HomeTown Bankshares (HMTA) 10-Q 2013 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒ Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 

for the quarterly period ended September 30, 2013.

Or

☐ Transition Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 

for the transition period from              to             .

Commission File Number: 333-158525

HOMETOWN BANKSHARESCORPORATION

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

Virginia	26-4549960
(State or other jurisdiction of Incorporation or organization)	(I.R.S. Employer Identification No.)
202 South Jefferson Street, Roanoke, Virginia	24011
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number: (540) 345-6000

(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the past 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  ☒    No  ☐

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large 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	☒

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

As of November 14, 2013, 3,270,299 shares of common stock, par value $5.00 per share, of the issuer were outstanding.

  HOMETOWN BANKSHARES CORPORATION

Form 10-Q

INDEX

PART 1. FINANCIAL INFORMATION
Item 1.	FINANCIAL STATEMENTS
Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012		3
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2013 and 2012		4
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2013and 2012		5
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012		6
Notes to Consolidated Financial Statements		7
Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	21
Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27
Item 4.	CONTROLS AND PROCEDURES	27
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosure	27
Item 5.	Other Information	27
Item 6.	Exhibits	27
SIGNATURES		28

All schedules have been omitted because they are inapplicable or the required information is provided in the financial statements, including the notes thereto. 

2

HOMETOWN BANKSHARES CORPORATION

Consolidated Balance Sheets

September 30, 2013 and December 31, 2012

In Thousands, Except Share and Per Share Data	September 30, 2013			December 31, 2012
	(Unaudited)
Assets
Cash and due from banks	$	14,464		$	9,812
Federal funds sold		1,420			196
Securities available for sale, at fair value		59,609			63,466
Restricted equity securities, at cost		2,414			2,591
Loans, net of allowance for loan losses of $3,684 in 2013 and $3,790 in 2012		283,640			271,147
Property and equipment, net		11,371			9,754
Other real estate owned, net of valuation allowance of $703 in 2013 and $575 in 2012		8,400			8,938
Deferred tax asset, net		1,388			1,338
Accrued income		1,781			1,590
Other assets		565			1,619
Total assets	$	385,052		$	370,451
Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	43,363		$	32,627
Interest-bearing		282,005			277,370
Total deposits		325,368			309,997
Short term borrowings		522			216
Federal Home Loan Bank borrowings		19,000			22,000
Accrued interest payable		309			332
Other liabilities		615			1,187
Total liabilities		345,814			333,732
Commitments and contingencies		-			-
Stockholders’ Equity:
Preferred stock, no par value; Series A 10,000 shares and Series B 374 shares authorized, issued and outstanding at December 31, 2012		-			10,374
Preferred stock, no par value; Series C 14,000 shares authorized, issued and outstanding at September 30, 2013 and no shares at December 31, 2012		13,300			-
Discount on preferred stock		-			(142	)
Common stock, $5 par value; authorized 10,000,000 shares, issued and outstanding 3,270,299 (includes 27,846 restricted shares) at September 30, 2013, and 3,262,518 (includes 25,896 restricted shares) at December 31, 2012		16,351			16,167
Surplus		15,330			15,487
Retained deficit		(5,427	)		(6,587	)
Accumulated other comprehensive (loss) income		(316	)		1,420
Total stockholders’ equity		39,238			36,719
Total liabilities and stockholders’ equity	$	385,052		$	370,451

See Notes to Consolidated Financial Statements 

3

HOMETOWN BANKSHARES CORPORATION

Consolidated Statements of Income

For the Three and Nine Months Ended September 30, 2013 and 2012

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2013		2012		2013		2012
	(Unaudited)		(Unaudited)		(Unaudited)		(Unaudited)
In Thousands, Except Share and Per Share Data
Interest income:
Loans and fees on loans	$	3,637	$	3,471	$	10,687	$	10,280
Taxable investment securities		288		371		979		1,282
Nontaxable investment securities		58		18		121		30
Dividends on restricted stock		25		25		73		64
Other interest income		12		11		33		38
Total interest income		4,020		3,896		11,893		11,694
Interest expense:
Deposits		459		558		1,402		1,779
Preferred stock dividends		-		-		-		38
Other borrowed funds		94		94		281		306
Total interest expense		553		652		1,683		2,123
Net interest income		3,467		3,244		10,210		9,571
Provision for loan losses		-		130		125		1,408
Net interest income after provision for loan losses		3,467		3,114		10,085		8,163
Noninterest income:
Service charges on deposit accounts		77		68		227		206
ATM and interchange income		80		55		233		165
Mortgage loan brokerage fees		62		110		225		262
Gains on sales of investment securities		8		-		116		127
Other income		91		78		287		219
Total noninterest income		318		311		1,088		979
Noninterest expense:
Salaries and employee benefits		1,355		1,264		4,072		3,629
Occupancy and equipment expense		331		307		972		942
Data processing expense		152		171		437		506
Advertising and marketing expense		99		100		364		297
Professional fees		58		77		355		271
Bank franchise taxes		51		34		152		103
FDIC insurance expense		128		126		399		369
Gains, losses on sales and writedowns of other real estate owned, net		-		111		351		146
Other real estate owned expense		91		72		192		249
Directors’ fees		52		51		162		168
Other expense		320		236		820		789
Total noninterest expense		2,637		2,549		8,276		7,469
Net income before income taxes		1,148		876		2,897		1,673
Income tax expense (benefit)		376		292		958		(2,366	)
Net income		772		584		1,939		4,039
Effective dividends on preferred stock		372		133		639		400
Accretion of discount on preferred stock		102		19		142		56
Net income available to common stockholders	$	298	$	432	$	1,158	$	3,583
Basic earnings per common share	$	0.09	$	0.13	$	0.35	$	1.10
Diluted earnings per common share	$	0.09	$	0.13	$	0.33	$	1.10
Weighted average common shares outstanding		3,270,299		3,262,518		3,268,646		3,258,385
Diluted average common shares outstanding		5,510,299		3,262,518		4,048,133		3,258,385

See Notes to Consolidated Financial Statements

4

HOMETOWN BANKSHARES CORPORATION

Consolidated Statements of Comprehensive Income

For the Three and Nine Months ended September 30, 2013 and 2012

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2013			2012			2013			2012
In Thousands	(Unaudited)			(Unaudited)			(Unaudited)			(Unaudited)
Net income	$	772		$	584		$	1,939		$	4,039
Other comprehensive (loss) income, net of deferred taxes
Net unrealized holding (losses) gains on securities available for sale during the period		(438	)		416			(2,505	)		1,213
Less: reclassification adjustment for gains included in net income, net of tax		5			-			77			84
Net securities (losses) gains during the period		(443	)		416			(2,582	)		1,129
Deferred income tax benefit (expense) on unrealized holding (losses) gains on securities available for sale		152			(142	)		885			(736	)
Tax expense related to realized gains on securities sold		(3	)		-			(39	)		(43	)
Total other comprehensive (loss) income		(294	)		274			(1,736	)		350
Comprehensive income	$	478		$	858		$	203		$	4,389

See Notes to Consolidated Financial Statements

5

HOMETOWN BANKSHARES CORPORATION

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2013 and 2012

	For the Nine Months Ended September 30,
In Thousands	2013			2012
Cash flows from operating activities:	(Unaudited)			(Unaudited)
Net income	$	1,939		$	4,039
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		391			382
Provision for loan losses		125			1,408
Amortization of premium on securities, net		519			572
Gains, losses on sales and writedowns of other real estate, net		351			146
Gains on sales of investment securities		(116	)		(127	)
Gains on disposals of fixed assets		(7	)		-
Stock compensation expense		29			21
Changes in assets and liabilities:
Deferred tax asset, net		835			(2,926	)
Accrued income		(191	)		(99	)
Other assets		1,054			267
Accrued interest payable		(23	)		(53	)
Other liabilities		(572	)		391
Net cash flows provided by operating activities		4,334			4,021
Cash flows from investing activities:
Net (increase) decrease in federal funds sold		(1,224	)		8,813
Purchases of investment securities		(16,684	)		(17,604	)
Sales, maturities, and calls of available for sale securities		17,517			20,663
Redemption (purchase) of restricted equity securities, net		177			(28	)
Net increase in loans		(14,231	)		(20,812	)
Proceeds from sales of other real estate		1,800			967
Purchases of property and equipment		(2,010	)		(471	)
Proceeds from disposals of property and equipment		9			-
Net cash flows used in investing activities		(14,646	)		(8,472	)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits		10,736			7,844
Net increase (decrease) in interest-bearing deposits		4,635			(3,891	)
Net increase in short-term borrowings		306			218
Net decrease in long-term FHLB borrowings		(3,000	)		-
Preferred stock issue, net		13,300			-
Preferred stock redeemed		(10,374	)
Preferred stock dividend payment		(639	)		(1,200	)
Net cash flows provided by financing activities		14,964			2,971
Net increase (decrease) in cash and cash equivalents		4,652			(1,480	)
Cash and cash equivalents, beginning		9,812			12,529
Cash and cash equivalents, ending	$	14,464		$	11,049
Supplemental disclosure of cash flow information:
Cash payments for interest	$	1,706		$	2,176
Cash payments for income taxes	$	38		$	23
Supplemental disclosure of noncash investing activities:
Transfer from loans to other real estate	$	1,613		$	1,641

See Notes to Consolidated Financial Statements 

6

Notes to Consolidated Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Organization

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

Basis of Presentation

The consolidated financial statements as of September 30, 2013 and for the periods ended September 30, 2013 and 2012 included herein, have been prepared by HomeTown Bankshares Corporation, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission.

Management believes that all interim adjustments for the period ended September 30, 2013 are of a normal recurring nature. The first quarter of 2012 included the recognition of cumulative deferred tax assets. The amount of the net tax benefit recognized in the first quarter was a non-recurring, cumulative adjustment that included the net tax benefit generated from years prior to 2012. Management believes that all other interim adjustments for 2012 were of a normal recurring nature. In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s financial position, results of operations and cash flows for such interim periods. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto as of December 31, 2012, included in the Company’s Form 10-K for the year ended December 31, 2012. Interim results are not necessarily indicative of results for a full year.

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

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary HomeTown Bank. All significant intercompany accounts and transactions associated with the Company’s wholly-owned subsidiary have been eliminated. In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

Our accounting policies and basic principles have not changed since the summary disclosure of these in our Annual Report on Form 10-K. Please refer to the Form 10-K for these policies.

Beginning with the first quarter of 2013, the Company changed the methodology of how historical loss rates were analyzed in the calculation of the allowance for loan losses. The revised calculation and application of historical loss rates impacted the calculation of the allowance for loan losses. Under the former methodology, the previous two calendar years and an annualized current calendar year of losses were analyzed and applied to the loans collectively evaluated for impairment. The former calculation would have resulted in a total allocation of $2,158,000. Under the revised methodology, a rolling three years of losses are analyzed and applied to the loans collectively evaluated for impairment, resulting in an allocation of $1,965,000. Consistent with accounting guidance, prior periods have not been restated and are shown as originally published using the segments and classes in effect for the period.

Note 2. Investment Securities

The amortized cost and fair value of securities available for sale as of September 30, 2013 and December 31, 2012, are as follows:

(Dollars In Thousands)	September 30, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U. S. Government agency securities	$	27,437	$	352	$	(372	)	$	27,417
Mortgage-backed securities		16,277		195		(136	)		16,336
Municipal securities		16,373		123		(640	)		15,856
	$	60,087	$	670	$	(1,148	)	$	59,609

7

(Dollars In Thousands)	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U. S. Government agency securities	$	28,825	$	1,049	$	(32	)	$	29,842
Mortgage-backed securities		21,533		486		(35	)		21,984
Municipal securities		10,965		698		(23	)		11,640
	$	61,323	$	2,233	$	(90	)	$	63,466

U.S. Government and federal agency securities.The unrealized losses on 16 of the Company’s investments in obligations of the U.S. government were caused by increases in market interest rates over the yields available at the time the securities were purchased.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2013.

Mortgage-backed securities.The unrealized losses on 9 of the Company’s investments in government-sponsored entity mortgage-backed securities were caused by increases in market interest rates over the yields available at the time the securities were purchased. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2013.

Municipal securities.The unrealized losses on 31 of the Company’s investments in obligations of municipal securities were caused by increases in market interest rates over the yields available at the time the securities were purchased. All municipal securities are investment grade. Because the decline in market value is attributable to changes in interest rates, credit spreads, ratings and not credit quality, and because the Company does not intend to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at September 30, 2013.

The following tables demonstrate the unrealized loss position of securities available for sale at September 30, 2013 and December 31, 2012.

	September 30, 2013
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss
U. S. Government agency securities	$	9,192	$	(366	)	$	996	$	(6	)	$	10,188	$	(372	)
Mortgage-backed securities		6,419		(128	)		507		(8	)		6,926		(136	)
Municipal securities		10,884		(621	)		216		(19	)		11,100		(640	)
	$	26,495	$	(1,115	)	$	1,719	$	(33	)	$	28,214	$	(1,148	)

	December 31, 2012
	Less than 12 months				12 months or more					Total
(Dollars In Thousands)	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss
U.S. Government agency securities	$	-	$	-	$	3,400	$	(32	)	$	3,400	$	(32	)
Mortgage-backed securities		-		-		3,701		(35	)		3,701		(35	)
Municipal securities		-		-		1,595		(23	)		1,595		(23	)
	$	-	$	-	$	8,696	$	(90	)	$	8,696	$	(90	)

There were 56 debt securities with fair values totaling $28.2 million considered temporarily impaired at September 30, 2013.  As of September 30, 2013, the Company does not consider any bond in an unrealized loss position to be other-than-temporarily impaired.

8

The Company realized gains on sales of securities of $116 thousand for the first nine months of 2013 compared to $127 thousand for the same period last year.

The amortized cost and estimated fair values of investment securities available for sale at September 30, 2013, by contractual maturity are as follows:

(Dollars In Thousands)	Amortized Cost		Estimated Fair Value
One year or less	$	-	$	-
Over one through five years		790		802
Over five through ten years		9,917		9,859
Greater than 10 years		49,380		48,948
	$	60,087	$	59,609

 Note 3. Loans Receivable

The major classifications of loans in the consolidated balance sheets at September 30, 2013 and December 31, 2012 were as follows:

(Dollars In Thousands)	September 30, 2013			December 31, 2012
Construction loans:
Residential	$	6,804		$	5,036
Land acquisition, development & commercial		20,120			20,198
Real estate:
Residential		68,733			69,691
Commercial		124,585			109,302
Commercial, industrial & agricultural		38,656			42,382
Equity lines		19,409			20,504
Consumer		9,017			7,824
Total		287,324			274,937
Less allowance for loan losses		(3,684	)		(3,790	)
Loans, net	$	283,640		$	271,147

The past due and nonaccrual status of loans as of September 30, 2013 was as follows:

(Dollars In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Nonaccrual Loans
Construction loans:
Residential	$	-	$	-	$	-	$	-	$	6,804	$	6,804	$	-
Land acquisition, development & commercial		-		-		-		-		20,120		20,120		-
Real estate:
Residential		173		-		520		693		68,040		68,733		520
Commercial		862		-		-		862		123,723		124,585		-
Commercial, industrial & agricultural		99		46		27		172		38,484		38,656		183
Equity lines		98		-		-		98		19,311		19,409		59
Consumer		39		-		-		39		8,978		9,017		39
Total	$	1,271	$	46	$	547	$	1,864	$	285,460	$	287,324	$	801

9

The past due and nonaccrual status of loans as of December 31, 2012 was as follows:

(Dollars In Thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Nonaccrual Loans
Construction loans:
Residential	$	-	$	-	$	-	$	-	$	5,036	$	5,036	$	-
Land acquisition, development & commercial		-		723		1,034		1,757		18,441		20,198		1,756
Real estate:
Residential		-		562		184		746		68,945		69,691		582
Commercial		-		-		236		236		109,066		109,302		236
Commercial, industrial & agricultural		-		157		-		157		42,225		42,382		-
Equity lines		60		-		115		175		20,329		20,504		115
Consumer		-		-		-		-		7,824		7,824		-
Total	$	60	$	1,442	$	1,569	$	3,071	$	271,866	$	274,937	$	2,689

There were no loans past due ninety days or more and still accruing at September 30, 2013 or December 31, 2012.

 Impaired loans and the related allowance at September 30, 2013, were as follows:

September 30, 2013 With no related allowance: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction loans:
Residential	$	-	$	-	$	-	$	-	$	-
Land acquisition, development & commercial		1,550		1,550		-		1,550		56
Real estate:
Residential		225		225		-		226		7
Commercial		9,341		9,341		-		9,383		353
Commercial, industrial & agricultural		283		283		-		885		43
Equity lines		-		-		-		-		-
Consumer		-		-		-		-		-
Total loans with no allowance	$	11,399	$	11,399	$	-	$	12,044	$	459

September 30, 2013 With an allowance recorded: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction loans:
Residential	$	-	$	-	$	-	$	-	$	-
Land acquisition, development & commercial		-		-		-		-		-
Real estate:
Residential		439		439		163		440		14
Commercial		-		-		-		-		-
Commercial, industrial & agricultural		43		43		10		32		1
Equity lines		-		-		-		-		-
Consumer		-		-		-		-		-
Total loans with an allowance	$	482	$	482	$	173	$	472	$	15

10

Impaired loans and the related allowance at December 31, 2012 were as follows:

December 31, 2012 With no related allowance: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction loans:
Residential	$	-	$	-	$	-	$	-	$	-
Land acquisition, development & commercial		3,632		3,692		-		3,647		187
Real estate:
Residential		611		611		-		611		23
Commercial		9,018		9,018		-		9,018		440
Commercial, industrial & agricultural		916		916		-		916		33
Equity lines		115		439		-		115		-
Consumer		-		-		-		-		-
Total loans with no allowance	$	14,292	$	14,676	$	-	$	14,307	$	683

December 31, 2012 With an allowance recorded: (Dollars In Thousands)	Recorded Investment in Loans		Unpaid Principal Balance		Related Allowance		Average Balance Total Loans		Interest Income Recognized
Construction loans:
Residential	$	-	$	-	$	-	$	-	$	-
Land acquisition, development & commercial		-		-		-		-		-
Real estate:
Residential		199		199		137		199		13
Commercial		1,139		1,139		71		1,139		74
Commercial, industrial & agricultural		-		-		-		-		-
Equity lines		-		-		-		-		-
Consumer		-		-		-		-		-
Total loans with an allowance	$	1,338	$	1,338	$	208	$	1,338	$	87

Troubled Debt Restructurings

Included in certain loan categories are troubled debt restructurings (“TDRs”). At September 30, 2013 and at December 31, 2012, there were 3 loans classified as TDRs totaling $6.3 million and $6.5 million, respectively. One TDR was classified as a substandard non-accruing loan at September 30, 2013 and at the end of 2012. This loan was restructured in the twelve months ended September 30, 2012, and became past due in the second quarter of 2013. As a result of this default, a partial charge off of $145 thousand was recorded in the second quarter of 2013. The outstanding balance of this loan was $39 thousand, $42 thousand, and $199 thousand at September 30, 2013, June 30, 2013 and December 31, 2012, respectively. There was no valuation allowance related to total TDR’s at September 30, 2013. The valuation allowance related to total TDRs was $137 thousand at December 31, 2012.

For the nine months ended September 30, 2013, no loans were modified as a TDR.

11

The following table presents by class of loan, information related to loans modified during the year ended December 31, 2012.

	Loans modified as TDR's For the year ended December 31, 2012
Class of Loan	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
			(In thousands)
Construction loans:
Residential		-	$	-	$	-
Land acquisition, development & commercial		-		-		-
Real estate:		-		-		-
Residential		1		202		202
Commercial		-		-		-
Commercial, industrial & agricultural		-		-		-
Equity lines		-		-		-
Consumer		-		-		-
Total Loans		1	$	202	$	202

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

Note 4. Allowance for Loan Losses

The following table presents, as of September 30, 2013, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment). 

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September 30, 2013	Allowance for loan losses																Loans
Class of Loan In thousands of dollars	Beginning balance		Charge- offs			Recoveries		Provisions			Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment
Construction loans:
Residential	$	117	$	-		$	-	$	(4	)	$	113	$	-	$	113	$	6,804	$	-	$	6,804
Land acquisition, development & commercial		811		-			-		(72	)		739		-		739		20,120		1,550		18,570
Real estate:
Residential		725		(301	)		81		382			887		163		724		68,733		664		68,069
Commercial		1,054		(88	)		250		(245	)		971		-		971		124,585		9,341		115,244
Commercial, industrial & agricultural		459		(27	)		-		(125	)		307		10		297		38,656		326		38,330
Equity lines		386		-			2		(39	)		349		-		349		19,409		-		19,409
Consumer		145		(148	)		-		61			58		-		58		9,017		-		9,017
Unallocated		93		-			-		167			260		-		260		-		-		-
Total	$	3,790	$	(564	)	$	333	$	125		$	3,684	$	173	$	3,511	$	287,324	$	11,881	$	275,443

The following table presents, as of December 31, 2012, the total allowance for loan losses, the allowance by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment), the total loans and loans by impairment methodology (individually evaluated for impairment or collectively evaluated for impairment).

December 31, 2012	Allowance for loan losses																Loans
Class of Loan In thousands of dollars	Beginning balance		Charge- offs			Recoveries		Provisions			Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment		Ending balance		Ending balance: individually evaluated for impairment		Ending balance: collectively evaluated for impairment
Construction loans:
Residential	$	90	$	-		$	-	$	27		$	117	$	-	$	117	$	5,036	$	-	$	5,036
Land acquisition, development & commercial		953		(519	)		-		377			811		-		811		20,198		3,632		16,566
Real estate:
Residential		538		(151	)		-		338			725		137		588		69,691		810		68,881
Commercial		1,314		(478	)		18		200			1,054		71		983		109,302		10,157		99,145
Commercial, industrial & agricultural		628		(71	)		-		(98	)		459		-		459		42,382		916		41,466
Equity lines		313		(393	)		-		466			386		-		386		20,504		115		20,389
Consumer		143		(4	)		1		5			145		-		145		7,824		-		7,824
Unallocated		-		-			-		93			93		-		93		-		-		-
Total	$	3,979	$	(1,616	)	$	19	$	1,408		$	3,790	$	208	$	3,582	$	274,937	$	15,630	$	259,307

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Loans by credit quality indicators as of September 30, 2013 were as follows:

(Dollars In Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Total
Construction loans:
Residential	$	6,804	$	-	$	-	$	-	$	6,804
Land acquisition, development & commercial		18,570		-		1,550		-		20,120
Real estate:
Residential		63,610		4,379		225		519		68,733
Commercial		120,497		425		3,663		-		124,585
Commercial, industrial & agricultural		37,589		105		778		184		38,656
Equity lines		19,350		-		-		59		19,409
Consumer		8,978		-		-		39		9,017
Total	$	275,398	$	4,909	$	6,216	$	801	$	287,324

Loans by credit quality indicators as of December 31, 2012 were as follows:

(Dollars In Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Total
Construction loans:
Residential	$	5,036	$	-	$	-	$	-	$	5,036
Land acquisition, development & commercial		16,479		-		1,963		1,756		20,198
Real estate:
Residential		63,299		5,581		229		582		69,691
Commercial		103,010		2,479		3,577		236		109,302
Commercial, industrial & agricultural		41,313		131		938		-		42,382
Equity lines		20,364		25		-		115		20,504
Consumer		7,824		-		-		-		7,824
Total	$	257,325	$	8,216	$	6,707	$	2,689	$	274,937

At September 30, 2013 and December 31, 2012, the Company had no loans classified as Loss.

Note 5. Foreclosed Properties

Changes in foreclosed properties for the nine months ended September 30, 2013 were as follows:

(Dollars In Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	9,513		$	(575	)	$	8,938
Additions		1,613			-			1,613
Writedowns		-			(377	)		(377	)
Sales		(2,023	)		249			(1,774	)
Balance at the end of period	$	9,103		$	(703	)	$	8,400

Changes in foreclosed properties for the nine months ended September 30, 2012 were as follows:

(Dollars In Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	9,893		$	(331	)	$	9,562
Additions		1,641			-			1,641
Writedowns		-			(100	)		(100	)
Sales		(1,188	)		175			(1,013	)
Balance at the end of period	$	10,346		$	(256	)	$	10,090

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The major classifications of other real estate owned in the consolidated balance sheets at September 30, 2013 and December 31, 2012 were as follows:

(Dollars In Thousands)	September 30, 2013		December 31, 2012
Construction loans:
Residential	$	-	$	588
Land acquisition, development & commercial		4,291		3,591
Real estate:
Residential		-		182
Commercial		2,663		2,905
Commercial, Industrial & agricultural		1,164		1,164
Equity lines		282		508
	$	8,400	$	8,938

Note 6. Stock Based Compensation

The Company has a 2005 Stock Option Plan pursuant to which the Company’s Board of Directors may grant stock options to directors, officers and employees. The Stock Option Plan authorizes grants of options to purchase up to 550,000 shares of the Company’s authorized but unissued common stock. Accordingly, options for the purchase of 413,710 shares of authorized common stock have been issued under the Stock Option Plan and 136,290 shares of authorized common stock are available for issue under the Stock Option Plan. There are options for 413,710 shares granted currently outstanding as of September 30, 2013, of which, all options are vested. All stock options have been granted with an exercise price equal to the stock’s fair market value at the date of the grant.  As of September 30, 2013, no options have been exercised. The Company recorded compensation expense of $29 thousand for the nine months ended September 30, 2013 and $21 thousand for the nine months ended September 30, 2012. The aggregate intrinsic value of outstanding stock options was $0 at September 30, 2013. The weighted average remaining contractual term of outstanding options was 2.78 years at September 30, 2013. No options were granted in the nine months ended September 30, 2013 or 2012.

The Board of Directors adopted a Restricted Stock Plan (the Plan) in September 2009 whereby 120,000 shares of the Company’s authorized but unissued common stock was set aside to be granted by the Company’s Board of Directors at its discretion. The principal purpose of the Plan was to make shares available for issue to the executive officers of the Company and the Bank in payment of incentives earned under the Incentive Compensation Plan. 

The restrictions attached to stock issued under the Plan provide for vesting over a five-year period. During the first quarter of 2013, the Company issued 7,781 shares of stock under the Plan, and in the same period of 2012, the Company issued 20,971 shares of stock under the Plan. A summary of the activity for restricted stock awards for the periods indicated is presented below:

	For the nine months ended September 30, 2013					For the nine months ended September 30, 2012
	Shares			Weighted- Average Grant Date Fair Value		Shares			Weighted- Average Grant Date Fair Value
Nonvested at beginning of year		25,896		$	4.76		6,566		$	7.16
Granted		7,781			5.98		20,971			4.20
Vested		(5,831	)		5.03		(1,641	)		7.16
Cancelled		-			-		-			-
Nonvested at the end of the period		27,846		$	5.05		25,896		$	4.76

The remaining unamortized compensation expense for restricted stock was $117 thousand at September 30, 2013 and will be recognized over the next 4.42 years. All compensation expense for stock options has been recognized.

Note 7. Fair Value Measurement

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

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

15

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

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

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

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

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

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

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012:

(Dollars In Thousands)			Carrying value at September 30, 2013
Description	Balance as of September 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U. S. Government agency securities	$	27,417		$	27,417
Mortgaged-backed securities		16,336			16,336
Municipal securities		15,856			15,856

(Dollars In Thousands)			Carrying value at December 31, 2012
Description	Balance as of December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
U. S. Government agency securities	$	29,842		$	29,842
Mortgaged-backed securities		21,984			21,984
Municipal securities		11,640			11,640
Derivative assets		67			67
Liabilities:
Derivative liabilities	$	67		$	67

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

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

16

Impaired Loans: The Company does not record loans at fair value on a recurring basis. However, from time to time a loan is considered impaired and a specific reserve is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the extent of any loss. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value, and discounted cash flow. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investment in such loans. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. If carried at market price based on appraised value using observable market data, it is recorded as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraisal value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

 Other Real Estate Owned (OREO): The carrying amount of real estate owned by the Company resulting from foreclosures is estimated at the lesser of cost or the fair value of the real estate based on an observable market price or a current appraised value less selling costs. If carried at market price based on appraised value using observable market data, it is recorded as nonrecurring Level 2. When an appraised value is not available or is not current, or management determines the fair value of the real estate is further impaired below the appraised value or there is no observable market price, the Company records the real estate as nonrecurring Level 3.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis as of September 30, 2013 and December 31, 2012.

(Dollars In Thousands)			Carrying value at September 30, 2013
Description	Balance as of September 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired Loans, net of valuation allowance	$	309	$	-	$	309	$	-
Other real estate owned, net of valuation allowance		8,400		-		6,407		1,993

(Dollars In Thousands)			Carrying value at December 31, 2012
Description	Balance as of December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired Loans, net of valuation allowance	$	1,130	$	-	$	62	$	1,068
Other real estate owned, net of valuation allowance		8,938		-		4,382		4,556

At September 30, 2013 and December 31, 2012, the Company did not have any liabilities measured at fair value on a nonrecurring basis.

17

The following tables display quantitative information about Level 3 Fair Value Measurements for September 30, 2013 and December 31, 2012:

(Dollars In Thousands)	Quantitative information about Level 3 Fair Value Measurements for September 30, 2013
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Impaired loans	$	309	Discounted appraised value	Selling cost	10%	-	10%	(10%)
				Discount for lack of marketabilityand age of appraisal	32%	-	32%	(32%)
Other real estate owned	$	1,458	Discounted appraised value	Selling cost	6%	-	6%	(6%)
				Discount for lack of marketabilityand age	4%	-	4%	(4%)
	$	535	Internal evaluations	Internal evaluations	0%	-	25%	(4%)

(Dollars In Thousands)	Quantitative information about Level 3 Fair Value Measurements for December 31, 2012
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Impaired loans	$	1,068	Discounted appraised value	Selling cost	6%	-	10%	(10%)
				Discount for lack of marketability and age of appraisal	0%	-	10%	(7%)
Other real estate owned	$	2,177	Discounted appraised value	Selling cost	6%	-	10%	(10%)
				Discount for lack of marketability and age	0%	-	30%	(1%)
	$	2,379	Internal evaluations	Internal evaluations	10%	-	50%	(13%)

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 consolidated balance sheet for cash on hand and amounts due from correspondent banks approximate their fair values. The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated contractual maturities on such time deposits.

Federal funds sold: Federal funds sold consist of overnight loans to other financial institutions and mature within one to three days. At September 30, 2013 and December 31, 2012, management believes the carrying value of federal funds sold approximates estimated market value.

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

Restricted equity securities: For these restricted equity securities, the carrying amount is a reasonable estimate of fair value based on the redemption provisions of the related securities.

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

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

18

Short term borrowings: Short term borrowings consist of overnight borrowings and mature within one to three days. At September 30, 2013 and December 31, 2012, management believes the carrying value of securities sold under agreements to repurchase approximates estimated market value.

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

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

Off-balance sheet financial instruments: The fair values of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements. At September 30, 2013 and December 31, 2012, the fair value of loan commitments and standby letters of credit were deemed to be immaterial.

The carrying amounts and approximate fair values of the Company’s financial instruments are as follows at September 30, 2013 and December 31, 2012:

(Dollars In Thousands)			Fair value at September 30, 2013
Description	Carrying value as of September 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Approximate Fair Values
Financial assets
Cash and due from banks	$	14,464	$	12,464			$	1,999	$	14,463
Federal funds sold		1,420		1,420						1,420
Securities available-for-sale		59,609				59,609				59,609
Restricted equity securities		2,414				2,414				2,414
Loans, net		283,640						284,832		284,832
Accrued income		1,781				1,781				1,781
Financial liabilities
Total deposits		325,368				325,614				325,614
Short term borrowings		522				522				522
FHLB borrowings		19,000				19,615				19,615
Accrued interest payable		309				309				309

(Dollars In Thousands)			Fair value at December 31, 2012
Description	Carrying value as of December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Approximate Fair Values
Financial assets
Cash and due from banks	$	9,812	$	9,812					$	9,812
Federal funds sold		196		196						196
Securities available-for-sale		63,466				63,466				63,466
Restricted equity securities		2,591				2,591				2,591
Loans, net		271,147						272,981		272,981
Accrued income		1,590				1,590				1,590
Derivative assets		67				67				67
Financial liabilities
Total deposits		309,997				310,453				310,453
Short term borrowings		216				216				216
FHLB borrowings		22,000				22,862				22,862
Accrued interest payable		332				332				332
Derivative liabilities		67				67				67

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Note 8. Capital Transaction

On June 28, 2013 HomeTown Bankshares Corporation completed a $14,000,000 private placement of its convertible preferred stock. Pursuant to the terms of the Private Placement Memorandum, dated April 17, 2013, the Company sold 14,000 shares of its 6.0% Series C NonCumulative Perpetual Convertible Preferred Stock at a price of $1,000 per share. The convertible preferred stock pays quarterly dividends equivalent to six percent (6%) per annum, and is convertible into shares of common stock of the Company based on a conversion price of $6.25 per share, subject to adjustment.

On September 24, 2013, the Company used the net proceeds from this offering to redeem the $10,374,000 of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A and Series B. The remaining proceeds have and will be used to support future growth and for general corporate purposes.

Note 9. Reclassifications Out of Other Comprehensive Income

Items not reclassified in their entirety to net income for the three and nine months ended September 30, 2013 and 2012 are as follows:

Details about Other  Comprehensive Components	Amounts Reclassified from Other Comprehensive Income for the Three Months Ended September 30,				Affected Line Item in the  Statement Where Net Income is Presented
In Thousands	2013		2012
	(Unaudited)		(Unaudited)
Available for sale securities
Realized gain on sale of securitiesheld for sale during the period	$	8	$	-	Gain on sale of investment securities
		3		-	Income tax expense
	$	5	$	-	Net income

Details about Other Comprehensive Components	Amounts Reclassified from Other Comprehensive Income for the Nine Months Ended September 30,				Affected Line Item in the Statement Where Net Income is Presented
In Thousands	2013		2012
	(Unaudited)		(Unaudited)
Available for sale securities
Realized gain on sale of securitiesheld for sale during the period	$	116	$	127	Gain on sale of investment securities
		39		43	Income tax expense
	$	77	$	84	Net income

Note 10. Earnings per Share

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

	Three Months Ended September 30,
	2013						2012
	(Unaudited)						(Unaudited)
In Thousands, except share and per share data	Shares		Net Income Available to Common Shareholders		Per Share Amount		Shares		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		3,270,299	$	298	$	0.09		3,262,518	$	432	$	0.13
Series C Preferred Stock Dividends				180		-				-		-
Effect of dilutive securities:
Convertible preferred stock		2,240,000				-		-				-
Earnings per common share, diluted		5,510,299	$	478	$	0.09		3,262,518	$	432	$	0.13

20

	Nine Months Ended September 30,
	2013							2012
	(Unaudited)							(Unaudited)
In Thousands, except share and per share data	Shares		Net Income Available to Common Shareholders		Per Share Amount			Shares		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		3,268,646	$	1,158	$	0.35			3,258,385	$	3,583	$	1.10
Series C Preferred Stock Dividends				180		-					-		-
Effect of dilutive securities:
Convertible preferred stock		779,487				(.02	)		-				-
Earnings per common share, diluted		4,048,133	$	1,338	$	0.33			3,258,385	$	3,583	$	1.10

Note 11. Contingencies and Other Matters

The Company currently is not involved in any litigation matters outside the normal operations associated with problem credits.

Note 12. Subsequent Events

In preparing these financial statements the Company has evaluated events and transactions for potential recognition of disclosure through the date the financials were issued.

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

Forward-looking Statements

HomeTown Bankshares makes forward-looking statements in this report. These forward-looking statements may include: statements of goals, intentions, earnings expectations, and other expectations; estimates of risks and of future costs and benefits; assessments of probable loan and lease losses; assessments of market risk; and statements of the ability to achieve financial and other goals. Forward-looking statements are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “project” and other similar words and expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made. The Company does not assume any duty and does not undertake to update its forward-looking statements. Because forward-looking statements are subject to assumptions and uncertainties, actual results or future events could differ, possibly materially, from those that the Company anticipated in its forward-looking statements, and future results could differ materially from historical performance.

The Company’s forward-looking statements are subject to the following principal risks and uncertainties: general economic conditions and trends, either nationally or locally; conditions in the securities markets; changes in interest rates; changes in deposit flows, and in the demand for deposit, loan, and investment products and other financial services; changes in real estate values; changes in the quality or composition of the Company’s loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; the Company’s ability to retain key members of management; changes in legislation, regulation, and policies; and a variety of other matters which, by their nature, are subject to significant uncertainties. The Company provides greater detail regarding some of these factors in its Form 10-K for the year ended December 31, 2012. The Company’s forward-looking statements may also be subject to other risks and uncertainties, including those that it may discuss elsewhere in this report or in its other filings with the SEC.

Our Business

HomeTown Bankshares provides a full complement of consumer and commercial banking services to its primary service area which includes the City of Roanoke, Roanoke County, Christiansburg, and Salem, Virginia and contiguous counties, including Bedford and Franklin, Virginia. We place an emphasis on personal service and offer a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, residential and commercial mortgages, home equity loans, consumer installment loans, commercial loans, lines and letters of credit. In addition to its main office, the Company has offices in Franklin County, Virginia at Westlake, in the town of Christiansburg, Virginia at 1540 and 1655 Roanoke Street, in Roanoke County, Virginia at the intersection of Colonial Avenue and Virginia Route 419, and in the City of Roanoke, Virginia at 3521 Franklin Road. The Christiansburg branch will relocate to its new 9,000 square foot facility in the fourth quarter enabling the branch to better serve existing customers and to expand our business in the New River Valley in the future.

The following is a discussion of factors that significantly affected the financial condition and results of operations of HomeTown Bankshares Corporation. This discussion should be read in connection with the financial statements presented herein.

Critical Accounting Policies

The Company’s significant accounting policies are set forth in Note 1 of the Notes to Financial Statements in the Annual Report for the year ended December 31, 2012. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues and expenses.

The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) that losses be accrued when they are probable of occurring and are capable of estimation and (ii) that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The allowance for loan losses is maintained at a level, which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio.

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The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Management reviews the past due reports and risk-rated loans and discusses individually the loans on these reports with the responsible loan officers. Management uses these tools and provides a detailed quarterly analysis of the allowance based on our historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions, and the economic trend. These are generally grouped by homogeneous loan pools. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. This allowance, then, is designated as a specific reserve. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms.

Discussion of Operations

Nine Months Ended September 30, 2013

Net income for the first nine months of 2013 was $1.9 million or $0.33 per diluted common share compared to $4.0 million or $1.10 per diluted common share for same period last year. Net income was less because 2012 included a one-time favorable adjustment of $2.9 million or $0.90 per diluted share for the recognition of cumulative net deferred tax assets since inception through year end 2011. Net income before taxes was $2.9 million for the nine months ended September 30, 2013, $1.2 million higher than the same period in 2012. Favorable variances in net interest income, provision for loan losses, and noninterest income were partially offset by higher noninterest expense.

Net interest income for the nine months ended September 30, 2013 totaled $10.2 million, an increase of $639 thousand or 6.7% over last year. Higher net interest income resulted from a higher volume of earning assets and an improved margin. Average earning assets were $352 million for the nine months ended September 30, 2013 compared to $336 million for the same period last year. The $16 million increase in average earning assets was the primary reason for the increase in net interest income for 2013 compared to 2012. This increase in the volume of earning assets was partially offset by a reduction in the tax equivalent yield on earning assets from 4.66% in 2012 to 4.54% in 2013.

Growth in average loans outstanding accounted for the increase in earning assets and was funded primarily by the strategic reduction of the volume of investment securities by $7.3 million and increases in average non-interest bearing demand deposits of $10.0 million. In 2012, yields on securities available for purchase declined, and the Company began and has continued to channel cash flow from lower rate investments in bonds to higher rate loans. Because of the low interest rate environment over the past few years, demand deposits at commercial banks have grown at unprecedented rate; this trend is expected to reverse itself once shorter term rates begin to rise.

The tax equivalent net interest margin was 3.91% for the first nine months of 2013, 8 basis points higher than the 3.83% for the same period of 2012. The improved margin resulted from the cost of interest bearing deposits falling 8 basis points more than the yield on interest earning assets. The improved margin was the result of lowering interest rates paid on deposits during 2012, and a favorable change in the mix of deposits. During the 2012, the interest rates paid on interest bearing deposits were gradually lowered to be more consistent with market rates and more in line with the lower rates on loans in the relatively low interest rate environment. Having reached historically low levels, there is little room for future downward adjustment of deposit rates.

The Federal Reserve has bought bonds over the last several years which have artificially kept interest rates down in an attempt to foster economic growth. In 2013, ten year Treasury rates have increased as the Federal Reserve’s monetary policy committee began discussing tapering the bond purchasing program. However, at the October 30, 2013 meeting, the Federal Reserve provided little specific guidance on when it might begin tapering. The committee expressed concern over the recent slowing of the housing recovery and confirmed again that the unemployment rate would need to be closer to 6.5% before the Fed would begin raising interest rates. Many Fed watchers expect tapering to begin sometime between mid-2014 and 2015.

The provision for loan losses was $125 thousand for the first nine months of 2013 compared to $1.4 million for the same period in 2012. Recoveries of $333 thousand during the first nine months of 2013 replenished the allowance for loan losses and lowered the amount of current year provision expense. During the nine months ended September 30, 2012, $1.4 million of loans were charged off compared to $564 thousand for the same period in 2013. Improvements in loan quality also contributed to a lower provision. Nonaccrual loans totaled $801 thousand or .28% of total loans at September 30, 2013 compared to $1.1 million or .41% of loans on the same day in 2012.

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During the nine months ended September 30, 2013, noninterest income totaled $1.1 million, $109 thousand or 11% higher than the same period in the prior year.  ATM and interchange income increased $68 thousand or 41% from the growth in the number of deposit accounts.  Other income was up $68 thousand over the prior year due to title insurance fees and rents collected from the leasing of foreclosed properties, and other miscellaneous fees. Year to date September 30, 2013, mortgage loan brokerage fees totaled $225 thousand and were $37 thousand or 14% less than last year due to the drop in the mortgage refinancing business in response to the rise in long term rates. 

Noninterest expense increased $807 thousand or 11% to $8.3 million for the nine months ended on September 30, 2013, when compared to the same period in 2012.  Due to the Company’s improved financial performance in 2013 compared to 2012, employee incentive plan awards accrued were higher than in 2012. Cost of living and merit increases along with staff additions as the Company expanded mortgage and brokerage operations, further contributed to higher salaries and employee benefits in the current year. The first nine months of 2013 included $351 thousand for net gains and losses on sales and writedowns of other real estate owned compared to $146 thousand in the prior year. Of the $351 thousand in 2013, $321 thousand was related to the writedowns of two properties as the result of new appraisals. Of the $84 thousand increase in professional fees over the same period as last year, over $50 thousand was associated with legal fees incurred that resulted in the recovery of $163 thousand of a loan charged off in a prior year, and the full recovery of $88 thousand for a loan charged off this year.

Three Months Ended September 30, 2013

Net income for the third quarter of 2013 totaled $772 thousand or $188 thousand or 32% more than the same period in the prior year. Favorable variances in net interest income and the provision for loan losses were partially offset by higher noninterest expense.

Earnings available to common shareholders for the three months ended September 30, 2013 was $134 thousand less than the same period in 2012. Series A and B preferred stock were redeemed on September 24, 2013. The remaining discount related to the redeemed shares was fully amortized in 2013, resulting in accretion of $102 thousand in the third quarter of 2013 versus accretion of $19 thousand in the third quarter of 2012. The fact that during the third quarter of 2013, dividends were paid to both Series A and B preferred shareholders’ as well as Series C preferred shareholders further reduced the earnings available to common shareholders. In future quarters, $210 thousand of dividends, or 6% per annum of 14,000 shares outstanding of $1,000 liquidation preference per share, will be paid each quarter to Series C preferred shareholders.

Net interest income was $3.5 million for the third quarter of 2013, $19 thousand over the $3.4 million earned in the previous quarter, and $223 thousand or 6.9% higher than the same quarter a year ago. The volume of average earning assets for the quarter ended September 30, 2013 was $1.8 million higher than the previous quarter, and $14.2 million higher than the same quarter a year ago. The tax equivalent net interest margin was 3.91%, 3.93%, and 3.80% for the three months ended, September 30, 2013, June 30, 2013, and September 30, 2012, respectively. During 2012, the interest rate spread between earning assets and interest bearing liabilities was widened by lowering rates paid on interest bearing deposits to be more consistent with market rates and more in line with the lower rates on loans in the current low interest rate environment. Rates paid on interest bearing deposits are now at or below in some cases, market rates and further reduction in the cost of deposit funding is not anticipated. Until the Federal Reserve tapers their bond purchasing program, interest rates are expected to remain at relatively low levels, and will continue to compress the interest rate spread between earning assets and interest bearing liabilities. Maturing time deposits will continue to reprice at lower rates in 2013 but to a lesser extent than 2012. The company will continue to focus on growing earning assets and maintaining margins.

No provision for loan losses was recorded for the three months ended September 30, 2013 compared to $130 thousand for the same period in 2012. The higher provision last year resulted from the replenishment of the allowance after net charge-offs of $248 thousand were recorded in the third quarter of 2012, compared to net recoveries of $24 thousand in the third quarter of the current year.  

During the three months ended September 30, 2013 and 2012, noninterest income totaled $318 thousand and $311 thousand, respectively. Service charges on deposit accounts for the second quarter of 2013 were up $9 thousand over the same quarter a year ago, due primarily to higher net NSF fees. ATM and interchange income increased $25 thousand over the third quarter of 2012. The increase in fees resulted from the growth in the number of deposit accounts.  Other income was up $13 thousand over the prior year due largely to fees generated by the expansion of the loan portfolio, and higher foreign ATM fees.  Lower mortgage loan brokerage fees of $48 thousand partially negated the favorable noninterest income variances.

Noninterest expense increased $88 thousand or 3.5% to $2.6 million for the three months ended on September 30, 2013, when compared to the same period in 2012.   Cost of living and merit increases along with staff additions as the Company expanded mortgage operations and securities brokerage resulted in higher salaries and employee benefits in the current period. No losses or writedowns on other real estate was necessitated in the third quarter of 2013 compared to $111 for the same quarter last year.

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Financial Condition

At September 30, 2013, the Company had total assets of $385 million compared to $370 million at December 31, 2012. Assets at the end of the third quarter were $6.8 million less than the end of the previous quarter as a result of using a portion of the funds raised through the capital raise to redeem the Series A and B preferred stock.  At September 30, 2013, assets were comprised principally of loans, cash and due from banks, and investment securities. The Company’s management, under the direction of the Asset/Liability Committee (ALCO) of the Board of Directors, reviews the mix of monetary assets and liabilities to ensure the Company maintains an adequate level of liquidity while maximizing interest rate spreads.

Cash and due from banks increased $4.7 million from December 31, 2012 to September 30, 2013. The more attractive yields available on loans over investments which began in 2012 continue into 2013. Total gross loans increased $12.4 million or about 4.5% since year end 2012. The rate of loan growth for the first nine months of 2013 is expected to continue or increase slightly over the remaining months of 2013.

The Company’s liabilities at September 30, 2013 totaled $346 million compared to $334 million at December 31, 2012, an increase of $12.1 million or 3.6%.   Deposits rose $15.4 million or 5.0% since year end 2012. Noninterest-bearing deposits were up $10.7 million from year end 2012 to September 30, 2013 due primarily to growth in commercial accounts.   Interest-bearing deposits increased $4.6 million. The increases were fueled by maturing CD’s and a marketing campaign to attract new customers.

At September 30, 2013 and December 31, 2012, the Company had stockholders’ equity of $39.2 million and $36.7 million, respectively, an increase of $2.5 million. The change in stockholders’ equity in 2013 was due to the net effect of the Company’s issuance of $14 million of Series C Preferred Stock and subsequent redemption of $10.4 million of Series A and B preferred stock. Net income contributed another $1.2 million to the growth of equity.  The increase was partially offset by the $1.7 million decrease in other comprehensive income as unrealized gains on securities available for sale at year end 2012 became unrealized losses in 2013. When interest rates are low, unrealized gains are typical in a bond portfolio, but when interest rates rise, these unrealized gains turn to unrealized losses. As long as other sources of liquidity are available in a financial institution, and the losses are not caused by credit problems, these losses do not need to manifest themselves into realized losses.

Management believes the Company has sufficient capital to fund its operations. At September 30, 2013, the Company was in compliance with all regulatory capital requirements. Management believes that the Company has sufficient liquidity on a short-term basis to meet any funding needs it may have, and expects that its long term liquidity needs can be achieved through deposit growth, however there can be no assurance that such growth will develop.

 Non-performing Assets

Non-performing assets consist of loans past-due ninety days or more and still accruing interest, non-accrual loans and repossessed and foreclosed assets.  Nonperforming assets decreased $2.4 million from year end 2012 to $9.2 million at September 30, 2013. There were no loans past due ninety days or more and still accruing interest at September 30, 2013 or December 31, 2012.   Nonaccrual loans decreased $1.9 million since year end 2012 to $801 thousand at September 30, 2013, largely as the result of the collateral of one large loan being foreclosed and $1.0 million moved to other real estate owned. Eight foreclosed properties have been sold through September 30, 2013 reducing other real estate, net by $1.8 million. The activity in other real estate owned for the first nine months of 2013 are included in Note 5.

At September 30, 2013 and December 31, 2012 the Company had 3 loans classified as troubled debt restructurings totaling $6.3 million and $6.5 million, respectively. A partial charge-off of one of the loans accounted for $145 thousand of the decrease since year end 2012. No loans were restructured during the nine months ended September 30, 2013.

Allowance for Loan Losses

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

Specific loss reserves for loans individually evaluated for impairment totaled $173 thousand at September 30, 2013 compared to $208 thousand at December 31, 2012.  Impaired loans declined $3.7 million from $15.6 million at December 31, 2012 to $11.9 million at September 30, 2013.    Based on the general reserves established on loans collectively evaluated for impairment and the specific reserves for loans individually evaluated for impairment, the Company recorded a provision for loan losses of $125 thousand in the first nine months of 2013.   Based on this evaluation, the percentage of the allowance for loan losses to total loans was 1.28% and 1.38% at September 30, 2013, and December 31, 2012, respectively; and reflects the improvement in loan quality.  

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The most recent economic activity report, dated October 16, 2013 from the Federal Reserve (the Beige Book), indicated that economic activity continued to expand at a modest to moderate pace during the reporting period September 2013 through early October 2013. The Federal Reserve Bank’s Fifth District reported some slowing in the growth rate during this period. Based on the Bureau of Labor Statistical data, unemployment in the Roanoke Metropolitan Area (MSA) continues to trend below the national rate. Preliminary data for August 2013 indicated an unemployment rate of 5.8% in the Roanoke MSA and continues to trend below the national rate of 7.3% for the month of October. According to the Roanoke Valley Association of Realtors statistics, home sales for each month of 2013 through September are higher than the same month a year ago. According to Standard and Poor’s the 16 day government shutdown took a $24 billion chunk out of the U.S. economy; and as a result the projection for growth in the fourth quarter was lowered from 3% to 2.4%. The local markets are largely shielded from national events and trends, but may realize some negative impact in subsequent quarters.

Liquidity

Liquidity represents the ability to meet present and future financial obligations through either the sale or maturity of existing assets or with borrowings from correspondent banks or other deposit markets.  Liquid assets include cash, and due from bank balances, federal funds sold, and securities available for sale, net of securities pledged and cash minimum balance requirements.  As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and to meet its customers’ borrowing needs.

At September 30, 2013, liquid assets totaled $62.4 million, compared to $54.2 million at year end 2012.

Lines of credit available to meet liquidity needs include: $19.0 million of federal funds lines of credit and $6.3 million in Federal Home Loan Bank lines of credit immediately available. The Company is approved to borrow 20% of our total assets from the Federal Home Loan Bank subject to providing qualifying collateral.  The Company also has an $8 million guidance line of credit to borrow against securities.  The limit on this line is 15% of assets. At September 30, 2013, there were no advances on these lines.

Capital Requirements

The maintenance of appropriate levels of capital is a priority and is continually monitored. Banks are subject to various regulatory capital requirements administered by federal and state banking agencies. Quantitative measures established by regulations to ensure capital adequacy require the Company to maintain minimum capital ratios. Failure to meet minimum capital ratios can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on the consolidated financial statements. The Consolidated ratios spiked upwards at the end of the second quarter compared to the first and third quarter ends of 2013, as the result of the capital raise at the end of June through the issuance of Series C preferred stock. The proceeds of the capital raise were not used to redeem the Series A and B preferred stock until September resulting in a temporary spike upwards in consolidated equity.

The following are the Company’s and Bank’s capital ratios:

(in thousands except for percentages)	Actual					Minimum Capital Requirement					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2013
Total Capital (to Risk-Weighted Assets)
Consolidated	$	43,238		14.5	%	$	23,910		8.0	%	N/A		N/A
HomeTown Bank	$	41,664		13.9	%	$	23,910		8.0	%	$	29,888		10.0	%
Tier I Capital (to Risk-Weighted Assets)
Consolidated	$	39,554		13.2	%	$	11,955		4.0	%	N/A		N/A
HomeTown Bank	$	37,980		12.7	%	$	11,955		4.0	%	$	17,933		6.0	%
Tier I Capital (to Average Assets)
Consolidated	$	39,554		10.1	%	$	15,675		4.0	%	N/A		N/A
HomeTown Bank	$	37,980		9.7	%	$	15,675		4.0	%	$	19,593		5.0	%

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Financial Instruments With Off-Balance-Sheet Risk

In the normal course of business to meet the financing needs of its customers, the Company is a party to financial instruments with off-balance-sheet risk. These financial instruments involve commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit is represented by the contractual amount of those instruments. The same credit policy is used in making commitments as is used for on-balance-sheet risk.

At September 30, 2013 outstanding commitments to extend credit including letters of credit were $61.3 million. There are no commitments to extend credit on impaired loans.

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

Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented.The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, “Derivatives and Hedging”, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company added Note 8 Reclassifications Out of Other Comprehensive Income.

In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this ASU permit the Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate under Topic 815. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this Update provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

26

ITEM 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable to smaller reporting companies.

ITEM 4.          CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Based upon an evaluation of the effectiveness of disclosure controls and procedures, the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO) have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures, as defined under Exchange Act Rule 13a-15(e) and 15d-15(e), were effective to provide reasonable assurance that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC and is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II OTHER INFORMATION

Item 1.            Legal Proceedings.

In the normal course of business, the Company becomes involved in litigation arising from the banking, financial and other activities it conducts. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising from these matters will have a material effect on the Company’s financial condition, operating results or liquidity.

Item 1A.         Risk Factors.

Not applicable to smaller reporting companies.

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

None

Item 3.            Defaults Upon Senior Securities

None

Item 4.            Mine Safety Disclosure

Not applicable.

Item 5.            Other Information

None

Item 6.            Exhibits

(a) Exhibits

27

Exhibit No.
31.1	Certification of Chief Executive of Officer (302 Certification).
31.2	Certification of Chief Financial Officer (302 Certification).
32	Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).
101*	Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2013, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at September 30, 2013, and December 31, 2012; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2013, and 2012; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013, and 2012;  (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012; and (v) Notes to Consolidated Financial Statements.

* As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

SIGNATURES

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

HOMETOWN BANK
Date: November 14, 2013	By:	/S/ SUSAN K. STILL
		Susan K. Still
		President
		Chief Executive Officer
Date: November 14, 2013	By:	/S/ CHARLES W. MANESS, JR.
		Charles W. Maness, Jr.
		Executive Vice President
		Chief Financial Officer

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HOMETOWN BANK

FORM 10Q

INDEX TO EXHIBITS

Exhibit	Description
31.1	Certification of Chief Executive of Officer (302 Certification).
31.2	Certification of Chief Financial Officer (302 Certification).
32	Certification pursuant to 18 U.S.C. Section 1350 (906 Certification).

101*   Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2013, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at September 30, 2013, and December 31, 2012; (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2013, and 2012; (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2013, and 2012;  (iv) Consolidated Statements of Cash Flows for the nine months ended September 30, 2013 and 2012; and (v) Notes to Consolidated Financial Statements.

* As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.