—
(In Thousands)
December 31, 2009
Investment securities available for sale:
U.S. Treasury securities	$	503	$	503	$	—	$	—
Government-sponsored enterprises		8,455		—		8,455		—
State and municipal securities		7,086		—		7,086		—
Corporate securities		46		46		—		—
Total assets at fair value	$	16,090	$	549	$	15,541	$	—

10

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 9. Fair Value, continued

Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below.

(In Thousands)
June 30, 2010	Total		Level 1		Level 2		Level 3
Impaired loans:
Commercial	$	503	$	—	$	468	$	35
Construction and land development		819		—		819		—
Real estate – Residential, 1-4 families		1,779		—		1,484		295
Real estate – Nonfarm, nonresidential		819		—		523		296
Total Impaired Loans		3,920		—		3,294		626
Other real estate owned		2,463		—		2,463		—
Total assets at fair value	$	6,383	$	—	$	5,757	$	626
(In Thousands)
December 31, 2009	Total		Level 1		Level 2		Level 3
Impaired loans:
Commercial	$	543	$	—	$	543	$	—
Construction and land development		1,494		—		1,494		—
Real estate – Residential, 1-4 families		2,067		—		2,067		—
Real estate – Nonfarm, nonresidential		937		—		644		293
Total Impaired Loans		5,041		—		4,748		293
Other real estate owned		1,322		—		1,322		—
Total assets at fair value	$	6,363	$	—	$	6,070	$	293

Transfers into Level 3 during the six month ended June 30, 2010 were related to management adjustments to third party appraisals. Management estimated the fair value of these loans to be further impaired and thereby below the appraised value, resulting in no observable market price. For the six months ended June 30, 2010 and 2009, the changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows (dollars in thousands):

	Six Months Ended June 30, 2010			Six Months Ended June 30, 2009
	Impaired Loans			Impaired Loans
Balance, January 1, 2010	$	293		$	3,794
Reclassification adjustment		—			(2,158	)
Included in earnings		(178	)		(10	)
Transfers into Level 3		1,337			1,405
Transfer out of Level 3		(715	)		—
Principal reductions		(111	)		(3	)
Balance, June 30, 2010	$	626		$	3,028

There were two transfers from Level 3 to Level 2 during the second quarter of 2010. One loan had principal reduction and then a charge-off of exposure bringing the balance back to the Level 2 $70,000 appraisal value. Another loan, in the amount of $362,500, was transferred from Level 3 to Level 2 following a new collateral analysis which revealed no exposure. One loan in the amount of $287,000 was transferred out of Level 3 during the first quarter of 2010 when impairment status was eliminated. The Company has no liabilities carried at fair value or measured at fair value on a recurring or nonrecurring basis.

11

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 9. Fair Value, continued

The estimated fair values of the Company’s financial instruments are as follows (dollars in thousands):

	June 30, 2010				December 31, 2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and due from banks	$	7,494	$	7,494	$	7,508	$	7,508
Interest-bearing deposits with banks		15,445		15,445		2,045		2,045
Federal funds sold		3,220		3,220		7,272		7,272
Investment securities, available for sale		14,667		14,667		16,090		16,090
Investment securities, held to maturity		100		100		100		100
Restricted equity securities		581		581		581		581
Loans, net		259,858		259,003		259,999		259,974
Accrued interest receivable		1,226		1,226		1,253		1,253
Financial liabilities
Deposits		288,103		290,709		279,840		282,474
Federal funds purchased		—		—		—		—
Accrued interest payable		578		578		685		685
Unused commitments		—		—		—		—

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

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

Interest-bearing deposits with bank and federal funds sold: The carrying amounts of interest–bearing deposits with banks and federal funds sold approximate their fair values.

Securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying values of restricted equity securities approximate fair values.

Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. The carrying amount of accrued interest receivable approximates its fair value.

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

Federal funds purchased: The carrying amounts of federal funds purchased approximate fair value

12

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 10. Dividend Reinvestment and Stock Purchase Plan

The Company maintains a Dividend Reinvestment and Stock Purchase Plan (“DRIP”) which provides for the issuance of 200,000 shares of common stock. The purchase price of shares acquired through the DRIP is recommended by the Dividend Reinvestment Plan Committee (“Committee”) of the Company and approved by the Board of Directors. In determining the purchase price per share, the Committee considers book value of the common stock of the Company, relationship between traded price and book value, known recent trades, and any additional information the Committee deems appropriate.

The following is a summary of the shares of common stock issued from dividends reinvested and optional cash purchases in 2010.

	Shares	Purchase Price
First Quarter	968	$	15.50
Second Quarter	964		15.50
Total Shares Issued	1,932

The inaugural dividend reinvestment and optional cash purchases occurred in the fourth quarter of 2009 when 762 shares of common stock were issued at an established purchase price of $16.75 per share.

Note 11. Recent Accounting Pronouncements and Future Accounting Considerations

The following is a summary of recent authoritative announcements.

In July 2010, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update entitled Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The guidance is intended to improve transparency in financial reporting by public and private companies that hold financing receivables, which include loans, lease receivables, and other long-term receivables. The guidance will require companies to provide more information in their disclosures about the credit quality of their financing receivables and the credit reserves held against them. The additional disclosures required for financing receivables include an aging of past due receivables, credit quality indicators, and modifications of financing receivables. Reporting companies will need to disaggregate new and existing disclosures based on how they develop their allowance for credit losses and how they manage credit exposures. Short-term accounts receivables, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt. For issuers, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. For nonissuers, the amendments are effective for periods ending on or after December 15, 2011. The guidance will not impact the Company’s accounting measurements but it is expected to result in additional disclosures.

On March 23, 2010, the Patient Protection and Affordable Care Act (“PPACA”) was signed into law. The PPACA provided for a major overhaul of the nation’s health insurance and health delivery systems with the phase in of various provisions over the next several years. One key provision of the law eliminates the tax deductibility of federal subsidies received by sponsors of postretirement medical plans that provide retiree prescription drug benefits equivalent to Medicare Part D coverage. Guidance related to income taxes requires the immediate recognition of the impact of this change in tax treatment of subsidies. The result of this tax change is to increase income tax expense in the current period by reflecting the full impact of the future loss of the employer’s tax deduction in income tax expense in the current period. On March 30, 2010, the President signed the Health Care and Education Reconciliation Act of 2010, which amended the Patient Protection and Affordable Care Act. Although the bills were signed on separate dates, the SEC has issued guidance providing that it would not object if the two Acts were considered together for accounting purposes. This view is based on the SEC staff’s understanding that the two Acts together represent the current health care reforms as passed by Congress and signed by the President. The amendment had no impact on the financial statements.

13

Botetourt Bankshares, Inc.

Notes to Consolidated Financial Statements, continued

June 30, 2010 (Unaudited)

Note 11. Recent Accounting Pronouncements and Future Accounting Considerations, continued

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated. The amendments were effective upon issuance and had no significant impact on the Company’s financial statements.

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation. The new disclosures are effective for the Company for the current quarter and have been reflected in the Fair Value footnote.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Note 12. Subsequent Events

Declaration of Cash Dividend

Effective July 28, 2010, the Company declared a second quarter $0.08 cash dividend per common share payable on August 10, 2010 to shareholders of record on July 28, 2010.

14

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion provides information about the major components of the results of operations and financial condition of the Company. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this report.

Critical Accounting Policy

For a discussion of the Company’s critical accounting policies, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Results of Operations

Net income for the six months ended June 30, 2010 was $571,937 compared to $477,790 for the same period last year, representing an increase of $94,147 or 19.70%. Both basic and diluted earnings per share increased $0.08 from $0.38 at June 30, 2009 to $0.46 at June 30, 2010. The increase in net income is primarily due to higher net interest income, resulting from lower noninterest expense.

Interest-earning assets increased $10,505,780 from $286,808,084 at June 30, 2009 to $297,313,864 at June 30, 2010. Total interest income decreased in the first six months of 2010 as compared to the first six months of 2009 due primarily to a decrease in fees on loans, and a decrease in investment income resulting from lower interest rates earned on a smaller investment portfolio. The decrease was partially offset with an increase in earnings on federal funds sold, interest earned on deposits at correspondent banks, and dividend income. Interest-bearing liabilities increased $12,861,881 to $254,795,792 at June 30, 2010 from $241,933,911 at June 30, 2009. Interest expense decreased during the period by $814,417, or 23.49%, due to interest-bearing deposits repricing at lower interest rates. Net interest income for the six months ended June 30, 2010 increased by $597,258 compared to the same time period in 2009.

The provision for loan losses was $1,225,000 for the six months ended June 30, 2010 and $785,000 for the six months ended June 30, 2009. The increase in the provision for loan losses in the first six months of 2010 was in response to the uncertainty of the economic climate and pace of recovery, a stagnant local real estate and housing market, and continued higher levels of impaired loan and loan delinquencies than in more normal economic periods. Given the current economic climate in which we operate and to ensure the most relevant data is being used in the allowance for loan losses model, the model’s historical loss period, including the current year, is four years in 2010 and five years in 2009. (A more detailed description of that model can be found under “Allowance for Loan Losses” in the Company’s Form 10-K, filed March 25, 2010.) The increase in the provision was primarily related to a higher provision required by the general component of the model to cover potential losses from non-impaired loans based on historical loss experience. Impaired loans remain at higher levels than in more normal economic times. However, the volume of impaired loans and the loss exposure determined by underlying collateral values showed improvement at June 30, 2010 from December 31, 2009 as more fully discussed in the “Non-performing Assets” section which follows. For the unallocated component, a thorough economic analysis is performed internally. Economic statistical data is obtained from a professional third party vendor, the Federal Reserve Bank, and other appropriate public domain sources. The economic data is reviewed, interpreted, and applied to our loan portfolio to quantify the financial impact of the current and forecasted economic trends. The allowance for loan losses represents management’s estimate of an amount adequate to provide for potential losses inherent in the loan portfolio. Management believes the provision and the resulting allowance for loan losses are adequate and appropriate. However, should economic conditions worsen, impacting our customer base, more increases to the allowance may be necessary.

Net charge-offs for the six months ended June 30, 2010 amounted to $1,729,000 compared to $956,000 for the same time period in 2009. The increase in net charge-offs is reflective of decreased collateral values and the deterioration of customers’ abilities to repay their debt obligations. During the first six months of 2010, the increase in charge-offs has been primarily related to a business failure in the residential real estate development industry, commercial loans, and personal residences in the 1-4 family real estate category. Charged-off loans with material balances had been previously identified as impaired with an allocated specific reserve. The negative trend in charge-offs is likely to continue in 2010 until the economy, sustained by stronger employment and stable real estate values and sales, significantly improves. These charge-off trends are considered in the quarterly review of the allowance for loan losses. There have been no changes to the Bank’s charge-off policy in 2010. To control the levels of our past due loans and the time required for problem resolution, additional personnel have been allocated to the collections function of the Bank.

15

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

Results of Operations, continued

Noninterest income decreased by 3.42% to $970,982 for the six months ended June 30, 2010 compared to $1,005,335 for the six months ended June 30, 2009. The decrease is primarily attributed to a decline in service charges on deposit accounts such as overdraft fees and lower mortgage loan origination fees. For the six months ended June 30, 2010, noninterest expense decreased by $21,788, or 0.49%, to $4,454,944 compared to $4,476,732 at June 30, 2009. The decrease is a result of the nonrecurring one time special assessment imposed by the FDIC in 2009, partially offset by an increase in salaries and employee benefits.

Net income for the six months ended June 30, 2010 was $255,786 compared to $136,462 for the same period last year, representing an increase of $119,324 or 87.44%. Both basic and diluted earnings per share increased $0.10 from $0.11 at June 30, 2009 to $0.21 at June 30, 2010. The increase in net income is attributable to higher net interest income due primarily to lower interest expense and lower noninterest expense. Total interest income decreased during the three month period compared to the same three month period in 2009 due primarily to a decrease in income generated from earning assets, such as loans and investment securities earning lower interest rates. However, the decrease in interest income was more than offset by lower interest expense as interest-bearing deposit liabilities repriced at lower interest rates. The combined effect resulted in net interest income increasing by $350,888 in the three months ended June 30, 2010 as compared to the same period in 2009.

Following management’s second quarter evaluation of the reasonableness of the allowance for loan losses, we recorded a provision for credit losses of $655,000 for the quarter ended June 30, 2010 compared with $310,000 for the quarter ended June 30, 2009. The increase in the provision was primarily related to a higher provision required by the general component of the model to cover potential losses from non-impaired loans based on historic loss experience.

Noninterest income decreased by $19,254 or 3.78% for the three months ended June 30, 2010 compared to the same quarter in the previous year. The decrease is primarily attributable to lower income from service charges on deposit accounts and a decrease in mortgage origination fees. Noninterest expense for the three months ended June 30, 2010 decreased by $192,772 or 7.95% over the same quarter in the previous year. A significant portion of the decrease is due to the nonrecurring expense for the FDIC’s one time special assessment as part of its restoration plan of the Deposit Insurance Fund imposed in June 2009, partially offset by an increase in salaries and employee benefits such as health insurance.

Financial Condition

Overall loan demand has been soft in our operating markets during the first six months of 2010. As a result, total loans decreased $644,598 during the six months ended June 30, 2010. Deposits increased by $8,263,293 as a result of competitive pricing and successful deposit campaigns, especially targeting the attraction and retention of individual retirement accounts and certificates of deposit. The decrease in loans combined with deposit growth increased liquid funds which were held as interest-bearing deposits with banks and federal funds sold. At June 30, 2010 federal funds sold and interest-bearing deposits with banks amounted to $18,664,515 compared to $9,316,636 at December 31, 2009. Investment securities, including restricted equity securities, decreased $1,423,020 as a result of maturing or called investment securities. Given the current interest rate environment and investment opportunities, management elected to invest primarily in the Federal Reserve’s interest on excess reserves program and the overnight federal funds market. Total assets increased by $8,470,085 to $317,004,658 from December 31, 2009 to June 30, 2010.

Stockholders’ equity totaled $27,028,798 at June 30, 2010 compared to $26,606,328 at December 31, 2009. The $422,470 increase during the period was the result of earnings for the six months combined with an increase in the market value of securities that are classified as available for sale, common stock issued under the Dividend Reinvestment and Stock Purchase Plan, offset by dividends paid for the period.

Non-Performing Assets

Non-performing assets, which consist of nonaccrual loans and foreclosed properties, were $12,042,401 at June 30, 2010 and $11,880,804 at December 31, 2009. While there was a decrease of $979,000 in nonaccrual loans, the overall increase is due to the additional foreclosed properties. Foreclosed assets consisted of ten properties totaling

16

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

Non-Performing Assets, continued

$2,463,250 at June 30, 2010. During the second quarter of 2010, the Bank foreclosed on seven loans to five borrowers and sold two foreclosed properties. One sale resulted in a net gain of $1,935 while the second sale resulted in a net loss of $24,215. Two properties are being leased and generating rental income. All foreclosed properties are currently being marketed for sale and no additional material loss is anticipated. The Bank had approximately $963,000 in loans secured by 1-4 family residential properties in the process of formal foreclosure at June 30, 2010.

Nonaccrual loans were $9,579,150 at June 30, 2010 and $10,558,000 at December 31, 2009. The overall decrease is primarily the result of three loans related to a personal bankruptcy being placed back on accrual status after a bankruptcy court approved a forbearance agreement and repayment plan during the first quarter. The decrease was partially offset by the addition of ten loans totaling $2,974,000 placed on nonaccrual status during the second quarter of 2010. These additions did not materially impact earnings related to the reversal of interest income. However, total nonaccrual loan balances continue to have a financial impact on the Bank in the form of foregone interest income until the loans are removed from nonaccrual status and provisions for future loan losses. A loan is removed from nonaccrual status when it is deemed a loss and appropriately charged to the allowance or when it begins performing consistently, normally for six months, according to contractual terms.

Loans are generally placed in nonaccrual status when the collection of principal and interest is 90 days or more past due, unless the obligation is both well-secured and in the process of collection. A loan is considered impaired if it is probable that the Bank will be unable to collect all amounts due under the contractual terms of the loan agreement. A loan that is placed as nonaccrual does not mean that we will not recover much of or all the principal balance due. In most cases, we have a secured interest in collateral, such as real property or equipment. Sales of the collateral will not always cover the full loan amount, but it should substantially reduce the risk of loss.

Impaired loans amounted to $17,310,705 at June 30, 2010 compared to $18,582,521 at December 31, 2009. The review of our loan portfolio during the first six months of 2010 identified some additional credits as impaired, including troubled debt restructurings. However, the increase in the balance of impaired loans from this identification process was offset by loans transferring to other real estate owned and loans exiting impairment following consistent performance and thereby no longer meeting the impairment criteria. The specific reserve component of the allowance for loan losses decreased $837,000 from December 31, 2009 to June 30, 2010. Loss exposure at June 30, 2010 decreased following the charge-off of certain loans with specific reserves and an updated calculation of loss exposure of impaired loans in the portfolio. At June 30, 2010, $648,000 of the $3,443,000 total allowance for loan losses was allocated for the loss exposure related to impaired loans. Management will continue to monitor the performance of loan repayments by borrowers who may be unable to pay according to contractual terms. We will take appropriate action, including identifying loss exposure and allocating specific reserves, when deemed necessary.

The Bank has made a conscious effort to attempt work-out loan situations with past due customers. In some cases, loan restructuring was appropriate. Bank management has procedures and processes in place to identify, monitor, and report troubled debt restructurings. At June 30, 2010, troubled debt restructurings totaled $4,675,000 compared to $2,733,000 at December 31, 2009, and were spread among all loan categories. In no case was principal forgiven. At June 30, 2010, $645,000 of troubled debt restructurings were on nonaccrual status compared to $851,000 at December 31, 2009. Bank management supports a philosophy of working with its customers during this downturn in the economy and has had general success in this area.

Capital Requirements

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

17

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

Capital Requirements, continued

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average assets, as all those terms are defined in the regulations. By definition, Tier 1 capital is comprised of common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles.

At June 30, 2010, the Bank’s Tier 1 risk-based capital ratio (Tier 1 capital divided by risk-weighted average assets) was 10.75% compared to 10.53% at December 31, 2009. The Company’s risk-based ratio (Tier 1 capital divided by risk-weighted average assets) was 10.81% at June 30, 2010 and 10.57% at December 31, 2009. Each of these ratios exceeded the required regulatory minimum ratio of 4.0%.

At June 30, 2010, the Bank’s total risk based capital ratio (total risk based capital divided by total risk-weighted assets) was 12.00% compared to 11.78% at December 31, 2009. The Company’s total risk based capital ratio (total risk based capital divided by total risk-weighted assets) was 12.06% at June 30, 2010 compared to 11.83% at December 31, 2009. Each of these ratios exceeded the required regulatory minimum leverage ratio of 8.0%.

At June 30, 2010, the Bank’s leverage ratio (Tier 1 capital divided by quarterly average assets) was 8.70% compared to 8.84% at December 31, 2009. At June 30, 2010, the Company’s leverage ratio (Tier 1 capital divided by quarterly average assets) was 8.72% compared to 8.90% at December 31, 2009. Each of these ratios exceeded the required regulatory minimum leverage ratio of 4.0%.

Management believes, as of June 30, 2010 that the Company and the Bank met all capital adequacy requirements to which we are subject.

Liquidity

One of the principal goals of the Bank’s asset and liability management strategy is to maintain adequate liquidity. Liquidity is the ability to convert assets to cash to fund depositors’ withdrawals or borrowers’ loans without significant loss. There were no material changes in the Company’s liquidity sources at June 30, 2010. Federal funds lines available from correspondent banks totaled $18,000,000 at June 30, 2010 and December 31, 2009. There was no balance outstanding on these lines at June 30, 2010 or December 31, 2009.

The secondary liquidity source for both short-term and long-term borrowings consists of a $13,700,000 secured line of credit from the Federal Home Loan Bank at June 30, 2010 and December 31, 2009. At June 30, 2010, a $6,000,000 letter of credit in favor of the Commonwealth of Virginia – Treasury Board, to secure public deposits, was utilized from this line of credit, leaving approximately $7,700,000 of available credit for secondary liquidity needs. Advancing the maximum available credit could require the pledging of additional collateral. No balance was outstanding on this line at June 30, 2010 and December 31, 2009.

The Bank has an approved $1,000,000 Discount Window facility at the Federal Reserve Bank of Richmond as part of its Contingency Liquidity Plan. No balance was outstanding on this line at June 30, 2010 or December 31, 2009.

The Bank is a participating institution in the Certificate of Deposit Account Registry Service (“CDARS”). CDARS is a technology based service that the Bank can incorporate into its traditional product offering. The service uses a web based application that allows participating institutions across the country to swap, sell, or buy deposits from other members. The CDARS program can be used to attract new deposits, diversify our funding sources, and manage liquidity.

The Bank uses cash and federal funds sold to meet its daily funding needs. If funding needs are met through holdings of excess cash and federal funds, then profits might be sacrificed as higher-yielding investments are foregone in the interest of liquidity. Therefore management determines, based on such items as loan demand and deposit activity, an appropriate level of cash and federal funds sold and seeks to maintain that level. During 2010 the Bank has become more liquid due to soft loan demand, investments called prior to maturity, and deposit growth. With limited attractive investment opportunities, the Bank’s interest-bearing deposits with banks increased from $2,045,000 to $15,445,000 from December 31, 2009 to June 30, 2010 as a result of more funds deposited with the Federal Reserve Bank of Richmond to earn interest income on excess reserves. Additionally, in the second quarter

18

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, continued

Liquidity, continued

of 2010, the Bank made application with the Federal Reserve to become an eligible institution in its Term Deposit Facility. The Term Deposit Facility is a program through which the Federal Reserve Banks offer interest-bearing term deposits to eligible institutions. A term deposit is a deposit with a specific maturity date. The Term Deposit Facility was established to facilitate the conduct of monetary policy by providing a tool that may be used to manage the aggregate quantity of reserve balances held by depository institutions. An increase in term deposits outstanding drains reserve balances because funds to pay for them are removed from the accounts of participating institutions for the life of the term deposit. At June 30, 2010, the Bank had no Term Deposits with the Federal Reserve.

The Bank’s investment portfolio also serves as a source of liquidity. The primary objectives of the investment portfolio are to satisfy liquidity requirements, maximize income on portfolio assets, and supply collateral required to secure public funds deposits. As investment securities mature, the proceeds are either reinvested in federal funds sold to fund loan demand or deposit withdrawal fluctuations or the proceeds are reinvested in similar investment securities. The majority of investment security transactions consist of replacing securities that have been called or matured. The Bank keeps a majority of its investment portfolio in unpledged assets that have less than a five year average life to maturity. These investments are a source of liquid funds as they can be sold in any interest rate environment without causing significant harm to the current period’s results of operations.

As a result of the steps described above, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

Forward-Looking Statements

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements contain the Company’s expectations, plans, future financial performance, and other statements that are not historical facts. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations applicable to the Company. Although the Company believes that its expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

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

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

19

PART II.

OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of business, the Company is involved in various legal proceedings. Management believes that the ultimate resolution of these proceedings will not have a material effect on the Company’s financial position, liquidity, or results of operations.

Item 1A. Risk Factors

Not applicable.

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Reserved

Item 5. Other Information

None.

Item 6. Exhibits

The following is a list of all exhibits filed or incorporated by reference as part of this Report on Form 10-Q.

3(i).1	Restated Articles of Incorporation filed on Schedule 14 A on March 30, 2007 and confirmed on Form 8-K on June 7, 2007
3(ii).1	Amended and restated Bylaws filed on the Form 8-K on October 14, 2008.
10.41,2	Change In Control Agreement filed as Exhibit 10.4 on the Form 10-SB 12G on April 30, 2002
10.51	Defined Benefit Plan filed as Exhibit 10.5 on the Form 10-SB 12G on April 30, 2002
10.61,2	Employment Agreement filed as Exhibit 10.6 on the Form 8-K on January 5, 2010.
10.71	2009 Incentive Stock Plan filed as Appendix B on the Schedule 14A on March 27, 2009
10.81	Dividend Reinvestment and Stock Purchase Plan filed on the Form S-3D on September 10, 2009
31.1	Certification of Chief Executive Officer pursuant to Rule 13 a-14(a) under the Securities Exchange Act of 1934
31.2	Certification of Chief Financial Officer pursuant to Rule 13 a-14(a) under the Securities Exchange Act of 1934
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

¹ Incorporated by Reference

² Designates a Management Contract

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SIGNATURES

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

	Botetourt Bankshares, Inc.
Date: August 11, 2010		By:	/s/ H. Watts Steger, III
			H. Watts Steger, III
			Chief Executive Officer
Date: August 11, 2010		By:	/s/ Michelle A. Alexander
			Michelle A. Alexander
			Chief Financial Officer

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