Management's discussion and analysis of the financial condition and results of operations of the Company as of June 30, 2012 and December 31, 2011 and for the three and six month periods ended June 30, 2012 and 2011 is as follows. The discussion should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Written Agreement with the Federal Reserve On September 30, 2010, the Company and the Bank entered into a written agreement ("Written Agreement") with the Federal Reserve Bank of Richmond (the "Reserve Bank"). Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval written plans to, among other matters, strengthen credit risk management policies, maintain an adequate allowance for loan and lease losses, revise its contingency funding plan, and improve the Bank's earnings and overall condition. Such plans have been submitted and accepted by the Reserve Bank.

Both the Company and the Bank have also submitted capital plans to maintain sufficient capital and to refrain from declaring or paying dividends without prior regulatory approval. The Company has agreed that it will not take any other form of payment representing a reduction in Bank's capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company also has agreed not to incur, increase or guarantee any debt or to purchase or redeem any shares of its stock without prior regulatory approval.

The Company and the Bank have appointed a committee to monitor compliance with the Written Agreement. The directors of the Company and the Bank have recognized and unanimously agree with the common goal of financial soundness represented by the Written Agreement and have confirmed the intent of the directors and executive management to diligently seek to comply with all requirements of the Written Agreement.

The Reserve Bank has informed the Company that it is in full compliance with the Written Agreement and that the Reserve Bank is considering terminating the Written Agreement. We anticipate that the Reserve Bank will make its determination prior to the end of this year.

Critical Accounting Estimates

General
The Company's financial statements are prepared in accordance with Accounting Principles Generally Accepted in the United States ("GAAP") and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates, which in the case of the determination of our allowance for loan losses, deferred tax assets, and foreclosed assets have been critical to the determination of our financial position and results of operations.

Management considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company's financial statements.

For a discussion on the Company's critical accounting estimates, see the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Non-GAAP Financial Measures

The Company measures the net interest margin as an indicator of profitability. The net interest margin is calculated by dividing tax-equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax-equivalent net interest income is considered in the calculation of this ratio. Tax-equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for 2012 and 2011 is 34%. The reconciliation of tax-equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.

                                               Three months ended                Six months ended
In thousands                                 6/30/2012        6/30/2011       6/30/2012       6/30/2011
Net interest income, non tax-equivalent     $      6,497     $     6,285     $    12,722     $    12,201
Less: tax-exempt interest income                    (132 )          (153 )          (265 )          (313 )
Add: tax-equivalent of tax-exempt
interest income                                      200             232             402             474
Net interest income, tax-equivalent         $      6,565     $     6,364     $    12,859     $    12,362

Results of Operations

Net Income

2012 Compared to 2011
Net income for the three-month period ending June 30, 2012 was a record $1,869,000 as compared to net income of $1,216,000 for the same period last year, an increase of $653,000 or 54%. After the dividend on preferred stock and accretion of discounts on warrants, net income available to common shareholders was a record $1,624,000, or $0.33 per diluted common share, as compared to $974,000 or $0.21 per diluted common share for the second quarter of 2011, an increase of 67%. The Company's earnings for the second quarter of 2012 produced an annualized return on average total assets of 0.94% and an annualized return on average shareholders' equity of 12.09%, as compared to 0.61% and 8.50%, respectively for the same period last year. For the six-month period ending June 30, 2012, net income available to common shareholders was $3,039,000 as compared to $1,833,000 for the same period last year, an increase of $1,206,000 or 66%.

2011 Compared to 2010
Net income for the three-month period ending June 30, 2011 was $1,216,000 as compared to net income of $1,255,000 for the same period in 2010, a decrease of $39,000 or 3%. After the dividend on preferred stock and accretion of discounts on warrants, net income available to common shareholders was $974,000, or $0.21 per diluted common share, as compared to $1,015,000 or $0.22 per diluted common share for the second quarter of 2010. The Company's earnings for the second quarter of 2011 produced an annualized return on average total assets of 0.61% and an annualized return on average shareholders' equity of 8.50%, as compared to 0.68% and 9.48%, respectively for the same period in 2010. For the six-month period ending June 30, 2011, net income available to common shareholders was $1,833,000 as compared to $1,624,000 for the same period in 2010, an increase of $209,000 or 13%.

The following table shows our key performance ratios for the periods ended June 30, 2012, December 31, 2011 and June 30, 2011:

                                        Key Performance Ratios(1)
                                                6 months ended       12 months ended       6 months ended
                                                  6/30/2012            12/31/2011            6/30/2011
Return on average assets                                   0.90 %                0.73 %               0.60 %
Return on average equity(2)                               11.56 %                9.88 %               8.24 %
Net interest margin(3)                                     3.54 %                3.39 %               3.38 %
Cost of funds                                              0.91 %                1.17 %               1.24 %
Yield on earning assets                                    4.44 %                4.54 %               4.60 %
Basic net earnings per common share            $           0.64     $            1.01     $           0.39
Diluted net earnings per common share          $           0.63     $            1.00     $           0.39

1. Ratios are annualized.

2. The calculation of ROE excludes the effect of any unrealized gains or losses on investment securities available-for-sale.

3. Calculated on a fully taxable equivalent basis ("FTE").

Net Interest Income
The primary source of the Company's banking revenue is net interest income, which represents the difference between interest income on earning assets and interest expense on liabilities used to fund those assets. Earning assets include loans, securities, and federal funds sold. Interest bearing liabilities include deposits and borrowings. To compare the tax-exempt yields to taxable yields, amounts are adjusted to pretax equivalents based on a 34% federal corporate income tax rate.

Net interest income is affected by changes in interest rates, volume of interest bearing assets and liabilities, and the composition of those assets and liabilities. The "interest rate spread" and "net interest margin" are two common statistics related to changes in net interest income. The interest rate spread represents the difference between the yields earned on interest earning assets and the rates paid for interest bearing liabilities. The net interest margin is defined as the percentage of net interest income to average earning assets. Earning assets obtained through noninterest bearing sources of funds such as regular demand deposits and shareholders' equity result in a net interest margin that is higher than the interest rate spread.

2012 Compared to 2011
Net interest income for the three-month period ended June 30, 2012 was $6,497,000, a $212,000 or 3% increase when compared to the $6,285,000 reported for the same period in 2011. The Company's net interest margin, at 3.57%, increased by 16 basis points over the 3.41% reported for the same quarter last year. In comparison to the linked quarter, the Company's net interest margin increased by 6 basis points over the 3.51% reported for the first quarter of 2012. Net interest income for the six-month period ended June 30, 2012 was $12,722,000, a $521,000 or 4% increase when compared to the $12,201,000 reported for the same period in 2011.

The increase in net interest income and corresponding increase in net interest margin was primarily attributable to the reduction in funding costs over the previous 12 months. The Company's cost of funds was 0.84% during the three-month period ended June 30, 2012, compared to the 1.16% reported in the same period last year and the 0.98% in the linked quarter. Decreased rates on our Prime Money Market accounts and more aggressive pricing on time deposits have led to the decrease in funding costs. The Company's yield on earning assets declined to 4.44% in comparison to the 4.51% from the same prior year period and the 4.48% yield earned in the linked quarter. We believe that continued margin expansion will be difficult due to the downward pressure we are seeing on yields in both our loan and investment portfolio.

2011 Compared to 2010
Net interest income for the three-month period ended June 30, 2011 was $6,285,000, a $1,086,000 or 21% increase when compared to the $5,199,000 reported for the same period in 2010. The Company's net interest margin increased by 45 bps to 3.41% compared to the 2.96% reported for the same quarter in 2010. In comparison to the linked quarter, the Company's net interest margin increased by 7 basis points from 3.33%. Net interest income for the six-month period ended June 30, 2011 was $12,201,000, a $2,024,000, or 20% increase when compared to the $10,177,000 reported for the same period in 2010. The increase in net interest income and corresponding increase in net interest margin is primarily attributable to the reduction in funding costs. The Company's cost of funds was 1.16% during the three-month period ended June 30, 2011, compared to 1.81% reported in 2010.

Noninterest Income

2012 Compared to 2011
Noninterest income for the three-month period ended June 30, 2012 was $991,000, a decrease of $183,000 or 16% compared to the $1,174,000 for the same period last year. However, included in the prior year results were gains taken on the sale of securities totaling $462,000. Absent these gains, noninterest income improved $279,000 or 39%, led by the Company's wealth management and mortgage divisions. Brokerage fee income increased $105,000, or 109% and mortgage fee income increased $132,000 or 322% compared to the second quarter of 2011. Noninterest income for the six-month period ended June 30, 2012 was $2,022,000, a $207,000 or 11% increase when compared to the $1,815,000 reported for the same period in 2011. Excluding realized gains on the sale of securities, noninterest income has risen by $643,000, or 48% from the same period last year. The Company's wealth management and mortgage divisions outperformed the prior year's six-month totals by $321,000 and $197,000 respectively.

2011 Compared to 2010
Noninterest income for the three-month period ended June 30, 2011 was $1,174,000, an increase of $515,000, or 78%, compared to the $659,000 for the same period in 2010. Excluding the $462,000 in realized gains from the sale of securities during the second quarter 2011, noninterest income would have totaled $712,000, an increase of $53,000, or 8%, from the same period in 2010. In comparison to the three-month period in 2010, brokerage fee income increased $17,000, or 22%, service charge fees increased $23,000, or 7%, and mortgage fee income increased $3,000, or 8%. For the six-month period ended June 30, 2011, noninterest income was $1,815,000, an increase of $620,000, or 52%, compared to the $1,195,000 in the same period of 2010. Excluding realized gains on the sale of securities, noninterest income would have totaled $1,339,000, an increase of $144,000, or 12%, from the same period in 2010. The Company experienced increases in all categories of noninterest income during 2011 as compared to 2010.

Noninterest Expense

2012 Compared to 2011
Noninterest expense for the three-month period ended June 30, 2012 was $4,841,000, a decrease of $173,000, or 4%, compared to the $5,014,000 recorded in same period last year. The Company's efficiency ratio for the second quarter of 2012 was 63.37%, as compared to 65.86% for the same period last year. Specific items to note are as follows:

· Insurance expense decreased $215,000 or 40% due to decreased FDIC insurance premiums;

· Professional fees decreased by $152,000 or 39% due to reduced legal expenses; and

· Net foreclosed asset expense decreased by $247,000 or 59% due to reduced impairment losses taken on its foreclosed asset portfolio during the second quarter of 2012 as compared to 2011.

These reductions were offset by a $428,000 increase in compensation expense, which is the result of equity and merit increases for all employees which went into effect January 1, 2012, increased commissions earned in our Mortgage and Valley Wealth Management areas, and increased incentive and profit sharing accruals based upon the Company's performance year-to-date. Noninterest expense for the six-month period ended June 30, 2012 was $9,712,000, a $760,000

or 7% decrease when compared to the $10,472,000 reported for the same period in 2011.
2011 Compared to 2010
Noninterest expense for the three-month period ended June 30, 2011 was $5,014,000, an increase of $663,000, or 15%, compared to the $4,351,000 for the three month period ended June 30, 2010. Specific items to note are as follows:

· Net foreclosed asset expense increased by $314,000 due to $340,000 in write-downs on foreclosed assets compared to $27,000 in similar charges in the same period in 2010;

· Legal fees increased $188,000 due to increased litigation costs; and

· Compensation expense increased $129,000 due to merit, equity, and promotional increases that went into effect January 1, 2011, as well as additional pension costs and increased health insurance costs.

Noninterest expense for the six-month period ended June 30, 2011 was $10,472,000, an increase of $1,937,000, or 23%, compared to the $8,535,000 for the six month period ended June 30, 2010. The primary increases in noninterest expense were in compensation, FDIC insurance, legal, and foreclosed asset expenses.

Asset Quality

Summary of Allowance for Loan Losses

2012 Compared to 2011
The allowance for loan losses ("ALLL") was $8,991,000 as of June 30, 2012, compared to $9,650,000 as of December 31, 2011 and $10,300,000 reported a year earlier. The ratio of the allowance for loan losses to total loans outstanding was approximately 1.69% at June 30, 2012, which compares to approximately 1.90% of total loans at December 31, 2011 and 1.96% of total loans at June 30, 2011. These estimates are primarily based on our historical loss experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $2,000,000 in specific reserves was included in the balance of the allowance for loan losses as of June 30, 2012 for impaired loans, which compares to a total of $2,099,000 as of December 31, 2011 and $1,156,000 at June 30, 2011. Total reserves represented 142% of the non-accrual loan balances as of June 30, 2012, up significantly from the 103% reported in the same period last year.

The Company recorded a net reduction of $53,000 in provision for loan losses during the second quarter of 2012 compared to a net provision expense of $697,000 in the same period last year. The negative provision for the second quarter is the result of principal payments made on impaired loans with valuation allowances, which reduced the valuation allowance required at June 30, 2012. We believe the allowance for loan losses is adequate to provide for expected losses in the loan portfolio, but there are no assurances that it will be.

We have been successful in gradually reducing the level of the allowance for loan losses needed over the past 12-18 months based upon our significantly reduced level of charge-offs, reduction in overall watch list credits, reduction in non-accrual loans, as well as an overall reduction in new credits migrating to watch list or impaired status. While the economic environment remains tenuous, we are cautiously optimistic that this trend will continue.

2011 Compared to 2010
The allowance for loan losses was $10,300,000 as of June 30, 2011, compared to $10,500,000 as of March 31, 2011 and $10,811,000 reported in 2010. The ratio of the allowance for loan losses to total loans outstanding was approximately 1.96% at June 30, 2011, which compares to approximately 2.02% of total loans at December 31, 2010 and 2.00% of total loans at June 30, 2010. A total of $1,156,000 in specific reserves was included in the balance of the allowance for loan losses as of June 30, 2011 for impaired loans, which compares to a total of $1,280,000 as of December 31, 2010 and $948,000 at June 30, 2010.

The Company recorded provision for potential loan losses of $697,000 for the second quarter of 2011, an increase of $1,032,000 as compared to the same period in 2010. During the second quarter of 2011, the Company's specific reserves decreased by a total of $312,000 primarily as a result of the following:

· The Company completed a troubled debt restructure on one of its impaired loans, resulting in charge-offs of $224,000 and new specific reserves of $107,000.

· The Company charged-off $500,000 of previously recorded specific reserves and added a total of $314,000 in new specific reserves on its impaired loan relationships.

Total reserves represented 103% of the non-accrual loan balances as of June 30, 2011, increased significantly from the 57% reported as of June 30, 2010.

For the six-month period ended June 30, 2011, the Company recorded provisions for potential loan losses of $261,000 compared to a reduction in provisions of $127,000 in the same period in 2010, an increase of $388,000.

Non-Performing Assets
Non-performing assets include nonaccrual loans, loans past due 90 days or more, restructured loans and foreclosed/ repossessed property. A loan will be placed on nonaccrual status when collection of all principal or interest is deemed unlikely. A loan will be placed on nonaccrual status automatically when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of being collected. In this case, the loan will continue to accrue interest despite its past due status.

A restructured loan is a loan in which the original contract terms have been modified due to a borrower's financial condition or there has been a transfer of assets in full or partial satisfaction of the loan. A modification of original contractual terms is generally a concession to a borrower that a lending institution would not normally consider.

Based on generally accepted accounting standards for receivables, a loan is impaired when, based on current information and events, it is likely that a creditor will be unable to collect all amounts, including both principal and interest, due according to the contractual terms of the loan agreement.

The Company's ratio of non-performing assets as a percentage of total assets decreased 13 basis points to 3.99% as compared to 4.12% one year earlier. Non-performing assets decreased $1.0 million from $32.8 million at June 30, 2011 to $31.8 million at June 30, 2012. Non-performing assets at June 30, 2012 consisted of non-accrual loans of $6.4 million, foreclosed assets of $21.7 million, and troubled-debt restructurings of $3.7 million. Non-performing assets at June 30, 2011 consisted of non-accrual loans of $10.0 million, foreclosed assets of $16.5 million, troubled-debt restructurings of $2.1 million, and loans totaling $4.2 million that were past due greater than 90 days and still accruing interest. While the Company's non-performing assets remain higher than desired, 68% represents assets held in the Company's foreclosed asset portfolio. These specific assets were written down to fair market value at the time of foreclosure and are evaluated on a periodic basis for subsequent impairment.

Net charge-offs as a percentage of average loans receivable amounted to 0.05% for the second quarter of 2012, compared to 0.07% for the first quarter of 2012 and 0.17% for the same quarter in the prior year. Net charge-offs for the quarter ended June 30, 2012 were $243,000, in comparison to $363,000 for the first quarter of 2012 and $897,000 for the same period last year.

Nonperforming assets at June 30, 2012, December 31, 2011 and June 30, 2011 are presented in the following table:

                                      Nonperforming Assets

In thousands                                          6/30/2012       12/31/2011       6/30/2011
Nonaccrual loans                                     $     6,353     $      8,638     $     9,959
Loans past due 90 days or more                                 -                4           4,219
Restructured loans                                         3,733            2,305           2,129
Total nonperforming loans                            $    10,086     $     10,947     $    16,307

Foreclosed, repossessed and idled properties              21,713           17,040          16,531
Total nonperforming assets                           $    31,799     $     27,987     $    32,838

If nonaccrual loans had performed in accordance with their original terms, additional interest income would have been recorded in the amount of $165,000 for the six months ended June 30, 2012; $550,000 for the year ended December 31, 2011; and $302,000 for the six months ended June 30, 2011.

Higher Risk Loans
Certain types of loans, such as option ARM products, interest-only loans, subprime loans, and loans with initial teaser rates, can have a greater risk of non-collection than other loans. We do not offer option ARM, interest-only, or subprime mortgage loans.

Junior-lien mortgages can also be considered higher risk loans and our junior lien portfolio currently consists of balances totaling $22,825,000 (4.3% of total portfolio) at June 30, 2012. Loans included in this category that were initially made with high loan-to-value ratios of 100% or greater have current balances totaling $1,347,000 at June 30, 2012. Since 2003, we have experienced net charge-offs totaling $830,000 in junior lien mortgages.

Financial Condition

Total assets at June 30, 2012 were $796,282,000, up $22,778,000 or 3% from $773,504,000 at December 31, 2011. The principal components of the Company's assets at the end of the period were $33,803,000 in cash and cash equivalents, $154,454,000 in securities available-for-sale, $27,069,000 in securities held-to-maturity and $531,363,000 in gross loans. Total assets at December 31, 2011 were $773,504,000 with the principal components consisting of $30,724,000 in cash and cash equivalents, $160,465,000 in securities available-for-sale, $28,770,000 in securities held-to-maturity and $508,586,000 in gross loans.

Total liabilities at June 30, 2012 were $732,088,000, up from $713,391,000 at December 31, 2011, an increase of $18,697,000 or 3%. Deposits increased $31,441,000 or 5% to $662,149,000 from the $630,708,000 level at December 31, 2011. Total shareholders' equity at June 30, 2012 was $64,194,000, up from $60,113,000 at December 31, 2011, an increase of $4,081,000 or 7%. Likewise, the Company's book value per share increased by 7% from $9.29 at December 31, 2011 to $9.91 at June 30, 2012.

Capital Adequacy
The management of capital in a regulated financial services industry must properly balance return on equity to shareholders while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. The Company's capital management strategies have been developed to provide attractive rates of returns to shareholders, while maintaining its "well-capitalized" position at the banking subsidiary.

The primary source of additional capital to the Company is earnings retention, which represents net income less dividends declared. Following the Company's entrance into a Written Agreement with the Reserve Bank on September 30, 2010, any decision by the Board of Directors to pay dividends on the Series A Preferred Stock, interest on the Preferred Stock, or dividends on common stock will require the approval of the Reserve Bank. The Company is current on all payments for the Series A Preferred Stock and Trust Preferred Securities. In the future, the Company plans, subject to Board approval, to seek approval from the Federal Reserve to pay dividends on the Company's Series A Preferred Stock and Trust Preferred Securities to keep them current.

The Company and its banking subsidiary also 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 and the subsidiary bank's financial . . .