Edgar Filing: Porter Bancorp, Inc.

a50468111.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 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: 001-33033

PORTER BANCORP, INC.

(Exact name of registrant as specified in its charter)


Kentucky		61-1142247
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky		40223
(Address of principal executive offices)		(Zip Code)

(502) 499-4800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 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

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

12,007,127 shares of Common Stock, no par value, were outstanding at October 27, 2012.

INDEX

		Page
PART I –	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS	1
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
	CONDITION AND RESULTS OF OPERATIONS	35
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	53
ITEM 4.	CONTROLS AND PROCEDURES	53

PART II –	OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	55
ITEM 1A.	RISK FACTORS	55
ITEM 2.	UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS	55
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	55
ITEM 4.	MINE SAFETY DISCLOSURES	55
ITEM 5.	OTHER INFORMATION	55
ITEM 6.	EXHIBITS	55

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Porter Bancorp Inc. and subsidiary, PBI Bank, Inc. are submitted:

Unaudited Consolidated Balance Sheets for September 30, 2012 and December 31, 2011

Unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and 2011

Unaudited Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2012 and 2011

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2012

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011

Notes to Unaudited Consolidated Financial Statements

PORTER BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

	September 30, 2012			December 31, 2011
Assets
Cash and due from financial institutions	$	78,688		$	104,680
Federal funds sold		3,094			1,282
Cash and cash equivalents		81,782			105,962
Securities available for sale		198,148			158,833
Mortgage loans held for sale		210			694
Loans, net of allowance of $54,019 and $52,579, respectively		897,792			1,083,444
Premises and equipment		20,955			21,541
Other real estate owned		48,837			41,449
Federal Home Loan Bank stock		10,072			10,072
Bank owned life insurance		8,328			8,106
Accrued interest receivable and other assets		19,917			25,323
Total assets	$	1,286,041		$	1,455,424

Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing	$	111,403		$	111,118
Interest bearing		1,066,124			1,212,645
Total deposits		1,177,527			1,323,763
Repurchase agreements		2,403			1,738
Federal Home Loan Bank advances		5,960			7,116
Accrued interest payable and other liabilities		12,967			7,628
Subordinated capital note		7,200			7,650
Junior subordinated debentures		25,000			25,000
Total liabilities		1,231,057			1,372,895

Stockholders’ equity
Preferred stock, no par, 1,000,000 shares authorized,
Series A – 35,000 issued and outstanding;
Liquidation preference of $35 million at September 30, 2012		34,795			34,661
Series C – 317,042 issued and outstanding;
Liquidation preference of $3.6 million at September 30, 2012		3,283			3,283
Common stock, no par, 86,000,000 shares authorized, 12,007,127 and 11,824,472 shares issued and outstanding, respectively		112,236			112,236
Additional paid-in capital		20,179			19,841
Retained deficit		(119,181	)		(91,656	)
Accumulated other comprehensive income		3,672			4,164
Total stockholders' equity		54,984			82,529
Total liabilities and stockholders’ equity	$	1,286,041		$	1,455,424

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Operations

(dollars in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Interest income Loans, including fees	$	12,797		$	16,652		$	40,998		$	52,351
Taxable securities		837			987			2,475			3,168
Tax exempt securities		220			298			666			826
Fed funds sold and other		133			166			415			572
		13,987			18,103			44,554			56,917
Interest expense
Deposits		3,568			4,966			11,294			15,598
Federal Home Loan Bank advances		50			138			161			419
Subordinated capital note		66			69			204			213
Junior subordinated debentures		169			156			508			468
Federal funds purchased and other		2			119			6			355
		3,855			5,448			12,173			17,053
Net interest income		10,132			12,655			32,381			39,864
Provision for loan losses		25,500			8,000			33,250			26,800
Net interest income (loss) after provision for loan losses		(15,368	)		4,655			(869	)		13,064

Non-interest income
Service charges on deposit accounts		563			690			1,673			1,979
Income from fiduciary activities		261			237			803			738
Bank card interchange fees		180			168			553			500
Other real estate owned rental income		180			93			242			147
Secondary market brokerage fees		27			32			75			184
Net gain on sales of loans originated for sale		138			123			260			664
Net gain on sales of securities		—			—			3,530			1,108
Other		372			357			1,048			1,032
		1,721			1,700			8,184			6,352
Non-interest expense
Salaries and employee benefits		4,264			3,780			12,558			12,084
Occupancy and equipment		971			957			2,826			2,910
Goodwill impairment		—			—			—			23,794
Other real estate owned expense		5,204			17,029			7,666			40,505
FDIC Insurance		559			930			2,264			2,640
Loan collection expense		792			802			1,738			1,989
Professional fees		776			329			1,699			963
State franchise tax		496			582			1,680			1,746
Communications		175			176			523			509
Postage and delivery		108			117			339			368
Advertising		44			93			105			282
Other		761			628			2,061			1,787
		14,150			25,423			33,459			89,577
Loss before income taxes		(27,797	)		(19,068	)		(26,144	)		(70,161	)
Income tax benefit		(65	)		(6,906	)		(65	)		(18,809	)
Net loss		(27,732	)		(12,162	)		(26,079	)		(51,352	)
Less:
Dividends on preferred stock		437			437			1,312			1,312
Accretion on Series A preferred stock		44			45			134			133
Earnings (losses) allocated to participating securities		(1,264	)		(463	)		(1,095	)		(1,995	)
Net loss attributable to common shareholders	$	(26,949	)	$	(12,181	)	$	(26,430	)	$	(50,802	)
Basic earnings (loss) per common share	$	(2.29	)	$	(1.04	)	$	(2.25	)	$	(4.34	)
Diluted earnings (loss) per common share	$	(2.29	)	$	(1.04	)	$	(2.25	)	$	(4.34	)

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Loss

(in thousands)

	Three Months Ended September 30,						Nine Month Ended September 30,
	2012			2011			2012			2011
Net loss	$	(27,732	)	$	(12,162	)	$	(26,079	)	$	(51,352	)
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on securities:
Unrealized gain (loss) arising in period
(net of tax of $821, $676,
$970, and $1,681, respectively)		1,525			1,257			1,803			3,122
Reclassification of amount realized through sales
(net of tax of $0, $0,
$1,235 and $388, respectively)		—			—			(2,295	)		(720	)
Net unrealized gain (loss) on securities		1,525			1,257			(492	)		2,402

Comprehensive loss	$	(26,207	)	$	(10,905	)	$	(26,571	)	$	(48,950	)

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statement of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2012

(dollars in thousands, except share and per share data)

Accumulated

Amount

Additional

Other

Series A

Series C

Series A

Series C

Paid-In

Retained

Comprehensive

Common

Preferred

Common

Preferred

Capital

Deficit

Income

Total

Balances, January 1, 2012

11,824,472

35,000

317,042

112,236

34,661

3,283

19,841

(91,656

)

4,164

82,529

Issuance of unvested stock

191,140

–

Forfeited unvested stock

(8,485

)

–

Stock-based compensation
expense

–

338

–

338

Net loss

–

(26,079

)

–

(26,079

)

Net change in accumulated
other comprehensive
income, net of taxes

–

(492

)

(492

)

Dividends 5% on Series A
preferred stock

–

(1,312

)

–

(1,312

)

Accretion of Series A preferred
stock discount

–

134

–

(134

)

–

Balances, September 30, 2012

12,007,127

35,000

317,042

112,236

34,795

3,283

20,179

(119,181

)

3,672

54,984

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2012 and 2011

(dollars in thousands)

	2012			2011
Cash flows from operating activities
Net loss	$	(26,079	)	$	(51,352	)
Adjustments to reconcile net loss to net cash from operating activities
Depreciation and amortization		1,819			1,838
Provision for loan losses		33,250			26,800
Net amortization on securities		2,610			1,036
Goodwill impairment charge		—			23,794
Stock-based compensation expense		338			342
Deferred income taxes (benefit)		—			(11,047	)
Net gain on loans originated for sale		(260	)		(664	)
Loans originated for sale		(12,214	)		(21,682	)
Proceeds from sales of loans originated for sale		12,910			21,851
Net gain on sales of investment securities		(3,530	)		(1,108	)
Net loss on sales of other real estate owned		1,481			7,549
Net write-down of other real estate owned		5,090			30,702
Earnings on bank owned life insurance		(222	)		(224	)
Net change in accrued interest receivable and other assets		5,075			(4,767	)
Net change in accrued interest payable and other liabilities		4,027			27
Net cash from operating activities		24,295			23,095
Cash flows from investing activities Purchases of available-for-sale securities		(141,232	)		(113,779	)
Sales of available-for-sale securities		65,695			50,023
Maturities and prepayments of available-for-sale securities		36,649			15,018
Proceeds from sale of other real estate owned		17,032			9,323
Improvements to other real estate owned		(1	)		(1,596	)
Loan originations and payments, net		120,958			51,793
Purchases of premises and equipment, net		(399	)		(324	)
Net cash from investing activities		98,702			10,458
Cash flows from financing activities
Net change in deposits		(146,236	)		(94,221	)
Net change in repurchase agreements		665			(288	)
Repayment of Federal Home Loan Bank advances		(1,156	)		(26,867	)
Advances from Federal Home Loan Bank		—			25,000
Repayment of subordinated capital note		(450	)		(675	)
Cash dividends paid on preferred stock		—			(1,319	)
Cash dividends paid on common stock		—			(237	)
Net cash from financing activities		(147,177	)		(98,607	)
Net change in cash and cash equivalents		(24,180	)		(65,054	)
Beginning cash and cash equivalents		105,962			185,435
Ending cash and cash equivalents	$	81,782		$	120,381
Supplemental cash flow information:
Interest paid	$	11,808		$	17,183
Income taxes paid (refunded)		(2,000	)		2,000
Supplemental non-cash disclosure:
Transfer from loans to other real estate	$	31,531		$	31,232
Financed sales of other real estate owned		541			7,956

See accompanying notes to unaudited consolidated financial statements.

PORTER BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Porter Bancorp, Inc. (Company or PBI) and its subsidiary, PBI Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2011 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments, stock compensation, deferred tax assets, other intangibles, and fair values of other real estate owned are particularly subject to change.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

New Accounting Standards – In July 2012, the FASB issued ASU No. 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment.” The provisions of ASU No. 2012-02 provide the option to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, it is concluded that it is not more likely than not that the indefinite-lived intangible asset is impaired, then no further action is required. However, if the conclusion is otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. The provisions of this new guidance are effective for fiscal years beginning after September 15, 2012. The adoption of ASU No. 2012-02 is not expected to have a material impact on the Company’s statements of operations and condition.

Note 2 – Recent Developments and Future Plans

During the first nine months of 2012, we reported net loss to common shareholders of $26.4 million. This loss was primarily attributable to $33.3 million of provision for loan losses expense due to continued decline in credit trends in our portfolio that resulted in net charge-offs of $31.8 million, OREO expense of $7.7 million resulting from fair value write-downs driven by new appraisals and reduced marketing prices, net loss on sales, and ongoing operating expense. We also had lower net interest margin due to lower average loans outstanding, loans repricing at lower rates, and the level of non-performing loans in our portfolio. Net loss to common shareholders of $26.4 million, for the first nine months of 2012, compares with net loss to common shareholders of $50.8 million for the first nine months of 2011.

During the year ended December 31, 2011, we recorded a net loss to common shareholders of $105.2 million. This loss was attributable to a $23.8 million goodwill impairment charge, the establishment of a $31.7 million valuation allowance on our deferred tax assets, OREO expense of $47.5 million related to valuation adjustments for our change in strategy related to certain properties, fair value write-downs related to new appraisals received for properties in the portfolio during 2011, net loss on the sale of OREO properties, and increase in carrying costs associated with carrying these higher levels of assets. We also recorded a provision for loan losses expense of $62.6 million due to the continued decline in credit trends within our portfolio.

In June 2011, the Bank agreed to a Consent Order with the FDIC and KDFI in which the Bank agreed, among other things, to improve asset quality, reduce loan concentrations, and maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Consent Order was included in our Current Report on 8-K filed on June 30, 2011. In October 2012, the Bank entered into a new Consent Order with the FDIC and KDFI again agreeing to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements.

We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan previously submitted by the Bank. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 Consent Order. The new Consent Order was included in our Current Report on 8-K filed on September 19, 2012. As of September 30, 2012, the capital ratios required by the Consent Order were not met.

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies to achieve the following objectives:

Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to continue to reduce the size of our balance sheet, reduce our lending concentrations, consider selling loans, and reduce other noninterest expense through the disposition of OREO.

Continuing with succession planning and adding resources to the management team. In March 2012, the Board of Directors formed a search committee comprised of its five independent directors to identify and hire a President and CEO for PBI Bank. John T. Taylor was named to these positions and appointed to the board of directors in July 2012. Additionally, John R. Davis was appointed Chief Credit Officer of PBI Bank, with responsibility for establishing and executing the credit quality policies and overseeing credit administration for the organization.

Evaluating our internal processes and procedures, distribution of labor, and work-flow to ensure we have adequately and appropriately deployed resources in an efficient manner in the current environment. To this end, we believe the opportunity exists for the centralization of key processes which will lead to improved execution and cost savings.

Raising capital by selling common stock through a public offering or private placement to existing and new investors. At our 2012 annual meeting of shareholders, our shareholders approved an increase in our common shares authorized for issuance from 19 million shares to 86 million shares. We continue to evaluate our opportunities to improve our capital structure and to increase common equity through the sale of additional common shares. The Board of Directors has engaged an investment banking firm to assist in this evaluation and to explore options for the redemption of our Series A preferred stock issued to the US Treasury in 2008 under the Capital Purchase Program.

Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

We have reduced the size of our loan portfolio significantly from $1.3 billion at December 31, 2010 to $1.1 billion at December 31, 2011, and $952 million at September 30, 2012. We have significantly improved our staffing in the commercial lending area which is now led by John R. Davis, who joined the team in August and now serves as Chief Credit Officer.

Our Consent Order calls for us to reduce our construction and development loans to not more than 75% of total risk-based capital. We were in compliance at September 30, 2012 with construction and development loans representing 75% of total risk-based capital. These loans totaled $69.3 million, or 75% of total risk-based capital, at September 30, 2012 and $101.5 million, or 85% of total risk-based capital, at December 31, 2011.

Our Consent Order also requires us to reduce non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans as a group, to not more than 250% of total risk-based capital. While we have made significant improvements over the last year, we were not in compliance with this concentration limit at September 30, 2012. These loans totaled $339.9 million, or 368% of total risk-based capital, at September 30, 2012 and $414.6 million, or 349% of total risk-based capital, at December 31, 2011.

We are working to reduce these loans by curtailing new construction and development lending and new non-owner occupied commercial real estate lending. We are also receiving principal reductions from amortizing credits and pay-downs from our customers who sell properties built for resale. We have reduced the construction loan portfolio from $199.5 million at December 31, 2010 to $69.3 million at September 30, 2012. Our non-owner occupied commercial real estate loans declined from $293.3 million at December 31, 2010 to $214.5 million at September 30, 2012.

Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.

The remediation process for loans secured by real estate has led the Bank to acquire significant levels of OREO in 2010 and 2011. This trend has continued into 2012. The Bank acquired $90.8 million and $41.9 million during 2010 and 2011, respectively. For the first nine months of 2012, we acquired $31.5 million of OREO.

We have incurred significant losses in disposing of this real estate. We incurred losses totaling $13.9 million and $42.8 million in 2010 and 2011, respectively, from sales and fair value write-downs attributable to declining valuations as evidenced by new appraisals and from changes in our sales strategies. During the nine month period ended September 30, 2012, we incurred OREO losses totaling $6.6 million, which consisted of $1.5 million in loss on sale and $5.1 million from declining values as evidenced by new appraisals and reduced marketing prices in connection with our sales strategies.

To ensure that we maximize the value we receive upon the sale of OREO, we continue to evaluate sales opportunities and channels. We are targeting multiple sales opportunities and channels through internal marketing and the use of brokers, auctions, technology sales platforms, and bulk sale strategies. Proceeds from the sale or OREO totaled $17.6 million during the nine months ended September 30, 2012 and $25.0 and $26.0 million during fiscal 2010 and 2011, respectively.

At December 31, 2011 the OREO portfolio consisted of 75% construction, development, and land assets. At September 30, 2012 this concentration had declined to 54%. This is consistent with our reduction of construction, development and other land loans, which have declined to $69.3 million at September 30, 2012 compared to $101.5 million at December 31, 2011. Over the past nine months, the composition of our OREO portfolio has shifted to be more heavily weighted towards commercial real estate properties with a cash flow opportunity and 1-4 family residential properties, which we have found to be more liquid than construction, development, and land assets. Commercial real estate of this nature represents 31% of the portfolio at September 30, 2012 compared with 15% at December 31, 2011. 1-4 family residential properties represent 14% of the portfolio at September 30, 2012 compared with 7% at December 31, 2011.

Evaluating other strategic alternatives, such as the sale of assets or branches.

Bank regulatory agencies can exercise discretion when an institution does not meet the terms of a consent order. Based on individual circumstances, the agencies may issue mandatory directives, impose monetary penalties, initiate changes in management, or take more serious adverse actions.

Note 3 – Securities

The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
September 30, 2012
U.S. Government and federal agency	$	5,647	$	556	$	—		$	6,203
Agency mortgage-backed: residential		125,722		1,738		(293	)		127,167
State and municipal		51,663		2,431		(71	)		54,023
Corporate bonds		7,271		999		—			8,270
Other		572		23		—			595
Total debt securities		190,875		5,747		(364	)		196,258
Equity		1,359		531		—			1,890
Total	$	192,234	$	6,278	$	(364	)	$	198,148

December 31, 2011	$	10,494	$	1,149	$	—		$	11,643
U.S. Government and federal agency	$	10,494	$	1,149	$	—		$	11,643
Agency mortgage-backed: residential		97,286		2,211		(22	)		99,475
State and municipal		35,456		2,610		(4	)		38,062
Corporate bonds		7,259		315		(242	)		7,332
Other		572		34		—			606
Total debt securities		151,067		6,319		(268	)		157,118
Equity		1,359		356		—			1,715
Total	$	152,426	$	6,675	$	(268	)	$	158,833

Sales and calls of available for sale securities were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
		2012		2011		2012		2011
	(in thousands)
Proceeds	$	—	$	370	$	65,695	$	50,023
Gross gains		—		—		3,530		1,108
Gross losses		—		—		—		—

The amortized cost and fair value of the debt investment securities portfolio are shown by contractual maturity. Contractual maturities may differ from actual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are detailed separately.

	September 30, 2012
	Amortized Cost		Fair Value
	(in thousands)
Maturity
Available-for-sale
Within one year	$	879	$	909
One to five years		12,436		13,578
Five to ten years		42,412		44,838
Beyond ten years		9,426		9,766
Agency mortgage-backed: residential		125,722		127,167
Total	$	190,875	$	196,258

Securities pledged at September 30, 2012 and December 31, 2011 had carrying values of approximately $56.9 million and $57.7 million, respectively, and were pledged to secure public deposits and repurchase agreements.

The Company evaluates securities for other than temporary impairment (OTTI) at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, 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 analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.

At September 30, 2012, the Company held 40 equity securities. Of these securities, one security had an unrealized loss less than $1,000 and had been in an unrealized loss position for less than twelve months. All other equity securities were in an unrealized gain position at September 30, 2012. Management monitors the underlying financial condition of the issuers and current market pricing for these equity securities monthly. As of September 30, 2012, management does not believe any securities in our portfolio with unrealized losses should be classified as other than temporarily impaired. Management currently intends to hold all securities with unrealized losses until recovery, which for fixed income securities may be at maturity.

Securities with unrealized losses at September 30, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

	Less than 12 Months					12 Months or More				Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
	(in thousands)
September 30, 2012
State and municipal	$	6,418	$	(71	)	$	—	$	—	$	6,418	$	(71	)
Agency mortgage-backed: residential		30,324		(293	)		—		—		30,324		(293	)
Equity		2		—			—		—		2		—
Total temporarily impaired	$	36,744	$	(364	)	$	—	$	—	$	36,744	$	(364	)


December 31, 2011
State and municipal	$	508	$	(4	)	$	—	$	—	$	508	$	(4	)
Agency mortgage-backed: residential		2,159		(22	)		—		—		2,159		(22	)
Corporate bonds		2,805		(242	)		—		—		2,805		(242	)
Total temporarily impaired	$	5,472	$	(268	)	$	—	$	—	$	5,472	$	(268	)

Note 4 – Loans


Loans were as follows:	September 30,			December 31,
	2012			2011
	(in thousands)
Commercial	$	56,050		$	71,216
Commercial Real Estate:
Construction		69,306			101,471
Farmland		84,426			90,958
Other		350,129			423,844
Residential Real Estate:
Multi-family		56,065			60,410
1-4 Family		287,613			337,350
Consumer		21,813			26,011
Agriculture		25,661			23,770
Other		748			993
Subtotal		951,811			1,136,023
Less: Allowance for loan losses		(54,019	)		(52,579	)
Loans, net	$	897,792		$	1,083,444

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2012 and 2011:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other			Total
	(in thousands)
September 30, 2012:
Beginning balance	$	3,811		$	31,049		$	15,587		$	792		$	343		$	12		$	51,594
Provision for loan losses		2,630			17,412			4,326			366			763			3			25,500
Loans charged off		(2,400	)		(16,192	)		(3,824	)		(375	)		(696	)		–			(23,487	)
Recoveries		27			324			16			24			21			–			412
Ending balance	$	4,068		$	32,593		$	16,105		$	807		$	431		$	15		$	54,019


September 30, 2011:
Beginning balance	$	2,668		$	26,021		$	9,260		$	616		$	143		$	9		$	38,717
Provision for loan losses		819			2,723			3,995			290			176			(3	)		8,000
Loans charged off		(764	)		(3,640	)		(2,560	)		(294	)		(109	)		–			(7,367	)
Recoveries		15			99			8			20			–			–			142
Ending balance	$	2,738		$	25,203		$	10,703		$	632		$	210		$	6		$	39,492

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2012 and 2011:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other		Total
	(in thousands)
September 30, 2012:
Beginning balance	$	4,207		$	33,024		$	14,217		$	792		$	325		$	14	$	52,579
Provision for loan losses		2,641			19,187			9,528			687			1,206			1		33,250
Loans charged off		(2,866	)		(20,055	)		(7,715	)		(747	)		(1,124	)		–		(32,507	)
Recoveries		86			437			75			75			24			–		697
Ending balance	$	4,068		$	32,593		$	16,105		$	807		$	431		$	15	$	54,019


September 30, 2011:
Beginning balance	$	2,147		$	24,075		$	7,224		$	701		$	134		$	4	$	34,285
Provision for loan losses		3,251			14,144			8,702			508			193			2		26,800
Loans charged off		(2,699	)		(13,134	)		(5,253	)		(627	)		(117	)		–		(21,830	)
Recoveries		39			118			30			50			–			–		237
Ending balance	$	2,738		$	25,203		$	10,703		$	632		$	210		$	6	$	39,492

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2012:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	202	$	10,242	$	4,091	$	—	$	9	$	11	$	14,555
Collectively evaluated for impairment		3,866		22,351		12,014		807		422		4		39,464
Total ending allowance balance	$	4,068	$	32,593	$	16,105	$	807	$	431	$	15	$	54,019


Loans:
Loans individually evaluated for impairment	$	3,671	$	109,008	$	58,012	$	293	$	82	$	529	$	171,595
Loans collectively evaluated\| for impairment		52,379		394,853		285,666		21,520		25,579		219		780,216
Total ending loans balance	$	56,050	$	503,861	$	343,678	$	21,813	$	25,661	$	748	$	951,811

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2011:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	554	$	9,580	$	2,172	$	—	$	—	$	8	$	12,314
Collectively evaluated for impairment		3,653		23,443		12,045		792		326		6		40,265
Total ending allowance balance	$	4,207	$	33,023	$	14,217	$	792	$	326	$	14	$	52,579


Loans:
Loans individually evaluated for impairment	$	5,032	$	116,676	$	27,848	$	—	$	631	$	540	$	150,727
Loans collectively evaluated for impairment		66,184		499,598		369,911		26,011		23,139		453		985,296
Total ending loans balance	$	71,216	$	616,274	$	397,759	$	26,011	$	23,770	$	993	$	1,136,023

In the current period, the allowance for loans subject to a troubled debt restructure is presented as individually evaluated for impairment. Amounts presented in the preceding table have been reclassified to conform to our current period presentation because the allowance for loans subject to a troubled debt restructure had historically been presented as collectively evaluated for impairment.

Impaired Loans

Impaired loans include restructured loans and commercial, commercial real estate, construction, residential real estate, and agriculture loans, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss had been provided.

The following table presents information related to loans individually evaluated for impairment by class of loans as of and for the three and nine months ended September 30, 2012:

							Three Months Ended September 30, 2012				Nine Months Ended September 30, 2012
	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Cash Basis Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	1,641	$	1,434	$	—	$	1,539	$	—	$	1,738	$	—	$	—
Commercial real estate:
Construction		1,240		1,195		—		1,525		—		1,904		2		1
Farmland		5,585		5,584		—		5,594		—		4,771		5		5
Other		2,981		2,606		—		3,424		—		3,822		3		3
Residential real estate:
Multi-family		997		997		—		1,212		—		977		—		—
1-4 Family		15,797		15,152		—		13,888		15		10,824		42		42
Consumer		292		292		—		312		1		256		4		2
Agriculture		61		61		—		324		—		447		—		—
Other		—		—		—		—		—		—		—		—

Three Months Ended

September 30, 2012

Nine Months Ended

September 30, 2012

Unpaid
Principal
Balance

Recorded Investment

Allowance

For Loan

Losses

Allocated

Average Recorded Investment

Interest
Income Recognized

Average Recorded Investment

Interest
Income Recognized

Cash

Basis

Income

Recognized

(in thousands)

With An Allowance Recorded:
Commercial		2,237		2,237		202		3,686		32		3,940		120		27
Commercial real estate:
Construction		12,713		11,668		1,530		15,103		106		18,028		302		4
Farmland		5,680		5,479		524		5,272		14		5,629		32		2
Other		85,080		82,477		8,188		81,108		777		82,219		1,636		185
Residential real estate:
Multi-family		14,691		14,691		1,158		12,010		207		10,257		348		—
1-4 Family		28,269		27,172		2,933		28,084		218		27,232		620		9
Consumer		—		—		—		—		—		—		—		—
Agriculture		21		21		9		11		—		5		—		—
Other		529		529		11		531		4		534		13		—
Total	$	177,814	$	171,595	$	14,555	$	173,623	$	1,374	$	172,583	$	3,127	$	280

The following table presents loans individually evaluated for impairment by class of loan as of December 31, 2011:

	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Cash Basis Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	1,868	$	1,825	$	—	$	1,984	$	26	$	26
Commercial real estate:
Construction		1,121		1,193		—		7,584		7		5
Farmland		3,302		3,218		—		2,218		36		36
Other		6,039		5,640		—		12,114		169		99
Residential real estate:
Multi-family		—		—		—		—		—		—
1-4 Family		—		—		—		1,351		34		—
Consumer		—		—		—		—		—		—
Agriculture		637		631		—		253		5		5
Other		—		—		—		—		—		—
With An Allowance Recorded:
Commercial		3,207		3,207		554		2,630		189		90
Commercial real estate:
Construction		23,175		20,174		4,275		6,090		143		—
Farmland		7,303		6,862		574		6,487		322		—
Other		85,535		79,859		4,731		36,583		899		148
Residential real estate:
Multi-family		4,795		4,316		558		2,824		150		—
1-4 Family		26,225		23,262		1,614		15,105		614		3
Consumer		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—
Other		540		540		8		108		—		—
Total	$	163,747	$	150,727	$	12,314	$	95,331	$	2,594	$	412

Troubled Debt Restructuring

A troubled debt restructuring (TDR) is where the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the customer.

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2012 and December 31, 2011:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
September 30, 2012
Commercial
Rate reduction	$	—	$	213	$	213
Principal deferral		889		—		889
Interest only payments		—		1,019		1,019
Commercial Real Estate:
Construction
Rate reduction		7,407		2,337		9,744
Farmland
Rate reduction		150		—		150
Principal deferral		729		2,483		3,212
Other
Rate reduction		36,818		21,886		58,704
Principal deferral		1,196		—		1,196
Interest only payments		2,467		2,174		4,641
Residential Real Estate:
Multi-family
Rate reduction		13,133		31		13,164
Interest only payments		655		—		655
1-4 Family
Rate reduction		17,957		5,025		22,982
Principal deferral		—		384		384
Other
Rate reduction		529		—		529
Total TDRs	$	81,930	$	35,552	$	117,482

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
December 31, 2011
Commercial
Rate reduction	$	1,231	$	—	$	1,231
Principal deferral		898		—		898
Commercial Real Estate:
Construction
Rate reduction		11,155		3,767		14,922
Interest only payments		—		1,404		1,404
Farmland
Rate reduction		182		—		182
Principal deferral		746		5,101		5,847
Other
Rate reduction		42,946		20,446		63,392
Interest only payments		1,288		—		1,288
Residential Real Estate:
Multi-family
Rate reduction		2,247		1,413		3,660
Interest only payments		656		—		656
1-4 Family
Rate reduction		12,255		7,176		19,431
Principal deferral		—		247		247
Other
Rate reduction		540		—		540
Total TDRs	$	74,144	$	39,554	$	113,698

At September 30, 2012, and December 31, 2011, 70% and 65%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $11.7 million and $10.6 million in reserves to customers whose loan terms have been modified in TDRs as of September 30, 2012, and December 31, 2011, respectively. The Company has committed to lend additional amounts totaling $358,000 and $317,000 as of September 30, 2012, and December 31, 2011, respectively, to customers with outstanding loans that are classified as TDRs.

The following table presents a summary of the types of TDR loan modifications by portfolio type that occurred during the three months ended September 30, 2012:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
September 30, 2012
Commercial Real Estate:
Farmland
Rate reduction	$	150	$	—	$	150
Other
Rate reduction		5,549		—		5,549
Total TDRs	$	5,699	$	—	$	5,699

As of September 30, 2012, 100% of the Company’s TDRs that occurred during the three months ended September 30, 2012, were performing in accordance with their modified terms. The Company has allocated $489,000 in reserves to customers whose loan terms have been modified during the three months ended September 30, 2012. For modifications occurring during the three month period ended September 30, 2012, the post- modification balances approximate the pre-modification balances.

The following table presents a summary of the types of TDR loan modifications by portfolio type that occurred during the nine months ended September 30, 2012:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
September 30, 2012
Commercial
Interest only payments	$	—	$	1,019	$	1,019
Commercial Real Estate:
Construction
Rate reduction		—		849		849
Farmland
Rate reduction		150		—		150
Other
Rate reduction		16,700		—		16,700
Principal deferral		1,196		—		1,196
Interest only payments		2,467		2,174		4,641
Residential Real Estate:
Multi-family
Rate reduction		12,848		31		12,879
1-4 Family
Rate reduction		7,440		—		7,440
Principal deferral		—		384		384
Total TDRs	$	40,801	$	4,457	$	45,258

As of September 30, 2012, 90% of the Company’s TDRs that occurred during the first nine months of 2012 were performing in accordance with their modified terms. The Company has allocated $3.9 million in reserves to customers whose loan terms have been modified during the first nine months of 2012. For modifications occurring during the nine month period ended September 30, 2012, the post-modification balances approximate the pre-modification balances.

During the first nine months of 2012, approximately $9.9 million TDRs defaulted on their restructured loan and the default occurred within the 12 month period following the loan modification. These defaults consisted of $6.9 million in commercial real estate loans, $1.2 million in commercial loans, and $1.7 million in 1-4 family residential real estate loans. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

Nonperforming Loans

Nonperforming loans include impaired loans not on accrual and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment.

The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2012, and December 31, 2011:

	Nonaccrual				Loans Past Due 90 Days And Over Still Accruing
	September 30, 2012		December 31, 2011		September 30, 2012		December 31, 2011
	(in thousands)

Commercial	$	2,783	$	2,903	$	367	$	109
Commercial Real Estate:
Construction		5,456		13,564		—		—
Farmland		10,184		9,152		—		26
Other		44,497		35,154		1,119		918
Residential Real Estate:
Multi-family		1,900		2,921		—		—
1-4 Family		23,501		27,375		—		265
Consumer		229		320		—		—
Agriculture		82		631		—		32
Total	$	88,632	$	92,020	$	1,486	$	1,350

The following table presents the aging of the recorded investment in past due loans as of September 30, 2012 and December 31, 2011:

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
September 30, 2012
Commercial	$	909	$	133	$	367	$	2,783	$	4,192
Commercial Real Estate:
Construction		326		280		—		5,456		6,062
Farmland		695		1,339		—		10,184		12,218
Other		4,555		1,003		1,119		44,497		51,174
Residential Real Estate:
Multi-family		438		—		—		1,900		2,338
1-4 Family		2,300		775		—		23,501		26,576
Consumer		394		30		—		229		653
Agriculture		9		8		—		82		99
Total	$	9,626	$	3,568	$	1,486	$	88,632	$	103,312

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
December 31, 2011
Commercial	$	2,792	$	91	$	109	$	2,903	$	5,895
Commercial Real Estate:
Construction		20		—		—		13,564		13,584
Farmland		1,353		305		26		9,152		10,836
Other		4,555		756		918		35,154		41,383
Residential Real Estate:
Multi-family		442		135		—		2,921		3,498
1-4 Family		7,568		2,511		265		27,375		37,719
Consumer		593		149		—		320		1,062
Agriculture		23		—		32		631		686
Total	$	17,346	$	3,947	$	1,350	$	92,020	$	114,663

Credit Quality Indicators – We categorize loans into risk categories at origination based upon original underwriting. Subsequent to origination, we categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are analyzed individually by classifying the loans as to credit risk. This analysis includes loans with an outstanding balance greater than $500,000 and non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a quarterly basis. We do not have any non-rated loans. The following definitions are used for risk ratings:

Watch – Loans classified as watch are those loans which have experienced a potentially adverse development which necessitates increased monitoring.

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that we will sustain some losses if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of September 30, 2012, and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
September 30, 2012
Commercial	$	35,084	$	11,097	$	1,988	$	7,815	$	66	$	56,050
Commercial Real Estate:
Construction		27,007		19,914		5,951		16,434		—		69,306
Farmland		53,569		11,359		3,006		16,492		—		84,426
Other		147,379		72,837		30,017		99,593		303		350,129
Residential Real Estate:
Multi-family		22,888		14,752		1,359		17,066		—		56,065
1-4 Family		175,987		42,051		4,636		64,929		10		287,613
Consumer		18,979		1,796		83		892		63		21,813
Agriculture		23,460		866		810		525		—		25,661
Other		219		529		—		—		—		748
Total	$	504,572	$	175,201	$	47,850	$	223,746	$	442	$	951,811

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
December 31, 2011
Commercial	$	53,223	$	9,357	$	3,237	$	5,300	$	99	$	71,216
Commercial Real Estate:
Construction		45,407		13,132		7,777		35,155		—		101,471
Farmland		69,881		4,955		2,688		13,236		199		90,959
Other		213,406		80,149		30,787		99,502		—		423,844
Residential Real Estate:
Multi-family		37,807		4,619		2,100		15,884		—		60,410
1-4 Family		247,422		28,734		2,276		58,891		26		337,349
Consumer		23,721		1,418		43		762		67		26,011
Agriculture		22,502		343		14		911		—		23,770
Other		453		540		—		—		—		993
Total	$	713,822	$	143,247	$	48,922	$	229,641	$	391	$	1,136,023

Note 5 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are taken.

For larger dollar residential and commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. We obtain updated appraisals each year on the anniversary date of ownership unless a sale is imminent.

We continue to explore opportunities to sell OREO properties in bulk. In 2011, as a result of adopting a strategy to more aggressively market our OREO properties, we determined that we would be willing to sell certain OREO properties at an amount below their individual appraised values. Accordingly, we adjusted our valuations for these properties downward by increasing their valuation allowances to reflect our more aggressive disposition strategy. These properties are primarily single and multi-family residential land development properties. The following table presents the major categories of OREO at the period-ends indicated:

	September 30, 2012			December 31, 2011
	(in thousands)
Commercial Real Estate:
Construction	$	27,262		$	32,538
Farmland		415			744
Other		15,806			6,620
Residential Real Estate:
1-4 Family		7,149			3,214

		50,632			43,116
Valuation allowance		(1,795	)		(1,667	)

	$	48,837		$	41,449

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2012			2011			2012			2011
	(in thousands)
OREO Valuation Allowance Activity:
Beginning balance	$	1,724		$	10,643		$	1,667		$	700
Provision to allowance		4,260			15,265			5,090			30,702
Write-downs		(4,189	)		(4,154	)		(4,962	)		(9,648	)
Ending balance	$	1,795		$	21,754		$	1,795		$	21,754

Net activity relating to other real estate owned during the nine months ended September 30, 2012 and 2011 is as follows:

	2012			2011
	(in thousands)
OREO Activity
OREO as of January 1	$	41,449		$	67,635
Real estate acquired		31,531			31,232
Valuation adjustments		(5,090	)		(30,702	)
Improvements		1			1,596
Loss on sale		(1,481	)		(7,549	)
Proceeds from sale of properties		(17,573	)		(17,279	)
OREO as of September 30	$	48,837		$	44,933

Expenses related to other real estate owned include:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
	(in thousands)
Net loss on sales	$	533	$	673	$	1,481	$	7,549
Provision to allowance		4,260		15,265		5,090		30,702
Operating expense		411		1,091		1,095		2,254
Total	$	5,204	$	17,029	$	7,666	$	40,505

Note 6 – Deposits

Time deposits of $100,000 or more were $422.1 million and $493.3 million at September 30, 2012 and December 31, 2011, respectively.

Scheduled maturities of total time deposits at September 30, 2012 for each of the next five years are as follows (in thousands):

	Retail		Brokered		Total
Year 1	$	422,755	$	104,073	$	526,828
Year 2		91,532		—		91,532
Year 3		226,500		—		226,500
Year 4		26,579		—		26,579
Year 5		10,775		—		10,775
Thereafter		89		—		89
	$	778,230	$	104,073	$	882,303

Historically, the Bank has utilized brokered and wholesale deposits to supplement its funding strategy. At September 30, 2012, and December 31, 2011, these deposits totaled $104.1 million and $118.4 million, respectively. As stipulated in the Consent Order, PBI Bank is currently restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators. Management intends to redeem brokered deposits at maturity.

Note 7 – Advance from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

	September 30,		December 31,
	2012		2011
	(in thousands)
Monthly amortizing advances with fixed rates from 0.00% to 5.25% and
maturities ranging from 2013 through 2033, averaging 3.24% for 2012	$	5,960	$	7,116

Each advance is payable per terms on agreement, with a prepayment penalty. The advances were collateralized by first mortgage loans. The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2012, our additional borrowing capacity with the FHLB was $19.9 million. The availability of our borrowing capacity could be affected by our financial position and the FHLB could require additional collateral or, among other things, exercise its right to deny a funding request, at its discretion. Additionally, any new advances are limited to a one year maturity or less.

Note 8 – Fair Values Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We use various valuation techniques to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, we classify the fair value hierarchy on the lowest level of input that is significant to the fair value measurement. We used the following methods and significant assumptions to estimate fair value.

Securities: The fair values of securities are determined by market quoted prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where the date of the appraisal of the collateral predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be for unique use. This is in addition to estimated discounts for cost to sell of ten percent.

We also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation of foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. We have utilized discounts ranging from 10% to 33% in our impairment evaluations when applicable.

Impaired loans are evaluated quarterly for additional impairment. We obtain updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and our assessment of deterioration of real estate values in the market in which the property is located. The first stage of our assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market makers to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. Our quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. Based on these consultations, we determine asking prices for OREO properties we are marketing for sale. If the internally evaluated fair value is below our recorded investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to other real estate owned. In some of these circumstances, an appraisal is in process at quarter end, and we must make our best estimate of fair value based on our internal evaluation of the property, review of the most recent appraisal, and discussions with the currently engaged appraiser. We obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.

We routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our OREO. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate to 25% for real estate that is determined (1) to have a thin trading market or (2) to be for unique use. This is in addition to estimated discounts for cost to sell of ten percent.

Given our change in strategy in 2011 to reduce non-performing assets in an accelerated manner, management adjusted downward the valuations for single and multi-family residential loan development properties in our OREO portfolio to amounts below their individual appraised values.

Financial assets measured at fair value on a recurring basis at September 30, 2012 are summarized below:

			Fair Value Measurements at September 30, 2012 Using
			(in thousands)
			Quoted Prices In				Significant
			Active Markets for		Significant Other		Unobservable
	Carrying		Identical Assets		Observable Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

Available-for-sale securities
U.S. Government and
federal agency	$	6,203	$	—	$	6,203	$	—
Agency mortgage-backed:
residential		127,167		—		127,167		—
State and municipal		54,023		—		54,023		—
Corporate bonds		8,270		—		8,270		—
Other debt securities		595		—		—		595
Equity securities		1,890		1,890		—		—
Total	$	198,148	$	1,890	$	195,663	$	595

There were no transfers between Level 1 and Level 2 during 2012 or 2011.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods ended September 30, 2012 and 2011:

	State and Municipal Securities					Other Debt Securities
	2012			2011		2012			2011
	(in thousands)
Balances of recurring Level 3 assets at January 1	$	1,173		$	—	$	606		$	572
Total gain (loss) for the period:
Included in other comprehensive income (loss)		—			—		(11	)		45
Sales		(1,173	)		—		—			—
Balance of recurring Level 3 assets at September 30	$	—		$	—	$	595		$	617

Level 3 state and municipal securities valuations are supported by analysis prepared by an independent third party. Their approach to determining fair value involves using recently executed transactions for similar securities and market quotations for similar securities. As securities of this type are not rated by the rating agencies and trading volumes are thin, it was determined that these were valued using Level 3 inputs. We sold our Level 3 municipal securities in the second quarter of 2012 and had no securities of this nature at September 30, 2012.

Our other debt security valuation is determined internally by calculating discounted cash flows using the security’s coupon rate of 6.5% and an estimated current market rate of 11.0% based upon the current yield curve plus spreads that adjust for volatility, credit risk, and optionality. We also consider the issuer(s) publicly filed financial information as well as assumptions regarding the likelihood of deferrals and defaults.

Financial assets measured at fair value on a non-recurring basis at September 30, 2012 are summarized below:

			Fair Value Measurements at September 30, 2012 Using
			(in thousands)
			Quoted Prices In				Significant
			Active Markets for		Significant Other		Unobservable
	Carrying		Identical Assets		Observable Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

Impaired loans:
Commercial
Commercial real estate:	$	2,035	$	—	$	—	$	2,035
Construction
Farmland		10,138		—		—		10,138
Other		4,955		—		—		4,955
Residential Real Estate		74,289		—		—		74,289
Multi-family
1-4 Family		13,533		—		—		13,533
Agriculture		24,239		—		—		24,239
Other		12		—		—		12
Other real estate owned, net:		518		—		—		518
Commerical real estate:
Construction		26,296		—		—		26,296
Farmland		400		—		—		400
Other		15,246		—		—		15,246
Residential real estate:
1-4 Family		6,895		—		—		6,895

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $144.3 million, with a valuation allowance of $14.6 million, at September 30, 2012, resulting in an additional provision for loan losses of $972,000 for the nine months ended September 30, 2012.

Other real estate owned, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $48.8 million as of September 30, 2012, compared with $44.9 million at September 30, 2011. Fair value write-downs of $5.1 million and $30.7 million were recorded on other real estate owned for the first nine months of 2012 and 2011, respectively.

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2012:

		Fair Value	Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
		(in thousands)

Impaired loans – Commercial	$	1,345	Market value approach	Adjustment for receivables and inventory discounts	20% - 75% (48%)

Impaired loans – Commercial real estate	$	50,442	Sales comparison approach	Adjustment for differences between the comparable sales	0% - 62% (23%)

Impaired loans – Residential real estate	$	11,794	Sales comparison approach	Adjustment for differences between the comparable sales	3% - 38% (15%)

Other real estate owned – Commercial real estate	$	41,942	Sales comparison approach Income approach	Adjustment for differences between the comparable sales Discount or capitalization rate Accelerated sales strategy	3% - 38% (18%) 9% - 16% (12%) 25% - 50% (35%)

Other real estate owned – Residential real estate	$	6,895	Sales comparison approach	Adjustment for differences between the comparable sales	2% - 31% (12%)

Financial assets measured at fair value on a recurring basis at December 31, 2011 are summarized below:

			Fair Value Measurements at December 30, 2011 Using
			(in thousands)
			Quoted Prices In				Significant
			Active Markets for		Significant Other		Unobservable
	Carrying		Identical Assets		Observable Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

Available-for-sale securities
U.S. Government and
federal agency	$	11,643	$	—	$	11,643	$	—
Agency mortgage-backed:		99,475		—		99,475		—
State and municipal		38,062		—		36,889		1,173
Corporate bonds		7,332		—		7,332		—
Other debt securities		606		—		—		606
Equity securities		1,715		1,715		—		—
Total	$	158,833	$	1,715	$	155,339	$	1,779

Financial assets measured at fair value on a non-recurring basis at December 31, 2011 are summarized below:

			Fair Value Measurements at December 31, 2011 Using
			(in thousands)
			Quoted Prices In				Significant
			Active Markets for		Significant Other		Unobservable
	Carrying		Identical Assets		Observable Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)

Impaired loans:
Commercial
Commercial real estate:	$	2,653	$	—	$	—	$	2,653
Construction
Farmland		15,899		—		—		15,899
Other		6,288		—		—		6,288
Residential Real Estate		75,128		—		—		75,128
Multi-family
1-4 Family		3,758		—		—		3,758
Other		21,648		—		—		21,648
Other real estate owned, net:		532		—		—		532
Commerical real estate:
Construction		31,280		—		—		31,280
Farmland		715		—		—		715
Other		6,364		—		—		6,364
Residential real estate:
1-4 Family		3,090		—		—		3,090

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a carrying amount of $73.9 million with a valuation allowance of $5.6 million as of December 31, 2011.

Other real estate owned, which is measured at the lower of carrying or fair value less estimated costs to sell, had a net carrying amount of $41.4 million as of December 31, 2011.

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

			Fair Value Measurements at September 30, 2012 Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	81,782	$	71,524	$	10,258	$	—	$	81,782
Securities available for sale		198,148		1,890		195,663		595		198,148
Federal Home Loan Bank stock		10,072		N/A		N/A		N/A		N/A
Mortgage loans held for sale		210		—		210		—		210
Loans, net		897,792		—		—		909,621		909,621
Accrued interest receivable		5,396		—		1,212		4,184		5,396
Financial liabilities
Deposits	$	1,177,527	$	111,403	$	1,072,182	$	—	$	1,183,585
Securities sold under agreements to repurchase		2,403		—		2,403		—		2,403
Federal Home Loan Bank advances		5,960		—		5,927		—		5,927
Subordinated capital notes		7,200		—		—		6,800		6,800
Junior subordinated debentures		25,000		—		—		19,617		19,617
Accrued interest payable		2,096		—		1,325		771		2,096

	Fair Value Measurements at December 31, 2011
	Carrying Amount		Fair Value

Financial assets
Cash and cash equivalents	$	105,962	$	105,962
Securities available for sale		158,833		158,833
Federal Home Loan Bank stock		10,072		N/A
Mortgage loans held for sale		694		694
Loans, net		1,083,444		1,093,456
Accrued interest receivable		6,682		6,682
Financial liabilities
Deposits	$	1,323,763	$	1,332,133
Securities sold under agreements to repurchase		1,738		1,738
Federal Home Loan Bank advances		7,116		7,015
Subordinated capital notes		7,650		7,110
Junior subordinated debentures		25,000		19,765
Accrued interest payable		1,732		1,732

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(d) Mortgage Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values disclosed for non-interest bearing deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in either a Level 1 classification. The carrying amounts of variable rate interest bearing deposits approximate their fair values at the reporting date resulting in either a Level 1 classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Securities Sold Under Agreements to Repurchase

The carrying amounts of borrowings under repurchase agreements approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings

The fair values of the Company’s FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

The fair values of the Company’s subordinated capital notes and junior subordinated debentures are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(h) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

Note 9 – Income Taxes

Deferred tax assets and liabilities were due to the following as of:

	September 30,			December 31,
	2012			2011
	(in thousands)
Deferred tax assets:
Allowance for loan losses	$	18,907		$	18,403
Other real estate owned write-down		10,182			12,905
Net operating loss carry-forward		13,970			2,470
New market tax credit carry-forward		191			208
Alternative minimum tax credit carry-forward		692			685
Net assets from acquisitions		580			543
Other than temporary impairment on securities		374			374
Amortization of non-compete agreements		21			27
Other		734			827
		45,651			36,442

Deferred tax liabilities:
Fixed assets		410			445
Net unrealized gain on securities available for sale		2,070			2,242
FHLB stock dividends		1,276			1,276
Originated mortgage servicing rights		99			103
Other		583			659
		4,438			4,725
Net deferred tax assets before valuation allowance		41,213			31,717
Valuation allowance		(41,213	)		(31,717	)
Net deferred tax asset	$	—		$	—

Our estimate of the realizability of the deferred tax asset depends on our estimate of projected future levels of taxable income as all carryback ability was fully absorbed by our estimated tax loss of approximately $40 million for 2011. In analyzing future taxable income levels, we considered all evidence currently available, both positive and negative. Based on our analysis, we established a valuation allowance for all deferred tax assets as of December 31, 2011. Our deferred tax assets and the related valuation allowance are analyzed and adjusted on a quarterly basis.

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the nine months ended September 30, 2012 or the year ended December 31, 2011 related to unrecognized tax benefits.

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2009.

Note 10 – Stock Plans and Stock Based Compensation

The Company has a stock option plan and a stock incentive plan. On February 23, 2006, the Company adopted the Porter Bancorp, Inc. 2006 Stock Incentive Plan. The 2006 Plan permits the issuance of up to 400,000 shares of the Company’s common stock upon the exercise of stock options or upon the grant of stock awards. As of September 30, 2012, the Company had granted 158,022 unvested shares net of forfeitures and vesting under the stock incentive plan. Shares issued under the plan vest annually on the anniversary date of the grant over two to ten years. The Company has 137,957 shares remaining available for issue under the plan. All shares issued under the above mentioned plans came from authorized and unissued shares.

On May 15, 2006, the Board of Directors approved the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, which was approved by holders of the Company’s voting common stock on June 8, 2006. On May 22, 2008, shareholders voted to amend the plan to change the form of incentive award from stock options to unvested shares. Under the terms of the plan, 100,000 shares are reserved for issuance to non-employee directors upon the exercise of stock options or upon the grant of unvested stock awards granted under the plan. Prior to the amendment, options were granted automatically under the plan at fair market value on the date of grant. The options vest over a three-year period and have a five year term. Unvested shares are granted automatically under the plan at fair market value on the date of grant and vest semi-annually on the anniversary date of the grant over three years.

On May 16, 2012, holders of the Company’s voting common stock voted to further amend the 2006 Non-Employee Directors Stock Ownership Incentive Plan to award restricted shares having a fair market value of $25,000 annually to each non-employee director, and to increase the number of shares issuable under the Directors’ Plan from 100,000 shares to 400,000 shares. Shares issued under the amended plan vest semi-annually on the anniversary date of the grant over three years.

To date, the Company has issued 96,610 unvested shares to non-employee directors. At September 30, 2012, 295,712 shares remain available for issuance under this plan.

The fair value of the 2012 unvested shares issued to certain employees was $169,000, or $1.74 per weighted-average share. The fair value of the 2012 unvested shares issued to non-employee directors was $155,000, or $1.65 per share. The Company recorded $338,000 and $342,000 of stock-based compensation during the first nine months of 2012 and 2011, respectively, to salaries and employee benefits. There was no significant impact on compensation expense resulting from forfeited or expiring shares. We expect substantially all of the unvested shares outstanding at the end of the period will vest according to the vesting schedule. A deferred tax benefit of $0 and $116,000, respectively, was recognized related to this expense.

The following table summarizes unvested share activity as of and for the periods indicated:

	Nine Months Ended					Twelve Months Ended
	September 30, 2012					December 31, 2011
				Weighted					Weighted
				Average					Average
				Grant					Grant
	Shares			Price		Shares			Price
Outstanding, beginning		100,226		$	13.21		157,697		$	13.43
Granted		191,140			1.69		2,800			5.36
Vested		(28,249	)		12.91		(35,836	)		13.00
Forfeited		(8,485	)		15.13		(24,435	)		14.04
Outstanding, ending		254,632		$	4.53		100,226		$	13.21

As of September 30, 2012, all stock options issued to non-employee directors had expired and none were exercised during their grant term. When granted, stock options have an exercise price that is equal to or greater than the fair market value of the Company’s stock on the date the options were granted. Options granted generally become fully exercisable at the end of three years of continued employment. Options have a life of five years.

The following table summarizes stock option activity:

	Nine Months Ended					Twelve Months Ended
	September 30, 2012					December 31, 2011
				Weighted					Weighted
				Average					Average
				Exercise					Exercise
	Shares			Price		Shares			Price
Outstanding, beginning		29,530		$	19.88		86,469		$	20.72
Forfeited		—			—		(9,557	)		19.49
Expired		(29,530	)	$	19.88		(47,382	)		21.49
Outstanding, ending		—			—		29,530		$	19.88

No options were exercised during the first nine months of 2012. The Company recorded no stock option compensation expense during the nine months ended September 30, 2012. No options were modified during the period. As of September 30, 2012, no stock options issued by the Company had been exercised, and all granted options had expired.

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2012 and beyond are estimated as follows (in thousands):

October 2012 – December 2012	$	133
2013		457
2014		325
2015		131
2016 & thereafter		31

Note 11 – Earnings (Loss) per Share

The factors used in the basic and diluted earnings per share computations follow:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
	(in thousands, except share and per share data)

Net loss	$	(27,732	)	$	(12,162	)	$	(26,079	)	$	(51,352	)
Less:
Preferred stock dividends		437			437			1,312			1,312
Accretion of Series A preferred stock discount		44			45			134			133
Loss attributable to unvested shares		(501	)		(117	)		(345	)		(551	)
Loss attributable to Series C preferred		(763	)		(346	)		(750	)		(1,444	)
Net loss attributable to common
shareholders, basic and diluted	$	(26,949	)	$	(12,181	)	$	(26,430	)	$	(50,802	)

Basic
Weighted average common shares including
unvested common shares outstanding		12,303,217			12,167,168			12,219,035			12,172,926
Less: Weighted average unvested
common shares		218,505			112,683			153,306			126,992
Less: Weighted average Series C preferred		332,894			332,894			332,894			332,894
Weighted average common shares outstanding		11,751,818			11,721,591			11,732,835			11,713,040

Basic earnings (loss) per common share	$	(2.29	)	$	(1.04	)	$	(2.25	)	$	(4.34	)

Diluted
Add: Dilutive effects of assumed exercises
of common and Preferred Series C
stock warrants		--			--			--			--
Weighted average common shares and
potential common shares		11,751,818			11,721,591			11,732,835			11,713,040

Diluted earnings (loss) per common share	$	(2.29	)	$	(1.04	)	$	(2.25	)	$	(4.34	)

Stock options for 29,530 shares of common stock for 2011 were not considered in computing diluted earnings per common share because they were anti-dilutive. The Company had no outstanding stock options at September 30, 2012. Additionally, a warrant for the purchase of 330,561 shares of the Company’s common stock at an exercise price of $15.88 was outstanding at September 30, 2012 and 2011 but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. Finally, warrants for the purchase of 1,380,437 shares of non-voting common stock at an exercise price of $11.50 per share were outstanding at September 30, 2012 and 2011, but were not included in the diluted EPS computation as inclusion would have been anti-dilutive.

Note 12 – Capital Requirements and Restrictions on Retained Earnings

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

On June 24, 2011, PBI Bank entered into a Consent Order with the FDIC and the Kentucky Department of Financial Institutions. The consent order required the Bank to complete a management study, to maintain Tier 1 capital as a percentage of total assets of at least 9% and a total risk based capital ratio of at least 12%, to develop a plan to reduce our risk position in each substandard asset in excess of $1 million, to complete board review of the adequacy of the allowance for loan losses prior to quarterly Call Report submissions, to adopt procedures which strengthen the loan review function and ensure timely and accurate grading of credit relationships, to charge-off all assets classified as loss, to develop a plan to reduce concentrations of construction and development loans to not more than 75% of total risk based capital and non-owner occupied commercial real estate loans to not more than 250% of total risk based capital, to limit asset growth to no more than 5% in any quarter or 10% annually, to not extend additional credit to any borrower classified substandard unless the board of directors adopts in advance a detailed statement giving reasons why the extension is in the best interest of the bank, and to not declare or pay any dividend without the prior consent of our regulators. We are also restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators.

On September 21, 2011, we entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, we made formal commitments to use our financial and management resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient capital.

In October 2012, PBI Bank entered into a new consent order with the FDIC and KDFI. The new consent order requires the Bank to maintain a minimum Tier 1 leverage ratio of 9% and a minimum total risk based capital ratio of 12%. The Bank also agreed that if it should be unable to reach the required capital levels, and if directed in writing by the FDIC, then the Bank would within 30 days develop, adopt and implement a written plan to sell or merge itself into another federally insured financial institution or otherwise immediately obtain a sufficient capital investment into the Bank to fully meet the capital requirements. We expect to continue to work with our regulators toward capital ratio compliance as outlined in the written capital plan previously submitted by the Bank. The new consent order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 consent order, and includes the substantive provisions of the June 2011 consent order.

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated:

										September 30, 2012						December 31, 2011
	Regulatory Minimums			Well-Capitalized Minimums			Minimum Capital Ratios Under Consent Order			Porter Bancorp			PBI Bank			Porter Bancorp			PBI Bank

Tier 1 Capital		4.0	%		6.0	%		N/A			7.03	%		7.78	%		9.23	%		8.86	%
Total risk-based capital		8.0			10.0			12.0	%		10.01			9.85			11.22			10.86
Tier 1 leverage ratio		4.0			5.0			9.0			5.00			5.53			6.53			6.23

At September 30, 2012, PBI Bank’s Tier 1 leverage ratio was 5.53%, which is below the 9% minimum capital ratio required by the Consent Order, and its total risk-based capital ratio was 9.85%, which is below the 12% minimum capital ratio required by the Consent Order. Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if undertaken, could have a materially adverse effect on our financial condition.

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. PBI Bank has agreed with its primary regulators to obtain their written consent prior to declaring or paying any future dividends. As a practical matter, PBI Bank cannot pay dividends to Porter Bancorp for the foreseeable future.

Note 13 – Contingencies

In 2010, the Company sold common shares, convertible preferred shares and warrants to purchase common shares to accredited investors for $32 million in a private placement. In the placement, an affiliate of Clinton Group, Inc. (“CGI”) purchased 456,524 common shares and warrants to purchase 228,262 common shares for $10.93 per share for $5,000,016. The numbers of shares and the warrant exercise price have been adjusted to reflect the Company’s 5% stock dividend in November 2010.

On July 11, 2011, CGI sent a letter to the Company, which was also attached as an exhibit to a Schedule 13D CGI filed with the Securities and Exchange Commission on the same date. In its letter CGI set forth concerns about the Company’s executive leadership team and its ability to properly manage the Bank's operations, compliance with GAAP, financial disclosures and relationships with regulators, referencing the consent order PBI Bank entered into with the Federal Deposit Insurance Corporation and the Commonwealth of Kentucky Department of Financial Institutions on June 24, 2011. CGI listed a number of steps it believed the Company must take to maximize shareholder value and comply with the consent order. In addition, CGI stated its belief “that it is likely that a number of representations and warranties made when the CGI affiliate entered into an agreement to purchase shares were false,” and demanded that the Company take immediate steps to “redress such breaches and make CGI and the other purchasers whole.”

On July 20, 2011, the Company’s board of directors established a new Risk Policy and Oversight Committee comprised of independent directors, to lead the Board’s oversight of the assessment and management of the risks of Porter Bancorp and PBI Bank. During the third quarter, the Oversight Committee undertook an investigation of the allegations raised in the CGI 13D to evaluate their merit and to ascertain the reasonableness of the Bank’s allowance for loan losses and OREO valuations at the time of Clinton’s investment.

The Oversight Committee reported its conclusions to the Company’s board of directors in October 2011. While recognizing opportunities for procedural improvements existed in the Bank’s lending and non-performing asset administration, the Oversight Committee concluded that this did not rise to a level that would result in the financial statements, or representations and warranties with respect to the financial statements, being misleading to investors in the 2010 private placement offering of the Company’s stock. The Oversight Committee further concluded that investors were afforded ample opportunity and access to information for their due diligence, including documentation involving asset valuation estimates, on-site management discussions and additional inquiries during visits to the Company headquarters, and access to loan files of their choosing and the appraisals contained therein, and that the Company’s disclosures were adequate in all material respects.

In a letter dated November 28, 2011, which was filed as an exhibit to its 13D amendment, CGI was critical of the Oversight Committee’s investigation and restated its belief the Company’s balance sheet was overstated. CGI called upon the independent directors to correct the balance sheet, replace the management team and raise capital. On January 30, 2012, CGI delivered a demand to inspect the Company’s records pursuant to the Kentucky Business Corporation Act. The Company has provided records to CGI in accordance with Kentucky law.

On June 18, 2010, three real estate development companies filed suit in Kentucky state court against PBI Bank and Managed Assets of Kentucky (“MAKY”). Signature Point Condominiums LLC, et al. v. PBI Bank, et al., Jefferson Circuit Court, Case No 10-CI-04295. The plaintiffs had borrowed funds from PBI Bank to finance a real estate development project in Jefferson County, Kentucky. In March 2010, PBI agreed to release the plaintiffs and the guarantors on the loans related to the project, and in exchange the plaintiffs conveyed the real estate securing the loans to PBI Bank. PBI Bank also granted the plaintiffs a right of first refusal to repurchase a +/- 30 acre tract of land within the project. In May 2010, PBI Bank submitted to plaintiffs the required notice of its intent to sell the land subject to the right of first refusal. After plaintiffs declined to exercise their right of first refusal, PBI Bank sold the land to MAKY in June 2010 for $3.8 million.

Plaintiffs filed suit shortly before the closing of the sale and recorded a lis pendens claiming an interest in the land, effectively preventing MAKY from taking clear title. Plaintiffs have asserted claims of fraud, breach of fiduciary duty, breach of the duty of good faith and fair dealing, tortuous interference with prospective business advantage and conspiracy to commit fraud, negligence, and conspiracy against PBI Bank and MAKY. Plaintiffs are seeking to rescind the agreement conveying the project to PBI Bank, but only with respect to the +/- 30 acre tract of land. PBI has filed a counterclaim against the plaintiffs and a third party complaint against the guarantors, asserting claims of fraud. MAKY has asserted claims against the plaintiffs for slander of title and interference with business opportunities. PBI’s position is that if the conveyance agreement is rescinded, then PBI’s notes, mortgages, and guarantees as well as the obligations of the plaintiffs and guarantors under the loans, which total more than $26 million, would all be reinstated. PBI would then seek to enforce its rights under such instruments. The matter is scheduled for trial in December 2012. We have not accrued liability related to this matter as we believe we have meritorious claims and defenses.

In the normal course of operations, we are defendants in various legal proceedings. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. Currently, we do not believe that any of our pending legal proceedings or claims will have a material impact on our financial position or results of operations.

Item 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

This item analyzes our financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited condensed consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Cautionary Note Regarding Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of our control. Factors that could contribute to differences in our results include, but are not limited to the factors listed in Part II, Item 1A – Risk Factors in this report and the more detailed risks identified, and the cautionary statements included in our December 31, 2011 Annual Report on Form 10-K.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and that they are reasonable. We caution you however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The forward-looking statements included in this report speak only as of the date of the report. We have no duty, and do not intend to, update these statements unless applicable laws require us to do so.

Overview

Porter Bancorp, Inc. (NASDAQ: PBIB) is a Louisville, Kentucky-based bank holding company which operates 18 full-service banking offices in twelve counties through its wholly-owned subsidiary, PBI Bank. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt, and extend south along the Interstate 65 corridor to Tennessee. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio and Daviess Counties. We also have an office in Lexington, the second largest city in Kentucky. The Bank is a traditional community bank with a wide range of commercial and personal banking products, including wealth management and trust services, with an online banking division which delivers competitive deposit products and services under the separate brand of Ascencia.

The Company reported net loss of $27.7 million and $26.1 million, respectively, for the three and nine months ended September 30, 2012, compared with net loss of $12.2 million and $51.4 million, respectively, for the same periods of 2011. After deductions for dividends on preferred stock, accretion on preferred stock, and loss allocated to participating securities, net loss to common shareholders was $26.9 million and $26.4 million, respectively, for the three and nine months ended September 30, 2012, compared with net loss to common shareholders of $12.2 million and $50.8 million, respectively, for the three and nine months ended September 30, 2011. Results for the first nine months of 2011 were negatively impacted by a non-recurring 100% goodwill impairment charge of $23.8 million and higher expense related to other real estate owned.

Basic and diluted loss per common share were $(2.29) and $(2.25) for the three and nine months ended September 30, 2012, respectively, compared with basic and diluted loss per common share of ($1.04) and ($4.34) for the three and nine months ended September 30, 2011, respectively.

Significant developments during the quarter and nine months ended September 30, 2012 consist of the following:

Provision for loan losses expense was $25.5 million for the third quarter of 2012, compared with $4.0 million for the second quarter of 2012, and $8.0 million for the prior year third quarter. This increase was due to the continued decline in credit trends in our portfolio that resulted in net charge-offs of $23.1 million for the third quarter. More specifically, the increase in the provision for loan losses in the third quarter 2012 is attributable to collateral value declines for impaired real estate secured loans as evidenced by new appraisals received during the quarter. This resulted in a provision for loan loss totaling approximately $6.8 million related to these loans during the third quarter of 2012.

The provision was also negatively impacted by a strategy change during the third quarter of 2012 related to classified loans which we expect to more quickly remediate by litigation or foreclosure. For loans subject to this expectation, we applied an additional fair value discount ranging from 10% to 33% to the underlying collateral in our impairment analysis estimates as resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. This resulted in a provision for loan loss of approximately $5.1 million related to these loans. Additionally, the provision for loan losses was negatively impacted by the rising level of loan charge-offs in our historical loss experience factors, which we use to estimate the general component of our allowance for loan losses as well as additional downgrades within the loan portfolio.

Net interest margin decreased 11 basis points to 3.35% in the first nine months of 2012 compared with 3.46% in the first nine months of 2011. The decrease in margin between periods was primarily due to a reduction in interest earning assets coupled with lower rates on those assets and elevated non-accrual loan levels. Average loans decreased 15.3% to $1.1 billion in the first nine months of 2012 compared with $1.3 billion in the first nine months of 2011. Net loans decreased 23.0% to $898 million at September 30 2012, compared with $1.2 billion at September 30, 2011.

We continue to execute on our strategy to reduce our commercial real estate and construction and development loans. Construction and development loans totaled $69.3 million, or 75% of total risk-based capital, at September 30, 2012 compared with $101.5 million, or 85% of total risk-based capital, at December 31, 2011. Non-owner occupied commercial real estate loans, construction and development loans, and multi-family residential real estate loans as a group totaled $339.9 million, or 368% of total risk-based capital, at September 30, 2012 compared with $414.6 million, or 349% of total risk-based capital, at December 31, 2011.

Loan proceeds received from the repayment of our commercial real estate and construction and development loans were used primarily to redeem maturing certificates of deposit during the quarter. Deposits decreased 14.3% to $1.18 billion compared with $1.37 billion at September 30, 2011. Certificate of deposit balances declined $142.0 million during the first nine months of 2012 to $882.3 million at September 30, 2012, from $1.02 billion at December 31, 2011. Demand deposits increased 0.3% during the first nine months of 2012 compared with the fourth quarter of 2011, and increased 6.4% compared with the first nine months of 2011.

Non-performing loans increased $8.4 million to $90.1 million at September 30, 2012, compared with $81.7 million at June 30 2012. The increase was primarily in the commercial real estate and residential real estate segments of our portfolio, partially offset by a decrease in the construction real estate segment.

·	Loans past due 30-59 days increased from $6.7 million at June 30, 2012 to $9.6 million at September 30, 2012 and loans past due 60-89 days decreased from $4.4 million at June 30, 2012 to $3.6 million at September 30, 2012.

Foreclosed properties were $48.8 million at September 30, 2012, compared with $54.4 million at June 30, 2012, and $44.9 million at September 30, 2011. The Company acquired $3.4 million of OREO and sold $4.7 million of OREO during the third quarter of 2012. In addition, fair value write-downs of $4.3 million were recorded during the third quarter of 2012 to reflect declining values as evidenced by new appraisals and reduced marketing prices in connection with our sales strategies. Our ratio of non-performing assets to total assets increased to 10.8% at September 30, 2012, compared with 10.2% at June 30, 2012, and 6.64% at September 30, 2011.

In October 2012, PBI Bank entered into a new Consent Order with the FDIC and KDFI. Under the new order, the Bank agreed to maintain the capital levels required by the June 2011 order and also agreed should the capital levels not be reached, and if directed in writing by the FDIC, the Bank would develop a plan to immediately raise sufficient capital, or to sell or merge itself into another FDIC insured institution. The new Consent Order also requires the Bank to continue to adhere to the plans implemented in response to the June 2011 Consent Order, and includes the substantive provisions of the June 2011 order.

These items are discussed in further detail throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” Section. For a discussion of our accounting policies, please see “Application of Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operation in our Annual Report on Form 10-K for the calendar year ended December 31, 2011.

Recent Developments and Future Plans

In order to meet these capital requirements, the Board of Directors and management are continuing to evaluate strategies to achieve the following objectives:

·	Continuing to operate the Company and Bank in a safe and sound manner. This strategy will require us to continue to reduce the size of our balance sheet, reduce our lending concentrations, consider selling loans, and reduce other noninterest expense through the disposition of OREO.

·	Executing on our commitment to improve credit quality and reduce loan concentrations and balance sheet risk.

·	Executing on our commitment to sell other real estate owned and reinvest in quality income producing assets.

·	Evaluating other strategic alternatives, such as the sale of assets or branches.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2012, compared with the same period of 2011:

	For the Three Months						Change from
	Ended September 30,						Prior Period
	2012			2011			Amount			Percent
	(dollars in thousands)

Gross interest income	$	13,987		$	18,103		$	(4,116	)		(22.7	)%
Gross interest expense		3,855			5,448			(1,593	)		(29.2	)
Net interest income		10,132			12,655			(2,523	)		(19.9	)
Provision for loan losses		25,500			8,000			17,500			218.8
Non-interest income		1,721			1,700			21			1.2
Non-interest expense		14,150			25,423			(11,273	)		(44.3	)
Net income (loss) before taxes		(27,797	)		(19,068	)		(8,729	)		45.8
Income tax expense (benefit)		(65	)		(6,906	)		6,841			(99.1	)
Net income (loss)		(27,732	)		(12,162	)		(15,570	)		128.0

Net loss for the three months ended September 30, 2012 increased $15.6 million to $27.7 million compared with net loss of $12.2 million for the comparable period of 2011. Provision for loan losses expense increased $17.5 million in the third quarter of 2012 compared with the same period in 2011 as the result of collateral value declines for certain larger collateral dependent commercial real estate credits as evidenced by new appraisals received during the quarter, higher net charge-offs, and a continued decline in credit trends in our portfolio. In addition, the third quarter 2012 provision for loan losses was negatively impacted by a strategy change during the third quarter of 2012 related to classified loans which we expect to more quickly remediate by litigation or foreclosure. For loans subject to this expectation, we applied an additional fair value discount to the underlying collateral in our impairment analysis estimates. Net interest income decreased $2.5 million from the 2011 third quarter due to a 15 basis point decline in net interest margin due to lower earning asset levels, lower average rates, and higher non-performing assets. These results were partially off-set by a decrease in OREO expense of $11.8 million for the third quarter of 2012 compared with the same period of 2011 due to lower loss on sales of OREO, lower valuation write-downs, and lower property maintenance expense.

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2012 compared with the same period of 2011:

	For the Nine Months						Change from
	Ended September 30,						Prior Period
	2012			2011			Amount			Percent
	(dollars in thousands)

Gross interest income	$	44,554		$	56,917		$	(12,363	)		(21.7	)%
Gross interest expense		12,173			17,053			(4,880	)		(28.6	)
Net interest income		32,381			39,864			(7,483	)		(18.8	)
Provision for credit losses		33,250			26,800			6,450			24.1
Non-interest income		8,184			6,352			1,832			28.8
Non-interest expense		33,459			89,577			(56,118	)		(62.6	)
Net income (loss) before taxes		(26,144	)		(70,161	)		44,017			(62.7	)
Income tax expense (benefit)		(65	)		(18,809	)		18,744			(99.7	)
Net income (loss)		(26,079	)		(51,352	)		25,273			(49.2	)

Net loss of $26.1 million for the nine months ended September 30, 2012 represented a decrease of $25.3 million from net loss of $51.4 million for the comparable period of 2011. A non-recurring 100% goodwill impairment charge of $23.8 million was recorded during the first nine months of 2011. OREO expense decreased $32.8 million from the first nine months of 2011 due to lower loss on sales of OREO, lower valuation write-downs, and lower property maintenance expense. Additionally, gain on sales of investment securities was $3.5 million for the first nine months of 2012 compared with $1.1 million for the first nine months of 2011. These improvements were partially offset by a decrease of $7.5 million in net interest income from the first nine months of 2011 due to an 11 basis point decline in net interest margin. In addition, provision for loan losses expense increased $6.5 million in the first nine months of 2012 compared with the same period in 2011 as the result of the continued decline in credit trends in our portfolio that resulted in higher net charge-offs compared to the previous period. More specifically, the 2012 provision for loan losses was negatively impacted by collateral value declines for certain larger collateral dependent commercial real estate credits as evidenced by new appraisals received during the period and a strategy change during the third quarter of 2012 related to classified loans which we expect to more quickly remediate by litigation or foreclosure. For loans subject to this expectation, we applied an additional fair value discount to the underlying collateral in our impairment analysis estimates.

Net Interest Income – Our net interest income was $10.1 million for the three months ended September 30, 2012, a decrease of $2.5 million, or 19.9%, compared with $12.7 million for the same period in 2011. Net interest spread and margin were 3.09% and 3.23%, respectively, for the third quarter of 2012, compared with 3.22% and 3.38%, respectively, for the third quarter of 2011. Net interest income was $32.4 million for the nine months ended September 30, 2012, a decrease of $7.5 million, or 18.8%, compared with $39.9 million for the same period of 2011. Net interest spread and margin were 3.19% and 3.35%, respectively, for the first nine months of 2012, compared with 3.30% and 3.46%, respectively, for the first nine months of 2011. Net average non-accrual loans were $90.2 million and $62.4 million in the first nine months of 2012 and 2011, respectively.

Average loans receivable declined approximately $219.0 million for the quarter ended September 30, 2012 compared with the third quarter of 2011. This resulted in a decline in interest revenue of approximately $3.9 million for the quarter ended September 30, 2012 compared with the prior year period. Average loans receivable declined approximately $193.4 million for the nine months ended September 30, 2012 compared with the first nine months of 2011. This resulted in a decline in interest revenue of approximately $11.4 million for the nine months ended September 30, 2012 compared with the prior year period. This decline in loan volume is attributable to soft loan demand in our markets as well as our efforts to reduce concentrations in our construction and development loan portfolio and our non-owner occupied commercial real estate loan portfolio.

Net interest margin decreased 15 basis points from our margin of 3.38% in the prior year third quarter. The yield on earning assets declined 36 basis points from the third quarter of 2011, compared with a 23 basis point decline in rates paid on interest-bearing liabilities. Net interest margin for the first nine months of 2012 decreased 11 basis points from our margin of 3.46% in the first nine months of 2011 due primarily to lower average earning assets relative to average interest bearing liabilities. The yield on earning assets declined 33 basis points from the first nine months of 2011, compared with a 22 basis point decline in rates paid on interest-bearing liabilities.

Net interest margin for the third quarter of 2012 decreased 12 basis points from our margin of 3.35% in the second quarter of 2012, due primarily to lower average loan receivables and lower yield on loans, coupled with lower yield on investment securities. Average loan receivables declined $70.4 million from the second quarter of 2012, due to our efforts to reduce concentrations in our construction and development loan portfolio and in our non-owner occupied commercial real estate loan portfolio, and increased charge-offs. Yield on loans was adversely affected by an increase in interest foregone on non-accrual loans. Interest foregone on non-accrual loans totaled $1.1 million in the third quarter of 2012, compared with $1.3 million in the second quarter of 2012, and $790,000 in the first quarter of 2012. The decrease in yield on investment securities was the result of reinvestment of scheduled principal and interest payment proceeds and securities sales proceeds at lower rates. Yield on average earning assets for the third quarter of 2012 decreased 14 basis points from 4.59% in the second quarter of 2012, compared with a 3 basis points decrease in rates paid on interest-bearing liabilities from 1.39% in the second quarter of 2012.

Average Balance Sheets

The following table presents the average balance sheets for the three month periods ended September 30, 2012 and 2011, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Three Months Ended September 30,
	2012								2011
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	1,008,053		$	12,797		5.05	%	$	1,227,024		$	16,652		5.38	%
Securities
Taxable		161,384			823		2.03			121,471			974		3.18
Tax-exempt (3)		28,075			220		4.80			31,471			298		5.78
FHLB stock		10,072			106		4.19			10,072			100		3.94
Other equity securities		1,359			14		4.10			1,400			13		3.68
Federal funds sold and other		52,921			27		0.20			114,946			66		0.23
Total interest-earning assets		1,261,864			13,987		4.45	%		1,506,384			18,103		4.81	%
Less: Allowance for loan losses		(51,594	)							(37,818	)
Non-interest earning assets		116,187								157,024
Total assets	$	1,326,457							$	1,625,590

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	899,118		$	3,389		1.50	%	$	1,100,280		$	4,546		1.64	%
NOW and money market deposits		146,913			141		0.38			163,198			361		0.88
Savings accounts		39,426			38		0.38			36,567			59		0.64
Repurchase agreements		2,260			2		0.35			11,029			119		4.28
FHLB advances		6,129			50		3.25			17,364			138		3.15
Junior subordinated debentures		32,199			235		2.90			33,099			225		2.70
Total interest-bearing liabilities		1,126,045			3,855		1.36	%		1,361,537			5,448		1.59	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		111,123								105,498
Other liabilities		8,260								7,500
Total liabilities		1,245,428								1,474,535
Stockholders’ equity		81,029								151,055
Total liabilities and stockholders’ equity	$	1,326,457							$	1,625,590

Net interest income				$	10,132							$	12,655

Net interest spread							3.09	%							3.22	%

Net interest margin							3.23	%							3.38	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

Average Balance Sheets

The following table presents the average balance sheets for the nine month periods ended September 30, 2012 and 2011, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Nine Months Ended September 30,
	2012								2011
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	1,068,356		$	40,998		5.13	%	$	1,261,790		$	52,351		5.55	%
Securities
Taxable		145,514			2,432		2.23			118,069			3,129		3.54
Tax-exempt (3)		26,059			666		5.25			28,754			826		5.91
FHLB stock		10,072			327		4.34			10,072			326		4.33
Other equity securities		1,359			43		4.23			1,400			39		3.72
Federal funds sold and other		55,230			88		0.21			138,980			246		0.24
Total interest-earning assets		1,306,590			44,554		4.59	%		1,559,065			56,917		4.92	%
Less: Allowance for loan losses		(52,674	)							(35,459	)
Non-interest earning assets		113,402								166,780
Total assets	$	1,367,318							$	1,690,386

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	935,061		$	10,678		1.53	%	$	1,141,997		$	14,223		1.67	%
NOW and money market deposits		149,718			496		0.44			169,159			1,193		0.94
Savings accounts		38,567			120		0.42			36,699			182		0.66
Repurchase agreements		2,019			6		0.40			11,180			355		4.25
FHLB advances		6,523			161		3.30			16,711			419		3.35
Junior subordinated debentures		32,421			712		2.93			33,323			681		2.73
Total interest-bearing liabilities		1,164,309			12,173		1.40	%		1,409,069			17,053		1.62	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		112,227								105,266
Other liabilities		7,565								6,782
Total liabilities		1,284,101								1,521,117
Stockholders’ equity		83,217								169,269
Total liabilities and stockholders’ equity	$	1,367,318							$	1,690,386

Net interest income				$	32,381							$	39,864

Net interest spread							3.19	%							3.30	%

Net interest margin							3.35	%							3.46	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a 35% federal income tax rate.

Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

	Three Months Ended September 30, 2012 vs. 2011									Nine Months Ended September 30, 2012 vs. 2011
	Increase (decrease) due to change in						Net Change			Increase (decrease) due to change in						Net Change
	Rate			Volume			Net Change			Rate			Volume			Net Change
	(in thousands)
Interest-earning assets:
Loan receivables	$	(1,024	)	$	(2,831	)	$	(3,855	)	$	(3,732	)	$	(7,621	)	$	(11,353	)
Securities		(490	)		261			(229	)		(1,450	)		593			(857	)
FHLB stock		6			—			6			1			—			1
Other equity securities		1			—			1			5			(1	)		4
Federal funds sold and other		(6	)		(33	)		(39	)		(23	)		(135	)		(158	)
Total decrease in interest income		(1,513	)		(2,603	)		(4,116	)		(5,199	)		(7,164	)		(12,363	)

Interest-bearing liabilities:
Certificates of deposit and other time deposits		(375	)		(782	)		(1,157	)		(1,115	)		(2,430	)		(3,545	)
NOW and money market accounts		(187	)		(33	)		(220	)		(573	)		(124	)		(697	)
Savings accounts		(26	)		5			(21	)		(71	)		9			(62	)
Federal funds purchased and repurchased agreements		(63	)		(54	)		(117	)		(183	)		(166	)		(349	)
FHLB advances		4			(92	)		(88	)		(7	)		(251	)		(258	)
Junior subordinated debentures		16			(6	)		10			50			(19	)		31
Total decrease in interest expense		(631	)		(962	)		(1,593	)		(1,899	)		(2,981	)		(4,880	)
Increase (decrease) in net interest income	$	(882	)	$	(1,641	)	$	(2,523	)	$	(3,300	)	$	(4,183	)	$	(7,483	)

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2012 and 2011:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
	(in thousands)
Service charges on deposit accounts	$	563	$	690	$	1,673	$	1,979
Income from fiduciary activities		261		237		803		738
Bank card interchange fees		180		168		553		500
Other real estate owned rental income		180		93		242		147
Secondary market brokerage fees		27		32		75		184
Gains on sales of loans originated for sale		138		123		260		664
Gains on sales of investment securities, net		—		—		3,530		1,108
Other		372		357		1,048		1,032
Total non-interest income	$	1,721	$	1,700	$	8,184	$	6,352

Non-interest income for the third quarter ended September 30, 2012 increased $21,000, or 1.2%, compared with the third quarter of 2011. The increase in non-interest income between the three month comparative periods was primarily due to increased income from fiduciary activities, bank card interchange fees, OREO rental income, and gains on sales of loans originated for sale. These increases were partially offset by lower service charges on deposit accounts, primarily due to decreased overdraft fees due to lower volumes than in past periods. For the nine months ended September 30, 2012, non-interest income increased by $1.8 million to $8.2 million compared with $6.4 million for the same period of 2011. The increase in non-interest income for the nine months ended September 30, 2012 was primarily due to increased gains on sales of investment securities, partially offset by lower service charges on deposit accounts due to lower transaction volume, and lower gains on sales of loans originated for sale due to fewer loans guaranteed by the USDA or SBA originated for sale.

Non-interest Expense – The following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2012 and 2011:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2012		2011		2012		2011
	(in thousands)
Salary and employee benefits	$	4,264	$	3,780	$	12,558	$	12,084
Occupancy and equipment		971		957		2,826		2,910
Goodwill impairment charge		—		—		—		23,794
Other real estate owned expense		5,204		17,029		7,666		40,505
FDIC insurance		559		930		2,264		2,640
Loan collection expense		792		802		1,738		1,989
Professional fees		776		329		1,699		963
State franchise tax		496		582		1,680		1,746
Communications		175		176		523		509
Postage and delivery		108		117		339		368
Office supplies		96		93		274		273
Advertising		44		93		105		282
Other		665		535		1,787		1,514
Total non-interest expense	$	14,150	$	25,423	$	33,459	$	89,577

Non-interest expense for the third quarter ended September 30, 2012 decreased $11.3 million, or 44.3%, compared with the third quarter of 2011. For the nine months ended September 30, 2012, non-interest expense decreased $56.2 million, or 62.6%, to $33.5 million compared with $89.6 million for the first nine months of 2011. The decreases in non-interest expense for the third quarter and nine months ended September 30, 2012, were primarily attributable to decreased other real estate owned expense due to lower loss on sales of OREO, lower valuation write-downs, and lower property maintenance expense; and lower FDIC insurance due to decreased deposit levels. Additionally, non-interest expense the first nine months of 2011 included a non-recurring 100% goodwill impairment charge of $23.8 million. These improvements were partially off-set by higher salaries and employee benefits expense due primarily to additions to staff in our credit administration and workout divisions, and higher professional fees due primarily to increased audit and accounting fees, and loan review fees.

Income Tax Expense – Income tax benefit was $6.9 million and $18.8 million, or 36.2% and 26.8% of pre-tax loss, for the three and nine months ended September 30, 2011, respectively. The income tax benefit of $65,000 recorded during the three and nine months ended September 30, 2012 is an adjustment to the prior year’s tax benefit. The income tax effect on net loss before taxes for the nine months ended September 30, 2012, increased our deferred tax assets and related valuation allowance by $9.5 million. See Footnote 9, “Income Taxes.”

Effective tax rates differ from the federal statutory rate of 35% applied to income before income taxes due to the following:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
	(dollars in thousands)
Federal statutory rate times financial statement income	$	(9,729	)	$	(6,673	)	$	(9,150	)	$	(24,556	)
Effect of:
Net operating loss carry-forward		9,760			—			9,376			—
Tax-exempt income		(78	)		(105	)		(237	)		(290	)
Goodwill impairment charge		—			—			—			6,169
Non-taxable life insurance income		(26	)		(29	)		(78	)		(78	)
Vesting of restricted stock		—			—			—			26
Federal tax credits		—			(11	)		—			(34	)
Other, net		8			(88	)		24			(46	)
Total	$	(65	)	$	(6,906	)	$	(65	)	$	(18,809	)

Analysis of Financial Condition

Total assets decreased $169.4 million, or 11.6%, to $1.29 billion at September 30, 2012, from $1.46 billion at December 31, 2011. This decrease was primarily attributable to decreases of $185.7 million and $24.2 million in net loans and cash and cash equivalents, respectively. These decreases were partially offset by increases of $39.3 million in securities available for sale. The decrease in net loans was due to loan payoffs outpacing loan funding, net loan charge-offs of $31.8 million, and efforts to move impaired loans through the collection, foreclosure, and disposition process. The decrease in cash and cash equivalents was due to cash outflows related to maturing time deposits. The increase in securities available for sale was primarily related to the reinvestment of cash equivalents and loan cash flows into securities available for sale rather than new loans.

Loans Receivable – Loans receivable decreased $184.2 million, or 16.2%, during the nine months ended September 30, 2012 to $952 million. Our commercial, commercial real estate and real estate construction portfolios decreased by an aggregate of $127.6 million, or 18.6%, during the nine months and comprised 58.8% of the total loan portfolio at September 30, 2012. The decline in loans receivable was attributable to net charge-offs of $31.8 million, transfers to OREO of $31.5 million, and loan payoffs outpacing loan funding by approximately $64.3 million.

Loan Portfolio Composition – The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio. Except for commercial real estate and residential real estate, there is no concentration of loans in any industry exceeding 10% of total loans.

	As of September 30,					As of December 31,
	2012					2011
	Amount		Percent			Amount		Percent
			(dollars in thousands)

Commercial	$	56,050		5.89	%	$	71,216		6.27	%
Commercial Real Estate
Construction		69,306		7.28			101,471		8.93
Farmland		84,426		8.87			90,958		8.01
Other		350,129		36.78			423,844		37.31
Residential Real Estate
Multi-family		56,065		5.89			60,410		5.31
1-4 Family		287,613		30.22			337,350		29.70
Consumer		21,813		2.29			26,011		2.29
Agriculture		25,661		2.70			23,770		2.09
Other		748		0.08			993		0.09
Total loans	$	951,811		100.00	%	$	1,136,023		100.00	%

Non-Performing Assets – Non-performing assets consist of loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure, and repossessed assets.

The following table sets forth information with respect to non-performing assets as of September 30, 2012 and December 31, 2011.

	September 30, 2012			December 31, 2011
	(dollars in thousands)
Loans past due 90 days or more still on accrual	$	1,486		$	1,350
Non-accrual loans		88,632			92,020
Total non-performing loans		90,118			93,370
Real estate acquired through foreclosure		48,837			41,449
Other repossessed assets		5			5
Total non-performing assets	$	138,960		$	134,824
Non-performing loans to total loans		9.47	%		8.22	%
Non-performing assets to total assets		10.81	%		9.26	%
Allowance for non-performing loans	$	11,100		$	11,382
Allowance for non-performing loans to non-performing loans		12.32	%		12.19	%

Nonperforming loans at September 30, 2012, were $90.1 million, or 9.47% of total loans, compared with $59.8 million, or 4.96% of total loans, at September 30, 2011, and $93.4 million, or 8.22% of total loans at December 31, 2011.

Loans past due 30-59 days decreased from $17.3 million at December 31, 2011 to $9.6 million at September 30, 2012. Loans past due 60-89 days decreased from $3.9 million at December 31, 2011 to $3.6 million at September 30, 2012. This represents an $8.1 million decrease from December 31, 2011 to September 30, 2012, in loans past due 30-89 days. These decreases were primarily in the 1-4 family residential real estate, and commercial segments of the portfolio. We considered this trend in delinquency levels during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

Troubled Debt Restructuring – A troubled debt restructuring (TDR) is where the Company has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The majority of the Company’s TDRs involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Company has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the customer. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral.

We do not have a formal loan modification program. Rather, we work with individual customers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan. If a customer is unable to make contractual payments, we review the particular circumstances of that customer’s situation and negotiate a revised payment stream. In other words, we identify performing customers experiencing financial difficulties, and through negotiations, we lower their interest rate, most typically on a short-term basis for three to six months. Our goal when restructuring a credit is to afford the customer a reasonable period of time to remedy the issue causing cash flow constraints within their business so that they can return to performing status over time.

Our loan modifications have taken the form of reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances we restructure real estate secured loans in a bifurcated fashion whereby we have a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. Our restructured loans are all collateral secured loans. If a customer fails to perform under the modified terms, we place the loan(s) on non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.

At September 30, 2012, we had 127 restructured loans totaling $117.5 million with borrowers who experienced deterioration in financial condition compared with 114 loans totaling $113.7 million at December 31, 2011. In general, these loans were granted interest rate reductions to provide cash flow relief to customers experiencing cash flow difficulties. Of these loans, 6 loans totaling approximately $5.7 million were also granted principal payment deferrals until maturity. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. Restructured loans also include $2.1 million of commercial loans.

In accordance with current guidance, we continue to report restructured loans as restructured until such time as the loan is paid in full, otherwise settled, sold, or charged-off. If the customer fails to perform, we place the loan on non-accrual status and seek to liquidate the underlying collateral for these loans. Our non-accrual policy for restructured loans is identical to our non-accrual policy for all loans. Our policy calls for a loan to be reported as non-accrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest has been in default for a period of 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses.

We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan to be a troubled debt restructure. Specifically, we consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) reduction or deferral of principal, or (iii) reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, we do not consider that to be a troubled debt restructuring. A primary example of a competitive modification would be an interest rate reduction for a performing customer’s loan to a market rate as the result of a market decline in rates.

See Footnote 4, “Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.

Foreclosed Properties – Foreclosed properties at September 30, 2012 were $48.8 million compared with $44.9 million at September 30, 2011 and $41.4 million at December 31, 2011. See Footnote 5, “Other Real Estate Owned,” to the financial statements. During the first nine months of 2012, we acquired $31.5 million of OREO properties, and sold properties totaling approximately $19.1 million. We value foreclosed properties at fair value less estimated costs to sell when acquired and expect to liquidate these properties to recover our investment in the due course of business.

Other real estate owned (OREO) is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. Subsequent reductions in fair value are recorded as non-interest expense. To determine the fair value of OREO for smaller dollar single family homes, we consult with internal real estate sales staff and external realtors, investors, and appraisers. If the internally evaluated market price is below our underlying investment in the property, appropriate write-downs are recorded.

For larger dollar commercial real estate properties, we obtain a new appraisal of the subject property in connection with the transfer to OREO. In some of these circumstances, an appraisal is in process at quarter end and we must make our best estimate of the fair value of the underlying collateral based on our internal evaluation of the property, our review of the most recent appraisal, and discussions with the currently engaged appraiser. We obtain updated appraisals on the anniversary date of ownership unless a sale is imminent.

Net loss on sales, write-downs, and operating expenses for OREO totaled $7.7 million for the nine months ended September 30, 2012, compared with $40.5 million for the same period of 2011. During the three months ended September 30, 2012, fair value write-downs of $4.3 million were recorded to reflect declining values as evidenced by new appraisals and reduced marketing prices in connection with our sales strategies. The 2011 results were significantly impacted by our determination in the 2011 second quarter that certain properties held in other real estate were not likely to be successfully disposed of in an acceptable time-frame using routine marketing efforts. It became apparent that certain condominium projects were going to require extended holding periods to sell the properties at their most recent appraised values. Accordingly, during June 2011, the Company sold, in a single transaction, 54 finished condominium property units from several condominium developments in our OREO portfolio, with a carrying value of approximately $11.0 million for $5.2 million, resulting in a pre-tax loss of $5.8 million. In addition, management adjusted its valuations for similar condominium and residential development properties held in other real estate through provision of an allowance of $10.6 million on other real estate held, with the objective of marketing these properties more aggressively.

Allowance for Loan Losses – The allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s best estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

Our loan loss reserve, as a percentage of total loans at September 30, 2012, increased to 5.68% from 3.27% at September 30, 2011, and from 4.63% at December 31, 2011. Provision for loan losses increased $17.5 million to $25.5 million for the third quarter of 2012 compared with $8.0 million for the third quarter of 2011. Provision for loan losses increased $6.5 million to $33.3 million for the nine months ended September 30, 2012 compared with $26.8 million for the same nine months of 2011. The increase in the third quarter of 2012 is attributable to the continued decline in credit trends in our portfolio that resulted in higher net charge-offs compared to the prior period. More specifically, the 2012 provision for loan losses was negatively impacted by collateral value declines for certain larger commercial real estate loans as evidenced by new appraisals received during the third quarter. In addition, the third quarter 2012 provision for loan losses was negatively impacted by a strategy change during the third quarter related to classified loans which we expect to more quickly remediate by litigation or foreclosure. For loans subject to this expectation, we applied an additional fair value discount to the underlying collateral in our impairment analysis estimates as it has been our experience that resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment.

Net loan charge-offs for the third quarter of 2012 were $23.1 million, or 2.29% of average loans, compared with $7.2 million, or 0.59% of average loans, for the third quarter of 2011, and $6.4 million, or 0.59% of average loans, for the second quarter of 2012. Net charge-offs for the nine months ended September 30, 2012, were $31.8 million, or 2.98% of average loans, compared with $21.6 million, or 1.71% of average loans, for the first nine months of 2011. Our allowance for loan losses to non-performing loans was 59.94% at September 30, 2012, compared with 56.31% at December 31, 2011, and 66.05% at September 30, 2011. The change in this metric between periods is attributable to the fluctuation in historical loss experience, qualitative factors, non-accrual loans, and provision expense. We have assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses.

The majority of our nonperforming loans are secured by real estate collateral and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of our principal. Our allowance for non-performing loans to non-performing loans was 12.3% at September 30, 2012 compared with 13.9% at September 30, 2011, and 12.2% at December 31, 2011.

An analysis of changes in allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2012 and 2011, and for the year ended December 31, 2011 follows:

	Three Months Ended September 30,						Nine Months Ended September 30,						Year Ended December 31,
	2012			2011			2012			2011			2011
	(dollars in thousands)
Balance at beginning of period	$	51,594		$	38,717		$	52,579		$	34,285		$	34,285
Provision for loan losses		25,500			8,000			33,250			26,800			62,600
Recoveries		412			142			697			237			340
Charge-offs		(23,487	)		(7,367	)		(32,507	)		(21,830	)		(44,646	)
Balance at end of period	$	54,019		$	39,492		$	54,019		$	39,492		$	52,579

Allowance for loan losses to period-end loans		5.68	%		3.27	%		5.68	%		3.27	%		4.63	%
Net charge-offs to average loans		2.29	%		0.59	%		2.98	%		1.71	%		3.56	%
Allowance for loan losses to non-performing loans		59.94	%		66.05	%		59.94	%		66.05	%		56.31	%

Liabilities – Total liabilities at September 30, 2012 were $1.23 billion compared with $1.37 billion at December 31, 2011, a decrease of $141.8 million, or 10.3%. This decrease was primarily attributable to a decrease in deposits of $146.2 million, or 11.0%, to $1.18 billion at September 30, 2012 from $1.32 billion at December 31, 2011. Certificate of deposit balances declined $142.0 million during the first nine months of 2012 to $882.3 million at September 30, 2012 from $1.02 billion at December 31, 2011. The decrease in deposits follows management’s strategy to match liability funding levels with lower loan balances.

Federal Home Loan Bank advances decreased by $1.2 million, or 16.2%, to $6.0 million at September 30, 2012, from $7.1 million at December 31, 2011. These advances are used from time to time to fund asset growth and manage interest rate risk in accordance with our asset/liability management strategies.

Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

	For the Nine Months					For the Year
	Ended September 30,					Ended December 31,
	2012					2011
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(dollars in thousands)
Demand	$	112,227		–		$	106,769
Interest checking		86,758		0.40	%		89,103		0.74	%
Money market		62,960		0.50			81,925		0.96
Savings		38,567		0.42			36,511		0.62
Certificates of deposit		935,061		1.53			1,120,154		1.65
Total deposits	$	1,235,573		1.22	%	$	1,434,462		1.40	%

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

	For the Nine Months					For the Year
	Ended September 30,					Ended December 31,
	2012					2011
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(dollars in thousands)
Less than $100,000	$	488,335		1.42	%	$	569,667		1.59	%
$100,000 or more		446,726		1.64	%		550,487		1.71	%
Total	$	935,061		1.53	%	$	1,120,154		1.65	%

The following table shows at September 30, 2012 and December 31, 2011 the amount of our time deposits of $100,000 or more by time remaining until maturity:

	As of		As of
	September 30,		December 31,
Maturity Period	2012		2011
	(in thousands)
Three months or less	$	94,750	$	77,118
Three months through six months		92,379		65,359
Six months through twelve months		74,693		167,811
Over twelve months		160,228		183,056
Total	$	422,050	$	493,344

Liquidity

Liquidity risk arises from the possibility we may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as our operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that we meet our cash flow needs at a reasonable cost. We maintain an investment and funds management policy, which identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. Our Asset Liability Committee regularly monitors and reviews our liquidity position.

Funds are available from a number of sources, including the sale of securities in the available-for-sale portion of the investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, brokered deposits and other wholesale funding. Historically, we have utilized brokered and wholesale deposits to supplement our funding strategy. At September 30, 2012, and December 31, 2011, these deposits totaled $104.1 million and $118.4 million, respectively. We are currently restricted from accepting, renewing, or rolling-over brokered deposits without the prior receipt of a waiver on a case-by-case basis from our regulators. It is our intent to redeem brokered deposits at maturity. The following table shows at September 30, 2012, the amount of our brokered certificates of deposit by time remaining to maturity (in thousands):

Three months or less	$	89,073
Six months through twelve months		15,000
Total	$	104,073

Traditionally, we have borrowed from the FHLB to supplement our funding requirements. The advances are collateralized by first mortgage residential loans. The borrowing capacity is based on the market value of the underlying pledged loans. At September 30, 2012, our additional borrowing capacity with the FHLB was $19.9 million. Any new advances are limited to a one year maturity or less.

We also have federal funds borrowing lines from major correspondent banks totaling $5.0 million on an unsecured basis. Management believes our sources of liquidity are adequate to meet expected cash needs for the foreseeable future, however, the availability of these lines could be affected by our financial position and our lenders could exercise their right to deny a funding request at their discretion. We are also subject to FDIC interest rate restrictions for deposits. As such, we are permitted to offer up to the “national rate” plus 75 basis points as published weekly by the FDIC.

We use cash to pay dividends on common stock, if and when declared by the Board of Directors, and to service debt. The main sources of funding include dividends paid by PBI Bank, management fees received from affiliated banks and financing obtained in the capital markets. During 2011, Porter Bancorp contributed $13.1 million to its subsidiary, PBI Bank, which substantially decreased its liquid assets. The contribution was made to strengthen the Bank’s capital in an effort to help it comply with its capital ratio requirements under the consent order. Liquid assets decreased from $20.3 million at December 31, 2010, to $3.8 million at September 30, 2012. Since the Bank is unlikely to be in a position to pay dividends to the parent company for the foreseeable future, cash inflows for the parent are limited to management fees from affiliate banks, earnings on investment securities, sales of investment securities, and interest on deposits with the Bank. These cash inflows along with the liquid assets held at September 30, 2012, totaling $3.8 million, are needed for the ongoing cash operating expenses of the parent company which have been reduced and are expected to be $1.5 million for 2012. We have elected to defer payments on our Series A preferred stock and on our trust preferred securities. The reduction in expected expenses for 2012 from actual cash expenses for 2011 is primarily the result of deferring payments on our Series A preferred stock issued to the U.S. Treasury and on our trust preferred securities. Parent company liquidity could be improved if a capital raise was completed.

Capital

In the fourth quarter of 2011, we began deferring the payment of regular quarterly cash dividends on our Series A Preferred Stock issued to the U.S. Treasury. At September 30, 2012, cumulative accrued and unpaid dividends on this stock totaled $2.0 million. If we defer dividend payments for six quarters, the holder of our Series A Preferred Stock (currently the U.S. Treasury) would then have the right to appoint representatives to our Board of Directors. We will continue to accrue any deferred dividends, which will be deducted from income to common shareholders for financial statement purposes.

In addition, effective with the fourth quarter of 2011, we began deferring interest payments on our junior subordinated notes which resulted in a deferral of distributions on our trust preferred securities. We have the option to defer interest payments from time-to-time for a period not to exceed 20 consecutive quarters. Thereafter, we must pay all deferred interest and resume quarterly interest payments or we will be in default. Future cash dividends on our common stock are subject to the prior payment of all deferred distributions on our trust preferred securities. At September 30, 2012, cumulative accrued and unpaid interest on our junior subordinated notes totaled $707,000.

Stockholders’ equity decreased $27.5 million to $55.0 million at September 30, 2012, compared with $82.5 million at December 31, 2011. The decrease was due the current year net loss, further reduced by dividends declared on cumulative preferred stock and net reduction in unrealized gain on available for sale securities.

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. In addition, PBI Bank has agreed with its primary regulators to maintain a ratio of total capital to total risk-weighted assets (“total risk-based capital ratio”) of at least 12.0%, and a ratio of Tier 1 capital to total assets (“leverage ratio”) of 9.0%. The Bank is currently not in compliance with this requirement.

The following table shows the ratios of Tier 1 capital and total capital to risk-adjusted assets and the leverage ratios for Porter Bancorp, Inc. and PBI Bank at the dates indicated:

										September 30, 2012						December 31, 2011
	Regulatory Minimums			Well-Capitalized Minimums			Minimum Capital Ratios Under Consent Order			Porter Bancorp			PBI Bank			Porter Bancorp			PBI Bank

Tier 1 Capital		4.0	%		6.0	%		N/A			7.03	%		7.78	%		9.23	%		8.86	%
Total risk-based capital		8.0			10.0			12.0	%		10.01			9.85			11.22			10.86
Tier 1 leverage ratio		4.0			5.0			9.0			5.00			5.53			6.53			6.23

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company’s interest sensitivity profile was asset sensitive at September 30, 2012, and December 31, 2011. Given a 100 basis point increase in interest rates sustained for one year, base net interest income would increase by an estimated 4.3% at September 30, 2012, compared with an increase of 5.8% at December 31, 2011, and is within the risk tolerance parameters of our risk management policy. Given a 200 basis point increase in interest rates sustained for one year, base net interest income would increase by an estimated 8.3% at September 30, 2012, compared with an increase of 10.9% at December 31, 2011, and is within the risk tolerance parameters of our risk management policy.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2012, as calculated using the static shock model approach:

	Change in Future Net Interest Income
	Dollar Change		Percentage Change
	(dollars in thousands)
+ 200 basis points	$	3,085		8.31	%
+ 100 basis points		1,592		4.29

We did not run a model simulation for declining interest rates as of September 30, 2012, because the Federal Reserve effectively lowered the federal funds target rate between 0.00% to 0.25% in December 2008. Therefore, no significant further short-term rate reductions can occur.

Item 4. Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of September 30, 2012, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.

As a result of regulatory examination and audit processes applied to our loan grading activities shortly before and after year end 2011, we determined that our internal process for assigning loan grades did not always establish an accurate grade for credit risk. Our internal control processes surrounding loan grades, which consist of a combination of internal and external loan review activities, identified and corrected grades for the majority of loans that were not initially graded correctly. However, our loan review had not sufficiently covered all loans subject to potential grading error throughout the 2011 fiscal year. In preparing our annual report on Form 10-K, we identified the extent to which our loan review controls did not operate and expanded the scope to cover the remainder of the portfolio and adjusted our allowance for loan losses to take the additional findings into consideration. Accordingly, we determined the controls regarding the determination of loan grades were not operating effectively as of December 31, 2011. Our management, overseen by the Audit Committee, worked throughout the first nine months of 2012 and continues to work to implement steps to improve the control weaknesses for loan grading discovered in the closing process for the year and quarter ended December 31, 2011.

These enhanced procedures include:

·	Completion of additional independent internal and external loan reviews of the portfolio to ensure accurate grading from March 2012 through September 2012.

·	Review of the portfolio by assigned loan officer for proper grading.

·	Analytical review of the portfolio by management based upon payment performance.

·	Retention of John R. Davis to serve as Chief Credit Officer overseeing credit administration and credit quality policy and procedures.

·	Implementation of a centralized loan administration and analysis team within the credit department to ensure more timely and regular review of grading, performance metrics, financial information, and collateral.

During the first nine months of 2012, we took steps to resolve the material weakness by changing our procedures for loan grading, as discussed above. Notwithstanding the steps taken during this period, the identified material weakness will not be considered remediated until the new procedures have been in operation for a sufficient period of time to be tested and determined by management to be operating effectively. Based on our evaluation and the reasons described above, management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were not effective as of the end of the period covered by this report. There were no other changes in our internal control over financial reporting that occurred during the nine months ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of operations, we are defendants in various legal proceedings. Except as described in Footnote 13, “Contingencies” in the Notes to our consolidated financial statement, in the opinion of management, there is no known legal proceeding pending which an adverse decision would be expected to result in a material adverse change in our business or consolidated financial position. See Footnote 13, “Contingencies” in the Notes to our consolidated financial statements for additional detail regarding ongoing legal proceedings.

Item 1A. Risk Factors

Information regarding risk factors appears in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 under Item 1A – Risk Factors. There have been no material changes from the risk factors previously discussed in our Form 10-K.

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

Not applicable.

Item 3. Default Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:

Exhibit Number	Description of Exhibit

10.1	Form of Porter Bancorp, Inc. Restricted Stock Award Agreement, 2006 Stock Incentive Plan.

10.2	Employment Agreement of John R. Davis, incorporated by reference to 8-K filed
	September 19, 2012.

31.1	Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a).

31.2	Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).

32.1	Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350,
	as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350,
	as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101	The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2012, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Loss, (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act if 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PORTER BANCORP, INC.
	(Registrant)

November 13, 2012	By:	/s/ Maria L. Bouvette
		Maria L. Bouvette
		Chairman & Chief Executive Officer

November 13, 2012	By:	/s/ Phillip W. Barnhouse
		Phillip W. Barnhouse
		Chief Financial Officer and Chief
		Accounting Officer