Annual Report (10-k)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

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

For the transition period from to

Commission File Number: 000-52640

OAK RIDGE FINANCIAL SERVICES, INC

(Exact name of registrant as specified in its charter)

North Carolina	20-8550086
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

Post Office Box 2

2211 Oak Ridge Road

Oak Ridge, North Carolina 27310

(Address of principal executive offices)

(336) 644-9944

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
None	None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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 (§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 x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	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 aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, based on the last sale price of common stock as of March 1, 2013 ($4.58), was $7,233,565.

The number of shares outstanding of each of the registrant’s classes of common stock, as of March 1, 2013, was as follows:

Class	Number of Shares
Common Stock, no par value	1,808,445

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2012 Annual Meeting of Shareholders of the Registrant to be held on June 6, 2013 (the “Proxy Statement”) are incorporated by reference into Part III.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements represent expectations and beliefs of Oak Ridge Financial Services, Inc. (hereinafter referred to as the “Company”) including but not limited to the Company’s operations, performance, financial condition, growth or strategies. These forward-looking statements are identified by words such as “expects”, “anticipates”, “should”, “estimates”, “believes” and variations of these words and other similar statements. For this purpose, any statements contained in this Annual Report on Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements. These forward-looking statements involve estimates, assumptions, risks and uncertainties that could cause actual results to differ materially from current projections depending on a variety of important factors, including without limitation:

•

Revenues are lower than expected;

•

Credit quality deterioration which could cause an increase in the provision for credit losses;

•

Competitive pressure among depository institutions increases significantly;

•

Changes in consumer spending, borrowings and savings habits;

•

Regulatory approval for paying dividends cannot be obtained;

•

Technological changes and security and operations risks associated with the use of technology;

•

The cost of additional capital is more than expected;

•

A change in the interest rate environment reduces interest margins;

•

Asset/liability repricing risks, ineffective hedging and liquidity risks;

•

Counterparty risk;

•

General economic conditions, particularly those affecting real estate values, either nationally or in the market area in which we do or anticipate doing business, are less favorable than expected;

•

The effects of the Federal Deposit Insurance Corporation deposit insurance premiums and assessments;

•

The effects of and changes in monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board;

•

Volatility in the credit or equity markets and its effect on the general economy;

•

Demand for the products or services of the Company and the Bank of Oak Ridge, as well as their ability to attract and retain qualified people;

•

The costs and effects of legal, accounting and regulatory developments and compliance;

•

Regulatory approvals for acquisitions cannot be obtained on the terms expected or on the anticipated schedule;

•

The effects of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations; and the enactment of further regulations related to this act.

The Company cautions that the foregoing list of important factors is not exhaustive. See also “Risk Factors” which begins on page 11. The Company undertakes no obligation to update any forward-looking statement, whether written or oral, that may be made from time to time, by or on behalf of the Company.

PART I

ITEM 1 – BUSINESS

General

Oak Ridge Financial Services, Inc. (referred to as the “Company,” “we,” “our” or “us”) is a bank holding company incorporated under the laws of the State of North Carolina and registered under the Bank holding Company Act of 1956, as amended (“BHCA”). The Company was incorporated on March 2, 2007 and became a bank holding company on April 20, 2007.

Bank of Oak Ridge (the “Bank”) was incorporated on April 6, 2000 as a North Carolina chartered commercial bank and opened for business on April 10, 2000. Including its main office, the Bank operates five (5) full service branch offices in Oak Ridge, Summerfield, and Greensboro, North Carolina.

The Company operates for the primary purpose of serving as the holding company for the Bank. The Company’s and the Bank’s headquarters are located at 8050 Fogleman Road, North Carolina 27310. The telephone number is (336) 644-9944, and its website is www.bankofoakridge.com.

The Bank operates for the primary purpose of serving the banking needs of individuals, and small to medium-sized businesses in its market area. The Bank offers a range of banking services including checking and savings accounts, commercial, consumer and personal loans, mortgage services and other associated financial services.

Lending Activities

General. The Bank provides a wide range of short to medium-term commercial, mortgage, construction and personal loans, both secured and unsecured. It also makes real estate mortgage and construction loans and Small Business Administration guaranteed loans. Many of the commercial loans are collateralized with real estate in the Bank’s market but such collateral is mainly a secondary, and not a primary, source of repayment. The Bank has maintained a balance between variable and fixed rate loans within its portfolio. Variable rate loans accounted for 31% of the loan balances outstanding at December 31, 2012, while fixed rate loans accounted for 69% of the loan balances at that time.

The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans, target markets, underwriting and collateral requirements, terms, interest rates and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the board of directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work.

Commercial Mortgage Loans. The Bank originates and maintains a significant amount of commercial real estate loans. This lending involves loans secured principally by commercial office buildings, both investment and owner occupied. The Bank requires the personal guaranty of principals and a demonstrated cash flow capability sufficient to service the debt. The real estate collateral is a secondary source of repayment. Loans secured by commercial real estate may be in greater amount and involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties. The Bank also makes loans secured by commercial/investment properties provided the subject property is either pre-leased or pre-sold before the Bank commits to finance its construction.

Construction Loans. Another of the Bank’s lending concentrations is construction/development lending. However, the Bank, like many other financial institutions, has greatly decreased its emphasis on this type of lending over the past two years. The Bank originates one-to-four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of homes. The Bank finances “starter” homes as well as “high-end” homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The Bank makes construction loans to builders of homes that are not pre-sold, but limits the number of such loans to any one builder. This type of lending is only done with local, well-established builders and not with large or national tract builders. The Bank lends to builders in its market who have demonstrated a favorable record of performance and profitable operations. The Bank will also finance small tract developments and sub-divisions; however, the Bank seeks to be only one of a number of financial institutions making construction loans in any one tract or sub-division. The Bank endeavors to further limit its construction lending risk through adherence to established underwriting procedures and the requirement of documentation of all draw requests. The Bank requires personal guarantees of the principals and demonstrated secondary sources of repayment on construction loans.

Commercial Loans. Commercial business lending is another focus of the Bank’s lending activities. Commercial loans include secured loans for working capital, expansion and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. Lending decisions are based on an evaluation of the financial strength, cash flow, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees of the principals and secondary sources of repayment, primarily a deed of trust on local real estate. Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as commercial mortgage loans. More frequent repricing means that yields on the Bank’s commercial loans adjust more quickly with changes in interest rates.

Loans to Individuals, Home Equity Lines of Credit and Residential Real Estate Loans. Loans to individuals (consumer loans) include automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate secondary source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank attempts to manage the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Residential real estate loans are made for purchasing and refinancing one-to-four family properties. The Bank offers fixed and variable rate options, but generally limits the maximum fixed rate term to five years. The Bank provides customers access to long-term conventional real estate loans through its mortgage loan department, which originates loans and brokers them for sale in the secondary market. Such loans are closed by mortgage brokers and are not funded by the Bank. The Bank anticipate that it will continue to be an active originator of mortgage loans and only hold for its own account a small number of well-collateralized, non-conforming residential loans.

Loan Approvals. The Bank’s loan policies and procedures establish the basic guidelines governing lending operations. Generally, the guidelines address the type of loans, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans and credit lines are subject to approval procedures and amount limitations. Depending upon the loan requested, approval may be granted by the individual loan officer, the Bank’s officers’ loan committee or, for the largest relationships, the directors’ loan committee. The Bank’s full Board of Directors is required to approve any single transaction that exceeds 90% of our legal lending limit. These amount limitations apply to the borrower’s total outstanding indebtedness to the Bank, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Board of Directors. Responsibility for loan review, underwriting, compliance and document monitoring resides with the Chief Credit Officer. The Chief Credit Officer is responsible for loan processing and approval. On an annual basis, the Board of Directors of the Bank determines the President’s lending authority, who then delegates lending authorities to the Chief Credit Officer and other lending officers of the Bank. Delegated authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the Board of Directors or the President within his delegated authority.

Credit Cards. The Bank offers credit cards to individuals and businesses in the Bank’s market.

Loan Participations. From time to time the Bank purchases and sells loan participations to or from other banks within and outside of its market area. All loan participations purchased have been underwritten using the Bank’s standard and customary underwriting criteria.

Commitments and Contingent Liabilities

In the ordinary course of business, the Bank enters into various types of transactions that include commitments to extend credit. The Bank applies the same credit standards to these commitments as the Bank uses in all of its lending activities and have included these commitments in its lending risk evaluations. The Bank’s exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See Note 12 of the “Notes to Consolidated Financial Statements.”

Asset Quality

The Bank considers asset quality to be of primary importance, and engages an independent third party as a loan reviewer to ensure adherence to the lending policy as approved by its Board of Directors. It is the responsibility of each lending officer to assign an appropriate risk grade to every loan originated. Credit administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, it is credit administration’s responsibility to change the borrower’s risk grade accordingly. At least annually the independent third party conducts a loan review of the Bank’s largest and highest risk loan relationships to review compliance with its underwriting standards and risk grading and provides a report detailing the conclusions of that review to the Audit Committee and senior management. The Audit Committee requires management to address any criticisms raised during the loan review and to take appropriate actions where warranted.

Investment Activities

The Bank’s investment portfolio plays a major role in management of liquidity and interest rate sensitivity and, therefore, is managed in the context of the overall balance sheet. The securities portfolio generates a significant percentage of the Bank’s interest income and serves as a necessary source of liquidity and income. Debt and equity securities that will be held for indeterminate periods of time, including securities that the Bank may sell in response to changes in market interest or prepayment rates, needs for liquidity and changes in the availability of and the yield of alternative investments, are classified as “available-for-sale.” The Bank carries these investments at market value, which it generally determines using published quotes or a pricing matrix obtained at the end of each month. Unrealized gains and losses are excluded from its earnings and are reported, net of applicable income tax, as a component of accumulated other comprehensive income in stockholders’ equity until realized.

Deposit Activities

The Bank provides a range of deposit services, including non-interest bearing checking accounts, interest bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. The Bank uses brokered deposits to supplement its funding sources. However, the Bank strives to establish customer relations to attract core deposits in non-interest bearing transactional accounts and thus reduce its cost of funds.

Borrowings

As additional sources of funding, the Bank uses advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) under a line of credit equal to 30% of the Bank’s total assets ($342.9 million at December 31, 2012), subject to satisfactory loans and investments to pledge. There were no outstanding advances at December 31, 2012. Pursuant to collateral agreements with the FHLB, at December 31, 2012 investment securities available-for-sale with a fair value of $1 million and by loans with a carrying amount of $27.8 million, which approximates market value, were pledged towards possible loan advances.

The Bank may purchase federal funds through two unsecured federal funds lines of credit consisting of $6 million in the aggregate. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of the advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate. Short-term borrowings may also consist of securities sold under a repurchase agreement. Securities sold under repurchase agreements generally mature within one to four days from the transaction date. There were no federal funds purchased as of December 31, 2012.

Junior Subordinated Debt

In June of 2007, the Company placed $8.2 million in trust preferred securities through its subsidiary, Oak Ridge Statutory Trust I (the “Trust”). The Trust invested the total proceeds from the sale of its trust preferred securities in junior subordinated deferrable interest debentures issued by the Bank. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to three-month LIBOR plus 160 basis points. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible by the Bank for income tax purposes. The trust preferred securities are redeemable on or after June 2012. The Bank has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Bank’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness. The principal reason for issuing trust preferred securities was that the proceeds from their sale qualify as Tier 1 capital for regulatory capital purposes (subject to certain limitations), thereby enabling the Bank to enhance its regulatory capital positions without diluting the ownership of its shareholders.

Investment Services

Oak Ridge Wealth Management offers financial planning services and sells investment products such as mutual funds, equities, and fixed and variable annuities. Until June 30, 2012, Oak Ridge Wealth Management operated in an independent office in downtown Greensboro, North Carolina while also servicing the Bank’s five banking offices. Oak Ridge Wealth Management separated from the Bank on July 1, 2012. The Bank now has an agreement with Oak Ridge Wealth Management and Invest Financial (Broker-dealer) whereby the Bank receives a percentage of the income from financial planning services and the sale of investment products, but incurs no costs.

Banking Technology

Because of the level of sophistication of its markets, the Bank commenced operations with a full array of technology available for its customers. The Bank’s customers have the ability to perform on-line and mobile banking and bill paying, access on-line check images, make transfers, initiate wire transfer requests and stop payment orders of checks. The Bank provides its customers with imaged check statements, thereby eliminating the cost of returning checks to customers and eliminating the clutter of canceled checks. Through branch image capture technology, the Bank offers same day credit for deposits made prior to 6:00 PM. The Bank also offers branch image capture technology to its commercial customers, which allows them to image and transmit check images and receive same day credit for deposits made prior to 6:00 PM.

Strategy

The Bank’s strategy is focused towards achieving growth and performance through exceptional customer service and sound asset quality, providing a comprehensive combination of products and services that allows it to compete with large and small financial institutions, and being able to quickly adapt to the rapidly changing financial services industry.

Primary Market Area

The Bank’s primary market area consists of Oak Ridge, Summerfield and Greensboro, North Carolina and their surrounding areas. Its main office is located in Oak Ridge, Guilford County, North Carolina and its four branch offices are located in Summerfield and Greensboro, North Carolina. The Bank’s loans and deposits are primarily generated from the Oak Ridge, Summerfield and Greensboro communities. To meet funding needs, the Bank solicits deposits outside its primary market area using a national certificate of deposit rate service.

Competition

Commercial banking in North Carolina is highly competitive, due in large part to North Carolina’s early adoption of statewide branching. Over the years, federal and state legislation (including the elimination of restrictions on interstate banking) has heightened the competitive environment in which all financial institutions conduct their business, and the potential for competition among financial institutions of all types has increased significantly. North Carolina is the home of the largest commercial bank in the United States, which has branches located in the Bank’s banking market, and the Bank competes with other commercial banks, savings banks and credit unions.

According to a market share report prepared by the Federal Deposit Insurance Corporation (the “FDIC”) dated June 30, 2012, there were 147 offices of 21 different commercial banks and one savings bank in Guilford County. Four banks (Wells Fargo, BB&T, Bank of America, and SunTrust) controlled an aggregate of 60 percent of all deposits in Guilford County, while the Bank held a 4.1 percent market share. Thus, the Bank’s market is highly competitive, and customers tend to aggressively “shop” the terms of both their loans and deposits.

Interest rates, both on loans and deposits, and prices of fee-based services are significant competitive factors among financial institutions generally. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and, in the case of larger commercial customers, relative lending limits and the ability to offer sophisticated cash management and other commercial banking services. Many of the Bank’s competitors have greater resources, broader geographic markets, more extensive branch networks, and higher lending limits than the Bank. They also can offer more products and services and can better afford and make more effective use of media advertising, support services and electronic technology than the Bank. In terms of assets, the Bank is smaller than many commercial banks in North Carolina, and there is no assurance that the Bank will be or continue to be an effective competitor in its banking market. However, the Bank believes that community banks can compete successfully by providing personalized service and making timely, local decisions, and that further consolidation in the banking industry is likely to create additional opportunities for community banks to capture deposits from affected customers who may become dissatisfied as their financial institutions grow larger. Additionally, the Bank believes that the continued growth of its banking market affords an opportunity to capture new deposits from new residents.

Substantially all of the Bank’s customers are individuals and small- and medium-sized businesses. The Bank attempts to differentiate itself from its larger competitors with a focus on relationship banking, personalized service, direct customer contact, innovative products and services; as well as its ability to make credit and other business decisions locally. We believe that our focus allows the Bank to be more responsive to its customers’ needs and more flexible in approving loans based on collateral quality and personal knowledge of its customers.

Employees

At December 31, 2012, the Company and the Bank had 89 full-time employees and 9 part-time employees. The Company, the Bank and their employees are not parties to any collective bargaining agreement, and each of the Company and the Bank considers its relations with its employees to be good.

REGULATION

Supervision and Regulation

Bank holding companies and commercial banks are extensively regulated under both federal and state law. The following is a brief summary of certain statutes and rules and regulations that affect or will affect the Company and the Bank. This summary is qualified in its entirety by reference to the particular statute and regulatory provisions referred to below, and is not intended to be an exhaustive description of the statutes or regulations applicable to the business of the Company and the Bank. Supervision, regulation and examination of the Company and the Bank by the regulatory agencies are intended primarily for the protection of depositors rather than shareholders of the Company. Statutes and regulations which contain wide-ranging proposals for altering the structures, regulations and competitive relationship of financial institutions are introduced regularly. The Company cannot predict whether, or in what form, any proposed statute or regulation will be adopted or the extent to which the business of the Company and the Bank may be affected by such statute or regulation.

General. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event the depository institution becomes in danger of default or in default. For example, to avoid receivership of an insured depository institution subsidiary, a holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the bank’s total assets at the time the bank became undercapitalized or (ii) the amount which is necessary (or would have been necessary) to bring the bank into compliance with all acceptable capital standards as of the time the bank fails to comply with such capital restoration plan. The Company, as a registered bank holding company, is subject to the regulation of the Board of Governors of the Federal Reserve System (“Federal Reserve”): Under a policy of the Federal Reserve with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. The Federal Reserve, under the BHCA, also has the authority to require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the holding company.

As a result of the Company’s ownership of the Bank, the Company is also registered under the bank holding company laws of North Carolina. Accordingly, the Company is also subject to supervision and regulation by the North Carolina Commissioner of Banks (the “Commissioner”).

U.S. Treasury Capital Purchase Program. Pursuant to the U.S. Department of Treasury (the “U.S. Treasury”) Capital Purchase Program (“CPP”), on January 30, 2009, we issued and sold for an aggregate purchase price of $7.7 million (i) 7,700 shares of Series A Preferred Stock (the “Series A Preferred Stock”) and (ii) a warrant to purchase 163,830 shares of the Company’s common stock, no par value, (the “Warrant”) to the U.S. Treasury. The Securities Purchase Agreement, dated January 30, 2009, pursuant to which the securities issued to the U.S. Treasury under the CPP were sold, restricts the Company, without the prior approval of the U.S. Treasury, from paying dividends, limits the Company’s ability to repurchase shares of its common stock (with certain exceptions, including the repurchase of its common stock to offset share dilution from equity-based compensation awards), grants the holders of the Series A Preferred Stock, the Warrant and the common stock of the Company to be issued under the Warrant, certain registration rights, and subjects the Company to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (“EESA”), the American Recovery and Reinvestment Act of 2009 (“ARRA”) and subsequent regulations issued by the U.S. Treasury.

FDIC Temporary Liquidity Guarantee Program. The Company and the Bank have chosen to participate in the FDIC’s Temporary Liquidity Guarantee Program (the “TLGP”), which applies to, among others, all U.S. depository institutions insured by the FDIC and all United States bank holding companies, unless they have opted out. Under the TLGP, the FDIC guarantees certain senior unsecured debt of the Company and the Bank, as well as noninterest bearing transaction account deposits at the Bank. Under the debt guarantee component of the TLGP, the FDIC will pay the unpaid principal and interest on an FDIC-guaranteed debt instrument upon the uncured failure of the participating entity to make a timely payment of principal or interest.

Capital Adequacy Guidelines for Bank Holding Companies. The Federal Reserve has adopted capital adequacy guidelines for bank holding companies and banks that are members of the Federal Reserve System and have consolidated assets of $150 million or more. Bank holding companies subject to the Federal Reserve’s capital adequacy guidelines are required to comply with the Federal Reserve’s risk-based capital guidelines. Under these regulations, the minimum ratio of total capital to risk-weighted assets is 8%. At least half of the total capital is required to be “Tier I capital,” principally consisting of common stockholders’ equity, noncumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock less certain goodwill items. The remainder (“Tier II capital”) may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, perpetual preferred stock and a limited amount of the general loan loss allowance. In addition to the risk-based capital guidelines, the Federal Reserve has adopted a minimum Tier I capital (leverage) ratio, under which a bank holding company must maintain a minimum level of Tier I capital to average total consolidated assets of at least 3% in the case of a bank holding company which has the highest regulatory examination rating and is not contemplating significant growth or expansion. All other bank holding companies are expected to maintain a Tier I capital (leverage) ratio of at least 1% to 2% above the stated minimum. The Company exceeded all applicable minimum capital adequacy guidelines as of December 31, 2012.

Capital Requirements for the Bank. The Bank, as a North Carolina commercial bank, is required to maintain a surplus account equal to 50% or more of its paid-in capital stock. As a FDIC insured commercial bank that is not a member of the Federal Reserve, the Bank is also subject to capital requirements imposed by the FDIC. Under the FDIC’s regulations, state nonmember banks that (a) receive the highest rating during the examination process and (b) are not anticipating or experiencing any significant growth, are required to maintain a minimum leverage ratio of 3% of total consolidated assets; all other banks are required to maintain a minimum ratio of 1% or 2% above the stated minimum, with a minimum leverage ratio of not less than 4%. The Bank exceeded all applicable minimum capital requirements as of December 31, 2012.

Dividend and Repurchase Limitations. The Company’s participation in the CPP limits our ability to repurchase shares of our common stock (with certain exceptions, including the repurchase of our common stock to offset share dilution from equity-based compensation awards), except with the prior approval of the U.S. Treasury. See “Supervision and Regulation—U.S. Treasury Capital Purchase Program.” Additionally, the Company must obtain Federal Reserve approval prior to repurchasing common stock for consideration in excess of 10% of its net worth during any 12-month period unless the Company (i) both before and after the redemption satisfies capital requirements for a “well capitalized” bank holding company; (ii) received a one or two rating in its last examination; and (iii) is not the subject of any unresolved supervisory issues.

The ability of the Company to pay dividends or repurchase shares is dependent upon the Company’s receipt of dividends from the Bank. North Carolina commercial banks, such as the Bank, are subject to legal limitations on the amounts of dividends they are permitted to pay. The Bank may only pay dividends from undivided profits, which are determined by deducting and charging certain items against actual profits, including any contributions to surplus required by North Carolina law. Also, an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is defined in the applicable law and regulations).

As a result of the Company’s participation in the CPP, the Company will require prior approval of the U.S. Treasury to pay dividends.

Deposit Insurance Assessments. The Bank is subject to insurance assessments imposed by the FDIC. Under current law, the insurance assessment to be paid by members of the Deposit Insurance Fund, such as the Bank, is specified in a schedule required to be issued by the FDIC. During the first quarter of 2009, the FDIC instituted a one-time special assessment equal to 5 cents per $100 of domestic deposits on FDIC insured institutions, which resulted in an additional $160 thousand in FDIC insurance expense for 2009. The assessment rate schedule can change from time to time at the discretion of the FDIC, subject to certain limits. On November 12, 2009, the FDIC adopted a rule requiring banks to prepay three year’s worth of estimated deposit insurance premiums by December 31, 2009. On February 7, 2012, the FDIC adopted a new assessment formula, effective with the second quarter of 2012. The impact of this change in 2012 was a reduction in expense of approximately $56 thousand.

Federal Home Loan Bank System. The FHLB system provides a central credit facility for member institutions. As a member of the FHLB, the Bank is required to own capital stock in the FHLB in an amount at least equal to 0.20% of the Bank’s total assets at the end of each calendar year, plus 4.5% of its outstanding advances (borrowings) from the FHLB. At December 31, 2012, the Bank was in compliance with these requirements. The most recent calculation performed by the FHLB was as of March 23, 2012 using the Bank’s total assets and advances as of December 31, 2011.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the FDIC, an insured institution has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop, consistent with the CRA, the types of products and services that it believes are best suited to its particular community. The CRA requires the federal banking regulators, in connection with their examinations of insured institutions, to assess the institutions’ records of meeting the credit needs of their communities, using the ratings “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those institutions. All institutions are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its last CRA examination, which was completed August 30, 2010.

Prompt Corrective Action. The FDIC has broad powers to take corrective action to resolve the problems of insured depository institutions. The extent of these powers will depend upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized”. Under the regulations, an institution is considered “well capitalized” if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier I risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater, and (iv) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. An “adequately capitalized” institution is defined as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier I risk-based capital ratio of 4% or greater, and (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of an institution with the highest examination rating). An institution is considered (A) “undercapitalized” if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based capital ratio of less than 4%, or (iii) a leverage ratio of less than 4% (or 3% in the case of an institution with the highest examination rating); (B) “significantly undercapitalized” if the institution has (i) a total risk-based capital ratio of less than 6%, (ii) a Tier I risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%; and (C) “critically undercapitalized” if the institution has a ratio of tangible equity to total assets equal to or less than 2%. At December 31, 2012, the Bank had the requisite capital levels to qualify as “well capitalized”.

Changes in Control. The BHCA prohibits the Company from acquiring direct or indirect control of more than 5% of the outstanding voting stock or substantially all of the assets of any bank or savings bank or merging or consolidating with another bank or financial holding company or savings bank holding company without prior approval of the Federal Reserve. Similarly, Federal Reserve approval (or, in certain cases, non-disapproval) must be obtained prior to any person acquiring control of the Company. Control is conclusively presumed to exist if, among other things, a person acquires more than 25% of any class of voting stock of the Company or controls in any manner the election of a majority of the directors of the Company. Control is presumed to exist if a person acquires more than 10% of any class of voting stock, the stock is registered under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”), and the acquiror will be the largest shareholder after the acquisition.

Federal Securities Law. The Company has registered its common stock with the Securities and Exchange Commission (“SEC”) pursuant to Section 12(g) of the Exchange Act. As a result of such registration, the proxy and tender offer rules, insider trading reporting requirements, annual and periodic reporting and other requirements of the Exchange Act are applicable to the Company.

Transactions with Affiliates. Under current federal law, depository institutions are subject to the restrictions contained in Section 22(h) of the Federal Reserve Act with respect to loans to directors, executive officers and principal shareholders. Under Section 22(h), loans to directors, executive officers and shareholders who own more than 10% of a depository institution (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the institution’s loans to one borrower limit (as discussed below). Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and shareholders who own more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the institution. Any “interested” director may not participate in the voting. The FDIC has prescribed the loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, pursuant to Section 22(h), the Federal Reserve requires that loans to directors, executive officers, and principal shareholders be made on terms substantially the same as offered in comparable transactions with non-executive employees of the Bank. The FDIC has imposed additional limits on the amount a bank can loan to an executive officer.

Loans to One Borrower. The Bank is subject to the loans to one borrower limits imposed by North Carolina Law, which are substantially the same as those applicable to national banks. Under these limits, no loans and extensions of credit to any borrower outstanding at one time and not fully secured by readily marketable collateral shall exceed 15% of the unimpaired capital and unimpaired surplus of the Bank. At December 31, 2012, this limit was $4.9 million. Loans and extensions of credit fully secured by readily marketable collateral may comprise an additional 10% of unimpaired capital and unimpaired surplus, or $3.3 million as of December 31, 2012.

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act, enacted in 1999 (the “GLB Act”), dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them. In doing so, it increased competition in the financial services industry, presenting greater opportunities for our larger competitors which were more able to expand their service and products than smaller, community-oriented financial institutions, such as the Bank.

USA Patriot Act of 2001. The USA Patriot Act of 2001 (the “Patriot Act”) was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Patriot Act was intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The impact of the Patriot Act on financial institutions of all kinds has been significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act (“SOX”) was signed into law in 2002 and addresses accounting, corporate governance and disclosure issues. The impact of SOX is wide-ranging as it applies to all public companies and imposes significant requirements for public company governance and disclosure requirements.

In general, SOX establishes corporate governance and financial reporting requirements intended to enhance the accuracy and transparency of public companies’ reported financial results. It establishes responsibilities for corporate chief executive officers, chief financial officers and audit committees in the financial reporting process. In addition, it created a new regulatory body to oversee auditors of public companies. It backed these requirements with SEC enforcement tools, increased criminal penalties for federal mail, wire and securities fraud, and created new criminal penalties for document and record destruction in connection with federal investigations. It also increased the opportunity for more private litigation by lengthening the statute of limitations for securities fraud claims and providing federal corporate whistleblower protection.

The economic and operational effects of SOX on public companies, including the Company, have been and will continue to be significant in terms of the time, resources and costs associated with compliance with its requirements.

Dodd-Frank Wall Street Reform and Consumer Protection Act . On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act was intended primarily to overhaul the financial regulatory framework following the global financial crisis and has impacted, and will continue to impact, all financial institutions including the Company and the Bank. The Dodd-Frank Act contains provisions that have, among other things, established a Bureau of Consumer Financial Protection, established a systemic risk regulator, consolidated certain federal bank regulators and imposed increased corporate governance and executive compensation requirements. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations and to prepare numerous studies and reports for the U.S. Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act are not yet known.

Limits on Rates Paid on Deposits and Brokered Deposits. FDIC regulations limit the ability of insured depository institutions to accept, renew or roll-over deposits by offering rates of interest which are significantly higher than the prevailing rates of interest on deposits offered by other insured depository institutions having the same type of charter in such depository institution’s normal market area. Under these regulations, “well capitalized” depository institutions may accept, renew or roll-over such deposits without restriction, “adequately capitalized” depository institutions may accept, renew or roll-over such deposits with a waiver from the FDIC (subject to certain restrictions on payments of rates) and “undercapitalized” depository institutions may not accept, renew, or roll-over such deposits. Definitions of “well capitalized,” “adequately capitalized” and “undercapitalized” are the same as the definitions adopted by the FDIC to implement the prompt corrective action provisions discussed above.

Other. Additional regulations require annual examinations of all insured depository institutions by the appropriate federal banking agency, with some exceptions for small, well-capitalized institutions and state chartered institutions examined by state regulators, and establish operational and managerial, asset quality, earnings and stock valuation standards for insured depository institutions, as well as compensation standards.

The Bank is subject to examination by the FDIC and the Commissioner. In addition, it is subject to various other state and federal laws and regulations, including state usury laws, laws relating to fiduciaries, consumer credit, equal credit and fair credit reporting laws and laws relating to branch banking. The Bank, as an insured North Carolina commercial bank, is prohibited from engaging as a principal in activities that are not permitted for national banks, unless (i) the FDIC determines that the activity would pose no significant risk to the Deposit Insurance Fund and (ii) the Bank is, and continues to be, in compliance with all applicable capital standards.

Future Requirements. Statutes and regulations, which contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions, are introduced regularly. Neither the Company nor the Bank can predict whether or what form any proposed statute or regulation will be adopted or the extent to which the business of the Company or the Bank may be affected by such statute or regulation.

ITEM 1A. RISK FACTORS

An investment in the Company’s common stock is subject to risks inherent in the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision, you should carefully consider these risks and uncertainties, together with all of the other information included or incorporated by reference in this Annual Report on Form 10-K. These risks and uncertainties are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors.

If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly, and you could lose all or part of your investment.

•	Our business has been and may continue to be adversely affected by current conditions in the financial markets and economic conditions generally.

The global, U.S. and North Carolina economies are continuing to experience significantly reduced business activity and consumer spending as a result of, among other factors, disruptions in the capital and credit markets that first occurred during 2008. Since 2008, dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could have one or more of the following adverse effects on our business:

•

a decrease in the demand for loans or other products and services offered by us;

•

a decrease in the value of our loans or other assets secured by consumer or commercial real estate;

•

a decrease in deposit balances due to overall reductions in the accounts of customers;

•

an impairment of certain intangible assets or investment securities;

•

a decreased ability to raise additional capital on terms acceptable to us or at all; or

•

an increase in the number of borrowers who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs and provision for credit losses, which would reduce our earnings.

Until conditions improve, we expect our business, financial condition and results of operations to continue to be adversely affected.

•	Financial reform legislation recently enacted by Congress will result in new laws and regulations that are expected to increase our costs of operations.

Congress enacted the Dodd-Frank Act in 2010. This law has significantly changed the current bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.

Certain provisions of the Dodd-Frank Act are expected to have a near term effect on us. For example, a provision eliminates the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts. Although not currently quantifiable, this significant change could have an adverse effect on our interest expense.

The Dodd-Frank Act also broadens the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and non-interest bearing transaction accounts have unlimited deposit insurance through December 31, 2012.

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizes the SEC to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not.

The Dodd-Frank Act created the Consumer Financial Protection Bureau with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets will be examined by their applicable bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

It is difficult to predict at this time what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on us in the future. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.

•	Additional requirements under our regulatory framework, especially those imposed under ARRA, EESA or other legislation or regulations intended to strengthen the U.S. financial system, could adversely affect us.

Recent government efforts to strengthen the U.S. financial system, including the implementation of ARRA, EESA, the TLGP and special assessments imposed by the FDIC, subject participants to additional regulatory fees and requirements, including corporate governance requirements, executive compensation restrictions, restrictions on declaring or paying dividends, restrictions on share repurchases, limits on executive compensation tax deductions and prohibitions against golden parachute payments. These requirements, and any other requirements that may be subsequently imposed, may have a material and adverse affect on our business, financial condition, and results of operations.

•	Increases in FDIC insurance premiums may adversely affect the Company’s net income and profitability.

Since 2008, higher levels of bank failures have dramatically increased resolution costs of the FDIC and depleted the Deposit Insurance Fund. In addition, the FDIC has instituted two temporary programs, to further insure customer deposits at FDIC insured banks: deposit accounts are now insured up to $250,000 per customer (up from $100,000), which in 2010 was made permanent, and noninterest-bearing transactional accounts are currently fully insured (unlimited coverage). These programs have placed additional stress on the Deposit Insurance Fund. In order to maintain a strong funding position and restore reserve ratios of the Deposit Insurance Fund, the FDIC has increased assessment rates of insured institutions. In addition, on November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years’ worth of estimated deposit insurance premiums by December 31, 2009. The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are additional bank or financial institution failures, or the cost of resolving prior failures exceeds expectations, the Bank may be required to pay higher FDIC premiums than those currently in force. Any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.

•	The soundness of other financial institutions could adversely affect us.

Since 2008, the financial services industry as a whole, as well as the securities markets generally, have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. Financial institutions in particular have been subject to increased volatility and an overall loss in investor confidence.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, and other institutional clients.

From time to time, we may utilize derivative financial instruments, primarily to hedge our exposure to changes in interest rates, but also to hedge cash flow. By entering into these transactions and derivative instrument contracts, we expose ourselves to counterparty credit risk in the event of default of our counterparty or client. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to us, which creates credit risk for us. We attempt to minimize this risk by selecting counterparties with investment grade credit ratings, limiting our exposure to any single counterparty and regularly monitoring our market position with each counterparty. Nonetheless, defaults by, or even rumors or questions about, one or more financial services companies, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan due us. There is no assurance that any such losses would not materially and adversely affect our businesses, financial condition or results of operations.

•	The capital and credit markets have experienced unprecedented levels of volatility.

During the economic downturn, the capital and credit markets experienced extended volatility and disruption. In some cases, the markets produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. If these levels of market disruption and volatility continue, worsen or abate and then arise at a later date, the Company’s ability to access capital could be materially impaired. The Company’s inability to access the capital markets could constrain the Bank’s ability to make new loans, to meet the Bank’s existing lending commitments and, ultimately jeopardize the Bank’s overall liquidity and capitalization.

•	Our allowance for loan losses may prove to be insufficient to absorb probable losses in our loan portfolio.

Lending money is a substantial part of our business. Every loan carries a degree of risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:

•

cash flow of the borrower and/or a business activity being financed;

•

in the case of a collateralized loan, changes in and uncertainties regarding future values of collateral;

•

the credit history of a particular borrower;

•

changes in economic and industry conditions; and

•

the duration of the loan.

We use underwriting procedures and criteria that we believe minimize the risk of loan delinquencies and losses, but banks routinely incur losses in their loan portfolios. Regardless of the underwriting criteria we use, we will experience loan losses from time to time in the ordinary course of our business, and many of those losses will result from factors beyond our control. These factors include, among other things, changes in market, economic, business or personal conditions, or other events (including changes in market interest rates), that affect our borrowers’ abilities to repay their loans and the value of properties that collateralize loans.

As a result of recent difficulties in the national economy and housing market, declining real estate values, rising unemployment, and loss of consumer confidence, we and most other financial institutions have experienced increasing levels of non-performing loans, foreclosures and loan losses. We maintain an allowance for loan losses which we believe is appropriate to provide for potential losses in our loan portfolio. The amount of our allowance is determined by our management through a periodic review and consideration of internal and external factors that affect loan collectability, including, but not limited to:

•

an ongoing review of the quality, size and diversity of the loan portfolio;

•

evaluation of non-performing loans;

•

historical default and loss experience;

•

historical recovery experience;

•

existing economic conditions;

•

risk characteristics of various classifications of loans; and

•

the amount and quality of collateral, including guarantees, securing the loans.

However, if delinquency levels continue to increase or we continue to incur higher than expected loan losses in the future, there is no assurance that our allowance will be adequate to cover resulting losses or that we will not have to make significant provisions to our allowance.

•	A large percentage of our loans are secured by real estate. Adverse conditions in the real estate market in our banking markets have adversely affected our loan portfolio.

While we do not have a sub-prime lending program, a relatively large percentage of our loans are secured by real estate. Our management believes that, in the case of many of those loans, the real estate collateral is not being relied upon as the primary source of repayment, and the level of our real estate loans reflects, at least in part, our policy to take real estate whenever possible as primary or additional collateral rather than other types of collateral. However, adverse conditions in the real estate market and the economy in general have decreased real estate values in our banking markets. If the value of our collateral for a loan falls below the outstanding balance of that loan, our ability to collect the balance of the loan by selling the underlying real estate in the event of a default will be diminished, and we would be more likely to suffer a loss on the loan. An increase in our loan losses could have a material adverse effect on our operating results and financial condition.

The FDIC recently adopted rules aimed at placing additional monitoring and management controls on financial institutions whose loan portfolios are deemed to have concentrations in commercial real estate (“CRE”). At December 31, 2012, our total commercial real estate loan portfolio excluding owner-occupied commercial real estate loans were below thresholds established by the FDIC for CRE concentrations and for additional regulatory scrutiny. At that same date, our total construction, land and acquisition and development loan portfolio to capital was approximately 123%, which is above the 100% threshold established by the FDIC for CRE concentrations and for additional regulatory scrutiny. Indications from regulators are that strict limitations on the amount or percentage of CRE within any given portfolio are not expected, but, rather, that additional reporting and analysis will be required to document management’s evaluation of the potential additional risks of such concentrations and the impact of any mitigating factors. It is possible that regulatory constraints associated with these rules could adversely affect our ability to grow loan assets and thereby limit our overall growth and expansion plans. These rules also could increase the costs of monitoring and managing this component of our loan portfolio. Either of these eventualities could have an adverse impact on our operating results and financial condition.

•	Liquidity risk could impair our ability to fund operations and jeopardize our financial condition.

Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities, or on terms which are acceptable to us, could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally affect our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as the current disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the turmoil faced by banking organizations and the continued deterioration in credit markets.

Among other sources of funds, we rely heavily on deposits, including out-of-market certificates of deposit, for funds to make loans and provide for our other liquidity needs. Those out-of-market deposits may not be as stable as other types of deposits and, in the future, depositors may not renew those time deposits when they mature, or we may have to pay a higher rate of interest to attract or keep them or to replace them with other deposits or with funds from other sources. Not being able to attract those deposits, or to keep or replace them as they mature, would adversely affect our liquidity. Paying higher deposit rates to attract, keep or replace those deposits could have a negative effect on our interest margin and operating results.

•	We may need to raise additional capital in the future in order to continue to grow, but that capital may not be available when it is needed.

Federal and state banking regulators require us to maintain adequate levels of capital to support our operations. In addition, in the future we may need to raise additional capital to support our business or to finance acquisitions, if any, or we may otherwise elect or be required to raise additional capital. In that regard, recently a number of financial institutions have sought to raise considerable amounts of additional capital in response to a deterioration in their results of operations and financial condition arising from increases in their non-performing loans and loan losses, deteriorating economic conditions, declines in real estate values and other factors. On December 31, 2012, our three capital ratios were above “well capitalized” levels under bank regulatory guidelines. However, growth in our earning assets resulting from internal expansion and new branch offices, at rates in excess of the rate at which our capital is increased through retained earnings, will reduce our capital ratios unless we continue to increase our capital. Also, future unexpected losses, whether resulting from loan losses or other causes, would reduce our capital.

Should we need, or be required by regulatory authorities, to raise additional capital, we may seek to do so through the issuance of, among other things, our common stock or preferred stock. However, our ability to raise additional capital will depend on conditions at that time in the capital markets, economic conditions, our financial performance and condition, and other factors, many of which are outside our control. There is no assurance that, if needed, we will be able to raise additional capital on terms favorable to us or at all. Our inability to raise additional capital, if needed, on terms acceptable to us, may have a material adverse effect on our ability to expand our operations, and on our financial condition, results of operations and future prospects.

•	If we are unable to redeem our Series A Preferred Stock after five years, the cost of this capital to us will increase substantially.

If we are unable to redeem the Series A Preferred Stock we sold to the U.S. Treasury prior to January 16, 2014, the cost of this capital to us will increase from 5.0% per annum (approximately $385,000 annually) to 9.0% per annum (approximately $693,000 annually). Depending on our financial condition at the time, this increase in the annual dividend rate on the Series A Preferred Stock could have a material adverse affect on our liquidity and on our net income available to holders of our common stock.

•	Our profitability is subject to interest rate risk. Changes in interest rates could have an adverse effect on our operating results.

Our profitability depends, to a large extent, on our net interest income, which is the difference between our income on interest-earning assets and our expense on interest-bearing deposits and other liabilities. In other words, to be profitable, we have to earn more interest on our loans and investments than we pay on our deposits and borrowings. Like most financial institutions, we are affected by changes in general interest rate levels and by other economic factors beyond our control. Interest rate risk arises in part from the mismatch ( i.e. , the interest sensitivity “gap”) between the dollar amounts of repricing or maturing interest-earning assets and interest-bearing liabilities, and is measured in terms of the ratio of the interest rate sensitivity gap to total assets. When more interest-earning assets than interest-bearing liabilities will reprice or mature over a given time period, a bank is considered asset-sensitive and has a positive gap. When more liabilities than assets will reprice or mature over a given time period, a bank is considered liability-sensitive and has a negative gap. A liability-sensitive position ( i.e. , a negative gap) may generally enhance net interest income in a falling interest rate environment and reduce net interest income in a rising interest rate environment. An asset-sensitive position ( i.e. , a positive gap) may generally enhance net interest income in a rising interest rate environment and reduce net interest income in a falling interest rate environment. Our ability to manage our gap position determines to a great extent our ability to operate profitably. However, fluctuations in interest rates are not predictable or controllable, and recent economic and financial market conditions have made it extremely difficult to manage our gap position. Our profitability and results of operations will be adversely affected if we do not successfully manage our interest sensitivity gap.

On December 31, 2012, we had a negative one-year cumulative interest sensitivity gap, which means that, during a one-year period, our interest-bearing liabilities generally would be expected to reprice at a faster rate than our interest-earning assets. A rising rate environment within that one-year period generally would have a negative effect on our earnings, while a falling rate environment generally would have a positive effect on our earnings.

•	Our long-range business strategy includes the continuation of our growth plans, and our financial condition and operating results could be negatively affected if we fail to grow or fail to manage our growth effectively.

Subject to market conditions and the economy, we intend to continue to grow in our existing banking markets (internally and through additional offices) and to expand into new markets as appropriate opportunities arise. We have opened five de novo branch offices since 2000. Consistent with our business strategy, and to sustain our growth, in the future we may establish other de novo branches or acquire other financial institutions or their branch offices.

There are considerable costs involved in opening branches, and new branches generally do not generate sufficient revenues to offset their costs until they have been in operation for some period of time. Any new branches we open can be expected to negatively affect our operating results until those branches reach a size at which they become profitable. In establishing new branches in new markets, we compete against other banks with greater knowledge of those local markets and may need to hire and rely on local managers who have local affiliations and to whom we may need to give significant autonomy. If we grow but fail to manage our growth effectively, there could be material adverse effects on our business, future prospects, financial condition or operating results, and we may not be able to successfully implement our business strategy. On the other hand, our operating results also could be materially affected in an adverse way if our growth occurs more slowly than anticipated, or declines.

Although we believe we have management resources and internal systems in place to successfully manage our future growth, we cannot assure you that we will be able to expand our market presence in our existing markets or successfully enter new markets, or that expansion will not adversely affect our operating results.

•	Our business depends on the condition of the local and regional economies where we operate.

We currently have offices only in Guilford County, North Carolina. Consistent with our community banking philosophy, a majority of our customers are located in and do business in that region, and we lend a substantial portion of our capital and deposits to commercial and consumer borrowers in our local banking markets. Therefore, our local and regional economy has a direct impact on our ability to generate deposits to support loan growth, the demand for loans, the ability of borrowers to repay loans, the value of collateral securing our loans (particularly loans secured by real estate), and our ability to collect, liquidate and restructure problem loans. If our local communities are adversely affected by current conditions in the national economy or by other specific events or trends, there could be a direct adverse effect on our operating results. Adverse economic conditions in our banking markets could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally affect our financial condition and operating results. We are less able than larger institutions to spread risks of unfavorable local economic conditions across a large number of diversified economies.

The economy of North Carolina’s Piedmont Triad region can be affected by adverse weather events. Our banking markets lie in one county, and we cannot predict whether or to what extent damage caused by future weather events will affect our operations, our customers or the economies in our banking markets. However, weather events could cause a decline in loan originations, destruction or decline in the value of properties securing our loans, or an increase in the risks of delinquencies, foreclosures and loan losses.

•	New or changes in existing tax, accounting, and regulatory rules and interpretations could have an adverse effect on our strategic initiatives, results of operations, cash flows, and financial condition.

We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a financial company’s shareholders. These regulations may sometimes impose significant limitations on our operations, and our compliance with regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits, and locations of offices.

The significant federal and state banking regulations that affect us are described under “Item 1. Business—Supervision and Regulation.” These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations, control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. The laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. As a result of turmoil in the financial services industry, there has been an increase in the regulation of all financial institutions. We cannot predict the effects of such changes on our business and profitability.

•	Significant legal actions could subject us to substantial liabilities.

We are from time to time subject to claims related to our operations. These claims and legal actions, including supervisory actions by our regulators, could involve large monetary claims and significant defense costs. As a result, we may be exposed to substantial liabilities, which could adversely affect our results of operations and financial condition.

Among the laws that apply to us, the Patriot Act and Bank Secrecy Act of 1970, as amended, require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. Several banking institutions have recently received large fines for non-compliance with these laws and regulations. Although we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.

•	Competition from financial institutions and other financial service providers may adversely affect our profitability.

Our future growth and success will depend on, among other things, our ability to compete effectively with other financial services providers in our banking markets. To date, we have grown our business by focusing on our lines of business and emphasizing the high level of service and responsiveness desired by our customers. However, commercial banking in our banking markets and in North Carolina as a whole is extremely competitive. We compete against commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as other local and community, super-regional, national and international financial institutions that operate offices in our market areas and elsewhere. We compete with these institutions in attracting deposits and in making loans, and we have to attract our customer base from other existing financial institutions and from new residents. Our larger competitors have greater resources, broader geographic markets and name recognition, and higher lending limits than we do, and they can offer more products and services and better afford and more effectively use media advertising, support services and electronic technology than we can. Also, larger competitors may be able to price loans and deposits more aggressively than we do. While we believe we compete effectively with other financial institutions, we may face a competitive disadvantage as a result of our size, lack of geographic diversification and inability to spread marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts and greater flexibility and responsiveness in working with local customers, we cannot assure you that we will continue to be an effective competitor in our banking markets.

•	We rely on dividends from the Bank for substantially all of our revenue.

We receive substantially all of our revenue as dividends from the Bank. As described under “Item 1. Business—Supervision and Regulation,” federal and state regulations limit the amount of dividends that the Bank may pay to us. If the Bank becomes unable to pay dividends to us, then we may not be able to service our debt, pay our other obligations or pay dividends on the Series A Preferred Stock we sold to the U.S. Treasury. Accordingly, our inability to receive dividends from the Bank could also have a material adverse effect on our business, financial condition and results of operations and the value of your investment in our common stock.

•	We depend on the services of our current management team.

Our operating results and ability to adequately manage our growth and minimize loan losses are highly dependent on the services, managerial abilities and performance of our executive officers. Smaller banks, like us, sometimes find it more difficult to attract and retain experienced management personnel than larger banks. We currently have an experienced management team that our Board of Directors believes is capable of managing and growing the Bank. However, changes in or losses of key personnel of any company could disrupt that company’s business and could have an adverse effect on its business and operating results.

•	The Company and the Bank compete with much larger companies for some of the same business.

The banking and financial services business in our market areas continues to be a competitive field and it is becoming more competitive as a result of:

•

Changes in regulations;

•

Changes in technology and product delivery systems; and

•

The accelerating pace of consolidation among financial services providers.

We may not be able to compete effectively in our markets, and our results of operations could be adversely affected by the nature or pace of change in competition. We compete for loans, deposits and customers with various bank and nonbank financial services providers, many of which are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services.

•	Negative publicity could damage our reputation.

Reputation risk, or the risk to our earnings and capital from negative public opinion, is inherent in our business. Negative public opinion could adversely affect our ability to keep and attract customers and expose us to adverse legal and regulatory consequences. Negative public opinion could result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance, mergers and acquisitions, and disclosure, sharing or inadequate protection of customer information, and from actions taken by government regulators and community organizations in response to that conduct.

•	The Bank is subject to environmental liability risk associated with lending activities.

A significant portion of the Bank’s loan portfolio is secured by real property. During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations of enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability. Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company’s financial condition and results of operations.

•	Financial services companies depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. We may also rely on representations of those customers, counterparties, or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could cause us to enter into unfavorable transactions, which could have a material adverse effect on our financial condition and results of operations.

•	Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows.

Liquidity is essential to our business. Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital, possible acquisitions and other general corporate purposes. An inability to raise funds through deposits, borrowings, securities sold under repurchase agreements, the sale of loans and other sources could have a substantial negative effect on our liquidity. We do not anticipate that our retail and commercial deposits will be sufficient to meet our funding needs in the foreseeable future. We therefore rely on deposits obtained through intermediaries, FHLB advances, securities sold under agreements to repurchase and other wholesale funding sources to obtain the funds necessary to manage our balance sheet.

Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general, including a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.

•	Impairment of investment securities, certain other intangible assets, or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.

In assessing the impairment of investment securities, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Under current accounting standards, certain other intangible assets with indeterminate lives are no longer amortized but, instead, are assessed for impairment periodically or when impairment indicators are present. Assessment of certain other intangible assets could result in circumstances where the applicable intangible asset is deemed to be impaired for accounting purposes. Under such circumstances, the intangible asset’s impairment would be reflected as a charge to earnings in the period during which such impairment is identified. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.

•	We rely on other companies to provide key components of our business infrastructure.

Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delay and expense.

•	Our information systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption, or security breach of our information systems, we cannot assure you that any such failures, interruptions, or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions, or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

•	Our common stock is not FDIC insured.

Our common stock is not a savings or deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental agency and is subject to investment risk, including the possible loss of principal. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, holders of our common stock may lose some or all of their investment.

•	The price of our common stock may fluctuate significantly, and this may make it difficult for you to resell our common stock when you want or at prices you find attractive.

We cannot predict how or at what prices our common stock will trade in the future. The market value of our common stock will likely continue to fluctuate in response to a number of factors including the following, most of which are beyond our control, as well as the other factors described in this “Risk Factors” section:

•

Actual or anticipated quarterly fluctuations in our operating and financial results;

•

Changes in financial estimates and recommendations by financial analysts;

•

Actions of our current shareholders, including sales of common stock by existing shareholders and our directors and executive officers;

•

Fluctuations in the stock price and operating results of our competitors;

•

Regulatory developments; and

•

Developments related to the financial services industry.

The market value of and trading in our common stock also is affected by conditions (including price and trading fluctuations) affecting the financial markets in general, and in the market for the stocks of financial services companies in particular. These conditions may result in volatility in the market prices of stocks generally and, in turn, our common stock. Also, market conditions may result in sales of substantial amounts of our common stock in the market. In each case, market conditions could affect the market price of our stock in a way that is unrelated or disproportionate to changes in our operating performance.

•	The trading volume in our common stock has been low, and the sale of a substantial number of shares in the public market could depress the price of our stock and make it difficult for you to sell your shares.

Our common stock is listed on the NASDAQ Capital Market, but it has a relatively low average daily trading volume relative to many other stocks. Thinly traded stock can be more volatile than stock trading in an active public market, which can lead to significant price swings even when a relatively small number of shares are being traded and limit an investor’s ability to quickly sell blocks of stock. We cannot predict what effect future sales of our common stock in the market, or the availability of shares of our common stock for sale in the market, will have on the market price of our common stock.

•	Our management beneficially owns a substantial percentage of our common stock, so our directors and executive officers can significantly affect voting results on matters voted on by our shareholders.

Our current directors and executive officers, as a group, beneficially own a significant percentage of our outstanding common stock. Because of their voting rights, in matters put to a vote of our shareholders it could be difficult for any group of our other shareholders to defeat a proposal favored by our management (including the election of one or more of our directors) or to approve a proposal opposed by management.

•	The Securities Purchase Agreement between us and the U.S. Treasury limits our ability to pay dividends on and repurchase our common stock.

The Securities Purchase Agreement between us and the U.S. Treasury provides that prior to the earlier of January 30, 2012, and the date on which all of the shares of Series A Preferred Stock held by the U.S. Treasury have been redeemed by us or transferred by the U.S. Treasury to third parties, we may not, without the consent of the U.S. Treasury:

•

increase the cash dividend on our common stock; or

•

subject to limited exceptions, redeem, repurchase or otherwise acquire shares of our common stock or preferred stock (other than the Series A Preferred Stock) or trust preferred securities.

In addition, we are unable to pay any dividends on our common stock unless we are current in our dividend payments on the Series A Preferred Stock. These restrictions, together with the potentially dilutive impact of the Warrant, could have a negative effect on the value of our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our Board of Directors. We have not historically paid cash dividends on our common stock.

• Our outstanding Series A Preferred Stock affects net income available to our common shareholders and earnings per common share.

The dividends declared on our Series A Preferred Stock will reduce the net income available to common shareholders and our earnings per common share. The Series A Preferred Stock will also receive preferential treatment in the event of liquidation, dissolution or winding up of Company.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

The following table summarizes certain information about the headquarters of the Company, the Bank’s branch offices in Summerfield and Greensboro, as well as information related to the Company’s administrative offices as of December 31, 2012.

Office Location	Year Opened	Approximate Square Footage		Owned or Leased	Lease Terms
Main Office 2211 Oak Ridge Road Oak Ridge, North Carolina	2003		6,800	Building Owned/ Land Leased (1)	Ground lease expires in 2023 with two (2) ten-year renewal options

Summerfield Office 4423 NC Highway 220 North Summerfield, North Carolina	2003		3,300	Leased	Expires in 2023 with four (4) five-year renewal options

Old Operations Center 1684 NC Highway 68 North Oak Ridge, North Carolina	2001		2,800	Owned (2)

Greensboro Office 1597 New Garden Road Greensboro, North Carolina	2005		3,500	Building Owned/ Land Leased	Ground lease expires in 2025 with four (4) five-year renewal options


Office Location	Year Opened	Approximate Square Footage		Owned or Leased	Lease Terms
Irving Park Office 2102 Elm Street, Suite C Greensboro, North Carolina	2006		2,500	Leased	Expires in 2013 with (2) five-year renewal options

Lake Jeanette Office 400 Pisgah Church Road Greensboro, North Carolina	2008		5,800	Owned		N/A

Headquarters Building 8050 Fogleman Road Oak Ridge, NC 27410	2009		14,000	Owned		N/A

(1)	The Bank leases the 2.04 acres of land underlying the building.

(2)	The Bank owns 1.2 acres of land that formerly occupied the Bank’s operation center. The land is presently for sale.

At December 31, 2012, the total consolidated net book value of the Company’s land, buildings and leasehold improvements totaled approximately $7.5 million. The total net book value of its furniture, fixtures and equipment at December 31, 2012 was approximately $1.9 million. Each of the existing and proposed facilities and locations of the Company and its subsidiaries is considered by management to be in good condition and adequately covered by insurance.

Any property acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until the time it is sold or otherwise disposed of by the Bank in an effort to recover its investment. At December 31, 2012, the Bank had $2.1 million in real estate acquired in settlement of loans.

ITEM 3. LEGAL PROCEEDINGS

From time to time the Company or one of its subsidiaries may become involved in legal proceedings occurring in the ordinary course of business. However, subject to the uncertainties inherent in any litigation, management believes there currently are no pending or threatened proceedings that are reasonably likely to result in a material adverse change in the Company’s financial condition or operations.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Bank’s common stock began trading on April 6, 2000 and began quotation on the NASDAQ Capital Market under the symbol “BKOR” on January 29, 2004. Prior to January 29, 2004, there was no established public market for the common stock. In April of 2007, the Bank was reorganized as a subsidiary of the Company. The common stock of the Company continues to be quoted on the NASDAQ Capital Market under the symbol “BKOR.”

As of March 1, 2013, the Company had approximately 864 shareholders of record, exclusive of Depository Trust Company’s nominee CEDE & Company.

The following table lists the high and low sales information for the Company’s common stock for the periods indicated. Prices in the table reflect inter-dealer prices, without retail mark-up, markdown, or commission, and may not represent actual transactions. On March 12, 2013, the last sale of the Company’s common stock quoted on the NASDAQ Capital Market was $3.16 per share.

	Sales Price Range
Quarter	High		Low
2012 First	$	3.92	$	2.15
Second	$	5.75	$	3.75
Third	$	4.84	$	2.56
Fourth	$	4.90	$	3.53

	Sales Price Range
Quarter	High		Low
2011 First	$	5.00	$	4.25
Second	$	5.89	$	4.80
Third	$	5.89	$	4.20
Fourth	$	5.00	$	4.10

Equity Compensation Plan Information

The following table presents the number of shares of common stock to be issued upon the exercise of outstanding options as of December 31, 2012, the weighted-average price of the outstanding options and the number of options remaining that may be issued under the Company’s stock option plans described below.

EQUITY COMPENSATION PLAN INFORMATION

Plan category	(a) Number of shares to be issued upon exercise of outstanding options		(b) Weighted-average exercise price of outstanding options		(c) Number of shares remaining available for future issuance under equity compensation plans (excluding shares reflected in column (a))
Equity compensation plans approved by the Bank’s security holders		227,390	$	9.68		451,728

Equity compensation plans not approved by the Bank’s security holders		—		N/A		—

Total		227,390	$	9.68		451,728

The Company did not repurchase any shares of common stock during the fourth quarter of 2012.

See “ITEM 1. DESCRIPTION OF BUSINESS–Supervision and Regulation” above for regulatory restrictions which limit the ability of the Company and the Bank to pay dividends. Neither the Company nor the Bank has paid any cash dividends since its inception.

See “ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT” below for information on equity compensation plans information.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following presents management’s discussion and analysis of our financial condition and results of operations and should be read in conjunction with the financial statements and related notes combined in Item 8 of this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from those anticipated in these forward-looking statements as a result of various factors. The following discussion is intended to assist in understanding the financial condition and results of operations of the Company. Because the Company has no material operations and conducts no business on its own other than owning its subsidiary, the Bank, the discussion contained in this Management's Discussion and Analysis concerns primarily the business of the Bank. However, for ease of reading and because the financial statements are presented on a consolidated basis, the Company and the Bank are collectively referred to herein as the Company unless otherwise noted.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations describes our results of operations for the year ended December 31, 2012 as compared to the year ended December 31, 2011, and also analyzes our financial condition as of December 31, 2012 as compared to December 31, 2011. Like most financial institutions, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on most of which we pay interest. Consequently, one of the key measures of our success is the amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb our estimate of probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.

Markets in the United States and elsewhere have experienced extreme volatility and disruption for more than 12 months. These circumstances have exerted significant downward pressure on prices of equity securities and virtually all other asset classes, and have resulted in substantially increased market volatility, severely constrained credit and capital markets, particularly for financial institutions, and an overall loss of investor confidence. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. Dramatic slowdowns in the housing industry with falling home prices and increasing foreclosures and unemployment have created strains on financial institutions. Many borrowers are now unable to repay their loans, and the value of the collateral securing these loans has, in some cases, declined below the loan balance. The following discussion and analysis describes our performance in this challenging economic environment.

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011

Net Income (loss)

In 2012, the Company had a net loss of $2.6 million or $1.45 basic and diluted earnings per share, compared to a net loss of $289 thousand or $0.16 basic and diluted earnings per share for the year ended December 31, 2011. The increase in our net loss is primarily attributable to increases in our provisions for loan losses.

The following table shows return on assets (net loss divided by average assets), return on equity (net income (loss) available to common shareholders divided by average common shareholders’ equity) and shareholders’ equity to assets ratio (average total shareholders’ equity divided by average total assets) for each of the years presented.

	Year Ended December 31,
	2012			2011			2010
Return on assets		(0.56	)%		0.10	%		0.21	%
Return (loss) on equity		(12.83	)		(1.85	)		2.59
Shareholders’ equity to assets		7.58			7.97			7.97

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. The level of net interest income is determined primarily by the average balances (volume) of interest-earning assets and our interest-bearing liabilities and the various rate spreads between our interest-earning assets and interest-bearing liabilities. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio, and the availability of particular sources of funds, such as non-interest-bearing deposits.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities. The net interest rate spread does not consider the impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing non-interest-bearing deposits in earning assets.

Our net interest income for the year ended December 31, 2012 was $13.4 million, a decrease of $731 thousand or 5.2% when compared to net interest income of $14.2 million for the year ended December 31, 2011. Our net interest margin for 2012 was 4.11% compared to 4.33% for 2011. The decrease in our net interest margin is mainly the result of a decline in yields on interest-earning assets offset by decreased rates paid on our interest bearing liabilities. Our net interest rate spread for 2012 was 3.98% compared to a 4.19% for 2011.

Total interest income decreased $1.8 million or 10.1% to $15.8 million in 2012 compared to $17.5 million in interest income in 2011. A decrease in the yield on interest-earning assets in 2012 when compared to 2011 resulted in a decline in interest income from 2011 to 2012. The yield on average earning assets decreased 56 basis points during 2012 compared to 2011.

The effect of variances in volume and rate on interest income and interest expense is illustrated in the table titled “Change in Interest Income and Expense” on page 27 of this Annual Report on Form 10-K. We attribute the majority of the decrease in the yield on our earning assets to a decline in the yield on our investment securities and loan portfolios, which was due to a decline in yields on new investment purchases and new and renewed loans during the year, respectively, in a lower interest rate environment.

Our average cost of funds for 2012 was 0.82%, a decrease of 35 basis points when compared to 1.17% for 2011. The average cost on interest bearing deposit accounts decreased 38 basis points from 1.16% paid in 2011 to 0.78% paid in 2012, while our average cost of borrowed funds also increased 78 basis points during 2012 compared to 2011.

Total interest expense decreased $1.1 million or 32.6% to $2.3 million in 2012 from $3.4 million in 2011, primarily the result of decreased market rates paid on Bank certificates of deposit as well as decreases in other interest-bearing deposit accounts. The volume of average interest-bearing deposits increased approximately $1.0 million when comparing 2012 with that of 2011. The decrease to interest expense resulting from decreased rates on all interest-bearing liabilities was $1.0 million and the decrease attributable to lower volumes of interest-bearing liabilities was $12 thousand.

Our net interest income for the year ended December 31, 2011 was $14.2 million, an increase of $801 thousand or 6.0% when compared to net interest income of $13.3 million for the year ended December 31, 2010. Our net interest margin for 2011 was 4.33% compared to 4.13% for 2010. The increase in our net interest margin is mainly the result of decreased rates paid on our interest bearing liabilities, offset by a decline in yields on interest-earning assets. Our net interest rate spread, on a tax-equivalent basis, for 2011 was 4.19% compared to a 3.97% for 2010.

Total interest income decreased $579 thousand or 3.2% to $17.5 million in 2011 compared to $18.1 million in interest income in 2010. A decrease in the yield on interest-earning assets in 2011 when compared to 2010 resulted in a decline in interest income from 2010 to 2011, but the decline in yield was partially offset by increases in average earning assets of $4.0 million in 2011 when compared to 2010. We funded the increases in interest-earning assets primarily with interest-bearing checking, savings, and money market deposit growth. The yield on average earning assets decreased 24 basis points during 2011 compared to 2010.

The effect of variances in volume and rate on interest income and interest expense is illustrated in the table titled “Change in Interest Income and Expense” on page 27 of this Annual Report on Form 10-K. We attribute the majority of the decrease in the yield on our earning assets to a decline in the yield on our taxable investment securities portfolio, which was due to a decline in yields on new investment purchases during the year. To a lesser extent, some of the decline in the total yield on interest-earning assets was caused by new and renewing fixed rate loans originated in a lower interest rate environment.

Our average cost of funds for 2011 was 1.17%, a decrease of 46 basis points when compared to 1.63% for 2010. The average cost on interest bearing deposit accounts decreased 50 basis points from 1.66% paid in 2010 to 1.16% paid in 2011, while our average cost of borrowed funds also increased 18 basis points during 2011 compared to 2010.

Total interest expense decreased $1.4 million or 29.2% to $3.4 million in 2011 from $4.8 million in 2010, primarily the result of decreased market rates paid on Bank certificates of deposit as well as decreases in other interest-bearing deposit accounts. The volume of average interest-bearing deposits increased approximately $986 thousand when comparing 2011 with that of 2010. The decrease to interest expense resulting from decreased rates on all interest-bearing liabilities was $1.3 million and the increase attributable to higher volumes of interest-bearing liabilities was $32 thousand.

Average Balances and Average Rates Earned and Paid

The following table presents an analysis of average interest-earning assets and interest-bearing liabilities, the interest income or expense applicable to each asset or liability category and the resulting yield or rate paid.

Net Interest Income and Average Balances (dollars in thousands)

	Years Ended December 31,
	2012							2011							2010
	Average Balance		Interest		Average Yield/ Rate			Average Balance		Interest		Average Yield/ Rate			Average Balance		Interest		Average Yield/ Rate
Interest-earning assets:
Federal funds sold and interest bearing bank deposits	$	15,582	$	52		0.33	%	$	15,917	$	69		0.43	%	$	22,159	$	80		0.36	%
Investment securities and restricted equity securities		57,174		2,267		4.36			57,174		2,922		5.11			48,176		3,006		6.24
Loans receivable and loans held for sale(1)(2)		259,447		13,433		5.16			254,039		14,535		5.72			252,800		15,019		5.94

Total interest-earning assets		332,203		15,752		4.80			327,130		17,526		5.36			323,135		18,105		5.60
Non-interest-earning assets		22,213							21,985							22,308
Total assets	$	354,416						$	349,115						$	345,443

Interest-bearing liabilities:
Deposit accounts	$	274,074	$	2,151		0.78	%	$	275,087	$	3,191		1.16	%	$	274,101	$	4,551		1.66	%
Borrowings		8,367		179		2.13			13,451		182		1.35			17,256		202		1.17
Total interest-bearing liabilities		282,441		2,330		0.82			288,538		3,373		1.17			291,357		4,753		1.63
Non-interest-bearing liabilities		39,049							32,609							25,849
Stockholders’ equity		27,663							27,968							28,237
Total liabilities and stockholders’ equity	$	349,153						$	349,115						$	345,443
Net interest income and interest rate spread			$	13,422		3.98	%			$	14,153		4.19	%			$	13,352		3.97	%
Net interest-earning assets and net interest margin(3)	$	44,499				4.11	%	$	31,778				4.33	%	$	31,778				4.13	%
Ratio of interest-earning assets to interest-bearing liabilities						115.76	%						113.38	%						110.91	%

(1)	Average loan balances include nonaccrual loans.

(2)	Deferred loan fees are included in interest income.

(3)	Net interest margin is net interest income divided by average interest earning assets.

The following table presents the relative impact on net interest income of the volume of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

Change in Interest Income and Expense

	Year Ended December 31, 2012 vs. 2011									Year Ended December 31, 2011 vs. 2010
	Increase (Decrease) Due to									Increase (Decrease) Due to
	Total			Rate			Volume			Total			Rate			Volume
	(dollars in thousands)
Interest income:
Federal funds sold and interest-bearing bank deposits	$	(17	)	$	(16	)	$	(1	)	$	(11	)	$	14		$	(25	)
Taxable investment and restricted equity securities		(655	)		(403	)		(252	)		(84	)		(594	)		510
Loans receivable		(1,102	)		(1,413	)		311			(484	)		(557	)		73
Total interest income		(1,774	)		(1,832	)		58			(579	)		(1,137	)		558

Interest expense:
Deposit accounts		(1,040	)		(1,028	)		(12	)		(1,360	)		(1,376	)		16
Borrowings		(3	)		81			(84	)		(20	)		28			(48	)
Total interest expense		(1,043	)		(947	)		(96	)		(1,380	)		(1,348	)		(32	)
Net interest income increase (decrease)	$	(731	)	$	(885	)	$	154		$	801		$	211		$	590

Rate Sensitivity Management

Rate sensitivity management, an important aspect of achieving satisfactory levels of net interest income, is the management of the composition and maturities of rate-sensitive assets and liabilities. The following table sets forth our interest sensitivity analysis at December 31, 2012 and describes, at various cumulative maturity intervals, the gap-ratios (ratios of rate-sensitive assets to rate-sensitive liabilities) for assets and liabilities that we consider to be rate sensitive. The interest-sensitivity position has meaning only as of the date for which it was prepared. Variable rate loans are considered to be highly sensitive to rate changes and are assumed to reprice within 12 months.

The difference between interest-sensitive asset and interest-sensitive liability repricing within time periods is referred to as the interest-rate-sensitivity gap. Gaps are identified as either positive (interest-sensitive assets in excess of interest-sensitive liabilities) or negative (interest-sensitive liabilities in excess of interest-sensitive assets).

As of December 31, 2012, we had a negative one year cumulative gap of 17.5%. We have interest-earning assets of $171.6 million maturing or repricing within one year and interest-bearing liabilities of $227.6 million repricing or maturing within one year. This is primarily the result of short-term interest sensitive liabilities being used to fund longer term interest-earning assets, such as loans and investment securities. A negative gap position implies that interest-bearing liabilities (deposits and other borrowings) will reprice at a faster rate than interest-earning assets (loans and investments). In a falling rate environment, a negative gap position will generally have a positive effect on earnings, while in a rising rate environment this will generally have a negative effect on earnings.

On December 31, 2012, savings, NOW and Money Market accounts totaled $143.1 million. In our rate sensitivity analysis, these deposits are considered as repricing in the earliest period (3 months or less) because the rate we pay on these interest-bearing deposits can be changed weekly. However, our historical experience has shown that changes in market interest rates have little, if any, effect on those deposits within a given time period and, for that reason, those liabilities could be considered non-rate sensitive. If those deposits were excluded from rate sensitive liabilities, our rate sensitive assets and liabilities would be more closely matched at the end of the one year period.

Rate Sensitivity Analysis as of December 31, 2012

	3 Months Or Less			4-12 Months			Total Within 12 Months			Over 12 Months			Total
	(Dollars in thousands)
Earning assets:
Loans held for sale	$	1,787		$	—		$	1,787		$	—		$	1,787
Loans—gross		103,770			44,732			148,502			111,345			259,847
Investment securities at amortized cost		4,179			4,650			8,829			36,570			45,399
Interest bearing deposits		11,909			—			11,909			—			11,909
FHLB stock		528			—			528			—			528

Total earning assets	$	122,173		$	49,382		$	171,555		$	147,915		$	319,470

Percent of total earnings assets		38.2	%		15.5	%		53.7	%		46.3	%		100.0	%
Cumulative percentage of total earning assets		38.2			53.7			53.7			100.0

Interest-bearing liabilities:
Savings, NOW and Money Market deposits	$	143,073		$	—		$	143,073		$	—		$	143,073
Time deposits		31,609			44,687			76,296			45,270			121,566
Long-term obligations		8,248			—			8,248			—			8,248

Total interest-bearing liabilities	$	182,930		$	44,687		$	227,617		$	45,270		$	272,887

Percent of total interest-bearing liabilities		67.0	%		16.4	%		83.4	%		16.6	%		100.0	%
Cumulative percent of total interest-bearing liabilities		67.0	%		83.4	%		83.4	%		100.0	%

Ratios:
Ratio of earning assets to interest-bearing liabilities (gap ratio)		66.8	%		110.5	%		75.4	%		326.7	%		117.1	%
Cumulative ratio of earning assets to interest-bearing liabilities (cumulative gap ratio)		66.8	%		75.4	%		75.4	%		117.1	%
Interest sensitivity gap	$	(60,757	)	$	4,695		$	(56,062	)	$	102,645		$	46,583
Cumulative interest sensitivity gap		(60,757	)		(56,062	)		(56,062	)		46,583			46,583
As a percent of total earnings assets		(19.0	)%		(17.5	)%		(17.5	)%		14.6	%		14.6	%

Management believes that the simulation of net interest income in different interest rate environments provides a more meaningful measure of interest rate risk. Income simulation analysis captures not only the potential of all assets and liabilities to mature or reprice, but also the probability that they will do so. Income simulation also attends to the relative interest rate sensitivities of these items, and projects their behavior over an extended period of time. Finally, income simulation permits management to assess the probable effects on the balance sheet not only of changes in interest rates, but also of proposed strategies for responding to them.

The Company’s income simulation model was developed by Profitstar, a financial-services consulting firm that provides asset/liability management solutions, product pricing solutions and other products and services to banks, thrifts, and credit unions nationwide. The model analyzes interest rate sensitivity by projecting net interest income and net income over the next 12 months in a flat rate scenario versus net interest income and net income in alternative interest rate scenarios. Management continually reviews and refines its interest rate risk management process in response to the changing economic climate.

The Company’s ALCO (Asset Liability Committee) policy has established that interest income sensitivity will be considered acceptable if net interest income does not decline from the flat rate scenario more than 5.0%, 12.0%, 22.0%, and 34.0% in the plus and minus 100, 200, 300 and 400 basis point scenarios, respectively. These interest rate scenarios assume that rates increase immediately and permanently. At December 31, 2012, the Company’s income simulation model projects that net interest income would increase 2.8%, 4.7%, 6.1% and 7.3% in the plus 100, 200, 300 and 400 basis point change scenarios. All of these forecasts are within an acceptable level of interest rate risk per the policies established by ALCO. ALCO did not consider the minus 100, 200, 300 and 400 basis point change scenarios relevant at December 31, 2012 due to the current low rate environment.

The ALCO policy also has established that interest income sensitivity will be considered acceptable if economic value of equity does not decline from the flat rate scenario more than 9.0%, 19.0%, 33.0%, and 51.0% in the plus and minus 100, 200, 300 and 400 basis point scenarios, respectively. These interest rate scenarios assume that rates increase immediately and permanently. At December 31, 2012, the Company’s income simulation model projects that economic value of equity would increase 12.7%, 15.1%, 13.6%, and 7.1% in the plus 100, 200, 300, and 400 basis point change scenarios, respectively. All of these forecasts are within an acceptable level of interest rate risk per the policies established by ALCO. ALCO did not consider the minus 100, 200, 300 and 400 basis point change scenarios relevant at December 31, 2012 due to the current low rate environment.

In the event the model indicates an unacceptable level of risk, management could undertake a number of actions that would reduce this risk, including the sale of a portion of the Company’s available-for-sale investment portfolio, the use of risk management strategies such as interest rate swaps and caps, or the extension of the maturities of its short-term borrowings.

Noninterest Income

Noninterest income, principally charges and fees assessed for the use of our services, is a significant contributor to our total revenue. The following table presents the components of noninterest income for 2012 and 2011.

Noninterest Income

	For the Twelve Months Ended			Changes from the Prior Year						For the Twelve Months Ended
	December 31, 2012			Amount			%			December 31, 2011
	(dollars in thousands)
Service charges on deposit accounts	$	556		$	88			18.8		$	468
Gain on sale of securities		-			(463	)		100.0			463
Gain(loss) on sale of property and equipment		60			64			(1600	)		(4	)
Mortgage loan origination fees		673			641			264.8			242
Investment and insurance commissions		648			(337	)		(34.2	)		985
Fee income from accounts receivable financing		695			(94	)		(11.9	)		789
Debit card interchange income		794			170			27.2			624
Impairment loss on securities		(1	)		47			(97.9	)		(48	)
Income earned on bank owned life insurance		139			(8	)		(5.4	)		147
Other service charges and fees		120			42			53.8			78
Total noninterest income	$	3,684		$	(60	)		(1.6	)	$	3,744

In 2012 noninterest income decreased approximately $60 thousand or 1.6% to $3.68 million compared to $3.74 million for the same period in 2011 due primarily to decreases in gains on the sale of securities, investment and insurance commissions, and fee income from accounts receivable financing, which were offset by increases in mortgage loan origination fees and debit card interchange income. Service charges on deposit accounts increased by $88 thousand or 18.8% due primarily to an increase in overdraft fees and service charges and fees on consumer accounts and contributed partly to the overall increase in service charges on deposit accounts. In 2012, the Bank reinstated its automated overdraft product, which replaced an adhoc decision overdraft program put in place in 2011. Service charges on deposit accounts also increased due to a conversion of existing consumer checking accounts on September 1, 2012 to new account types, some of which contain monthly service charges if certain activities are not performed by the account holder. Gains on the sale of securities decreased $463 thousand or 100.0% due to no such sales in 2012. Gain (loss) on the sale of property and equipment increased by $64 thousand compared to 2011 as a result of the sale of certain leasehold improvements and equipment to Gate City Advisors. Mortgage loan origination fees were up by $641 thousand or 178.1% due to a strong refinance market amid a continuing low mortgage interest rate environment. Investment and insurance commissions decreased by $337 thousand or 34.2%, as a result of the separation of the Oak Ridge Wealth Management division from the Bank as of July 1, 2012. Under the arrangement in place after July 1, 2012, the Bank receives a smaller portion of investment commissions originated by Oak Ridge Wealth Management but incurs no costs for employees or associated expenses. Debit card interchange income was up by $170 thousand or 27.2% due to a high number of debit cards and increased transactions due to the continued implementation of a debit cards reward program by the Bank in late 2009. The introduction of new consumer checking accounts that incent increased debit card usage also contributed to the increase. Income earned on bank owned life insurance decreased by $8 thousand or 5.4% due to lower rates in 2012 on the underlying life insurance policies. Other service charges and fees increased by $42 thousand, or 53.8% from 2011 to 2012, primarily due to the recovery of expenses in excess of those incurred by the Bank in a prior period on a former borrowing relationship.

Noninterest Expense

Noninterest expense increased $1,107 thousand or 8.2% to $14.6 million in 2012 compared to $13.5 million in 2011. The following table presents the components of noninterest expense for 2012 and 2011.

Sources of Noninterest Expense

	For the Twelve Months Ended		Changes from the Prior Year						For the Twelve Months Ended
	December 31, 2012		Amount			%			December 31, 2011
	(dollars in thousands)
Salaries	$	6,243	$	268			4.5		$	5,975
Employee benefits		802		(16	)		(2.0	)		818
Occupancy expense		882		8			0.9			874
Equipment expense		940		71			8.2			869
Data and items processing		1,227		252			25.8			975
Professional and advertising		1,175		(1	)		(0.1	)		1,176
Stationary and supplies		289		(113	)		(28.1	)		402
Net cost of foreclosed assets		967		560			137.6			407
Telecommunications expense		322		104			47.7			218
FDIC assessment		304		(58	)		(16.0	)		362
Accounts receivable financing expense		200		(45	)		(18.4	)		245
Other expense		1,278		77			6.4			1,201
Total noninterest expense	$	14,629	$	1,107			8.2		$	13,522

Salary expense increased $268 thousand or 4.5% in 2012 compared to 2011. This increase is the result of general cost of living and merit increases for employees, which was offset by a reduction in the number of employees in 2012 as compared to 2011. Full time equivalent employees declined from 105 as of December 31, 2011 to 90 as of December 31, 2012, but most of the reduction occurred in the second half of 2012 which mitigated the impact on salary expense. Employee benefits decreased $16 thousand or 2.0% in 2012 over the prior year, principally due to a reduction in the number of employees receiving benefits and a nominal increase in insurance rates when the Bank’s policy renewed in June 2012.

Occupancy expense increased $8 thousand or 0.9%, from 2011 to 2012 due primarily to an impairment charge of $68 thousand on the land where the Bank’s former operations building was located, which was offset by declines in repairs and maintenance, rental expense, and depreciation expense. Equipment expense increased $71 thousand or 8.2% from 2011 to 2012 due to increases in depreciation expense related to equipment purchases in 2011 and 2012.

Data and items processing increased $252 thousand or 25.8% from 2011 to 2012 due to higher data processing activity overall which included higher processing costs associated with greater debit card usage of the Bank’s clients.

Professional and advertising expenses, which include audit, legal, consulting and marketing and advertising fees, decreased $1 thousand in 2012, compared to the same period of 2011. This decrease was the result of increased legal fees, which were offset by lower marketing and advertising expenses. Stationary and supplies expense decreased $113 thousand in 2012 compared to the same period of 2011 resulting primarily from the reduction in checking, savings, and money market paper statements associated with the a $3 per statement charge by the Bank for all clients as of September 1, 2012.

Net cost of foreclosed and repossessed assets increased $560 thousand or 137.6% in 2012 compared to 2011 as a result of the Bank's objective of managing the levels of other real estate by attempting to move real estate at sometimes less than current market values.

Telecommunication expenses, which include voice and data communications, increased $104 thousand or 47.7% from 2011 to 2012 as a result of an upgrade in bandwidth capacity at all of the Bank’s locations.

FDIC insurance decreased $58 thousand in 2012 due to a change in the formula by the FDIC that bases the insurance on the Bank' assets instead of the prior formula that based insurance on total deposits.

Accounts receivable financing expense decreased $45 thousand or 18.4% in 2012 compared to the same period in 2011. The decrease in this expense items was due to a decrease in the fees paid, in relation to the outstanding receivables, to the vendor the Bank uses to administer the accounts receivable program.

Other expenses increased $77 thousand or 6.4% in 2012 compared to the same period in 2011. Increases in this area are attributable to increased expenses associated with loan servicing, debit and checking account charges, and insurance expense, offset by decreases in training and education expenses.

Income Taxes

For the year ended December 31, 2012 we recorded an income tax benefit of $1.5 million and an effective tax rate of 43.1%. For the year ended December 31, 2011 we recorded income tax expense of $35 thousand and an effective tax rate of 8.8%. The effective rate was significantly lower in 2012 compared to 2011 due the Bank’s purchase of municipal securities in late 2010 and throughout 2011, some of which are exempt from Federal, and in some cases, State income taxes.

Analysis of Financial Condition

Average earning assets decreased slightly to $326.9 million in 2012, or 0.1%, from $327.1 million in 2011. Earning assets represented 93.6% of total assets during the year ended December 31, 2012, and 93.7% and 93.5% during the years ended December 31, 2011 and 2010, respectively. The mix of average earning assets changed from December 31, 2011 to December 31, 2012, with loans increasing from 72.8% of total assets in 2011 to 74.2% in 2012, and investment securities decreasing from 16.4% of total assets in 2011 to 14.9% in 2012. The shift in earning assets from investments to loans was primarily due to two factors. First, for its commercial loan officers, management consciously implemented strategies to increase loans by the continuing implementation of a sales management program. Second, investment security purchases were deemphasized due to the low prevailing rates and high prices for most fixed income investment classes as a result of the Federal Reserve’s economic stimulus activities which involved purchasing mortgage-backed securities.

Average earning assets increased to $327.1 million in 2011, or 1.2%, from $323.1 million in 2010. Earning assets represented 93.7% of total assets during the year ended December 31, 2011, and 93.5% and 92.3% during the years ended December 31, 2010 and 2009, respectively. The mix of average earning assets changed from December 31, 2010 to December 31, 2011, with loans decreasing from 73.2% of total assets in 2010 to 72.8% in 2011, and investment securities increasing from 13.9% of total assets in 2010 to 16.4% in 2011. The shift in earning assets from loans to investments was primarily due to two factors. First, in late 2010 and throughout 2011, management began purchasing longer maturity municipal securities and shorter maturity government agency collateralized mortgage obligations as part of an asset liability strategy. Second, higher than predicted loan charge offs coupled with lower than predicted loan demand caused loans to increase only slightly from 2010 to 2011.

Average Asset Mix

	For the Years Ended December 31,
	2012					2011					2010
	Average Balance		Percent			Average Balance		Percent			Average Balance		Percent
	(dollars in thousands)
Earning assets:
Loans	$	259,477		74.2	%	$	254,039		72.8	%	$	252,800		73.2	%
Investment securities		51,911		14.9			57,174		16.4			48,176		13.9
Federal funds sold and interest-bearing balances		15,582		4.5			15,917		4.6			22,159		6.4
Total earning assets		326,970		93.6			327,130		93.7			323,135		93.5

Nonearning assets:
Cash and due from banks		5,167		1.5			3,923		1.1			3,977		1.2
Property and equipment		9,791		2.8			10,221		2.9			10,461		3.0
Other assets		7,255		2.1			7,841		2.2			7,870		2.3
Total nonearning assets		22,213		6.4			21,985		6.3			22,308		6.5
Total assets	$	349,183		100.0	%	$	349,115		100.0	%	$	345,443		100.0	%

Loans Receivable

As of December 31, 2012, total loans increased to $259.9 million, up 1.8% from total loans of $255.3 million at December 31, 2011. Real estate construction and land development loans decreased from $41.3 million, or 16.2% of total loans, in 2011 to $38.0 million, or 14.6% of total loans, in 2012. The decrease in construction and development loans was a function of the declining economic conditions during the past two years, as well as a conscious effort by management to decrease the Bank’s exposure to this segment. While management has consciously focused on decreasing its concentration to construction and development loans, it is honoring any commitments to existing credit worthy borrowers and beginning to make new real estate construction loans to credit worthy borrowers. The decline in construction and development loans does not take into account the advances from January 1, 2012 to December 31, 2012 on unfunded or partially funded one-to-four family residential construction loans.

Residential, one-to-four family loans increased from $81.4 million in 2011 to $89.6 million in 2012. The increase in this category was a result of a residential loan program introduced by the bank in mid-2011 that continued through the first three months of 2012 that offered loan terms ranging from eight to 20 years. Loans in the category “Residential, 5 or more family” decreased in 2012 from 2011 due primarily to charge-offs and payoffs of loans from this category. Other commercial real estate loans increased $2.7 million from 2011 to 2012 due to increased emphasis on prudently increasing activity in this loan category. Commercial and industrial loans increased from $36.1 million in 2011 to $37.5 million in 2012. The increase in this loan segment was due to a conscious strategy by the Bank to locate and fund more of these loans to credit qualified businesses. The Bank’s portfolios of loans secured by farmland and consumer loans remained relatively unchanged from 2011 to 2012.

At December 31, 2012, our loan portfolio contained no foreign loans, and we believe the portfolio is adequately diversified. Real estate loans represent approximately 84.8% of our loan portfolio. Real estate loans are loans secured by real estate, including mortgage and construction loans. Residential mortgage loans accounted for approximately $89.6 million or 34.5% of our real estate loans at December 31, 2012. Commercial loans are spread throughout a variety of industries, with no particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio. At December 31, 2012, our ten largest loans accounted for approximately 8.4% of our loans outstanding. As of December 31, 2012 we had outstanding loan commitments of approximately $30.7 million. The amounts of loans outstanding at the indicated dates are shown in the following table according to loan type.

Loan Portfolio Composition

	At December 31,
	2012		2011		2010		2009		2008
	(dollars in thousands)
Real estate construction and development	$	38,004	$	41,295	$	46,687	$	55,014	$	55,124
Secured by farmland		2,450		2,876		2,298		1,865		2,105
Residential, one-to-four families		89,621		81,365		74,044		75,378		66,934
Residential, 5 or more families		2,085		6,143		7,821		4,988		4,415
Other commercial real estate		88,167		85,469		88,411		85,414		85,362
Total real estate		220,327		217,148		219,261		222,659		213,940
Commercial and industrial		37,517		36,066		34,478		25,868		28,698
Consumer		2,025		2,124		2,849		2,773		2,910
Total	$	259,869	$	255,338	$	256,588	$	251,300	$	245,548

Loan Portfolio Summary, as a percent of total loans

	At December 31,
	2012			2011			2010			2009			2008
Real estate construction and development		14.6	%		16.2	%		18.2	%		21.9	%		22.4	%
Secured by farmland		0.9			1.1			0.9			0.7			0.9
Residential, one-to-four families		34.5			31.9			28.9			30.0			27.2
Residential, 5 or more families		0.8			2.4			3.0			2.0			1.8
Other commercial real estate		34.0			33.5			34.5			34.0			34.8
Total real estate		84.8			85.1			85.5			88.6			87.1
Commercial and industrial		14.4			14.1			13.4			10.3			11.7
Consumer		0.8			0.8			1.1			1.1			1.2
Total		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%

Loan Maturity/Repricing Distribution

The following table sets forth the maturity distribution of our loans as of December 31, 2012. A significant majority of our loans maturing after one year reprice at three and five year intervals. Approximately 38.8% of our loan portfolio is comprised of variable rate loans.

	Commercial and Industrial		Real Estate Construction and Development		Others		Total Amount		%
	(dollars in thousands)
Three months or less	$	6,571	$	6,992	$	31,797	$	45,360		17.5	%
Over 3 months to 12 months		10,951		8,435		25,346		44,732		17.2
Over 1 year to 5 years		17,948		14,977		90,357		123,282		47.4
Over 5 years		2,047		7,600		36,848		46,495		17.9
Total loans	$	37,517	$	38,004	$	184,348	$	259,869		100.00	%

Allowance for Loan Losses

We consider the allowance for loan losses adequate to cover estimated probable loan losses relating to the loans outstanding as of each reporting period. The procedures and methods used in the determination of the allowance necessarily rely upon various judgments and assumptions about economic conditions and other factors affecting our loans. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Those agencies may require us to recognize adjustments to the allowance for loan losses based on their judgments about the information available to them at the time of their examinations. No assurance can be given that we will not in any particular period sustain loan losses that are sizable in relation to the amount reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings.

The following table summarizes the balances of loans outstanding, average loans outstanding, changes in the allowance arising from charge-offs and recoveries by category and additions to the allowance that have been charged to expense.

Analysis of the Allowance for Loan Losses

	At December 31,
	2012			2011			2010			2009			2008
	(dollars in thousands)
Allowance for loan losses at beginning of year	$	4,446		$	4,375		$	3,667		$	2,450		$	2,120
Charge-offs:
Real estate		(3,088	)		(3,950	)		(1,612	)		(609	)		(104	)
Commercial and industrial		(1,862	)		(80	)		(201	)		(782	)		(135	)
Loans to individuals		(41	)		(15	)		(28	)		(49	)		(73	)
Total charge-offs		(4,991	)		(4,045	)		(1,841	)		(1,440	)		(312	)

Recoveries:
Real estate - mortgage		131			123			112			—			—
Commercial and industrial		1			—			8			83			9
Loans to individuals		5			16			23			30			30
Total recoveries		137			139			143			113			39

Net (charge-offs) recoveries		(4,754	)		(3,906	)		(1,698	)		(1,327	)		(273	)
Provision for loan losses charged to operations		5,908			3,977			2,406			2,544			603
Balance at end of period	$	5,500		$	4,446		$	4,375		$	3,667		$	2,450
Total loans outstanding at year-end	$	259,937		$	255,338		$	256,588		$	251,300		$	245,548

Average loans outstanding for the year	$	259,447		$	254,039		$	252,800		$	249,264		$	232,351

Ratio of net loan charge-offs to average loans outstanding		1.83	%		1.54	%		0.67	%		0.53	%		0.12	%

Ratio of allowance for loan losses to loans outstanding at period-end		2.12	%		1.74	%		1.71	%		1.46	%		1.00	%

At December 31, 2012, our allowance for loan losses as a percentage of loans was 2.12%, up from 1.74% at December 31, 2011. The increase in part reflects the increase in our historical loss rate as our charge-offs have increased during the past year. The increase also reflects the recognition of additional loans identified as being impaired. In evaluating the allowance for loan losses, we prepare an analysis of our current loan portfolio through the use of historical loss rates, homogeneous risk analysis grouping to include probabilities for loss in each group by risk grade, estimation of years to impairment in each homogeneous grouping, analysis of internal credit processes, and past due loan portfolio performance and overall economic conditions, both regionally and nationally.

Historical loss calculations for each homogeneous risk group are based on a weighted average loss ratio calculation. The most recent eight quarter loss histories are used in the loss history and is adjusted to reflect current losses in the homogeneous risk groups. Current losses translate into a higher loss ratio which is further increased by the associated risk grades within the group. The impact is to more quickly recognize and increase the loss history in a respective grouping, resulting in an increase in the allowance for that particular homogeneous group. For those groups with little or no loss history, management bases the historical factor based on current economic conditions and their potential impact on that particular loan group.

Loans are considered impaired if, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is based on either the fair value of the underlying collateral, the present value of the future cash flows discounted at the historical effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses a comparison to the recent selling price of similar assets, which is consistent with those that would be utilized by unrelated third parties.

As of December 31, 2012, we had 140 loans with a current principal balance of $33.2 million on the watch list, compared to 142 loans with a current principal balance of $33.8 million at December 31, 2011. The watch list is the classification utilized by us when we have an initial concern about the financial health of a borrower. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either move it to “substandard” or back to its original risk rating after a review of the information. There are times when we may leave the loan on the “watch list,” if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we want to review it on a more regular basis. Loans on the watch list are not considered “potential problem loans” until they are determined by management to be classified as substandard.

Loans past due 30-89 days amounted to $3.4 million at December 31, 2012 as compared to $4.0 million at December 31, 2011. Past due loans are often regarded as a precursor to further credit problems which would lead to future increases in nonaccrual loans and other real estate owned. At December 31, 2012, there were loans totaling $216 thousand past due greater than 90 days and still accruing interest. At December 31, 2011, there were no loans past due greater than 90 days that were not already placed on nonaccrual. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is applied against the principal balance. During the years ended December 31, 2012 and 2011, we received approximately $113 thousand and $129 thousand, respectively, in interest income in relation to loans that were on nonaccrual status at the respective year end prior to them being placed on nonaccrual status. Foregone interest income related to loans on nonaccrual status were approximately $430 thousand and $621 thousand, during the years ended December 31, 2012 and 2011, respectively.

While we believe that our management uses the best information available to determine the allowance for loan losses, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected if circumstances differ substantially from the assumptions used in making the final determination. Because these factors and management’s assumptions are subject to change, the allocation is not necessarily indicative of future loan portfolio performance.

Loans are charged-off against the Bank’s allowance for loan losses as soon as the loan becomes uncollectible. Unsecured loans are considered uncollectible when no regularly scheduled monthly payment has been made within three months, the loan matured over 90 days ago and has not been renewed or extended or the borrower files for bankruptcy. Secured loans are considered uncollectible when the liquidation of collateral is deemed to be the most likely source of repayment. Once secured loans reach 90 days past due, they are placed into non-accrual status unless the loan is considered to be well secured and in process of collection. If the loan is deemed to be collateral dependent, the principal balance is either written down immediately or reserved as a write-down in the Bank’s allowance model to reflect the current market valuation based on an independent appraisal which may be adjusted by management based on more recent market conditions. Included in the write-down is the estimated expense to liquidate the property and typically an additional allowance for the foreclosure discount. Generally, if the loan is unsecured the loan must be charged-off in full while if it is secured the loan is charged down to the net liquidation value of the collateral.

Net charge-offs of $4.8 million in 2012 increased $0.9 million and $2.5 million when compared to 2011 and 2010, respectively. Net charge-offs from real estate secured loans were $3.0 million, $3.8 million, and $1.5 million in 2012, 2011, and 2010, respectively. Additionally, charge-offs related to commercial loans were $1.9 million in 2012, increasing significantly from $80 thousand and $201 thousand in 2011 and 2010, respectively. Asset quality remains a top priority of the Bank. For the year ending December 31, 2012, net loan charge-offs were 1.83% of average loans compared to 1.54% for the year ending December 31, 2011. The ratio of net charge-offs to average loans increased mainly due to the Bank writing-down several large collateral dependent loans and completely charging off other loans deemed to be uncollectible. Declining economic conditions resulted in an increased number of impaired collateral dependent loans which resulted in a portion of these loans being charged-off. The increase in the allowance for loan losses, as a percentage of loans to 2.12% at December 31, 2012 from 1.74% at December 31, 2011 mostly reflects the increase in our historical loss rate as our charge-offs have increased during the past two years. The ratio of our allowance for loan losses to nonperforming loans decreased to 49% as of December 31, 2012 compared to 97% at December 31, 2011. This change is the result of our allowance increasing approximately 23.7% from 2011 to 2012 and our nonperforming loans increasing approximately 145.8% from 2011 to 2012. Commercial and business related real estate secured loans comprise a significant portion of total nonperforming loans. These types of loans are subject to impairment testing, which determines whether the loan should be written down or charged off to its fair value. Therefore, an increase or a decrease in total nonperforming loans should not always correspond equally with a change in the allowance for loan loss.

Allocation of Allowance for Loan Loss

	At December 31,
	2012			2011			2010			2009			2008
	Amount		%(1)	Amount		%(1)	Amount		%(1)	Amount		%(1)	Amount		%(1)
	(dollars in thousands)
One-to-four residential first liens	$	886	27.69	$	704	24.83	$	1,207	20.22	$	911	20.36	$	536	17.62
Real estate construction and development		1,361	14.94		2,072	16.17		1,970	18.20		1,231	21.89		571	22.45
One-to-four family junior liens		360	6.12		171	7.04		30	8.63		206	9.63		208	9.64
All other real estate secured		1,520	37.63		1,276	37.01		329	38.41		889	36.73		762	37.42
Total real estate loans		4,127	86.38		4,223	85.05		3,536	85.46		3,237	88.61		2,077	87.13
Commercial and industrial		1,351	12.80		200	14.12		815	13.44		392	10.29		334	11.68
Consumer		22	0.82		23	0.83		24	1.10		38	1.10		37	1.19
Unallocated		—	—		—	—		—	—		—	—		2	—
Total	$	5,500	100.00	$	4,446	100.00	$	4,375	100.00	$	3,667	100.00	$	2,450	100.00

(1)	Represents total of all outstanding loans in each category as a percent of total loans outstanding.

Management realizes that general economic trends greatly affect loan losses and no assurances can be made about future losses. Management, however, does consider the allowance for loan losses to be adequate at December 31, 2012.

Loans Considered Impaired

We review our nonperforming loans and other groups of loans based on loan size or other factors for impairment. At December 31, 2012, we had loans totaling $13.8 million (which includes $10.1 million in nonperforming loans) which were considered to be impaired compared to $14.1 million at December 31, 2011. Loans are considered impaired if, based on current information, circumstances or events, it is probable that the Bank will not collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. However, treating a loan as impaired does not necessarily mean that we expect to incur a loss on that loan, and our impaired loans may include loans that currently are performing in accordance with their terms. For example, if we believe it is probable that a loan will be collected, but not according to its original agreed upon payment schedule, we may treat that loan as impaired even though we expect that the loan will be repaid or collected in full. As indicated in the table below, when we believe a loss is probable on a non-collateral dependent impaired loan, a portion of our reserve is allocated to that probable loss. If the loan is deemed to be collateral dependent, the principal balance is written down immediately, or a portion of our reserve is allocated to that probable loss, to reflect the current market valuation based on a current independent appraisal.

The following table sets forth the number and volume of loans net of previous charge-offs considered impaired and their associated reserve allocation, if any, at December 31, 2012 and 2011.

Analysis of Loans Considered Impaired


	As of December 31, 2012
	Number of Loans		Loan Balances Outstanding		Allocated Reserves
	(Dollars in thousand)
Non-accrual loans		35	$	10,099	$	545
Restructured loans		1		249		—
Total nonperforming loans		36	$	10,348	$	545
Other impaired loans with allocated reserves		1		81		32
Impaired loans without allocated reserves		11		3,371		—
Total impaired loans		48	$	13,800	$	577


	As of December 31, 2011
	Number of Loans		Loan Balances Outstanding		Allocated Reserves
	(Dollars in thousand)
Non-accrual loans		10	$	3,476	$	25
Restructured loans		8		4,591		103
Total nonperforming loans		18	$	8,067	$	128
Other impaired loans with allocated reserves		2		1,206		246
Impaired loans without allocated reserves		7		4,820		—
Total impaired loans		27	$	14,093	$	374

The following table summarizes our nonperforming assets and past due loans at the dates indicated.

Nonperforming Assets and Past Due Loans

	December 31,
	2012		2011		2010		2009		2008
	(Dollars in thousands)
Non-accrual loans	$	11,106	$	4,607	$	5,268	$	2,280	$	437
Loans past due 90 days or more and still accruing		216		—		—		484		—
Restructured loans		4,373		4,980		2,345		1,009		—
Foreclosed assets and repossessions		2,116		2,216		2,216		1,288		1,508
Total	$	17,595	$	11,803	$	9,829	$	5,061	$	1,945

A loan is placed on non-accrual status when, in our judgment, the collection of interest income appears doubtful or the loan is past due 90 days or more. Interest receivable that has been accrued and is subsequently determined to have doubtful collectability is charged to the appropriate interest income account. Interest on loans that are classified as non-accrual is recognized when received. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the original terms.

At December 31, 2012 and 2011, nonperforming assets, loans past due 90 days or more and still accruing, and foreclosed assets and repossessions, were approximately 5.17% and 4.62%, respectively, of the loans outstanding at such dates. The general downturn in the overall economy and the deterioration in several of our borrowing relationships during 2012 has contributed to the overall increase in nonperforming assets reflected at year end. The impact of our nonperforming loans at December 31, 2012 on our interest income was approximately $579 thousand as we would have accrued $1.3 million in interest income versus the $348 thousand recognized.

Any loans that are classified for regulatory purposes as loss, doubtful, substandard or special mention, and that are not included as non performing loans, do not (i) represent or result from trends or uncertainties that management reasonably expects will materially impact future operating results; or (ii) represent material credits about which management has any information which causes management to have serious doubts as to the ability of such borrower to comply with the loan repayment terms.

Investment Portfolio

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. We use two categories to classify our securities: “held-to-maturity” and “available-for-sale.” While we have no plans to liquidate a significant amount of our securities, the securities classified as available-for-sale may be sold to meet liquidity needs should management deem it to be in our best interest.

Our available-for-sale investment securities totaled $43.9 million at December 31, 2012, $51.2 million at December 31, 2011 and $48.3 million at December 31, 2010. Our held-to-maturity investment securities totaled $3.9 million at December 31, 2012 and $5.2 million at December 31, 2011. For the most part during 2012, the Bank’s investment portfolio strategy consisted of allowing the existing investment portfolio to runoff with regular principal payment and prepayments. However, the Bank did purchase $6.2 million in investment securities in the first six months 2012. Additions to the investment securities portfolio depend to a large extent on the availability of investable funds that are not otherwise needed to satisfy loan demand. Investable funds not otherwise utilized are temporarily invested as federal funds sold or as interest-bearing balances at other banks, the level of which is affected by such considerations as near-term loan demand and liquidity needs. Subinvestment grade available-for-sale and held-to-maturity private label mortgage-backed securities are analyzed on a quarterly basis for impairment by utilizing an independent third party that performs an analysis of the estimated principal the Bank is expected to collect on these securities. The results of this analysis determines whether the bank records an impairment loss on these securities. During the years ended December 31, 2012 and 2011, the Company recorded impairment losses of $1 thousand and $48 thousand, respectively.

The carrying values of investment securities held by us at the dates indicated are summarized as follows:

Investment Portfolio Composition

	December 31,
	2012		Percentage		2011		Percentage		2010		Percentage
	(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises securities	$	1,079		2.5	$	2,128		4.2	$	2,170		4.5
FNMA or GNMA mortgage-backed securities		8,628		19.6		16,049		31.3		13,803		28.5
Private label mortgage-backed securities		9,075		20.7		7,859		15.3		14,344		29.7
Municipal Securities		14,020		31.9		12,971		25.3		4,681		10.0
SBA debentures		10,635		24.2		11,725		22.9		12,763		26.3
Other domestic debt securities		500		1.1		500		1.0		500		1.0

Total securities available-for-sale	$	43,937		100.0	$	51,212		100.0	$	48,261		100.0

Securities held-to-maturity:
Private label mortgage-backed securities	$	3,928		100.0	$	5,211		100.0	$	7,625		100.0

Total securities held-to-maturity	$	3,928		100.0	$	5,211		100.0	$	7,625		100.0

The following table shows maturities of the carrying values and the weighted-average yields of investment securities held by us at December 31, 2012.

Investment Portfolio Maturity Schedule

	3 months or less			Over 3 months through 1 year			Over 1 year through 5 years			Over 5 years but within 10 years			Over 10 years
	Amount/ Yield			Amount/ Yield			Amount/ Yield			Amount/ Yield			Amount/ Yield			Total/ Yield
	(Dollars in thousands)
Securities available-for-sale:
Government-sponsored enterprises securities	$	—		$	—		$	1,079		$	—		$	—		$	1,079
		—	%		—	%		3.33	%		—	%		—	%		3.33	%
FNMA or GNMA mortgage-backed securities		—			—			317			4,386			3,925			8,628
		—			—			5.53	%		3.25	%		(0.10	)%		1.81	%
Private label mortgage-backed securities		—			—			35			5,409			3,631			9,075
		—			—			7.03	%		7.60	%		3.09	%		5.79	%
Municipal securities		—			—			—			5,016			9,004			14,020
		—			—			—			3.56	%		3.23	%		3.34	%
SBA debentures		—			—			—			1,267			9,368			10,635
		—			—			—			4.73	%		3.45	%		3.60	%
Other domestic debt securities		—			—			—			500			—			500
		—			—			—			3.96	%		—			3.96	%
Total available-for-sale securities	$	—		$	—		$	1,431		$	16,578		$	25,928		$	43,937
		—	%		—	%		3.91	%		4.90	%		2.78	%		3.62	%

Securities held-to-maturity:
Private label mortgage-backed securities	$	—		$	—		$	—		$	—		$	3,928		$	3,928
		—	%		—	%		—	%		—	%		9.38	%		9.38	%

Total held-to-maturity securities	$	—		$	—		$	—		$	—		$	5,211		$	5,211
		—	%		—	%		—	%		—	%		7.55	%		7.55	%

Deposits

Deposits decreased to $306.2 million, down 2.5% as of December 31, 2012 compared to deposits of $313.9 million at December 31, 2011. Noninterest-bearing deposits increased $11.2 million, or 36.9%, from year end 2011 to year end 2012, while total interest-bearing deposits decreased $18.9 million, or 6.7%, over the same period. The increase in noninterest bearing deposits was largely due to a consumer checking account conversion that combined several interest checking accounts into one noninterest bearing checking account. The decline in interest bearing deposits was largely due a conscious effort by management to decrease these types of deposits to better manage the Bank’s liquidity position.

The average balance of deposits and interest rates thereon for the years ended December 31, 2012, 2011, and 2010 are summarized below.

Average Deposit Balances and Rates

	For the Years Ended December 31,
	2012					2011					2010
	Amount		Rate			Amount		Rate			Amount		Rate
	(dollars in thousands)
Interest-bearing deposits:
Demand accounts	$	70,288		0.52	%	$	75,039		0.77	%	$	40,464		1.36	%
Savings and money market		77,996		0.51			65,906		0.92			64,765		0.98
Time deposits		125,790		1.09			147,574		1.41			168,872		1.99
Total interest-bearing deposits		274,074		0.78			288,519		1.13			274,101		1.66
Non-interest-bearing deposits		36,347		—			29,677		—			23,457		—
Total deposits	$	310,421		0.69	%	$	318,196		1.03	%	$	297,558		1.53	%

For the years ended December 31, 2012, 2011 and 2010, our average noninterest-bearing deposits were approximately 11.7%, 9.3% and 7.9%, respectively, of our average total deposits. The Bank made a conscious effort in 2012 to reduce time deposits to reduce the amount of excess liquidity in the form of cash or cash equivalents on the asset side of the balance sheet

The following table is a maturity schedule of our time deposits as of December 31, 2012.

Time Deposit Maturity Schedule

	At December 31, 2012
	3 Months or Less		Over 3 to 6 Months		Over 6 to 12 Months		Over 12 Months		Total
	(dollars in thousands)
Certificates of deposit:
Less than $100,000	$	26,727	$	8,904	$	19,225	$	14,493	$	69,349
$100,000 or more		4,882		4,734		11,824		30,777		52,217
Total	$	31,609		13,638	$	31,049	$	45,270	$	121,566

Borrowings

Short-term debt includes sweep accounts, advances from the FHLB having maturities of one year or less, Federal Funds purchased and repurchase agreements. The Company had no short-term debt at December 31, 2012 and 2011. At both December 31, 2012 and 2011 we had Federal Funds purchased lines of credit totaling $6.0 million. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. The Company had no outstanding balances under these lines of credit at December 31, 2011.

There were no long-term borrowings from the FHLB at December 31, 2012 and 2011.

Federal Home Loan Bank Advances

As a member of the FHLB, the Bank has the ability to borrow up to 10% of total assets in the form of FHLB advances. There were no FHLB advances at December 31, 2012 and 2011. Approximately $27.8 million in first and second lien one-to-four family residential loans were pledged as collateral for short- and long-term FHLB advances at December 31, 2012.

Junior Subordinated Debentures

In 2007, the Company issued $8.248 million of junior subordinated debentures to the Trust in exchange for the proceeds of trust preferred securities issued by the Trust. The junior subordinated debentures are included in long-term debt and the Company’s equity interest in the Trust is included in other assets.

The junior subordinated debentures pay interest quarterly at an annual rate, reset quarterly, equal to three-month LIBOR plus 1.60%. The debentures are redeemable on June 17, 2012 or afterwards, in whole or in part, on any December 17, March 17, June 17 or September 17. Redemption is mandatory at June 17, 2037. The Bank guarantees the trust preferred securities through the combined operations of the junior subordinated debentures and other related documents. The Bank’s obligations under the guarantee are unsecured and subordinate to the senior and subordinated indebtedness of the Bank.

The trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority consolidated interest in a consolidated subsidiary. The junior subordinated debentures do not qualify as Tier 1 regulatory capital. On March 1, 2005, the Federal Reserve Board issued a final rule stating that trust preferred securities will continue to be included in Tier 1 capital, subject to stricter quantitative and qualitative standards. For bank holding companies, trust preferred securities will continue to be included in Tier 1 capital up to 25% of core capital elements (including trust preferred securities) net of goodwill less any associated deferred tax liability.

The following table details the maturities and rates of our borrowings, at December 31, 2012.

Maturity Date		Balance				Current Rate			Type of Debt, Rate Repricing Frequency
6/17/2037			8,248,000				1.99	%	Junior Subordinated Debentures, Quarterly, next reprice date 3/16/2013

Liquidity

Liquidity refers to our continuing ability to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses and provide funds for payment of dividends, debt service and other operational requirements. Liquidity is immediately available from five major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of Federal Funds sold; (c) lines for the purchase of Federal Funds from other banks; (d) lines of credit established at the FHLB, less existing advances; and (e) our investment securities portfolio. All our debt securities are of investment grade quality and, if the need arises, can promptly be liquidated on the open market or pledged as collateral for short-term borrowing.

Consistent with our general approach to liquidity management, loans and other assets of the Bank are funded primarily using a core of local deposits, proceeds from retail repurchase agreements and excess Bank capital. During 2012 and 2011, the Bank relied less heavily on time deposits to meet its liquidity needs. The Bank intends to focus on increasing core deposits in order to decrease the amount of wholesale and retail time deposits.

We are a member of the FHLB of Atlanta. Membership, along with a blanket collateral commitment of our one-to-four family residential mortgage loan portfolio provided us the ability to draw up to $18.8 million and $18.4 million of advances from the FHLB at December 31, 2012 and 2011, respectively. There were no borrowings from the FHLB at December 31, 2012 or 2011.

As a requirement for membership, we invest in stock of the FHLB in the amount of 1.0% of our outstanding residential loans or 5.0% of our outstanding advances from the FHLB, whichever is greater. That stock is pledged as collateral for any FHLB advances drawn by us. At December 31, 2012, we owned 5,279 shares of the FHLB’s $100 par value capital stock, compared to 7,949 shares at December 31, 2011. No ready market exists for FHLB stock, which is carried at cost.

We also had unsecured Federal Funds lines in the aggregate amount of $6 million available to us at December 31, 2012 under which we can borrow funds to meet short-term liquidity needs. At December 31, 2011, we did not have any advances under these federal funds lines. Another source of funding available is loan participations sold to other commercial banks (in which we retain the servicing rights). As of December 31, 2012, we had $109 thousand in loan participations sold. We believe that our liquidity sources are adequate to meet our operating needs.

Capital Resources and Stockholders’ Equity

As of December 31, 2012, our total stockholders’ equity was $26.0 million (consisting of common shareholders’ equity of $18.6 million and preferred stock of $7.4 million) compared with total shareholders’ equity of $27.9 million (consisting of common shareholders’ equity of $20.9 million and preferred stock of $7.0 million) as of December 31, 2011. On January 30, 2009, the Company entered into an agreement with the U.S. Treasury. The Company issued and sold to the U.S. Treasury 7,700 shares of the Company’s Series A Preferred Stock. The Series A Preferred Stock calls for cumulative dividends at a rate of 5% per year for the first five years, and at a rate of 9% per year in following years. The Company also issued a Warrant to purchase 163,830 shares of the Company’s common stock. The Company received $7.7 million in cash, in exchange for the Series A Preferred Stock and the Warrant. On October 31, 2012, the U.S. Treasury sold all of its Series A Preferred Stock to third parties. In addition, on February 6, 2013, the Company repurchased the Warrant for a total purchase price of $122,887.50.

In 2012, we experienced net losses of $1.95 million, other comprehensive income of $346 thousand, dividends of $385 thousand, and other increases to equity of $31 thousand.

The Bank is subject to minimum capital requirements. As the following table indicates, at December 31, 2012, all capital ratios place the Bank in excess of the minimum necessary to be considered “well-capitalized” under bank regulatory guidelines.

	At December 31, 2012
	Actual Ratio			Minimum Requirement			Well-Capitalized Requirement
Total risk-based capital ratio		13.4	%		8.0	%		10.0	%
Tier 1 risk-based capital ratio		12.1	%		4.0	%		6.0	%
Leverage ratio		8.9	%		4.0	%		5.0	%

Inflation and Other Issues

Because our assets and liabilities are primarily monetary in nature, the effect of inflation on our assets is less significant compared to most commercial and industrial companies. However, inflation does have an impact on the growth of total assets in the banking industry and the resulting need to increase capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. Inflation also has a significant effect on other expenses, which tend to rise during periods of general inflation. Notwithstanding these effects of inflation, management believes our financial results are influenced more by our ability to react to changes in interest rates than by inflation.

Except as discussed in this Management’s Discussion and Analysis, management is not aware of trends, events or uncertainties that will have or that are reasonably likely to have a material adverse effect on the liquidity, capital resources or operations. Management is not aware of any current recommendations by regulatory authorities which, if they were implemented, would have such an effect.

Recent Accounting Pronouncements

Please refer to Note (1)(T) of our consolidated financial statements for a summary of recent authoritative pronouncements that could impact our accounting, reporting, and/or disclosure of financial information.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS

Table of Contents

Report of Independent Registered Public Accounting Firm	43
Consolidated Balance Sheets	44
Consolidated Statements of Operations	45
Consolidated Statements of Comprehensive Income (Loss)	46
Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income	47
Consolidated Statements of Cash Flows	49
Notes to Consolidated Financial Statements	51
Stockholder Information	80

Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Oak Ridge Financial Services, Inc.

Oak Ridge, North Carolina

We have audited the accompanying consolidated balance sheets of Oak Ridge Financial Services, Inc. and subsidiaries (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Oak Ridge Financial Services, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ Elliott Davis, PLLC

Charlotte, North Carolina

March 25, 2013

Elliott Davis PLLC | www.elliottdavis.com

Consolidated Balance Sheets

December 31, 2012 and 2011

(Dollars in thousands)

	2012			2011

Assets

Cash and due from banks	$	5,134		$	5,293
Interest-bearing deposits with banks		11,909			16,150
Total cash and cash equivalents		17,043			21,443
Time deposits		—			1,050
Securities available-for-sale		43,937			51,212
Securities held-to-maturity (fair values of $4,183 in 2012 and $5,204 in 2011)		3,928			5,211
Federal Home Loan Bank Stock, at cost		528			795
Loans held for sale		1,787			808
Loans, net of allowance for loan losses of $5,500 in 2012 and $4,446 in 2011		254,347			250,832
Property and equipment, net		9,371			9,973
Foreclosed assets		2,116			2,216
Accrued interest receivable		1,514			1,554
Bank owned life insurance		5,078			4,939
Other assets		3,202			2,122
Total assets	$	342,851		$	352,155

Liabilities and Stockholders’ Equity

Liabilities
Deposits:
Noninterest-bearing	$	41,538		$	30,338
Interest-bearing		264,639			283,573
Total deposits		306,177			313,911
Junior subordinated notes related to trust preferred securities		8,248			8,248
Accrued interest payable		94			119
Other liabilities		2,342			1,929
Total liabilities		316,861			324,207

Commitments and contingencies (Notes 6 and 12)

Stockholders’ equity
Preferred stock, Series A, 7,700 shares authorized and outstanding; no par value, $1,000 per share liquidation preference		7,366			7,075
Common stock, no par value; 50,000,000 shares authorized; 1,808,445 issued and outstanding in 2012 and 2011		15,956			15,925
Warrant		1,361			1,361
Retained earnings (deficit)		(208	)		2,418
Accumulated other comprehensive income		1,515			1,169
Total stockholders’ equity		25,990			27,948
Total liabilities and stockholders’ equity	$	342,851		$	352,155

See Notes to Consolidated Financial Statements

Consolidated Statements of Operations

For the years ended December 31, 2012 and 2011

(Dollars in thousands except per share data)

	2012			2011
Interest and dividend income
Loans and fees on loans	$	13,433		$	14,535
Interest on deposits in banks		40			69
Federal Home Loan Bank stock dividends		12			9
Taxable investment securities		2,267			2,913
Total interest and dividend income		15,752			17,526
Interest expense
Deposits		2,151			3,191
Short-term and long-term debt		179			182
Total interest expense		2,330			3,373
Net interest income		13,422			14,153
Provision for loan losses		5,908			3,977
Net interest income after provision for loan losses		7,514			10,176
Noninterest income
Service charges on deposit accounts		556			468
Gain on sale of securities		—			463
Gain (loss) on sale of property and equipment		60			(4	)
Gain on sale of mortgage loans		673			242
Investment and insurance commissions		648			985
Fee income from accounts receivable financing		695			789
Debit card interchange income		794			624
Impairment loss on securities		(1	)		(48	)
Income earned on bank owned life insurance		139			147
Other service charges and fees		120			78
Total noninterest income		3,684			3,744
Noninterest expense
Salaries		6,243			5,975
Employee benefits		802			818
Occupancy expense		882			874
Equipment expense		940			869
Data and item processing		1,227			975
Professional and advertising		1,175			1,176
Stationary and supplies		289			402
Net cost of foreclosed assets		967			407
Telecommunications expense		322			218
FDIC assessment		304			362
Accounts receivable financing expense		200			245
Other expense		1,278			1,201
Total noninterest expense		14,629			13,522
Income (loss) before income taxes		(3,431	)		398
Income tax expense (benefit)		(1,481	)		35
Net income (loss)	$	(1,950	)	$	363
Preferred stock dividends		(385	)		(385	)
Accretion of discount		(291	)		(267	)
Loss available to common stockholders	$	(2,626	)	$	(289	)
Basic loss per common share	$	(1.45	)	$	(0.16	)
Diluted loss per common share	$	(1.45	)	$	(0.16	)
Basic weighted average shares outstanding		1,808,445			1,808,445
Diluted weighted average shares outstanding		1,808,445			1,808,445

See Notes to Consolidated Financial Statements

Consolidated Statements of Comprehensive Income (Loss)

For the years ended December 31, 2012 and 2011

(Dollars in thousands except per share data)

	2012			2011
Net income (loss)	$	(1,950	)	$	363
Other comprehensive income:
Unrealized holding gains on securities available-for-sale		563			500
Tax effect		(217	)		(194	)
Unrealized holding gains on securities available-for-sale, net of tax amount		346			306
Reclassification adjustment for realized gains		—			(463	)
Tax effect		—			170
Reclassification adjustment for realized gains, net of tax		—			(293	)
Other comprehensive income net of tax		346			13
Comprehensive income (loss)	$	(1,604	)	$	376

See Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity

Years ended December 31, 2012 and 2011

(In thousands except shares of common and preferred stock)

			Common Stock									Accumulated
	Preferred stock, Series A		Number		Amount		Common stock warrant		Retained earnings (deficit)			other comprehensive income		Total
Balance December 31, 2010	$	6,808		1,792,876	$	15,841	$	1,361	$	2,707		$	1,156	$	27,873
Net income										363					363
Other comprehensive income													13		13
Preferred stock dividends										(385	)				(385	)
Stock option expense						49									49
Common stock issued pursuant to restricted stock awards				15,569		35									35
Preferred stock accretion		267								(267	)				—
Balance December 31, 2011		7,075		1,808,445		15,925		1,361		2,418			1,169		27,948
Net loss										(1,950	)				(1,950	)
Other comprehensive income													346		346
Preferred stock dividends										(385	)				(385	)
Stock option expense						5									5
Common stock issued pursuant to restricted stock awards						26									26
Preferred stock accretion		291								(291	)				—
Balance December 31, 2012	$	7,366		1,808,445	$	15,956	$	1,361	$	(208	)	$	1,515	$	25,990

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

Years ended December 31, 2012 and 2011

(In thousands)

	2012			2011
Cash flows from operating activities
Net income (loss)	$	(1,950	)	$	363
Adjustments to reconcile net income (loss) to net cash provided by operations:
Depreciation		936			887
Provision for loan losses		5,908			3,977
Impairment loss on securities		1			48
Gain on sale of securities		—			(463	)
Gain on sale of mortgage loans		(673	)		—
(Gain) loss on sale of property and equipment		(60	)		4
Impairment of land		68			—
Income earned on bank owned life insurance		(139	)		(147	)
Losses on sale of and writedowns on foreclosed assets		665			289
Deferred income tax (benefit) expense		(1,088	)		486
Originations of mortgage loans held-for-sale		(37,477	)		(808	)
Proceeds from sale of mortgage loans		37,171			—
Net (accretion) amortization of discounts and premiums on securities		124			(44	)
Changes in assets and liabilities:
Employee Stock Ownership Plan accrual		—			(900	)
Income taxes payable		(489	)		(1,128	)
Accrued income		40			(77	)
Other assets		280			795
Accrued interest payable		(25	)		(54	)
Other liabilities		413			244
Net cash provided by operating activities		3,705			3,472

Cash flows from investing activities
Activity in available-for-sale securities:
Purchases		(6,249	)		(17,171	)
Sales		—			3,763
Maturities and repayments		13,780			10,442
Activity in held-to-maturity securities:
Maturities and repayments		1,466			2,375
Time deposit maturities		1,050			3,210
Redemptions of Federal Home Loan Bank stock		267			404
Net increase in loans		(10,814	)		(4,169	)
Purchases of property and equipment		(563	)		(514	)
Proceeds from sale of property and equipment		221			2
Proceeds from sale of foreclosed assets		856			1,222
Net cash provided by (used in) investing activities		14			(436	)

Cash flows from financing activities
Net increase (decrease) in deposits		(7,734	)		13,636
Repayment of borrowings		—			(9,000	)
Dividends paid on preferred stock		(385	)		(385	)
Net cash provided by (used in) financing activities		(8,119	)		4,251
Net increase (decrease) in cash and cash equivalents		(4,400	)		7,287
Cash and cash equivalents, beginning		21,443			14,156
Cash and cash equivalents, ending	$	17,043		$	21,443

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

Years ended December 31, 2012 and 2011 (In thousands)

	2012		2011
Supplemental disclosure of cash flow information

Cash paid for:
Interest	$	2,335	$	3,427
Taxes	$	125	$	694

Non-cash investing and financing activities
Foreclosed assets acquired in settlement of loans	$	1,391	$	1,700

See Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(A) Consolidation

The consolidated financial statements include the accounts of Oak Ridge Financial Services, Inc. (“Oak Ridge”) and its wholly owned subsidiary, Bank of Oak Ridge (the “Bank”) (collectively referred to hereafter as the “Company”). The Bank has one wholly-owned subsidiary, Oak Ridge Financial Corporation, which is currently inactive. All significant inter-company transactions and balances have been eliminated in consolidation.

(B) Basis of Financial Statement Presentation

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and the reported amounts of income and expenses for the periods presented. Actual results could differ significantly 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 valuation of the deferred tax asset.

Substantially all of the Company’s entire loan portfolio consists of loans in its market area. Accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse and is influenced by the manufacturing and retail segment of the economy.

While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Company’s allowances for loan losses. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan losses may change materially in the near term.

Oak Ridge is a bank holding company incorporated in North Carolina in April of 2007. The principal activity of Oak Ridge is ownership of the Bank. The Bank provides financial services through its branch network located in Guilford County, North Carolina. The Bank competes with other financial institutions and numerous other non-financial services commercial entities offering financial services products. The Bank is further subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. The Company has no foreign operations, and the Company’s customers are principally located in Guilford County, North Carolina, and adjoining counties.

(D) Cash and Cash Equivalents

Cash and cash equivalents include demand and time deposits (with original maturities of 90 days or less) at other financial institutions and overnight investments. Overnight investments include federal funds sold which are generally outstanding for one day periods.

(E) Securities

Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held-to-maturity or trading, including equity securities with readily determinable fair values, are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated comprehensive income.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In determining whether other-than-temporary impairment exists, management considers many factors, including (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued

(F) Loans

Loans are generally stated at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs. Loan origination fees net of certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual life of the related loans using the level-yield method.

Loans Held-for-Sale ‑ Loans held-for-sale primarily consist of one to four family residential loans originated for sale in the secondary market and are carried at the lower of cost or market determined on an aggregate basis. Gains and losses on sales of loans held-for-sale are included in other non-interest income in the consolidated statements of operations. Gains and losses on loan sales are determined by the difference between the selling price and the carrying value of the loans sold.

Impaired loans are defined as those which management believes it is probable the Bank will not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms have been modified in a troubled debt restructuring.

Interest on loans is recorded based on the principal amount outstanding. The Company ceases accruing interest on loans (including impaired loans) when, in management’s judgment, the collection of interest appears doubtful or the loan is past due 90 days or more. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Management may return a loan classified as nonaccrual to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms over an extended period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

(G) Allowance for Loan Losses

The allowance for loan losses (AFLL) is established through provisions for losses charged against income. Loan amounts deemed to be uncollectible are charged against the AFLL, and subsequent recoveries, if any, are credited to the allowance. The AFLL represents management’s estimate of the amount necessary to absorb estimated probable losses in the loan portfolio. Management’s periodic evaluation of the adequacy of the allowance is based on individual loan reviews, past loan loss experience, economic conditions in the Company’s market areas, the fair value and adequacy of underlying collateral, and the growth and loss attributes of the loan portfolio. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Thus, future changes to the AFLL may be necessary based on the impact of changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s AFLL. Such agencies may require the Company to recognize adjustments to the AFLL based on their judgments about information available to them at the time of their examination.

The AFLL related to loans that are identified for evaluation and deemed impaired is based on discounted cash flows using the loan’s initial effective interest rate, the loan’s observable market price, or the fair value of the collateral for collateral dependent loans. Another component of the AFLL covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is also maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

(H) Foreclosed Assets

Real estate acquired in settlement of loans consists of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Costs related to the improvement of the property are capitalized, whereas those related to holding the property are expensed. Such properties are held for sale and, accordingly, no depreciation or amortization expense is recognized. Repossessions are recorded at the fair value less cost to sell.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued

(I) Membership/Investment in Federal Home Loan Bank Stock

The Company is a member of the Federal Home Loan Bank of Atlanta (“FHLB”). Membership, along with a signed blanket collateral agreement, provided the Company with the ability to draw up to $24.0 million and $18.4 million of advances from the FHLB at December 31, 2012 and 2011, respectively. At December 31, 2012 and 2011 the Company had no outstanding advances with the FHLB.

As a requirement for membership, the Company invests in stock of the FHLB in the amount of 1% of its outstanding residential loans or 5% of its outstanding advances from the FHLB, whichever is greater. Such stock is pledged as collateral for any FHLB advances drawn by the Company. At December 31, 2012 and 2011, the Company owned 5,279 and 7,949 shares, respectively, of the FHLB’s $100 par value capital stock. No ready market exists for such stock, which is carried at cost. Due to the redemption provisions of the FHLB, cost approximates market value.

(J) Property and Equipment

Land is carried at cost. Buildings and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method and is charged to operations over the estimated useful lives of the assets which range from 25 to 50 years for bank premises and 3 to 10 years for furniture and equipment. Construction in progress includes buildings and equipment carried at cost and depreciated once placed into service.

Maintenance, repairs, renewals and minor improvements are charged to expense as incurred. Major improvements are capitalized and depreciated.

(K) Short-Term Debt

Short-term debt consists of securities sold under agreements to repurchase, overnight sweep accounts, federal funds purchased and short-term FHLB advances.

(L) Long-Term Debt and Junior Subordinated Notes Related to Trust Preferred Securities

Long-term debt consists of advances from FHLB with maturities greater than one year. The Company had no long-term borrowing from FHLB at December 31, 2012 and no long-term borrowing from FHLB at December 31, 2011. The Company formed Oak Ridge Statutory Trust I (the “Trust”) during 2007 to facilitate the issuance of trust preferred securities. The Trust is a statutory business trust formed under the laws of the state of Connecticut, of which all common securities are owned by the Company. The Trust is not included in the Company’s consolidated financial statements. The Company’s equity interests for junior subordinated debentures issued by the Company to the Trust are included in other assets.

(M) Employee Stock Ownership Plan

In 2010, the Company established an Employee Stock Ownership Plan (the “ESOP”) for the employees of the Bank. The ESOP is a qualifying plan under Internal Revenue Service guidelines. It covers all employees who work at least 1,000 hours per year, are at least 21 years of age, and have completed one year of service. During the year ended December 31, 2010, the Company accrued $900,000 to be contributed to the plan. The Company paid the amount accrued in 2010 to the Plan in 2011. There were no accruals or contributions in the year ended December 31, 2012.

(N) Income Taxes

The Company uses the liability method in accounting for income taxes. Deferred taxes and liabilities are recognized for operating loss and tax credit carry-forwards and for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities on their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. Current accounting standards prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return, as well as guidance on de-recognition, classification, interest and penalties, accounting in interim periods, and disclosures. The Company’s policy is to classify any interest recognized as interest expense and to classify any penalties recognized as an expense other than income tax expense.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued

(O) Advertising Costs

Advertising costs are expensed as incurred and totaled $313 thousand and $437 thousand for the years end December 31, 2012 and 2011, respectively.

(P) Stock Option Plan

The Company recognizes compensation cost relating to share-based payment transactions in the financial statements in accordance with generally accepted accounting principles. The cost is measured based on the fair value of the equity or liability instruments issued. The expense measures the cost of employee services received in exchange for stock options based on the grant-date fair value of the award, and recognizes the cost over the period the employee is required to provide services for the award.

The Company adopted both the Employee Stock Option Plan (Incentive Plan) and the Director Stock Option Plan (Nonstatutory Plan). Under each plan up to 178,937 shares may be issued for a total of 357,874 shares. Both of these plans expired on June 29, 2010. Options granted under both plans expire no more than 10 years from date of grant. Option exercise price under both plans were set by a committee of the Board of Directors at the date of grant, at a price not less than 100 percent of fair market value at the date of the grant. Options granted under either plan vest according to the terms of each particular grant.

The Company has also adopted the Long-Term Incentive Plan . Under this plan, up to 500,000 shares may be issued as either stock options, restricted stock, or performance units. The plan terminates on April 20, 2017, except with respect to awards then outstanding. The exercise price for awards under this plan shall be set by a committee of the Board of Directors at the date of grant, but shall not be less than 100 percent of fair market value at the date of the grant. Awards granted under this plan vest according to the terms of each particular grant. Restricted stock awards shall be in the form of restricted stock, subject to the terms and restrictions of the Long-Term Incentive Plan. The restricted stock awards are subject to forfeiture or cancellation under the plan and cannot be sold or transferred until the restrictions have lapsed.

(Q) Net Income (Loss) Per Share

The computation of diluted earnings (loss) per common share is similar to the computation of basic earnings (loss) per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares.

In computing diluted net income (loss) per common share, it is assumed that all dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the number of shares bought back is added to the number of weighted-average common shares outstanding during the period. The sum is used as the denominator to calculate diluted net income (loss) per common share for the Company. As of December 31, 2012 the warrant, covering approximately 164,000 shares, issued to the U.S. Treasury Department was not included in the computation of diluted net income (loss) per common share for the period because its exercise price exceeded the average market price of the Company’s stock for the period.

At December 31, 2012 and 2011, all exercisable options had an exercise price greater than the average market price for the year and were not included in computing diluted earnings (loss) per common share. The number of antidilutive shares totaled 232,190 at December 31, 2012 and 2011.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued

(Q) Net Income (Loss) Per Share, continued

The following is a reconciliation of the numerators and denominators used in computing basic and diluted net income (loss) per common share.

	Year Ended December 31, 2012
	Income (Numerator)			Shares (Denominator)		Per Share Amount
	(Amounts in thousands, except per share data)
Basic loss per common share	$	(2,626	)		1,808,445	$	(1.45	)
Effect of dilutive securities		—			—
Diluted loss per common share	$	(2,626	)		1,808,445	$	(1.45	)

	Year Ended December 31, 2011
	Income (Numerator)			Shares (Denominator)		Per Share Amount
	(Amounts in thousands, except per share data)
Basic loss per common share	$	(289	)		1,808,445	$	(0.16	)
Effect of dilutive securities		—			—
Diluted loss per common share	$	(289	)		1,808,445	$	(0.16	)

(R) Risks and Uncertainties

In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different basis, than its interest-earning assets. Credit risk is the risk of default on the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

The Company is subject to the regulations of various governmental agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances and operating restrictions from the regulators’ judgments based on information available to them at the time of their examination.

(S) Reclassifications

Certain prior year amounts have been reclassified in the consolidated financial statements to conform with the current year presentation. The reclassifications had no effect on previously reported net income (loss) or stockholders’ equity.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued

(T) New Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

The Financial Accounting Standards Board (“FASB”) amended the Comprehensive Income topic of the ASC in February 2013. The amendments addresses reporting of amounts reclassified out of accumulated other comprehensive income. Specifically, the amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments do require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, in certain circumstances an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The amendments will be effective for the Company on a prospective basis for reporting periods beginning after December 15, 2012. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

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

(U) Subsequent Events

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

2. INVESTMENT SECURITIES

The amortized cost and fair value of securities, with gross unrealized gains and losses, follows (dollars in thousands):

	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-sale
Government-sponsored enterprise securities	$	1,021	$	58	$	-		$	1,079
FNMA or GNMA mortgage-backed securities		8,323		347		(42	)		8,628
Private label mortgage-backed securities		8,868		295		(88	)		9,075
Municipal securities		12,868		1,158		(6	)		14,020
SBA debentures		9,891		744		-			10,635
Other domestic debt securities		500		-		-			500
Total securities available-for-sale	$	41,471	$	2,602	$	(136	)	$	43,937

Held-to-maturity
Private label mortgage-backed securities		3,928		255		-			4,183
Total securities held-to-maturity	$	3,928	$	255	$	-		$	4,183

	December 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-sale
Government-sponsored enterprise securities	$	2,029	$	99	$	-		$	2,128
FNMA or GNMA mortgage-backed securities		15,703		488		(142	)		16,049
Private label mortgage-backed securities		7,582		278		(21	)		7,839
Municipal securities		12,292		679		-			12,971
SBA debentures		11,204		521		-			11,725
Other domestic debt securities		500		-		-			500
Total securities held-to-maturity	$	49,310	$	2,065	$	(163	)	$	51,212

Held-to-maturity
Private label mortgage-backed securities		5,211		288		(295	)		5,204
Total securities available-for-sale	$	5,211	$	288	$	(295	)	$	5,204

Subinvestment grade available-for-sale and held-to-maturity private label mortgage-backed securities are analyzed on a quarterly basis for impairment by utilizing an independent third party that performs an analysis of the estimated principal the Bank is expected to collect in a number of different economic scenarios. The Bank utilizes a model developed by an independent third party that estimates the portion of a loss on a security that is attributable to credit by estimating the expected cash flows of the underlying collateral using a credit and prepayment risk model that incorporate management's best estimate of current key assumptions such as default rates, loss severity and prepayment rates. Assumptions used for the underlying loans that support the MBS can vary widely from loan to loan and are influenced by such factors as loan interest rate, geographic location of the borrower, borrower characteristics and collateral type. The result of this analysis determines whether the Bank records an impairment loss on these securities. In 2012 and 2011, the Bank recorded impairment charges of $1 thousand and $48 thousand, respectively, on two different private label securities.

The Bank had approximately $528 thousand and $795 thousand at December 31, 2012 and 2011, respectively, of investments in stock of the FHLB, which is carried at cost. The following factors have been considered in determining the carrying amount of FHLB stock; 1) the recoverability of the par value, 2) the Company has sufficient liquidity to meet all operational needs in the foreseeable future and would not need to dispose of the stock below recorded amounts, 3) redemptions and purchases of the stock are at the discretion of the FHLB, 4) the Company feels the FHLB has the ability to absorb economic losses given the expectation that the various FHLBs have a high degree of government support and 5) the unrealized losses related to securities owned by the FHLB are manageable given the capital levels of the organization. The Company estimated that the fair value equaled or exceeded the cost of this investment (that is, the investment was not impaired) on the basis of the redemption provisions of the issuing entity. Investment securities with amortized costs of $3.3 million and $3.8 million at December 31, 2012 and 2011 were pledged as collateral on public deposits or for other purposes as required or permitted by law.

2. INVESTMENT SECURITIES, continued

Gross realized gains and losses for the years ended December 31, 2012 and 2011 follows (dollars in thousands):

	December 31,
	2012		2011
Realized gains	$	-	$	463
Realized losses		-		—
	$	-	$	463

The following tables detail unrealized losses and related fair values in the Company’s held-to-maturity and available-for-sale investment securities portfolios at December 31, 2012 and 2011. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2012 and 2011 (dollars in thousands).

	Less Than 12 Months					12 Months or Greater					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
2012
Available-for-sale

FNMA mortgage-backed securities	$	3,290	$	(42	)	$	-	$	-		$	3,290	$	(42	)
Private label mortgage-backed securities		-		-			5,900		(88	)		5,900		(88	)
Municipal Securities		371		(6	)		-		-			371		(6	)
Total temporarily impaired securities	$	3,661	$	(48	)	$	5,900	$	(88	)	$	9,561	$	(136	)

	Less Than 12 Months					12 Months or Greater					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
2011
Available-for-sale
FNMA mortgage-backed securities	$	4,196	$	(83	)	$	2,632	$	(58	)	$	6,828	$	(142	)
Private label mortgage-backed securities		3,167		(21	)		-		-			3,167		(21	)
Total temporarily impaired securities	$	7,363	$	(104	)	$	2,632	$	(58	)	$	9,995	$	(163	)

Held-to-maturity
Private label mortgage-backed securities	$	-	$	-		$	1,835	$	(295	)	$	1,835	$	(295	)

At December 31, 2012, the unrealized losses in the available-for-sale portfolio relate to four Federal National Mortgage Association (“FNMA”) mortgage-backed-securities, one Government National Mortgage Association (“GNMA”) mortgage-backed-security, three private label mortgage-backed-securities, and one municipal security. At December 31, 2011, the unrealized losses in the available-for-sale portfolio relate to five FNMA mortgage-backed-securities. The key factors considered in evaluating the private label collateralized mortgage obligations were cash flows of this investment and the assessment of other relative economic factors. The unrealized losses are largely due to increases in the market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or re-pricing date or if market yields for such securities decline.

2. INVESTMENT SECURITIES, continued

Maturities of mortgage-backed securities are presented based on contractual amounts. Actual maturities will vary as the underlying loans prepay. The scheduled maturities of securities at December 31, 2012 were as follows (dollars in thousands):

	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	-	$	-	$	-	$	-
Due after one year through five years		1,354		1,431		-		-
Due after five years through ten years		15,613		16,578		-		-
Due after ten years		24,504		25,928		3,928		4,183
	$	41,471	$	43,937	$	3,928	$	4,183

3. LOANS

The major components of loans on the balance sheet at December 31, 2012 and 2011 are as follows (dollars in thousands):

	December 31,
	2012			2011
Commercial	$	37,517		$	36,066
Real estate:
Real estate construction and development		38,004			41,295
Residential, one-to-four families		89,621			81,365
Residential, 5 or more families		2,085			6,143
Other commercial real estate		88,167			85,469
Agricultural		2,450			2,876
Consumer		2,025			2,124
		259,869			255,338
Deferred loan origination fees, net of costs		(22	)		(60	)
Allowance for loan losses		(5,500	)		(4,446	)
	$	254,347		$	250,832

Real Estate Loans . Real estate loans include construction and land development loans, one-to-four and 5 or more family loans, and commercial real estate loans.

Commercial real estate loans totaled $88.2 million and $85.5 million at December 31, 2012 and 2011, respectively. This lending has involved loans secured by owner-occupied commercial buildings for office, storage and warehouse space, as well as non-owner occupied commercial buildings. The Bank generally requires the personal guaranty of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate may be larger in size and may involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

Construction and development lending totaled $38.0 million and $41.3 million at December 31, 2012 and 2011, respectively. The Bank originates one-to-four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The Bank also makes commercial real estate construction loans, primarily for owner-occupied properties.

Residential one-to-four family loans amounted to $89.6 million and $81.4 million at December 31, 2012 and 2011, respectively. The Bank’s residential mortgage loans are typically either construction loans that convert into permanent financing and are secured by properties located within the Bank’s market areas, or refinances of existing one-to-four properties or financing of newly purchased one-to-four family properties.

Commercial Loans. At December 31, 2012 and 2011, the Bank’s commercial loan portfolio totaled $37.5 million and $36.1 million, respectively. Commercial loans include both secured and unsecured loans for working capital, expansion, and other business purposes.

3. LOANS, continued

Short-term working capital loans are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, cash flow, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment. Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans.

Loans to Individuals. Loans to individuals (consumer loans) include automobile loans, boat and recreational vehicle financing, and miscellaneous secured and unsecured personal loans and totaled $2.0 million and $2.1 million at December 31, 2012 and 2011, respectively. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank manages the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Loans of approximately $27.8 million at December 31, 2012 are pledged as eligible collateral for FHLB advances.

Loan Approvals . The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. The guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including any indebtedness as a guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan reviews by independent, outside professionals experienced in loan review. Responsibility for loan review and loan underwriting resides with the Chief Credit Officer position. This position is responsible for loan underwriting and approval. On an annual basis, the Board of Directors of the Bank determines officers lending authority. Authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the Board of Directors.

The Company, through its normal lending activity, originates and maintains loans receivable that are substantially concentrated in Guilford, Forsyth and Alamance counties in North Carolina.

Credit Review and Evaluation. The Bank has a credit review department that reports to the Chief Credit Officer. The focus of the department is on policy compliance and proper grading of higher credit risk loans as well as new and existing loans on a sample basis. Additional reporting for problem/criticized assets has been developed along with an after-the-fact loan review.

The Bank uses a risk grading program to facilitate the evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses for real estate, commercial and consumer loans. In this program, risk grades are initially assigned by loan officers, reviewed by credit officers, and reviewed by internal credit review analysts on a test basis. The Bank strives to maintain the loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of the Bank’s market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies.

All loans are risk graded on a scale from 1 (highest quality) to 8 (loss). Acceptable loans at inception are grades 1 through 4, and these grades have underwriting requirements that at least meet the minimum requirements of a secondary market source. If borrowers do not meet credit history requirements, other mitigating criteria such as substantial liquidity and low loan-to-value ratios could be considered and would generally have to be met in order to make the loan. The Bank’s loan policy states that a guarantor may be necessary if reasonable doubt exists as to the borrower’s ability to repay.

The risk grades, normally assigned by the loan officers when the loan is originated and reviewed by the credit officers, are based on several factors including historical data, current economic factors, composition of the portfolio, and evaluations of the total loan portfolio and assessments of credit quality within specific loan types. In some cases the risk grades are assigned by regional executives, depending upon dollar exposure. Because these factors are dynamic, the provision for loan losses can fluctuate. Credit quality reviews are based primarily on an analysis of the borrowers’ cash flows, with asset values considered only as a second source of payment. Credit officers work with lenders in underwriting, structuring and risk grading the Bank’s credits. The credit review department focuses on lending policy compliance, credit risk grading, and credit risk reviews on larger dollar exposures. Management uses the information developed from the procedures above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in determining the appropriate levels of the allowance for loan losses.

3. LOANS, continued

The following is a summary of the credit risk grade definitions for all loan types. These credit risk indicators were last updated in June 2012:

“1” — Highest Quality- These loans represent a credit extension of the highest quality. The borrower’s historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has access to alternative financial markets.

“2” — Good Quality- These loans have a sound primary and secondary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher graded borrower. This loan carries a normal level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the highest quality loans.

“3” — Satisfactory- The borrowers are a reasonable credit risk and demonstrate the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. Historic financial information may indicate erratic performance, but current trends are positive. Quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher graded loans. If adverse circumstances arise, the impact on the borrower may be significant.

“4” — Satisfactory – Merits Attention- These credit facilities have potential developing weaknesses that deserve extra attention from the account manager and other management personnel. If the developing weakness is not corrected or mitigated, there may be deterioration in the ability of the borrower to repay the bank’s debt in the future.

“5” — Watch or Special Mention - These loans are typically existing loans, made using the passing grades outlined above, that have deteriorated to the point that cash flow is not consistently adequate to meet debt service or current debt service coverage is based on projections. Secondary sources of repayment may include specialized collateral or real estate that is not readily marketable or undeveloped, making timely collection in doubt.

“6” — Substandard- Loans and other credit extensions bearing this grade are considered inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions jeopardizing repayment of principal and interest as originally intended. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.

“7” — Substandard Impaired (also includes any loans over 90 days past due, excluding sold mortgages )- Loans and other credit extensions graded “7” have all the weaknesses inherent in those graded “6,” with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high.

“8” — Loss- Loans in this classification are considered uncollectible and cannot be justified as a viable asset of the bank. Such loans are to be charged-off or charged-down. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.

3. LOANS, continued

The following is a summary of credit quality indicators by class at December 31, 2012 and 2011:

As of December 31, 2012 (dollars in thousands):

	Pass (Grades 1-4)		Special Mention (Grade 5)		Substandard and lower (Grades 6-8)		Total

Commercial	$	34,190	$	680	$	2,647	$	37,517
Real estate construction and development		30,036		3,774		4,194		38,004
Residential, one-to-four families		87,036		1,465		1,120		89,621
Residential, 5 or more families		1,768		317		—		2,085
Other commercial real estate		69,148		12,802		6,217		88,167
Agricultural		2,450		—		—		2,450
Consumer		2,022		3		—		2,025

Total	$	226,650	$	19,041	$	14,178	$	259,869

As of December 31, 2011 (dollars in thousands):

	Pass (Grades 1-4)		Special Mention (Grade 5)		Substandard and lower (Grades 6-8)		Total

Commercial	$	32,467	$	1,957	$	1,642	$	36,066
Real estate construction and development		28,969		8,283		4,043		41,295
Residential, one-to-four families		76,638		2,829		1,898		81,365
Residential, 5 or more families		4,502		848		793		6,143
Other commercial real estate		73,999		4,846		6,624		85,469
Agricultural		2,876		—		—		2,876
Consumer		2,111		13		—		2,124

Total	$	221,562	$	18,776	$	15,000	$	255,338

The following tables presents the Bank’s aged analysis of past due loans:

As of December 31, 2012 (dollars in thousands):

	30-89 Days Past Due		Greater than 90 Days Past Due (Nonaccrual)		Total Past Due		Current		Total loans		Past due 90 days or more and still accruing

Commercial	$	1,578	$	820	$	2,398	$	35,119	$	37,517	$	—
Real estate construction and development		331		3,001		3,332		34,672		38,004		—
Residential, one-to-four families		585		1,071		1,656		87,965		89,621		216
Residential, 5 or more families		—		—		—		2,085		2,085		—
Other commercial real estate		852		6,214		7,066		81,101		88,167		—
Agricultural		—		—		—		2,450		2,450		—
Consumer		14		—		14		2,011		2,025		—

Total	$	3,360	$	11,106	$	14,466	$	245,403	$	259,869	$	216

3. LOANS, continued

As of December 31, 2011 (dollars in thousands):

	30-89 Days Past Due		Greater than 90 Days Past Due (Nonaccrual)		Total Past Due		Current		Total loans		Past due 90 days or more and still accruing

Commercial	$	15	$	70	$	85	$	35,979	$	36,066	$	—
Real estate construction and development		816		690		1,506		39,789		41,295		—
Residential, one-to-four families		1,620		754		2,374		78,989		81,365		—
Residential, 5 or more families		—		793		793		5,352		6,143		—
Other commercial real estate		1,515		2,300		3,815		81,656		85,469		—
Agricultural		—		—		—		2,876		2,876		—
Consumer		13		—		13		2,111		2,124		—

Total	$	3,979	$	4,607	$	8,586	$	246,752	$	255,338	$	—

Past due loans reported in the following table do not include loans granted forbearance terms since payment terms have been modified or extended, although the loans are past due based on original contract terms. All loans with forbearance terms are included and reported as impaired loans.

Loans are considered past due if the required principal and interest income have not been received as of the date such payments were due.

Nonaccrual loans were $11.1 million and $4.6 million at December 31, 2012 and 2011, respectively. There were loans totaling $216,000 past due 90 days or more and still accruing at December 31, 2012. There were no loans past due 90 days or more and still accruing at December 31, 2011.

Impaired Loans. Management considers certain loans graded “substandard impaired” (loans graded 7) or “loss” (loans graded 8) to be individually impaired and may consider “substandard” loans (loans graded 6) individually impaired depending on the borrower’s payment history. The Bank measures impairment based upon probable cash flows or the value of the collateral. Collateral value is assessed based on collateral value trends, liquidation value trends, and other liquidation expenses to determine logical and credible discounts that may be needed. Updated appraisals are required for all impaired loans and typically at renewal or modification of larger loans if the appraisal is more than 12 months old.

Impaired loans for all classes of loans typically include nonaccrual loans, loans over 90 days past due and still accruing, troubled debt restructured loans and other potential problem loans considered impaired based on other underlying factors. TDR loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. Interest on TDR loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur and a sustained payment performance period is obtained. Due to the borrowers’ inability to make the payments required under the original loan terms, the Bank modifies the terms by granting a longer amortized repayment structure or reduced interest rates. Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans above, but about which we have concerns as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or troubled debt restructured loans, so they are considered by management in assessing the adequacy of the allowance for loan losses. Impaired loans are generally placed in nonaccrual status when they are greater than 90 days past due unless they are well secured and in process of collection.

3. LOANS, continued

The following tables present the Bank’s investment in loans considered to be impaired and related information on those impaired loans as of December 31, 2012 and 2011:

As of December 31, 2012 (dollars in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	2,745	$	2,943	$	—	$	2,409	$	92
Real estate construction and development		4,047		4,243		—		4,485		175
Residential, one-to-four families		672		871		—		1,220		14
Other commercial real estate		5,565		6,637		—		10,114		163
Total impaired loans with no related allowance recorded	$	13,029	$	14,694	$	—	$	18,228	$	444

With an allowance recorded:
Commercial	$	437	$	1,437	$	243	$	952	$	40
Other commercial real estate		334		820		334		1,125		—
Total impaired loans with allowance recorded	$	771	$	2,257	$	577	$	2,077	$	40

Total
Commercial	$	1,878	$	4,380	$	243	$	3,361	$	132
Real estate construction and development		4,047		4,243		—		4,485		175
Residential, one-to-four families		672		871		—		1,220		14
Other commercial real estate		7,203		7,457		334		11,239		163
Total impaired loans	$	13,800	$	16,951	$	577	$	20,305	$	484

As of December 31, 2011 (dollars in thousands):

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	1,275	$	1,275	$	—	$	638	$	37
Real estate construction and development		3,227		3,988		—		3,765		205
Residential, one-to-four families		1,206		1,206		—		1,224		82
Residential, 5 or more families		765		1,289		—		1,030		36
Other commercial real estate		6,017		6,547		—		6,854		295
Total impaired loans with no related allowance recorded	$	12,490	$	14,305	$	—	$	13,511	$	655

With an allowance recorded:
Real estate construction and development	$	1,355	$	1,355	$	301	$	1,482	$	64
Residential, one-to-four families		24		24		1		24		1
Other commercial real estate		223		223		72		223		10
Total impaired loans with allowance recorded	$	1,602	$	1,602	$	374	$	1,729	$	75

Total
Commercial	$	1,275	$	1,275	$	—	$	638	$	37
Real estate construction and development		4,583		5,343		301		5,247		269
Residential, one-to-four families		1,230		1,230		1		1,248		83
Residential, 5 or more families		765		1,289		—		1,030		36
Other commercial real estate		6,240		6,770		72		7,077		305
Total impaired loans	$	14,093	$	15,907	$	374	$	15,240	$	730

4. ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate for probable losses that have been incurred within the existing portfolio of loans. The primary risks inherent in the Bank’s loan portfolio, including the adequacy of the allowance or reserve for loan losses, are based on management’s assumptions regarding, among other factors, general and local economic conditions, which are difficult to predict and are beyond the Bank’s control. In estimating these risks, and the related loss reserve levels, management also considers the financial conditions of specific borrowers and credit concentrations with specific borrowers, groups of borrowers, and industries.

The allowance for loan losses is adjusted by direct charges to provision expense. Losses on loans are charged against the allowance for loan losses in the accounting period in which they are determined by management to be uncollectible. Recoveries during the period are credited to the allowance for loan losses. The provision for loan losses was $5.9 million for the year ended December 31, 2012 as compared to $4.0 million for the year ended December 31, 2011. The provision expense is determined by the Bank’s allowance for loan losses model. The components of the model are specific reserves for impaired loans and a general allocation for unimpaired loans. The general allocation has two components, an estimate based on historical loss experience and an additional estimate based on internal and external environmental factors due to the uncertainty of historical loss experience in predicting current embedded losses in the portfolio that will be realized in the future.

The portion of the general allocation on environmental factors includes estimates of losses related to interest rate trends, unemployment trends, past due and nonaccrual trends, watch list trends, charge-off trends, and monitoring assessments. The market served by the Bank continues to experience softening from the general economy and declines in real estate values.

The following table summarizes the balances by loan category of the allowance for loan losses with changes arising from charge-offs, recoveries and provision expense for the years ended December 31, 2012 and 2011:

For the year ended December 31, 2012 (dollars in thousands):

Allowance for Loan Losses	Commercial			Real estate Construction and Development			Residential, one-to-four families			Residential, 5 or more families			Other commercial real estate			Agricultural			Consumer			Total
Allowance for credit losses:
Beginning balance	$	200		$	2,072		$	875		$	380		$	892		$	4		$	23		$	4,446
Charge-offs		(1,862	)		(889	)		(1,406	)		—			(793	)		—			(41	)		(4,991	)
Recoveries		1			1			5			89			36			—			5			137
Provision		3,012			177			1,772			(383	)		1,296			(1	)		35			5,908

Ending balance	$	1,351		$	1,361		$	1,246		$	86		$	1,431		$	3		$	22		$	5,500

For the year ended December 31, 2011 (dollars in thousands):

Allowance for Loan Losses	Commercial			Real estate Construction and Development			Residential, one-to-four families			Residential, 5 or more families			Other commercial real estate			Agricultural		Consumer			Total
Allowance for credit losses:
Beginning balance	$	815		$	1,970		$	1,237		$	120		$	208		$	1	$	24		$	4,375
Charge-offs		(80	)		(1,986	)		(511	)		(496	)		(957	)		—		(15	)		(4,045	)
Recoveries		—			123			—			—			—			—		16			139
Provision		(535	)		1,965			149			756			1,641			3		(2	)		3,977

Ending balance	$	200		$	2,072		$	875		$	380		$	892		$	4	$	23		$	4,446

The following tables summarize the allowance for loan losses and recorded investment in loans:

December 31, 2012 (dollars in thousands):

	Allowance for Loan Losses						Recorded Investment in Loans
	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total

Commercial	$	243	$	1,108	$	1,351	$	1,878	$	35,639	$	37,517
Real estate construction and development		—		1,361		1,361		4,047		33,957		38,004
Residential, one-to-four families		—		1,246		1,246		672		88,949		89,621
Residential, 5 or more families		—		86		86		—		2,085		2,085
Other commercial real estate		334		1,097		1,431		7,203		80,964		88,167
Agricultural		—		3		3		—		2,450		2,450
Consumer		—		22		22		—		2,025		2,025

Total	$	577	$	4,923	$	5,500	$	13,800	$	246,069	$	259,869

December 31, 2011 (dollars in thousands):

	Allowance for Loan Losses						Recorded Investment in Loans
	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total

Commercial	$	—	$	200	$	200	$	1,275	$	34,789	$	36,066
Real estate construction and development		301		1,771		2,072		4,583		36,712		41,295
Residential, one-to-four families		1		874		875		1,230		80,133		81,365
Residential, 5 or more families		—		380		380		765		5,380		6,143
Other commercial real estate		72		820		892		6,240		79,231		85,469
Agricultural		—		4		4		—		2,876		2,876
Consumer		—		23		23		—		2,124		2,124

Total	$	374	$	4,072	$	4,446	$	14,093	$	241,245	$	255,338

5. TROUBLED DEBT RESTRUCTURINGS

The total amount of TDR loans outstanding as of December 31, 2012 was $4.4 million with no related reserves. Approximately $543 thousand TDR were accruing interest as of December 31, 2012, as these loans had sufficient evidence of paying according to the new restructured terms to warrant a return to accrual status. The total amount TDR loans outstanding as of December 31, 2011 was $6.1 million with related reserves of $253 thousand. Approximately $4.8 million of TDR loans are accruing interest as of December 31, 2011, as these loans had sufficient evidence of paying according to the new restructured terms.

The following tables include the recorded investment and number of modifications for TDR restructured loans for the year ended December 31, 2011. There were no modifications for TDR loans for the year ended December 31, 2012. The Company reports the recorded investment in the loans prior to a modification and also the recorded investment in the loans after the loans were restructured. Reductions in the recorded investment are primarily due to the partial charge-off of the principal balance prior to modification.

	Year ended December 31, 2011
Extended payment terms:	Number of loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Adjustment to Reserves as a Result of the Restructuring
Commercial		1	$	151	$	151	$	—
Real estate construction and development		2	2,124		2,202		—
Residential, one-to-four families		1	13		391		—
Other commercial real estate		3	2,184		3,793		—
		7	$	4,472	$	4,472	$	—

During the years ended December 31, 2012 and 2011 there were no loans in default that had been previously restructured. Restructured loans are deemed to be in default if payments in accordance with the modified terms are not received within 90 days of the payment due date.

6. BANK PREMISES AND EQUIPMENT

Components of property and equipment and total accumulated depreciation are as follows (dollars in thousands):

	December 31,
	2012			2011
Land, buildings and improvements	$	8,867		$	9,139
Furniture and equipment		6,103			5,737
Property and equipment, total		14,970			14,876
Less accumulated depreciation		(5,599	)		(4,903	)
Property and equipment, net of depreciation	$	9,371		$	9,973

Depreciation expense for the years ended December 31, 2012 and 2011 was $936,000 and $887,000, respectively.

Leases

The Company has non-cancelable operating leases for four branch locations and one administrative office. These lease agreements have terms ranging from 5 to 20 years and will expire between 2013 and 2025. Most of them have options to terminate the lease without penalty at specific intervals ranging from 3 to 5 years. Rent expense related to these leases was $375,000 and $403,000 for the years ended December 31, 2012 and 2011, respectively. Pursuant to the terms of the non-cancelable lease agreements in effect at December 31, 2012, the schedule of future minimum rent payments is as follows: (dollars in thousands)


2013		327
2014		308
2015		316
2016		323
2017		328
Thereafter		2,065
	$	3,667

7. INCOME TAXES

Current and Deferred Income Tax Components

The components of income tax expense (benefit) for the years ended December 31, 2012 and 2011 are as follows (dollars in thousands):

	2012			2011
Current
Federal	$	(382	)	$	(374	)
State		(11	)		(78	)
		(393	)		(452	)

Deferred
Federal		(856	)		396
State		(237	)		87
Deferred tax asset valuation change		5			4
Deferred taxes		(1,088	)		487
Net income tax expense (benefit)	$	(1,481	)	$	35

7. INCOME TAXES, continued

Rate Reconciliation

A reconciliation of income tax expense (benefit) computed at the statutory federal income tax rate included in the statement of operations for the years ended December 31, 2012 and 2011 is as follows (dollars in thousands):

	2012			2011
Tax at statutory federal rate	$	(1,167	)	$	135
Income from bank owned life insurance		(47	)		(50	)
Tax-exempt income		(112	)		(68	)
State taxes, net of federal benefit		(164	)		6
Deferred tax asset valuation allowance change		5			4
Other		4			8
Total	$	(1,481	)	$	35

Deferred Income Tax Analysis

The significant components of net deferred tax assets at December 31, 2012 and 2011 are summarized as follows (dollars in thousands):

	2012			2011
Deferred tax assets
Allowance for loan losses	$	1,848		$	1,382
Accrued compensation		580			481
State carryforwards		78			31
Other real estate owned		247			156
Federal tax credits		84			-
Charitable contributions carryforward		3			-
Unrealized loss on investment securities		69			68
Post retirement benefit obligation		119			112
Stock Compensation		31			34
Total deferred tax assets		3,059			2,264
Valuation allowance		(36	)		(31	)
Deferred tax asset		3,023			2,233

Deferred tax liabilities
Accretion of bond discount		(346	)		(518	)
Depreciation		(618	)		(712	)
Deferred loan fees		9			(23	)
Unrealized appreciation on available-for-sale securities		(951	)		(733	)
Total deferred tax liabilities		(1,906	)		(1,986	)
Net deferred tax asset	$	1,117		$	247

At December 31, 2012 and 2011 the Company had net loss carry-forwards for state income tax purposes of approximately $1.7 million and $672 thousand, respectively. The state net loss carry-forwards begin to expire in 2022. Utilization of state net loss carry-forwards to reduce future income taxes will depend on the Company’s ability to generate sufficient taxable income of the appropriate type and character prior to expiration. Accordingly, the Company has established a deferred tax valuation allowance to offset state net loss carry-forwards. For the years ended December 31, 2012 and 2011, the valuation allowance increased $5 thousand and $4 thousand, respectively.

Unrecognized Tax Benefits

Current accounting standards prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, as well as guidance on de-recognition, classification, interest and penalties, accounting in interim periods and disclosure.

There have been no gross amounts of unrecognized tax benefits, interest or penalties related to uncertain tax positions since adoption. There are no unrecognized tax benefits that would, if recognized, affect the effective tax rate. There are no positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months.

Subsequent to December 31, 2010, an examination of the Company’s federal income tax returns for 2007, 2008, and 2009 was completed with no significant adjustments. Years prior to December 31, 2009 are closed for federal, state and local income tax matters.

8. BORROWED FUNDS

The Company had no advances outstanding with the FHLB at December 31, 2012 and 2011. Pursuant to a collateral agreement with the FHLB, advances are collateralized by all the Company’s FHLB stock and qualifying first and second mortgage loans. The eligible residential one-to-four family first and second mortgage loans as of December 31, 2012, were $27.8 million. This agreement with the FHLB provides for a line of credit of up to 30% of the Bank’s assets, subject to the Bank providing adequate collateral to secure the borrowings. In addition, the Bank had investments with a market value of $3.8 million held in safekeeping that the Bank can provide as collateral for borrowings.

The Company has established various credit facilities to provide additional liquidity if and as needed. These include unsecured lines of credit with correspondent banks totaling $6.0 million and are subject to cancellation without notice.

Junior Subordinated Debentures

The Trust was created by the Company on June 28, 2007, at which time the Trust issued $8.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature on June 28, 2037. Distributions are payable on the securities at the floating rate equal to the three-month London Interbank Offered Rate (“LIBOR”) plus 1.60%, and the securities may be prepaid at par by the Trust at any time after June 28, 2012. The principal assets of the Trust are $8.3 million of the Company’s junior subordinated debentures which mature on June 28, 2037, and bear interest at the floating rate equal to the three-month LIBOR plus 1.60%, and which are callable by the Company after June 28, 2012. All $248,000 in the aggregate liquidation amount of the Trust’s common securities are held by the Company.

9. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS

Defined Contribution Plan

The Company maintains a profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Code”). The plan covers substantially all employees. Participants may contribute a percentage of compensation, subject to the maximum allowed under the Code. In addition, the Company may make additional contributions at the discretion of the Board of Directors. The Company paid $168,000 in each of the years ended December 31, 2012 and 2011.

Employee Stock Ownership Plan

In 2010, the Company established an Employee Stock Ownership Plan (the “ESOP”) for the employees of the Bank. The ESOP is a qualifying plan under Internal Revenue Service guidelines. It covers all employees who work at least 1,000 hours per year, are at least 21 years of age, and have completed one year of service. During the year ended December 31, 2010, the Company accrued $900,000 to be contributed to the Plan. The Company contributed the amount accrued in 2010 to the Plan in 2011. There were no accruals or contributions in the year ended December 31, 2012.

Flexible Benefits Plan

The Company maintains a Flexible Benefits Plan, which covers substantially all employees. Participants may set aside pre-tax dollars to provide for the future expenses such as insurance, dependent care or health care. Expenses of the plan were $532,000 and $526,000 for the years ended December 31, 2012 and 2011, respectively.

Cash Value of Life Insurance

The Company is the owner and beneficiary of life insurance policies on certain executive officers. Policy cash values on the balance sheet totaled $5.1 million at December 31, 2012, and $4.9 million at December 31, 2011.

9. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS, continued

Supplemental Executive Retirement Plan

In January of 2006, the Company adopted a supplemental executive retirement plan to provide benefits for certain members of management. Under plan provisions, aggregate fixed annual payments of $252,400 are payable for these members of management for their lifetime, beginning with their normal retirement ages of 65. The liability is calculated by discounting the anticipated future cash flows at 6%. The liability accrued for this obligation was $1.8 million and $1.5 million at December 31, 2012 and 2011, respectively. Charges to income and expense are based on changes in the cash value of insurance as well as any additional charges required to fund the liability. The Company funded the supplemental executive retirement plan through the purchase of bank ‑ owned life insurance (“BOLI”) during 2003 and 2004 with initial investments of $1.9 million and $1.8 million, respectively. The corresponding cash surrender values of the BOLI policies as of December 31, 2012 and 2011 was $5.1 million and $4.9 million, respectively.

Stock Option Plans

The Company adopted both the Employee Stock Option Plan (Incentive Plan) and the Director Stock Option Plan (Nonstatutory Plan). Under each plan up to 178,937 shares may be issued for a total of 357,874 shares. Both of these plans expired on June 29, 2010. Options granted under both plans expire no more than 10 years from date of grant. Option exercise price under both plans were set by a committee of the Board of Directors at the date of grant, at a price not less than 100% of fair market value at the date of the grant. Options granted under either plan vest according to the terms of each particular grant.

During 2007, the Company adopted the Long-Term Stock Incentive Plan. The Plan provides for the issuance of up to an aggregate of 500,000 shares of common stock in the form of stock options, restricted stock awards and performance unit awards. The Long-Term Incentive Plan expires on April 20, 2017.

Compensation cost charged to income for the years ended December 31, 2012 and 2011 was approximately $30 thousand and $85 thousand, respectively.

Stock Options

Stock options may be issued as incentive stock options or as nonqualified stock options. The term of the option will be established at the time is it granted but shall not exceed ten years. Vesting will also be established at the time the option is granted. The exercise price may not be less than the fair market value of a share of common stock on the date the option is granted. It is the Company’s policy to issue new shares of stock to satisfy option exercises.

Restricted Stock Awards

Restricted stock awards are subject to restrictions and the risk of forfeiture if conditions stated in the award agreement are not satisfied at the end of a restriction period. During the restriction period, restricted stock covered by the award will be held by the Company. If the conditions stated in the award agreement are satisfied at the end of the restriction period, the restricted stock will become unrestricted and the certificate evidencing the stock will be delivered to the employee.

A summary of the status of stock options as of December 31, 2012 and 2011, and changes during the years then ended, is presented below:

	2012				2011
	Number		Weighted Average Option Price		Number			Weighted Average Option Price
Options outstanding, beginning of year		232,190	$	9.68		320,471		$	9.44
Granted		—		—		—			—
Expired		—		—		(88,281	)		8.80
Forfeited		—		—		—			—

Options outstanding, end of year		232,190	$	9.68		232,190		$	9.68

Information regarding the stock options outstanding at December 31, 2012 is as follows:

Range of Exercise Prices			Number Outstanding		Weighted Average Remaining Contractual Life ( Years)	Weighted Average Exercise Price		Aggregate Intrinsic Value
	$4.50			25,500	7.67	$	4.82	$	—
$10.00	-	10.39		119,794	1.58	$	10.00		—
$10.40	-	11.20		86,896	1.37	$	10.68		—
				232,190	2.17	$	9.68	$	—

9. RETIREMENT PLANS AND OTHER POSTRETIREMENT BENEFITS, continued

Information regarding the stock options outstanding and exercisable at December 31, 2012 is as follows (dollars in thousands):

Range of Exercise Prices			Number Outstanding		Weighted Average Remaining Contractual Life (Years)	Weighted Average Exercise Price		Aggregate Intrinsic Value
	$4.50			20,700	7.67	$	4.82	$	—
$10.00	-	10.39		119,794	1.58	$	10.00		—
$10.40	-	11.20		86,896	1.37	$	10.68		—
				227,390	2.06	$	9.79	$	—

No options were granted in the years ended December 31, 2012 and 2011. Options of 800 shares vested in the years ended December 31, 2012 and 2011.

Anticipated total unrecognized compensation costs related to outstanding non-vested stock options and restricted stock grants will be recognized over the following periods:

	Stock Options
	(Dollars in thousands)
2013	$	13
2014		5
2015		2
2016		—
2017		—
Total	$	20

In 2012 and 2011, the Company granted 2,501 and 3,000 shares of restricted stock, respectively. The shares have a one year vesting period.

10. DEPOSITS

At December 31, 2012 and 2011 certificates of deposit of $100,000 or more amounted to approximately $52.0 million and $45.6 million, respectively. At December 31, 2012, the scheduled maturities of time deposits are as follows: (dollars in thousands)


Three months or less	$	31,609
Four months to one year		44,687
Two to three years		24,927
Three to four years		15,386
Four to five years		4,957
Thereafter		—
	$	121,566

Brokered deposits were $29.8 million and $36.0 million as of December 31, 2012 and 2011, respectively.

11. RESERVE REQUIREMENTS

The aggregate net reserve balances maintained under the requirements of the Federal Reserve were $3.7 million at both December 31, 2012 and 2011.

12. COMMITMENTS AND CONTINGENCIES

The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to meet the financing needs of its customers. These financial instruments included commitments to extend credit on unfunded lines of credit and mortgage loans held-for-sale of $30.0 million and standby letters of credit of $755 thousand at December 31, 2012.

The Company’s exposure to credit loss for commitments to extend credit and standby letters of credit is the contractual amount of those financial instruments. The Company uses the same credit policies for making commitments and issuing standby letters of credit as it does for on-balance sheet financial instruments. Each customer’s creditworthiness is evaluated on an individual case-by-case basis. The amount and type of collateral, if deemed necessary by management, is based upon this evaluation of creditworthiness. Collateral obtained varies, but may include marketable securities, deposits, property, plant and equipment, investment assets, real estate, inventories and accounts receivable. Management does not anticipate any significant losses as a result of these financial instruments and anticipates funding them from normal operations.

The Company is not involved in any legal proceedings which, in management’s opinion, could have a material effect on the consolidated financial position or results of operations of the Company.

13. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.

Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at December 31, 2012 and 2011 (dollars in thousands):

	December 31, 2012				December 31, 2011
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	17,043	$	17,043	$	21,443	$	21,443
Time deposits		—		—		1,050		1,050
Securities, available-for-sale		43,937		43,937		51,212		51,212
Securities, held-to-maturity		3,928		4,183		5,211		5,204
FHLB Stock		528		528		795		795
Loans held for sale		1,787		1,787		808		808
Loans, net of allowance for loan losses		254,347		255,058		250,832		254,148
Bank owned life insurance		5,078		5,078		4,939		4,939

Financial liabilities
Deposits		306,177		313,855		313,911		318,708
Junior subordinated notes related to trust preferred securities		8,248		8,248		8,248		8,248

The estimated fair values of net loans and deposits at December 31 are based on estimated cash flows discounted at market interest rates. The carrying values of other financial instruments, including various receivables and payables, approximate fair value. The carrying amounts and the fair values of the junior subordinated notes related to trust preferred securities and long-term debt are equal as the rates on the underlying obligations reprice every three months. Refer to Note 1(E) for investment securities fair value information. The fair value of off-balance sheet financial instruments is considered immaterial. As discussed in Note 12, these off-balance sheet financial instruments are commitments to extend credit and are either short-term in nature or subject to immediate repricing.

13. FAIR VALUE OF FINANCIAL INSTRUMENTS, continued

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1	Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2	Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3	Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

There were no changes to the techniques used to measure fair value during the period ended December 31, 2012.

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. The sensitivity of fair value to unobservable inputs may result in a significantly higher or lower value.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, market price and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2012, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. 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 Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

13. FAIR VALUE OF FINANCIAL INSTRUMENTS, continued

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral 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 Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

The following table presents the carrying values and estimated fair values of the Company’s financial instruments at December 31, 2012 2011 (dollars in thousands):

	December 31 , 2012
	Carrying amount		Estimated fair value		Level 1		Level 2		Level 3
	(Amounts in thousands)
Financial assets:
Cash and cash equivalents	$	17,043	$	17,043	$	17,043	$	—	$	—
Securities, available-for-sale		43,937		43,937		—		43,437		500
Securities, held-to-maturity		3,928		4,183		—		4,183		—
Federal Home Loan Bank stock		528		528		528		—		—
Loans held for sale		1,787		1,787		1,787		—		—
Loans, net of allowance for loan losses		254,347		255,058		—		—		255,058
Bank owned life insurance		5,078		5,078		—		—		5,078
Financial liabilities:
Deposits		306,177		313,855		—		313,855		—
Junior subordinated notes related to trust preferred securities		8,248		8,248		—		—		8,248

	December 31, 2011
	Carrying amount		Estimated fair value		Level 1		Level 2		Level 3
	(Amounts in thousands)
Financial assets:
Cash and cash equivalents	$	21,443	$	21,443	$	21,443	$	—	$	—
Time deposits		1,050		1,050		—		1,050		—
Securities, available-for-sale		51,212		51,212		1,914		48,798		500
Securities, held-to-maturity		5,211		5,204		—		5,204		—
Federal Home Loan Bank stock		795		795		795		—		—
Loans held for sale		808		808		808		—		—
Loans, net of allowance for loan losses		250,832		254,148		—		—		254,148
Bank owned life insurance		4,939		4,939		—		—		4,939
Financial liabilities:
Deposits		313,911		318,708		—		318,708		—
Junior subordinated notes related to trust preferred securities		8,248		8,248		—		—		8,248

Assets recorded at fair value on a recurring basis

December 31, 2012 (Dollars in thousands)	Total		Level 1		Level 2		Level 3
Government-sponsored enterprise securities	$	1,079	$	—	$	1,079	$	—
FNMA or GNMA mortgage-backed securities		8,628		—		8,628		—
Private label mortgage-backed securities		9,075		—		9,075		—
Municipal securities		14,020		—		14,020		—
SBA debentures		10,635		—		10,635		—
Other domestic debt securities		500		—		—		500
Investment securities available-for-sale	$	43,937	$	—	$	43,437	$	500
Total assets at fair value	$	43,937	$	—	$	43,437	$	500

December 31, 2011 (Dollars in thousands)	Total		Level 1		Level 2		Level 3
Government-sponsored enterprise securities	$	2,128	$	—	$	2,128	$	—
FNMA or GNMA mortgage-backed securities		16,049		—		16,049		—
Private label mortgage-backed securities		7,598		—		7,598		—
Municipal securities		13,212		—		13,842		—
SBA debentures		11,725		—		11,725		—
Other domestic debt securities		500		—		—		500
Investment securities available-for-sale	$	51,212	$	—	$	50,712	$	500
Total assets at fair value	$	51,212	$	—	$	50,712	$	500

13. FAIR VALUE OF FINANCIAL INSTRUMENTS, continued

Assets recorded at fair value on a nonrecurring basis

December 31, 2012 (Dollars in thousands)	Total		Level 1		Level 2		Level 3
Commercial loans	$	437	$	—	$	—	$	437
Other commercial real estate loans		334		—		—		334
Impaired commercial and commercial real estate loans		771		—		—		771
Foreclosed assets		2,116		—		—		2,116
Total assets at fair value	$	2,887	$	—	$	—	$	2,887
Total liabilities at fair value	$	—	$	—	$	—	$	—

December 31, 2011 (Dollars in thousands)	Total		Level 1		Level 2		Level 3
Construction and development loans	$	702	$	—	$	—	$	702
Land and acquisition and development loans		653		—		—		653
Closed-end first lien loans secured by one-to-four family residential properties		24		—		—		24
Secured by nonfarm nonresidential properties		223		—		—		223
Impaired loans receivable		1,602		—		—		1,602
Foreclosed assets		2,216		—		—		2,216
Total assets at fair value	$	3,818	$	—	$	—	$	3,818
Total liabilities at fair value	$	—	$	—	$	—	$	—

The following table provides Quantitative Information about Level 3 Fair Value Measurements

	Fair Value at December 31, 2012		Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value

Impaired Loans	$	771	Appraised Value	Appraisals and/or sales of comparable properties		n/a

Foreclosed assets	$	2,116	Appraised Value/ Comparable Sales/ Other Estimates from Independent Sources	Appraisals and/or sales of comparable properties/ Independent quotes/bids		n/a

13. FAIR VALUE OF FINANCIAL INSTRUMENTS , continued

The table below presents reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2012 and 2011.

(Dollars in thousands)	Available-for Sale Securities
Balance, January 1, 2012	$	500
Total gains or losses (realized/unrealized):
Included in earnings		—
Included in other comprehensive income		—
Purchases, issuances, and settlements		—
Transfers in to/out of Level 3		—
Balance, December 31, 2012	$	500

(Dollars in thousands)	Available-for Sale Securities
Balance, January 1, 2011	$	500
Total gains or losses (realized/unrealized):
Included in earnings		—
Included in other comprehensive income		—
Purchases, issuances, and settlements		—
Transfers in to/out of Level 3		—
Balance, December 31, 2011	$	500

14. REGULATORY MATTERS

Oak Ridge (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Oak Ridge and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Oak Ridge’s dividends will be made from dividends received from the Bank. The Bank, as a North Carolina chartered bank, may pay dividends only out of undivided profits (retained earnings) as determined pursuant to North Carolina Statutes 53-87. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure the financial soundness of such bank.

Quantitative measures established by regulation to ensure capital adequacy require Oak Ridge and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier I capital to average assets (as defined in the regulations). Management believes, as of December 31, 2012, that the Bank and Oak Ridge meet all capital adequacy requirements to which they are subject.

Based on the most recent notification from the FDIC, the Bank is well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category.

14. REGULATORY MATTERS, continued

The Bank’s and Oak Ridge’s actual capital amounts, in thousands, and ratios are presented in the following table:

	Actual					Minimum Capital Requirement					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2012
Total Capital
(to Risk-Weighted Assets)
Oak Ridge	$	35,652		14.1	%	$	20,288		8.0	%		n/a		n/a
Bank	$	33,777		13.4	%	$	20,165		8.0	%	$	25,207		10.0	%
Tier I Capital
(to Risk-Weighted Assets)
Oak Ridge	$	30,178		12.0	%	$	10,059		4.0	%		n/a		n/a
Bank	$	30,600		12.1	%	$	10,116		4.0	%	$	15,174		6.0	%
Tier I Capital
(to Average Assets)
Oak Ridge	$	30,178		8.8	%	$	13,717		4.0	%		n/a		n/a
Bank	$	30,600		8.9	%	$	13,753		4.0	%	$	17,191		5.0	%

December 31, 2011
Total Capital
(to Risk-Weighted Assets)
Oak Ridge	$	38,014		14.7	%	$	20,688		8.0	%		n/a		n/a
Bank	$	34,640		13.5	%	$	20,681		8.0	%	$	25,851		10.0	%
Tier I Capital
(to Risk-Weighted Assets)
Oak Ridge	$	33,347		12.9	%	$	10,647		4.0	%		n/a		n/a
Bank	$	31,405		12.2	%	$	10,296		4.0	%	$	15,445		6.0	%
Tier I Capital
(to Average Assets)
Oak Ridge	$	33,347		9.5	%	$	14,041		4.0	%		n/a		n/a
Bank	$	31,405		8.0	%	$	13,958		4.0	%	$	17,447		5.0	%

15. OAK RIDGE FINANCIAL SERVICES, INC. (PARENT COMPANY)

Condensed financial information for Oak Ridge is as follows:

CONDENSED BALANCE SHEETS (dollars in thousands)

	December 31,
	2012		2011
Assets
Cash	$	1,857	$	3,344
Investment in subsidiary		32,115		32,574
Other assets		289		287

Total assets	$	34,261	$	36,205

Liabilities and Stockholders’ Equity
Accrued interest payable	$	23	$	7
Junior subordinated notes related to trust preferred securities		8,248		8,248

Total liabilities		8,271		8,255

Commitments and contingencies		—		—
Total stockholders’ equity		25,990		27,948

Total liabilities and stockholders’ equity	$	34,261	$	36,205

CONDENSED STATEMENTS OF INCOME (dollars in thousands)

	For the Year ended
	2012			2011
Dividends from bank subsidiary	$	559		$	545
Interest income		58			87
Equity in undistributed loss of subsidiary		(2,430	)		(130	)
Interest expense		(178	)		(165	)
Income tax benefit		41			26

Net income (loss)	$	(1,950	)	$	363

15. OAK RIDGE FINANCIAL SERVICES, INC. (PARENT COMPANY), continued

CONDENSED STATEMENTS OF CASH FLOWS (dollars in thousands)

	For the Year ended
	2012			2011
OPERATING ACTIVITIES:
Net income (loss)	$	(1,950	)	$	363
Equity in loss of subsidiary		2,430			130
Stock option expense		—			—
Net change in other assets and other liabilities		13			(26	)

Net cash provided by operating activities		493			467

INVESTING ACTIVITIES:
Investment in subsidiary		(1,595	)		(3,500	)

Net cash used in investing activities		(1,595	)		(3,500	)

FINANCING ACTIVITIES:
Payment of dividends on preferred stock		(385	)		(385	)

Net cash used in financing activities		(385	)		(385	)

Net change in cash		(1,487	)		(3,418	)
Cash and cash equivalents, beginning		3,344			6,762
Cash and cash equivalents, ending	$	1,857		$	3,344

16. RELATED PARTY TRANSACTIONS

Oak Ridge and the Bank have had, and expect to have in the future, banking transactions in the ordinary course of business with directors, officers and their associates (“Related Parties”) on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with others. Those transactions neither involve more than normal risk of collectability nor present any unfavorable features.

Loans at December 31, 2012 and 2011 include loans to officers and directors and their associates totaling approximately $3.5 million and $3.8 million, respectively. During 2012, approximately $176 thousand in loans were disbursed to officers, directors and their associates and principal repayments of approximately $457 thousand were received on such loans.

17. U.S. TREASURY’S TROUBLED ASSET RELIEF PROGRAM (TARP) CAPITAL PURCHASE PROGRAM

On January 30, 2009, Oak Ridge entered into an agreement with the United States Department of the Treasury (“U.S. Treasury”). Oak Ridge issued and sold to the U.S. Treasury 7,700 shares of the Oak Ridge’s Fixed Rate Cumulative Preferred Stock, Series A. The preferred stock calls for cumulative dividends at a rate of 5% per year for the first five years, and 9% per year in following years. Oak Ridge also issued a warrant to purchase 163,830 shares of its common stock. Oak Ridge received $7.7 million in cash. This resulted in restrictions on Oak Ridge’s ability to pay dividends on its common stock and to repurchase shares of its common stock. Unless all accrued dividends on the preferred stock have been paid in full, (1) no dividends may be declared or paid on Oak Ridge’s common stock, and (2) Oak Ridge may not repurchase any of its outstanding common stock. On October 31, 2012, the U.S. Treasury sold all of its Oak Ridge Preferred Stock, and on February 16, 2013, Oak Ridge repurchased the Warrant from the U.S. Treasury for a total purchase price of approximately $123,000.

Stockholder Information

Annual Meeting

The Annual Meeting of Shareholders will be held on June 7, 2013 at 7 PM at the Corporate Center for Oak Ridge Financial Services, Inc. located at 8050 Fogleman Road, Oak Ridge, NC 27310.

Requests for Information

Requests for information should be directed to Mr. Ronald O. Black, President and CEO, or Mr. Thomas W. Wayne, CFO, at Oak Ridge Financial Services Inc., P.O. Box 2, Oak Ridge, North Carolina, 27310; telephone (336) 644-9944.


Independent Auditors		Stock Transfer Agent
Elliott Davis, PLLC		Registrar and Transfer Company
Certified Public Accountants		10 Commerce Drive
700 East Morehead Street, Suite 400		Cranford, New Jersey 07016
Charlotte, North Carolina 28202

Federal Deposit Insurance Corporation

The Bank is a member of the FDIC. This statement has not been reviewed, or confirmed for accuracy or relevance by the FDIC.

Banking Offices


2211 Oak Ridge Road Oak Ridge, North Carolina 27310 Phone: (336) 644-9944	2102 North Elm Street Greensboro, North Carolina 27408 Phone: (336) 272-1250

1597 New Garden Road Greensboro, North Carolina 27410 Phone: (336) 315-2400	4423 Highway 220 North Summerfield, North Carolina 27358 Phone: (336) 644-7310

400 Pisgah Church Road

Greensboro, NC 27455

Phone: (336) 286-1900

http://www.bankofoakridge.com

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

ITEM 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s management, including its Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of December 31, 2012. Based upon that evaluation, the Company’s CEO and CFO each concluded that as of December 31, 2012, the end of the period covered by this Annual Report on Form 10-K, the Company effectively maintained disclosure controls and procedures.

Management’s Annual Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s CEO and CFO to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America. Management has made a comprehensive review, evaluation and assessment of the Company’s internal control over financial reporting as of December 31, 2012. In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control — Integrated Framework. Based on this assessment, management believes that, as of December 31, 2012, the Company’s internal control over financial reporting is effective.

This Report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. The Company’s independent registered public accounting firm was not required to issue an attestation on its internal controls over financial reporting pursuant to the rules and regulations of the SEC.

Changes in Internal Control over Financial Reporting

Management of the Company has evaluated, with the participation of the Company’s CEO and CFO, changes in the Company’s internal control over financial reporting during the fourth quarter of 2012. In connection with such evaluation, the Company has determined that there have been no changes in internal control over financial reporting during the fourth quarter that have materially affected or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

Not applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

(a) Directors and Executive Officers - The information required by this Item regarding directors and executive officers of the Company is set forth under the sections captioned “Proposal I—Election of Directors–Nominees” and “Proposal I—Election of Directors–Executive Officers” in the Proxy Statement, which sections are incorporated herein by reference.

(b) The information required by this Item regarding the Company’s Audit Committee is set forth under the section captioned “Audit Committee” and “Report of Audit Committee” in the Proxy Statement, which sections are incorporated herein by reference.

(c) Section 16(a) Compliance - The information required by this Item regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended is set forth under the section captioned “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement, which section is incorporated herein by reference.

(d) Nomination Procedures - There were no material changes to the procedures by which security holders may recommend nominees to the Company’s Board of Directors since the Company last provided disclosures.

(e) Audit Committee Financial Expert - The information required about the Company’s Audit Committee Financial Expert is set forth under the section captioned “Audit Committee” in the Proxy Statement, which section is incorporated herein by reference.

(f) Code of Ethics - The Company has adopted its “Code of Ethics for Senior Officers Policy”, a code of ethics that applies to its senior officers. The Code of Ethics for Senior Officers Policy is Exhibit 14 to this Report. In the event that the Company makes any amendment to, or grants any waivers of, a provision of the Code of Ethics for Senior Officers Policy that applies to the principal executive officer or senior financial officers that requires disclosure under applicable SEC rules, the Company intends to disclose such amendment or waiver by filing a Form 8-K with the SEC.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is set forth under the sections captioned “Proposal I—Election of Directors–Director Compensation” and “–Management Compensation” in the Proxy Statement, which sections are incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item is set forth under the section captioned “Security Ownership of Certain Beneficial Owners” in the Proxy Statement, which section is incorporated herein by reference.

The equity compensation plan information required by this Item is set forth above in “Item 5 – Equity Compensation Plan Information.”

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

The information required by this Item is set forth under the section captioned “Certain Indebtedness and Transactions of Management” in the Proxy Statement, which section is incorporated herein by reference.

For a complete list of each director and nominee of the Company, see “Proposal I-Election of Directors–Nominees” in the Proxy Statement, which section is incorporated herein by reference. For information on director independence, see the section captioned “Board Composition” in the Proxy Statement, which section is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item is set forth under the section captioned “Proposal 3-Ratification of Selection of the Independent Registered Public Accounting Firm” in the Proxy Statement, which section is incorporated herein by reference.

ITEM 15. EXHIBITS

15(a)

Exhibits

Exhibit (3)(i)	Articles of Incorporation, incorporated herein by reference to Exhibit (3)(i) to the Form 8-K filed with the SEC on May 10, 2007.

Exhibit (3)(ii)	Bylaws, incorporated herein by reference to Exhibit (3)(ii) to the Form 8-K filed with the SEC on May 10, 2007.

Exhibit (4)(i)	Specimen Stock Certificate, incorporated herein by reference to Exhibit 4 to the Form 8-K filed with the SEC on May 10, 2007.

Exhibit (4)(ii)	Articles of Amendment, filed with the North Carolina Department of the Secretary of State on January 28, 2009, incorporated herein by reference to Exhibit 4.1 of the Current Report on Form 8-K filed with the SEC on February 2, 2009.

Exhibit (4)(iii)	Form of Certificate for the Fixed Rate Cumulative Perpetual Preferred Stock, Series A, incorporated herein by reference to Exhibit 4.2 of the Current Report on Form 8-K filed with the SEC on February 2, 2009.

Exhibit (4)(iv)	Warrant for Purchase of Shares of Common Stock issued by the Company to the United States Department of the Treasury on January 30, 2009, incorporated herein by reference to Exhibit 4.3 of the Current Report on Form 8-K filed with the SEC on February 2, 2009.

Exhibit (10)(i)	Employment Agreement with Ronald O. Black, as amended, incorporated herein by reference to Exhibit (10)(i) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(ii)	Employment Agreement with L. William Vasaly, III, as amended, incorporated herein by reference to Exhibit (10)(ii) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(iii)	Employment Agreement with Thomas W. Wayne, as amended, incorporated herein by reference to Exhibit (10)(iii) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(iv)	Outparcel Ground Lease between J.P. Monroe, L.L.C. and Bank of Oak Ridge dated June 1, 2002, incorporated herein by reference to Exhibit (10)(iv) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(v)	Ground and Building Lease between KRS of Summerfield, LLC and Bank of Oak Ridge dated September 25, 2002, incorporated herein by reference to Exhibit (10)(v) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(vi)	Ground Lease between Friendly Associates XVIII LLLP and Bank of Oak Ridge dated September 13, 2004, incorporated herein by reference to Exhibit (10)(vi) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(vii)	Bank of Oak Ridge Second Amended and Restated Director Stock Option Plan (amended March 16, 2004; approved by stockholders June 8, 2004), incorporated herein by reference to Exhibit 10(ix) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(viii)	Bank of Oak Ridge Second Amended and Restated Employee Stock Option Plan (amended March 16, 2004; approved by stockholders June 8, 2004), incorporated herein by reference to Exhibit (10)(x) to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(ix)	Salary Continuation Agreements with Ronald O. Black, L. William Vasaly III and Thomas W. Wayne dated January 20, 2006, incorporated herein by reference to Exhibits (10)(ix) to (10)(xi) to Form 8-K filed with the SEC on March 28, 2008.

Exhibit (10)(x)	Amended Endorsement Split Dollar Agreement between Bank of Oak Ridge and Ronald O. Black, incorporated herein by reference to Exhibit (10)(xiii) to the Form 8-K filed with the SEC on December 21, 2007.

Exhibit (10)(xi)	Amended Endorsement Split Dollar Agreement between Bank of Oak Ridge and L. William Vasaly III, incorporated herein by reference to Exhibit (10)(xiv) to the Form 8-K filed with the SEC on December 21, 2007.

Exhibit (10)(xii)	Amended Endorsement Split Dollar Agreement between Bank of Oak Ridge and Thomas W. Wayne, incorporated herein by reference to Exhibit (10)(xv) to the Form 8-K filed with the SEC on December 21, 2007.

Exhibit (10)(xiii)	Indemnification Agreement, incorporated herein by reference to Exhibit (10)(xvi) to the Form 8-K filed with the SEC on March 7, 2008.

Exhibit (10)(xiv)	Contract for the Purchase and Sale of Real Property, incorporated herein by reference to Exhibit 99.1 to the Form 8-K filed with the SEC on January 14, 2008.

15(a) Exhibits

Exhibit (10)(xv)	Oak Ridge Financial Services, Inc. Long-Term Stock Incentive Plan, incorporated herein by reference to Exhibit (10)(xiii) to the Form 10-QSB filed with the SEC on May 15, 2007.

Exhibit (10)(xvi)	Bank of Oak Ridge 2012 Semi-Annual Incentive Plan.

Exhibit (10)(xvii)	Letter Agreement, dated January 30, 2009, between the Company and the United States Department of the Treasury, with respect to the issuance and sale of the Fixed Rate Cumulative Perpetual Preferred Stock, Series A and the Warrant, incorporated herein by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC on February 2, 2009.

Exhibit (10)(xviii)	Form of Employment Agreement Amendment, dated January 30, 2009 among the Company, the Bank and the senior executive officers, incorporated herein by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the SEC on February 2, 2009.

Exhibit (10)(xix)	Bank of Oak Ridge Employee Stock Ownership Plan and Trust effective January 1, 2010, incorporated herein by reference to Exhibit 99.1 of the Current Report in Form 8-k filed with the SEC on September 24, 2010.

Exhibit (14)	Code of Ethics for Senior Officers Policy incorporated herein by reference to Exhibit 14 to the Form 8-K filed with the SEC on March 28, 2008.

Exhibit (21)	Subsidiary of the Company.

Exhibit (31.1)	Certification of Ronald O. Black.

Exhibit (31.2)	Certification of Thomas W. Wayne.

Exhibit (32)	Certificate of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350.

Exhibit (99.01)	Certification Pursuant to the Emergency Economic Stabilization Act of 2009, as amended by the American Recovery and Reinvestment Act of 2009.

Exhibit (99.02)	Certification Pursuant to the Emergency Economic Stabilization Act of 2009, as amended by the American Recovery and Reinvestment Act of 2009.

Exhibit (101)	The following materials from the Annual Report on Form 10-K of Oak Ridge Financial Services, Inc. for the year ended December 31, 2012, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income (loss), (iv) Consolidated Statement of Changes in Shareholders' Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Audited Consolidated Financial Statements.*

*Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	OAK RIDGE FINANCIAL SERVICES, INC.

	By:	/s/ Ronald O. Black
Dated: March 25, 2012		Ronald O. Black
		President and Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ Ronald O. Black	President, Chief Executive Officer and Director	March 25, 2013
Ronald O. Black


/s/ Thomas W. Wayne	Senior Vice President and Chief Financial Officer	March 25, 2013
Thomas W. Wayne


/s/ L. William Vasaly, III	Senior Vice President and Chief Credit Officer	March 25, 2013
L. William Vasaly, III


/s/ Douglas G. Boike	Director	March 25, 2013
Douglas G. Boike


/s/ Stanley Tennant	Director	March 25, 2013
Stanley Tennant


/s/ James W. Hall	Director	March 25, 2013
James W. Hall


/s/ Billy R. Kanoy	Director	March 25, 2013
Billy R. Kanoy


/s/ Lynda J. Anderson	Director	March 25, 2013
Lynda J. Anderson


/s/ Stephen S. Neal	Director	March 25, 2013
Stephen S. Neal


/s/ John S. Olmsted	Director	March 25, 2013
John S. Olmsted


/s/ Manuel L. Perkins	Director	March 25, 2013
Manuel L. Perkins

INDEX TO EXHIBITS


Exhibit No.		Description

Exhibit (10)(xvi)		Bank of Oak Ridge 2012 Semi-Annual Incentive Plan.

Exhibit (21)		Subsidiary of the Company.

Exhibit (31.1)		Certification of Ronald O. Black.

Exhibit (31.2)		Certification of Thomas W. Wayne.

Exhibit (32)		Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350.

Exhibit (99.01)		Certification Pursuant to the Emergency Economic Stabilization Act of 2009, as amended by the American Recovery and Reinvestment Act of 2009.

Exhibit (99.02)		Certification Pursuant to the Emergency Economic Stabilization Act of 2009, as amended by the American Recovery and Reinvestment Act of 2009.
Exhibit (101)		XBRL Instance Document.

Oak Ridge Financial Serv... (PK) (USOTC:BKOR)
Gráfica de Acción Histórica
De May 2024 a Jun 2024

Haga Click aquí para más Gráficas Oak Ridge Financial Serv... (PK).

Oak Ridge Financial Serv... (PK) (USOTC:BKOR)
Gráfica de Acción Histórica
De Jun 2023 a Jun 2024

Datos

Noticias

Herramientas

Mercados

Descubrir

Hot Features

Follow Feed

Flujo de Opciones

Monitor

BKOR Oak Ridge Financial Services Inc (PK)

Noticias sobre Oak Ridge Financial Services, Inc. BKOR

Su Consulta Reciente

Empresa

Negocios

Popular

Obtener la aplicación

Tendencias Ahora

Listas Principales

Datos

Noticias

Herramientas

Mercados

Descubrir

Hot Features

Follow Feed

Flujo de Opciones

Monitor

BKOR Oak Ridge Financial Services Inc (PK)

Noticias sobre Oak Ridge Financial Services, Inc. BKOR

Su Consulta Reciente

Empresa

Negocios

Popular

Obtener la aplicación