HomeTown Bankshares 10Q 2016 Q1 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 March 31, 2016.

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

for the transition period from to .

Commission File Number: 333-158525

HOMETOWN BANKSHARES CORPORATION

(Exact name of 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 May 12, 2016, 3,373,259 shares of common stock, par value $5.00 per share, of the issuer were outstanding.

HOMETOWN BANKSHARES CORPORATION

Form 10-Q

INDEX

PART I. FINANCIAL INFORMATION

Item 1.	FINANCIAL STATEMENTS

Consolidated Balance Sheets as of March 31, 2016 (unaudited) and December 31, 2015		3

Consolidated Statements of Income for the Three months Ended March 31, 2016 and 2015(unaudited)		4

Consolidated Statements of Comprehensive Income for the Three months Ended March 31, 2016 and 2015(unaudited)		5

Consolidated Statements of Cash Flows for the Three months Ended March 31, 2016 and 2015(unaudited)		6

Notes to Consolidated Financial Statements(unaudited)		7

Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	22

Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	32

Item 4.	CONTROLS AND PROCEDURES	32

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 3.	Defaults Upon Senior Securities	33

Item 4.	Mine Safety Disclosure	33

Item 5.	Other Information	33

Item 6.	Exhibits	33

SIGNATURES		34

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

HomeTown Bankshares Corporation

Consolidated Balance Sheets

March 31, 2016 and December 31, 2015

Dollars In Thousands, Except Share and Per Share Data	March 31, 2016		December 31, 2015
	(Unaudited)			*
Assets
Cash and due from banks	$	27,890	$	28,745
Federal funds sold		1,082		1,329
Securities available for sale, at fair value		54,757		52,544
Restricted equity securities, at cost		2,765		2,535
Loans held for sale		289		1,643
Loans, net of allowance for loan losses of $3,347 in 2016 and $3,298 in 2015		377,716		364,060
Property and equipment, net		13,864		14,008
Other real estate owned, net of valuation allowance of $420 in 2016 and in 2015		5,686		5,237
Bank owned life insurance		6,328		6,285
Accrued income		2,010		2,057
Other assets		935		942
Total assets	$	493,322	$	479,385

Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	80,060	$	77,268
Interest-bearing		333,558		322,278
Total deposits		413,618		399,546
Federal Home Loan Bank borrowings		22,000		22,000
Subordinated notes		7,202		7,194
Other borrowings		1,072		2,361
Accrued interest payable		569		372
Other liabilities		1,621		1,521
Total liabilities		446,082		432,994

Commitments and contingencies		–		–

Stockholders’ equity:
Convertible preferred stock, no par value; Series C authorized 20,000 shares, issued and outstanding 13,600 at March 31, 2016 and at December 31, 2015		12,893		12,893
Common stock, $5 par value; authorized 10,000,000 shares, issued and outstanding 3,373,259 (includes 37,633 restricted shares) at March 31, 2016 and 3,362,536 (includes 37,848 restricted shares) at December 31, 2015		16,801		16,801
Surplus		15,521		15,484
Retained earnings		1,040		443
Accumulated other comprehensive income		597		396
Total HomeTown Bankshares Corporation stockholders’ equity		46,852		46,017
Non-controlling interest in consolidated subsidiary		388		374
Total stockholders’ equity		47,240		46,391
Total liabilities and stockholders’ equity	$	493,322	$	479,385

*Derived from consolidated audited financial statements.

See Notes to Consolidated Financial Statements

HomeTown Bankshares Corporation

Consolidated Statements of Income

For the three months ended March 31, 2016 and 2015

	For the Three Months Ended March 31,
Dollars In Thousands, Except Share and Per Share Data	2016		2015
	(Unaudited)		(Unaudited)
Interest and dividend income:
Loans and fees on loans	$	4,256	$	3,899
Taxable investment securities		204		206
Nontaxable investment securities		101		103
Dividends on restricted stock		34		33
Other interest income		19		9
Total interest and dividend income		4,614		4,250
Interest expense:
Deposits		504		448
Subordinated notes		134		–
Other borrowed funds		97		92
Total interest expense		735		540
Net interest income		3,879		3,710
Provision for loan losses		60		–
Net interest income after provision for loan losses		3,819		3,710

Noninterest income:
Service charges on deposit accounts		154		110
ATM and interchange income		147		122
Mortgage banking		175		120
Gains on sales of investment securities		5		40
Other income		130		143
Total noninterest income		611		535

Noninterest expense:
Salaries and employee benefits		1,726		1,541
Occupancy and equipment expense		434		445
Data processing expense		232		212
Advertising and marketing expense		94		242
Professional fees		101		112
Bank franchise taxes		92		66
FDIC insurance expense		83		75
Other real estate owned expense		22		30
Directors’ fees		107		52
Other expense		371		334
Total noninterest expense		3,262		3,109
Net income before income taxes		1,168		1,136
Income tax expense		353		346
Net income		815		790
Less net income attributable to non-controlling interest		14		14
Net income attributable to HomeTown Bankshares Corporation		801		776
Effective dividends on preferred stock		204		210
Net income available to common stockholders	$	597	$	566
Basic earnings per common share	$	0.18	$	0.17
Diluted earnings per common share	$	0.14	$	0.14
Weighted average common shares outstanding		3,366,778		3,291,517
Diluted weighted average common shares outstanding		5,565,629		5,531,517

See Notes to Consolidated Financial Statements

HomeTown Bankshares Corporation

Consolidated Statements of Comprehensive Income

For the three months ended March 31, 2016 and 2015

	For the Three Months Ended March 31,
	2016			2015
Dollars In Thousands	(Unaudited)			(Unaudited)
Net income	$	815		$	790

Other comprehensive income:
Net unrealized holding gains on securities available for sale during the period		310			312
Deferred income tax expense on unrealized holding gains on securities available for sale		(106	)		(106	)
Reclassification adjustment for gains on sales of investment securities included in net income		(5	)		(40	)
Tax expense related to realized gains on securities sold		2			14
Total other comprehensive income		201			180

Comprehensive income		1,016			970
Less: Comprehensive income attributable to the non-controlling interest		14			14
Comprehensive income attributable to HomeTown Bankshares Corporation	$	1,002		$	956

See Notes to Consolidated Financial Statements

HomeTown Bankshares Corporation

Consolidated Statements of Cash Flows

For the three months ended March 31, 2016 and 2015

	For the Three Months Ended March 31,
Dollars in Thousands	2016			2015
	(Unaudited)			(Unaudited)
Cash flows from operating activities:
Net income	$	815		$	790
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		189			185
Provision for loan losses		60			–
Amortization of premium on securities, net		139			145
Amortization of discount on subordinated notes		8			–
Gains on sales of loans held for sale		(144	)		(86	)
Gains on sales of investment securities		(5	)		(40	)
Increase in value of life insurance contracts		(43	)		(28	)
Stock compensation expense		37			33
Originations of loans held for sale		(4,664	)		(3,367	)
Proceeds from sales of loans held for sale		6,162			3,156
Changes in assets and liabilities:
Accrued income		47			(64	)
Other assets		7			(18	)
Deferred taxes, net		(303	)		(92	)
Accrued interest payable		197			31
Other liabilities		299			(373	)
Net cash flows provided by operating activities		2,801			272
Cash flows from investing activities:
Net (increase) decrease in federal funds sold		247			(721	)
Purchases of available for sale securities		(4,002	)		(1,748	)
Sales, maturities, and calls of available for sale securities		1,935			5,360
Purchase of restricted equity securities, net		(230	)		(204	)
Net increase in loans		(14,164	)		(7,681	)
Proceeds from sales of other real estate		24			69
Purchases of bank owned life insurance		–			(2,500	)
Purchases of property and equipment		(45	)		(186	)
Net cash flows used in investing activities		(16,235	)		(7,611	)
Cash flows from financing activities:
Net increase in noninterest-bearing deposits		2,792			1,656
Net increase in interest-bearing deposits		11,280			2,344
Net increase in FHLB borrowings		–			4,000
Net increase (decrease) in other borrowings		(1,289	)		392
Net increase in equity of non-controlling interest		–			317
Preferred stock dividend payment		(204	)		(210	)
Net cash flows provided by financing activities		12,579			8,499
Net increase (decrease) in cash and cash equivalents		(855	)		1,160
Cash and cash equivalents, beginning		28,745			13,795
Cash and cash equivalents, ending	$	27,890		$	14,955
Supplemental disclosure of cash flow information:
Cash payments for interest	$	538		$	509
Cash payments for income taxes	$	28		$	646
Supplemental disclosure of noncash investing activities:
Change in unrealized gains on available for sale securities	$	305		$	272
Transfer from loans to other real estate	$	473		$	–

See Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Organization

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

Basis of Presentation

The consolidated financial statements as of March 31, 2016 and for the periods ended March 31, 2016 and 2015 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 March 31, 2016 are 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, 2015, included in the Company’s Form 10-K for the year ended December 31, 2015. Interim financial performance is not necessarily indicative of performance for the 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 of HomeTown Bankshares Corporation include the accounts of its wholly-owned subsidiary HomeTown Bank and the accounts of its subsidiary, HomeTown Residential Mortgage LLC. HomeTown Bank owns a 49% interest in HomeTown Residential Mortgage LLC which originates and sells mortgages secured by personal residences. Due to the marketing support and direction provided by HomeTown Bank to HomeTown Residential Mortgage LLC, along with guarantees of warehouse lines of credit used in its operation, the Company is deemed to exercise control of this entity. The ownership interest in HomeTown Residential Mortgage LLC not owned by the Company is reported as Non-Controlling Interest in a Consolidated Subsidiary. All significant intercompany balances andtransactions have been eliminated in consolidation.

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 Form 10-K for these policies.

Note 2. Investment Securities

The amortized cost and fair value of available-for-sale securities as of March 31, 2016 and December 31, 2015, are as follows:

(Dollars In Thousands)	March 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government agency securities	$	28,507	$	330	$	(99	)	$	28,738
Mortgage-backed securities		8,353		65		(45	)		8,373
Municipal securities		17,017		661		(32	)		17,646
	$	53,877	$	1,056	$	(176	)	$	54,757

(Dollars In Thousands)	December 31, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U. S. Government agency securities	$	26,385	$	242	$	(191	)	$	26,436
Mortgage-backed securities		8,803		60		(90	)		8,773
Municipal securities		16,756		594		(15	)		17,335
	$	51,944	$	896	$	(296	)	$	52,544

U. S. Government and federal agency securities:The unrealized losses on seventeen 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 March 31, 2016.

Mortgage-backed securities:The unrealized losses on eleven 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 March 31, 2016.

Municipal securities:The unrealized losses on eight of the Company’s investments in 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, 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 March 31, 2016.

The following tables demonstrate the unrealized loss position of available-for-sale securities at March 31, 2016 and December 31, 2015. This information summarizes the amount of time individual securities have been in a continuous, unrealized loss position.

	March 31, 2016
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U. S. Government agency securities	$	6,850	$	(50	)	$	3,284	$	(49	)	$	10,134	$	(99	)
Mortgage-backed securities		1,562		(5	)		2,504		(40	)		4,066		(45	)
Municipal securities		1,743		(26	)		539		(6	)		2,282		(32	)
	$	10,155	$	(81	)	$	6,327	$	(95	)	$	16,482	$	(176	)

	December 31, 2015
	Less than 12 months					12 months or more					Total
(Dollars In Thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government agency securities	$	8,878	$	(106	)	$	5,275	$	(85	)	$	14,153	$	(191	)
Mortgage-backed securities		3,447		(32	)		2,718		(58	)		6,165		(90	)
Municipal securities		805		(10	)		526		(5	)		1,331		(15	)
	$	13,130	$	(148	)	$	8,519	$	(148	)	$	21,649	$	(296	)

There are thirty-six debt securities with fair values totaling $16.5 million considered temporarily impaired at March 31, 2016. As of March 31, 2016, the Company does not consider any bond in an unrealized loss position to be other-than-temporarily impaired.

The Company realized gains of $5 thousand and no realized losses on sales of securities in the first three months of 2016. The Company realized gains of $55 thousand and $15 thousand of losses during the same period last year.

The amortized cost and fair values of investment securities available for sale at March 31, 2016, by contractual maturity are as follows:

(Dollars In Thousands)	Amortized Cost		Fair Value
One year or less	$	2	$	2
Over one through five years		1,963		1,993
Over five through ten years		10,708		10,771
Greater than 10 years		41,204		41,991
	$	53,877	$	54,757

Note 3. Loans Receivable

The major classifications of loans in the consolidated balance sheets at March 31, 2016 and December 31, 2015 were as follows:

(Dollars In Thousands)	March 31, 2016			December 31, 2015
Construction loans:
Residential	$	10,983		$	11,779
Land acquisition, development & commercial		30,167			27,440
Real estate:
Residential		105,055			100,268
Commercial		147,561			140,952
Commercial, industrial & agricultural		52,913			53,012
Equity lines		26,954			26,376
Consumer		7,430			7,531
Total		381,063			367,358
Less allowance for loan losses		(3,347	)		(3,298	)
Loans, net	$	377,716		$	364,060

The past due and nonaccrual status of loans as of March 31, 2016 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	$	−	$	−	$	−	$	−	$	10,983	$	10,983	$	−
Land acquisition, development & commercial		−		−		10		10		30,157		30,167		10
Real estate:
Residential		495		815		−		1,310		103,745		105,055		−
Commercial		−		−		−		−		147,561		147,561		360
Commercial, industrial & agricultural		167		−		34		201		52,712		52,913		45
Equity lines		−		98		305		403		26,551		26,954		−
Consumer		2		−		−		2		7,428		7,430		−
Total	$	664	$	913	$	349	$	1,926	$	379,137	$	381,063	$	415

The past-due and nonaccrual status of loans as of December 31, 2015 was as follows:

(Dollars In Thousands)	30-59 Days Past-Due		60-89 Days Past-Due		90 Days or More Past- Due		Total Past- Due		Current		Total Loans		Nonaccrual Loans
Construction:
Residential	$	−	$	−	$	−	$	−	$	11,779	$	11,779	$	−
Land acquisition, development & commercial		−		−		11		11		27,429		27,440		11
Real Estate:
Residential		297		−		50		347		99,921		100,268		−
Commercial		44		−		792		836		140,116		140,952		368
Commercial, industrial & agricultural		52		84		35		171		52,841		53,012		47
Equity lines		105		−		−		105		26,271		26,376		−
Consumer		−		−		−		−		7,531		7,531		−
Total	$	498	$	84	$	888	$	1,470	$	365,888	$	367,358	$	426

There was one loan of $305 thousand that was past due ninety days or more and still accruing interest as of March 31, 2016. There were two loans, totaling $842 thousand, which were past due ninety days or more and still accruing interest at December 31, 2015.

Impaired loans, which include TDR’s of $6.6 million, and the related allowance at March 31, 2016, were as follows:

March 31, 2016

With no related allowance:

(Dollars In Thousands)

Recorded

Investment

in Loans

Unpaid

Principal

Balance

Allowance

Average

Balance

Total

Loans

Interest

Income

Recognized

Construction loans:

Residential

−

Land acquisition, development & commercial

−

Real estate:

Residential

195

−

213

Commercial

7,476

7,652

−

7,481

Commercial, industrial & agricultural

−

Equity lines

−

Consumer

−

Total loans with no allowance

7,683

7,859

−

7,706

March 31, 2016

With an allowance recorded:

(Dollars In Thousands)

Recorded

Investment

in Loans

Unpaid

Principal

Balance

Allowance

Average

Balance

Total

Loans

Interest

Income

Recognized

Construction loans:

Residential

−

Land acquisition, development & commercial

−

Real estate:

Residential

−

Commercial

124

127

−

Commercial, industrial & agricultural

−

Equity lines

−

Consumer

−

Total loans with an allowance

124

127

−

Impaired loans, which include TDRs of $6.7 million, and the related allowance at December 31, 2015, were as follows:

December 31, 2015

Recorded

Unpaid

Average

Interest

With no related allowance:

Investment

Principal

Balance

Income

(Dollars In Thousands)

in Loans

Balance

Allowance

Total Loans

Recognized

Construction:

Residential

−

–

−

Land acquisition, development & commercial

−

–

−

Real Estate:

Residential

247

–

255

Commercial

7,451

7,627

–

7,623

291

Commercial, industrial & agricultural

–

−

Equity lines

−

–

−

Consumer

−

–

−

Total loans with no allowance

7,710

7,886

–

7,890

304

December 31, 2015

Recorded

Unpaid

Average

Interest

With an allowance recorded:

Investment

Principal

Balance

Income

(Dollars In Thousands)

in Loans

Balance

Allowance

Total Loans

Recognized

Construction:

Residential

−

Land acquisition, development & commercial

−

Real Estate:

Residential

−

Commercial

127

135

−

Commercial, industrial & agricultural

−

Equity lines

−

Consumer

−

Total loans with an allowance

127

135

−

Troubled Debt Restructurings

Troubled debt restructurings (“TDR’s”) were comprised of six loans totaling $6.6 million at March 31, 2016. This compares with $6.7 million in total restructured loans at December 31, 2015.

No loans were modified in a TDR during the first quarter of 2016.

The following table presents by class of loan, information related to the loan modified in a TDR during the three months ended March 31, 2015:

	Loans modified as TDR's For the three months ended March 31, 2015
Class of Loan	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
			(Dollars in Thousands)
Construction loans:
Residential		—	$	—	$	—
Land acquisition, development & commercial		—		—		—
Real estate loans:
Residential		—		—		—
Commercial		1		260		255
Commercial, industrial, agricultural		—		—		12
Equity lines		—		—		—
Consumer		—		—		—
Total Loans		1	$	260	$	267

Four of the six loans totaling $6.4 million were not on nonaccrual status at March 31, 2016. The other two loans totaling $247 thousand were on nonaccrual status at the end of the first quarter of 2016. The loan identified above in the table restructured into two TDR’s during the three months ended March 31, 2015. It was included in substandard nonaccrual loans and impaired loans at the end of 2014. All six TDR’s were current with their restructured terms at March 31, 2016.

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, if a specific reserve is associated with the loan it 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 March 31, 2016, 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).

March 31, 2016	Allowance for loan losses																Loans
Class of Loan (Dollars in Thousands)	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	$	83	$	−		$	−	$	(6	)	$	77	$	−	$	77	$	10,983	$	−	$	10,983
Land acquisition, development & commercial		187		−			−		33			220		−		220		30,167		−		30,167
Real estate:
Residential		1,047		−			−		(7	)		1,040		−		1,040		105,055		195		104,860
Commercial		1,001		−			−		95			1,096		17		1,079		147,561		7,600		139,961
Commercial, industrial & agricultural		531		−			−		(102	)		429		−		429		52,913		12		52,901
Equity lines		277		−			−		19			296		−		296		26,954		−		26,954
Consumer		85		(15	)		4		23			97		−		97		7,430		−		7,430
Unallocated		87		−			−		5			92		−		92		−		−		−
Total	$	3,298	$	(15	)	$	4	$	60		$	3,347	$	17	$	3,330	$	381,063	$	7,807	$	373,256

The following table presents, as of December 31, 2015, 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, 2015	Allowance for loan losses																Loans
Class of Loan (Dollars in Thousands)	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	$	43	$	−		$	−	$	40		$	83	$	−	$	83	$	11,779	$	−	$	11,779
Land acquisition, development & commercial		453		−			−		(266	)		187		−		187		27,440		−		27,440
Real estate:
Residential		833		−			1		213			1,047		−		1,047		100,268		247		100,021
Commercial		1,012		−			−		(11	)		1,001		17		984		140,952		7,578		133,374
Commercial, industrial & agricultural		319		−			10		202			531		−		531		53,012		12		53,000
Equity lines		423		−			1		(147	)		277		−		277		26,376		−		26,376
Consumer		65		(80	)		34		66			85		−		85		7,531		−		7,531
Unallocated		184		−			−		(97	)		87		−		87		−		−		−
Total	$	3,332	$	(80	)	$	46	$	−		$	3,298	$	17	$	3,281	$	367,358	$	7,837	$	359,521

Loans by credit quality indicators as of March 31, 2016 were as follows:

(Dollars In Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Total
Construction loans:
Residential	$	10,983	$	−	$	−	$	−	$	10,983
Land acquisition, development & commercial		30,157		−		−		10		30,167
Real estate loans:
Residential		104,859		−		196		−		105,055
Commercial		145,762		−		1,439		360		147,561
Commercial, industrial, agricultural		52,181		687		−		45		52,913
Equity lines		26,954		−		−		−		26,954
Consumer		7,424		−		6		−		7,430
Total Loans	$	378,320	$	687	$	1,641	$	415	$	381,063

Loans by credit quality indicators as of December 31, 2015 were as follows:

(Dollars In Thousands)	Pass		Special Mention		Substandard Accruing		Substandard Nonaccrual		Total
Construction loans:
Residential	$	11,779	$	−	$	−	$	−	$	11,779
Land acquisition, development & commercial		27,429		−		−		11		27,440
Real estate loans:
Residential		95,809		4,212		247		−		100,268
Commercial		138,034		1,155		1,395		368		140,952
Commercial, industrial, agricultural		51,801		1,164		−		47		53,012
Equity lines		26,376		−		−		−		26,376
Consumer		7,523		−		8		−		7,531
Total Loans	$	358,751	$	6,531	$	1,650	$	426	$	367,358

At March 31, 2016 and December 31, 2015, the Company had no loans classified as Doubtful or Loss.

Note 5. Foreclosed Properties

Changes in foreclosed properties for the nine months ended March 31, 2016 were as follows:

(Dollars In Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	5,657		$	(420	)	$	5,237
Additions		473			—			473
Writedowns		—			—			—
Sales		(24	)		—			(24	)
Balance at the end of the period	$	6,106		$	(420	)	$	5,686

Changes in foreclosed properties for the nine months ended March 31, 2015 were as follows:

(Dollars In Thousands)	Other Real Estate Owned			Valuation Allowance			Net
Balance at the beginning of the year	$	7,408		$	(422	)	$	6,986
Additions		—			—			—
Writedowns		—			—			—
Sales		(69	)		—			(69	)
Balance at the end of the period	$	7,339		$	(422	)	$	6,917

The major classifications of other real estate owned in the consolidated balance sheets at March 31, 2016 and December 31, 2015 were as follows:

(Dollars In Thousands)	March 31, 2016		December 31, 2015
Residential lots	$	2,496	$	2,520
Residential development		423		423
Commercial lots		90		90
Commercial buildings		2,677		2,204
Total Other Real Estate Owned	$	5,686	$	5,237

There were no residential real estate loans in the process of foreclosure at March 31, 2016 or December 31, 2015.

Other real estate owned related expenses in the consolidated statements of income for the three months ended March 31, 2016 and March 31, 2015 include:

(Dollars In Thousands)	Three months Ended March 31, 2016		Three months Ended March 31, 2015
Net gain on sales	$	—	$	—
Provision for unrealized losses		—		—
Operating expenses		22		30
Total Other Real Estate Owned	$	22	$	30

Note 6. Stock Based Compensation

The Company recorded stock based compensation expense of $37 thousand and $33 thousand for the years to date March 31, 2016 and 2015, respectively.

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

The Company uses the Black-Scholes option pricing model to determine the fair value of stock options. The fair value of the stock based payment awards is affected by the price of our stock and a number of financial assumptions and variables. These variables include the risk free interest rate, expected dividend rate, expected stock price volatility and the expected life of the options. On December 18, 2014, the Board of Directors granted 165 thousand shares which will vest over a five year period. Financial assumptions and variables used to determine the fair value of these stock options are; risk free interest rate of 2.01%, an expected term of 7.5 years, an expected stock price volatility of 26% and a dividend rate of 0%. The fair value of the options was determined to be $2.29 per option. Compensation expense will be charged to income ratably over the vesting period and was $19 thousand year to date March 31, 2016 and $18 thousand year to date March 31, 2015. As of March 31, 2016 there was $282 thousand of total unrecognized compensation cost related to nonvested stock options granted under the Plan. The cost will be recognized over the next 3.75 years. No options were granted during the three months ended March 31, 2016. All previously issued options were fully vested at the end of 2012.

A summary of option activity under the 2005 stock option plan year to date March 31, 2016 is as follows:

	Options Outstanding		Weighted Average Exercise Price		Aggregate Intrinsic Value(1)		Weighted Average Contractual Term (years)
Balance at December 31, 2015		546,460	$	8.62
Granted		–		–
Exercised		–		–
Forfeited		–		–
Balance at March 31, 2016		546,460	$	8.62	$	461,028		2.81
Exercisable at March 31, 2016		437,793	$	9.04	$	200,228		1.34

(1)

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2016.

In 2009, the Board of Directors authorized 132,000 shares of common stock for issuance under the Restricted Stock Plan. The plan provides for restricted stock awards to key employees. Restricted shares awarded to employees generally vest over a five year period and compensation expense is charged to income ratably over the vesting period and was $18 thousand and $15 thousand for the years to date March 31, 2016 and 2015, respectively. Compensation is accounted for using the fair market value of the Company’s common stock on the date the restricted shares are awarded. The Company granted 10,723 and 8,670 shares of restricted stock under the plan during the years to date March 31, 2016 and 2015, respectively. The weighted-average grant date fair value of restricted stock granted in 2016 was $9.45 compared to $7.70 in 2015.

As of March 31, 2016, there was $165 thousand of total unrecognized compensation cost related to restricted stock granted under the Plan. The cost is expected to be recognized through 2021. A summary of the activity for restricted stock awards for the periods indicated is presented below:

	For the three months ended March 31, 2016					For the three months ended March 31, 2015
	Shares			Weighted- Average Grant Date Fair Value		Shares			Weighted- Average Grant Date Fair Value
Nonvested at beginning of year		37,848		$	6.24		37,727		$	5.56
Granted		10,723			9.45		8,670			7.70
Vested		(10,938	)		5.65		(10,848	)		5.56
Cancelled		–			–		–			–
Nonvested at the end of the period		37,633		$	7.33		35,549		$	6.08

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.

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

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

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

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015:

(Dollars In Thousands)

Carrying value at March 31, 2016

Description

Balance as of

March 31,

2016

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

28,738

–

28,738

–

Mortgaged-backed securities

8,373

–

8,373

–

Municipal securities

17,646

–

17,646

–

(Dollars In Thousands)

Carrying value at December 31, 2015

Description

Balance as of December 31,

2015

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

26,436

–

26,436

–

Mortgaged-backed securities

8,773

–

8,773

–

Municipal securities

17,335

–

17,335

–

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 write-downs 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 consolidated financial statements:

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, 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.

Loans held for sale: The carrying value of these loans approximates the fair value. These loans close in the name of the Bank’s consolidated joint venture subsidiary HomeTown Residential Mortgage, LLC, but are generally sold within a two-week period.

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 March 31, 2016 and December 31, 2015.

(Dollars In Thousands)			Carrying value at March 31, 2016
Description	Balance as of March 31, 2016		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	$	107	$	–	$	–	$	107
Loans held for sale		289		–		289		–
Other real estate owned		5,686		–		1,773		3,913

(Dollars In Thousands)			Carrying value at December 31, 2015
Description	Balance as of December 31, 2015		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	$	110	$	–	$	–	$	110
Loans held for sale		1,643		–		1,643		–
Other real estate owned		5,237		–		1,300		3,937

At March 31, 2016 and December 31, 2015, the Company did not have any liabilities measured at fair value on a nonrecurring basis.

The following table displays quantitative information about Level 3 Fair Value Measurements for March 31, 2016:

(Dollars In Thousands)	Quantitative information about Level 3 Fair Value Measurements for March 31, 2016
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Impaired loans	$	107	Discounted appraised value	Selling cost	6%	-	6%	(6%)
				Discount for lack of marketability and age of appraisal	95%	-	95%	(95%)

Other real estate owned	$	1,735	Discounted appraised value	Selling cost	6%	-	6%	(6%)
				Discount for lack of marketability and age of appraisal	4%	-	9%	(8%)

	$	2,178	Internal evaluations	Internal evaluations	4%	-	39%	(22%)

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2015:

(Dollars In Thousands)	Quantitative information about Level 3 Fair Value Measurements for December 31, 2015
Assets	Fair Value		Valuation Technique(s)	Unobservable input	Range (Weighted Average)
Impaired loans	$	110	Discounted appraised value	Selling cost	0%	-	0%	(0%)
				Discount for lack of marketability and age of appraisal	95%	-	95%	(95%)

Other real estate owned	$	1,735	Discounted appraised value	Selling cost	6%	-	6%	(6%)
				Discount for lack of marketability and age of appraisal	4%	-	9%	(8%)

	$	2,202	Internal evaluations	Internal evaluations	4%	-	39%	(21%)

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 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 March 31, 2016 and December 31, 2015, management believes the carrying value of federal funds sold approximates estimated market value.

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).

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 held for sale: The carrying value of these loans approximates the fair value. These loans close in the name of the Bank’s joint venture subsidiary HomeTown Residential Mortgage, LLC, but are generally sold within a two-week period.

Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. Their fair values are measured utilizing independent valuation techniques of similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. 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.

Bank owned life insurance: The cash values of these policies are estimates using information provided by insurance carriers. The policies are carried at their cash surrender value, which approximates fair value.

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

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

Subordinated notes: The fair value of the subordinated notes is estimated using a discounted cash flow calculation that applies current incremental borrowing rates for similar types of borrowing arrangements.

Other borrowings: The warehouse line of credit is a short term revolving credit facility used to fund mortgage loans originations until the underlying loan is sold. The warehouse line of credit, federal funds purchased, borrowings under repurchase agreements mature within 30 days and approximate their fair values.

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 March 31, 2016 and December 31, 2015, 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 March 31, 2016:

(Dollars In Thousands)			Fair value at March 31, 2016
Description	Carrying value as of March 31, 2015		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	$	27,890	$	26,140	$	1,761	$	–	$	27,901
Federal funds sold		1,082		1,082		–		–		1,082
Securities available-for-sale		54,757		–		54,757		–		54,757
Restricted equity securities		2,765		–		2,765		–		2,765
Loans held for sale		289		–		289		–		289
Loans, net		377,716		–		–		380,568		380,568
Bank owned life insurance		6,328		–		6,328		–		6,328
Accrued income		2,010		–		2,010		–		2,010
Financial liabilities
Total deposits		413,618		–		414,104		–		414,104
FHLB borrowings		22,000		–		22,165		–		22,165
Subordinated notes		7,202		–		7,055		–		7,055
Other borrowings		1,072		–		1,072		–		1,072
Accrued interest payable		569		–		569		–		569

The carrying amounts and approximate fair values of the Company's financial instruments are as follows at December 31, 2015:

(Dollars In Thousands)			Fair value at December 31, 2015
Description	Carrying value as of December 31, 2015		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	$	28,745	$	26,995	$	1,767	$	–	$	28,762
Federal funds sold		1,329		1,329		–		–		1,329
Securities available for sale		52,544		–		52,544		–		52,544
Restricted equity securities		2,535		–		2,535		–		2,535
Loans held for sale		1,643		–		1,643		–		1,643
Loans, net		364,060		–		–		362,440		362,440
Bank owned life insurance		6,285		–		6,285		–		6,285
Accrued income		2,057		–		2,057		–		2,057
Financial liabilities
Total deposits		399,546		–		400,117		–		400,117
FHLB borrowings		22,000		–		22,191		–		22,191
Subordinated notes		7,194		–		7,354		–		7,354
Other borrowings		2,361		–		2,361		–		2,361
Accrued interest payable		372		–		372		–		372

Note 8. Reclassifications Out of Other Comprehensive Income

Items reclassified in their entirety to net income for the three months ended March 31, 2016 and 2015 are as follows:

	Amounts Reclassified from
Details about Other Comprehensive	Other Comprehensive Income				Affected Line Item in the Statement
Components	for the Three Months Ended March 31,				Where Net Income is Presented
(Dollars In Thousands)	2015		2015
Available for sale securities
Realized gains on sales of securities held for sale during the period consider available for sale	$	5	$	40	Gains on sales of investment securities
Tax expense related to realized gains on securities sold		2		14	Income tax expense
	$	3	$	26	Net income

Note 9. Earnings per Common 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.

	For the Three Months Ended March 31,
	2016							2015
Dollars In Thousands, except share and per share data	Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount			Weighted Average Common Shares Outstanding		Net Income Available to Common Shareholders		Per Share Amount
Earnings per common share, basic		3,366,778	$	597	$	0.18			3,291,517	$	566	$	0.17
Series C Preferred Stock Dividends				204							210
Effect of dilutive securities:
Convertible preferred stock		2,176,000		−		(0.04	)		2,240,000		−		(0.03	)
Dilutive stock options		22,851		−		−			−		−		−
Earnings per common share, diluted		5,565,629	$	801	$	0.14			5,531,517	$	776	$	0.14

Nonvested restricted shares were included in weighted average common shares outstanding for computing basic earnings per share, as the holder has voting rights and would share in a stock or cash dividend during the vesting period.

Note 10. Subsequent Events

On April 28, 2016, the Company’s Board of Directors declared a quarterly cash dividend in the amount of $15.00 per Series C convertible preferred share, payable on June 15, 2016 to preferred shareholders of record May 31, 2016.

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, 2015. 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 Roanoke Valley, the New River Valley and Smith Mountain Lake. The Company serves these markets through a network of six branches, seven ATM’s, HomeTown Mortgage and HomeTown Investments. A high level of responsive and personal service coupled with local decision-making are the hallmarks of the Company’s customer oriented strategy. The Company offers 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 2950 Market Street; in Roanoke County, Virginia at the intersection of Colonial Avenue and Virginia Route 419; in the City of Roanoke, Virginia at 3521 Franklin Road; and in the City of Salem, Virginia at 852 West Main Street. HomeTown Bank, with a 49% interest in the joint venture HomeTown Residential Mortgage, LLC, operates a dedicated mortgage office on Colonial Ave., next to the existing branch. The Company has a secure Operations Center at 4633 Brambleton Avenue in Roanoke.

HomeTown Investments provides diverse investment products and financial advisory services to existing and prospective customers. These products and services provide another source of revenue for the Company. Investment and insurance products and services are offered through an unaffiliated entity Infinex Investments, Inc., Member FINRA/SIPC. HomeTown Investments is a subsidiary of the Bank. Products and services made available through Infinex are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.

The Private Wealth Group offers personalized, banking solutions to work with customers to clarify financial goals and bring together professionals to satisfy their investment, trust, credit and other financial needs. Revenue from wealth management activities is comprised mostly of fees based upon the market value of the accounts under administration as well as commissions on investment transactions.

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, 2015. 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.

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 the Company’s historical loan loss experience, risk-rated loans, past dues, concentrations of credit, unsecured loans, loan exceptions, and economic trends. These are generally grouped by homogeneous loan pools. Allowances for impaired loans are generally determined based on collateral values less cost to sell, 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

Executive Summary

HomeTown Bankshares reported earnings for the first quarter of 2016 exceeded earnings for the same period in the prior year by 3.2%. Favorable variances in net interest income, and noninterest income were partially negated by higher provision for loan losses and noninterest expense. Net interest income rose as the result of increased interest earned on the expanding loan portfolio, partially negated by the higher cost of interest expense to fund the expansion. The increase in the size of the loan portfolio also required an increase in the allowance for loan losses through a provision entry in 2016. The credit quality of the loan portfolio continued to be good during the first quarter of 2016.

Three Months Ended March 31, 2016

Net income attributable to HomeTown Bankshares was $801 thousand for the first quarter of 2016, an increase of $25 thousand or 3.2% over the same quarter last year. Favorable variances in net interest income, and noninterest income were partially offset by an unfavorable variance in provision for loan losses and noninterest expense.

Net interest income for the three months ended March 31, 2016 totaled $3.9 million, and was $169 thousand or 4.6% greater than the same quarter in the prior year. The expansion of the loan portfolio provided $363 thousand in additional interest income. Average loans for the quarter were $371 million, $36.3 million or 10.9% over the first quarter of 2015. Deposits and proceeds from the subordinated notes issued in December 2015 funded much of the expansion of the loan portfolio. Average total interest bearing deposits for the first quarter of 2016 totaled $323 million, an increase of $10.8 million over the average for the same quarter in 2015.

The net interest margin was 3.62%, 3.77%, and 3.84% for the three months ended March 31, 2016, December 31, 2015, and March 31, 2015, respectively. The subordinated notes were issued at the end of 2015 to provide a more stable source of liquidity to fund earning asset growth. The cost of the subordinated notes accounted for 10 basis points of the 15 basis points drop for the first quarter of 2016 compared to the last quarter of 2015, and 12 basis points of the 22 basis points decline for the first quarter of 2016 compared to the same quarter last year. The remainder of the decrease in the net interest margin was due to spread compression as the yield on earning assets declined while the cost of funds rose. Early payoffs of several loans in the first quarter accelerated the amortization of the net deferred loan costs which contributed to lower loan yields along with downward pressure on rates stemming from stiff competition in the market place. A CD promotion in June 2015 contributed to higher costs of time deposits for the first quarter of 2016 compared to the first quarter last year. The CD promotion was used to generate funding last year. There were a few downward adjustments of other interest bearing deposit rates since March 31, 2015. Management does not expect any additional downward adjustments in 2016, and, in fact, rates paid on deposits products may rise.

The artificially low interest rate environment is expected to continue to put pressure on the margin. The Federal Open Market Committee in its April 27, 2016 press release stated they “…expect that economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate; the federal funds rate is likely to remain , for some time, below levels that are expected to prevail in the longer run.”

	For the Three Months Ended March 31, 2016								For the Three Months Ended March 31, 2015
(Dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate			Average Balance			Interest Income/ Expense		Yield/ Rate
Assets:
Federal funds sold	$	1,482		$	1		0.38	%	$	1,034		$	—		0.16	%
Deposits in banks		8,362			18		0.87			5,850			9		0.60
Securities, taxable		37,470			204		2.18			38,012			206		2.17
Securities, nontaxable (1)		14,827			101		4.07			14,706			103		4.23
Restricted equity securities		2,598			34		5.31			2,638			33		5.01
Loans held for sale		374			4		3.92			304			3		4.25
Loans (1)		370,890			4,252		4.61			334,567			3,896		4.72
Total earnings assets		436,003			4,614		4.30			397,111			4,250		4.39
Less: Allowance for loan losses		(3,292	)							(3,331	)
Total non-earning assets		51,068								39,894
Total Assets	$	483,779							$	433,674

Liabilities and shareholders’ equity
Interest bearing deposits:
Checking	$	74,120		$	26		0.14	%	$	82,177		$	33		0.16	%
Money market savings		67,907			40		0.24			59,550			42		0.28
Regular savings		39,581			36		0.37			34,044			35		0.42
Time Deposits		141,191			402		1.15			136,237			338		1.01
FHLB borrowings		22,000			90		1.62			23,441			89		1.51
Subordinated notes		7,197			134		7.37			—			—		—
Other borrowings		1,647			7		1.68			913			3		1.25
Total interest bearing liabilities		353,643			735		0.83			336,362			540		0.65
Non-interest bearing liabilities:
Demand deposits		81,036								51,494
Other liabilities		1,991								2,031
Total liabilities		436,670								389,887
Total HomeTown Bankshares Corporation stockholders’ equity		46,523								43,783
Non-controlling interest in consolidated subsidiary		586			—					4			—
Total Liabilities and Stockholders’ Equity	$	483,779			735				$	433,674			540
Net interest income				$	3,879							$	3,710
Interest rate spread							3.47								3.74
Interest expense to average earning assets							0.68								0.55
Net interest margin							3.62	%							3.84	%

(1)	Income and yields are reported on a tax equivalent basis assuming a federal income tax rate of 34 percent.

	Three Months Ended March 31, 2016 Compared to Three Months Ended March 31, 2014
	Increase			Change Due To:
(Dollars in thousands)	(Decrease)			Rate			Volume
Interest income:
Federal funds sold	$	1		$	1		$	—
Deposits in banks		9			5			4
Securities, taxable		(2	)		1			(3	)
Securities, nontaxable		(2	)		(3	)		1
Restricted equity securities		1			1			—
Loans held for sale		1			—			1
Loans		356			(7	)		363
Total interest income		364			(2	)		366

Interest expense:
Interest bearing liabilities:
Checking		(7	)		(4	)		(3	)
Money market savings		(2	)		(7	)		5
Regular savings		1			(4	)		5
Time Deposits		64			36			28
FHLB borrowings		1			7			(6	)
Subordinated notes		134			—			134
Other borrowings		4			—			4
Total interest expense		195			28			167
Net interest income	$	169		$	(30	)	$	199

A provision for loan losses of $60 thousand was recorded in the first quarter of 2016 compared to none in any quarter of the prior year. Loan quality remains strong. The continuing growth of the loan portfolio precipitated the recordation of a provision in the current period. See discussion under Allowance for Loan Losses for additional information.

Excluding gains on the sales of securities, noninterest income increased $111 or 22.4% from the same quarter last year. Service charges on deposit accounts, and ATM and interchange income were up $69 thousand for the first quarter of 2016 compared to 2015 due to deposit growth and changes late in the quarter in the fee structure to be more in line with industry norms in the last half of 2015. Mortgage banking income was $55 thousand higher than the prior year. The Virginia Association of Realtors reported 1,737 homes sold in the first quarter of 2016 compared to 1,627 for the same quarter last year for the Roanoke, Lynchburg and Blacksburg region. Other income was $13 thousand lower for the quarter ended March 31, 2016 compared to the same quarter last year. Favorable variances from the continued growth of merchant processing income, investment brokerage commission fees, and loan fees, were largely offset by the loss of $59 thousand in rental income from the sale of a building adjacent to a branch for a gain in the last quarter of 2015.

For the three months ended March 31, 2016, noninterest expense was $3.3 million, $153 thousand or 4.9% more than the $3.1 million recorded in the same quarter last year. Salaries and employee benefits for the three months ended March 31, 2016 were $185 thousand or 12.0% greater for the first three months of 2016 than 2015. The numbers of full time equivalent employees were 96 and 89 at March 31, 2016 and March 31, 2015, respectively. The increase was due to several factors including the addition of Private Wealth which contributed to loan and deposit growth during the quarter. Other factors included unfilled open positions in the prior year, and new positions to accommodate growth, as well as annual merit raises. Advertising and marketing expense for the first quarter of 2016 varied favorably with the prior year. Last year efforts were accelerated in the first part of 2015 to take advantage of competitive opportunities in the local banking market created by the acquisition of Valley Bank by a North Carolina headquartered financial institution. HomeTown Bank is now the largest community bank headquartered in the Roanoke Valley. Bank Franchise Tax was $26 thousand more than the previous year through March 31. The increase in the Bank’s equity from retained earnings, the capital infusion of $6.0 million from the proceeds of the subordinated notes issued at the end of 2015, and the reduction in real estate taxes paid on foreclosed properties which are deducted from capital on the Bank Franchise return. Board of Directors fees were raised in 2016 in recognition of the Company’s growth in asset size.

Financial Condition

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.

At March 31, 2016, the Company had total assets of $493 million, up $13.9 million or 2.9% since year end 2015. The continuing expansion of the loan portfolio by $13.7 million during the three months since December 31, 2015, accounted for most of the asset growth. Gross loans increased $13.7 million during the three months since year end. The investments in securities available for sale increased $2.2 million since year end 2015 to $54.8 million at March 31, 2016.

The Company’s liabilities at March 31, 2016 totaled $446 million compared to $433 million at December 31, 2015, an increase of $13.1 million or 3.0%. Deposits rose $14.1 million during the same period to $414 million at quarter end, due to core deposit growth. Interest-bearing deposits accounted for $11.3 million of the total increase in deposits.

At March 31, 2016 and December 31, 2015, the stockholders’ equity of HomeTown Bankshares was $46.9 million and $46.0 million, respectively, an increase of $835 thousand or 1.8%. The change in stockholders’ equity in the first three months of 2016 was mainly the result of net income.

Non-performing Assets

Non-performing assets consist of nonaccrual loans, restructured loans, and repossessed and foreclosed assets.

(Dollars in thousands)	March 31, 2016		December 31, 2015
Real Estate:
Construction and land development	$	10	$	11
Residential 1-4 families		—		—
Commercial real estate		360		368
Commercial loans		45		47
Equity lines		—		—
Loans to individuals		—		—
Total nonperforming loans		415		426
Other real estate owned		5,686		5,237
Total nonperforming assets, excluding performing restructured loans		6,101		5,663
Performing restructured loans		6,378		6,398
Total nonperforming assets, including restructured loans	$	12,479	$	12,061

During the first quarter of 2016, the Bank added $473 thousand to other real estate owned. At December 31, 2015, the related loan was included in “Current” in Note 3 and “Pass” in Note 4. The borrower was an independent church and the membership voted to disband in the first quarter of 2016, prompting the Bank to negotiate a deed-in-lieu of foreclosure. Additional collateral in the form of an assigned note receivable was received as part of the negotiation. No loss was recognized when the loan was transferred to other real estate.Two of the three borrowers, with nonaccrual loans comprising $371 thousand of the total nonaccruing loans of $415 thousand, were making payments and were not past due at the end of the quarter; however, they are remaining on nonaccrual until performance warrants return to accrual status.

Troubled debt restructurings (“TDR’s”) were comprised of six loans totaling $6.6 million at March 31, 2016. Four of the six loans were performing in accordance with their restructured terms and were not on nonaccrual status. For the three months ended March 31, 2016, no loans were modified in a TDR compared to one loan modified into two restructured loans for the same period in 2015 . See Note 3 Loans for more information.

The major classifications of other real estate owned in the consolidated balance sheets at March 31, 2016 and December 31, 2015 are included in Note 5, and the activity in other real estate owned for the first three months of 2016 and 2015 is also included in Note 5.

No gains or losses on sales of other real estate or writedowns were recorded in the first three months of 2016 or 2015.

Allowance for Loan Losses

The allowance for loan losses is increased by charges to income and decreased by charge-offs, net of recoveries. The allowance consists of three components: specific, general, and unallocated. Their adequacy is evaluated separately. 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. Based on the Company’s allowance for loan losses calculation and analysis at the end of the first quarter of 2016, a provision of $60 thousand was recorded.

Specific reserves are determined on a loan by loan basis and relate to loans classified as impaired. Management classifies loans as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Included in potentially impaired loan category are current “watch list” credits plus any additional credits which have been past due three or more times within the past 12-month period. Management individually reviews these potentially impaired loans based on generally accepted accounting principles (GAAP) related to receivables and makes a determination if the loan in fact is impaired. Management does not consider a loan impaired during a period of delay in payment if management expects the ultimate collection of all amounts due. If a loan is found to be impaired, an allowance is established when the collateral value less estimated cost to dispose, discounted cash flows, or observable market price of the impaired loan is lower than the carrying value of that loan.Specific reserves for loans individually evaluated for impairment totaled $17 thousand at March 31, 2016 and December 31, 2015. Impaired loans totaled $7.8 million at March 31, 2016 and December 31, 2015.

The percentage of the allowance for loan losses to total loans was 0.88% and 0.90% at March 31, 2016, and December 31, 2015, respectively. Unallocated reserves were $92 thousand at March 31, 2016 and $87 thousand at December 31, 2015. Some surplus or unallocated reserve is desirable given the inherent weakness in this type of predictive analysis. The major indicators of loan quality have continued to be favorable. The driver of the provision recorded in 2016 was the increase in loan volume. Net charges offs continue to be relatively low and as a percent of average loans were 0.01% for the first quarter of 2016. Nonperforming loans were 0.11% and 0.12% of total loans at the end of the first quarter of 2016 and at the end of 2015, respectively. The allowance for loan losses to nonaccrual loans was over 807% at March 31, 2016 and 775% at December 31, 2015.

Liquidity

Liquidity is identified as the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate

withdrawals, payments of debt, and increased loan demand. Liquid assets include cash, federal funds sold, securities classified as available for sale as well as loans and securities maturing within one year. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

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

The Company’s asset based liquidity position, cash and due from bank balances, federal funds sold, loans held for sale, securities available for sale, net of securities pledged and cash balance requirements totaled $73.2 million at March 31, 2016, compared to $73.0 million at December 31, 2015, and $55.7 million at March 31, 2015. The changes in the level of liquidity over the prior 12 month period reflect the depletion of available liquid funds to expand the loan portfolio in the first half of 2015. Higher levels of commercial noninterest bearing deposits contributed to higher levels of liquidity since mid-2015, peaking at the end of the 3^rd quarter 2015. Commercial deposits are by their nature highly volatile, and withdrawals may result in less liquidity in the future. To provide a more stable source of liquidity, at the end of the 4^th quarter 2015, the Company issued $7.5 million in subordinated notes. The Company expects liquidity to trend downward in the future as the funds from the debt issuance are invested in earning assets and used for general operating purposes. Surges and declines in commercial deposits will continue to impact liquidity in an unpredictable manner. Commercial noninterest bearing deposits were $3.4 million higher at March 31, 2016 than at December 31, 2015, and $15.9 million higher than one year ago.

The Company’s primary source of funding is its retail deposit base. The Company aggressively markets in its trade area and seeks demand deposits through service-related tactics and savings deposits through competitive pricing tactics. If this funding source is not attractive either for reasons of maturity or pricing, alternative funding sources include Federal Home Loan Bank (FHLB) advances, brokered deposits, fed funds purchased and guidance lines of credit. The Company is approved to borrow 20% of our total assets from the FHLB subject to providing qualifying collateral. At March 31, 2016, the Company had borrowed $22.0 million of the $33.1 million of lendable collateral value, leaving $11.1 million of unused credit immediately available. The Company also has an $8 million guidance line of credit to borrow against securities. The limit on this line is 15% of assets. In addition, the Company had $21.5 million of fed funds lines of credit available at March 31, 2016. At the end of the first quarter of 2016, there were no advances on the fed funds or guidance lines.

Capital

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

At March 31, 2016 and December 31, 2015, the Company had stockholders’ equity of $47.2 million and $46.4 million, respectively, an increase of $849 thousand or 1.8%. The convertible preferred shares pay dividends at the rate of 6% per year. Each share of Series C preferred stock is convertible into 160 shares of common stock. The ability to pay dividends to common stockholders is limited by regulatory restrictions and the need to maintain sufficient capital in the Company and in our subsidiaries. The Company must consider different factors to ensure that any future dividends to common stockholders would be prudent relative to the organization’s financial position and is not based on overly optimistic earnings scenarios. The Company had $1.0 million in retained earnings at March 31, 2016. No dividends were paid to common stockholders in the first quarter of 2016.

The Basel III capital framework represents the most comprehensive overhaul of the U.S. banking capital framework in over two decades. This new capital framework and related changes to the standardized calculations of risk-weighted assets are complex and create additional compliance burdens.Basel III rules became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule. The Basel III Capital Rules require significantly more capital and adopted more demanding regulatory capital risk weightings and calculations. As a result of the Basel III Capital Rules, many community banks could be forced to limit banking operations and activities, and growth of loan portfolios, in order to focus on retention of earnings to improve capital levels. The Company believes that it maintains sufficient levels of Tier 1 and Common Equity Tier 1 capital to comply with the Basel III Final Rules. However, increased capital requirements imposed by the Basel III Capital Rules may require the Company to limit its banking operations, retain net income to improve regulatory capital levels, which could negatively affect our business, financial condition and results of operations.

The Company meets eligibility the criteria of a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital. The table presents the Bank’s capital amounts and ratios calculated using the Basel III rules in effect at March 31, 2016 and December 31, 2015.

Risk Based Capital Analysis

Capital Analysis

HomeTown Bank
(Dollars in thousands)	March 31, 2016		December 31, 2015
Common Equity Tier 1 Capital:
Common Stock	$	14,697	$	14,697
Surplus		31,967		31,930
Retained Earnings		5,842		4,929
Common Equity Tier 1 Capital		52,506		51,556
Tier 1 Capital:
Tier 1 Minority Interest		9		36
Tier 1 Capital		52,515		51,592
Total Capital:
Allowance for Loan Losses (allowable portion)		3,347		3,298
Total Capital	$	55,862	$	54,890

The Bank’s total capital increased $972 thousand from December 31, 2015 to March 31, 2016, primarily as the result of retaining $913 thousand of the year to date March 31, 2016.

The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital. In July 2013, the Federal Reserve Bank issued revised final rules that made technical changes to its market risk capital rules to align it with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final new capital rules required the Bank to comply with the following new minimum capital ratios, effective January 1, 2015: (1) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the previous requirement of 4%); (3) a total capital ratio of 8% of risk-weighted assets (unchanged from current requirement); and, (4) a leverage ratio of 4% of total assets. Beginning January 1, 2016, a capital conservation buffer of .625% became effective. The capital conservation buffer will be gradually increased through January 1, 2019 to 2.5%. Banks will be required to maintain capital levels that meet the required minimum plus the capital conservation buffer in order to make distributions or discretionary bonus payments.

The Bank’s actual capital amounts and ratios are also presented in the following tables:

HomeTown Bank						Minimum Capital					Minimum To Be Well Capitalized Under Prompt Corrective Action
March 31, 2016	Actual					Requirement					Provisions
(in thousands except for percentages)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to Risk-Weighted Assets)	$	55,862		13.33	%	$	32,833		8.00	%	$	41,042		10.00	%
Tier I Common Equity (to Risk-Weighted Assets)	$	52,506		12.53	%	$	18,469		4.50	%	$	26,677		6.50	%
Tier I Capital (to Risk-Weighted Assets)	$	52,515		12.53	%	$	24,625		6.00	%	$	32,833		8.00	%
Tier I Leverage (to Average Assets)	$	52,515		10.86	%	$	19,351		4.00	%	$	24,189		5.00	%

HomeTown Bank						Minimum Capital					Minimum To Be Well Capitalized Under Prompt Corrective Action
December 31, 2015	Actual					Requirement					Provisions
(in thousands except for percentages)	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to Risk-Weighted Assets)	$	54,890		13.80	%	$	31,822		8.00	%	$	39,778		10.00	%
Tier I Common Equity (to Risk-Weighted Assets)	$	51,556		12.96	%	$	17,900		4.50	%	$	25,855		6.50	%
Tier I Capital (to Risk-Weighted Assets)	$	51,592		12.97	%	$	23,867		6.00	%	$	31,822		8.00	%
Tier I Capital (to Average Assets)	$	51,592		10.83	%	$	19,053		4.00	%	$	23,816		5.00	%

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 March 31, 2016 outstanding commitments to extend credit including letters of credit were $928 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 June 2014, the FASB issued ASU No. 2014-12, “Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation – Stock Compensation (Topic 718),” should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Company does not expect the adoption of ASU 2014-12 to have a material impact on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” This update is intended to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.

In November 2014, the FASB issued ASU No. 2014-16, “Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity.” The amendments in ASU do not change the current criteria in U.S. GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. The amendments clarify how current U.S. GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. The amendments in this ASU also clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (i.e., the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weight those terms and features. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption, including adoption in an interim period, is permitted. The Company does not expect the adoption of ASU 2014-16 to have a material impact on its consolidated financial statements.

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” The amendments in this ASU eliminate from U.S. GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions. Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item. If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively. A reporting entity also may apply the amendments retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company does not expect the adoption of ASU 2015-01 to have a material impact on its consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” The amendments in this ASU are intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). In addition to reducing the number of consolidation models from four to two, the new standard simplifies the FASB Accounting Standards Codification™ and improves current GAAP by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity (VIE), and changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or VIEs. The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. ASU 2015-02 may be applied retrospectively in previously issued financial statements for one or more years with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated. The Company does not expect the adoption of ASU 2015-02 to have a material impact on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” The amendments in this ASU are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. The Company does not expect the adoption of ASU 2015-03 to have a material impact on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” The amendments in this ASU provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments do not change the accounting for a customer’s accounting for service contracts. As a result of the amendments, all software licenses within the scope of Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets. The amendments in this ASU are effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. An entity can elect to adopt the amendments either: (1) prospectively to all arrangements entered into or materially modified after the effective date; or (2) retrospectively. The Company does not expect the adoption of ASU 2015-05 to have a material impact on its consolidated financial statements.

In May 2015, the FASB issued ASU No. 2015-08, “Business Combinations (Topic 805): Pushdown Accounting – Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115.” The amendments in ASU 2015-08 amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115, Topic 5: Miscellaneous Accounting, regarding various pushdown accounting issues, and did not have a material impact on our consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-12, “Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), and Health and Welfare Benefit Plans (Topic 965) – 1. Fully Benefit-Responsive Investment Contracts, 2. Plan Investment Disclosures, and 3. Measurement Date Practical Expedient.” The amendments within this ASU are in 3 parts. Among other things, Part 1 amendments designate contract value as the only required measure for fully benefit-responsive investment contracts; Part II amendments eliminate the requirement that plans disclose: (a) individual investments that represent 5 percent or more of net assets available for benefits; and (b) the net appreciation or depreciation for investments by general type requirements for both participant-directed investments and nonparticipant-directed investments. Part III amendments provide a practical expedient to permit plans to measure investments and investment-related accounts (e.g., a liability for a pending trade with a broker) as of a month-end date that is closest to the plan’s fiscal year-end, when the fiscal period does not coincide with month-end. The amendments in Parts 1 and 2 of this ASU are effective on a retrospective basis and Part 3 is effective on a prospective basis, for fiscal years beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2015-12 to have a material impact on its consolidated financial statements.

In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date.” The amendments in ASU 2015-14 defer the effective date of ASU 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. All other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. All other entities may apply the guidance in ASU 2014-09 earlier as of an annual reporting period beginning after December 15, 2016, including interim reporting periods within that reporting period. All other entities also may apply the guidance in ASU 2014-09 earlier as of an annual reporting period beginning after December 15, 2016, and interim reporting periods within annual reporting periods beginning one year after the annual reporting period in which the entity first applies the guidance in ASU 2014-09. The Company does not expect the adoption of ASU 2015-14 (or ASU 2014-09) to have a material impact on its consolidated financial statements.

In August 2015, the FASB issued ASU 2015-15, “Interest – Imputation of Interest (Subtopic 835-30) – Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting).” On April 7, 2015, the FASB issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability. The guidance in ASU 2015-03 (see paragraph 835-30-45-1A) does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff stated that they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-15 adds these SEC comments to the "S" section of the Codification. The adoption of ASU 2015-15 did not have a material impact on our consolidated financial statements.

In September 2015, the FASB issued ASU 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.” The amendments in ASU 2015-16 require that an acquirer recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the estimated amounts, calculated as if the accounting had been completed at the acquisition date. The amendments also require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. The Company does not expect the adoption of ASU 2015-16 to have a material impact on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in ASU 2016-01, among other things: 1) Requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). 4) Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that ASU 2016-01 will have on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-07, “Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting.” Among other things, the amendments in ASU 2016-07, eliminate the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor's previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The amendments require that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Early Adoption is permitted. The Company is currently assessing the impact that ASU 2016-07 will have on its consolidated financial statements.

During March 2016, the FASB issued ASU No. 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Shares-Based Payment Accounting.” The amendments in this ASU simplify several aspects of the accounting for share-based payment award transactions including: (a) income tax consequences; (b) classification of awards as either equity or liabilities; and (c) classification on the statement of cash flows. The amendments are effective for public companies for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company is currently assessing the impact that ASU 2016-09 will have on its consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable to smaller reporting companies.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended.) Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.

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

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 March 31, 2016, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at March 31, 2016, and December 31, 2015; (ii) Consolidated Statements of Income for the three months ended March 31, 2016, and 2015; (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2016, and 2015; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 20154; 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: May 13, 2016	By:	/S/ SUSAN K. STILL
		Susan K. Still
		President
		Chief Executive Officer

Date: May 13, 2016	By:	/S/ CHARLES W. MANESS, JR.
		Charles W. Maness, Jr.
		Executive Vice President
		Chief Financial Officer

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 March 31, 2016, is formatted in XBRL interactive data files: (i) Consolidated Balance Sheets at March 31, 2016, and December 31, 2015; (ii) Consolidated Statements of Income for the three months ended March 31, 2016, and 2015; (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2016, and 2015; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 20154; 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.

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

HomeTown Bankshares (HMTA) Inactive 10-Q2016 Q1 Quarterly report

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