Tri City Bankshares (TRCY) 10-Q 2010 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

Commission file number 000-09785

TRI CITY BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Wisconsin             (State or other jurisdiction of incorporation or organization)	39-1158740             (IRS Employer Identification No.)
6400 S. 27th Street, Oak Creek, WI (Address of principal executive offices)
53154 Zip Code
(414) 761-1610 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES   X            NO ___

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ____                        Accelerated filer ___

Non-accelerated filer (Do not check if a smaller reporting company) _____

Smaller reporting company   X  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES                  NO   X  

The number of shares outstanding of the registrant’s $1.00 par value common stock as of November 12, 2010 was 8,904,915 shares.

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PART I - FINANCIAL INFORMATION

ITEM 1 -	FINANCIAL STATEMENTS	4
ITEM 2 -	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	20
ITEM 3 -	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT   MARKET  RISK	40
ITEM 4T -	CONTROLS AND PROCEDURES	40

PART II - OTHER INFORMATION
ITEM 1 -	LEGAL PROCEEDINGS	41
ITEM 1A -	RISK FACTORS	41
ITEM 2 -	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	42
ITEM 3 -	DEFAULTS UPON SENIOR SECURITIES	42
ITEM 4 -	RESERVED	42
ITEM 5 -	OTHER INFORMATION	42
ITEM 6 -	EXHIBITS	42

Signatures	43
Exhibit Index	44

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PART I -  FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

TRI CITY BANKSHARES CORPORATION

CONSOLIDATED BALANCE SHEETS

ASSETS

		September 30, 2010 (Unaudited)		December 31, 2009
Cash and due from banks	$	25,164,234	$	60,364,695
Federal funds sold		56,204,985		39,737,847
Cash and cash equivalents		81,369,219		100,102,542
Held to maturity securities, fair value of $191,481,970 and $191,484,866 as of September 30, 2010 and December 31 2009, respectively		189,275,533		189,788,913
Loans, less allowance for loan losses of $8,514,500 and $6,034,187 as of 2010 and 2009, respectively		758,877,187		781,845,638
Premises and equipment – net		20,679,645		20,021,428
Cash surrender value of life insurance		11,906,344		11,552,684
Mortgage servicing rights – net		1,676,872		1,794,635
Core deposit intangible		1,565,282		1,991,066
Other real estate owned		4,514,486		4,681,481
Accrued interest receivable and other assets		7,934,934		13,930,465
TOTAL ASSETS	$	1,077,799,502	$	125,708,852

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES
Deposits
Demand	$	161,469,906	$	156,303,510
Savings and NOW		561,918,037		595,129,305
Other time		221,995,053		236,550,882
Total Deposits		945,382,996		987,983,697
Other borrowings		709,237		1,812,016
Accrued interest payable and other liabilities		8,367,593		14,516,835
Total Liabilities		954,459,826		1,004,312,548
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY
Cumulative preferred stock, $1 par value, 200,000 shares authorized, no shares issued		-		-
Common stock, $1 par value, 15,000,000 shares authorized, 8,904,915 shares issued and outstanding as of September 30, 2010 and December 31, 2009		8,904,915		8,904,915
Additional paid-in capital		26,543,470		26,543,470
Retained earnings		87,891,291		85,947,919
Total Stockholders’ Equity		123,339,676		121,396,304
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,077,799,502	$	1,125,708,852

See notes to unaudited consolidated financial statements.

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TRI CITY BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

For Three Months Ended September 30, 2010 and 2009

(Unaudited)

		2010		2009
INTEREST INCOME
Loans	$	14,279,531	$	9,020,349
Investment Securities:
Taxable		708,131		639,793
Tax exempt		387,225		346,938
Federal funds sold		25,436		6,674
Total Interest Income		15,400,323		10,013,754
INTEREST EXPENSE
Deposits		1,301,108		1,686,121
Other borrowings		-		394
Total Interest Expense		1,301,108		1,686,515
Net interest income before provision for loan losses		14,099,215		8,327,239
Provision for loan losses		1,400,000		552,000
Net interest income after provision for loan losses		12,699,215		7,775,239
NONINTEREST INCOME
Service charges on deposits		2,619,663		2,534,185
Loan servicing income		64,681		50,415
Net gain on sale of loans		314,838		367,515
Net loss on sale of OREO		(100,963)		(51,930)
Increase in cash surrender value of life insurance		119,166		125,604
Non-accretable loan discount		306,040		-
Other income		415,989		361,122
Total Noninterest Income		3,739,414		3,386,911
NONINTEREST EXPENSE
Salaries and employee benefits		5,431,699		4,241,117
Net occupancy costs		1,044,260		732,746
Furniture and equipment expenses		454,549		392,515
Computer services		934,132		750,225
Advertising and promotional		341,232		258,501
Regulatory agency assessments		447,565		264,515
Office supplies		213,795		180,706
Acquisition expense		16,083		-
Core deposit intangible amortization		141,928		-
Other		1,457,000		930,502
Total Noninterest Expense		10,482,243		7,750,827
Income before income taxes		5,956,386		3,411,323
Less:  Applicable income taxes		2,202,000		1,171,000
Net Income	$	3,754,386	$	2,240,323
Basic and fully diluted earnings per share	$	0.42	$	0.25
Dividends per share	$	0.30	$	0.27
Weighted average shares outstanding		8,904,915		8,904,915

See notes to unaudited consolidated financial statements.

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TRI CITY BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

For Nine Months Ended September 30, 2010 and 2009

(Unaudited)

		2010	2009
INTEREST INCOME
Loans	$	43,750,805	$ 27,057,286
Investment Securities:
Taxable		3,083,938	2,039,375
Tax exempt		1,148,351	1,046,236
Federal funds sold		45,525	11,352
Other		9,663	9,663
Total Interest Income		48,038,282	30,163,912
INTEREST EXPENSE
Deposits		4,225,309	5,152,227
Other borrowings		844	30,159
Total Interest Expense		4,226,153	5,182,386
Net interest income before provision for loan losses		43,812,129	24,981,526
Provision for loan losses		4,130,000	1,270,000
Net interest income after provision for loan losses		39,682,129	23,711,526
NONINTEREST INCOME
Service charges on deposits		7,679,966	7,352,311
Loan servicing income (expense)		298,684	(123,427)
Net gain on sale of loans		652,149	2,081,499
Net gain (loss) on sale of OREO		287,806	(91,845)
Increase in cash surrender value of life insurance		353,661	376,817
Non-accretable loan discount		1,653,619	-
Other income		1,151,704	1,071,800
Total Noninterest Income		12,077,589	10,667,155
NONINTEREST EXPENSE
Salaries and employee benefits		16,287,048	12,598,796
Net occupancy costs		3,043,167	2,337,240
Furniture and equipment expenses		1,326,138	1,140,371
Computer services		2,626,717	2,120,793
Advertising and promotional		1,008,853	753,066
Regulatory agency assessments		2,021,868	850,225
Office supplies		616,501	497,598
Acquisition expense		370,214	-
Core deposit intangible amortization		425,784	-
Other		3,873,661	2,866,245
Total Noninterest Expense		31,599,951	23,164,334
Income before income taxes		20,159,767	11,214,347
Less:  Applicable income taxes		7,530,500	3,905,000
Net Income	$	12,629,267	$ 7,309,347
Basic and fully diluted earnings per share	$	1.42	$ 0.82
Dividends per share	$	0.90	$ 0.81
Weighted average shares outstanding		8,904,915	8,904,915

See notes to unaudited consolidated financial statements.

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TRI CITY BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

For Nine Months Ended September 30, 2010 and 2009

(Unaudited)

		2010	2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$ 12,629,267	$ 7,309,347
Adjustments to reconcile net income to net cash flows provided by operating activities:
Depreciation		1,712,516	1,602,622
Amortization of servicing rights, premiums and discounts -net		908,371	689,643
Net gain on sale of loans		(652,149)	(2,081,499)
Amortization of core deposit intangible		425,784	-
Provision for loan losses		4,130,000	1,270,000
Proceeds from sales of loans held for sale		33,586,566	109,369,037
Originations of loans held for sale		(33,145,073)	(108,098,260)
Increase in cash surrender value of life insurance		(353,660)	(376,817)
Gain on disposal of fixed assets		(38,620)	-
(Gain)/loss on sale of other real estate owned		(1,074,657)	30,712
Net change in:
Accrued interest receivable and other assets		5,987,201	(895,772)
Accrued interest payable and other liabilities		(8,820,776)	219,692
Net Cash Flows Provided by Operating Activities		15,294,770	9,038,705
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in held to maturity securities:
Maturities, prepayments and calls		155,199,588	45,232,248
Purchases		(155,257,830)	(56,291,655)
Net decrease/(increase) in loans		13,465,836	(5,626,470)
Proceeds from sales of premises and equipment		216,998	-
Purchases of premises and equipment – net		(2,549,111)	(908,010)
Proceeds from sale of other real estate owned		6,614,267	490,626
Net Cash Flows Provided by/(Used In) Investing Activities		17,689,748	(17,103,261)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase/(decrease) in deposits		(42,600,701)	507,315
Net change in other borrowings		(1,102,779)	(3,357,948)
Dividends paid		(8,014,361)	(7,213,088)
Net Cash Flows Used in Financing Activities		(51,717,841)	(10,063,721)
Net Change in Cash and Cash Equivalents		(18,733,323)	(18,128,277)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD		100,102,542	52,961,833
CASH AND CASH EQUIVALENTS - END OF PERIOD	$	81,369,219	$ 34,833,556
Non Cash Transactions:
Loans receivable transferred to other real estate owned	$	5,372,615	$ 2,893,726
Mortgage servicing rights resulting from sale of loans	$	210,656	$ 810,722
Supplemental Cash Flow Disclosures:
Cash paid for interest	$	5,709,896	$ 5,250,792
Cash paid for income taxes	$	11,880,000	$ 4,096,525

See notes to unaudited consolidated financial statements.

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TRI CITY BANKSHARES CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(A)  Basis of Presentation

The accompanying unaudited consolidated financial statements of Tri City Bankshares Corporation (“Tri City” or the “Corporation”) have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”).  The December 31, 2009 financial information included herein is derived from the December 31, 2009 Consolidated Balance Sheet of Tri City, which is included in the 2009 Form 10-K.

The Corporation’s business is conducted primarily through its wholly-owned banking subsidiary, Tri City National Bank (“Bank”).

In the opinion of management, the accompanying unaudited consolidated financial statements contain all interim adjustments, consisting of normal recurring accruals, for a fair presentation of the results for the interim periods presented.  The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the recorded amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period.  The operating results for the first nine months of 2010 are not necessarily indicative of the results that may be expected for the entire 2010 fiscal year.  Tri City has evaluated the consolidated financial statements for subsequent events through the date of the filing of Form 10-Q.

(B)  Use of Estimates

In preparing consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the estimated fair market values of both the acquired loans and other real estate owned.

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(C)  Recent Accounting Pronouncements

ASU No. 2010-20, “Receivables (Topic 310): Disclosure about Credit Quality of Financing Receivables and Allowance For Credit Losses.” This guidance requires an entity to provide disclosures that facilitate the evaluation of the nature of credit risk inherent in its portfolio of financing receivables; how that risk is analyzed and assessed in determining the allowance for credit losses; and the changes and reasons for those changes in the allowance for credit losses.  To achieve those objectives, disclosures on a disaggregated basis must be provided on two defined levels: (1) portfolio segment; and (2) class of financing receivable.  This guidance makes changes to existing disclosure requirements and includes additional disclosure requirements relating to financing receivables.  Short-term accounts recei vable, receivables measured at fair value or lower of cost or fair value and debt securities are exempt from this guidance.  The disclosures related to period-end information are required to be provided in all interim and annual periods ending on or after December 15, 2010.  Disclosures of activity that occurs during the reporting period are required in interim and annual periods beginning on or after December 15, 2010.  The provisions of this guidance are not expected to have a significant impact on the Corporation’s consolidated financial condition, results of operations or liquidity.  

(D)  Fair Value of Financial Instruments

Accounting guidance on fair value establishes a framework for measuring fair value and expands disclosures about fair value measurements. The definition of fair value under this guidance is market-based as opposed to company-specific and includes the following:

·

Defines fair value as the price that would be received to sell an asset or paid to transfer a liability, in either case through an orderly transaction between market participants at a measurement date, and establishes a framework for measuring fair value;

·

Establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date;

·

Nullifies previous fair value guidance, which required the deferral of profit at inception of a transaction involving a derivative financial instrument in the absence of observable data supporting the valuation technique;

·

Eliminates large position discounts for financial instruments quoted in active markets and requires consideration of a company’s creditworthiness when valuing liabilities; and

·

Expands disclosures about instruments that are measured at fair value.

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Determination of Fair Value

The Corporation has an established process for determining fair values.  Fair value is based upon quoted market prices, where available.  If listed prices or quotes are not available, fair value is based upon internally developed models that use primarily market-based or independently-sourced market parameters, including interest rate yield curves and option volatilities. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value.  These adjustments include amounts to reflect counterparty credit quality, creditworthiness, liquidity and unobservable parameters that are applied consistently over time.  Any changes to the valuation methodology are reviewed by management to determine appropriateness of the changes.  As markets develop and the pricing for certain products becomes more transparent, the Corporation expects to continue to refine its valuation methodo logies.

The methods described above may produce a fair value estimate that may not be indicative of net realizable value or reflect future fair values.  While the Corporation believes its valuation methods are appropriate and consistent with valuation methods used by other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in different estimates of fair values of the same financial instruments at the reporting date.

Valuation Hierarchy

The accounting guidance for fair value measurements and disclosures establishes a three-level valuation hierarchy for disclosure of fair value measurements.  The valuation hierarchy favors the transparency of inputs to the valuation of an asset or liability as of the measurement date and thereby favors use of Level 1 if appropriate information is available, and otherwise Level 2 if Level 1 input is not available and finally Level 3 if Level 2 input is not available. The three levels are defined as follows.

·

Level 1 — Fair value is based upon quoted prices (unadjusted) for identical assets or liabilities in active markets in which the Corporation can participate.

·

Level 2 — Fair value is based upon quoted prices for similar (i.e., not identical) assets and liabilities in active markets, and other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

·

Level 3 — Fair value is based upon financial models using primarily unobservable inputs.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input within the valuation hierarchy that is significant to the fair value measurement.

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The following is a description of the valuation methodologies used by the Corporation for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Assets

Loans held for investment.  The Bank does not record loans held for investment at fair value on a recurring basis.  However, from time to time, a particular loan may be considered impaired and an allowance for loan losses 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 impairment in accordance with relevant accounting guidance.  The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value or discounted cash flows.  Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded inves tments in such loans.  At September 30, 2010, substantially all of the impaired loans were evaluated based on the fair value of the collateral.  In accordance with relevant accounting guidance, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the impaired loan as a non-recurring Level 2 valuation.  Valuations based on management estimates are recorded as non-recurring Level 3.

Other real estate owned.  Loans on which the underlying collateral has been repossessed are adjusted to fair value upon transfer to other real estate owned.  Subsequently, other real estate owned is carried at the lower of carrying value or fair value less estimated costs to sell.  Fair value is based upon independent market prices, appraised values or management’s estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Bank records the other real estate owned as a non-recurring Level 2 valuation.  Valuations based on management estimates are recorded as non-recurring Level 3.

Mortgage Servicing Rights.  The Bank does not record Mortgage Servicing Rights (“MSRs”) at fair value on a recurring basis.  However, from time to time, MSRs may be considered impaired and a valuation allowance established.  MSRs for which amortized cost exceeds fair value are considered impaired.  The fair value of MSRs is estimated using the third party information for selected asset price tables for servicing cost and servicing fees applied to the Bank’s portfolio of serviced loans.  The Bank records impaired MSRs as a non-recurring Level 2 valuation.

As of September 30, 2010, the Bank does not carry any assets that are measured at fair value on a recurring basis or use significant unobservable inputs.

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Assets measured at fair value on a non-recurring basis

The Bank has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis.  These include assets that are measured at the lower of cost or market and had a fair value below cost at the end of the period as summarized below.  The Bank has classified loans held for investment and other real estate owned as Level 3 at September 30, 2010 and December 31, 2009 based on values determined internally by management derived from their experience using cash flow analysis, estimated collateral values, credit scores, delinquency history and current economic conditions to determine the estimated fair values.

		Balance at 9/30/10		Level 1		Level 2		Level 3
Loans held for investment	$	70,368,909	$	-	$	-	$	70,368,909
Other real estate owned		4,514,486		-		-		4,514,486
Totals	$	74,883,395	$	-	$	-	$	74,883,395

		Balance at 12/31/09		Level 1		Level 2		Level 3
Loans held for investment	$	78,584,475	$	-	$	-	$	78,584,475
Other real estate owned		4,681,481		-		-		4,681,481
Totals	$	83,265,956	$	-	$	-	$	83,265,956

The following table presents the estimated fair values of certain financial instruments.

	September  30, 2010				December 31, 2009
		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
FINANCIAL ASSETS
Cash and due from banks	$	25,164,234		25,164,234	$	60,364,695	$	60,364,695
Federal funds sold		56,204,985		56,204,985		39,737,847		39,737,847
Held to maturity securities		189,275,533		191,481,970		189,788,913		191,484,866
Federal reserve stock		322,100		322,100		322,100		322,100
Loans – net		758,877,187		765,483,230		781,845,638		789,383,531
Cash surrender value of life insurance		11,906,344		11,906,344		11,552,684		11,552,684
Mortgage servicing rights		1,676,872		2,747,129		1,794,635		3,144,221
Accrued interest receivable		4,227,634		4,227,634		4,743,727		4,743,727
FINANCIAL LIABILITIES
Deposits	$	945,382,996	$	943,117,098	$	987,983,697	$	985,983,697
Other borrowings		709,237		709,237		1,812,016		1,812,016
Accrued interest payable		431,243		431,243		559,508		559,508

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The estimated fair value of fee income on letters of credit at September 30, 2010 and December 31, 2009 is insignificant.  Loan commitments on which the committed interest rate is less than the current market rate are also insignificant at September 30, 2010 and December 31, 2009.

The following methods and assumptions were used by the Bank to estimate the fair value of each class of financial instruments and certain non-financial instruments for which it is practicable to estimate that value.

Cash and due from banks - Due to their short-term nature, the carrying amount of cash and due from banks approximates fair value.

Federal funds sold - Due to their short-term nature, the carrying amount of Federal funds sold approximates fair value.

Held to maturity securities - The fair value is estimated using quoted market prices.

Non marketable equity securities - The fair value is estimated using values of comparable securities.

Loans, net - Mortgage loans held for investment are valued using fair values attributable to similar mortgage loans. The fair value of the other loans is based on the fair value of obligations with similar credit characteristics.

Cash surrender value of life insurance- The fair value of cash surrender value of life insurance policies is based on the cash surrender value of the individual policies as provided by the insurance agency.

Mortgage servicing rights - The fair value is determined using comparable industry information.

Deposit Accounts - The fair value of demand deposits and savings accounts approximates the carrying amount. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for certificates of deposits with similar remaining maturities.

The Bank assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations.  As a result, fair values of the Bank’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Bank.  Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment.  Conversely, depositors who are receiving fixed rates are more likely to withdraw funds

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before maturity in a rising rate environment and less likely to do so in a falling rate environment.  Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Bank’s overall interest rate risk.

(E)

Held to Maturity Securities

Amortized costs and fair values of held to maturity securities as of September 30, 2010 and December 31, 2009 are summarized as follows:

	September 30, 2010
		Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Obligations of:
States and political subdivisions	$	47,815,863	$	1,326,309	$	(11,877)	$	49,130,295
U.S. government-sponsored entities and corporations		141,359,670		899,335		(7,330)		142,251,675
Other		100,000		-		-		100,000
Totals	$	189,275,533	$	2,225,644	$	(19,207)	$	191,481,970

	December 31, 2009
		Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Obligations of:
States and political subdivisions	$	45,269,078	$	1,206,022	$	(65,061)	$	46,410,039
U.S. government-sponsored entities and corporations		144,269,835		1,056,016		(500,944)		144,824,907
Other		250,000		-		(80)		249,920
Totals	$	189,788,913	$	2,262,038	$	(566,085)	$	191,484,866

Obligations of U.S. government-sponsored entities consist of securities issued by the Federal Home Loan Mortgage Corporation and Federal National Mortgage Association.

The amortized cost and fair value of held-to-maturity securities at September 30, 2010 by contractual maturity are shown below.  Expected maturities differ from contractual maturities because borrowers or issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

		Amortized Cost		Fair Value
Due in one year or less	$	45,552,511	$	45,902,537
Due after one year less than 5 years		106,601,939		108,025,372
Due after 5 years less than 10 years		33,224,710		33,511,186
Due in more than 10 years		3,896,373		4,042,875
Totals	$	189,275,533	$	191,481,970

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The following table summarizes the portion of the Bank’s held to maturity securities portfolio which has gross unrealized losses, reflecting the length of time that individual securities have been in a continuous unrealized loss position at September 30, 2010 and December 31, 2009.

	September 30, 2010
	Continuous unrealized losses existing for less than 12 Months			Continuous unrealized losses existing for more than 12 Months		Total
	Fair Value	Unrealized Losses	Fair Value		Unrealized Losses	Fair Value	Unrealized Losses
Obligations of:
States and political subdivisions	$  1,793,384	$ (10,609)	$ 514,100		$ (1,268)	$  2,307,484	$ (11,877)
U.S. government-sponsored entities and corporations	21,003,700	(7,330)	-		-	21,003,700	(7,330)
Totals	$ 22,797,084	$ (17,939)	$ 514,100		$ (1,268)	$23,311,184	$ (19,207)

	December 31, 2009
	Continuous unrealized losses existing for less than 12 Months			Continuous unrealized losses existing for more than 12 Months		Total
	Fair Value	Unrealized Losses	Fair Value		Unrealized Losses		Fair Value	Unrealized Losses
Obligations of:
States and political subdivisions	$ 3,048,656	$ 62,525	$ 309,941		$ 2,535		$ 3,358,597	$ 65,060
U.S. government-sponsored entities and corporations	44,675,359	500,949	-		-		44,675,359	500,949
Other	99,920	80	-		-		99,920	80
Totals	$ 47,823,935	$ 563,554	$ 309,941		$ 2,535		$ 48,133,876	$566,089

Management does not believe any individual unrealized loss as of September 30, 2010 represents other than temporary impairment.  At September 30, 2010 the Bank held one investment security that had unrealized losses existing for greater than 12 months and held four that had unrealized losses existing for less than 12 months.  Management believes the temporary impairment in fair value was caused by market fluctuations in interest rates and not by a deterioration in credit quality of the underlying portfolio of securities.  Since securities are held to maturity, management does not believe that the Bank will experience any losses on these investments.

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(F)

Loans

Major classifications of loans are as follows as of September 30, 2010 and December 31, 2009:

		September 30, 2010		December 31, 2009
Commercial	$	26,557,337	$	28,480,419
Real Estate
Construction		63,129,023		65,602,195
Commercial		289,640,402		285,381,799
Residential		329,176,758		349,903,914
Multifamily		41,055,616		38,086,583
Installment and Consumer		17,832,551		20,424,936
	$	767,391,687	$	787,879,846
Less:  Allowance for loan losses		(8,514,500)		(6,034,187)
Net Loans	$	758,877,187	$	781,845,659

The Corporation continues to evaluate loans purchased in conjunction with its October 2009 acquisition of the Bank of Elmwood for impairment in accordance with the relevant and applicable accounting standards.  The purchased loans were considered impaired at the acquisition date if there was evidence of deterioration since origination and if it was probable that not all contractually required principal and interest payments would be collected.  The following table reflects the carrying value of all purchased loans as of September 30, 2010.

		Contractually Required Payments Receivable
		Credit Impaired		Non-Credit Impaired		Carrying Value of Purchased Loans
Commercial	$	1,806,449	$	3,909,933	$	4,511,843
Real Estate
Construction		15,532,569		630,602		10,209,650
Commercial		17,853,957		18,692,514		24,497,420
Residential		68,785,432		76,306,394		106,348,662
Multifamily		3,105,225		424,145		2,424,800
Installment and Consumer		43,588		5,755,496		3,149,831
Total	$	107,127,220	$	105,719,084	$	151,142,206

As of September 30, 2010 the estimated contractually required payments receivable on credit impaired and non-credit impaired loans was $107.1 million and $105.7 million, respectively.  The cash flows expected to be collected as of September 30, 2010 on all purchased loans is $151.1 million.  These amounts are based upon the estimated fair values of the underlying collateral or discounted cash flows at September 30, 2010.  The difference between the contractually required payments at acquisition and the cash flow expected to be collected at acquisition is referred to as the non-accretable difference.  Subsequent decreases to the expected cash flows will generally result in a provision for loan losses.  Subsequent increases in cash flows will result in a reversal of the provision to the extent of prior charges or a reclassification of the difference from

16

non-accretable to accretable with a positive impact on interest income.  Further, any excess of cash flows expected over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.  

The change in the carrying amount of accretable yield for purchased loans was as follows for the nine months ended September 30, 2010.

		Accretable Yield		Contractually Required Payments Receivable
Balance at December 31, 2009	$	23,859,358	$	146,443,056
Accretion(1)		7,956,372		40,723,972
Balance at September 30, 2010	$	15,902,986	$	105,719,084

(1) Accretable yield is recognized as the purchased loans pay down, mature, renew or pay off.

(G)

Allowance for Loan Losses

The allowance for loan losses reflected in the accompanying consolidated financial statements represents the allowance available to absorb loan losses that are probable and inherent in the portfolio.  An analysis of changes in the allowance is presented in the following tabulation:

.

ALLOWANCE FOR LOAN LOSSES

(Dollars in Thousands)

For Three Months Ended	For Nine Months Ended
September 30,	September 30,

	2010	2009	2010	2009
Balance at beginning of period	$ 8,276	$ 5,995	$ 6,034	$ 5,945
Total loans charged-off	(1,204)	(566)	(2,668)	(1,304)
Total recoveries	43	16	1,019	86
Net loans charged-off	(1,161)	(550)	(1,649)	(1,218)
Additions to allowance charged to expense	1,400	552	4,130	1,270
Balance at end of period	$           8,515	$        5,997	$          8,515	$        5,997

The allowance for loan losses as of September 30, 2010 related to the purchased loans included $2.1 million based on management’s estimate of losses inherent in the portfolio of non-credit impaired loans that have been renewed and $0.7 million due to the subsequent decrease in expected cash flows on credit impaired loans.

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(H)

Other Real Estate Owned

Real estate acquired by foreclosure or by deed in lieu of foreclosure is held for sale and are initially recorded at fair value at the date of foreclosure less estimated selling expenses, establishing a new cost basis.  Subsequent to foreclosure, valuations are periodically performed and the assets are carried at fair value, less estimated selling expenses.  At the date of foreclosure any write down to fair value less estimated selling costs is charged to the allowance for loan losses.  Costs relating to the development and improvement of the property may be capitalized; holding period costs and subsequent changes to the valuation allowance are charged to expense.

A summary of the activity in other real estate owned is as follows:

	Nine Months Ended	Year Ended
	September 30, 2010	December 31, 2009
Beginning Balance	$                     4,681,481	$                     109,553
Additions	5,372,615	6,674,381
Valuation Adjustments	-	(363,947)
Gain on Sale	1,074,657	57,069
Sales	(6,614,267)	(1,795,575)
Ending Balance	$                     4,514,486	$                  4,681,481

(I)

Regulatory Capital Requirements

As of September 30, 2010, the most recent notification from the regulatory agencies categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action.  To be categorized as well-capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table:

					To Be Well Capitalized
			For Capital		Under Prompt Corrective
	Actual		Adequacy Purposes		Action Provisions
	Amount	Ratio	Amount	Ratio	Amount	Ratio
As of September 30, 2010
Total capital (to risk weighted assets)	$ 125,616,000	16.1%	$62,412,000	8.0%	$78,015,000	10.0%
Tier 1 capital (to risk weighted assets)	117,101,000	15.0%	31,206,000	4.0%	46,809,000	6.0%
Tier 1 capital (to average assets)	117,101,000	10.8%	43,318,000	4.0%	54,148,000	5.0%
As of December 31, 2009
Total capital (to risk weighted assets)	$ 120,515,000	15.3%	$63,133,000	8.0%	$78,916,000	10.0%
Tier 1 capital (to risk weighted assets)	114,481,000	14.5%	31,566,000	4.0%	57,350,000	6.0%
Tier 1 capital (to average assets)	114,481,000	11.6%	39,709,000	4.0%	49,636,000	5.0%

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(J)

Subsequent Event

The Board of Directors declared a special dividend of $1.20 per share payable on December 10^th, 2010 to shareholders as of the record date of November 30^th, 2010.

This dividend was approved due to the possibility of less favorable tax treatment of dividend income in 2011.  The board intends to significantly reduce or eliminate dividend payments in 2011.  In effect, The Corporation is “prepaying” next year’s dividend in consideration of the potential advantage to our shareholders under the current dividend tax structure.

The Corporation presently plans to resume quarterly dividend payments after 2011.  However, the Corporation cannot predict the economy in 2012.  The Board will review earnings, regulatory requirements and other factors at that time and approve an appropriate dividend.

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

Forward-Looking Statements

This report contains statements that may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements other than historical facts contained or incorporated by reference in this report.  These statements speak of the Corporation’s plans, goals, beliefs or expectations, refer to estimates or use similar terms. Forward looking statements are identified generally by statements containing words and phrases such as “may,” “project,” “are confident,” “should be,” “predict,” “believe,” “plan,” “expect,” “estimate,” “anticipate” and similar expressions. Future filings by the Corporation with the Securities and Exchange Commission, and statements other than historical facts contained in this Report and in any written material, press releases and oral st atements issued by, or on behalf of the Corporation may also constitute forward-looking statements.

Forward-looking statements are subject to significant risks and uncertainties and the Corporation’s actual results may differ materially from the results discussed in such forward-looking statements.  Factors that might cause actual results to differ from the results discussed in forward-looking statements include, but are not limited to, the factors set forth in Item 1A of the 2009 Form 10-K, which item is incorporated herein by reference, and any other risks identified in Part II, Item 1A and elsewhere in this Report.

All forward-looking statements contained in this report or which may be contained in future statements made for or on behalf of the Corporation are based upon information available at the time the statement is made and the Corporation assumes no obligation to update any forward-looking statement.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) into law. The Dodd-Frank Act makes extensive changes to the laws regulating financial services firms and requires significant rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action.  While the full effects of the Dodd-Frank Act on the Corporation and the Bank cannot yet be determined, this legislation is generally perceived as negatively impacting the banking industry. The Dodd-Frank Act may result in higher compliance and other costs, reduced revenues and higher capital and liquidity requirements, among other things, which could adversely affect the business of the Corporation and the Bank, perhaps materially.

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Critical Accounting Policies

In the course of our normal business activity, management must select and apply many accounting policies and methodologies that lead to the financial results presented in our consolidated financial statements. The following is a summary of what management believes are our critical accounting policies.

Allowance for Loan Losses

The allowance for loan losses (“ALL”) is a valuation allowance for probable and inherent losses incurred in the loan portfolio. Management maintains an ALL at levels that it believes to be adequate to absorb estimated probable credit losses incurred in the loan portfolio. The adequacy of the ALL is determined based on periodic evaluations of the loan and lease portfolios and other relevant factors. The ALL comprises both a specific component and a general component. Even though the entire ALL is available to cover losses on any loan, specific allowances are provided on impaired loans pursuant to accounting standards. The general allowance is based on historical loss experience, adjusted for qualitative and environmental factors. At least quarterly, management reviews the assumptions and methodology related to the general allowance in an effort to update and refine the estimate.

In determining the general allowance, management has segregated the loan portfolio by collateral type. By doing so it is better able to identify trends in borrower behavior and loss severity. For each collateral type, management computes a historical loss factor. In determining the appropriate period of activity to use in computing the historical loss factor management looks at trends in quarterly net charge-off ratios. It is management’s intention to utilize a period of activity that it believes to be most reflective of current experience. Changes in the historical period are made when there is a distinct change in the trend of net charge-off experience.

In addition to the historical loss factor, management considers the impact of the following qualitative factors: changes in lending policies, procedures and practices, economic and industry trends and conditions, experience, ability and depth of lending management, level of and trends in past dues and delinquent loans, changes in the quality of the loan review system, changes in the value of the underlying collateral for collateral dependent loans, changes in credit concentrations and portfolio size and other external factors such as legal and regulatory.

In determining the impact, if any, of an individual qualitative factor, management compares the current underlying facts and circumstances surrounding a particular factor with those in the historical periods, adjusting the historical loss factor in a directionally consistent manner with changes in the qualitative factor. Management will continue to analyze the qualitative factors on a quarterly basis, adjusting the historical loss factor both up and down, to a factor it believes is appropriate for the probable and inherent risk of loss in its portfolio.

21

Specific allowances are determined as a result of the Corporation’s impairment process. When a loan is identified as impaired it is evaluated for loss using either the fair value of collateral less selling costs or a discounted cash flow analysis as a determinant of fair value. If fair value exceeds the Bank’s carrying value of the loan no loss is anticipated and no specific reserve is established. However, if the Bank’s carrying value of the loan is greater than fair value a specific reserve is established. In either situation, loans identified as impaired are excluded from the calculation of the general reserve.

The ALL is increased by provisions charged to earnings and reduced by charge-offs, net of recoveries. The adequacy of the ALL is reviewed and approved by the Bank's Board of Directors. The ALL reflects management's best estimate of the probable and inherent losses on loans, and is based on a risk model developed and implemented by management and approved by the Bank's Board of Directors.  In addition, various regulatory agencies periodically review the ALL.  These agencies may suggest additions to the ALL based on their judgments of collectability based on information available to them at the time of their examination.

Loans Acquired Through Transfer

Loans acquired through the completion of a transfer, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Corporation will be unable to collect all contractually required payments receivable, are initially recorded at fair value with no valuation allowance. Loans are evaluated individually to determine if there is evidence of deterioration of credit quality since origination.  Loans where there is evidence of deterioration of credit quality since origination may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics.  The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as impairment. If the Corporation does not have the information necessary to reasonably estimate cash flows to be expected, it may use the cost recovery method or cash basis method of income recognition.  Valuation allowances on these impaired loans reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received).

For acquired loans that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics.  Subsequent to the purchase date, the methods used to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Corporation records a provision for loan

22

losses only when the required allowance exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.

Other Real Estate Owned

Real estate acquired by foreclosure or by deed in lieu of foreclosure, upon initial recognition, is recorded at fair value less estimated selling expenses. At the date of foreclosure, any write down to fair value less estimated selling costs is charged to the ALL.  Costs relating to the development and improvement of the property are capitalized; holding period costs and subsequent changes to the valuation allowance are charged to expense. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses.

Recent Acquisition

On October 23, 2009, the Bank acquired substantially all of the assets and assumed substantially all of the liabilities of the Bank of Elmwood (the “Acquired Bank”), a Wisconsin state-chartered bank headquartered in Racine, Wisconsin, from the Federal Deposit Insurance Corporation (the “FDIC”), as receiver for the Bank of Elmwood (the “Acquisition”).  The Acquisition was completed pursuant to a Whole Bank Purchase Without Loss Share Agreement.  This purchase option provided no FDIC assistance to the Bank beyond the initial purchase discount accepted by the FDIC.  The Acquisition has had a significant impact on the Corporation’s balance sheet, core earnings and net income due to Acquisition-related accounting adjustments.  Management continues to believe the Acquisition will enhance net interest income, provide additional fee income opportunities and leverage operating expenses throughout the Corporation, resulting in significant accretion to core net income in future years.

Financial Condition

Total Assets

The Corporation’s total assets decreased $47.9 million, or 4.3%, to $1,077.8 million at September 30, 2010 from $1,125.7 million at December 31, 2009.

Cash and Cash Equivalents

Cash and cash equivalents, including federal funds sold, decreased $18.7 million or 18.7% since December 31, 2009.  Cash and due from banks decreased $35.2 million while federal funds sold increased $16.5 million.  The decrease in cash and due from banks is due to the short-term increase in deposits at year-end associated with municipal deposits of property taxes and commercial deposits resulting from holiday spending. These deposits typically run off during the first quarter of each year.  The increase in federal funds sold, however, is reflective of the strong liquidity position of the Bank.  Management continues to search for suitable investments in which to reinvest these excess funds given the continued low interest rate environment.  

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Investment Securities

Investment securities decreased $0.5 million or 0.3% during the first nine months of 2010 to $189.3 million.  The small change during the year, however, does not reflect the volume of activity in the investment portfolio as $155.8 million of the Bank’s investment portfolio was redeemed through normal maturities, scheduled calls and amortization of premiums and discounts while $155.3 million of new securities were purchased during the first nine months of 2010.  This transaction volume is the result of increased call activity as interest rates continue to fall and resulted a significant reduction in interest income as reinvestment rates are at very low levels.  Management continues to follow its practice of holding the securities in the investment portfolio to maturity.

Loans Receivable

Loans decreased $20.5 million or 2.6% during the first nine months of 2010 from $787.9 million at December 31, 2009 to $767.4 million at September 30, 2010.  The decrease in total loans outstanding was partially due to the continued aggressive management of the loans acquired in the Acquisition as those relationships were converted to the Bank’s historical underwriting standards, which in some cases resulted in the borrower refinancing elsewhere.  In addition, management continues to focus on credit quality resulting in continued scrutiny of equity, cash flow and borrower character for new loan opportunities created as borrowers refinance their credits with competing banks.  The Bank does not make “subprime” or so-called “Alt-A” loans (alternative documentation loans with lower approval standards) and does not hold any such loans in its portfolio.

LOAN PORTFOLIO ANALYSIS
(Dollars in Thousands)
	September 30, 2010	December 31, 2009	September 30, 2009

		Loan Balance	Percent of Loans in each Category			Loan Balance	Percent of Loans in each Category			Loan Balance	Percent of Loans in each Category
Commercial	$	26,557	3.46	%	$	28,481	3.61	%	$	21,592	3.59	%
Real Estate
Construction		63,129	8.23	%		65,600	8.33	%		50,574	8.41	%
Commercial		289,640	37.74	%		285,382	36.22	%		249,947	41.58	%
Residential		329,291	42.91	%		349,904	44.41	%		232,519	38.68	%
Multi-Family		41,056	5.35	%		38,087	4.83	%		33,270	5.53	%
Installment and Consumer		17,718	2.31	%		20,426	2.60	%		13,258	2.21	%
Total	$	767,391	100.00	%	$	787,880	100.00	%	$	601,160	100.00	%

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Accrued Interest Receivable and Other Assets

Accrued interest receivable and other assets decreased $6.0 million or 43.0% during the first nine months of 2010.  The change is primarily due to a $3.3 million decrease in current and deferred tax assets, a $1.1 million decrease in prepaid expenses and a $0.5 million decrease in accrued interest receivable.

Total Deposits and Borrowings

Deposits at the Bank decreased $42.6 million, or 4.3%, to $945.4 million at September 30, 2010 from $988.0 million at December 31, 2009.  Demand deposits increased $5.2 million, savings and NOW accounts decreased $33.2 million, and time deposits decreased $14.6 million.  The decrease in savings and NOW accounts was driven by a decrease of $75.6 million in municipal accounts, which was offset by significant growth in both money market and savings accounts.  The decrease in municipal deposits during the year is typical due to the increase in municipal deposits from property tax payments in December of each year.  A portion of these deposits tend to be transferred to the State of Wisconsin investment fund after the first of the year  with the remaining balances declining throughout the year as funds are spent on operating activities.  In addition, a portion of the increase in savings and NOW acc ounts is due to a shift from CD’s into money market accounts as many customers have chosen to keep their funds more liquid in the current low interest rate environment.

Total borrowings decreased $1.1 million or 60.9% during the first nine months of 2010.  The Bank adjusts its level of daily borrowing and short term daily investment depending upon its needs each day.  Excess funds or funding requirements are addressed at the close of each business day.  Funding needs are met through the Bank’s federal funds facility with its primary correspondent bank.

Accrued Interest Payable and Other Liabilities

Accrued interest payable and other liabilities decreased $6.1 million or 42.4% during the first nine months of 2010.  The change is primarily due to a decrease in tax liabilities that were initially realized due to the Acquisition in October of 2009.  The tax liabilities have decreased as estimated tax payments have been made during 2010.

Capital Resources

Total stockholders’ equity increased $1.9 million or 1.6% during the first nine months of 2010.  The Corporation posted net income of $12.6 million, paid $8.0 million in dividends and declared $2.7 million of additional dividends during the first nine months of 2010.

Federal banking regulatory agencies have established capital adequacy rules applicable to banks that take into account risk attributable to balance sheet assets and off-balance-sheet activities.  As of September 30, 2010 the Bank’s Tier 1 leverage ratio was

25

10.81% compared to 10.93% at December 31, 2009.  The leverage ratio declined from December 31, 2009 levels as the Acquisition in October of 2009 was fully reflected in average assets during the current period.  Tier 1 risk-based capital ratios were 15.01% at September 30, 2010 and 14.53% at December 31, 2009.  The increase in the Tier 1 risk-based capital ratio was due to a decrease in total risk-based assets and an increase in capital through retained earnings.  As of September 30, 2010 the Bank’s total risk based capital ratio was 16.10% compared to 15.30% at December 31, 2009.  The increase in the Tier 1 risk-based capital ratio was due to a decrease in total risk-based assets as well as an increase in capital through both retained earnings and a higher loan loss reserve.

All ratios are significantly in excess of minimum regulatory requirements.  A bank is “well capitalized” if it maintains a minimum Tier 1 leverage ratio of 5.0%, a minimum Tier 1 risk based capital ratio of 6.0% and a minimum total risk based capital ratio of 10.0%.  Earnings continue to be stable and provide sufficient capital retention for anticipated growth.  Management believes the Bank has a strong capital position and is positioned to take advantage of opportunities for profitable geographic and product expansion, and to provide depositor and investor confidence.  Management actively reviews capital strategies for the Bank in light of perceived business risks, future growth opportunities, industry standards and regulatory requirements. 

Nonperforming Assets and ALL

Non-performing loans were $35.3 million at September 30, 2010 compared to $33.8 million at December 31, 2009 and $11.7 million at September 30, 2009.  There continued to be significant activity in the Bank’s non-performing loans as many of those loans moved to Other Real Estate Owned (“OREO”) but were replaced by new non-performing loans.  The $23.6 million increase compared to September 30, 2009 was primarily due to the Acquisition, as well as the continued depressed state of the economy and real estate markets over the past two years.

The carrying value of OREO was $4.5 million at September 30, 2010 compared to $4.7 million at December 31, 2009 and $2.9 million at September 30, 2009.  Thirty-nine properties remain in OREO at September 30, 2010, of which twenty-five were single family homes representing $3.0 million of the total carrying value.  OREO balances decreased during the first nine months of 2010 as fifty-eight properties were sold during the period compared to fifty-one properties that were moved into OREO during the period.  The increase during the fourth quarter of 2009 was primarily due to the Acquisition, as well as the continued depressed state of the economy and real estate markets over the past two years.  The Bank’s goal is to minimize the delay in liquidation of OREO properties.  As a result of the Acquisition, management estimates it will continue to foreclose and liquidate a significant number of proper ties in 2010.  Management expects that the fair values recorded in the Acquisition accounting will be sufficient to cover any necessary write downs and realized losses on such liquidations.

26

The ALL increased $2.5 million or 41.1% during the first nine months of 2010.  A $4.1 million provision for loan loss was charged to earnings for the nine months ended September 30, 2010.  In addition, a total of $2.6 million of loans were charged-off during the first nine months of 2010, which was partially offset by $1.0 million in recoveries during the period on loans that had been previously charged-off.  The Bank’s charge-offs and the corresponding provision for loan losses reflect activity on acquired loans as well as the adverse effects of the continuing recession.

The ALL represents management’s estimate of the amount necessary to provide for probable and inherent credit losses in the loan portfolio.  To assess the adequacy of the ALL, management uses significant judgment, focusing on specific allocations applied to loans that are identified for evaluation on an individual loan basis.  In addition, loans are analyzed on a group basis using risk characteristics that are common to groups of similar loans.  The factors that are considered include changes in the size and character of the loan portfolio, changes in the levels of impaired and nonperforming loans, historical losses in each category, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing economic conditions, and the fair value of underlying collateral, as well as changes to the fair value of underlying collateral in the continued recessionary environme nt.

SUMMARY OF ALLOWANCE FOR LOAN LOSSES

(Dollars in Thousands)

	September 30, 2010		December 31, 2009
Balance of ALL at beginning of period	$ 6,034		$ 5,945
Total loans charged-off	(2,668)		(3,740)
Total recoveries	1,019		123
Net loans charged-off	(1,649)		(3,617)
Additions to allowance charged to expense	4,130		3,706
Balance of ALL at end of period	$ 8,515		$ 6,034
Total Loans	$ 767,392		$ 787,880
Total nonperforming loans(1)	$ 21,003		$ 15,328
Ratio of nonperforming loans to total loans	2.74	%	1.95	%
Ratio of ALL to total nonperforming loans	40.54	%	39.37	%
Ratio of net loans charged-off during the period to average loans outstanding (2)	0.28	%	0.57	%
Ratio of ALL to total loans	1.11	%	0.77	%

⁽¹⁾This amount excludes purchased credit-impaired loans.  Purchased credit-impaired loans have evidence of deterioration in credit quality prior to acquisition.  Fair value of these loans as of the acquisition date includes estimates of credit losses.

⁽²⁾September 30, 2010 net loans charged-off have been annualized.

27

Liquidity

The ability to provide the necessary funds for the Bank’s day-to-day operations depends on a sound liquidity position.  Management monitors the Bank’s liquidity by reviewing the maturity distribution between interest-earning assets and interest-bearing liabilities.  Fluctuations in interest rates can be the primary cause for the flow of funds into or out of a financial institution.  The Bank continues to offer products that are competitive and encourages depositors to invest their funds in these products.  Management believes that these efforts will help the Bank to not only retain these deposits, but to encourage continued deposit growth.  The Bank has the ability to borrow up to $75.0 million in federal funds purchased, and has an additional $111.8 million available for short-term liquidity through the Federal Reserve Bank Discount window.

Results of Operations

Comparison of the Three Months Ended September 30, 2010 and September 30, 2009

The following table sets forth the Corporation’s consolidated results of operations and related summary information for the three-month periods ended September 30, 2010 and September 30, 2009.

SUMMARY RESULTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)
	Three months ended
	September 30,
	2010	2009
Net income	$          3,754	$          2,240
Earnings per share	$            0.42	$            0.25
Cash dividends per share	$            0.30	$            0.27
Return on average assets	1.38%	1.14%
Return on average equity	12.27%	8.16%
Efficiency ratio, as reported(1)	58.76%	66.17%

⁽¹⁾

Non-interest expense divided by the sum of net interest income plus non-interest income.  

The Corporation posted net income of $3.8 million for the third quarter of 2010, an increase of $1.5 million or 67.6% compared to the third quarter of 2009.  Earnings per share increased to $0.42 for the three months ended September 30, 2010 compared to $0.25 for the same period in 2009.

The quarterly results were significantly impacted by the Acquisition.  The purchase accounting related to the Acquisition resulted in additional pre-tax income of $3.1 million during the third quarter of 2010.  Loan discount accretion and non-accretable

28

loan discounts taken into income accounted for $2.8 million of this total.  This income was partially offset by an increase in the provision for loan losses of $0.8 million, largely due to write-downs of acquired loans.  Operating income during the third quarter of 2010 compared to 2009 was also positively effected by enhanced core income from the Acquired Bank, and was partially offset by higher regulatory compliance expenses and increased loan collection expenses.

Interest Income

Total interest income on loans increased $5.3 million or 58.3% in the third quarter of 2010 compared to the third quarter of 2009.  The purchase accounting related to the Acquisition included $2.5 million in loan discount accretion during the third quarter of 2010.  Management expects loan discount accretion to have a significant impact during 2010 but decline in future years as loans in the Acquired Bank’s loan portfolio continue to amortize, mature, renew or pay off.  The remaining year-to-year increase in interest income on loans was due primarily to the increased volume from the Acquisition.  Interest income on loans for the third quarter of 2010, excluding loan discount accretion of $2.5 million, increased by $2.8 million compared to same period in 2009.  The majority of the increase was due to increased loan volume, as average loans increased $173.4 million or 29.0% for the quarter ende d September 30, 2010 compared to average loans during the third quarter of 2009 largely as a result of the Acquisition.  In addition to increased loan volume, loan yields increased 8 basis points to 6.11% for the third quarter of 2010 compared to 6.03% for the third quarter of 2009 as the acquired loan portfolio had higher interest rate yields than the Bank’s legacy portfolio.  Including the $2.5 million of interest income related to loan accretion discount, loan yields increased 140 basis points to 7.40% for the third quarter of 2010 compared to 6.00% for the third quarter of 2009.

Interest income on investment securities on a tax-equivalent basis increased $0.1 million or 12.6% for the third quarter of 2010 compared to the third quarter of 2009.  This change is the net result of an increase in the average amount of U. S. government sponsored agency, municipal security investments and fed funds sold of $116.2 million offset by a decrease of 142 basis points in the average tax equivalent yield on the investment securities to 2.13% during the third quarter of 2010 compared to 3.55% in the same period of 2009.

Interest Expense

Interest expense for the three months ended September 30, 2010 decreased $0.4 million or 22.9%, compared to the same period in 2009.  Interest expense in the third quarter of 2010 was reduced by $0.5 million of deposit premium amortization due to the purchase accounting related to the Acquisition. The deposit premium amortization will continue into the fourth quarter of 2010, at which point it will be fully amortized.  Excluding the premium amortization, interest expense would have increased by $0.1 million due to increased volume from the Acquisition and core deposit growth, which was partially offset by declining interest rates.  Average interest-bearing liabilities

29

increased $243.7 million to $798.5 million for the third quarter of 2010 compared to $554.8 million for the third quarter of 2009 due primarily to the Acquisition.  The increase in volume was offset by a decrease of 34 basis points in the average yield on interest-bearing liabilities to 0.88% during the third quarter of 2010 compared to 1.22% in the third quarter of 2009.  Including the $0.5 million of premium amortization, the average yield on interest-bearing liabilities decreased 57 basis points to 0.65% during the third quarter of 2010 compared to 1.22% in the same period of 2009.

Net Interest Margin

The tax-equivalent net interest margin for the three months ended September 30, 2010 was 5.61% compared to 4.66% for the three months ended September 30, 2009.  Excluding the purchase accounting related to the Acquisition (including $2.5 million of interest income and a reduction of interest expense of $0.5 million), the tax-equivalent net interest margin for the three months ended September 30, 2010 would have been 4.45% compared to 4.66% for the three months ended September 30, 2009.  

30

NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS

(Dollars in Thousands)

	Three months ended September 30, 2010			Three months ended September 30, 2009
	Average Balance	Interest Income/ Expense	Average Yield/ Rate	Average Balance	Interest Income/ Expense	Average Yield/ Rate
ASSETS
Interest-earning assets:
Loans (1)	$ 771,573	$ 14,280	7.40%	$ 598,145	$ 9,020	6.03%
Taxable investment securities	134,735	708	2.10%	71,134	640	3.60%
Non-taxable investment
Securities(2)	46,234	586	5.07%	40,161	526	5.24%
Federal funds sold	67,400	26	0.15%	20,913	6	0.11%
Total Interest Earning Assets	$ 1,019,942	$ 15,600	6.12%	$ 730,353	$ 10,192	5.58%
Noninterest earning assets:
Other assets	67,372			58,663
TOTAL ASSETS	$ 1,087,314			$ 789,016

	Average Balance	Interest Income/ Expense	Average Yield/ Rate	Average Balance	Interest Income/ Expense	Average Yield/ Rate
LIABILITIES AND EQUITY
Interest-earning liabilities:
Transaction accounts	$ 233,333	$ 202	0.35%	$ 166,776	$ 228	0.55%
Money market	159,392	326	0.82%	96,987	336	1.39%
Savings deposits	168,570	130	0.31%	141,976	148	0.42%
Other time deposits	235,839	644	1.09%	148,103	974	2.63%
Short-term borrowings	1,410	-	0.00%	956	-	0.00%
Total interest-bearing liabilities	798,544	1,302	0.65%	554,798	1,686	1.22%
Noninterest bearing liabilities:
Demand deposits	157,107			121.496
Other	9,276			2,966
Stockholders’ equity	122,387			109,756
Total liabilities and
stockholders’ equity	$  1,087,314			$   789,016
Net interest earnings and interest
rate spread(3)		$   14,298	5.47%		$ 8,506	4.37%
Net interest margin(4)			5.61%			4.66%

⁽¹⁾

The average loan balances and rates include non-accrual loans.

⁽²⁾

The interest income on tax exempt securities is computed on a tax-equivalent basis

using a tax rate of 34% for all periods presented.

⁽³⁾  

Interest rate spread represents the difference between the average yield earned on average interest-earning assets for the period and the average  rate of interest accrued on average interest-bearing liabilities for the period and is represented on a tax-equivalent basis.

⁽⁴⁾

Net interest margin represents net interest income for a period dividend by average interest-earning assets for the period and is represented on a tax-equivalent basis.

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The following table sets forth, for the periods indicated, a summary of the changes in interest earned on a tax-equivalent basis and interest paid resulting from changes in volume and rates:

For the three months ended

September 30, 2010 and 2009

Increase (Decrease) Due to

Interest earned on:	Volume	Rate(1)	Net
Loans	$        2,615	$       2,645	$       5,260
Taxable investment securities	572	(504)	68
Nontaxable investment securities	80	(20)	60
Federal funds sold	13	-	20
Total interest-earning assets	$       3,280	$      2,128	$       5,408
Transaction Accounts	$            91	$       (117)	$         (26)
Money Market	216	(226)	(10)
Savings	28	(46)	(18)
Other Time	577	(907)	(330)
Total interest-bearing liabilities	$          912	$    (1,296)	$       (384)
Increase in net interest income			$      5,792

⁽¹⁾ The change in interest due to both rate and volume has been allocated to rate changes.

Provision for Loan Losses

The Bank recorded a provision for loan loss (“PLL”) of $1.4 million during the three months ended September 30, 2010 compared to $0.6 million during the same period in 2009.  The PLL related to the acquired loans included $0.5 million based on management’s estimate of losses inherent in the portfolio of non-credit impaired loans that were renewed during the quarter and no change due to the subsequent decrease in expected cash flows on credit impaired loans during the quarter.  The PLL during the period is also influenced by the amount of charge-offs and recoveries that impact the ALL during the period.

Noninterest Income

Noninterest income for the three months ended September 30, 2010 increased $0.4 million or 10.4% compared to the same period in 2009.  Noninterest income included $0.3 million of non-accretable discount recorded to income as part of the purchase accounting related to the Acquisition.  This income is related to loans acquired in the Acquisition that were specifically identified as credit-impaired loans pursuant to applicable guidance for accounting for acquired loans, but which were paid or charged off during the quarter.  The $0.3 million represents the excess of net amounts received over the recorded fair value of such loans.  In future periods, non-accretable income could vary significantly as it is dependent on the difference between expected future cash flows and the

32

acquisition accounting fair value discounts applied to the loans specifically impaired.  In addition, service charges on deposits increased $0.1 million or 3.4% during the three months ended September 30, 2010 compared to the three months ended September 30, 2009 due to the increased number of deposit relationships resulting from the Acquisition.  

Noninterest Expense

Noninterest expense increased $2.7 million or 35.2% during the three months ended September 30, 2010 compared to the same period in 2009.  There were significant increases across many expense categories largely related to the Acquisition as well as normal increases in the cost of doing business.  In addition, core deposit intangible amortization of $0.1 million was recognized in the third quarter of 2010 as part of the purchase accounting related to the Acquisition.  The core deposit intangible will continue to be amortized over the next eight years.  

Income Taxes

Income tax expense for the third quarter of 2010 was $2.2 million compared to $1.2 million for the third quarter of 2009.  The Corporation’s effective tax rate (income tax expense divided by income before income taxes) was 37.0% for the third quarter of 2010 compared to 34.3% during the third quarter of 2009.  The increase in the effective tax rate in 2010 was due to the significant increase in pre-tax income which resulted in moving into a higher statutory tax bracket and reducing the impact of tax exempt investment income.

Comparison of the Nine Months Ended September 30, 2010 and September 30, 2009

The following table sets forth our consolidated results of operations and related summary information for the nine month period ended September 30, 2010 and September 30, 2009.

SUMMARY RESULTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)
	Nine months ended
	September 30,
	2010	2009
Net income	$ 12,629	$ 7,309
Earnings per share	$ 1.42	$ 0.82
Cash dividends per share	$ 0.90	$ 0.81
Return on average assets	1.55%	1.26%
Return on average equity	13.79%	8.90%
Efficiency ratio, as reported(1)	56.54%	64.98%

⁽¹⁾

Noninterest expense divided by the sum of net interest income plus noninterest income.  

33

The Corporation posted net income of $12.6 million for the first nine months of 2010, an increase of $5.3 million or 72.8% compared to the first nine months of 2009.  Earnings per share increased to $1.42 for the nine months ended September 30, 2010 compared to $0.82 for the same period in 2009.

The year-to-date results were significantly impacted by the Acquisition.  The purchase accounting related to the Acquisition resulted in additional pre-tax income of $10.5 million during the first three quarters of 2010.  Loan discount accretion and non-accretable loan discounts taken into income accounted for $9.6 million of this total.  This income was partially offset by an increase in the PLL of $2.9 million, largely due to write-downs of acquired loans.  Operating income during the nine months of 2010 compared to 2009 was also positively effected by enhanced core income from the Acquired Bank, and was partially offset by slower mortgage refinancing activity, higher regulatory compliance expenses and increased loan collection expenses.

Interest Income

Total interest income on loans increased $16.7 million or 61.7% in the first nine months of 2010 compared to the first nine months of 2009.  The purchase accounting related to the Acquisition included $8.0 million in loan discount accretion during the first nine months of 2010.  Management expects loan discount accretion to have a significant impact during 2010, but decline in future years as loans from the Acquired Bank’s loan portfolio continue to amortize, mature, renew or pay off.  The remaining year-to-year increase in interest income on loans was primarily due to the increased volume from the Acquisition.  Interest income on loans for the first nine months of 2010, excluding loan discount accretion of $8.0 million, increased by $8.7 million compared to same period in 2009.  The majority of the increase was due to increased loan volume, as average loans increased $178.4 million or 29.8% for the nine months ended September 30, 2010 compared to average loans during the first nine months of 2009 largely as a result of the Acquisition.  In addition to increased loan volume, loan yields increased 12 basis points to 6.14% for the first nine months of 2010 compared to 6.02% for the first nine months of 2009 as the acquired loan portfolio had higher interest rate yields than the Bank’s legacy portfolio.  Including the $8.0 million of interest income related to loan discount accretion, loan yields increased 148 basis points to 7.50% for the first three quarters of 2010 compared to 6.02% for the same period in 2009.

Tax-equivalent interest income on investment securities increased $1.2 million or 33.8% for the first nine months of 2010 compared to the first nine months of 2009.  This change is the net result of an increase in the average amount of U. S. government sponsored agency, municipal security investments and fed funds sold of $119.5 million offset by a decrease of 138 basis points in the average tax equivalent yield on the investment securities to 2.74% during the first nine months of 2010 compared to 4.12% in the same period in 2009.

34

Interest Expense

Interest expense decreased $1.0 million or 18.5% during the nine months ended September 30, 2010 compared to the same period in 2009.  Interest expense in the first nine months of 2010 was reduced by $1.4 million of deposit premium amortization due to the purchase accounting related to the Acquisition. The deposit premium amortization will continue into the fourth quarter of 2010, at which point it will be fully amortized.  Excluding the deposit premium amortization, interest expense would have increased by $0.4 million due to increased volume from the Acquisition and core deposit growth, which was partially offset by declining interest rates.  Average interest-bearing liabilities increased $261.8 million to $802.1 million for the nine months ended September 30, 2010 compared to $540.3 million for the first nine months of 2009.  The increase in volume was offset by a decrease of 35 basis points in the average yield on interest-bearing liabilities to 0.93% during the first three quarters of 2010 compared to 1.28% in the first three quarters of 2009.  Including the $1.4 million of premium amortization, the average yield on interest-bearing liabilities decreased 58 basis points to 0.70% during the first nine months of 2010 compared to 1.28% in the same period of 2009.

Net Interest Margin

The tax-equivalent net interest margin for the nine months ended September 30, 2010 was 5.83% compared to 4.75% for the nine months ended September 30, 2009.  Excluding the purchase accounting related to the Acquisition (including $8.0 million of interest income and a reduction of interest expense of $1.4 million), the tax-equivalent net interest margin for the nine months ended September 30, 2010 would have been 4.61% compared to 4.75% for the nine months ended September 30, 2009.  

35

NET INTEREST INCOME ANALYSIS ON A TAX-EQUIVALENT BASIS

(Dollars in Thousands)

	Nine months ended September 30, 2010			Nine months ended September 30, 2009
	Average Balance	Interest Income/ Expense	Average Yield/ Rate	Average Balance	Interest Income/ Expense	Average Yield/ Rate
ASSETS
Interest-earning assets:
Loans (1)	$ 777,643	$ 43,751	7.50%	$ 599,197	$ 27,057	6.02%
Taxable investment securities	153,148	3,094	2.69%	67,177	2,049	4.07%
Non-taxable investment
Securities(2)	45,599	1,739	5.08%	39,064	1,585	5.41%
Federal funds sold	38,614	46	0.16%	11,644	11	0.13%
Total Interest Earning Assets	$ 1,015,004	$ 48,630	6.39%	$ 717,082	$ 30,702	5.71%
Noninterest earning assets:
Other assets	71,070			57,362
TOTAL ASSETS	$ 1,086,074			$ 774,444

	Average Balance	Interest Income/ Expense	Average Yield/ Rate	Average Balance	Interest Income/ Expense	Average Yield/ Rate
LIABILITIES AND EQUITY
Interest-earning liabilities:
Transaction Accounts	$ 253,267	$ 675	0.36%	$ 161,717	$ 728	0.60%
Money Market	148,425	993	0.89%	89,826	917	1.36%
Savings Deposits	163,372	391	0.32%	136,034	443	0.43%
Other Time Deposits	235,395	2,166	1.23%	144,963	3,064	2.82%
Short-term borrowings	1,640	1	0.08%	7,780	30	0.51%
Total interest-bearing liabilities	802,099	4,226	0.70%	540,320	5,182	1.28%
Noninterest bearing liabilities:
Demand deposits	152,354			121,574
Other	9,523			3,089
Stockholders’ equity	122,098			109,461
Total liabilities and
stockholders’ equity	$ 1,086,074			$ 774,444
Net interest earnings and interest
rate spread(3)		$ 44,404	5.69%		$ 25,520	4.43%
Net interest margin(4)			5.83%			4.75%

⁽¹⁾

The average loan balances and rates include non-accrual loans.

⁽²⁾

The interest income on tax exempt securities is computed on a tax-equivalent basis  

using a tax rate of 34% for all periods presented.

⁽³⁾  

Interest rate spread represents the difference between the average yield earned on average interest-earning assets for the period and the average

rate of interest accrued on average interest-bearing liabilities for the period and is represented on a tax equivalent basis.

⁽⁴⁾

Net interest margin represents net interest income for a period divided by average interest-earning assets for the period and is represented on a tax equivalent basis.

36

The following table sets forth, for the periods indicated, a summary of the changes in interest earned on a tax-equivalent basis and interest paid resulting from changes in volume and rates:

	For the nine months ended September 30, 2010 and 2009
	Increase (Decrease) Due to
Interest earned on:	Volume	Rate(1)	Net
Loans	$ 8,058	$ 8,636	$ 16,694
Taxable investment securities	2,622	(1,577)	1,045
Nontaxable investment securities	266	(111)	155
Federal funds sold	26	10	35
Total interest-earning assets	$      10,971	$        6,958	$   17,929
Interest paid on:
Transaction Accounts	$ 413	$ (465)	$ (53)
Money Market	599	(522)	77
Savings	89	(141)	(52)
Other Time	1,912	(2,810)	(898)
Short-term borrowings	(24)	(5)	(29)
Total interest-bearing liabilities	$ 2,988	$ (3,943)	$ (955)
Increase in net interest income			$ 18,884

⁽¹⁾ The change in interest due to both rate and volume has been allocated to rate changes.

Provision for Loan Losses

The Bank recorded a PLL of $4.1 million during the nine months ended September 30, 2010 compared to $1.3 million during the same period in 2009.  The PLL related to the acquired loans included $2.1 million based on management’s estimate of losses inherent in the portfolio of non-credit impaired loans that were renewed during the first three quarters and $0.7 million due to the subsequent decrease in expected cash flows on credit impaired loans during the same period.  The PLL for the period is also influenced by the amount of charge-offs and recoveries that impacted the ALL during the period.

37

Noninterest Income

Noninterest income increased $1.4 million or 13.2% during the nine months ended September 30, 2010 compared to the same period in 2009.  The increase was primarily caused by three factors.  Noninterest income included an increase of $1.7 million in non-accretable discount recorded to income as part of the purchase accounting related to the Acquisition.  This is income related to loans acquired in the Acquisition that were specifically identified as credit impaired loans pursuant to applicable guidance for accounting for acquired loans, but which were paid or charged off during the quarter.  The $1.7 million represents the excess of net amounts received over the recorded fair value of such loans.  In future periods, non-accretable income could vary significantly as it is dependent on the difference between expected future cash flows received and the acquisition accounting fair value discounts appli ed to the loans specifically impaired.  Gains on the sale of OREO properties increased $0.4 million during the first nine months of 2010 compared to the same period in 2009 due to increased activity as a result of the Acquisition and current economic conditions.  Service charges on deposits also increased $0.3 million or 4.5% during the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 due to the increased number of deposit relationships resulting from the Acquisition.  The increases discussed above were offset by declining mortgage refinancing activity, resulting in reduced mortgage banking revenue and fewer gains on sales of loans in the secondary market, which collectively decreased $1.0 million or 51.4% during the first nine months of 2010 compared to the same period of 2009.

Noninterest Expense

Noninterest expense increased $8.4 million or 36.4% during the nine months ended September 30, 2010 compared to the same period in 2009.  There were significant increases across many expense categories largely resulting from the Acquisition as well as normal increases in the cost of doing business.  Regulatory agency assessments increased significantly from $0.9 million for the first three quarters of 2009 to $2.0 million for the same period in 2010 due to an increase in average deposits due to the Acquisition and increased assessment rates.  The Bank also incurred Acquisition-related expenses of $0.4 million in the first nine months of 2010, primarily related to professional fees and severance payments.  In addition, core deposit intangible amortization of $0.4 million was recognized in the first three quarters of 2010 as part of the purchase accounting related to the Acquisition.  The core depos it intangible will continue to be amortized over the next eight years.  

38

Income Taxes

Income tax expense for the first nine months of 2010 was $7.5 million compared to $3.9 million for the first nine months of 2009.  The Corporation’s effective tax rate (income tax expense divided by income before income taxes) was 37.4% for the first three quarters of 2010 compared to 34.8% during the same period in 2009.  The increase in the effective tax rate in 2010 was due to the significant increase in pre-tax income which resulted in moving into a higher statutory tax bracket and reducing the impact of tax exempt investment income.

Off-Balance Sheet Arrangements

The Bank’s obligations also include off-balance sheet arrangements consisting of loan-related commitments, of which only a portion are expected to be funded.  At September 30, 2010, the Bank’s loan-related commitments, including standby letters of credit and financial guarantees, totaled $110.6 million.  During the year, the Bank manages its overall liquidity, taking into consideration funded and unfunded commitments as a percentage of its liquidity sources.  The Bank’s liquidity sources have been and are expected to continue to be sufficient to meet the cash requirements of its lending activities.

39

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK

The 2009 Form 10-K contains certain disclosures about market risks affecting the Corporation.  There have been no material changes to the information provided which would require additional disclosures as of the date of this filing.

ITEM 4T - CONTROLS AND PROCEDURES

The Corporation maintains a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by it in the reports filed by it under the Securities Exchange Act of 1934, as amended (“Exchange Act”), is recorded and processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  As of September 30, 2010 the Corporation carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures pursuant to Rule 13a-15(e) and 15d-15(e) of the Exchange Act.  Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer of the Corporation concluded that the Corporation’s disclosure controls and proced ures are effective as of the end of the period covered by this report.

There have been no changes in the Corporation’s internal control over financial reporting identified in connection with the evaluation discussed above that occurred during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

40

PART 11 - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

There have been no material changes to the discussion in response to Item 3 of Part I of the 2009 Form 10-K.

ITEM 1A - RISK FACTORS

Except as set forth below, there have been no material changes to the risk factors previously disclosed in response to Item 1A to Part I of the 2009 Form 10-K.

The Dodd-Frank Act and related regulations may affect the Corporation’s and the Bank���s business activities, financial position and profitability.

The Dodd-Frank Act, signed into law on July 21, 2010, makes extensive changes to the laws regulating financial services firms and requires significant rulemaking.  In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory action. The Corporation is currently reviewing the impact the legislation will have on its and the Bank’s business.

The legislation charges the federal banking agencies, including the Federal Reserve and the FDIC with drafting and implementing enhanced supervision, examination and capital standards for depository institutions and their holding companies.  The Dodd-Frank Act also authorizes various new assessments and fees, expands supervision and oversight authority over nonbank subsidiaries, increases the standards for certain covered transactions with affiliates and requires the establishment of increased minimum leverage and risk-based capital requirements for insured depository institutions.  In addition, the Dodd-Frank Act contains several provisions that change the manner in which deposit insurance premiums are assessed and which could increase the FDIC deposit insurance premiums paid by the Bank.

The Dodd-Frank Act establishes a new, independent Consumer Financial Protection Bureau which will have broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products, residential mortgages, home-equity loans and credit cards.  States will be permitted to adopt stricter consumer protection laws and state attorney generals can enforce consumer protection rules issued by the Bureau.

The changes resulting from the Dodd-Frank Act, as well as the regulations promulgated by federal agencies, may impact the profitability of the Corporation’s and the Bank’s business activities, require changes to certain of their business practices or otherwise adversely affect their businesses. These changes may also require the Corporation and the Bank to invest significant management attention and resources to evaluate and make necessary changes.

41

ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS

Not applicable.

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4 - [RESERVED]

ITEM 5 - OTHER INFORMATION

Not applicable

ITEM 6 – EXHIBITS

31.1

Certification of Ronald K. Puetz, Chief Executive Officer, under Rule 13a-14(a)/15d-14(a)

31.2

Certification of Frederick R. Klug, Chief Financial Officer, under Rule 13a-14(a)/15d-14(a)

32.1

Certification of Ronald K. Puetz, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Frederick R. Klug, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

42

SIGNATURES

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

TRI CITY BANKSHARES CORPORATION

DATE: November 15, 2010                     Ronald K. Puetz President, Chief Executive Officer (Principal Executive Officer)	/s/ Ronald K. Puetz
DATE: November 15, 2010                      Frederick R. Klug Senior Vice President (Chief Financial Officer)	/s/ Frederick R. Klug

43

Tri City Bankshares Corporation

Index of Exhibits

Exhibit No.

31.1

Certification of Ronald K. Puetz, Chief Executive Officer, under Rule 13a 14(a)/15d-14(a)

31.2

Certification of Frederick R. Klug, Chief Financial Officer, under Rule 13a 14(a)/15d-14(a)

32.1

Certification of Ronald K. Puetz, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Frederick R. Klug, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

44