PINNACLE BANKSHARES CORP (Form: 10-K, Received: 03/27/2013 10:54:17)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2012

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

For the transition period from to

Commission file number: 000-23909

PINNACLE BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)


Virginia		54-1832714
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

622 Broad Street, Altavista, Virginia		24517-1830
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (434) 369-3000

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


Title of each class		Name of each exchange on which registered
n/a		n/a

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

n/a

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

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

*	See explanatory note below

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T

(§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of the issuer’s common stock held by non-affiliates as of June 30, 2012 was $13,915,046.47.

There were 1,507,589 shares of common stock of the issuer outstanding as of March 26, 2013.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the 2012 Annual Report to Shareholders, which is attached hereto as Exhibit 13, are incorporated by reference in Part II of this report. [Portions of the Proxy Statement for the Company’s Annual Meeting of Shareholders to be held on April 9, 2013 are incorporated by reference in Part III of this report

Explanatory Note

PINNACLE BANKSHARES CORPORATION

2011 FORM 10-K ANNUAL REPORT

TABLE OF CONTENTS


	PART I

Item 1.	Business	4

	General Development of Business	4
	Competition	4
	Regulation and Supervision	5
	Employees	14
	Executive Officers of the Registrant	14
Item 1A.	Risk Factors	15
Item 1B.	Unresolved Staff Comments	15
Item 2.	Properties	15
Item 3.	Legal Proceedings	15
Item 4.	Mine Safety Disclosures	16

	PART II

Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	16
Item 6.	Selected Financial Data	16
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	16
Item 8.	Financial Statements and Supplementary Data	16
Item 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure	16
Item 9A.	Controls and Procedures	16
Item 9B.	Other Information	17

	PART III

Item 10.	Directors, Executive Officers and Corporate Governance	17
Item 11.	Executive Compensation	17
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	18
Item 13.	Certain Relationships and Related Transactions, and Director Independence	18
Item 14.	Principal Accountant Fees and Services	18

	PART IV

Item 15.	Exhibits, Financial Statement Schedules	18

SIGNATURES		21

PART I

Item 1.

Business.

General Development of Business

Pinnacle Bankshares Corporation, a Virginia corporation (the “Company”), was organized in 1997 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is headquartered in Altavista, Virginia. The Company conducts all of its business activities through the branch offices of its wholly-owned subsidiary bank, First National Bank (the “Bank”). The Company exists primarily for the purpose of holding the stock of its subsidiary, the Bank, and of such other subsidiaries as it may acquire or establish. The Company’s administrative offices are located at 622 Broad Street, Altavista, Virginia.

The Bank was organized as a national bank in 1908 and commenced general banking operations in December of that year, providing services to commercial and agricultural businesses and individuals in the Altavista area. With an emphasis on personal service, the Bank today offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, merchant bankcard processing, residential and commercial mortgages, home equity loans, consumer installment loans, agricultural loans, investment loans, small business loans, commercial lines of credit and letters of credit. The Bank also offers a full range of investment, insurance and annuity products through its association with Infinex Investments, Inc. and Banker’s Insurance, LLC.

The Bank serves a trade area consisting primarily of Campbell County, northern Pittsylvania County, eastern Bedford County, Amherst County and the city of Lynchburg from facilities located in Campbell County, Bedford County, the town of Altavista, the town of Amherst, the town of Rustburg and the city of Lynchburg, Virginia. In June 1999 the Company opened the Airport facility, located just outside the Lynchburg city limits, and in August 2000, opened the Old Forest Road facility, located on Old Forest Road in Lynchburg, and the Brookville Plaza facility, located on Timberlake Road in Lynchburg. In August 2004 the Company opened the Forest facility, located in Forest, Bedford County, Virginia. In July 2005 the Company opened the Smith Mountain Lake loan production facility, located in Moneta, Franklin County, Virginia and closed the facility in May 2011. In May 2006 the Company relocated the Brookville Plaza facility to Timberlake Road in Campbell County. In November 2006, the Company opened a temporary Amherst facility located in the town of Amherst. The Company opened a permanent Amherst facility on South Main Street in Amherst in March 2008. In February 2009, the Company opened the Rustburg facility, located on Village Highway in the Rustburg Marketplace Shopping Center, which further increases our presence in Campbell County.

The Bank has two wholly-owned subsidiaries. FNB Property Corp., which is a Virginia corporation, was formed to hold title to Bank premises real estate. FNB Property Corp. sold land held for sale in 2003 and purchased land in Forest, Virginia that was used to build the Forest facility. First Properties, Inc., also a Virginia corporation, was formed to hold title to other real estate owned. Sixteen properties valued at $2,393,000 are being held in other real estate owned as of December 31, 2012.

Competition

The banking business in central Virginia is highly competitive with respect to both loans and deposits and is dominated by a number of major banks that have offices operating throughout the state and in the Company’s market area. The Company actively competes for all types of deposits and loans with other banks and with nonbank financial institutions, including savings and loan associations, finance companies, credit unions, mortgage companies, insurance companies and other lending institutions.

Institutions such as brokerage firms, credit card companies and even retail establishments offer alternative investment vehicles such as money market funds as well as traditional banking services. Other entities (both public and private) seeking to raise capital through the issuance and sale of debt or equity securities also represent a source of competition for the Company with respect to the acquisition of deposits. Among the advantages that the major banks have over the Company is their ability to finance extensive advertising campaigns and to allocate their investment assets to regions of highest yield and demand over a more diverse geographic area. Although major banks have these competitive advantages over small independent banks, the Company actively tries to

turn the loss of local independent banks to its competitive advantage by soliciting customers who prefer the personal service offered by a small independent bank.

The Company does not depend upon a single customer or industry, the loss of which would have a material adverse effect on the Company’s financial condition. The Company is located in a market rich in industrial and retail diversification.

The Company believes that its prompt response to lending requests is a key factor to the Company’s competitive position in its primary service area. In addition, local decision-making and the accessibility of senior management to customers also distinguish the Company from other area financial institutions.

In order to compete with the other financial institutions in its primary service area, the Company relies principally upon local promotional activities, personal contact by its officers, directors, employees and stockholders and its ability to offer specialized services to customers. The Company’s promotional activities emphasize the advantages of dealing with a local bank attuned to the particular needs of the community.

Suspension of Duty to File SEC Reports

The Company has filed Forms 15 with respect to the termination of registration under Section 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the suspension of the duty to file reports under Section 15(d) of the Exchange Act. As a result, the Company expects that this annual report on Form 10-K and amendments, if any, thereto , will be the last report filed by the Company with the SEC pursuant to Section 13 of the Exchange Act for the foreseeable future. Despite the suspension of the Company’s reporting obligations, management remains committed to providing quarterly and annual updates on the Company’s performance to its shareholders by mailing such information to shareholders and posting such information on the Bank’s website at www.1stnatbk.com under the Investor Relations tab. Additionally, quarterly call reports will continue to be filed with the Bank’s primary regulator, the Office of the Comptroller of the Currency. Call reports are available for review on the Federal Deposit Insurance Corporation’s website at www.fdic.gov.

Regulation and Supervision

Set forth below is a brief description of the material laws and regulations that affect the Company. The description of these statutes and regulations is only a summary and does not purport to be complete. This discussion is qualified in its entirety by reference to the statutes and regulations summarized below. No assurance can be given that these statutes or regulations will not change in the future.

General. The financial crisis of 2008, including the downturn of global economic, financial and money markets and the threat of collapse of numerous financial institutions, and other recent events have led to the adoption of numerous new laws and regulations that apply to, and focus on, financial institutions. The most significant of these new laws is the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which was adopted on July 21, 2010 and, in part, is intended to implement significant structural reforms to the financial services industry. The Dodd-Frank Act is discussed in more detail below.

As a result of the Dodd-Frank Act and other regulatory reforms, the Company is experiencing a period of rapidly changing regulations. These regulatory changes could have a significant impact on how the Company conducts its business. The specific implications of the Dodd-Frank Act and other proposed regulatory reforms cannot yet be predicted and will depend to a large extent on the specific regulations that are adopted in the coming months and years to implement regulatory reform initiatives.

The Company is currently subject to the periodic reporting requirements of the Exchange Act, which include, but are not limited to, the filing of annual, quarterly and other reports with the SEC. However, following the filing of this annual report on Form 10-K, the Company will no longer be subject to the periodic reporting requirements of the SEC. As an Exchange Act reporting company, the Company is directly affected by the Sarbanes-Oxley Act of 2002 (the “SOX”), which is aimed at improving corporate governance and reporting procedures and requires additional corporate governance measures and expanded disclosure with respect to the Company’s corporate operations and internal controls. The Company is currently complying with the SEC and other rules and regulations

implemented pursuant to the SOX. Although the Company has incurred additional expense in complying with the provisions of the SOX and the resulting regulations, this compliance has not had a material impact on the Company’s financial condition or results of operations.

The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 (the “BHCA”), and is registered as such with, and subject to the supervision of, the Board of Governors of the Federal Reserve System (the “FRB”). Generally, a bank holding company is required to obtain the approval of the FRB before it may acquire all or substantially all of the assets of any bank, and before it may acquire ownership or control of the voting shares of any bank if, after giving effect to the acquisition, the bank holding company would own or control more than 5% of the voting shares of such bank. The FRB’s approval is also required for the merger or consolidation of bank holding companies. The Dodd-Frank Act amended provisions of the BHCA (and corresponding provisions of the Federal Deposit Insurance Act (the “FDIA”)) to require that a bank holding company be well capitalized and well managed before the FRB will approve an interstate bank acquisition or merger. Also as a result of the Dodd-Frank Act, banks also are able to branch across state lines, provided that the law of the state in which the branch is to be located would permit establishment of the branch if the bank were a state bank chartered by such state. Additionally, the FRB has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the FRB has reasonable grounds to believe that continuation of such activity or ownership constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.

The Company is required to file periodic reports with the FRB and provide any additional information the FRB may require. The FRB also has the authority to examine the Company and the Bank, as well as any arrangements between the Company and the Bank, with the cost of any such examinations to be borne by the Company.

Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by Federal law in dealings with their holding companies and other affiliates. Subject to certain restrictions set forth in the Federal Reserve Act, a bank can loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate or issue a guarantee, acceptance or letter of credit on behalf of an affiliate, as long as the aggregate amount of such transactions of a bank and its subsidiaries with its affiliates does not exceed 10% of the capital stock and surplus of the bank on a per affiliate basis or 20% of the capital stock and surplus of the bank on an aggregate affiliate basis. In addition, such transactions must be on terms and conditions that are consistent with safe and sound banking practices. In particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. These restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts. Additionally, the Company and the Bank are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services.

A bank holding company is also prohibited from engaging in or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company engaged in nonbanking activities. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities which the FRB has determined by regulation or order are so closely related to banking as to be a proper incident to banking. In making these determinations, the FRB considers whether the performance of such activities by a bank holding company would offer advantages to the public that outweigh possible adverse effects.

As a national bank, the Bank is also subject to regulation, supervision and regular examination by the Office of the Comptroller of the Currency (the “Comptroller”). Each depositor’s account with the Bank is insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the maximum amount permitted by law, which is currently $250,000 for each depositor for interest bearing accounts. For non-interest-bearing accounts the Bank is insured by the FDIC to the maximum amount permitted by law which is currently unlimited. The Bank is also subject to certain regulations promulgated by the FRB and applicable provisions of Virginia law, insofar as they do not conflict with or are not preempted by Federal banking law.

The regulations of the FDIC, the Comptroller and the FRB govern most aspects of the Company’s business, including deposit reserve requirements, investments, loans, certain check clearing activities, issuance of securities, payment of dividends, branching,

deposit interest rate ceilings and numerous other matters. As a consequence of the extensive regulation of commercial banking activities in the United States, the Company’s business is particularly susceptible to changes in state and Federal legislation and regulations, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition.

Governmental Policies and Legislation. Banking is a business that depends primarily on interest rate differentials. In general, the difference between the interest rates paid by the Company on its deposits and its other borrowings and the interest rates received by the Company on loans extended to its customers and securities held in its portfolio comprise the major portion of the Company’s earnings. These rates are highly sensitive to many factors that are beyond the Company’s control. Accordingly, the Company’s growth and earnings are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.

The commercial banking business is affected not only by general economic conditions, but is also influenced by the monetary and fiscal policies of the Federal government and the policies of its regulatory agencies, particularly the FRB. The FRB implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in U.S. Government securities, and, at times, other securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.

From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of bank holding companies, banks and other financial institutions are frequently made in Congress, in the Virginia legislature and brought before various bank holding company and bank regulatory agencies. The likelihood of any major changes and the impact such changes might have are impossible to predict.

Dividends. There are regulatory restrictions on dividend payments by both the Bank and the Company that may affect the Company’s ability to pay dividends on its common stock. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

Capital Requirements. The FRB, the Comptroller and the FDIC have adopted risk-based capital adequacy guidelines for bank holding companies and banks. These capital adequacy regulations are based upon a risk-based capital determination, whereby a bank holding company’s capital adequacy is determined in light of the risk, both on- and off-balance sheet, contained in the company’s assets. Different categories of assets are assigned risk weightings and are counted as a percentage of their book value.

The regulations divide capital between Tier 1 capital (core capital) and Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of common stock, related surplus, noncumulative perpetual preferred stock, minority interests in consolidated subsidiaries and a limited amount of qualifying cumulative preferred securities. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an amount equal to the allowance for loan losses up to a maximum of 1.25% of risk weighted assets, limited other types of preferred stock not included in Tier 1 capital, hybrid capital instruments and term subordinated debt. Investments in and loans to unconsolidated banking and finance subsidiaries that constitute capital of those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2 capital constitutes qualifying total capital. The guidelines generally require banks to maintain a total qualifying capital to weighted risk assets ratio of 8% (the “Risk-based Capital Ratio”). At least 4% of the total qualifying capital to weighted risk assets (the “Tier 1 Risk-based Capital Ratio”) must be Tier 1 capital.

The FRB, the Comptroller and the FDIC have adopted leverage requirements that apply in addition to the risk-based capital requirements. Banks and bank holding companies are required to maintain a minimum leverage ratio of Tier 1 capital to average total consolidated assets (the “Leverage Ratio”) of at least 3.0% for the most highly-rated, financially sound banks and bank holding companies and a minimum Leverage Ratio of at least 4.0% for all other banks. The FDIC and the FRB define Tier 1 capital for banks in

the same manner for both the Leverage Ratio and the Risk-based Capital Ratio. However, the FRB defines Tier 1 capital for bank holding companies in a slightly different manner. An institution may be required to maintain Tier 1 capital of at least 4% or 5%, or possibly higher, depending upon the activities, risks, rate of growth, and other factors deemed material by regulatory authorities.

As of December 31, 2012, the Company and Bank both met all applicable capital requirements imposed by regulation. At December 31, 2012, the Risk-based Capital Ratios of the Company and the Bank were 11.39 percent and 11.85 percent, respectively. At December 31, 2012, the Tier 1 Risk-based Capital Ratios of the Company and the Bank were 10.15 percent and 10.60 percent, respectively. At December 31, 2012, the Leverage Ratios of the Company and the Bank were 8.49 percent and 8.86 percent, respectively.

Federal Deposit Insurance Corporation Improvement Act of 1991. There are five capital categories applicable to insured institutions, each with specific regulatory consequences. If the appropriate Federal banking agency determines, after notice and an opportunity for hearing, that an insured institution is in an unsafe or unsound condition, it may reclassify the institution to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition. The Comptroller has issued regulations to implement these provisions.

Under these regulations, the categories are:

a. Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution is one (i) having a Risk-based Capital Ratio of 10% or greater, (ii) having a Tier 1 Risk-based Capital Ratio of 6% or greater, (iii) having a Leverage Ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

b. Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution is one (i) having a Risk-based Capital Ratio of 8% or greater, (ii) having a Tier 1 Risk-based Capital Ratio of 4% or greater and (iii) having a Leverage Ratio of 4% or greater or a Leverage Ratio of 3% or greater if the institution is rated composite 1 under the CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) rating system.

c. Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution is one (i) having a Risk-based Capital Ratio of less than 8% or (ii) having a Tier 1 Risk-based Capital Ratio of less than 4% or (iii) having a Leverage Ratio of less than 4%, or if the institution is rated a composite 1 under the CAMEL rating system, a Leverage Ratio of less than 3%.

d. Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution is one (i) having a Risk-based Capital Ratio of less than 6% or (ii) having a Tier 1 Risk-based Capital Ratio of less than 3% or (iii) having a Leverage Ratio of less than 3%.

e. Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate Federal banking agency. A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%.

An institution which is less than adequately capitalized must adopt an acceptable capital restoration plan, is subject to increased regulatory oversight, and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate Federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate Federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or

fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution, if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such would cause the Bank to become undercapitalized, it could not pay a management fee or dividend to the Company.

As of December 31, 2012, both the Company and the Bank were considered “well capitalized.”

Basel III Capital Framework. In June 2012, the federal bank regulatory agencies proposed (i) rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision, and (ii) rules for calculating risk-weighted assets. The federal bank regulatory agencies have delayed the implementation of Basel III and the new risk-weighted assets calculations to consider comments received on the proposed rules. The timing for the agencies’ publication of revised proposed rules regarding, or final rules to implement, Basel III and the new risk-weighted assets calculations is uncertain. Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.

The Basel III final capital framework, among other things, (i) introduces as a new capital measure “Common Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.

When fully phased in, Basel III would require banks to maintain, (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

Basel III also provides for a “countercyclical capital buffer,” generally designed to absorb losses during periods of economic stress and to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk. This buffer would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%).

The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.

Implementation of the deductions and other adjustments to CET1 are currently expected to be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer is expected to begin at 0.625% and be phased in over a four-year period (increasing by that amount each year, until it reaches 2.5%).

The regulations ultimately applicable to the Company may be substantially different from the Basel III proposed rules that were issued in June 2012.

Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company’s net income and return on equity.

The Dodd-Frank Act. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including changes that will affect all bank holding companies and banks, including the Company and the Bank. Provisions that significantly affect the business of the Company and the Bank include the following:

•

Insurance of Deposit Accounts. The Dodd-Frank Act changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital. The Dodd-Frank Act also made permanent the $250,000 limit for federal deposit insurance and increased the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000.

•

Payment of Interest on Demand Deposits. The Dodd-Frank Act repealed the federal prohibitions on the payment of interest and demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

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Creation of the Consumer Financial Protection Bureau. The Dodd-Frank Act centralized significant aspects of consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the “CFPB”), which is discussed in more detail below.

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Debit Card Interchange Fees. The Dodd-Frank Act amended the Electronic Fund Transfer Act to, among other things, require that debit card interchange fees be reasonable and proportional to the actual cost incurred by the issuer with respect to the transaction. In June 2011, the FRB adopted regulations setting the maximum permissible interchange fee as the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction, with an additional adjustment of up to one cent per transaction if the issuer implements additional fraud-prevention standards. Although issuers that have assets of less than $10 billion are exempt from the FRB’s regulations that set maximum interchange fees, these regulations could significantly impact the interchange fees that financial institutions with less than $10 billion in assets are able to collect.

In addition, the Dodd-Frank Act implemented other far-reaching changes to the financial regulatory landscape, including provisions that:

•

Restrict the preemption of state law by Federal law and disallow subsidiaries and affiliates of national banks, such as subsidiaries and affiliates of the Bank, from availing themselves of such preemption.

•

Impose comprehensive regulation of the over-the-counter derivatives market, subject to significant rulemaking processes, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself.

•

Require depository institutions with total consolidated assets of more than $10 billion to conduct regular stress tests and require large, publicly traded bank holding companies to create a risk committee responsible for the oversight of enterprise risk management.

•

Require loan originators to retain 5 percent of any loan sold or securitized, unless it is a “qualified residential mortgage”, subject to certain exceptions.

•

Prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies.

•

Implement corporate governance revisions that apply to all public companies, not just financial institutions.

Many aspects of the Dodd-Frank Act remain subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company and the Bank or their customers or the financial industry more generally. Provisions in the legislation that affect the payment of interest on demand deposits and interchange fees are likely to increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Provisions in the legislation that require revisions to the capital requirements of the Company and the Bank

could impact the Company’s and the Bank’s future raising activities. Although the Company and Bank have not issued trust preferred securities, provisions in the legislation that revoke the Tier 1 capital treatment of trust preferred securities could cause the Company and the Bank to seek other sources of capital in the future. Some of the rules that have been proposed and, in some cases, adopted to comply with the Dodd-Frank Act’s mandates are discussed further below.

Insurance of Accounts, Assessments and Regulation by the FDIC . The Bank’s deposits are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the standard maximum insurance amount for each deposit insurance ownership category. As of January 1, 2013, the basic limit on FDIC deposit insurance coverage is $250,000 per depositor.

Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC, subject to administrative and potential judicial hearing and review processes.

Deposit Insurance Assessments. The DIF is funded by assessments on banks and other depository institutions. The Bank’s deposits are insured up to applicable limits by the FDIC. Under the risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned. Unlike the other categories as applied to small institutions, Risk Category 1, which contains the least risky depository institutions, contains further risk differentiation based on the FDIC’s analysis of financial ratios, examination component ratings (CAMELS components) and other information. Assessment rates are determined by the FDIC and, beginning April 1, 2011, initial base assessment rates ranged from 2.5 to 45 basis points. The FDIC may make the following further adjustments to an institution’s initial base assessment rates: decreases for long-term unsecured debt, including most senior unsecured debt and subordinated debt; increases for holding long-term unsecured debt or subordinated debt issued by other insured depository institutions; and increases for broker deposits in excess of 10 percent of domestic deposits for insurances not well rated and well capitalized. The Dodd-Frank Act transferred to the FDIC increased discretion with regard to managing the required amount of reserves for the DIF, or the “designated reserve ratio.” Among other changes, the Dodd-Frank Act (i) raised the minimum designated reserve ratio to 1.35 percent and removed the upper limit on the designated reserve ratio, (ii) requires that the designated reserve ratio reach 1.35 percent by September 2020, and (iii) requires the FDIC to offset the effect on institutions with total consolidated assets of less than $10 billion of increasing of raising the designated reserve ratio from 1.15 percent to 1.35 percent. The FDIA requires that the FDIC consider the appropriate level for the designated reserve ratio on at least an annual basis.

In an effort to restore capitalization levels and to ensure the DIF will adequately cover projected losses from future bank failures, the FDIC, effective April 1, 2009, implemented a rule providing for initial base assessment rates for Risk Category 1 institutions of 12 to 16 basis points, subject to potential base-rate adjustments, including (i) a potential decrease of up to 5 basis points for long-term unsecured debt, including senior and subordinated debt, (ii) a potential increase for secured liabilities in excess of 25% of domestic deposits and (iii) for non-Risk Category 1 institutions, a potential increase for brokered deposits in excess of 10% of domestic deposits. Taking into account these potential base-rate adjustments, the annualized assessment rate for Risk Category 1 institutions would range from 7 to 24 basis points.

In October 2010, the FDIC adopted a new DIF restoration plan to ensure that the fund reserve ratio reaches 1.35 percent by September 30, 2020, as required by the Dodd-Frank Act. The restoration plan requires the FDIC to update its loss and income projections for the DIF at least semiannually, and if needed the FDIC may increase or decrease assessment rates, following a notice-and-comment rulemaking.

In February 2011, the FDIC approved a final rule that changed the assessment base from domestic deposits to average consolidated total assets minus average tangible equity (defined as Tier 1 capital); adopted a new large-bank pricing assessment scheme; and set a target “designated reserve ratio” for the DIF. The rule, as mandated by the Dodd-Frank Act, finalizes a target size for the DIF at 2 percent of insured deposits. It also implements a lower assessment rate schedule when the fund reaches 1.15 percent and, in

lieu of dividends, provides for a lower rate schedule when the reserve ratio reaches 2 percent and 2.5 percent. The changes went into effect beginning with the second quarter of 2011, and began affecting premiums payable at the end of September 2011.

Mortgage Banking Regulation . The Bank’s mortgage banking operation is subject to the rules and regulations of, and examination by the U.S. Department of Housing and Urban Development, the Federal Housing Administration, the Veterans Administration and state regulatory authorities with respect to originating, processing and selling mortgage loans. Those rules and regulations, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers and, in some cases, restrict certain loan features, and fix maximum interest rates and fees. In addition to other Federal laws, mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth-in-Lending Act, Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Home Ownership Equity Protection Act, and the regulations promulgated thereunder. These laws prohibit discrimination, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level. The Dodd-Frank Act has transferred rulemaking authority under many of these laws to the CFPB.

Financial Holding Company Status. As provided by the Gramm-Leach-Bliley Act of 1999 (the “GLBA”), a bank holding company may become eligible to engage in activities that are financial in nature or incidental or complimentary to financial activities by qualifying as a financial holding company.

To qualify as a financial holding company, each insured depository institution controlled by the bank holding company must be well-capitalized, well-managed and have at least a satisfactory rating under the CRA (discussed below). In addition, the bank holding company must file with the FRB a declaration of its intention to become a financial holding company. While the Company satisfies these requirements, the Company has not elected for various reasons to be treated as a financial holding company under the GLBA.

To date, the Company has not qualified as a financial holding company, and qualification as such by other bank holding companies has not had a material impact on the Company’s or the Bank’s business.

Confidentiality and Required Disclosures of Customer Information. The Company is subject to various laws and regulations that address the privacy of nonpublic financial information of customers. The GLBA and other regulations issued thereunder protect against the transfer and use by financial institutions of consumer nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated third parties unless the institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.

The Company is also subject to various laws and regulations that attempt to combat money laundering and terrorist financing. The Bank Secrecy Act requires all financial institutions to, among other things, create a system of controls designed to prevent money laundering the financing of terrorism, and imposes recordkeeping and reporting requirements. The USA Patriot Act facilitates information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering, and requires financial institutions to establish anti-money laundering programs. The Federal Bureau of Investigation (FBI) sends banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities, and requests banks to search their records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report with the Treasury and contact the FBI. The Office of Foreign Assets Control (“OFAC”), which is a division of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. If the Bank finds a name of an “enemy” of the United States on any transaction, account or wire

transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report with the Treasury and notify the FBI.

Although these laws and programs impose compliance costs and create privacy obligations and, in some cases, reporting obligations, these laws and programs do not materially affect the Bank’s products, services or other business activities.

Stress Testing. As required by the Dodd-Frank Act, the federal banking agencies have implemented stress testing requirements for certain financial institutions, including bank holding companies and state chartered banks, with more than $10 billion in total consolidated assets. Although these requirements do not apply to institutions with less than $10 billion in total consolidated assets, the federal banking agencies emphasize that all banking organizations, regardless of size, should have the capacity to analyze the potential impact of adverse market conditions or outcomes on the organization’s financial condition. Based on existing regulatory guidance, the Company and the Bank will be expected to consider the institution’s interest rate risk management, commercial real estate concentrations and other credit-related information, and funding and liquidity management during this analysis of adverse outcomes.

Community Reinvestment Act. The Bank is subject to the requirements of the Community Reinvestment Act (the “CRA”). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community credit needs is evaluated as part of the examination process pursuant to twelve assessment factors and then given a rating of “Outstanding,” “Satisfactory,” “Needs to improve” or “Substantial noncompliance.” These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility. The Bank received a rating of “Satisfactory” in its most recent CRA performance evaluation as of September 30, 2010.

Consumer Laws and Regulations. The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Fair Housing Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.

The Dodd-Frank Act created the CFPB, a federal regulatory agency that is responsible for implementing, examining and enforcing compliance with federal consumer financial laws for institutions with more than $10 billion of assets and, to a lesser extent, smaller institutions. The Dodd-Frank Act gives the CFPB authority to supervise and regulate providers of consumer financial products and services, and establishes the CFPB’s power to act against unfair, deceptive or abusive practices, and gives the CFPB rulemaking authority with numerous federal consumer financial protection laws (for example, but not limited to, the Truth-in-Lending Act and the Real Estate Settlement Procedures Act).

As a smaller institution (i.e., with assets of $10 billion or less), most consumer protection aspects of the Dodd-Frank Act will continue to be applied to the Company by the FRB and to the Bank by the Comptroller. However, the CFPB may include its own examiners in regulatory examinations by a smaller institution’s prudential regulators and may require smaller institutions to comply with certain CFPB reporting requirements. In addition, regulatory positions taken by the CFPB and administrative and legal precedents established by CFPB enforcement activities, including in connection with supervision of larger bank holding companies, could influence how the FRB and Comptroller apply consumer protection laws and regulations to financial institutions that are not directly supervised by the CFPB. The precise impact of the CFPB’s consumer protection activities on the Company cannot be forecast.

Incentive Compensation. The FRB, the Comptroller and the FDIC have issued regulatory guidance (the “Incentive Compensation Guidance”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. Banking organizations are instructed to review their incentive compensation policies to ensure that they do not encourage excessive risk-taking and implement corrective programs as needed. The Federal Reserve Board will review, as part of the regular, risk-focused

examination process, the incentive compensation arrangements of banking organizations, such as the Bank, that are not “large, complex banking organizations.” The findings will be included in reports of examination, and deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

The Dodd-Frank Act requires the SEC and the federal bank regulatory agencies to establish joint regulations or guidelines that require financial institutions with assets of at least $1 billion to disclose the structure of their incentive compensation practices and prohibit such institutions from maintaining compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material financial loss to the financial institution. The SEC and the federal bank regulatory agencies proposed such regulations in March 2011, which may become effective before the end of 2013. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which the Corporation may structure compensation for its executives only if the Corporation’s total consolidated assets exceed $1 billion. These proposed regulations incorporate the principles discussed in the Incentive Compensation Guidance.

Future Regulation . From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank, or any of its subsidiaries, could have a material effect on the business of the Company.

Employees

As of December 31, 2012, the Company had 105 full-time and part-time employees. The Company’s management believes that its employee relations are good.

Executive Officers of the Registrant


Name (Age)		Principal Occupation During Past Five Years

Aubrey H. Hall, III (42)		President & Chief Executive Officer of Pinnacle Bankshares Coporation and Chief Executive Officer and Trust Officer of First National Bank since July 2011; Director, Pinnacle Bankshares Corporation and First National Bank since 2011. Previously, Executive Vice President of Pinnacle Bankshares Corporation and President and Chief Operating Officer of First National Bank from January 2011 to July 2011 and Chief Lending Officer of First National Bank from 2007 to 2011.

Carroll E. Shelton (62)		Vice President of Pinnacle Bankshares Corporation and Senior Vice President and Chief Credit Officer of First National Bank since 1990; Director, Pinnacle Bankshares Corporation since 1990.

Bryan M. Lemley (41)		Secretary, Treasurer and Chief Financial Officer of Pinnacle Bankshares Corporation since 2000 and Senior Vice President of First National Bank since April 2010, Cashier and Chief



		Financial Officer of First National Bank since June 2000.

Item 1A.

Risk Factors.

Not required.

Item 1B.

Unresolved Staff Comments.

Not required.

Item 2.

Properties.

The Company’s main office and corporate headquarters, located at 622 Broad Street in downtown Altavista, Virginia, is owned and principally occupied by the Bank.

The Vista Office, located at 1301 N. Main Street in Altavista, Virginia, consists of a single-story building owned by the Bank but was destroyed by fire last year. The Company expects its new Vista Branch Office located in Altavista, which will replace the one destroyed by fire last year, to be completed and open for business in early May of 2013. A temporary location behind the office site in the Town and Country Shopping Plaza has been established for customer convenience during the rebuilding process.

The Airport Office, located at 14580 Wards Road in Campbell County, Virginia, consists of a single-story building owned by the Bank.

The Old Forest Road Office, located at 3309 Old Forest Road in Lynchburg, Virginia, consists of a single-story building owned by the Bank.

The Timberlake Office, located at 20865 Timberlake Road in Campbell County, Virginia, consists of a single-story building leased for $4,282 per month through April 2012.

The Forest Office, located at 14417 Forest Road in Forest, Virginia, consists of a single-story building owned by the Bank.

The Amherst Office, located at 130 South Main Street in Amherst, Virginia, consists of a single-story building leased for $10,878 per month through March 2013.

The Rustburg Office, located at 1033 Village Highway in Rustburg, Virginia, consists of a single-story building owned by the Bank.

The Wyndhurst Administrative and Training Office, located at 201 Archway Court in Lynchburg, Virginia, consists of a single-story building leased for $3,846 per month through January 2013.

With the noted exception of the Vista Office, which was destroyed by fire last year with the new branch expected to be completed in May 2013, the Company believes all of these properties are in good operating condition and are adequate for the Company’s present and anticipated future needs. The Company maintains comprehensive general liability and casualty loss insurance covering its properties and activities conducted in or about its properties. The Company believes this insurance provides adequate protection for liabilities or losses that might arise out of the ownership and use of such properties.

Item 3.

Legal Proceedings.

Neither the Company nor the Bank nor any of their properties is involved in any pending legal proceedings, nor are any such proceedings threatened, other than nonmaterial

proceedings arising in the ordinary course of the Company’s and the Bank’s business.

Item 4 .

Mine Safety Disclosures

None.

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The information contained on the inside back cover of the 2012 Annual Report to Shareholders, under the caption “Market for Common Equity and Related Stockholder Matters” is incorporated herein by reference.

Item 6.

Selected Financial Data.

The information presented under the caption “Selected Consolidated Financial Information” on page 7 of the 2012 Annual Report to Shareholders is incorporated herein by reference.

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The information presented under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 8 through 27 of the 2012 Annual Report to Shareholders is incorporated herein by reference.

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk.

Not required.

Item 8.

Financial Statements and Supplementary Data.

The consolidated financial statements of the Company and its subsidiary, including the accompanying notes, and independent auditors’ report thereon, contained on pages 28 through 66 of the 2012 Annual Report to Shareholders, are incorporated herein by reference.

Item 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

Item 9A.

Controls and Procedures.

Disclosure Controls and Procedures. The Company’s management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company to disclose material information required to be set forth in the Company’s periodic reports.

Management’s Report on Internal Control over Financial Reporting. The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework . Based on this assessment, the Company’s management concluded that, as of December 31, 2012, the Company’s internal control over financial reporting was effective based on those criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this annual report.

Changes in Internal Controls. No changes in the Company’s internal control over financial reporting occurred during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 9B.

Other Information.

None

PART III

Except as otherwise indicated, information called for by the following items under Part III is contained in the Proxy Statement for the Company’s 2013 Annual Meeting of Shareholders (“2013 Proxy Statement”) to be held on April 9, 2013.

Item 10.

Directors, Executive Officers and Corporate Governance.

The information with respect to the directors of the Company required by this item is contained on pages 5 through 10 of the 2013 Proxy Statement under the caption “Election of Directors,” and is incorporated herein by reference. The information regarding the Section 16(a) reporting requirements of the directors and executive officers is contained on page 19 of the 2013 Proxy Statement under the caption “Section 16(a) Beneficial Ownership Reporting Compliance,” and is incorporated herein by reference. The information concerning the executive officers of the Company required by this item is included in Part I of this Form 10-K under the caption “Executive Officers of the Registrant.” The information regarding the Company’s Audit Committee required by this item is contained on page 11 of the 2013 Proxy Statement under the caption “Committees of the Board of Directors-Audit Committee,” and is incorporated herein by reference. The information regarding the Company’s Nominating Committee required by this item is contained on pages 12 and 13 of the 2013 Proxy Statement under the caption “Committees of the Board of Directors-Nominating Committee” and is incorporated herein by reference.

The Company has adopted a Code of Conduct and Conflict of Interest Policy that applies to the directors, executives and employees of the Company and the Bank, including the Company’s Chief Executive Officer, Chief Financial Officer, Controller and other persons performing similar functions. We have posted this Code on our internet website at www.1stnatbk.com under “Investor Relations”. We intend to provide any required disclosure of any amendment to or waiver from the Code that applies to our Chief Executive Officer, Chief Financial Officer, Controller, or persons performing similar functions, on www.1stnatbk.com “Investor Relations” promptly following the amendment or waiver. We may elect to disclose any such amendment or waiver in a report on Form 8-K filed with the SEC either in addition to or in lieu of the website disclosure. The information contained on or connected to our internet website is not incorporated by reference into this report and should not be considered part of this or any other report that we file with or furnish to the SEC.

Item 11.

Executive Compensation.

The information on Executive Compensation required by this item is contained on pages 14 through 19 of the 2013 Proxy Statement under the caption “Executive Compensation” and is incorporated herein by reference. Information on compensation of directors is contained on page 13 of the 2013 Proxy Statement under the caption “Director Compensation” and is incorporated herein by reference.

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The information on security ownership of certain beneficial owners and management required by this item is contained on page 4 of the 2013 Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference.

The following table sets forth information as of December 31, 2012 with respect to certain compensation plans under which equity securities of the Company are authorized for issuance.

Equity Compensation Plan Information


Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights			Weighted- average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column 1)
Equity compensation plans approved by shareholders		37,250	(1)	$	9.00		55,000	(2)
Equity compensation plans not approved by shareholders		—			—		—
Total		37,250		$	9.00		55,000

(1)	Reflects shares to be issued pursuant to outstanding options granted under the Company’s 1997 Incentive Stock Plan and 2004 Incentive Stock Plan.

(2)	Reflects shares available to be granted in the form of options, restricted stock or stock appreciation rights under the Company’s 2004 Incentive Stock Plan.

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

The information on the interest of management in certain transactions and certain committees of the board of directors required by this item is contained on pages 11 through 14 of the 2013 Proxy Statement under the captions “Committees of the Board of Directors” and “Interest of Management in Certain Transactions,” and is incorporated herein by reference.

Item 14.

Principal Accountant Fees and Services.

The information contained on page 21 of the 2013 Proxy Statement under the captions “Principal Accountant Fees” and “Pre-Approval Policies” is incorporated herein by reference.

PART IV

Item 15.

Exhibits, Financial Statement Schedules.

(a) (1)

The response to this portion of Item 15 is included in Item 8 above.

(a) (2)

All schedules are omitted because they are not applicable, or the required information is either not material or is shown in the financial statements or the related notes.

(a) (3) Exhibits


Exhibit Number		Description

3.1		Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to registrant’s quarterly report on Form 10-Q filed on November 13, 2008)

3.1(a)		Articles of Amendment to the Articles of Incorporation, effective May 1, 2009 (incorporated by reference to Exhibit 3.1(a) to registrant’s current report on Form 8-K filed on May 4, 2009)

3.2		Bylaws (incorporated by reference to Exhibit 3(ii) to registrant’s registration statement on Form S-4 filed on January 24, 1997)

10.1*		1997 Incentive Stock Plan (incorporated by reference to Exhibit 4.3 to registrant’s registration statement on Form S-8 filed on September 14, 1998)

10.3*		VBA Directors’ Deferred Compensation Plan for Pinnacle Bankshares Corporation, effective December 1, 1997 (incorporated by reference to Exhibit 10.3 to registrant’s annual report on Form 10-KSB filed on March 25, 2003)

10.4*		Pinnacle Bankshares Corporation 2004 Incentive Stock Plan, as amended December 20, 2012

10.5*		Directors’ Annual Compensation

10.6*		Base Salaries of Executive Officers of the Registrant

10.7*		Amended and Restated Change in Control Agreement between Pinnacle Bankshares Corporation and Bryan M. Lemley, dated December 31, 2008 (incorporated by reference to Exhibit 10.7 to registrant’s annual report on Form 10-K filed on March 27, 2009)

10.8*		Amended and Restated Change in Control Agreement between Pinnacle Bankshares Corporation and Carroll E. Shelton, dated December 31, 2008 (incorporated by reference to Exhibit 10.8 to registrant’s annual report on Form 10-K filed on March 27, 2009)

10.9		Pinnacle Bankshares Corporation Promissory Note, effective December 31, 2008, delivered to Community Bankers’ Bank (incorporated by reference to Exhibit 10.9 to registrant’s current report on Form 8-K filed on January 7, 2009)

10.10*		Form of Restricted Stock Agreement under Pinnacle Bankshares Corporation 2004 Incentive Stock Plan, as amended February 9, 2010 (incorporated by reference to Exhibit 10.10 to registrant’s current report on Form 8-K filed on April 19, 2010)

10.12*		Form of Incentive Stock Option Agreement with Tandem Stock Appreciation Right under Pinnacle Bankshares Corporation 2004 Incentive Stock Plan, as amended February 9, 2010 (incorporated by reference to Exhibit 10.12 to registrant’s current report on Form 8-K filed on April 19, 2010)

10.13*		Change in Control Agreement between Pinnacle Bankshares Corporation and Aubrey H. Hall, III, effective July 1, 2011 (incorporated by reference to Exhibit 10.13 to registrant’s current report on Form 8-K filed on July 7, 2011)

13		2012 Annual Report to Shareholders



21		Subsidiaries of Registrant

31.1		CEO Certification Pursuant to Rule 13a-14(a)

31.2		CFO Certification Pursuant to Rule 13a-14(a)

32.1		CEO/CFO Certification Pursuant to § 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350)

101		The following materials from Pinnacle Bankshares Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012, formatted in XBRL (Extensible Business Reporting Language), furnished herewith: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements.

*	Denotes management contract.

(b)	Exhibits – See exhibit index included in Item 15(a)(3) above.

(c)	Financial Statement Schedules – See Item 15(a)(2) above.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


				PINNACLE BANKSHARES CORPORATION
				(Registrant)

March 27, 2013				/s/ Aubrey H. Hall, III
Date				Aubrey H. Hall, III, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date

/s/ Aubrey H. Hall, III	President, Chief Executive Officer and Director (principal executive officer)	March 27, 2013
Aubrey H. Hall, III

/s/ Bryan M. Lemley	Secretary, Treasurer and Chief Financial Officer (principal financial and accounting officer)	March 27, 2013
Bryan M. Lemley

/s/ A. Willard Arthur	Director	March 27, 2013
A. Willard Arthur

/s/ James E. Burton, IV	Director	March 27, 2013
James E. Burton, IV

/s/ Judson H. Dalton	Director	March 27, 2013
Judson H. Dalton

/s/ John P. Erb	Director	March 27, 2013
John P. Erb

/s/ Thomas F. Hall	Director	March 27, 2013
Thomas F. Hall

/s/ R.B. Hancock, Jr.	Director	March 27, 2013
R.B. Hancock, Jr.

/s/ A. Patricia Merryman	Director	March 27, 2013
A. Patricia Merryman

/s/ Carroll E. Shelton	Director	March 27, 2013
Carroll E. Shelton

/s/ C. Bryan Stott	Director	March 27, 2013
C. Bryan Stott

/s/ John L. Waller	Director	March 27, 2013
John L. Waller

/s/ Michael E. Watson	Director	March 27, 2013
Michael E. Watson

EXHIBIT 10.4

PINNACLE BANKSHARES CORPORATION

2004 INCENTIVE STOCK PLAN

(as amended December 20, 2012)

ARTICLE I

Establishment, Purpose, and Duration

1.1 Establishment and Amendment of the Plan . Pinnacle Bankshares Corporation, a Virginia corporation (the “Company”), hereby amends its incentive compensation plan for the Company and its subsidiaries, as amended, known as the “2004 Incentive Stock Plan”, as set forth in this document. Unless otherwise defined herein, all capitalized terms shall have the meanings set forth in Section 2.1 herein. The Plan permits the grant of Incentive Stock Options, Non-qualified Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units and Stock Awards.

The Plan was originally adopted by the Board of Directors of the Company on January 13, 2004, and became effective on May 1, 2004 (the “Effective Date”), upon approval by vote of shareholders of the Company in accordance with applicable laws. Awards under the Plan could not be granted prior to the Effective Date of the Plan.

The Plan was amended by the Board of Directors of the Company on February 9, 2010 to (i) require mandatory adjustments to retain the economic value or opportunity of outstanding Awards in the event of certain capital adjustments, (ii) permit the award of Stand-Alone Stock Appreciation Rights, Restricted Stock Units and Stock Awards, and (iii) make certain changes in connection with the potential applicability of Section 409A of the Code to Awards under the Plan, as well as to clarify certain terms and provisions of the Plan (the “2010 Plan Amendments”). The 2010 Plan Amendments were effective as of February 9, 2010.

The Plan was further amended by the Board of Directors of the Company on November 13, 2012, subject to the deregistration of the Company’s Stock under Section 12(g) of the Exchange Act having become effective as of December 20, 2012. The amendments effect certain revisions in connection with such deregistration and clarify certain terms and provisions of the Plan (the “2012 Plan Amendments”). The 2012 Plan Amendments are effective as of December 20, 2012.

1.2 Purpose of the Plan . The purpose of the Plan is to promote the success of the Company and its Subsidiaries by providing incentives to Key Employees that will promote the identification of their personal interest with the long-term financial success of the Company and with growth in shareholder value. The Plan is designed to provide flexibility to the Company and its Subsidiaries, in its ability to motivate, attract, and retain the services of Key Employees upon whose judgment, interest, and special effort the successful conduct of its operation is largely dependent.

1.3 Duration of the Plan . The Plan commenced on the Effective Date, as described in Section 1.1 herein, and shall remain in effect, subject to the right of the Board of Directors to terminate the Plan at any time pursuant to Article XIII herein, until April 30, 2014, at which time it shall terminate except with respect to Awards made prior to, and outstanding on, that date which shall remain valid in accordance with their terms.

ARTICLE II

Definitions

2.1 Definitions . Except as otherwise defined in the Plan, the following terms shall have the meanings set forth below:

(a) “Affiliate” and “Associate” shall have the respective meanings ascribed to such terms in Rule 12b-2 under the Exchange Act.

(b) “Agreement” means a written agreement implementing the grant of each Award signed by an authorized officer of the Company and by the Participant.

(c) “Award” means, individually or collectively, a grant under this Plan of Incentive Stock Options, Non-qualified Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units and Stock Awards.

(d) “Award Date” or “Grant Date” means the date on which an Award is made by the Committee under this Plan.

(e) “Beneficial Owner” shall have the meaning ascribed to such term in Rule 13d-3 under the Exchange Act.

(f) “Board” or “Board of Directors” means the Board of Directors of the Company, unless otherwise indicated.

(g) “Change in Control” shall be deemed to have occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied:

(i) any Person (other than the Company, any Subsidiary, a trustee or other fiduciary holding securities under any employee benefit plan of the Company, or its Subsidiaries), who or which, together with all Affiliates and Associates of such Person, is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 20% or more of the combined voting power of the Company’s then outstanding securities, determined without regard to whether the Exchange Act or the rules promulgated thereunder actually apply to such Person; or

(ii) if, at any time after the Effective Date, the composition of the Board of Directors of the Company shall change such that a majority of the Board of the Company shall no longer consist of Continuing Directors; or

(iii) if at any time, (A) the Company shall consolidate with, or merge with, any other Person and the Company shall not be the continuing or surviving corporation, (B) any Person shall consolidate with or merge with the Company, and the Company shall be the continuing or surviving corporation and, in connection therewith, all or part of the outstanding Stock shall be changed into or exchanged for stock or other securities of any other Person or cash or any other property, (C) the Company shall be a party to a statutory share exchange with any other Person after which the Company is a subsidiary of any other Person, or (D) the Company shall sell or otherwise transfer 50% or more of the assets or earning power of the Company and its Subsidiaries (taken as a whole) to any Person or Persons.

(h) “Code” means the Internal Revenue Code of 1986, as amended from time to time.

(i) “Committee” means the committee of the Board appointed to administer the Plan pursuant to Article III herein. At any time the Company is subject to the Exchange Act, all of the members of the Committee shall be “non-employee directors” as defined in Rule 16b-3, as amended, under the Exchange Act, or any similar or successor rule, and “outside directors” within the meaning of Section 162(m)(4)(C)(i) of the Code, as amended. Unless otherwise determined by the Board, the Committee shall consist of the Compensation Committee of the Board.

(j) “Company” means Pinnacle Bankshares Corporation, or any successor thereto as provided in Article XV herein.

(k) “Continuing Director” means an individual who was a member of the Board of Directors of the Company on the Effective Date or whose subsequent nomination for election or re-election to the Board of Directors of the Company was recommended or

approved by the affirmative vote of two-thirds of the Continuing Directors then in office.

(l) “Exchange Act” means the Securities Exchange Act of 1934, as amended.

(m) “Fair Market Value” of a Share means: (i) for Awards granted prior to February 9, 2010, the fair market value as determined pursuant to a reasonable method adopted by the Committee in good faith for such purpose, (ii) for Awards granted on or after February 9, 2010 but prior to December 20, 2012, the closing market price (that is, the price at which last sold on the principal U.S. market or quotation system) of the Stock on the relevant date if it is a trading date or, if not, on the most recent date on which the Stock was traded prior to such date, as reported by the exchange for the principal U.S. market or principal quotation system on which the Stock is traded; or if, in the opinion of the Committee, this method is inapplicable or inappropriate for any reason, the fair market value as determined pursuant to a reasonable method adopted by the Committee in good faith for such purpose, and (iii) for Awards granted on or after December 20, 2012, and for any other determination of Fair Market Value with respect to any Award when such determination is to be made on or after December 20, 2012, the fair market value as determined pursuant to a reasonable application of a reasonable valuation method (consistent with Treasury Regulations Section 1.409A-1(b)(5)(iv)) adopted by the Committee in good faith for such purpose.

(n) “Incentive Stock Option” or “ISO” means an option to purchase Stock, granted under Article VI herein, which is designated as an incentive stock option and is intended to meet the requirements of Section 422 of the Code.

(o) “Key Employee” means an officer or other key employee of the Company or its Subsidiaries, who, in the opinion of the Committee, can contribute significantly to the growth and profitability of, or perform services of major importance to, the Company and its Subsidiaries.

(p) “Non-qualified Stock Option” or “NQSO” means an option to purchase Stock, granted under Article VI herein, which is not intended to be an Incentive Stock Option.

(q) “Option” means an Incentive Stock Option or a Non-qualified Stock Option.

(r) “Participant” means a Key Employee who is granted an Award under the Plan.

(s) “Performance Criteria” means one or more specified performance goals, which may be stated in terms of the value of the Stock, return on equity, earnings per share, total earnings, earnings growth, return on assets, or return on capital, with respect to Awards of Restricted Stock or Restricted Stock Units pursuant to Article VIII or IX herein.

(t) “Period of Restriction” means the period during which Restricted Stock or Restricted Stock Units are restricted, pursuant to Article VIII or IX herein.

(u) “Person” shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a “group” as described in Section 13(d) thereof, without regard to whether the Exchange Act or the rules promulgated thereunder actually apply to such Person.

(v) “Plan” means the Pinnacle Bankshares Corporation 2004 Incentive Stock Plan, as described herein and as hereafter from time to time amended.

(w) “Related Option” means an Option with respect to which a Tandem SAR has been granted.

(x) “Restricted Stock” means an Award of Stock granted to a Participant pursuant to Article VIII herein.

(y) “Restricted Stock Unit” means an Award, designated as a Restricted Stock Unit, which is a bookkeeping entry granted to a Participant pursuant to Article IX herein and valued by reference to the Fair Market Value of a Share, which is subject to restrictions and forfeiture until the designated conditions for the lapse of the restrictions are satisfied. A Restricted Stock Unit is sometimes

referred to as a “Restricted Unit.” Restricted Stock Units represent an unfunded and unsecured obligation of the Company, except as otherwise provided for by the Committee.

(z) “Securities Act” means the Securities Act of 1933, as amended.

(aa) “Stock” or “Shares” means the common stock of the Company.

(bb) “Stock Appreciation Right” or “SAR” means an Award, designated as a stock appreciation right, granted to a Participant pursuant to Article VII herein.

(cc) “Stock Award” means an award of Stock granted to a Participant pursuant to Article X herein.

(dd) “Subsidiary” shall mean a corporation at least 50% of the total combined voting power of all classes of stock of which is owned by the Company, either directly or through one or more of its Subsidiaries.

ARTICLE III

Administration

3.1 The Committee . The Plan shall be administered by the Committee, which shall have all powers necessary or desirable for such administration. The express grant in this Plan of any specific power to the Committee shall not be construed as limiting any power or authority of the Committee. In addition to any other powers and subject to the provisions of the Plan, the Committee shall have the following specific powers: (i) to determine the terms and conditions upon which the Awards may be made, exercised, paid or distributed; (ii) to determine all terms and provisions of each Agreement, which need not be identical; (iii) to construe and interpret the Agreements and the Plan; (iv) to establish, amend, or waive rules or regulations for the Plan’s administration; (v) to accelerate the exercisability of any Award or the termination of any Period of Restriction or other restrictions imposed under the Plan; and (vi) to make all other determinations and take all other actions necessary or advisable for the administration of the Plan in its sole and absolute discretion. Any determination by the Committee shall be in the Committee’s sole and absolute discretion, and its determination shall be final and binding on all parties.

The Chairman of the Committee, the Chief Executive Officer, or such other officers or directors of the Company as shall be designated by the Committee are hereby authorized to execute Agreements on behalf of the Company and to cause them to be delivered to the recipients of Awards.

For purposes of determining the applicability of Section 422 of the Code (relating to Incentive Stock Options), or in the event that the terms of any Award provide that it may become vested or be earned or exercised only during employment or within a specified period of time after termination of employment, the Committee may decide to what extent leaves of absence for governmental or military service, illness, temporary disability, or other reasons shall not be deemed interruptions of employment or continuous employment.

Subject to limitations under applicable law, the Committee is authorized in its sole and absolute discretion to issue Awards and/or accept notices, elections, consents, and/or other forms or communications by Participants by electronic or similar means, including, without limitation, transmissions through e-mail and other permissible methods, on such basis and for such purposes as it determines from time to time.

A majority of the entire Committee shall constitute a quorum and the action of a majority of the members present at any meeting at which a quorum is present (in person or as otherwise permitted by applicable law), or acts unanimously approved in writing by the Committee without a meeting, shall be deemed the action of the Committee.

3.2 Selection of Participants . The Committee shall have the authority to grant Awards under the Plan, from time to time, to such Key Employees as may be selected by it to be Participants. Each Award shall be evidenced by an Agreement.

3.3 Decisions Binding . All determinations and decisions made by the Board or the Committee pursuant to the provisions of the Plan shall be made in its sole and absolute discretion and shall be final, conclusive, and binding.

3.4 Requirements of Rule 16b-3 and Code Section 162(m) . Notwithstanding any other provision of the Plan, at any time the Company is subject to the Exchange Act, the

Board or the Committee may impose such conditions on any Award, and amend the Plan in any such respects, as may be required to satisfy the requirements of Rule 16b-3, as amended (or any successor or similar rule), under the Exchange Act or Section 162(m) of the Code.

Any provision of the Plan to the contrary notwithstanding, and except to the extent that the Committee determines otherwise, at any time the Company is subject to the Exchange Act: (i) transactions by and with respect to officers and directors of the Company who are subject to Section 16(b) of the Exchange Act shall comply with any applicable conditions of Rule 16b-3, as amended (or any successor or similar rule), under the Exchange Act; (ii) transactions with respect to persons, if any, whose remuneration is subject to the provisions of Section 162(m) of the Code shall conform to the requirements of Section 162(m)(4)(C) of the Code; and (iii) every provision of the Plan shall be administered, interpreted, and construed to carry out the foregoing provisions of this sentence.

Notwithstanding any provision of the Plan to the contrary, the Plan is intended to give the Committee the authority to grant Awards that qualify as performance-based compensation under Code Section 162(m)(4)(C) as well as Awards that do not so qualify. Every provision of the Plan shall be administered, interpreted, and construed to carry out such intention, and any provision that cannot be so administered, interpreted, and construed shall to that extent be disregarded; and any provision of the Plan that would prevent an Award that the Committee intends to qualify as performance-based compensation under Code Section 162(m)(4)(C) from so qualifying shall be administered, interpreted, and construed to carry out such intention, and any provision that cannot be so administered, interpreted, and construed shall to that extent be disregarded.

3.5 Indemnification . In addition to such other rights of indemnification as they may have as directors or as members of the Committee, the members of the Committee shall be indemnified by the Company against reasonable expenses, including attorneys’ fees, actually and reasonably incurred in connection with the defense of any action, suit, or proceeding, or in connection with any appeal therein, to which they or any of them may be a party by reason of any action taken or failure to act under or in connection with the Plan or any Award granted or made hereunder, and against all amounts reasonably paid by them in settlement thereof or paid by them in satisfaction of a judgment in any such action, suit, or proceeding, if such members acted in good faith and in a manner which they believed to be in, and not opposed to, the best interests of the Company and its Subsidiaries.

3.6 Certain Determinations . In connection with the Committee’s good faith determination of Fair Market Value as required herein, the Committee may, as guidance, take into consideration the book value of the Stock of the Company, the relationship between the traded price and book value of shares for financial institutions of similar size and similar operating results to the Company and its subsidiary bank, any reasonably recent trades of the Stock of the Company brought to the attention of the Committee and such additional relevant information as the Committee in its judgment deems necessary. In its sole discretion, the Committee may, but is not obligated to, consult with and/or engage an investment banker or other appropriate advisor to advise the Committee in connection with its good faith determination of Fair Market Value herein.

ARTICLE IV

Stock Subject to the Plan

4.1 Number of Shares . Subject to adjustment as provided in Section 4.3 herein, the maximum aggregate number of Shares that may be issued pursuant to Awards made under the Plan shall not exceed 100,000. No more than one-third of the aggregate number of such Shares shall be issued in connection with Restricted Stock Awards. Except as provided in Section 4.2 herein, the issuance of Shares in connection with the exercise of, or as other payment for Awards, under the Plan shall reduce the number of Shares available for future Awards under the Plan.

4.2 Lapsed Awards or Forfeited Shares . If any Award granted under this Plan (for which no material benefits of ownership have been received, including dividends) terminates, expires or lapses for any reason other than by virtue of exercise of the Award, or if Shares issued pursuant to an Award (for which no material benefits of ownership have been received, including dividends) are forfeited, any Stock subject to such Award or such forfeited Shares, as applicable, again shall be available for grant under the Plan, subject to Section 7.2 herein. Notwithstanding the foregoing and except as provided in Section 7.2, Shares related to any Award, or portion thereof, that is settled in cash in lieu of Stock again shall be available for grant under the Plan, subject to Section 7.2 herein. Any shares

covered by a Stand-Alone SAR shall be counted as used only to the extent Shares are actually issued to the Participant when the Stand-Alone SAR is exercised.

4.3 Capital Adjustments . The number and class of Shares subject to each outstanding Award, the Option Price, and the annual limits on and the aggregate number and class of Shares for which Awards thereafter may be made shall be proportionately, equitably, and appropriately adjusted in such manner as the Committee shall determine in order to retain the economic value or opportunity to reflect any stock dividend, stock split, recapitalization, merger, consolidation, reorganization, reclassification, combination, exchange of shares or similar event in which the number or class of Shares is changed without the receipt or payment of consideration by the Company. Where an Award being adjusted is an ISO or is subject to Section 409A of the Code, the adjustment shall also be effected so as to comply with Section 424(a) of the Code and not to constitute a modification within the meaning of Section 424(h) or 409A, as applicable, of the Code.

ARTICLE V

Eligibility

Persons eligible to participate in the Plan and receive Awards are all employees of the Company and its Subsidiaries who, in the opinion of the Committee, are Key Employees. Key Employees may not include directors of the Company who are not employees of the Company or its Subsidiaries.

ARTICLE VI

Stock Options

6.1 Grant of Options . Subject to the terms and provisions of the Plan, Options may be granted to Key Employees at any time and from time to time as shall be determined by the Committee. The Committee shall have complete discretion in determining the number of Shares subject to Options granted to each Participant, provided, however, that (i) no Key Employee may be granted Options in any calendar year for more than 20,000 Shares, (ii) the aggregate Fair Market Value (determined at the time the Award is made) of Shares with respect to which any Participant may first exercise ISOs granted under the Plan during any calendar year may not exceed $100,000 or such amount as shall be specified in Section 422 of the Code and rules and regulations thereunder, and (iii) no ISO may be granted on or following the tenth anniversary of the earlier of the Effective Date of the Plan or the date of shareholder approval of the Plan.

6.2 Option Agreement . Each Option grant shall be evidenced by an Agreement that shall specify the type of Option granted, the Option Price (as defined in Section 6.3 herein), the duration of the Option, the number of Shares to which the Option pertains, any conditions imposed upon the exercisability of Options in the event of retirement, death, disability or other termination of employment, and such other provisions as the Committee shall determine (subject to the limitations of Section 6.8 herein). The Agreement shall specify whether the Option is intended to be an Incentive Stock Option within the meaning of Section 422 of the Code, or Non-qualified Stock Option not intended to be within the provisions of Section 422 of the Code, provided, however, that if an Option is intended to be an Incentive Stock Option but fails to be such for any reason, it shall continue in full force and effect as a Non-qualified Stock Option.

6.3 Option Price . The exercise price per Share of Stock covered by an Option (“Option Price”) shall be determined by the Committee subject to the following limitations. The Option Price shall not be less than 100% of the Fair Market Value of such Stock on the Grant Date. In addition, an ISO granted to an employee who, at the time of grant, owns (within the meaning of Section 424(d) of the Code) Stock possessing more than 10% of the total combined voting power of all classes of stock of the Company, shall have an Option Price which is at least equal to 110% of the Fair Market Value of the Stock.

6.4 Duration of Options . Each Option shall expire at such time as the Committee shall determine at the time of grant; provided, however, no ISO shall be exercisable after the expiration of ten years from its Award Date. In addition, an ISO granted to a Key Employee who, at the time of grant, owns (within the meaning of Section 424(d) of the Code) Stock possessing more than 10% of the total combined voting power of all classes of Stock of the Company, shall not be exercisable after the expiration of five years from its Award Date.

6.5 Exercisability . Options granted under the Plan shall be exercisable at such times and be subject to such restrictions and conditions as the Committee shall determine (subject to the limitations of Section 6.8 herein), which need not be the same for all Participants.

6.6 Method of Exercise and Delivery of Shares After Exercise . Options shall be exercised by delivery of a notice of exercise to the Company in the form prescribed by the Committee setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares. The Option Price shall be payable to the Company in full either in cash, by delivery of Shares of Stock valued at Fair Market Value at the time of exercise (determined in the Committee’s sole and absolute discretion), by delivery of a promissory note (satisfactory to the Committee in its sole and absolute discretion and subject to restrictions and prohibitions of applicable law) or by a combination of the foregoing. In addition, with respect to Options granted on or after February 9, 2010, the Option Price may also be paid to the Company in whole or in part by the Company’s withholding and retention of sufficient Shares issuable in connection with the exercise to cover the Option Price (determined in the Committee’s sole and absolute discretion) (a “net share exercise”).

As soon as practicable, after receipt of the notice of exercise and payment of the Option Price and completion of payment of (or an arrangement satisfactory to the Company for the Participant to pay) any tax withholding required in connection with the Option exercise, the Company shall cause the appropriate number of Shares to be issued in the Participant’s name, which issuance shall be effected in book-entry or electronic form, provided that issuance and delivery in certificated form shall occur if the Participant so requests or the Committee so directs.

6.7 Restrictions on Stock Transferability . The Committee shall impose such restrictions on any Shares acquired pursuant to the exercise of an Option under the Plan as it may deem advisable, including, without limitation, restrictions under applicable Federal securities laws, under applicable requirements of the Financial Industry Regulatory Authority, Inc. or any stock exchange or quotation system upon which such Shares are then listed, and under any blue sky or state securities laws applicable to such Shares. In addition to applicable restrictions under Article VI, the Committee may impose such restrictions on any Shares delivered to a Participant in settlement of an Option as it may deem advisable in its sole and absolute discretion, including, without limitation, restricting transferability and/or designating such Shares as Restricted Stock or Stock subject to further service, performance, consulting or noncompetition period after settlement. Any certificate representing such Shares shall bear a legend referencing the restrictions on such Stock, which legend may be similar to the legend placed on certificates pursuant to Section 8.5 herein.

6.8 Nontransferability of Options . No Option granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution. Further, all Options granted to a Participant under the Plan shall be exercisable during his lifetime only by such Participant or his guardian or legal representative.

6.9 Disqualifying Disposition of Stock Issued on Exercise of an ISO . If a Participant makes a “disposition” (within the meaning of Section 424(c) of the Code) of Shares issued upon exercise of an ISO within two years from the date of grant or within one year from the date the Shares of Stock are transferred to the Participant, the Participant shall, within ten days of disposition, notify the Committee in order that any income realized as a result of such disposition can be properly reported by the Company on IRS forms W-2 or 1099.

ARTICLE VII

Stock Appreciation Rights

7.1 Grant of Tandem SARs . Subject to the terms and conditions of the Plan, Stock Appreciation Rights may be granted to Key Employees, at the discretion of the Committee in connection with the grant, and exercisable in lieu, of Options (“Tandem SARs”). No Key Employee may be granted more than 20,000 Tandem SARs and Stand-Alone SARs in any calendar year.

7.2 Exercise of Tandem SARs . Tandem SARs may be exercised with respect to all or part of the Shares subject to the Related Option. The exercise of Tandem SARs shall cause a reduction in the number of Shares subject to the Related Option equal to the number of Shares with respect to which the Tandem SAR is exercised. Conversely, the exercise, in whole or in part, of a Related Option, shall cause a reduction in the number of Shares subject to the Related Option equal to the number of Shares with respect to which the Related Option is exercised. Shares with respect to which the Tandem SAR shall have been exercised may not be subject again to an Award under the Plan.

Notwithstanding any other provision of the Plan to the contrary, a Tandem SAR shall expire no later than the expiration of the Related Option, shall be transferable only when and under the same conditions as the Related Option and shall be exercisable only when the Related Option is eligible to be exercised. In addition, if the Related Option is an ISO, a Tandem SAR shall be exercised for no more than 100% of the difference between the Option Price of the Related Option and the Fair Market Value of Shares subject to the Related Option at the time the Tandem SAR is exercised.

7.3 Other Conditions Applicable to Tandem SARs . No Tandem SAR shall be exercisable after the expiration of ten years from its Award Date; and the term of any Tandem SAR granted under the Plan shall not exceed ten years from the Grant Date. A Tandem SAR may be exercised only when the Fair Market Value of a Share exceeds the Option Price of the Related Option. A Tandem SAR shall be exercised by delivery to the Committee of a notice of exercise in the form prescribed by the Committee.

7.4 Payment Upon Exercise of Tandem SARs . Subject to the provisions of the Agreement, upon the exercise of a Tandem SAR, the Participant is entitled to receive, without any payment to the Company (other than required tax withholding amounts), an amount equal to the product of multiplying (i) the number of Shares with respect to which the Tandem SAR is exercised by (ii) an amount equal to the excess of (A) the Fair Market Value per Share on the date of exercise of the Tandem SAR over (B) the Option Price of the Related Option.

Payment to the Participant shall be made in Shares, valued at the Fair Market Value on the date of exercise, or if the Agreement relating to the Award expressly so provides, in cash or a combination thereof.

7.5 Nontransferability of Tandem SARs . No Tandem SAR granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution. Further, all Tandem SARs granted to a Participant under the Plan shall be exercisable during his lifetime only by such Participant or his guardian or legal representative.

7.6 Grant of Stand-Alone SARs . Subject to the terms and conditions of the Plan, Stock Appreciation Rights may be granted to Key Employees at the discretion of the Committee not in connection with the grant of Options (“Stand-Alone SARs”). No Key Employee may be granted more than 20,000 Tandem SARs and Stand-Alone SARs in any calendar year.

7.7 Stand-Alone SAR Agreement . Each Stand-Alone SAR grant shall be evidenced by an Agreement that shall specify the Base Value (as defined in Section 7.10 herein), the duration of the Stand-Alone SAR, the number of Shares to which the Stand-Alone SAR pertains, any conditions imposed upon the exercisability of the Stand-Alone SAR in the event of retirement, death, disability or other termination of employment, and such other provisions as the Committee shall determine consistent with the Plan. Stand-Alone SARs granted under the Plan shall be exercisable at such times and be subject to such restrictions and conditions as the Committee shall determine, which need not be the same for all Participants.

7.8 Exercise of Stand-Alone SARs . Stand-Alone SARs may be exercised with respect to all or part of the Shares upon whatever terms and conditions the Committee, in its sole discretion, imposes upon such Stand-Alone SARs. A Stand-Alone SAR shall be exercised by delivery to the Committee of a notice of exercise in the form prescribed by the Committee.

7.9 Other Conditions Applicable to Stand-Alone SARs . In no event shall the term of any Stand-Alone SAR granted under the Plan exceed ten years from the Award Date. A Stand-Alone SAR may be exercised only when the Fair Market Value of a Share exceeds the Base Value.

7.10 Payment Upon Exercise of Stand-Alone SARs . Subject to the provisions of the Agreement, upon the exercise of a Stand-Alone SAR, the Participant is entitled to receive, without any payment to the Company (other than required tax withholding amounts), an amount (the “Stand-Alone SAR Value”) equal to the product of multiplying (i) the number of Shares with respect to which the Stand-Alone SAR is exercised by (ii) an amount equal to the excess of (A) the Fair Market Value per Share on the date of exercise of the Stand-Alone SAR over (B) the Base Value of the Stand-Alone SAR as designated in the Agreement (which Base Value shall be the Fair Market Value per Share on the Award Date or any amount greater than such Fair Market Value stated as the Base Value in the Agreement).

Payment of the Stand-Alone SAR Value to the Participant shall be made (i) in Shares, valued at the Fair Market Value on the date of exercise in the case of an immediate payment after exercise or on the date of settlement in the case of a delayed payment after exercise, or if the Agreement relating to the Award expressly so provides, (ii) in cash or (iii) in a combination thereof.

7.11 Restrictions on Stock Transferability . The Committee shall impose such restrictions on any Shares acquired pursuant to the exercise of a SAR under the Plan as it may deem advisable, including, without limitation, restrictions under applicable Federal securities laws, under applicable requirements of the Financial Industry Regulatory Authority, Inc. or any stock exchange or quotation system upon which such Shares are then listed, and under any blue sky or state securities laws applicable to such Shares. In addition to applicable restrictions under Article VII, the Committee may impose such restrictions on any Shares delivered to a Participant in settlement of a SAR as it may deem advisable in its sole and absolute discretion, including, without limitation, restricting transferability and/or designating such Shares as Restricted Stock or Stock subject to further service, performance, consulting or noncompetition period after settlement. Any certificate representing such Shares shall bear a legend referencing the restrictions on such Stock, which legend may be similar to the legend placed on certificates pursuant to Section 8.5 herein.

ARTICLE VIII

Restricted Stock

8.1 Grant of Restricted Stock . Subject to the terms and conditions of the Plan, the Committee, at any time and from time to time, may grant Shares of Restricted Stock under the Plan to such Key Employees and in such amounts as it shall determine, provided, however, that no Key Employee may be granted Restricted Stock Awards, Restricted Stock Unit Awards and Stock Awards in any calendar year for more than 10,000 shares of Stock. Participants receiving Restricted Stock Awards are not required to pay the Company therefor (except for applicable tax withholding) other than by the rendering of services. As determined by the Committee, Shares of Restricted Stock may be issued in book-entry or electronic form or in certificated form. Unless otherwise determined by the Committee, custody of Shares of Restricted Stock in certificated form shall be retained by the Company or held in escrow by an escrow agent selected, and subject to change from time to time, by the Committee until the termination of the Period of Restriction pertaining thereto.

8.2 Restricted Stock Agreement . Each Restricted Stock Award shall be evidenced by an Agreement that shall specify the number of Restricted Stock Shares granted, the applicable Period of Restriction, Performance Criteria or other restrictions and provisions as the Committee shall determine.

8.3 Transferability . Except as provided in this Article and subject to the limitation in the next sentence, the Shares of Restricted Stock granted hereunder may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the termination of the applicable Period of Restriction and/or the satisfaction of any Performance Criteria or other restrictions specified by the Committee in its sole discretion and set forth in the Agreement. All rights with respect to the Restricted Stock granted to a Participant under the Plan shall be exercisable during his lifetime only by such Participant or his guardian or legal representative.

8.4 Other Restrictions . The Committee may impose such other restrictions on any Shares of Restricted Stock granted pursuant to the Plan as it may deem advisable including, without limitation, restrictions under applicable Federal securities laws, under applicable requirements of the Financial Industry Regulatory Authority, Inc. or any stock exchange or quotation system upon which such Shares are then listed, and under any blue sky or state securities laws applicable to such Shares, and may legend the certificates representing Restricted Stock to give appropriate notice of such restrictions. Unless otherwise determined by the Committee, custody of Shares of Restricted Stock shall be retained by the Company until the termination of the restrictions pertaining thereto.

8.5 Certificate Legend . In addition to any legends placed on certificates pursuant to Section 8.4 herein, any certificate representing Shares of Restricted Stock granted pursuant to the Plan shall bear the following legend:

The sale or other transfer of the Shares of Stock represented by this certificate, whether voluntary, involuntary, or by operation of law, is subject to certain restrictions on transfer set forth in the 2004 Incentive Stock Plan of Pinnacle Bankshares Corporation, in the rules and administrative procedures adopted pursuant

to such Plan, and in a Restricted Stock Agreement dated . A copy of the Plan, such rules and procedures, and such Restricted Stock Agreement may be obtained from the Secretary of Pinnacle Bankshares Corporation.

8.6 Removal of Restrictions . Except as otherwise provided in this Article, Shares of Restricted Stock covered by each Restricted Stock Award made under the Plan shall become freely transferable by the Participant after the last day of the Period of Restriction or on the day immediately following the date on which the Performance Criteria have been timely satisfied, as applicable. Once the Shares are released from the restrictions, the Participant shall be entitled to have the legend required by Section 8.5 herein removed from any Stock certificate representing such shares.

8.7 Voting Rights . Participants entitled to or holding Shares of Restricted Stock granted hereunder may exercise full voting rights with respect to those Shares while subject to restrictions hereunder.

8.8 Dividends and Other Distributions . Unless otherwise provided in the Agreement, while subject to restrictions hereunder, Participants entitled to or holding Shares of Restricted Stock granted hereunder shall be entitled to receive all dividends and other distributions paid with respect to those Shares while they are so held. If any such dividends or distributions are paid in Shares, the Shares shall be subject to the same restrictions on transferability and the same rules for custody as the Shares of Restricted Stock with respect to which they were distributed.

8.9 Termination of Employment Due to Retirement . Unless otherwise provided in the Agreement, in the event that a Participant terminates his employment with the Company or one of its Subsidiaries because of normal retirement (as defined in the rules of the Company in effect at the time), any restrictions applicable to the Restricted Stock Shares pursuant to Section 8.3 herein shall automatically terminate and, except as otherwise provided in Section 8.4 herein the Shares of Restricted Stock shall thereby be free of restrictions and freely transferable. Unless otherwise provided in the Agreement, in the event that a Participant terminates his employment with the Company because of early retirement (as defined in the rules of the Company in effect at the time), the Committee, in its sole discretion, may waive the restrictions remaining on any or all Shares of Restricted Stock pursuant to Section 8.3 herein and add such new restrictions to those Shares of Restricted Stock as it deems appropriate.

8.10 Termination of Employment Due to Death or Disability . Unless otherwise provided in the Agreement, in the event a Participant’s employment is terminated because of death or disability while subject to restrictions hereunder, any remaining restrictions applicable to the Restricted Stock pursuant to Section 8.3 herein shall automatically terminate and, except as otherwise provided in Section 8.4 herein the Shares of Restricted Stock shall thereby be free of restrictions and fully transferable.

8.11 Termination of Employment for Other Reasons . Unless otherwise provided in the Agreement, in the event that a Participant terminates his employment with the Company for any reason other than for death, disability, or retirement, as set forth in Sections 8.9 and 8.10 herein, while subject to restrictions hereunder, then any Shares of Restricted Stock still subject to restrictions as of the date of such termination shall automatically be forfeited and returned to the Company.

8.12 Failure to Satisfy Performance Criteria . In the event that the specified Performance Criteria are established with respect to an Award and are not satisfied within the time period established by the Committee, the Shares of Restricted Stock which were awarded subject to the satisfaction of such performance goals shall be automatically forfeited and returned to the Company.

ARTICLE IX

Restricted Stock Units

9.1 Grant of Restricted Stock Units . Subject to the terms and conditions of the Plan, the Committee, at any time and from time to time, may grant Restricted Stock Units under the Plan (with one Restricted Stock Unit representing one Share) to such Key Employees and in such amounts as it shall determine, provided, however, that no Key Employee may be granted Restricted Stock Awards, Restricted Stock Unit Awards and Stock Awards in any calendar year for more than 10,000 shares of Stock. Unless otherwise provided by the Committee, Participants receiving Restricted Stock Unit Awards are not required to pay the Company therefor (except for applicable tax withholding) other than the rendering of services.

9.2 Restricted Stock Unit Agreement . Each Restricted Stock Unit Award shall be evidenced by an Agreement that shall specify the Period of Restriction, the number of Restricted Stock Units granted, and the applicable restrictions (whether service-based restrictions, with or without performance acceleration, and/or performance-based restrictions) and such other provisions as the Committee shall determine. If a Restricted Stock Unit Award is intended to be a performance-based compensation Award, the terms and conditions of such Award, including the Performance Criteria and Period of Restriction and, if different, performance period, shall be set forth in an Agreement, and the requirements to satisfy or achieve the performance goal(s) as so provided therein shall be considered to be restrictions under the Plan.

9.3 Transferability . Except as provided in this Article IX and subject to the limitation in the next sentence, the Restricted Stock Units granted hereunder ands the rights thereunder may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the termination of the applicable Period of Restriction and/or the satisfaction of any Performance Criteria or other restrictions specified by the Committee in its sole discretion and set forth in the Agreement. All rights with respect to the Restricted Stock Units granted to a Participant under the Plan shall be exercisable during his lifetime only by such Participant or his guardian or legal representative.

9.4 Dividends and Other Distributions . Unless otherwise provided in the Agreement (which may or may not provide for the current payment, or for the accumulation subject to the same restrictions, vesting, forfeiture, and payment as the Restricted Stock Units to which they are attributable, of dividends and other distributions made in cash or property other than Shares), during the Period of Restriction, Participants holding Restricted Stock Units shall have no rights to dividends and other distributions made in cash or property other than Shares which would have been paid with respect to the Shares represented by those Restricted Stock Units if such Shares were outstanding. Participants holding Restricted Stock Units shall have no right to vote the Shares represented by such Restricted Stock Units until such Shares are actually issued. Unless otherwise provided in the Agreement, if any deemed dividends or other distributions would be paid in Shares, such Shares shall be considered to increase the Participant’s Restricted Stock Units with respect to which they were declared based on one Share equaling one Restricted Stock Unit. In addition, unless otherwise provided in the Agreement, during the Period of Restriction, any such deemed dividends and other distributions for which rights are provided but which are not paid currently shall be deemed converted to additional Restricted Stock Units based on the Fair Market Value of a Share on the date of payment or distribution of the deemed dividend or distribution.

9.5 Settlement After Lapse of Restrictions . Subject to the provisions of the Agreement, upon the lapse of restrictions with respect to a Restricted Stock Unit, the Participant is entitled to receive, without any payment to the Company (other than required tax withholding amounts), (i) if paid in Shares, a number of Shares equal to the number of Shares with respect to which the restrictions lapse, or (ii) if paid in cash, an amount equal to the product of multiplying (A) an amount or number of Shares having a Fair Market Value equal to the product of multiplying (i) the number of Units with respect to which the restrictions lapse by (ii) the Fair Market Value per Share on the date the restrictions lapse (such amount, the “RSU Value”).

The Agreement may provide for payment of the RSU Value at the time of vesting or, on an elective or non-elective basis, for payment of the RSU Value at a later date, adjusted (if so provided in the Agreement) from the date of vesting based on an interest, dividend equivalent, earnings, or other basis (including deemed investment of the RSU Value in Shares) set out in the Agreement (the “adjusted RSU Value”). The Committee is expressly authorized to grant Restricted Stock Units which are deferred compensation covered by Section 409A of the Code, as well as Restricted Stock Units which are not deferred compensation covered by Section 409A of the Code.

Payment of the RSU Value or adjusted RSU Value to the Participant shall be made in cash or Shares as provided in the Agreement, and if paid in cash shall be valued at the Fair Market Value on the date or dates the restrictions on the Award lapse in the case of an immediate payment after vesting, or at the Fair Market Value on the date of settlement in the event of an elective or non-elective delayed payment. Any payment in Shares shall be effected in book-entry or electronic form, provided that issuance and delivery in certificated form shall occur if the Participant so requests in writing or the Committee so directs.

9.6 Incorporation of Sections 8.9, 8.10, 8.11 and 8.12 by Reference . Unless otherwise provided in the Agreement, the provisions of Sections 8.9, 8.10, 8.11 and 8.12 herein shall apply to Restricted Stock Units awarded under the Plan.

9.7 Restrictions on Stock Transferability . The Committee shall impose such restrictions on any Shares acquired upon settlement of an Award of Restricted Stock Units under the Plan as it may deem advisable, including, without limitation, restrictions under applicable Federal securities laws, under applicable requirements of the Financial Industry Regulatory Authority, Inc. or any stock exchange or quotation system upon which such Shares are then listed, and under any blue sky or state securities laws applicable to such Shares. In addition to applicable restrictions under Article XI, the Committee may impose such restrictions on any Shares delivered to a Participant in settlement of a Restricted Stock Unit as it may deem advisable in its sole and absolute discretion, including, without limitation, restricting transferability and/or designating such Shares as Restricted Stock or Stock subject to further service, performance, consulting or noncompetition period after settlement. Any certificate representing such Shares shall bear a legend referencing the restrictions on such Stock, which legend may be similar to the legend placed on certificates pursuant to Section 8.5 herein.

ARTICLE X

Stock Awards

Subject to the terms and provisions of the Plan, the Committee, at any time and from time to time, may grant unrestricted Stock Awards under the Plan to one or more Key Employees in such amount or amounts as it shall determine, provided, however, that no Participant may be granted Restricted Stock Awards, Restricted Stock Unit Awards and Stock Awards in any calendar year for more than 10,000 Shares. Participants receiving Stock Awards are not required to pay the Company therefor (except for applicable tax withholding). Payment of a Stock Award shall be effected as soon as practicable after the Award Date in book-entry or electronic form, provided that issuance and delivery in certificated form shall occur if the Participant so requests in writing or the Committee so directs.

ARTICLE XI

Change in Control

In the event of a Change in Control of the Company, the Committee, as constituted before such Change in Control, in its sole discretion (except that it may not take any action which would cause any Award not to comply with Section 409A of the Code) may, as to any outstanding Award, either at the time the Award is made or any time thereafter, take any one or more of the following actions: (i) provide for the acceleration of any time periods relating to the exercise or realization of any such Award so that such Award may be exercised or realized in full on or before a date initially fixed by the Committee; (ii) provide for the purchase or settlement of any such Award by the Company, upon a Participant’s request, for an amount of cash equal to the amount which could have been obtained upon the exercise of such Award or realization of such Participant’s rights had such Award been currently exercisable or payable; (iii) make such adjustment to any such Award then outstanding as the Committee deems appropriate to reflect such Change in Control; or (iv) cause any such Award then outstanding to be assumed, or new rights substituted therefor, by the acquiring or surviving corporation in such Change in Control.

ARTICLE XII

Modification, Extension and Renewals of Awards

Subject to the terms and conditions and within the limitations of the Plan, and with the intent to comply with Section 409A of the Code or maintain an exemption therefrom, the Committee may modify, extend or renew outstanding Awards, or, if authorized by the Board, accept the surrender of outstanding Awards (to the extent not yet exercised) granted under the Plan and authorize the granting of new Awards pursuant to the Plan in substitution therefor, and the substituted Awards may specify a lower exercise price than the surrendered Awards provided the replacement Awards are not granted until at least six months and a day after the Awards are surrendered, may provide for a longer term than the surrendered Awards, may provide for more rapid vesting and exercisability than the surrendered Awards, or may contain any other provisions that are authorized by the Plan. The Committee may also modify the terms of any outstanding Agreement. Notwithstanding the foregoing, however, no modification of an Award, shall, without the consent of the Participant, adversely affect the rights or obligations of the Participant.

ARTICLE XIII

Amendment, Modification and Termination of the Plan

13.1 Amendment, Modification and Termination . At any time and from time to time,

the Board may terminate, amend, or modify the Plan. Such amendment or modification may be without shareholder approval except to the extent that such approval is required by the Code, pursuant to the rules under Section 16 of the Exchange Act, if applicable, by any stock exchange or quotation system upon which the Stock is then listed, by any regulatory body having jurisdiction with respect thereto, or under any other applicable laws, rules or regulations.

13.2 Awards Previously Granted . No termination, amendment or modification of the Plan other than pursuant to Section 4.3 and 17.8 herein shall in any manner adversely affect any Award theretofore granted under the Plan, without the written consent of the Participant.

ARTICLE XIV

Withholding

14.1 Tax Withholding . The Company shall have the power and the right to deduct or withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy Federal, state and local taxes (including the Participant’s FICA obligation, if any) required by law to be withheld with respect to any grant, exercise, issuance, settlement or payment made under or as a result of this Plan.

14.2 Stock Withholding . With respect to withholding required upon the exercise of Non-qualified Stock Options, or upon the lapse of restrictions on Restricted Stock or upon the occurrence of any other taxable event with respect to any Award, Participants may elect, subject to the approval of the Committee, to satisfy the withholding requirement, in whole or in part, by having the Company withhold Shares of Stock having a Fair Market Value equal to the amount required to be withheld. The value of the Shares to be withheld shall be based on Fair Market Value of the Shares on the date that the amount of tax to be withheld is to be determined. All elections shall be irrevocable and be made in writing, signed by the Participant on forms approved by the Committee in advance of the day that the transaction becomes taxable.

ARTICLE XV

Successors

All obligations of the Company under the Plan, with respect to Awards granted hereunder, shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation or otherwise, of all or substantially all of the business and/or assets of the Company.

ARTICLE XVI

Restrictions on Transferability of Stock

16.1 General Restrictions .

(a) Any other provision of the Plan notwithstanding, the obligation of the Company to issue Shares under the Plan shall be subject to all applicable laws, rules and regulations and such approval by any regulatory body as may be required. The Company shall not be required to register in a Participant’s name or deliver any Shares prior to the completion of any registration or qualification of such Shares under any Federal, state or foreign law or any ruling or regulation of any government body which the Committee shall, in its sole and absolute discretion, determine to be necessary or advisable.

(b) The Company shall be under no obligation to qualify Shares subject to any Award or to cause a registration statement or a post-effective amendment to any registration statement to be prepared for the purpose of covering the issuance of Shares subject to any Award or causing the issuance of such Shares to be exempt from registration and qualification under applicable Federal and state securities laws now in force or as hereinafter amended, except as otherwise agreed to by the Company in writing in its sole discretion.

16.2 Acquisition for Investment: Rights of Holder on Subsequent Registration .

(a) Unless and until the Shares to be issued upon grant or exercise of, or otherwise attributable to, an Award under the Plan have been effectively registered under the Securities Act, the Company shall be under no obligation to issue any Shares unless the person to whom such Shares are to be issued shall give a written representation and undertaking to the Company which is satisfactory in

form and scope to counsel for the Company and upon which, in the opinion of such counsel, the Company may reasonably rely, that he is acquiring the Shares issued pursuant to, or otherwise attributable to, the Award for his own account as an investment and not with a view to, or for sale in connection with, the distribution of any such Shares, and that he will make no transfer of the same except in compliance with any rules and regulations in force at the time of such transfer under the Securities Act, or any other applicable law, and that if Shares are issued without such registration, a legend to this effect may be endorsed upon the securities so issued.

(b) In the event that the Company shall, nevertheless, deem it necessary or desirable to register under the Securities Act or other applicable statutes any Shares attributable to an Award under the Plan, or to qualify any such Shares for exemption from the Securities Act or other applicable statutes, then the Company may take such action and may require from each Participant such information in writing for use in any registration statement, supplementary registration statement, prospectus, preliminary prospectus, offering circular or any other document that is reasonably necessary for such purpose and may require reasonable indemnity to the Company and its officers and directors from such holder against all losses, claims, damages and liabilities arising from such use of the information so furnished and caused by any untrue statement of any material fact therein or caused by the omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances under which they were made.

ARTICLE XVII

General

17.1 Requirements of Law . The granting of Awards and the issuance of Shares of Stock under this Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by any governmental agencies or self regulatory organizations (e.g., any stock exchange or quotation system upon which the Stock is then listed) as may be required.

17.2 Effect of Plan . The establishment of the Plan shall not confer upon any Key Employee any legal or equitable right against the Company, a Subsidiary or the Committee, except as expressly provided in the Plan. The Plan does not constitute an inducement or consideration for the employment of any Key Employee, nor is it a contract between the Company or any of its Subsidiaries and any Key Employee. Participation in the Plan shall not give any Key Employee any right to be retained in the service of the Company or any of its Subsidiaries. Except as may be otherwise expressly provided in the Plan or in an Agreement, no Key Employee who receives an Award shall have rights as a shareholder of the Company prior to the date Shares are issued to the Key Employee pursuant to the Plan.

17.3 Unfunded Status of Plan . The Plan is intended to constitute an “unfunded” plan for incentive and deferred compensation. With respect to any payments as to which a Participant has a fixed and vested interest but which are not yet made to a Participant by the Company, nothing contained herein shall give any such Participant any rights that are greater than those of a general unsecured creditor of the Company.

17.4 Creditors . The interests of any Participant under the Plan or any Agreement are not subject to the claims of creditors and may not, in any way, be assigned, alienated or encumbered.

17.5 Governing Law . The Plan, and all Agreements hereunder, shall be governed, construed and administered in accordance with the laws of the Commonwealth of Virginia and the intention of the Company is that ISOs granted under the Plan qualify as such under Section 422 of the Code.

17.6 Severability . In the event any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included.

17.7 Termination of Employment . The Committee may provide in an Agreement made under the Plan for vesting of Awards in connection with the termination of a Participant’s employment on such basis as it deems appropriate, including, without limitation, any provisions for vesting at death, disability, retirement, or in connection with a Change in Control, with or without the further consent of the Committee. The Agreements evidencing Awards may contain such provisions as the Committee may approve with reference to the effect of approved leaves of absence. Unless otherwise provided herein or in the

Agreement pertaining to an Award, in the event that a Participant terminates his employment with the Company and its Subsidiaries for any reason, then the unvested portion of such Award shall automatically be forfeited to the Company. Unless otherwise provided in the Agreement pertaining to an Award or as may be required by applicable law, in determining cessation of employment, transfers between the Company and/or any Subsidiary shall be disregarded.

17.8 Non-qualified Deferred Compensation Plan Omnibus Provision . Unless otherwise provided in the applicable Agreement, it is intended that any compensation, benefits, or other remuneration, which is provided pursuant to or in connection with the Plan, which is considered to be non-qualified deferred compensation subject to Section 409A of the Code, shall be provided and paid in a manner, and at such time and in such form, as complies with the applicable requirements of Section 409A of the Code to avoid the unfavorable tax consequences provided therein for non-compliance. The Committee is authorized to amend any Agreement and to amend or declare void any election by a Participant as may be determined by it to be necessary or appropriate to evidence or further evidence required compliance with Section 409A of the Code. The Committee, however, shall have no responsibility or liability if any Award is subject to adverse taxation under Section 409A of the Code.

17.9 Share Certificates and Book Entry . To the extent that the Plan provides for issuance of stock certificates to represent shares of Stock, the issuance may be effected on a non-certificated basis to the extent not prohibited by applicable law or the applicable rules of any stock exchange or quotation system upon which the Stock is then listed. Notwithstanding any other provisions contained in this Plan, in its discretion the Committee may satisfy any obligation to deliver Shares represented by stock certificates by delivering Shares in electronic form or book-entry credit. If the Company issues any Shares in electronic form or book-entry credit that are subject to terms, conditions and restrictions on transfer, a notation shall be made in the records of the transfer agent with respect to any such Shares describing all applicable terms, conditions and restrictions on transfer. In the case of Restricted Stock granted under the Plan, such notation shall be substantially in the form of the legend contained in Section 8.5 herein.

17.10 Banking Regulatory Provision. All Awards shall be subject to any condition, limitation or prohibition under any financial institution regulatory policy or rule to which the Company is subject.

EXHIBIT 10.5

Pinnacle Bankshares Corporation

Directors’ Annual Compensation

As of December 31, 2012


	Amount
Annual Retainer

Service as Director for the Company	$	2,000

Service as Director for the Bank	$	4,000

Additional Retainer

Additional Retainer for Chairman of the Board	$	1,500

Additional Retainer for Vice Chairman of the Board	$	500

Additional Retainer for Chair of Audit Committee	$	1,500

Additional Retainer for Chair of Compensation Committee	$	1,000

Meeting Fees (Non-Employee Directors)

Committee Meetings for the Company	$	250 per meeting

Committee Meetings for the Bank	$	250 per meeting

EXHIBIT 10.6

Pinnacle Bankshares Corporation

Base Salaries of Executive Officers of the Registrant

As of March 27, 2013, the following are the base salaries (on an annual basis) of the executive officers of Pinnacle Bankshares Corporation:



Aubrey H. Hall, III President and Chief Executive Officer	$	190,000

Carroll E. Shelton Vice President	$	129,922

Bryan M. Lemley Secretary, Treasurer and Chief Financial Officer	$	128,400

EXHIBIT 13

LOGO

BOARD OF DIRECTORS

LOGO

Front Row: R. B. Hancock, Jr., John P. Erb (Chairman), Aubrey H. Hall, III, A. Patricia Merryman

Back Row: Thomas F. Hall, John L. Waller, C. Bryan Stott, Judson H. Dalton,

James E. Burton, IV (Vice Chairman), Carroll E. Shelton

Not Pictured: A. Willard Arthur and Michael E. Watson

SENIOR MANAGEMENT

LOGO

Front Row: Lucy H. Johnson, Aubrey H. Hall, III (President and CEO), Judith A. Clements

Back Row: Thomas R. Burnett, Jr., Bryan M. Lemley, Caroll E. Shelton, William J. Sydnor, II

PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Table of Contents


		Page

First National Bank Office Locations		2

Officers and Managers		3

President’s Letter		4

Selected Consolidated Financial Information		7

Management’s Discussion and Analysis of Financial Condition and Results of Operations		8

Consolidated Balance Sheets		28

Consolidated Statements of Income		29

Consolidated Statements of Comprehensive Income		30

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income		31

Consolidated Statements of Cash Flows		32

Notes to Consolidated Financial Statements		33

Management’s Report on Internal Control over Financial Reporting		66

Report of Independent Registered Public Accounting Firm		67

Shareholder Information		68

PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

First National Bank Office Locations

ALTAVISTA

MAIN OFFICE

622 Broad Street

Altavista, Virginia 24517

Telephone: (434) 369-3000

VISTA OFFICE

1301 N. Main Street

Altavista, Virginia 24517

Telephone: (434) 369-3001

LYNCHBURG

AIRPORT OFFICE

14580 Wards Road

Lynchburg, Virginia 24502

Telephone: (434) 237-3788

TIMBERLAKE OFFICE

20865 Timberlake Road

Lynchburg, Virginia 24502

Telephone: (434) 237-7936

OLD FOREST ROAD OFFICE

3309 Old Forest Road

Lynchburg, Virginia 24501

Telephone: (434) 385-4432

FOREST

FOREST OFFICE

14417 Forest Road

Forest, Virginia 24551

Telephone: (434) 534-0451

AMHERST

AMHERST OFFICE

130 South Main Street

Amherst, Virginia 24521

Telephone: (434) 946-7814

RUSTBURG

RUSTBURG OFFICE

1033 Village Highway

Rustburg, Virginia 24588

Telephone: (434) 332-1742

PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY


Officers of Pinnacle Bankshares Corporation
Aubrey H. Hall, III		President & Chief Executive Officer
Carroll E. Shelton		Vice President
Bryan M. Lemley		Secretary, Treasurer & Chief Financial Officer

Officers and Managers of First National Bank
Aubrey H. Hall, III		President, Chief Executive Officer & Trust Officer
Carroll E. Shelton		Senior Vice President & Chief Credit Officer
Bryan M. Lemley		Senior Vice President, Cashier & Chief Financial Officer
Lucy H. Johnson		Senior Vice President & Chief Information Officer
William J. Sydnor, II		Senior Vice President, Director of Retail Branch Operations and Security Officer
Judith A. Clements		Senior Vice President & Director of Human Resources
Thomas R. Burnett, Jr.		Senior Vice President & Chief Lending Officer
Pamela R. Adams		Vice President & Loan Administration Manager
James M. Minear		Vice President & Commercial Officer
Shawn D. Stone		Vice President & Commercial Officer
Daniel R. Wheeler		Vice President & Commercial Officer
Tracie A. Gallahan		Vice President & Mortgage Production Manager
Bianca K. Allison		Vice President & Mortgage Loan Officer
Tony J. Bowling		Vice President & Network Administrator
Cecilia L. Doyle		Vice President & Senior Credit Analyst
John E. Tucker		Vice President & Investment Consultant
Vivian S. Brown		Vice President & Retail Sales and Service Manager
Tarry R. Pribble		Vice President & Collection and Recovery Manager
Nancy J. Holt		Assistant Vice President & Branch Manager (Main)
Janet H. Whitehead		Assistant Vice President & Branch Manager (Airport)
M. Amanda Ramsey		Assistant Vice President & Branch Manager (Amherst)
Andria C. Smith		Assistant Vice President & Branch Manager (Rustburg)
Courtney M. Woody		Assistant Vice President & Branch Manager (Old Forest Road)
Kathleen P. Morgan		Assistant Vice President & Branch Manager (Forest)
Melissa T. Campbell		Assistant Vice President & Branch Manager (Timberlake)
Charlene A. Thompson		Assistant Vice President & Branch Administration Support
Marian E. Marshall		Assistant Vice President & Retail Business Development Officer (Forest)
Christine A. Hunt		Assistant Vice President & Internal Auditor
Vicki G. Greer		Assistant Vice President & Financial Analyst
Lisa M. Landrum		Assistant Vice President & Dealer Finance Officer
Dianna C. Hamlett		Assistant Vice President, Compliance & Bank Secrecy Act Officer
Anita M. Jones		Assistant Vice President & Loan Production Officer
Romonda F. Davis		Assistant Vice President & E-Commerce Sales Officer
Lauren R. Michael		Training Officer
J. Wayne Drumheller		Collection Officer
Alison G. Daniels		Loan Quality Control Officer
Ann L. Dalton		Real Estate Loan Portfolio Manager
Barbara H. Caldwell		Assistant Branch Manager (Main)
Arin L. Brown		Retail Business Development Officer (Main)
April A. Morris		Retail Business Development Officer (Main)
Doris N. Trent		Retail Business Development Officer (Vista)
Patricia D. Canada		Retail Business Development Officer (Airport)
Cathy C. Simms		Assistant Portfolio Manager & Loan Officer
Cynthia I. Gibson		Bookkeeping Manager

LOGO

DEAR SHAREHOLDERS,

It is my pleasure to report to you that Pinnacle Bankshares Corporation, the one-bank holding company for First National Bank, continued its trend of significantly improved financial performance during 2012 while executing strategic initiatives that are focused on positioning your Company for enhanced future returns. Progress was made on many fronts; however the year’s most important achievement was the substantial reduction of problem loans. This “cleansing” of our loan portfolio was driven by disciplined adherence to our credit quality improvement plan, the expansion of processes utilized to identify and quantify risk and the continued improvement of our regional economy. Our ability to rebound from the fire that destroyed our Vista Branch Office in April 2012 and remain focused on our objectives is a testament to Pinnacle’s culture of teamwork and our determination to move your Company forward. I am excited about the foundations for success that are being laid and the opportunities we have to further acquire and expand customer relationships across the Region 2000 market.

For 2012 Pinnacle generated net income of $1,338,000, which was a 26% increase as compared to the $1,063,000 produced in 2011. The higher level of net income was largely driven by a significant reduction in the Company’s provision for loan losses as a result of improved asset quality and a lower amount of loan charge-offs. From an asset quality point of view, the Company’s total criticized and classified loans decreased $11,892,000 or 51% during the year. This reduction was substantial and to some degree achieved through difficult decisions to exit relationships and liquidate collateral. As a result loan charge-offs, while lower compared to 2011, were still elevated for the year. However, there are also numerous examples of loans that were upgraded throughout 2012 due to improvement in the borrower’s financial condition. We view these occurrences as evidence that the economy is healing. In fact, we have been encouraged by recent announcements regarding companies expanding in our area, declining local unemployment numbers and a noticeable uptick in the real estate market caused by shrinking inventories, shorter marketing times and some price appreciation. The growth of area colleges and universities has positively contributed to our region’s economic recovery along with the existence of companies on the forefront of technology and energy innovation and a strong healthcare system. The combination of these factors leads us to believe that a corner has been turned in regards to asset quality and that problem loans should continue to diminish.

For 2012 Pinnacle also continued to benefit from strong non-interest income, which increased $190,000 or approximately 6% compared to the prior year due in large part to the outstanding performance of the Company’s secondary market mortgage operation. Fees generated from the sale of mortgage loans increased $177,000 as the number of originations were up 44%, which were driven by historically low interest rates and improved residential real estate activity. Tracie A. Gallahan, Vice President and Mortgage Production Manager, has done a magnificent job of leading our mortgage team through a multitude of regulatory changes and increased burden over the last couple of years while also increasing our mortgage loan volume.

Pinnacle’s lower provision and increased non-interest income combined to offset a decline in net interest income during 2012, which decreased $490,000 or approximately 4%. The decline was driven by lower yields on interest earning assets, comprised primarily of loans and investments, due to a continuation of the low interest rate environment and ever increasing competition for opportunities to extend credit to qualified borrowers. The Company’s cost of funds also decreased during 2012, however the decline was less than the reduction in yields on interest earning assets as it became increasingly difficult to further lower the interest paid on deposits. Volume was not a significant factor as interest earning assets actually increased due to improved loan demand and interest bearing liabilities only declined slightly. As of December 31, 2012 the net interest margin was 3.54%, which is a decrease of seventeen basis points as compared to the

net interest margin as of the prior year end. We expect continued pressure on asset yields for the foreseeable future due to the number of banks aggressively seeking opportunities to deploy excess funds and limited availability of investment options offering appreciable returns that do not expose the Company to significant interest rate risk. We anticipate that further margin compression will be somewhat mitigated by the re-pricing of maturing longer term certificates of deposit throughout 2013.

The Company’s non-interest expense was up $366,000 or approximately 3% for 2012 as compared to 2011, although core operating expenses were well controlled. The increase was primarily related to the credit quality improvement plan and resulting expenses associated with foreclosures. The Company also increased the amount of funds spent on advertising as part of its effort to expand the Bank’s visibility and brand recognition. Hopefully many of you have noticed the television commercials, billboards and radio advertisements depicting First National as a “104 Year Old Bank With A Little Flair.”

The 2012 year-end balance sheet for Pinnacle reflected total assets of $348,694,000, which represents modest growth of 1.8% as compared to the end of 2011. Net loans grew $6,549,000 or approximately 2.5% during the year, while the Company’s investment portfolio declined $2,563,000 due to maturing and called issues. Cash and cash equivalents were down $1,757,000 to $35,790,000. Deposit balances increased $4,764,000 or approximately 1.5% to $315,157,000 as of year-end with demand deposits, savings and NOW accounts increasing a combined $13,189,000, which more than offset an $8,425,000 decrease in time deposits. Management continues to focus attention on the acquisition of checking accounts in an effort to establish more core relationships, lower the Company’s cost of funds and further reduce time deposit dependency. Our asset and liability structure has your Company positioned to benefit from a rising interest rate environment.

Total stockholders’ equity was $28,089,000 as of December 31, 2012, with average equity to average assets improving to 8.04% as compared to 7.93% as of the prior year end. Most importantly, Pinnacle Bankshares Corporation and First National Bank continue to be considered well capitalized by all regulatory definitions. We are proud of the fact that your Company did not participate in the government’s Troubled-Asset Relief Program or TARP during the height of the financial crisis and that we did not have the need to embark on a capital raise or issuance of capital notes during a time when those actions could have resulted in a substantial dilution of your ownership stake in the Company. Our ability to “weather the storm” without taking these actions should position our shareholders well for enhanced levels of returns in the future.

Pinnacle’s allowance for loan losses was $3,646,000 as of December 31, 2012, which was 1.31% of total loans. In comparison the allowance was 1.48% of total loans as of year-end 2011. The decline was a direct result of improved loan quality as the ratio of nonperforming loans to total loans decreased from 1.74% as of the prior year end to 1.09% as of the end of 2012. Our allowance balance actually increased as a percentage of nonperforming loans during 2012, improving to 121% as compared to 85% as of the prior year end, which is indicative of the allowance’s adequacy. The ratio of nonperforming assets to total assets was almost unchanged at 1.55% as of December 31, 2012 as the Company’s other real estate owned increased due to properties acquired through foreclosures.

During December of 2012, Pinnacle completed the deregistration of its common shares with the Securities and Exchange Commission and, on January 2, 2013, the Company suspended its reporting obligations. We expect these actions to provide material costs savings for the Company going forward. The trading platform for the Company’s stock has not been impacted as a result of these actions and Management is committed to providing updated information regarding the Company’s financial performance to shareholders on a regular basis. This information is available on our website, www.1stnatbk.com, under the “Investor Relations” tab.

Improved asset quality and earnings combined with anticipated future cost savings from deregistration prompted the declaration of a $0.05 per share cash dividend to shareholders during the fourth quarter of 2012 and again during the first quarter of 2013. We are appreciative of our shareholders support and confidence throughout the great recession and subsequent slow recovery and we are pleased to reach a point where we can provide a return to our shareholders in the form of a cash dividend.

The fire that destroyed the Vista Branch Office on April 10, 2012 certainly was an unexpected setback; however in many ways we were extremely fortunate. The fast action of our Vista employees in the face of adversity resulted in no one being harmed, minimal loss of cash and coin and no damage to safe deposit box contents. Soon after the fire the Bank’s Board of Directors announced its intention to rebuild the office, confirming its commitment to the Altavista Community, our clients and employees. We broke ground on our new facility in late December and, as of this letter, the building is under roof with early May of 2013 being its anticipated opening date.

Transition and change are a part of business and life. On this note I would like to take the opportunity to inform you that Carroll E. Shelton, Vice President of Pinnacle Bankshares Corporation and Senior Vice President and Chief Credit Officer of First National Bank, has communicated his intention to retire from the Bank, effective July 1, 2013, after forty years of service. Carroll’s contributions to the success of our Company throughout his career are too many to list in this letter; however there are none more significant than the leadership he has provided throughout the execution of the credit quality improvement plan. His efforts to help change our credit culture will have a lasting positive impact on the Company and its ability to further improve financial performance. While Carroll is retiring from the Bank as an employee, he will remain a member of the Board of Directors for both the Company and the Bank at least until his current term expires in April of 2015.

As a result of Carroll’s decision, a succession plan was developed and I am pleased to announce that William J.“Buck” Sydnor, II will assume the Chief Credit Officer’s role for the Bank effective July, 1, 2013. Buck is a proven leader, a team player and a long-term Senior Manager who possesses a diversified banking background that includes retail management and commercial lending. His business minded, process oriented approach to banking will ensure that we stay on the right track in regards to further enhancement of the Bank’s credit culture.

Vivian Brown, Retail Sales and Service Manager, will replace Buck as Branch Administration Officer effective July 1, 2013. Vivian has worked closely with Buck in guiding our Retail Branches over the last couple of years and has been instrumental in the further cultivation of the Bank’s sales culture. She is a respected leader with a diversified retail banking background. Vivian has been well-groomed to take on this role and I am confident in her ability to successfully execute our sales initiatives.

In closing, your Board and Management Team are committed to the development and execution of strategies to further improve Pinnacle’s performance and enhance returns while operating within the parameters of what is considered safe and sound banking practices. We realize that the road to success is not a path easily traveled; however hard work, dedication and perseverance always tend to help pave the way.

To hear more about the performance and direction of Pinnacle Bankshares Corporation, please plan to attend our Annual Meeting of Shareholders to be held at 11:00 am, Tuesday, April 9, 2013 in the Fellowship Hall of Altavista Presbyterian Church, 707 Broad Street, Altavista, Virginia. We are hopeful that you will be able to join us for this occasion.

Thank you for your support, confidence and the opportunity to serve your interests as President and Chief Executive Officer of Pinnacle Bankshares Corporation.

Sincerely,

LOGO

Aubrey H. Hall, III “Todd”

President & Chief Executive Officer

PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Selected Consolidated Financial Information

(In thousands, except ratios, share and per share data)


	Years ended December 31,
	2012			2011			2010			2009			2008
Income Statement Data:
Net interest income	$	11,601			12,091			10,776			10,004			10,209
Provision for loan losses		1,177			2,227			1,878			1,530			2,881
Noninterest income		3,443			3,253			3,134			3,148			2,896
Noninterest expense		11,910			11,544			11,037			11,171			9,846
Income tax expense		619			510			308			100			72
Net income		1,338			1,063			687			351			306
Per Share Data:
Basic net income	$	0.89			0.71			0.46			0.24			0.21
Diluted net income		0.89			0.71			0.46			0.24			0.21
Cash dividends		0.05			0.00			0.05			0.10			0.60
Book value		18.63			18.01			17.71			17.41			16.78
Weighted-Average Shares Outstanding:
Basic		1,503,952			1,496,260			1,492,137			1,485,089			1,485,089
Diluted		1,503,952			1,496,260			1,492,137			1,485,089			1,488,213
Balance Sheet Data:
Assets	$	348,694			342,484			337,113			332,210			321,243
Loans, net		273,672			267,123			265,030			265,904			279,199
Securities		22,206			24,769			26,517			20,156			13,931
Cash and cash equivalents		35,790			37,547			32,533			32,060			15,926
Deposits		315,157			310,393			306,954			302,119			287,233
Stockholders’ equity		28,089			26,947			26,482			25,851			24,919
Performance Ratios:
Return on average assets		0.39	%		0.31	%		0.21	%		0.11	%		0.10	%
Return on average equity		4.83	%		3.95	%		2.62	%		1.40	%		1.14	%
Dividend payout		5.61	%		0.00	%		10.92	%		41.88	%		291.50	%
Asset Quality Ratios:
Allowance for loan losses to total loans, net of unearned income and fees		1.31	%		1.48	%		1.50	%		1.38	%		1.40	%
Net charge-offs to average loans, net of unearned income and fees		0.57	%		0.84	%		0.59	%		0.65	%		0.24	%
Capital Ratios:
Leverage		8.49	%		8.12	%		7.74	%		8.04	%		8.28	%
Risk-based:
Tier 1 capital		10.15	%		9.99	%		9.36	%		9.50	%		9.20	%
Total capital		11.39	%		11.24	%		10.61	%		10.75	%		10.45	%
Average equity to average assets		8.04	%		7.93	%		7.88	%		7.69	%		9.14	%

Management’s Discussion and Analysis

of Financial Condition and Results of Operations

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

Cautionary Statement Regarding Forward-Looking Statements

The following discussion is qualified in its entirety by the more detailed information and the consolidated financial statements and accompanying notes appearing elsewhere in this Annual Report. In addition to the historical information contained herein, this Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are not statements of historical fact and are based on certain assumptions and describe future plans, strategies, and expectations of management, are generally identifiable by use of words such as “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “may,” “will” or similar expressions. These forward-looking statements may include, but are not limited to, statements relating to future reporting obligations, anticipated future financial performance, funding sources including cash generated by banking operations, loan portfolio composition, trends in asset quality and strategies to address nonperforming assets and nonaccrual loans, adequacy of the allowance for loan losses and future provisions for loan losses, securities portfolio composition and future performance, interest rate environments, deposit insurance assessments, and strategic business initiatives.

Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results, performance or achievements could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: the effectiveness of management’s efforts to improve asset quality and control operating expenses; the quality, composition and growth of the loan and investment portfolios; interest rates; decrease in net interest margin, declining collateral values, especially in the real estate market; general economic conditions, including stagnation in general business and economic conditions and in the financial markets; unemployment levels; the legislative/regulatory climate, including the impact of any policies or programs implemented pursuant to the Emergency Economic Stabilization Act of 2008 (the EESA), the American Recovery and Reinvestment Act of 2009 (the ARRA), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) or other laws; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System; demand for loan products; deposit flows; competition; demand for financial services in our market area; regulatory compliance costs; accounting principles, policies and guidelines; and an increase in shareholders that would require the Company to be subject to the reporting obligations of the Securities Exchange Act of 1934, as amended. These risks and uncertainties should be considered in evaluating forward-looking statements contained herein. We base our forward-looking statements on management’s beliefs and assumptions based on information available as of the date of this report. You should not place undue reliance on such statements, because the assumptions, beliefs, expectations and projections about future events on which they are based may, and often do, differ materially from actual results. We undertake no obligation to update any forward-looking statement to reflect developments occurring after the statement is made.

In addition, although nonperforming assets substantially improved in 2012, since the recession that began in the second half of 2008, we have experienced increases in loan losses. Continued difficulties in significant portions of the global financial markets, particularly if it worsens, could further impact our performance, both directly by affecting our revenues and the value of our assets and liabilities, and indirectly by affecting our counterparties and the economy generally. Dramatic declines in the residential and commercial real estate markets in recent years have resulted in significant write-downs of asset values by financial institutions in the United States. Concerns about the stability of the U.S. financial markets generally have reduced the availability of funding to certain financial institutions, leading to a tightening of credit and reduction of business activity. There can be no assurance that the EESA, the ARRA, the Dodd-Frank Act or other actions taken by the Federal government will stabilize the U.S. financial system or alleviate the industry or economic factors that may adversely affect our business. In addition, our business and financial performance could be impacted as the financial industry restructures in the current environment, both by changes in the creditworthiness and performance of our counterparties and by changes in the competitive and regulatory landscape.

Company Overview

Pinnacle Bankshares Corporation, a Virginia corporation (Bankshares), was organized in 1997 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Bankshares is headquartered in Altavista, Virginia. Bankshares conducts all of its business activities through the branch offices of its wholly owned subsidiary bank, First National Bank (the Bank). Bankshares exists primarily for the purpose of holding the stock of its subsidiary, the Bank, and of such other subsidiaries as it may acquire or establish.

First National Bank was organized in 1908 and currently maintains a total of eight offices to serve its customers. The Main Office and Vista Branch (which is in the process of being rebuilt after being destroyed by fire in 2012 and is expected to be open in May 2013) are located in the Town of Altavista, the Airport Branch, Timberlake Branch and Rustburg Branch in Campbell County, the Old Forest Road Branch in the City of Lynchburg, the Forest Branch in Bedford County and the Amherst Branch in the Town of Amherst. The Bank also maintains an administrative and training facility in the Wyndhurst section of the City of Lynchburg.

A total of one-hundred five full and part-time staff members serve the Bank’s customers.

With an emphasis on personal service, the Bank today offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, merchant bankcard processing, residential and commercial mortgages, home equity loans, consumer installment loans, agricultural loans, investment loans, small business loans, commercial lines of credit and letters of credit. The Bank also offers a full range of investment, insurance and annuity products through its association with Infinex Investments, Inc. and Banker’s Insurance, LLC. The Bank has two wholly-owned subsidiaries: FNB Property Corp., which holds title to Bank premises real estate; and First Properties, Inc., which holds title to other real estate owned acquired through foreclosures.

The following discussion supplements and provides information about the major components of the results of operations and financial condition, liquidity and capital resources of Bankshares and its subsidiary (collectively the Company). This discussion and analysis should be read in conjunction with the Company’s consolidated financial statements and accompanying notes. The Securities and Exchange Commission defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Our significant accounting policies are described in Note 1 in the Notes to the Consolidated Financial Statements.

Executive Summary

The Company serves a trade area known as Region 2000, consisting primarily of Campbell County, northern Pittsylvania County, eastern Bedford County, Amherst County and the city of Lynchburg, from nine facilities located within the area. The Company operates in a well-diversified industrial economic region that does not depend upon one or a few types of commerce.

The Company earns revenues on the interest margin between the interest it charges on loans it extends to customers and interest received on the Company’s securities portfolio net of the interest it pays on deposits to customers. The Company also earns revenues on service charges on deposit and loan products, gains on securities that are called or sold, fees from origination of mortgages, and other noninterest income items including but not limited to overdraft fees, commissions from the sale of investment products, insurance and annuity sales, safe deposit box rentals, and automated teller machine surcharges. In 2012, an increase in net income was realized due to a substantial decrease in provision for loan losses due to asset quality improvement as well as an increase in mortgage loan fees. The Company’s revenue generating activities and related expenses are outlined in the consolidated statements of income and consolidated statements of changes in stockholders’ equity and comprehensive income and accompanying notes and in “Results of Operations” below.

The Company generates and utilizes cash through its operating, investing and financing activities. The generation and utilization of cash flows is outlined more fully in the consolidated statements of cash flows and accompanying notes and in “Liquidity and Asset/Liability Management” below.

The Company’s balance sheet experienced a slight increase in its loan and deposit portfolios in 2012. The overall growth of the Company is outlined in the consolidated balance sheets and accompanying notes and the “Investment Portfolio,” “Loan Portfolio,” “Bank Premises and Equipment,” “Deposits” and “Capital Resources” discussions below.

The Company expects limited loan portfolio growth in 2013, as the Company further improves its capital ratios by limiting its growth and accreting capital through retained earnings. The Company will look to continue growth in its branches, especially the Amherst and Rustburg locations, as the Company continues to build relationships with businesses and individuals within each market. While growing, the Company continues to leverage efficiencies from its reporting and imaging systems. The Company is also making its customers’ banking experience more convenient by offering innovative products and services and providing many channels to bank with the Company including Internet banking, Internet bill pay, telephone banking, mobile banking, remote deposit capture, debit and credit cards and real-time ATMs. The Company will continue to identify and install convenient products and services in 2013 with the goal to better enhance the customer’s experience with the Company.

Overview of 2012 and 2011

Total assets at December 31, 2012 were $348,694, up 1.81% from $342,484 at December 31, 2011. The principal components of the Company’s assets at the end of the year were $35,790 in cash and cash equivalents, $22,206 in securities and $273,672 in net loans. During the year ended December 31, 2012, gross loans increased 2.28% or $6,180. The Company’s lending activities are a principal source of income. Loans increased in 2012 as the Company experienced slightly higher demand for credit, despite higher credit standards, as loan rates fell.

Total liabilities at December 31, 2012 were $320,605, up 1.61% from $315,537 at December 31, 2011, primarily due to an increase in total deposits of $4,764 or 1.53%, to $315,157 at December 31, 2012 from $310,393 at December 31, 2011. Noninterest-bearing demand deposits increased $4,523 or 13.53% and represented 12.04% of total deposits at December 31, 2012, compared to 10.77% at December 31, 2011. Savings and NOW accounts increased $8,666 or 6.54% and represented 44.79% of total deposits at December 31, 2012, compared to 42.69% at December 31, 2011. Time deposits decreased $8,425 or 5.83% and represented 43.16% of total deposits at December 31, 2012, compared to 46.54% at December 31, 2011. The Company’s deposits are provided by individuals and businesses located within the communities served. The Company had no brokered deposits as of December 31, 2012 and December 31, 2011.

Total stockholders’ equity at December 31, 2012 was $28,089, including $24,244 in retained earnings. At December 31, 2011, stockholders’ equity totaled $26,947, including $22,981 in retained earnings. The increase in stockholders’ equity resulted largely from the Company’s net income of $1,338.

The Company had net income of $1,338 for the year ended December 31, 2012, compared to net income of $1,063 for the year ended December 31, 2011, an increase of 25.87%. The Company’s net income increased primarily due to a $1,050, or 47.15%, decrease in provision for loan losses as asset quality improved throughout the year and a $190, or 5.84%, increase in noninterest income as mortgage loan fees increased in 2012 by $177, or 39.25%. These positive factors that contributed to the increase in net income were partially offset by a $490, or 4.05%, decrease in net interest income as the net interest margin declined in 2012 and a $366, or 3.17%, increase in noninterest expense as losses on OREO sales and cost of foreclosures increased in 2012. Management expects continued improvement in net income, although whether the Company can continue to improve net income could be adversely affected by numerous factors including factors related to the Company’s asset quality. We do not expect the Company’s net interest margin to decrease further in 2013. We expect a minimal increase in noninterest income in 2013. We expect no substantial increase in noninterest expense in 2013.

Profitability as measured by the Company’s return on average assets (ROA) was 0.39% in 2012, compared to 0.31% in 2011. Return on average equity (ROE), was 4.83% for 2012, compared to 3.95% for 2011.

Overview of 2011 and 2010

Total assets at December 31, 2011 were $342,484, up 1.59% from $337,113 at December 31, 2010. The principal components of the Company’s assets at the end of the year were $37,547 in cash and cash equivalents, $24,769 in securities and $267,123 in net loans. During the year ended December 31, 2011, gross loans increased 0.77% or $2,071. Loans increased in 2011 as the Company experienced slightly higher demand for credit, despite higher credit standards, as loan rates fell.

Total liabilities at December 31, 2011 were $315,537, up 1.58% from $310,631 at December 31, 2010, primarily due to an increase in total deposits of $3,439 or 1.12%. Noninterest-bearing demand deposits increased $2,248 or 7.21% and represented 10.77% of total deposits at December 31, 2011, compared to 10.16% at December 31, 2010. Savings and NOW accounts increased $14,557 or 12.34% and represented 42.69% of total deposits at December 31, 2011, compared to 38.42% at December 31, 2010. Time deposits decreased $13,366 or 8.47% and represented 46.54% of total deposits at December 31, 2011, compared to 51.42% at December 31, 2010. The Company’s deposits are provided by individuals and businesses located within the communities served. The Company had no brokered deposits as of December 31, 2011 and December 31, 2010.

Total stockholders’ equity at December 31, 2011 was $26,947, including $22,981 in retained earnings. At December 31, 2010, stockholders’ equity totaled $26,482, including $21,918 in retained earnings. The increase in stockholders’ equity resulted largely from the Company’s net income of $1,063 during 2011 partially offset by $871 in unrealized losses to our defined benefit plan.

The Company had net income of $1,063 for the year ended December 31, 2011, compared to net income of $687 for the year ended December 31, 2010, an increase of 54.73%. The Company’s net income increased primarily due to an increase in net interest income, which was largely due to improvements to the Company’s net interest margin, and an increase in noninterest income, partially offset by an increase in provision for loan losses and noninterest expense.

Profitability as measured by the Company’s return on average assets (ROA) was 0.31% in 2011, compared to 0.21% in 2010. Return on average equity (ROE), was 3.95% for 2011, compared to 2.62% for 2010.

Results of Operations

Net Interest Income . Net interest income represents the principal source of earnings for the Company. Net interest income is the amount by which interest and fees generated from loans, securities and other interest-earning assets exceed the interest expense associated with funding those assets. Changes in the amounts and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. Changes in the interest rate environment and the Company’s cost of funds also affect net interest income.

The net interest spread decreased to 3.31% for the year ended December 31, 2012 from 3.47% for the year ended December 31, 2011. Net interest income was $11,601 ($11,690 on a tax-equivalent basis) for the year ended December 31, 2012, compared to $12,091 ($12,178 on a tax-equivalent basis) for the year ended December 31, 2011, and is attributable to interest income from loans, federal funds sold and securities exceeding the cost associated with interest paid on deposits and other borrowings. In 2012, the Company’s loans repriced at lower rates more rapidly than did its deposits in the low interest rate environment, causing the Company’s interest rate spread to decrease. The Bank’s cost of funds rate on interest-bearing liabilities in 2012 was 15 basis points lower compared to 2011. The Bank’s yield on interest-earning assets for the year ended December 31, 2012 was 31 basis points lower than the year ended December 31, 2011 due to higher yielding assets being replaced by lower yielding assets in 2012 and repricing of existing assets in the low interest rate environment.

The net interest spread increased to 3.47% for the year ended December 31, 2011 from 3.07% for the year ended December 31, 2010. Net interest income was $12,091 ($12,178 on a tax-equivalent basis) for the year ended December 31, 2011, compared to $10,776 ($10,842 on a tax-equivalent basis) for the year ended December 31, 2010, and is attributable to interest income from loans, federal funds sold and securities exceeding the cost associated with interest paid on deposits and other borrowings. In 2011, our deposits repriced at lower rates more

rapidly than did our loans in the low rate environment, causing our interest rate spread to increase. The Bank’s cost of funds rate on interest-bearing liabilities in 2011 was 53 basis points lower compared to 2010. The Bank’s yield on interest-earning assets for the year ended December 31, 2011 was 13 basis points lower than the year ended December 31, 2010 due to higher yielding assets being replaced by lower yielding assets in 2011 and repricing of existing assets in the low rate environment.

In an effort to stimulate economic activity, the Federal Reserve has maintained interest rates at exceptionally low levels, causing the Company’s interest-earning assets and interest-bearing liabilities to reprice downward. The Company’s net interest margins expanded from 2010 to 2011 and compressed from 2011 to 2012. The Company’s lower net interest margin in 2012 was due to lower yields from new loans and investments as a result of this lower interest rate environment. The Company attempts to conserve net interest margin by product pricing strategies, such as attracting deposits with longer maturities when rates are relatively low and attracting deposits with shorter maturities when rates are relatively high, all depending on our funding needs. Many economic forecasts of interest rates including those of the Federal Open Market Committee, predict that interest rates will continue to remain at historically low levels for 2013. The Company does not expect its net interest margin to decrease further in 2013 as it expects interest-bearing liabilities to reprice downward slightly faster than interest-earning assets. While there is no guarantee of how rates may change in 2013, the Company will price products that are competitive in the market, allow for growth and strive to maintain the net interest margin as much as possible. The Company also continues to seek new sources of noninterest income to combat the effects of volatility in the interest rate environment.

The following table presents the major categories of interest-earning assets, interest-bearing liabilities and stockholders’ equity with corresponding average balances, related interest income or interest expense and resulting yield and rates for the periods indicated.

ANALYSIS OF NET INTEREST INCOME


	Years ended December 31,
	2012								2011								2010
	Average balance(1)			Interest income/ expense		Rate earned/ paid			Average balance(1)			Interest income/ expense		Rate earned/ paid			Average balance(1)			Interest income/ expense		Rate earned/ paid
Assets

Interest-earning assets:
Loans (2)(3)	$	270,077		$	14,904		5.52	%	$	268,549		$	15,726		5.86	%	$	264,604		$	15,835		5.98	%
Investment securities:
Taxable		17,574			395		2.25	%		22,170			537		2.42	%		20,456			587		2.87	%
Tax-exempt (4)		6,924			261		3.77	%		5,934			255		4.30	%		3,063			167		5.45	%
Interest-earning deposits		34,297			100		0.29	%		30,336			83		0.27	%		31,912			84		0.26	%
Federal funds sold		998			2		0.20	%		1,000			3		0.30	%		1,261			4		0.32	%


Total interest-earning assets		329,870			15,662		4.75	%		327,989			16,604		5.06	%		321,296			16,677		5.19	%

Other assets:
Allowance for loan losses		(3,829	)							(4,067	)							(3,774	)
Cash and due from banks		3,290								3,326								2,419
Other assets, net		14,791								12,359								14,058


Total assets	$	344,122							$	339,607							$	333,999


Liabilities and Stockholders’ equity
Interest-bearing liabilities:
Savings and NOW	$	136,165		$	584		0.43	%	$	127,490		$	728		0.57	%	$	113,100		$	1,271		1.12	%
Time		140,096			3,388		2.42	%		150,091			3,698		2.46	%		162,489			4,564		2.81	%
Other borrowings		—			—		—			—			—		—			—			—		—
Federal funds purchased		—			—		—			—			—		—			—			—		—

		276,261			3,972		1.44	%		277,581			4,426		1.59	%		275,589			5,835		2.12	%

Noninterest-bearing liabilities:
Demand deposits		35,544								31,522								27,884
Other liabilities		4,641								3,582								4,262

		316,446								312,685								307,735
Stockholders’ equity		27,676								26,922								26,264


	$	344,122							$	339,607							$	333,999

Net interest income				$	11,690							$	12,178							$	10,842

Net interest margin (5)							3.54	%							3.71	%							3.37	%

Net interest spread (6)							3.31	%							3.47	%							3.07	%

(1)	Averages are daily averages.

(2)	Loan interest income includes accretion of loan fees of $11 in 2012, $13 in 2011 and $30 in 2010

(3)	For the purpose of these computations, non-accrual loans are included in average loans.

(4)	Tax-exempt income from investment securities is presented on a tax-equivalent basis assuming a 34% U.S. Federal tax rate for 2012, 2011 and 2010.

(5)	The net interest margin is calculated by dividing net interest income by average total interest-earning assets.

(6)	The net interest spread is calculated by subtracting the interest rate paid on interest-bearing liabilities from the interest rate earned on interest-earning assets.

As discussed above, the Company’s net interest income is affected by the change in the amounts and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume change,” as well as by changes in yields earned on interest-earning assets and rates paid on deposits and other borrowed funds, referred to as “rate change.” The following table presents, for the periods indicated, a summary of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities and the amounts of change attributable to variations in volumes and rates.

RATE/VOLUME ANALYSIS


	Years ended December 31,
	2012 compared to 2011 increase (decrease)									2011 compared to 2010 increase (decrease)
	Volume			Rate			Net			Volume			Rate			Net
Interest earned on interest-earning assets:
Loans (1)	$	90			(912	)		(822	)		247			(356	)		(109	)
Investment securities:
Taxable		(105	)		(37	)		(142	)		59			(108	)		(49	)
Tax-exempt (2)		17			(13	)		4			113			(26	)		87
Interest-earning deposits		11			6			17			(6	)		5			(1	)
Federal funds sold		—			(1	)		(1	)		(1	)		—			(1	)

Total interest earned on interest-earning assets		13			(957	)		(944	)		412			(485	)		(73	)

Interest paid on interest-bearing liabilities:
Savings and NOW		54			(197	)		(143	)		189			(732	)		(543	)
Time		(243	)		(69	)		(312	)		(332	)		(534	)		(866	)

Total interest paid on interest-bearing liabilities		(189	)		(266	)		(455	)		(143	)		(1,266	)		(1,409	)

Change in net interest income	$	202			(691	)		(489	)		555			781			1,336

(1)	Non-accrual loans are included in the average loan totals used in the calculation of this table.

(2)	Tax-exempt income from investment securities is presented on a tax equivalent basis assuming a 34% U.S. Federal tax rate.

Provision for Loan Losses . The provision for loan losses is based upon the Company’s evaluation of the quality of the loan portfolio, total outstanding and committed loans, the Company’s previous loan loss experience and current and anticipated economic conditions. The amount of the provision for loan losses is a charge against earnings. Actual loan losses are charges against the allowance for loan losses.

The Company’s allowance for loan losses is maintained at a level deemed by management to be adequate to provide for known and inherent losses in the loan portfolio. No assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future, or that the allowance for loan losses will be adequate for actual losses. Additionally, regulatory examiners may require the Company to recognize additions to the allowance based upon their judgment about information available to them at the time of their examinations.

The provisions for loan losses for the years ended December 31, 2012, 2011 and 2010 were $1,177, $2,227 and $1,878, respectively. The provision for loan losses, although much improved in 2012, has been elevated since 2008 as management recognized and continues to recognize weaknesses in the credit quality of the loan portfolio

due to declining economic conditions, declining collateral values and the increased risk of some customer’s inability to service their loans due to job losses. The provision for loan losses decreased 47.15% from 2011 to 2012 as criticized and classified loans and loan chargeoffs decreased due to the success of an aggressive asset quality improvement plan implemented in 2011 that has led to higher loan quality. The provision for loan losses increased 18.58% from 2010 to 2011 due to a higher level of chargeoffs as management addressed problem loans with an aggressive asset quality improvement plan. The Company saw an improvement in its nonperforming loans to total loans from 1.74% on December 31, 2011 to 1.09% on December 31, 2012. Nonperforming loans were $3,014 as of December 31, 2012 and $4,711 as of December 31, 2011. The Company, however, expects to continue to see some weaknesses in its loan portfolio in 2013 and is working to minimize its losses from non-accrual and past due loans. See “Allowance for Loan Losses” for further discussion.

Noninterest Income. Total noninterest income for the year ended December 31, 2012 increased $190, or 5.84%, to $3,443 from $3,253 in 2011. The Company’s principal source of noninterest income is service charges and fees on deposit accounts, particularly transaction accounts, fees on sales of mortgage loans, and commissions and fees from investment, insurance, annuity and other bank products. The increase in 2012 is primarily attributable to the following factors: mortgage loan fees increased $177, or 39.25%, for the year ended December 31, 2012, compared to 2011; service charges on deposit accounts increased $37, or 2.56%, in 2012 compared to 2011 due mainly to a $21, or 2.78%, increase in non-sufficient funds (NSF) charges; and recoveries from sold other real estate owned increased $39 from 2011 as the Company sold 18 properties in 2012 compared to 16 properties in 2011. The increases in noninterest income were partially offset by a $92, or 12.90%, decrease in commissions and fees, mainly from investments sales and service charges on loan accounts which decreased by $8 in 2012 compared to 2011.

Total noninterest income for the year ended December 31, 2011 increased $119, or 3.80%, to $3,253 from $3,134 in 2010. The increase in 2011 is primarily attributable to the following factors. Commissions and fees increased $189 for the year ended December 31, 2011, compared to 2010, and were mainly derived from investment sales. Service charges on loan accounts increased by $11 due to slightly higher loan volume in 2011 compared with 2010. Recoveries from sold other real estate owned increased $134 from 2010 as the Company sold 16 properties in 2011 compared to 5 properties in 2010. The increases in noninterest income were partially offset by a $55 or 3.67% decreases in service charges on deposit accounts and a $120 or 21.02% decrease in mortgage loan fees.

Noninterest Expense. Total noninterest expense for the year ended December 31, 2012 increased $366, or 3.17%, to $11,910 from $11,544 in 2011. The increase in noninterest expense is primarily due to a $376, or 293.76%, increase in other losses attributable to sales of foreclosed property (OREO). Cost of foreclosures increased $37 or 27.82%. Advertising increased $87 or 84.47% as more emphasis was focused on television, radio and internet advertising. Office supplies and printing increased $26 or 12.21%, due to computer and tablet purchases. The increase in noninterest expense was partially offset by a $141, or 2.25%, decrease in salaries and employee benefits as retirement expense decreased $107 or 18.87%. Additionally, Federal Deposit Insurance Corporation (FDIC) premiums decreased a $105, or 25.42%, and furniture and equipment expense decreased $38, or 3.59%.

Total noninterest expense for the year ended December 31, 2011 increased $507, or 4.59%, to $11,544 from $11,037 in 2010. The increase in noninterest expense is primarily attributable to a $222 increase in retirement plan expense included in the $295, or 4.94%, increase in salary and benefits. Costs and losses attributed to foreclosed properties increased $123 and debit card losses increased $51. Furniture and Equipment increased $58 due to repairs. The increase in noninterest expense was partially offset by an $88, or 17.56%, decrease in FDIC premiums, a $64, or 23.10%, decrease in office supplies, a $32, or 4.32%, decrease in occupancy expense and a $19, or 15.57%, decrease in advertising expense.

Income Tax Expense . Applicable income taxes on 2012 earnings amounted to $619, resulting in an effective tax rate of 31.63% compared to $510, or 32.42%, in 2011. The effective tax rate for 2012 is a function of the effects of interest earned on tax-exempt securities and income earned from bank-owned life insurance.

Applicable income taxes on 2011 earnings amounted to $510, resulting in an effective tax rate of 32.42% compared to $308, or 30.95%, in 2010. The effective tax rate for 2011 is a function of the higher net income earned in 2011 than in 2010 and the effects of interest earned on tax-exempt securities.

Liquidity and Asset/Liability Management

Effective asset/liability management includes maintaining adequate liquidity and minimizing the impact of future interest rate changes on net interest income. The responsibility for monitoring the Company’s liquidity and the sensitivity of its interest-earning assets and interest-bearing liabilities lies with the Investment Committee of the Bank which meets at least quarterly to review liquidity and the adequacy of funding sources.

Cash Flows . The Company derives cash flows from its operating, investing and financing activities. Cash flows of the Company are primarily used to fund loans and purchase securities and are provided by the deposits and borrowings of the Company.

The Company’s operating activities for the year ended December 31, 2012 resulted in net cash provided from operating activities of $3,647 compared to net cash provided from operating activities of $4,127 in 2011, a decrease of $480, or 11.63%. This decrease is primarily attributable to cash received from net interest income of $11,672, which is $484 lower than in 2011, cash paid for noninterest expense of $11,417, which is $1,965 higher than in 2011, and cash paid for income taxes of $834 compared to cash received from income taxes of $111 in 2011. These were partially offset by cash received from noninterest income of $4,143, which was $2,915 higher than 2011. Management expects the Company to continue to provide cash from operating activities in 2013 through deposit pricing strategies and continued focus on improving the efficiency of the Company’s operations.

The Company’s cash flows from investing activities for the year ended December 31, 2012 resulted in net cash used of $10,093, compared to net cash used of $2,552 in 2011. The increase is primarily attributable to a $9,349 increase in cash used to make loans to customers and a $3,000 purchase of bank owned life insurance. The Company experienced more maturities and calls from available-for sale securities and more paydowns of maturities and sales of available-for-sale mortgage-backed securities in 2012. The Company expects a lower volume of paydowns in available-for-sale mortgage-backed securities in 2013 due to fewer mortgage-backed securities in the investment portfolio.

Net cash provided by financing activities for the year ended December 31, 2012 was $4,689, compared to net cash provided by financing activities of $3,439 in 2011. The increase in net cash provided is primarily attributable to a lower decrease in time deposits from 2011 to 2012 as compared to the increase from 2010 to 2011. This was partially offset by a smaller increase in demand, savings and NOW deposits from 2011 to 2012.

The Company’s operating activities for the year ended December 31, 2011 resulted in net cash provided from operating activities of $4,127 compared to net cash provided from operating activities of $3,706 in 2010, an increase of $421. This increase is primarily attributable to cash received from net interest income of $12,156, which is $1,294 higher than in 2010. The increase in net cash provided from operating activities is also due to cash paid for noninterest expense of $9,452, which is $1,533 lower than in 2010, and from cash received from income taxes of $111 compared to cash paid for income taxes of $1,283 in 2010. These were partially offset by cash received from noninterest income of $1,228, which was $3,794 lower than 2010. Management expects continued increases in the Company’s cash provided by operating activities through deposit pricing strategies and continued focus on improving the efficiency of the Company’s operations.

The Company’s cash flows from investing activities for the year ended December 31, 2011 resulted in net cash used of $2,552, compared to net cash used of $7,993 in 2010. The decrease is primarily attributable to a $3,223 increase in cash used to make loans to customers. The Company experienced more maturities and calls from available-for sale securities and more paydowns of maturities and sales of available-for-sale mortgage-backed securities in 2011. The Company expects a lower volume of paydowns in available-for-sale mortgage-backed securities in 2012 due to fewer mortgage-backed securities in the investment portfolio.

Net cash provided by financing activities for the year ended December 31, 2011 was $3,439, compared to net cash provided by financing activities of $4,760 in 2010. The decrease in net cash provided is primarily attributable to an accelerated decrease in time deposits from 2010 to 2011 as compared to the change from 2009 to 2010. This was partially offset by net increases in demand, savings and NOW deposits from 2010 to 2011.

Liquidity . Liquidity measures the ability of the Company to meet its maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers’ credit needs. Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds from alternative funding sources.

The Company’s liquidity is provided by cash and due from banks, federal funds sold, investments available-for-sale, managing investment maturities, interest-earning deposits in other financial institutions and loan repayments. The Company’s ratio of liquid assets to deposits and short-term borrowings was 15.30% as of December 31, 2012 as compared to 17.33% as of December 31, 2011. The Company sells excess funds as overnight federal funds sold to provide an immediate source of liquidity. Federal funds sold at December 31, 2012 and 2011 was $0 as funds were kept in the Company’s Federal Reserve account, which is interest-bearing. Cash and due from banks of $35,790, which includes funds in the Company’s Federal Reserve account, as of December 31, 2012 was $1,757 lower when compared to December 31, 2011. The Company expects to deploy some of this cash into securities and loans in 2013.

The level of deposits may fluctuate significantly due to seasonal business cycles of depository customers. Levels of deposits are also affected by convenience of branch locations and ATMs to the customer, the rates offered on interest-bearing deposits and the attractiveness of noninterest-bearing deposit offerings compared with the competition. Similarly, the level of demand for loans may vary significantly and at any given time may increase or decrease substantially. However, unlike the level of deposits, management has more direct control over lending activities and maintains the level of those activities according to the amounts of available funds. Loan demand may be affected by the overall health of the local economy, loan rates compared with the competition and other loan features offered by the Company.

As a result of the Company’s management of liquid assets and its ability to generate liquidity through alternative funding sources, management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors’ requirements and to meet customers’ credit needs. Additional sources of liquidity available to the Company include its capacity to borrow funds through correspondent banks and the Federal Home Loan Bank. The total amount available for borrowing to the Company for liquidity purposes was $65,210 on December 31, 2012.

The Company obtains sources of funds through growth in deposits, scheduled payments and prepayments from the loan and investment portfolios and retained earnings growth, and may purchase or borrow funds from the Federal Home Loan Bank or through the Federal Reserve’s discount window. The Company also has sources of liquidity through three correspondent banking relationships. The Company uses its funds to fund loan and investment growth. Excess funds are sold daily to other institutions. The Company also has a $5,000 holding company line of credit with a correspondent bank for bank capital purposes with an outstanding balance of $1,900 on December 31, 2012 and $2,000 on December 31, 2011.

Contractual Obligations

The Company has entered into certain contractual obligations including long-term debt and operating leases. The table does not include deposit liabilities entered into in the ordinary course of banking. Operating Leases include leases of our Amherst, Timberlake and Wyndhurst facilities. Also included are contractual leases for offsite ATMs and postage machinery. The following table summarizes the Company’s contractual obligations as of December 31, 2012.


Pinnacle Bankshares Corporation Line of Credit	2013	$	1,900

Operating Leases


Year	Payments
2013	$	141
2014		141
2015		141
2016		149
2017		152
After 2018		1,709

Total	$	2,433

Interest Rates

While no single measure can completely identify the impact of changes in interest rates on net interest income, one gauge of interest rate sensitivity is to measure, over a variety of time periods, the differences in the amounts of the Company’s rate-sensitive assets and rate-sensitive liabilities. These differences or “gaps” provide an indication of the extent to which net interest income may be affected by future changes in interest rates. A “positive gap” exists when rate-sensitive assets exceed rate-sensitive liabilities and indicates that a greater volume of assets than liabilities will reprice during a given period. This mismatch may enhance earnings in a rising interest rate environment and may inhibit earnings in a declining interest rate environment. Conversely, when rate-sensitive liabilities exceed rate-sensitive assets, referred to as a “negative gap,” it indicates that a greater volume of liabilities than assets will reprice during the period. In this case, a rising interest rate environment may inhibit earnings and a declining interest rate environment may enhance earnings. The cumulative one-year gap as of December 31, 2012 was $38,688, representing 11.10% of total assets. This positive gap falls within the parameters set by the Company.

The following table illustrates the Company’s interest rate sensitivity gap position at December 31, 2012.

REPRICING GAP POSITION


	Repricing period at December 31, 2004
	1 year		1-3 years			3-5 years		5-15 years
ASSET/(LIABILITY):
Cumulative interest rate sensitivity gap	$	38,688		(9,015	)		21,065		45,641

As of December 31, 2012, the Company was asset-sensitive in all periods up to 15 years except the 1-3 year period. The foregoing table does not necessarily indicate the impact of general interest rate movements on the Company’s net interest yield, because the repricing of various categories of assets and liabilities is discretionary and is subject to competition and other pressures. As a result, various assets and liabilities indicated as repricing within the same period may reprice at different times and at different rate levels. Management attempts to mitigate the impact of changing interest rates in several ways, one of which is to manage its interest rate-sensitivity gap. In addition to managing its asset/liability position, the Company has taken steps to mitigate the impact of changing interest rates by generating noninterest income through service charges, and offering products that are not interest rate-sensitive.

Effects of Inflation

The effect of changing prices on financial institutions is typically different from other industries as the Company’s assets and liabilities are monetary in nature. Interest rates are significantly impacted by inflation, but neither the timing nor the magnitude of the changes is directly related to price level indices. Impacts of inflation on interest rates, loan demand and deposits are not reflected in the consolidated financial statements.

Investment Portfolio

The Company’s investment portfolio is used primarily for investment income and secondarily for liquidity purposes. The Company invests funds not used for capital expenditures or lending purposes in securities of the U.S. Government and its agencies, mortgage-backed securities, taxable and tax-exempt municipal bonds, corporate securities or certificates of deposit. Obligations of the U.S. Government and its agencies include treasury notes and callable or noncallable agency bonds. The mortgage-backed securities include mortgage-backed security pools that are diverse as to interest rates. The Company has not invested in derivatives.

Investment securities available-for-sale as of December 31, 2012 totaled $15,246, a decrease of $3,534 or 18.82% from $18,780 as of December 31, 2011. Investment securities held-to-maturity increased to $6,960 as of December 31, 2012 from $5,989 as of December 31, 2011, an increase of $971 or 16.21%. Available-for-sale securities decreased in 2012 as calls and pay downs were not fully used to buy additional bonds but were utilized to fund loan growth. Held-to-maturity securities increased in 2012 as the Company purchased taxable and tax-exempt bonds in 2012 which are normally classified as held-to-maturity.

The following table presents the composition of the Company’s investment portfolios as of the dates indicated.


	December 31,
	2012				2011				2010
	Amortized cost		Fair value		Amortized cost		Fair value		Amortized cost		Fair value
Available-for-Sale
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	11,150		11,411		14,567		14,738		17,247		17,196
Obligations of states and political subdivisions		2,816		2,999		2,841		2,980		3,381		3,471
Mortgage-backed securities – government		668		726		875		952		1,211		1,271
Other securities		110		110		110		110		110		110

Total available-for-sale	$	14,744		15,246		18,393		18,780		21,949		22,048


	December 31,
	2012				2011				2010
	Amortized cost		Fair value		Amortized cost		Fair value		Amortized cost		Fair value
Held-to-Maturity
Obligations of states and political subdivisions	$	6,960		7,178		5,989		6,165		4,469		4,400

Total held-to-maturity	$	6,960		7,178		5,989		6,165		4,469		4,400

The following table presents the maturity distribution based on fair values and amortized costs of the investment portfolios as of the dates indicated.

INVESTMENT PORTFOLIO – MATURITY DISTRIBUTION


	December 31, 2012
	Amortized Cost		Fair Value		Yield
Available-for-Sale
U.S. Treasury securities and obligations of U.S. Government corporations:
After one but within five years	$	10,150		10,407		2.30	%
After five years through ten years		1,000		1,004		2.00	%
Obligations of states and political subdivisions (1):
Within one year		100		101		4.20	%
After one but within five years		1,240		1,269		5.44	%
After five years through ten years		989		1,043		3.71	%
After ten years		487		586		5.17	%
Mortgage-backed securities – government		668		726		4.52	%
Other securities (2)		110		110		—

Total available-for-sale	$	14,744		15,246


Held-to-Maturity
Obligations of states and political subdivisions (1):
Within one year		705		708		2.88	%
After one but within five years		4,406		4,478		3.05	%
After five years through ten years		1,849		1,992		4.18	%

Total held-to-maturity	$	6,960		7,178

(1)	Obligations of states and political subdivisions include yields of tax–exempt securities presented on a tax-equivalent basis assuming a 34% U.S. Federal tax rate.

(2)	Equity securities are assumed to have a life greater than ten years.

Loan Portfolio

The Company’s net loans were $273,672 as of December 31, 2012, an increase of $6,549, or 2.45%, from $267,123 as of December 31, 2011. This increase resulted primarily from an increased volume of commercial loan originations during 2012. The Company’s ratio of net loans to total deposits was 86.84% as of December 31, 2012 compared to 86.06% as of December 31, 2011.

Typically, the Company maintains a ratio of loans to deposits of between 80% and 100%. The loan portfolio primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate), and loans to individuals for household, family and other consumer expenditures. However, the Company adjusts its mix of lending and the terms of its loan programs according to market conditions and other factors. The Company’s loans are typically made to businesses and individuals located within the Company’s market area, most of whom have account relationships with the Bank. There is no concentration of loans exceeding 10% of total loans that is not disclosed in the categories presented below. The Company has not made any loans to any foreign entities including governments, banks, businesses or individuals. Commercial and construction loans in the Company’s portfolio are primarily variable rate loans and have little interest rate risk.

The Company had no option adjustable rate mortgages, subprime loans or loans with teaser rates and similar products as of December 31, 2012. Junior lien mortgages totaled $23,022 as of December 31, 2012 with a specific allowance for loan loss calculation of $217. The Company had interest only loans totaling $12,331 as of December 31, 2012. Residential mortgage loans with a loan to collateral value ratio exceeding 100% were $2,727 as of December 31, 2012.

The following table presents the composition of the Company’s loan portfolio as of the dates indicated.

LOAN PORTFOLIO


	December 31,
	2012			2011			2010			2009			2008
Real estate loans:
Residential real estate	$	114,864			116,006			111,369			116,259			117,806
Commercial real estate		86,283			86,293			87,216			81,219			86,915
Loans to individuals for household, family and other consumer expenditures		48,234			46,954			47,545			50,097			54,329
Commercial and industrial loans		28,054			21,756			22,794			21,589			23,820
All other loans		—			238			262			612			514

Total loans, gross		277,435			271,247			269,186			269,776			283,384
Less unearned income and fees		(117	)		(109	)		(119	)		(149	)		(216	)

Loans, net of unearned income and fees		277,318			271,138			269,067			269,627			283,168
Less allowance for loan losses		(3,646	)		(4,015	)		(4,037	)		(3,723	)		(3,969	)

Loans, net	$	273,672			267,123			265,030			265,904			279,199

Commercial and Industrial Loans . Commercial and industrial loans accounted for 10.11% of the Company’s gross loan portfolio as of December 31, 2012 compared to 8.02% as of December 31, 2011. Such loans are generally made to provide operating lines of credit, to finance the purchase of inventory or equipment, and for other business purposes. Commercial loans are primarily made at rates that adjust with changes in the prevailing prime interest rate, are generally made for a maximum term of five years (unless they are term loans), and generally require interest payments to be made monthly. The creditworthiness of these borrowers is reviewed, analyzed and evaluated on a periodic basis. Most commercial loans are collateralized with business assets such as accounts receivable, inventory and equipment. Even with substantial collateralization such as all of the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business.

Real Estate Loans . Real estate loans accounted for 72.50% of the Company’s gross loan portfolio as of December 31, 2012 compared to 74.58% as of December 31, 2011. The Company makes commercial real estate term loans that are typically secured by a first deed of trust.

As of December 31, 2012, 57.10% of the real estate loans were secured by 1-4 family residential properties. Of these 1-4 family residential property loans, 8.37% were construction loans, 32.14% were home equity lines of credit, 55.67% were closed end loans secured by a first deed of trust and 3.82% were closed end loans secured by a second deed of trust.

As of December 31, 2012, 42.90% of the real estate loans were secured by commercial real estate. Of the total commercial real estate loans as of December 31, 2012, 28.98% were acquisition and development loans, 12.06% were secured by farmland, 42.91% were secured by owner occupied commercial real estate and 16.05% were secured by non-owner occupied commercial real estate, typically 1 ^st and 2 ^nd deeds of trust.

Real estate lending involves risk elements when there is lack of timely payment and/or a decline in the value of the collateral. Both commercial and residential real estate values in the Company’s market improved slightly in 2012. The Company is still seeing evidence of some borrowers being strained in their ability to service loans although this improved in 2012. These factors along with a slightly improved local economy have resulted in a lower number of net chargeoffs in 2012. The Company continuously monitors the local real estate market for signs of weakness that could decrease collateral values.

Installment Loans . Installment loans are represented by loans to individuals for household, family and other consumer expenditures with typical collateral such as automobile titles. Installment loans accounted for 17.39% of the Company’s loan portfolio as of December 31, 2012 compared to 17.31% as of December 31, 2011.

Loan Maturity and Interest Rate Sensitivity . The following table presents loan portfolio information related to maturity distribution of commercial and industrial loans and real estate construction loans based on scheduled repayments at December 31, 2012.

LOAN MATURITY


	Due within one year		Due one to five years		Due after five years		Total
Commercial and industrial loans	$	26,409	$	1,488	$	157	$	28,054
Real estate – construction		9,618		—		—		9,618

The following table presents the interest rate sensitivity of commercial and industrial loans and real estate construction loans maturing after one year or longer as of December 31, 2012.

INTEREST RATE SENSITIVITY


Fixed interest rates	$	1,629
Variable interest rates		16

Total maturing after one year	$	1,645

Loan Modifications and Troubled Debt Restructurings. The Company had three restructured loans totaling $1,756 at December 31, 2012 and had four restructured loans totaling $3,766 at December 31, 2011.

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories.

Rate Modification is a modification in which the interest rate is changed.

Term Modification is a modification in which the maturity date, timing of payments or frequency of payments is changed.

Interest Only Modification is a modification in which the loan is converted to interest only payments for a period of time.

Payment Modification is a modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification is any other type of modification, including the use of multiple categories above.

There were no available commitments for troubled debt restructurings outstanding as of December 31, 2012 or December 31, 2011.

Nonperforming Assets . Interest on loans is normally accrued from the date a disbursement is made and recognized as income as it is earned. Generally, the Company reviews any loan on which payment has not been made for 90 days for potential nonaccrual. The loan is examined and the collateral is reviewed to determine loss potential. If the loan is placed on nonaccrual status, any prior accrued interest that remains unpaid is reversed. Loans on nonaccrual status amounted to $2,843, $4,708 and $7,073 as of December 31, 2012, 2011 and 2010, respectively. Interest income that would have been earned on nonaccrual loans if they had been current in accordance with their original terms and the recorded interest that was included in income on these loans was not significant for 2012, 2011 or 2010. There were no commitments to lend additional funds to customers whose loans were on nonaccrual status at December 31, 2012. Sixteen foreclosed properties totaling $2,393 were on hand as of December 31, 2012 compared to eight properties totaling $645 as of December 31, 2011 and five properties totaling $474 as of 2010.

The recession that began in 2008 and subsequent economic conditions have led to an elevated level in the Company’s nonperforming assets over the last three years. Some commercial borrowers have struggled to service their loans due to the difficult business climate, lower revenues, tightening of credit markets and difficulties in

moving their products. Some noncommercial borrowers have experienced job losses and other economic challenges, as well. The Company expects nonperforming assets to decrease in 2013 as the local economy continues to recover. The Company will continue to monitor the situation and take steps necessary to mitigate losses in its loan portfolio, such as increased early monitoring of its portfolio to identify “problem” credits and continued counseling of customers to discuss options available to them. The following table presents information with respect to the Company’s nonperforming assets and nonaccruing loans 90 days or more past due by type as of the dates indicated.

NONPERFORMING ASSETS


			December 31,
	2012		2011		2010
Nonaccrual loans	$	2,843		4,708		7,073
Loans 90 days or more past due		171		3		770
Foreclosed properties		2,393		645		474

Total nonperforming assets	$	5,407		5,356		8,317

Nonperforming assets totaled $5,407, or 1.55%, of total assets as of December 31, 2012, compared to $5,356, or 1.56%, as of December 31, 2011 and $8,317, or 2.47%, as of December 31, 2010. The following table presents the balance of accruing loans 90 days or more past due by type as of the dates indicated.

ACCRUING LOANS 90 DAYS OR MORE

PAST DUE BY TYPE


			December 31,
	2012		2011		2010
Loans 90 days or more past due by type:
Real estate loans	$	171		—		732
Loans to individuals		—		3		38
Commercial loans		—		—		—

Total accruing loans 90 days or more past due	$	171		3		770

Allowance for Loan Losses . The Company maintains an allowance for loan losses which it considers adequate to cover the risk of losses in the loan portfolio. The allowance is based upon management’s ongoing evaluation of the quality of the loan portfolio, total outstanding and committed loans, previous charges against the allowance and current and anticipated economic conditions. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance. The Company’s management believes that as of December 31, 2012, 2011 and 2010, the allowance was adequate. The amount of the provision for loan losses is a charge against earnings. Actual loan losses are charged against the allowance for loan losses.

Management evaluates the reasonableness of the allowance for loan losses on a monthly basis and adjusts the provision as deemed necessary in accordance with generally accepted accounting principles, as well as industry standards. Management uses historical loss data by loan type as well as current economic factors in its calculation of allowance for loan loss. Management also uses qualitative factors such as changes in lending policies and procedures, changes in national and local economies, changes in the nature and volume of the loan portfolio, changes in experience of lenders and the loan department, changes in volume and severity of past due and classified loans, changes in quality of the Bank’s loan review system, the existence and effect of concentrations of credit and external factors such as competition and regulation in its allowance for loan loss calculation. Each qualitative factor is evaluated and applied to each type of loan in the Company’s portfolio and a percentage of each loan is reserved as allowance. A percentage of each loan is also reserved according to the loan type’s historical loss data. Larger percentages of allowance are taken as the risk for a loan is determined to be greater. As of December 31, 2012, the allowance for loan losses totaled $3,646, or 1.31%, of total loans, net of unearned income and fees, compared to $4,015, or 1.48%, of total loans, net of unearned income and fees, as of December 31, 2011. The provision for loan losses for the years ended December 31, 2012 and 2011 was $1,177 and $2,227, respectively. Net charge-offs for the Company were $1,546 and $2,249 for the years ended

December 31, 2012 and 2011, respectively. The ratio of net loan charge-offs during the period to average loans outstanding for the period was 0.57% and 0.84% for the years ended December 31, 2012 and 2011, respectively.

As of December 31, 2011, the allowance for loan losses totaled $4,015 or 1.48% of total loans, net of unearned income and fees compared to $4,037 or 1.50% of total loans, net of unearned income and fees as of December 31, 2010. The provision for loan losses for the years ended December 31, 2011 and 2010 was $2,227 and $1,878, respectively. Net charge-offs for the Company were $2,249 and $1,564 for the years ended December 31, 2011 and 2010, respectively. The ratio of net loan charge-offs during the period to average loans outstanding for the period was 0.84% and 0.59% for the years ended December 31, 2011 and 2010, respectively.

The following table presents charged off loans, provisions for loan losses, recoveries on loans previously charged off, allowance adjustments and the amount of the allowance for the years indicated.

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES


				December 31,
	2012			2011			2010			2009			2008
Balance at beginning of year	$	4,015			4,037			3,723			3,969			1,720

Loan charge-offs:
Real estate loans – residential		(1,218	)		(1,412	)		(774	)		—			—
Real estate loans – commercial		(345	)		(461	)		(315	)		(1,252	)		(252	)
Commercial and industrial loans		(84	)		(109	)		(232	)		(112	)		(200	)
Loans to individuals for household, family and other consumer expenditures		(404	)		(505	)		(444	)		(693	)		(353	)

Total loan charge-offs		(2,051	)		(2,487	)		(1,765	)		(2,057	)		(805	)

Loan recoveries:

Real estate loans – residential		216			27			12			—			—
Real estate loans – commercial		114			4			8			80			33
Commercial and industrial loans		1			37			37			37			25
Loans to individuals for household, family and other consumer expenditures		174			170			144			164			115

Total recoveries		505			238			201			281			173

Net loan charge-offs		(1,546	)		(2,249	)		(1,564	)		(1,776	)		(632	)

Provisions for loan losses		1,177			2,227			1,878			1,530			2,881

Balance at end of year	$	3,646			4,015			4,037			3,723			3,969

The following table presents net charge offs to average loans net of unearned income and fees.


	2012			2011			2010			2009			2008
Net charge-offs to average loans, net of unearned income and fees		0.57	%		0.84	%		0.59	%		0.65	%		0.24	%

The primary risk elements considered by management with respect to each installment and conventional real estate loan are lack of timely payment and the value of the collateral. The primary risk elements with respect to real estate construction loans are fluctuations in real estate values in the Company’s market areas, inaccurate estimates of construction costs, fluctuations in interest rates, the availability of conventional financing, the demand for housing in the Company’s market area and general economic conditions. The primary risk elements with respect to commercial loans are the financial condition of the borrower, general economic conditions in the Company’s market area, the sufficiency of collateral, the timeliness of payment and, with respect to adjustable rate loans, interest rate fluctuations. Management has a policy of requesting and reviewing annual financial statements from its commercial loan customers and periodically reviews the existence of collateral and its value at least annually. Management also has a reporting system that monitors all past due loans and has adopted policies to pursue its creditor’s rights in order to preserve the Company’s position. Management also recognizes the real estate values may decline in the Company’s markets and is diligently monitoring appraisal values at least annually.

Loans are charged against the allowance when, in management’s opinion, they are deemed uncollectible, although the Company continues to aggressively pursue collection. The Company considers a number of factors to determine the need for and timing of charge-offs including the following: whenever any commercial loan becomes past due for 120 days for any scheduled principal or interest payment and collection is considered uncollectible; whenever foreclosure on real estate collateral or liquidation of other collateral does not result in full payment of the obligation and the deficiency or some portion thereof is deemed uncollectible, the uncollectible portion is charged-off; whenever any installment loan becomes past due for 120 days and collection is considered unlikely; whenever any repossessed vehicle remains unsold for 60 days after repossession; whenever a bankruptcy notice is received on any installment loan and review of the facts results in an assessment that all or most of the balance will not be collected, the loan will be placed in non-accrual status; whenever a bankruptcy notice is received on a small, unsecured, revolving installment account; and whenever any other small, unsecured, revolving installment account becomes past due for 180 days.

Although management believes that the allowance for loan losses is adequate to absorb losses as they arise, there can be no assurance that (i) the Company will not sustain losses in any given period which could be substantial in relation to the size of the allowance for loan losses, (ii) the Company’s level of nonperforming loans will not increase, (iii) the Company will not be required to make significant additional provisions to its allowance for loan losses, or (iv) the level of net charge-offs will not increase and possibly exceed applicable reserves.

The following table presents the allocation of the allowance for loan losses as of the dates indicated. Notwithstanding these allocations, the entire allowance for loan losses is available to absorb charge-offs in any category of loans.


	December 31, 2012					December 31, 2011					December 31, 2010					December 31, 2009					December 31, 2008
	Allowance for loan losses		Percent of loans in each category to total loans			Allowance for loan losses		Percent of loans in each category to total loans			Allowance for loan losses		Percent of loans in each category to total loans			Allowance for loan losses		Percent of loans in each category to total loans			Allowance for loan losses		Percent of loans in each category to total loans
Real estate loans:
Residential	$	1,410		41.40	%		1,614		42.76	%		1,631		41.37	%		2,179		43.10	%		1,530		41.57	%
Commercial		1,119		31.10	%		1,489		31.81	%		1,723		32.40	%		1,042		30.11	%		1,231		30.67	%
Loans to individuals for households, family and other consumer expenditures		445		17.39	%		393		17.31	%		424		17.66	%		293		18.57	%		635		19.17	%
Commercial and industrial loans		324		10.11	%		448		8.02	%		259		8.47	%		209		8.00	%		573		8.41	%
All other loans		—		0.00	%		1		0.10	%		—		0.10	%		—		0.22	%		—		0.18	%
Unallocated		348		—			70		—			—		—			—		—			—		—

Totals	$	3,646		100.00	%		4,015		100.00	%		4,037		100.00	%		3,723		100.00	%		3,969		100.00	%

While consumer related charge-offs represent many of the charge-offs over the last three years, they are of a relatively low dollar amount on an individual loan basis. Commercial and real estate loans on the other hand, though relatively few in terms of the number of charge-offs over the past three years, have the potential to greatly impact the allowance if a particular loan defaults. Bank management uses the principles of the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) topic Receivables , when determining the allocation of allowance for loan losses between loan categories. The determination of a loan category’s allowance is based on the probability of a loan’s default and the probability of loss in the event of a default.

Credit Risk Management

The risk of nonpayment of loans is an inherent aspect of commercial banking. The degree of perceived risk is taken into account in establishing the structure of, and interest rates and security for, specific loans and various types of loans. The Company strives to minimize its credit risk exposure by its credit underwriting standards and

loan policies and procedures. Management continually evaluates the credit risks of its loans and believes it has provided adequately for the credit risks associated with these loans. The Company has implemented and expects to continue to implement and update new policies and procedures to maintain its credit risk management systems.

Bank Premises and Equipment

Bank premises and equipment decreased 3.43% in 2012 due to normal depreciation and no major purchases compared to a decrease of 5.70% in 2011, due also to normal depreciation and no major purchases. The Company is leasing the Timberlake and Amherst branch facilities. In early 2008, the Company began leasing a building in the Wyndhurst section of Lynchburg for administrative and training purposes. In April 2012, the Company’s Vista branch facility was destroyed by fire. Most all of the Bank premises and equipment were fully depreciated and a majority of the cost to rebuild the fire is covered by the Company’s insurance policy. The bank is currently operating the branch out of a temporary facility. The Company expects construction on the new Vista facility to be completed by May 2013.

Deposits

Average deposits were $311,805 for the year ended December 31, 2012, an increase of $2,702 or 0.87% from $309,103 of average deposits for the year ended December 31, 2011. As of December 31, 2012, total deposits were $315,157 representing an increase of $4,764, or 1.53%, from $310,393 in total deposits as of December 31, 2011. The change in deposits during 2012 was primarily due to increased deposit balances in previously existing deposit accounts, new deposit accounts opened as a result of new banking relationships, growth at the Company’s newer branch locations, competitive pricing of the Company’s products and services and the continued success of our KaChing! Rewards checking product.

For the year ended December 31, 2012, average demand deposits were $35,544, or 11.40%, of average deposits. For the year ended December 31, 2011, average demand deposits were $31,522, or 10.20%, of average deposits. Average interest-bearing deposits were $276,261 for the year ended December 31, 2012, representing a decrease of $1,320, or 0.48%, over the $277,581 in average interest-bearing deposits for the year ended December 31, 2011.

The levels of demand deposits (including retail accounts) are influenced by such factors as customer service, service charges and the availability of banking services. No assurance can be given that the Company will be able to maintain its current level of demand deposits. Competition from other banks, credit unions and thrift institutions as well as money market funds, some of which offer interest rates substantially higher than the Company, makes it difficult for the Company to maintain the current level of demand deposits. Management continually works to implement pricing and marketing strategies designed to control the cost of interest-bearing deposits and to maintain a stable deposit mix.

The following table presents the Company’s average deposits and the average rate paid for each category of deposits for the periods indicated.


	AVERAGE DEPOSIT INFORMATION
	Year ended		Year ended								Year ended
	December 31, 2012		December 31, 2011								December 31, 2010
	Average amount of deposits(1)		Average rate paid			Average amount of deposits(1)		Average rate paid			Average amount of deposits(1)		Average rate paid
Demand deposits		35,544		N/A			31,522		N/A			27,884		N/A
Savings and NOW deposits		136,165		0.43	%		127,490		0.57	%		113,100		1.12	%
Time deposits:
Under $100,000		94,324		2.20	%		104,555		2.24	%		113,767		2.69	%
$100,000 and over		45,772		2.87	%		45,536		2.97	%		48,722		3.10	%

Total average time deposits		140,096					150,091					162,489

Total average deposits	$	311,805					309,103					303,473

(1)	Averages are daily averages.

The following table presents the maturity schedule of time certificates of deposit of $100,000 and over and other time deposits of $100,000 and over as of December 31, 2012.

TIME DEPOSITS OF $100,000 AND OVER


	Certificates of deposit		Other time deposits		Total
Three months or less	$	2,719		611		3,330
Over three through six months		3,666		2,254		5,920
Over six through 12 months		10,203		7,406		17,609
Over 12 months		11,155		7,546		18,701

Total time deposits of $100,000 and over	$	27,743		17,817		45,560

Financial Ratios

The following table presents certain financial ratios for the periods indicated.

RETURN ON EQUITY AND ASSETS


	Years ended
	December 31,
	2012			2011			2010
Return on average assets		0.39	%		0.31	%		0.21	%
Return on average equity		4.83	%		3.95	%		2.62	%
Dividend payout ratio		5.61	%		0.00	%		10.92	%
Average equity to average assets		8.04	%		7.93	%		7.88	%

Capital Resources

The Company’s financial position at December 31, 2012 reflects liquidity and capital levels currently adequate to fund anticipated funding needs and budgeted growth of the Company. Capital ratios are in excess of required regulatory minimums for a “well-capitalized” institution. The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the Company’s capital is reviewed by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

The primary indicators relied on by bank regulators in measuring the capital position are the Tier 1 capital, total risk-based capital and leverage ratios. Tier 1 capital consists generally of common and qualifying preferred stockholders’ equity less goodwill. Total capital generally consists of Tier 1 capital, qualifying subordinated debt and a portion of the allowance for loan losses. Risk-based capital ratios are calculated with reference to risk-

weighted assets. The Company’s Tier 1 capital ratio was 10.15% at December 31, 2012 and 9.99% at December 31, 2011. The total capital ratio was 11.39% at December 31, 2012 and 11.24% at December 31, 2011.

These ratios exceed the mandated minimum requirements of 4% and 8%, respectively. As of December 31, 2012 and 2011, the Company and Bank met all regulatory capital ratio requirements and were considered “well capitalized” in accordance with the Federal Deposit Insurance Corporation Improvement Act.

Stockholders’ equity was $28,089 at December 31, 2012 compared to $26,947 at December 31, 2011.

The leverage ratio consists of Tier 1 capital divided by quarterly average assets. At December 31, 2012, the Company’s leverage ratio was 8.49% compared to 8.12% at December 31, 2011. Each of these leverage ratios exceeds the required minimum leverage ratio of 4%. The dividend payout ratio was 5.61% and 0.00% in 2012 and 2011, respectively, with the increase due to a $0.05 per share dividend paid in the fourth quarter of 2012. The Company paid no dividends in 2011 as the Company held retained earnings to build and further improve capital levels.

Off-Balance Sheet Arrangements

The Company did not use any interest rate ceiling, floor or interest rate swap financial derivatives during 2012 and 2011. However, the Company, as a normal business practice in 2012, has mortgage rate lock commitments that are subsequently funded by the Company. The Company then sells the mortgage loan to a secondary market bank that had underwritten the mortgage loan before the Company funded the loan. The secondary market bank pays a fee that was agreed upon on the lock commitment date to the Company and buys the loan within five days of the initial funding by the Company. As of December 31, 2012, the Company had $3,002 in lock commitments that had not yet been funded with agreed upon fees of $49 to be paid to the Company after the loan was purchased by the secondary market bank. Also, the Company has off-balance sheet arrangements that may have a material effect on the results of operations in the future. The Company, in the normal course of business, may at times be a party to financial instruments such as standby letters of credit. Standby letters of credit as of December 31, 2012 equaled $2,475 compared with $963 as of December 31, 2011. Other commitments include commitments to lend money. Not all of these commitments will be acted upon; therefore, the cash requirements will likely be significantly less than the commitments themselves. As of December 31, 2012, the Company had unused loan commitments of $60,168 including $28,403 in unused commitments with an original maturity exceeding one year compared with $54,161 including $28,696 in unused commitments with an original maturity exceeding one year as of December 31, 2011. See Note 9 of the Notes to Consolidated Financial Statements.

Critical Accounting Policies

The reporting policies of the Company are in accordance with U.S. generally accepted accounting principles (GAAP). Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. The Company’s single most critical accounting policy relates to the Company’s allowance for loan losses, which reflects the estimated losses resulting from the inability of the Company’s borrowers to make required loan payments. If the financial condition of the Company’s borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the Company’s estimates would be updated, and additional provisions for loan losses may be required. Further discussion of the estimates used in determining the allowance for loan losses is contained in the discussion on “Allowance for Loan Losses” on page 22 and “Loans and Allowance for Loan Losses” in Note 1 of the Notes to Consolidated Financial Statements.

Impact of Recently Issued Accounting Standards

For a discussion of recently adopted accounting pronouncements and recently issued pronouncements which are not yet effective and the impact, if any, on our financial statements, see Note 1(u), “Current Accounting Developments” of the Notes to Consolidated Financial Statements included in this Annual Report.

PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

December 31, 2012 and 2011

(In thousands of dollars, except share data)


	2012			2011
Assets
Cash and cash equivalents (note 2):
Cash and due from banks	$	35,790		$	37,547

Securities (note 3):
Available-for-sale, at fair value		15,246			18,780
Held-to-maturity, at amortized cost		6,960			5,989
Federal Reserve Bank stock, at cost (note 1(c))		140			137
Federal Home Loan Bank stock, at cost (note 1(c))		513			528
Loans, net (notes 4, 9 and 11)		273,672			267,123
Bank premises and equipment, net (note 5)		6,313			6,537
Accrued interest receivable		993			1,009
Prepaid FDIC Insurance		703			991
Bank owned life insurance		3,017			—
Goodwill		539			539
Other real estate owned		2,393			645
Other assets (notes 7 and 8)		2,415			2,659


Total assets	$	348,694		$	342,484


Liabilities and Stockholders’ Equity

Liabilities:
Deposits (note 6):
Demand	$	37,955		$	33,432
Savings and NOW accounts		141,167			132,501
Time		136,035			144,460

Total deposits		315,157			310,393


Note payable under line of credit (note 1 (d))		1,900			2,000
Accrued interest payable		398			419
Other liabilities (note 7)		3,150			2,725


Total liabilities		320,605			315,537


Stockholders’ equity (notes 7, 12 and 15):
Common stock, $3 par value. Authorized 3,000,000 shares, issued and outstanding 1,507,589 shares in 2012 and 1,496,589 shares in 2011	$	4,492		$	4,473
Capital surplus		987			923
Retained earnings		24,244			22,981
Accumulated other comprehensive loss, net		(1,634	)		(1,430	)

Total stockholders’ equity		28,089			26,947


Commitments, contingencies and other matters (notes 9, 10 and 12)

Total liabilities and stockholders’ equity	$	348,694		$	342,484

See accompanying notes to consolidated financial statements.

PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 2012, 2011 and 2010

(In thousands of dollars, except per share data)


	2012		2011		2010
Interest income:
Interest and fees on loans	$	14,904	$	15,726	$	15,835
Interest on securities:
U.S. Government agencies		304		427		416
Corporate		—		—		3
States and political subdivisions (taxable)		91		110		159
States and political subdivisions (tax-exempt)		172		168		110
Other		100		83		84
Interest on federal funds sold		2		3		4


Total interest income		15,573		16,517		16,611


Interest expense:
Interest on deposits:
Savings and NOW accounts		585		728		1,271
Time - under $100,000		2,073		2,347		3,056
Time - $100,000 and over		1,314		1,351		1,508


Total interest expense		3,972		4,426		5,835


Net interest income		11,601		12,091		10,776

Provision for loan losses (note 4)		1,177		2,227		1,878


Net interest income after provision for loan losses		10,424		9,864		8,898

Noninterest income:
Service charges on deposit accounts		1,480		1,443		1,498
Commissions and fees		621		713		524
Mortgage loan fees		628		451		571
Service charges on loan accounts		240		248		237
Other operating income		474		398		304


Total noninterest income		3,443		3,253		3,134


Noninterest expense:
Salaries and employee benefits (note 7)		6,127		6,268		5,973
Occupancy expense		717		708		740
Furniture and equipment expense		1,021		1,059		1,001
Office supplies and printing		239		213		277
Federal deposit insurance premiums		308		413		501
Capital stock tax		236		229		226
Advertising expense		190		103		122
Other operating expenses		3,072		2,551		2,197


Total noninterest expense		11,910		11,544		11,037


Income before income tax expense		1,957		1,573		995

Income tax expense (note 8)		619		510		308


Net income	$	1,338	$	1,063	$	687


Basic net income per share (note 1(o))	$	0.89	$	0.71	$	0.46
Diluted net income per share (note1(o))	$	0.89	$	0.71	$	0.46

See accompanying notes to consolidated financial statements.

PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Years ended December 31, 2012, 2011 and 2010

(In thousands of dollars)


	2012			2011			2010

Net income	$	1,338		$	1,063		$	687
Other comprehensive income (loss), net of related income taxes:
Unrealized gains (losses) on available-for-sale securities
Before tax		115			287			(121	)
Income tax (expense) benefit		(39	)		(98	)		33
Changes in plan assets and benefit obligation of defined benefit pension plan
Before tax		(425	)		(1,319	)		56
Income tax (expense) benefit		145			448			(19	)

Comprehensive income	$	1,134		$	381		$	636

See accompanying notes to consolidated financial statements.

PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Years ended December 31, 2012, 2011 and 2010

(In thousands of dollars, except share and per share data)


	Common Stock				Capital Surplus		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
	Shares		Par Value		Capital Surplus		Retained Earnings						Total
Balances, December 31, 2009		1,485,089	$	4,455	$	787	$	21,306		$	(697	)	$	25,851

Net income								687						687
Change in net unrealized gains on available-for-sale securities, net of deferred tax benefit of $33											(88	)		(88	)
Adjustment to apply ASC topic, Compensation-Retirement Benefits, net of tax of $19											37			37

Comprehensive income														636
Issuance of restricted stock and related expense		10,500		7		16								23
Stock-based compensation expense						47								47
Cash dividends declared by Bankshares ($0.05 per share)								(75	)					(75	)

Balances, December 31, 2010		1,495,589	$	4,462	$	850	$	21,918		$	(748	)	$	26,482

Net income								1,063						1,063
Change in net unrealized gains on available-for-sale securities, net of deferred tax benefit of $99											189			189
Adjustment to apply ASC topic, Compensation- Retirement Benefits , net of tax of $449											(871	)		(871	)

Comprehensive income														381
Issuance of restricted stock and related expense		1,000		11		24								35
Stock-based compensation expense						49								49

Balances, December 31, 2011		1,496,589	$	4,473	$	923	$	22,981		$	(1,430	)	$	26,947

Net income								1,338						1,338
Change in net unrealized gains on available-for-sale securities, net of deferred tax benefit of $39											76			76
Adjustment to apply ASC topic, Compensation- Retirement Benefits , net of tax of $144											(280	)		(280	)

Comprehensive income														1,134
Issuance of restricted stock and related expense		11,000		19		38								57
Stock-based compensation expense						26								26
Cash dividends declared by Bankshares ($0.05 per share)		—		—		—		(75	)		—			(75	)

Balances, December 31, 2012		1,507,589	$	4,492	$	987	$	24,244		$	(1,634	)	$	28,089

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2012, 2011 and 2010

(In thousands of dollars)


	2012			2011			2010

Cash flows from operating activities:
Net income	$	1,338		$	1,063		$	687

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of bank premises and equipment		492			544			522
Accretion of unearned fees, net		11			13			30
Net amortization of premiums and discounts on securities		65			65			56
Provision for loan losses		1,168			2,227			1,878
Provision for deferred income taxes		26			280			(304	)
Accrual of stock option vesting		83			84			70
Increase in cash value of life insurance		(17	)		—			—
Net decrease (increase) in:
Accrued interest receivable		16			68			113
Prepaid FDIC insurance		400			385			466
Other assets		85			(2,069	)		751
Net increase (decrease) in:
Accrued interest payable		(21	)		(81	)		(113	)
Other liabilities		1			1,548			(450	)


Net cash provided by operating activities		3,647			4,127			3,706


Cash flows from investing activities:
Purchases of held-to-maturity securities		(1,516	)		(1,550	)		(5,672	)
Purchases of available-for-sale securities		(14,005	)		(13,111	)		(15,325	)
Proceeds from maturities and calls of held-to-maturity securities		500			—			2,250
Proceeds from maturities and calls of available-for-sale securities		17,429			16,297			11,909
Proceeds from paydowns and maturities of available-for-sale mortgage-backed securities		205			334			300
Sale of Federal Home Loan Bank stock		15			51			—
Purchase of Federal Reserve Stock		(3	)		(2	)		(30	)
Net increase in loans made to customers		(9,349	)		(4,422	)		(1,199	)
Purchases of bank premises and equipment		(369	)		(149	)		(226	)
Puchase of bank owned life insurance		(3,000	)		—			—


Net cash used in investing activities		(10,093	)		(2,552	)		(7,993	)


Cash flows from financing activities:
Net increase in demand, savings and NOW deposits		13,189			16,805			13,407
Net decrease in time deposits		(8,426	)		(13,366	)		(8,572	)
Net proceeds from insurance company for branch rebuild		101			—			—
Repayment of line of credit		(100	)		—			—
Cash dividends paid		(75	)		—			(75	)


Net cash provided by financing activities		4,689			3,439			4,760


Net (decrease) increase in cash and cash equivalents		(1,757	)		5,014			473

Cash and cash equivalents, beginning of year		37,547			32,533			32,060


Cash and cash equivalents, end of year	$	35,790		$	37,547		$	32,533


Supplemental disclosure of cash flows information
Cash paid during the year for:
Income taxes	$	489		$	1,039		$	300
Interest		3,999			4,507			5,948

Supplemental schedule of noncash investing and financing activities:
Transfer of (from) loans to repossessed properties	$	(127	)	$	(82	)	$	152
Loans charged against the allowance for loan losses		2,051			2,488			1,765
Unrealized gains (losses) on available-for-sale securities		115			287			(122	)
Defined benefit plan adjustment per ASC topic Compensation-Retirement Benefits		(424	)		(1,319	)		56

See accompanying notes to consolidated financial statements.

PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Notes to Consolidated Financial Statements

(In thousands, except ratios, share and per share data)

(1)

Summary of Significant Accounting Policies and Practices

The accounting and reporting policies of Bankshares and its wholly owned subsidiary (collectively, the Company), conform to accounting principles generally accepted in the United States of America and general practices within the banking industry. The following is a summary of the more significant accounting policies and practices:

(a)

Consolidation

The consolidated financial statements include the accounts of Bankshares and the Bank. All material intercompany balances and transactions have been eliminated.

(b)

Securities

The Company classifies its securities in three categories: (1) debt securities that the Company has the positive intent and ability to hold to maturity are classified as “held-to-maturity securities” and reported at amortized cost; (2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as “trading securities” and reported at fair value, with unrealized gains and losses included in net income; and (3) debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as “available-for-sale securities” and reported at fair value, with unrealized gains and losses excluded from net income and reported in accumulated other comprehensive income, a separate component of stockholders’ equity, net of deferred taxes. Fair value is determined from quoted prices obtained and reviewed by management. Held-to-maturity securities are stated at cost, adjusted for amortization of premiums and accretion of discounts on a basis, which approximates the level yield method. As of December 31, 2012, the Company does not maintain trading securities. Gains or losses on disposition are based on the net proceeds and adjusted carrying values of the securities called or sold, using the specific identification method on a trade date basis.

The Company assesses other-than-temporary impairment (“OTTI”) or permanent impairment based upon whether it intends to sell a security or if it is likely that it would be required to sell the security before recovery of the amortized cost basis of the investment, which may be maturity. For debt securities, if the Company intends to sell the security or it is likely that the Company will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that the Company will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (OCI). Impairment losses related to all other factors are presented as separate categories within OCI. For investment securities

held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the amount recorded in OCI increases the carrying value of the investment and does not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above

(c)

Restricted Equity Investments

As a member of the Federal Reserve Bank (FRB) and the Federal Home Loan Bank (FHLB) of Atlanta, the Company is required to maintain certain minimum investments in the common stock of the FRB and FHLB, which are carried at cost. Required levels of investment are based upon the Company’s capital and a percentage of qualifying assets.

In addition, the Company is eligible to borrow from the FHLB with borrowings collateralized by qualifying assets, primarily residential mortgage loans, and the Company’s capital stock investment in the FHLB.

Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB.

(d)

Borrowings

At December 31, 2012, the Company’s available borrowing limit with the FHLB was approximately $45,010. The Company had $0 in borrowings from the FHLB outstanding at December 31, 2012 and 2011. The Company also has a $5,000 line of credit secured by the authorized capital stock of the Company with a corresponding bank with $1,900 outstanding as of December 31, 2012 and $2,000 outstanding as of December 31, 2011 with a 5.00% interest rate that matures on June 30, 2017.

(e)

Loans and Allowance for Loan Losses

Loans are stated at the amount of unpaid principal, reduced by unearned income and fees on loans, and an allowance for loan losses. Income is recognized over the terms of the loans using methods that approximate the level yield method. The allowance for loan losses is a cumulative valuation allowance consisting of an annual provision for loan losses, plus any amounts recovered on loans previously charged off, minus loans charged off. The provision for loan losses charged to operating expenses is the amount necessary in management’s judgment to maintain the allowance for loan losses at a level it believes adequate to absorb probable losses inherent in the loan portfolio. Management determines the adequacy of the allowance based upon reviews of individual credits, recent loss experience, delinquencies, current economic conditions, the risk characteristics of the various categories of loans and other pertinent factors. Management uses historical loss data by loan type as well as current economic factors in its calculation of allowance for loan loss. Management also uses qualitative factors such as changes in lending policies and procedures, changes in national and local economies, changes in the nature and volume of the loan portfolio, changes in experience of lenders and the loan department, changes in volume and severity of past due and classified loans, changes in quality of the Company’s loan review system, the existence and effect of concentrations of credit and external factors such as competition and regulation in its allowance for loan loss calculation. Each qualitative factor is evaluated and applied to each type of loan in the Company’s portfolio and a percentage of each loan is reserved as allowance. A percentage of each loan type is also reserved according to the loan type’s historical loss data. Larger percentages of allowance are taken as the risk for a loan is determined to be greater. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is uncollectible. While

management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions or the Company’s recent loss experience. It is reasonably possible that management’s estimate of loan losses and the related allowance may change materially in the near term. However, the amount of change that is reasonably possible cannot be estimated. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examinations.

Loans are charged against the allowance when, in management’s opinion, they are deemed doubtful, although the Company continues to aggressively pursue collection. The Company considers a number of factors to determine the need for and timing of charge-offs including the following: whenever any commercial loan becomes past due for 120 days for any scheduled principal or interest payment and collection is considered uncollectible; whenever foreclosure on real estate collateral or liquidation of other collateral does not result in full payment of the obligation and the deficiency or some portion thereof is deemed uncollectible, the uncollectible portion shall be charged-off; whenever any installment loan becomes past due for 120 days and collection is considered unlikely; whenever any repossessed vehicle remains unsold for 60 days after repossession; whenever a bankruptcy notice is received on any installment loan and review of the facts results in an assessment that all or most of the balance will not be collected, the loan will be placed in non-accrual status; whenever a bankruptcy notice is received on a small, unsecured, revolving installment account; and whenever any other small, unsecured, revolving installment account becomes past due for 180 days.

Loans are generally placed in non-accrual status when the collection of principal and interest is 90 days or more past due, unless the obligation relates to a consumer or residential real estate loan or is both well-secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, which usually requires a minimum of six months of sustained repayment performance.

Impaired loans are required to be presented in the financial statements at net realizable value of the expected future cash flows or at the fair value of the loan’s collateral. Homogeneous loans such as real estate mortgage loans, individual consumer loans and home equity loans are evaluated collectively for impairment. Management, considering current information and events regarding the borrower’s ability to repay their obligations, considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Cash receipts on impaired loans receivable are applied first to reduce interest on such loans to the extent of interest contractually due and any remaining amounts are applied to principal.

(f)

Loan Origination and Commitment Fees and Certain Related Direct Costs

Loan origination and commitment fees and certain direct loan origination costs charged by the Company are deferred and the net amount amortized as an adjustment of the related loan’s yield. The Company amortizes these net amounts over the contractual life of the related loans or, in the case of demand loans, over the estimated life. Fees related to standby letters of credit are recognized over the commitment period.

(g)

Bank Premises and Equipment

Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed by the straight-line and declining-balance methods over the estimated useful lives of the assets. Depreciable lives include 15 years for land improvements, 40 years for buildings, and 3 to 7 years for equipment, furniture and fixtures. The cost of assets retired and sold and the related accumulated depreciation are eliminated from the accounts and the resulting gains or losses are

included in determining net income. Expenditures for maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized.

(h)

Goodwill

The Company performs a goodwill impairment analysis on an annual basis as of December 31. Additionally, the Company performs a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists. The Company performed goodwill impairment testing in the fourth quarter of 2012 because Bankshares’ common stock had been trading below book value per share in 2012. Management determined that no goodwill impairment charge was required because the fair value of the Company was not less than the Company’s carrying value. Management will continue to monitor the relationship of Bankshares’ market capitalization to both its book value and tangible book value, which management attributes to both financial services industry-wide and Company-specific factors, and to evaluate the carrying value of goodwill.

While management has a plan to return the Company’s business fundamentals to levels that support Bankshares’ common stock trading at or above book value per common share, there is no assurance that the plan will be successful, or that the market price of the common stock will increase to such levels in the foreseeable future. If Bankshares’ common stock price continues to trade below book value per common share, the Company may have to recognize an impairment of all, or some portion of, its goodwill.

(i)

Foreclosed Assets

Foreclosed properties consist of properties acquired through foreclosure or deed in lieu of foreclosure. At time of foreclosure, the properties are recorded at the fair value less costs to sell. Subsequently, these properties are carried at the lower of cost or fair value less estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged to expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale.

(j)

Impairment or Disposal of Long-Lived Assets

The Company’s long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used, such as bank premises and equipment, is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of, such as foreclosed properties, are reported at the lower of the carrying amount or fair value less costs to sell.

(k)

Pension Plan

The Company maintains a noncontributory defined benefit pension plan, which covers substantially all of its employees. The net periodic pension expense includes a service cost component, interest on the projected benefit obligation, a component reflecting the actual return on plan assets, the effect of deferring and amortizing certain actuarial gains and losses, and the amortization of any unrecognized net transition obligation on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan. The Company’s funding policy is to make annual contributions in amounts necessary to satisfy the Internal Revenue Service’s funding standards, to the extent that they are tax deductible.

ASC Topic 715, Defined Benefit Pension Plans requires a business entity to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. Defined Benefit Plans also requires a

business entity to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions.

(l)

Advertising

The Company expenses advertising expenses as incurred.

(m)

Income Taxes

Income taxes are accounted for under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in net income in the period that includes the enactment date.

Deferred taxes are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

(n)

Stock Options and Restricted Stock

The Company accounts for its stock based compensation plan under the provisions of ASC topic, Share-Based Payment which requires recognizing expense for options granted equal to the grant date fair value of the unvested amounts over their remaining vesting periods. There were 11,000 shares of restricted stock granted in 2012 compared to 1,000 shares of restricted stock granted in 2011. There were 37,250 stock options outstanding as of December 31, 2012 and 11,000 shares of restricted stock granted in 2012. Future levels of compensation cost recognized related to share-based compensation awards may be impacted by new awards and/or modification, repurchases and cancellations of existing awards after the adoption of this standard.

(o)

Net Income per Share

Basic net income per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.

The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the periods indicated:


	Net income		Shares		Per share
	(numerator)		(denominator)		amount
Year ended December 31, 2012
Basic net income per share	$	1,338		1,503,952	$	0.89

Effect of dilutive stock options		—		—

Diluted net income per share	$	1,338		1,503,952	$	0.89


	Net income (numerator)		Shares (denominator)		Per share amount
Year ended December 31, 2011
Basic net income per share	$	1,063		1,496,260	$	0.71

Effect of dilutive stock options		—		—

Diluted net income per share	$	1,063		1,496,260	$	0.71


	Net income (numerator)		Shares (denominator)		Per share amount
Year ended December 31, 2010
Basic net income per share	$	687		1,492,137	$	0.46

Effect of dilutive stock options		—		—

Diluted net income per share	$	687		1,492,137	$	0.46

Options to purchase 37,250 shares which were outstanding at December 31, 2012 and options to purchase 45,000 shares were outstanding December 31, 2011, were not included in the computation of diluted EPS because the effect would have been anti-dilutive.

(p)

Consolidated Statements of Cash Flows

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks (with original maturities of three months or less), and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.

(q)

Comprehensive Income

ASC topic Comprehensive Income, requires the Company to classify items of “Other Comprehensive Income” (such as net unrealized gains (losses) on available-for-sale securities) by their nature in a financial statement and present the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The Company’s other comprehensive income consists of net income, and net unrealized gains (losses) on securities available-for-sale, net of income taxes, and adjustments relating to its defined benefit plan, net of income taxes.

(r)

Fair Value Measurements

ASC topic, Fair Value Measurements and Disclosures establishes a framework for using fair value. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

In accordance with Fair Value Measurements and Disclosures , the Company groups its financial assets and financial liabilities in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The most significant instruments that the Company measures at fair value are available-for-sale securities. All available-for-sale securities fall into Level 2 fair value hierarchy. Valuation methodologies for the fair value hierarchy are as follows:

Level 1 – Valuations are based on quoted prices for identical assets and liabilities traded in active exchange markets, such as the New York Stock Exchange.

Level 2 – Valuations for assets and liabilities are obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities, model-based valuation techniques, or other observable inputs.

Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and are not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining fair value assigned to such assets and liabilities.

(s)

Use of Estimates

In preparing the consolidated financial statements in accordance with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated balance sheets and revenues and expenses for the years ended December 31, 2012, 2011 and 2010. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses.

(t)

Bank Owned Life Insurance

The Company has purchased life insurance policies on certain key members of management. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

(u)

Current Accounting Developments

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities . The ASU requires an entity to offset, and present as a single net amount, a recognized eligible asset and a recognized eligible liability when it has an unconditional and legally enforceable right of setoff and intends either to settle the asset and liability on a net basis or to realize the asset and settle the liability simultaneously. The ASU requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The ASU is effective for annual and interim reporting periods beginning on or after January 1, 2013. The Company does not expect this ASU, when adopted, to have a material impact on the Company’s consolidated financial statements.

On July 27, 2012, the FASB issued ASU No. No. 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment . The ASU simplifies the guidance for testing the decline in the realizable value (impairment) of indefinite-lived intangible assets other than goodwill. The amendments allow an organization the option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test. An organization electing to perform a qualitative assessment is no longer required to calculate the fair value of an indefinite-lived intangible asset unless the organization determines, based on a qualitative assessment, that it is “more likely than not” that the asset is impaired. Under former guidance, an organization was required to test an indefinite-lived intangible asset for impairment on at least an annual basis by comparing the fair value of the asset with its carrying amount. The amendments in this ASU are effective for annual and interim tests performed for fiscal years after September 15, 2012. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

On January 31, 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. ASU 2013-01 clarifies that ordinary trade receivables and receivables are not in the scope of ASU No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, ASU 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in

the FASB Accounting Standards Codification ™ (Codification) or subject to a master netting arrangement or similar agreement. The FASB undertook this clarification project in response to concerns expressed by U.S. stakeholders about the standard’s broad definition of financial instruments. After the standard was finalized, companies realized that many contracts have standard commercial provisions that would equate to a master netting arrangement, significantly increasing the cost of compliance at minimal value to financial statement users. An entity is required to apply the amendments in ASU 2013-01 for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented. The effective date is the same as the effective date of ASU 2011-11. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements

On February 5, 2013 the FASB issued Accounting Standards Update (ASU) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in this ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period and cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense. The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). A private company is required to meet the reporting requirements of the amended paragraphs about the roll forward of accumulated other comprehensive income for both interim and annual reporting periods. However, private companies are only required to provide the information about the effect of reclassifications on line items of net income for annual reporting periods, not for interim reporting periods. The amendments are effective for reporting periods beginning after December 15, 2012, for public companies and are effective for reporting periods beginning after December 15, 2013, for private companies. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

(2)

Restrictions on Cash

To comply with Federal Reserve regulations, the Company is required to maintain certain average reserve balances. The daily average reserve requirements were approximately $2,716 and $2,694 for the weeks including December 31, 2012 and 2011, respectively.

(3)

Securities

The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities at December 31, 2012 and 2011 are as follows:


	2012
	Amortized costs		Gross unrealized gains		Gross unrealized losses		Fair values
Available-for-Sale
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	11,150		261		—		11,411
Obligations of states and political subdivisions		2,816		183		—		2,999
Mortgage-backed securities – government		668		58		—		726
Other securities		110		—		—		110

Total available-for-sale	$	14,744		502		—		15,246


	2012
	Amortized costs		Gross unrealized gains		Gross unrealized losses			Fair values
Held-to-Maturity
Obligations of states and political subdivisions	$	6,960		227		(9	)		7,178


	2011
	Amortized costs		Gross unrealized gains			Gross unrealized losses			Fair values
Available-for-Sale
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	14,567		174	(3)		(3	)		14,738
Obligations of states and political subdivisions		2,841		139			—			2,980
Mortgage-backed securities – government		875		77			—			952
Other securities		110		—			—			110

Total available-for-sale	$	18,393		390			(3	)		18,780


	2011
	Amortized costs		Gross unrealized gains		Gross unrealized losses		Fair values
Held-to-Maturity
Obligations of states and political subdivisions	$	5,989		176		—		6,165

The following table shows the gross unrealized losses and fair value of the Company’s investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2012:


	Less than 12 months				Total
	Fair value		Gross unrealized losses		Fair value		Gross unrealized losses
Description of Securities
Obligations of states and political subdivisions	$	1,176		9		1,176		9

Total temporarily impaired securities	$	1,176		9		1,176		9


	Less than 12 months				Total
	Fair value		Gross unrealized losses		Fair value		Gross unrealized losses
Description of Securities
Obligations of states and political subdivisions	$	2,035		3		2,035		3

Total temporarily impaired securities	$	2,035		3		2,035		3

The Company does not consider the unrealized losses other-than-temporary losses based on the volatility of the securities market price involved, the credit quality of the securities, and the Company’s ability, if necessary, to hold the securities until maturity. The securities include 3 bonds that have continuous losses for less than 12 months and no bonds that have continuous losses for more than 12 months. There were no gross realized gains or losses on securities sold in 2012, 2011 and 2010.

The amortized costs and fair values of available-for-sale and held-to-maturity securities at December 31, 2012, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	2012
	Available-for-Sale				Held-to-Maturity
	Amortized costs		Fair values		Amortized costs		Fair values

Due in one year or less	$	210		211		705		708
Due after one year through five years		11,390		11,676		4,406		4,478
Due after five years through ten years		1,989		2,047		1,849		1,992
Due after ten years		487		586		—		—

		14,076		14,520		6,960		7,178

Mortgage-backed securities		668		726		—		—

Totals	$	14,744		15,246		6,960		7,178

Securities with amortized costs of approximately $4,507 and $5,158 (fair values of $4,695 and $5,335, respectively) as of December 31, 2012 and 2011, respectively, were pledged as collateral for public deposits and to the Federal Reserve for overdraft protection.

(4)

Loans, Allowance for Loan Losses and Credit Quality

A summary of loans at December 31, 2012 and 2011 follows:


	2012			2011
Real estate loans:
Residential-mortgage	$	105,246			109,001
Residential-construction		9,618			7,005
Commercial		86,283			86,293
Loans to individuals for household, family and other consumer expenditures		48,234			46,954
Commercial and industrial loans		28,054			21,756
All other loans		—			238

Total loans, gross		277,435			271,247
Less unearned income and fees		(117	)		(109	)

Loans, net of unearned income and fees		277,318			271,138
Less allowance for loan losses		(3,646	)		(4,015	)

Loans, net	$	273,672			267,123

In the normal course of business, the Bank has made loans to executive officers and directors. At December 31, 2012 and 2011, loans to executive officers and directors totaled $278 and $160 respectively. During 2012, new loans made to executive officers and directors totaled $118, advances totaled $38 and repayments amounted to approximately $38. Loans to companies in which executive officers and directors have an interest amounted to $698 and $781 at December 31, 2012 and 2011, respectively. All such loans were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unrelated persons, and, in the opinion of management, do not involve more than normal risk of collectability or present other unfavorable features.

Activity in the allowance for loan losses for the years ended December 31, 2012, 2011 and 2010 is summarized as follows:


	2012			2011			2010

Balances at beginning of year	$	4,015			4,037			3,723
Provision for loan losses		1,177			2,227			1,878
Loans charged off		(2,051	)		(2,487	)		(1,765	)
Loan recoveries		505			238			201


Balances at end of year	$	3,646			4,015			4,037

The following table presents information on the Company’s allowance for loan losses and recorded investment in loans:

Allowance for Loan Losses and Recorded Investment in Loans

For the Year Ended December 31, 2012


	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning balance	$	448		$	1,489		$	394		$	1,684		$	4,015
Chargeoffs		(84	)		(345	)		(404	)		(1,218	)		(2,051	)
Recoveries		1			114			174			216			505
Provision		(41	)		204			281			733			1,177

Ending Balance	$	324		$	1,462		$	445		$	1,415		$	3,646


	Commercial		Commercial Real Estate		Consumer		Residential		Total
Ending balance: individually evaluated for impairment		—		—		—		—		—

Ending balance: collectively evaluated for impairment	$	324		1,466		445		1,411		3,646

Loans:
Total loans ending balance	$	28,054		86,283		48,234		114,864		277,435

Ending balance: individually evaluated for impairment	$	110		1,199		83		1,451		2,843

Ending balance: collectively evaluated for impairment	$	27,944		85,084		48,151		113,413		274,592

For the Year Ended December 31, 2011


	Commercial		Commercial Real Estate		Consumer		Residential			Total
Allowance for Loan Losses:
Beginning balance	$	258	$	264	$	424	$	3,091		$	4,037
Chargeoffs		109		461		506		1,412			2,488
Recoveries		37		4		172		26			239
Provision		262		1,682		304		(21	)		2,227
Ending Balance	$	448	$	1,489	$	394	$	1,684		$	4,015

Ending balance individually evaluated for impairment		—		—		—		—			—

Ending balance: collectively evaluated for impairment	$	448		1,489		394		1,684			4,015

Loans:
Total loans ending balance	$	21,756		86,293		47,192		116,006			271,247

Ending balance: individually evaluated for impairment	$	78		288		46		4,296			4,708

Ending balance: collectively evaluated for impairment	$	21,678		86,005		47,146		111,710			266,539

The following table represents an age analysis of the Company’s past due loans:

Age Analysis of Past Due Loans

As of December 31, 2012


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment 90 Days and Accruing
Commercial	$	261		4		110		375		27,679		28,054		—
Commercial real estate		135		—		1,198		1,333		84,950		86,283		—
Consumer		427		58		83		568		47,666		48,234		—
Residential		1,495		87		1,623		3,205		111,659		114,864		171

Total	$	2,318		149		3,014		5,481		271,954		277,435		171

As of December 31, 2011


	30-59 Days Past Due		60-69 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment 90 Days and Accruing
Commercial	$	188		5		77		270		21,486		21,756		—
Commercial real estate		66		24		288		378		85,915		86,293		—
Consumer		417		93		49		559		46,633		47,192		3
Residential		668		93		4,297		5,058		110,948		116,006		—

Total	$	1,339		215		4,711		6,265		264,982		271,247		3

Loans in Nonaccrual Status

As of December 31, 2012 and 2011


	2012		2011
Commercial	$	110		78
Commercial real estate		1,198		288
Consumer		83		46
Residential		1,452		4,296

Total	$	2,843		4,708

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories.

Rate Modification is a modification in which the interest rate is changed.

Term Modification is a modification in which the maturity date, timing of payments or frequency of payments is changed.

Interest Only Modification is a modification in which the loan is converted to interest only payments for a period of time.

Payment Modification is a modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification is any other type of modification, including the use of multiple categories above.

There were no additional commitments to extend credit related to these troubled debt restructurings that were outstanding as of December 31, 2012 or December 31, 2011.

The following tables present troubled debt restructurings as of December 31, 2012 and 2011:


	December 31, 2012
	Accrual Status		Non-Accrual Status		Total Modifications

Commercial	$	—		—		—

Commercial real estate		666		—		666

Consumer		—		—		—

Residential		556		534		1,090


Total	$	1,222		534		1,756


	December 31, 2011
	Accrual Status		Non-Accrual Status		Total Modifications

Commercial	$	—		—		—

Commercial real estate		677		—		677

Consumer		—		—		—

Residential		557		2,532		3,089


Total	$	1,234		2,532		3,766

During 2012, there were no newly restructured loans. For 2011, there was one residential loan that was considered a combination modification that had a pre-modification balance of $490 and a post-modification balance of $555 as of September 30, 2011.

The following table represents financing receivables modified as troubled debt restructurings and with a payment default, with the payment default occurring (i) within 12 months of the restructure date (ii) during the year ended December 31, 2011. There were no occurrences in 2012:


	Year ended December 31, 2011
	#
Commercial real estate			$	—
Consumer		1		44
Residential		—		—
Total		1		555

		2	$	599

The following table presents information on the Company’s impaired loans and their related allowance for loan losses:

Impaired Loans

For the Year Ended December 31, 2012


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	110		110		—		201		4
Commercial real estate		1,198		1,198		—		1,292		19
Consumer		83		83		—		114		1
Residential		1,452		1,452		—		3,167		140
With allowance recorded:
Commercial		—		—		—		—		—
Commercial real estate		—		—		—		6		—
Consumer		—		—		—		—		—
Residential		—		—		—		88		—

Total:
Commercial		110		110		—		201		4
Commercial real estate		1,198		1,198		—		1,298		19
Consumer		83		83		—		114		1
Residential	$	1,452		1,452		—		3,255		140

For the Year Ended December 31, 2011


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial	$	78		78		—		39		1
Commercial real estate		965		965		—		945		12
Consumer		46		46		—		51		—
Residential		4,853		4,853		—		5,429		142
With allowance recorded:
Commercial		—		—		—		—		—
Commercial real estate		—		—		—		—		—
Consumer		—		—		—		—		—
Residential		—		—		—		40		—

Total:
Commercial		78		78		—		39		1
Commercial real estate		965		965		—		945		12
Consumer		46		46		—		51		—
Residential	$	4,853		4,853		—		5,469		142

The Company utilizes a risk rating matrix to assign a risk grade to each of its loans. A description of the general characteristics of the risk grades is as follows:

Pass – These loans have minimal and acceptable credit risk.

Special Mention – These loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date.

Substandard – These loans are inadequately protected by the net worth or paying capacity of the obligor or collateral pledged, if any. Loans classified as substandard must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct probability that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful – These loans have all of the weakness inherent in one classified as substandard with the added characteristic that the weaknesses make collection liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable.

The following table illustrates the Company’s credit quality indicators:

Credit Quality Indicators

As of December 31, 2012


	Commercial		Commercial Real Estate		Consumer		Residential		Total
Credit Exposure
Pass	$	26,953		80,561		48,056		110,630		266,200
Special Mention		971		3,526		105		735		5,337
Substandard		130		2,196		73		3,499		5,898
Doubtful		—		—		—		—		—

Total	$	28,054		86,283		48,234		114,864		277,435

As of December 31, 2011


	Commercial		Commercial Real Estate		Consumer		Residential		Total
Credit Exposure
Pass	$	17,752		76,879		47,058		106,431		248,120
Special Mention		3,636		5,754		—		1,549		10,939
Substandard		368		3,660		134		8,026		12,188
Doubtful		—		—		—		—		—

Total	$	21,756		86,293		47,192		116,006		271,247

(5)

Bank Premises and Equipment

Bank premises and equipment, net were comprised of the following as of December 31, 2012 and 2011:


	2012			2011
Land improvements	$	536			453
Buildings		5,728			6,042
Equipment, furniture and fixtures		4,678			4,652

		10,942			11,147
Less accumulated depreciation		(6,309	)		(6,290	)

		4,633			4,857
Land		1,680			1,680

Bank premises and equipment, net	$	6,313			6,537

(6)

Deposits

A summary of deposits at December 31, 2012 and 2011 follows:


	2012		2011
Noninterest-bearing demand deposits	$	37,955		33,432
Interest-bearing:
Savings and money market accounts		73,704		64,862
NOW accounts		67,463		67,639
Time deposits – under $100,000		90,341		98,229
Time deposits – $100,000 and over		45,694		46,231

Total interest-bearing deposits		277,202		276,961

Total deposits	$	315,157		310,393

At December 31, 2012, the scheduled maturity of time deposits is as follows: $77,566 in 2013; $23,306 in 2014; $24,763 in 2015; $5,977 in 2016 and $4,423 in 2017.

In the normal course of business, the Bank has received deposits from executive officers and directors. At December 31, 2012 and 2011, deposits from executive officers and directors were approximately $3,225

and $3,602, respectively. All such deposits were received in the ordinary course of business on substantially the same terms and conditions, including interest rates, as those prevailing at the same time for comparable transactions with unrelated persons.

(7)

Employee Benefit Plans

The Bank maintains a noncontributory defined benefit pension plan that covers substantially all of its employees. Benefits are computed based on employees’ average final compensation and years of credited service. Pension expense amounted to approximately $456, $557 and $340 in 2012, 2011 and 2010, respectively. The change in benefit obligation, change in plan assets and funded status of the pension plan at December 31, 2012, 2011 and 2010 and pertinent assumptions are as follows:


	Pension Benefits
	2012			2011			2010
Change in Benefit Obligation

Benefit obligation at beginning of year	$	6,892			6,697			6,253
Service cost		379			329			308
Interest cost		309			365			371
Actuarial loss		818			1,026			231
Benefits paid		(139	)		(1,644	)		(466	)
Settlement Loss		—			119			—


Benefit obligation at end of year	$	8,259			6,892			6,697

Change in Plan Assets

Fair value of plan assets at beginning of year		4,389			5,024			4,865
Actual return on plan assets		628			(38	)		625
Employer contribution		489			1,047			—
Benefit paid		(139	)		(1,644	)		(466	)

Projected fair value of plan assets at end of year	$	5,367			4,389			5,024

Funded Status at the End of the Year		(2,893	)		(2,503	)		(1,673	)

Amounts Recognized in the Balance Sheet
Other liabilities, accrued pension		(2,893	)		(2,503	)		(1,673	)

Amounts Recognized in Accumulated Other Comprehensive Income Net of Tax Effect
Unrecognized net actuarial loss		1,964			1,684			814

Benefit obligation included in accumulated other comprehensive income	$	1,964			1,684			814

Funded Status
Benefit obligation		(8,259	)		(6,892	)		(6,697	)
Fair value of assets		5,367			4,389			5,024
Unrecognized net actuarial loss		2,976			2,553			1,233

(Accrued)/prepaid benefit cost included in the balance sheet	$	84			50			(440	)


	Pension Benefits
	2012			2011			2010
Weighted Average Assumptions as of December 31, 2012 and 2011 and September 30, 2010:
Discount rate		4.00	%		4.50	%		5.50	%
Expected long-term return on plan assets		8.00	%		8.00	%		8.00	%
Rate of compensation increase		3.00	%		3.00	%		4.00	%


	Pension Benefits
	2012		2011		2010
Other Changes in Plan Assets and Benefit Obligation Recognized in Other Comprehensive Income Net of Tax Effect
Net (gain)/loss	$	280		871		(32	)
Prior service cost		—		—		—
Amortization of prior service cost		—		—		(3	)
Net obligation at transition		—		—		—
Amortization of net obligation at transition		—		—		(2	)

Total recognized in other comprehensive income	$	280		871		(37	)

Total Recognized in Net Periodic Benefit Cost and Other Comprehensive Income	$	879		1,877		285

The estimated portion of prior service cost and net transition obligation included in accumulated other comprehensive income that will be recognized as a component of net periodic pension cost over the next fiscal year are each $252.

The Company selects the expected long-term rate-of-return-on-assets assumption in consultation with its investment advisors and actuary. This rate is intended to reflect the average rate of return expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed – especially with respect to real rates of return (net of inflation) – for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience, which may not continue over the measurement period, and higher significance is placed on current forecasts of future long-term economic conditions.

Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further – solely for this purpose – the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).

The components of net pension benefit cost under the plan for the years ended December 31, 2012, 2011 and 2010 is summarized as follows:


	Pension Benefits
	2012			2011			2010

Service cost	$	379			329			308
Interest cost		310			364			371
Expected return on plan assets		(350	)		(459	)		(383	)
Recognized net (gain)/loss due to settlement		—			287			—
Net amortization		—			—			6
Recognized net actuarial loss		117			36			38


Net pension benefit cost	$	456			557			340

Projected Benefit Payments

The projected benefit payments under the plan are summarized as follows for the years ending December 31:


2013	$	499
2014		350
2015		277
2016		1,311
2017		1,122
2018-2022		1,650

Plan Asset Allocation

Plan assets are held in a pooled pension trust fund administered by the Virginia Bankers Association. The pooled pension trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 20% fixed income and 80% equities. The Investment Manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the pension plan’s investment strategy. The Investment Manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.

It is the responsibility of the Virginia Bankers Association to administer the investments of the pooled pension trust fund within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs.

The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. Following is a description of the valuation methodologies used for assets measured at fair value.

Mutual funds-fixed income and equity funds : Valued at the net asset value of shares held at year-end.

Cash and equivalents : Valued at cost which approximates fair value.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different fair value measurement as of December 31, 2012.

The following table presents the fair value of the assets, by asset category, at December 31, 2012 and 2011.


	2012		2011
Cash and equivalents	$	—		263
Mutual funds-fixed income		1,333		966
Mutual funds-equity		4,034		3,160

Total assets at fair value	$	5,367		4,389

The following table sets forth by level, within the fair value hierarchy, the assets carried at fair value as of December 31, 2012 and 2011.


	Assets at Fair Value as of December 31, 2012
	Level 1		Level 2		Level 3		Total
Cash and equivalents	$	—		—		—		—
Mutual funds-fixed income		1,333		—		—		1,333
Mutual funds-equity		4,034		—		—		4,034

Total assets at fair value	$	5,367		—		—		5,367


	Assets at Fair Value as of December 31, 2011
	Level 1		Level 2		Level 3		Total
Cash and equivalents	$	263		—		—		263
Mutual funds-fixed income		966		—		—		966
Mutual funds-equity		3,160		—		—		3,160

Total assets at fair value	$	4,389		—		—		4,389

Contributions

The Company expects to contribute $3,000 to its pension plan in 2013 to fund our accrued pension liabilities resulting mainly from the market performance of underlying pension assets.

The Company also has a 401(k) plan under which the Company matches employee contributions to the plan. In 2012 and 2011, the Company matched 100% of the first 1% of salary deferral and 50% of the next 5% of salary deferral to the 401(k) savings provision. The amount expensed for the 401(k) plan was $111 during the year ended December 31, 2012 and $114 during the year ended December 31, 2011.

(8)

Income Taxes

Income tax expense (benefit) attributable to income before income tax expense for the years ended December 31, 2012, 2011 and 2010 is summarized as follows:


	2012		2011		2010
Current	$	593		230		612
Deferred		26		280		(304	)

Total income tax expense	$	619		510		308

Reported income tax expense for the years ended December 31, 2012, 2011 and 2010 differed from the amounts computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense as a result of the following:


	2012			2011			2010
Computed at statutory Federal tax rate	$	665			535			338
Increase (reduction) in income tax expense resulting from:
Tax-exempt interest		(58	)		(61	)		(39	)
Disallowance of interest expense		5			5			4
Other, net		7			31			5

Reported income tax expense	$	619			510			308

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2012 and 2011 are as follows:


	2012			2011
Deferred tax assets:
Loans, principally due to allowance for loan losses	$	753			957
Defined benefit plan valuation adjustments		1,012			868
Loans, due to unearned fees, net		16			19
Other		297			132

Total gross deferred tax assets		2,078			1,976


Deferred tax liabilities:
Bank premises and equipment, due to differences in depreciation		(196	)		(223	)
Accrued pension, due to actual pension contributions in excess of accrual for financial reporting purposes		(28	)		(17	)
Net unrealized gains on available-for-sale securities		(171	)		(131	)
Other		(184	)		(184	)

Total gross deferred tax liabilities		(579	)		(555	)

Net deferred tax asset, included in other assets	$	1,499			1,421

The Bank has determined that a valuation allowance for the gross deferred tax assets is not necessary at December 31, 2012, 2011 and 2010, since realization of the entire gross deferred tax assets can be supported by the amounts of taxes paid during the carryback periods available under current tax laws.

The Company adopted the provisions of Accounting Standards topic, Income Taxes , on January 1, 2007 with no impact on the financial statements. The Company did not recognize any interest or penalties related to income tax during the years ended December 31, 2011 and 2012. The Company does not have an accrual for uncertain tax positions as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years 2008 and thereafter are subject to future examination by tax authorities.

(9)

Financial Instruments with Off-Balance-Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include mortgage sale lock commitments, commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.

Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in accordance with the terms of the contract. The Company’s maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

The Company requires collateral to support financial instruments when it is deemed necessary. The Bank evaluates such customers’ creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral may include deposits held in financial institutions, U.S. Treasury securities, other marketable securities, real estate, accounts receivable, inventory, and property, plant and equipment.

Financial instruments whose contract amounts represent credit risk:


	2012		2011
Mortgage rate lock commitments	$	3,002		—

Commitments to extend credit	$	60,168		54,161

Standby letters of credit	$	2,475		963

In the ordinary course of business, the Company may enter into mortgage rate lock commitments that are subsequently funded by the Company. The Company then sells the mortgage loan to a secondary market bank that had underwritten the mortgage loan before the Company funded the loan. The secondary market bank pays a fee that was agreed upon on the lock commitment date to the Company and buys the loan within five days of the initial funding by the Company.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions. Unless renewed, substantially all of the Company’s standby letters of credit commitments at December 31, 2012 will expire within one year. Management does not anticipate any material losses as a result of these transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

(10)

Leases

The Company leases premises and equipment under various operating lease agreements. Generally, operating leases provide for one or more renewal options on the same basis as current rental terms. Certain leases require increased rentals under cost-of-living escalation clauses. The following are future minimum lease payments as required under the agreements:


Year	Payments
2013	$	141
2014		141
2015		141
2016		149
2017		152
After 2017		1,709

Total	$	2,433

The Company entered into a lease of the Amherst branch facility with an entity in which a director of the Company has a 50% ownership interest in 2009. The original term of the lease is twenty years and may be renewed at the Company’s option for two additional terms of five years each. The Company’s current rental payment under the lease is $141 annually.

(11)

Concentrations of Credit Risk and Contingencies

The Company grants commercial, residential and consumer loans to customers primarily in the central Virginia area. The Company has a diversified loan portfolio that is not dependent upon any particular economic sector. As a whole, the portfolio is affected by general economic conditions in the central Virginia region.

The Company’s commercial and real estate loan portfolios are diversified, with no significant concentrations of credit other than the geographic focus on the central Virginia region. The installment loan portfolio consists of consumer loans primarily for automobiles and other personal property. Overall, the Company’s loan portfolio is not concentrated within a single industry or group of industries, the loss of any one or more of which would generate a materially adverse impact on the business of the Company.

The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property. Credit approval is principally a function of collateral and the evaluation of the creditworthiness of the borrower based on available financial information.

At times, the Company may have cash and cash equivalents at a financial institution in excess of insured limits. The Company places its cash and cash equivalents with high credit quality financial institutions whose credit rating is monitored by management to minimize credit risk.

In the ordinary course of business, various claims and lawsuits are brought by and against the Company. In the opinion of management, there is no pending or threatened proceeding in which an adverse decision could result in a material adverse change in the Company’s consolidated financial condition or results of operations.

(12)

Dividend Restrictions and Capital Requirements

Bankshares’ principal source of funds for dividend payments is dividends received from its subsidiary Bank. For the years ended December 31, 2012 and 2011, dividends from the subsidiary Bank totaled $385 and $280, respectively.

Substantially all of Bankshares’ retained earnings consist of undistributed earnings of its subsidiary Bank, which are restricted by various regulations administered by federal banking regulatory agencies. Under applicable federal laws, the Comptroller of the Currency restricts, without prior approval, the total dividend payments of the Bank in any calendar year to the net profits of that year, as defined, combined with the retained net profits for the two preceding years. At December 31, 2012, retained net profits of the Bank that were free of such restriction approximated $2,938.

Bankshares and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bankshares’ consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bankshares and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Bankshares and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require Bankshares and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2012, that Bankshares and the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2012, the most recent notification from Office of the Comptroller of the Currency categorized Bankshares and the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” Bankshares and the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table below. There are no conditions or events since that notification that management believes have changed Bankshares and the Bank’s category.

Bankshares and the Bank’s actual capital amounts and ratios are presented in the table below.


	Actual					For Capital Adequacy Purposes					To Be “Well Capitalized” Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2012:
Total Capital
(to Risk Weighted Assets):
Bankshares consolidated	$	32,771		11.39	%	$	23,011		8.0	%	$	N/A		N/A
Bank		34,005		11.85	%		22,957		8.0	%		28,696		10.0	%
Tier 1 Capital
(to Risk Weighted Assets):
Bankshares consolidated		29,183		10.15	%		11,505		4.0	%		N/A		N/A
Bank		30,417		10.60	%		11,478		4.0	%		17,217		6.0	%
Tier 1 Capital (Leverage)
(to Average Assets):
Bankshares consolidated		29,183		8.49	%		13,756		4.0	%		N/A		N/A
Bank		30,417		8.86	%		13,729		4.0	%		17,161		5.0	%


	Actual					For Capital Adequacy Purposes					To Be “Well Capitalized” Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2011:
Total Capital
(to Risk Weighted Assets):
Bankshares consolidated	$	31,318		11.24	%	$	22,282		8.0	%	$	N/A		N/A
Bank		32,763		11.79	%		22,237		8.0	%		27,797		10.0	%
Tier 1 Capital
(to Risk Weighted Assets):
Bankshares consolidated		27,837		9.99	%		11,141		4.0	%		N/A		N/A
Bank		29,281		10.53	%		11,119		4.0	%		16,678		6.0	%
Tier 1 Capital (Leverage)
(to Average Assets):
Bankshares consolidated		27,837		8.12	%		13,709		4.0	%		N/A		N/A
Bank		29,281		8.56	%		13,687		4.0	%		17,109		5.0	%

(13)

Disclosures about Fair Value of Financial Instruments

The ASC topic Fair Value Option , requires the Company to disclose estimated fair values of its financial instruments.

The following methods and assumptions were used to estimate the approximate fair value of each class of financial instrument for which it is practicable to estimate that value.

(a)

Cash and Due from Banks and Federal Funds Sold

The carrying amounts are a reasonable estimate of fair value.

(b)

Securities

The fair value of securities is estimated based on bid prices as quoted on national exchanges or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations; so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.

(c)

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate - residential, real estate - other, loans to individuals and other loans. Each loan category is further segmented into fixed and adjustable rate interest terms.

The fair value of fixed rate loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan as well as estimates for prepayments. The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

(d)

Bank Owned Life Insurance

Fair values of insurance policies owned are based on the insurance contract’s cash surrender value.

(e)

Deposits and Note Payable to Federal Home Loan Bank

The fair value of demand deposits, NOW accounts, and savings deposits is the amount payable on demand. The fair value of fixed maturity time deposits, certificates of deposit and the note payable to the Federal Home Loan Bank is estimated by discounting scheduled cash flows through the estimated maturity using the rates currently offered for deposits or borrowings of similar remaining maturities.

(f)

Commitments to Extend Credit and Standby Letters of Credit

The only amounts recorded for commitments to extend credit and standby letters of credit are the deferred fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant at December 31, 2012 and 2011, and as such, the related fair values have not been estimated.

The carrying amounts and approximate fair values of the Company’s financial instruments are as follows at December 31, 2012 and 2011:


	2012				2011
	Carrying amounts		Approximate fair values		Carrying amounts		Approximate fair values
Financial assets:
Cash and due from banks	$	35,790		35,790		37,547		37,547
Securities:
Available-for-sale		15,246		15,246		18,780		18,780
Held-to-maturity		6,960		7,178		5,989		6,165
Federal Reserve Bank Stock		140		140		137		137
Federal Home Loan Bank Stock		513		513		528		528
Loans, net of unearned income and fees		277,435		282,841		267,123		276,862
Bank owned life insurance		3,017		3,017		—		—


Total financial assets	$	339,101		345,227		330,104		340,019

Financial liabilities:
Deposits	$	315,157		317,922		310,393		315,578
Line of credit		1,900		1,900		2,000		2,000

Total financial liabilities	$	317,057		319,822		312,393		317,578

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial

instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated funding needs and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets and premises and equipment and other real estate owned. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

(g)

Fair Value Methodologies

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Available-for-Sale Securities

Available-for-sale securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available, and would in such case be included as a Level 1 asset. The Company currently carries no Level 1 securities. If quoted prices are not available, valuations are obtained from readily available pricing sources from independent providers for market transactions involving similar assets or liabilities. The Company’s principal market for these securities is the secondary institutional markets, and valuations are based on observable market data in those markets. These would be classified as Level 2 assets. The Company’s entire available-for-sale securities portfolio is classified as Level 2 securities. The Company currently carries no Level 3 securities for which fair value would be determined using unobservable inputs.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC topic, Impairment of a Loan. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of a similar debt, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans at which fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2012, substantially all of the impaired loans were evaluated based on the fair value of the collateral. In accordance with Impairment of a Loan, impaired loans where an allowance is established based on the fair value of the collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as a nonrecurring Level 2 asset. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as a nonrecurring Level 3 asset. For substantially all of the Company‘s impaired loans as of December 31, 2012 and December 31, 2011, the valuation methodology utilized by the Company was collateral based measurements such as a real estate appraisal and the discount to reflect current market conditions and ultimately collectability ranged from 0% to 25% for each of the respective periods.

Foreclosed Assets

Foreclosed assets are adjusted to fair value less estimated selling costs upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on observable market price or a current appraised value, the Company records the foreclosed asset as a nonrecurring Level 2 asset. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as a nonrecurring Level 3 asset. For substantially all of the Company’s foreclosed assets as of December 31, 2012 and December 31, 2011, the valuation methodology utilized by the Company was collateral based measurements such as a real estate appraisal and the discount to reflect current market conditions ranged from 0% to 20% for each of the respective periods.

Below are tables that present information about certain assets and liabilities measured at fair value:

Fair Value Measurements on December 31, 2012


	Total Carrying Amount in The Consolidated Balance Sheet		Assets/Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description
Available-for-sale securities	$	15,246	$	15,246		NA	$	15,246		NA
Impaired loans (nonrecurring)	$	2,843	$	2,843		NA		NA	$	2,843
Foreclosed assets (nonrecurring)	$	2,393	$	2,393		NA		NA	$	2,393

Fair Value Measurements on December 31, 2011


	Total Carrying Amount in The Consolidated Balance Sheet		Assets/Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Description
Available-for-sale securities	$	18,780	$	18,780		NA	$	18,780		NA
Impaired loans (nonrecurring)	$	5,942	$	5,942		NA		NA	$	5,942
Foreclosed assets (nonrecurring)	$	645	$	645		NA		NA	$	645

The following table sets forth a summary of changes in the fair value of the Company’s nonrecurring Level 3 assets for the year ended December 31, 2012:


	Level 3 Assets
	Year Ended December 31, 2012
	Impaired Loans			Foreclosed Assets
Balance, beginning of the year	$	5,942			645
Purchases, sales, issuances, and settlements (net)		(3,099	)		1,748

Balance, end of year	$	2,843			2,393

There were no significant transfers between Level 1 and Level 2 investments during the year ended December 31, 2012.

(14)

Parent Company Financial Information

Condensed financial information of Bankshares (Parent) is presented below:

Condensed Balance Sheets


.	December 31,
	2012			2011
Assets
Cash due from subsidiary	$	13			16
Investment in subsidiary, at equity		29,324			28,390
Other assets		680			567

Total assets	$	30,017			28,973


Liabilities and stockholders’ equity
Notes payable	$	1,900			2,000
Other liabilities		28			26

Total liabilities	$	1,928			2,026


Stockholders’ equity
Common stock of $3 par value, authorized 3,000,000 shares; issued and outstanding 1,507,089 shares in 2012 and 1,486,089 in 2011	$	4,492			4,473
Capital surplus		987			923
Retained earnings		24,244			22,981
Accumulated other comprehensive income (loss), net		(1,634	)		(1,430	)

Total stockholders’ equity	$	28,089			26,947
Commitments, contingencies and other matters		—			—

Total liabilities and stockholders’ equity	$	30,017			28,973

Condensed Statements of Income


	Years ended
	December 31,
	2012		2011		2010
Income:
Dividends from subsidiary	$	506		280		338
Equity in undistributed net income of subsidiary		1,052		978		523

Total Income		1,558		1,258		861

Expenses:
Other expenses		333		296		264

Income before income tax benefit		1,225		962		597
Applicable income tax benefit		113		101		90

Net income	$	1,338		1,063		687

Condensed Statements of Cash Flows


	Years ended
	December 31,
	2012			2011			2010
Cash flows from operating activities:
Net income	$	1,338			1,063			687
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net income of subsidiary		(1,052	)		(978	)		(523	)
Increase in other assets		(113	)		(89	)		(81	)

Net cash provided by operating activities		173			(4	)		83

Cash flows from investing activities:
Additional investment in Bank		—			—			(1,000	)

Net cash used in financing activity		—			—			(1,000	)

Cash flows from financing activities
Cash dividends paid		(76	)		—			(75	)
Draw on line of credit		—			—			1,000
Repayment of line of credit		(102	)		—			—
Increase (decrease) in other liabilities		2			2			3

Net cash provided by (used in) financing activities		(176	)		2			928

Net increase (decrease) in cash due from subsidiary		(3	)		(2	)		11
Cash due from subsidiary, beginning of year		16			18			7

Cash due from subsidiary, end of year	$	13			16			18

(15)

Stock-based Compensation

The Company has two incentive stock option plans. The 1997 Incentive Stock Plan (the 1997 Plan), pursuant to which the Company’s Board of Directors could grant stock options to officers and key employees, became effective as of May 1, 1997. The 1997 Plan authorized grants of options to purchase up to 50,000 shares of the Company’s authorized, but unissued common stock. Accordingly, 50,000 shares of authorized, but unissued common stock were reserved for use in the 1997 Plan. All stock options were granted with an exercise price equal to the stock’s fair market value at the date of grant. At December 31, 2012, there were no additional shares available for grant under the 1997 Plan as the plan expired on May 1, 2007.

The 2004 Incentive Stock Plan (the 2004 Plan), pursuant to which the Company’s Board of Directors may grant stock options to officers and key employees, was approved by shareholders on April 13, 2004 and became effective as of May 1, 2004. The 2004 Plan authorizes grants of options to purchase up to 100,000 shares of the Company’s authorized, but unissued common stock. Accordingly, 100,000 shares of

authorized, but unissued common stock were reserved for use in the 2004 Plan. All stock options are granted with an exercise price equal to the stock’s fair market value at the date of the grant. At December 31, 2012, there were 40,000 shares available for grant under the 2004 Plan.

Stock options generally have 10-year terms, vest at the rate of 25% per year, and become fully exercisable four years from the date of grant.

During 2012 and 2011, no stock options were granted or exercised. On May 1, 2012 and 2011, 11,000 and 1,000 shares, respectively of restricted stock were granted to employees. The 2012 grants will vest on the third anniversary of the grant date. The 2011 grant will vest on the second anniversary of the grant date. On May 1, 2010, options to acquire 48,000 shares of common stock were granted to employees. Equity awards to acquire 37,500 shares were granted in the form of incentive stock options with tandem stock appreciation rights with a four year vesting period, and 10,500 shares of restricted stock that vest on the third anniversary of the grant date were granted to employees.

At December 31, 2012, options for 18,125 shares were exercisable at an exercise price of $9.00 per share.

The Company expensed $26 in 2012 in compensation expensed as a direct result of the issuance of the 45,000 incentive stock options with tandem stock appreciation rights and will recognize $13 in 2013 and $3 in 2014 in compensation expense related to unvested stock options. The fair value $3.96 per share of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions used: dividend yield of 2.065%, expected volatility of 45.61%, a risk-free interest rate of 4.63%, and expected lives of 9 years.

The Company also expensed $57 in 2012 in compensation expensed as a direct result of the granting of 10,500 shares of restricted stock in 2010, 1,000 shares of restricted stock in 2011 and 11,000 shares of restricted stock in 2012 and will recognize $45 in 2013, $35 in 2014 and $8 in 2015. The restricted stock was granted at a market price of $9.25 per share

Stock option activity during the years ended December 31, 2012 and 2011 is as follows:


	Number of Shares		Weighted average exercise price

Balance at December 31, 2010		54,500	$	10.66
Forfeited		9,500		14.00
Exercised		—
Granted		—
Balance at December 31, 2011		45,000	$	10.66
Forfeited		7,750	$	14.56
Exercised		—
Granted		—
Balance at December 31, 2012		37,250	$	9.00

The following table summarizes information about stock options outstanding at December 31, 2012:


Exercise Price		Number Outstanding at 12/31/12		Average Remaining Contractual Life (in years)		Weighted- Average Exercise Price		Number Exercisable at 12/31/2012		Weighted- Average Exercise Price

$	9.00		37,250		7.4	$	9.00		18,125	$	9.00

The aggregate intrinsic value of options outstanding was $0, of options exercisable was $0, and of options unvested and expected to vest was $0 at December 31, 2012.

The aggregate intrinsic value of restricted stock granted during 2012 was $102.

The total intrinsic value (market value on date of exercise less exercise price) of options exercised during each of the years ended December 31, 2012 and 2011 was $0.

(16)

Quarterly Results of Operations (Unaudited)

The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2012, 2011 and 2010:


	2012
	First quarter		Second quarter		Third quarter		Fourth quarter
Income statement data:
Interest income	$	3,943		3,904		3,877		3,849
Interest expense		1,001		998		997		976

Net interest income		2,942		2,906		2,880		2,873
Provision for loan losses		168		467		174		368
Noninterest income		777		935		857		874
Noninterest expense		2,839		3,063		2,971		3,037
Income tax expense		234		99		193		93

Net income	$	478		212		399		249

Per share data:
Basic net income per share	$	0.32		0.14		0.26		0.17
Diluted net income per share		0.32		0.14		0.26		0.17
Cash dividends per share		0.00		0.00		0.00		0.05
Book value per share		18.32		18.40		18.34		18.63


	2011
	First quarter		Second quarter		Third quarter		Fourth quarter
Income statement data:
Interest income	$	4,116		4,122		4,172		4,107
Interest expense		1,217		1,117		1,066		1,026

Net interest income		2,899		3,005		3,106		3,081
Provision for loan losses		673		709		309		536
Noninterest income		724		810		858		861
Noninterest expense		2,779		2,964		2,750		3,051
Income tax expense		45		35		297		133

Net income	$	126		107		608		222

Per share data:
Basic net income per share	$	0.09		0.07		0.40		0.15
Diluted net income per share		0.09		0.07		0.40		0.15
Cash dividends per share		0.00		0.00		0.00		0.00
Book value per share		17.83		17.99		18.44		18.01


	2010
	First quarter		Second quarter		Third quarter		Fourth quarter
Income statement data:
Interest income	$	4,084		4,107		4,124		4,295
Interest expense		1,521		1,505		1,470		1,340

Net interest income		2,563		2,602		2,654		2,955
Provision for loan losses		263		509		191		915
Noninterest income		672		714		855		894
Noninterest expense		2,708		2,711		2,764		2,853
Income tax expense (benefit)		81		29		180		18

Net income	$	183		67		374		63

Per share data:
Basic net income (loss) per share	$	0.12		0.05		0.25		0.04
Diluted net income (loss) per share		0.12		0.05		0.25		0.04
Cash dividends per share		0.00		0.00		0.00		0.05
Book value per share		17.55		17.54		17.84		17.71

(17)

Subsequent Events

Management’s Report on Internal Control over Financial Reporting.

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) under the Exchange Act, as amended.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control – Integrated Framework. Based on this assessment, our management concluded that, as of December 31, 2012, the Company’s internal control over financial reporting was effective based on those criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Changes in Internal Controls.

No changes in our internal control over financial reporting occurred during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Pinnacle Bankshares Corporation

Altavista, Virginia

We have audited the accompanying consolidated balance sheets of Pinnacle Bankshares Corporation and subsidiary (The “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. These consolidated financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pinnacle Bankshares Corporation and subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

/s/ Cherry Bekaert LLP

Raleigh, North Carolina

February 27, 2013

Shareholder Information

PERFORMANCE GRAPH

The graph below compares total returns assuming reinvestment of dividends of Pinnacle Bankshares Common Stock, the NASDAQ Market Index, and an Industry Peer Group Index. In addition, we have included the S&P 500 and the SNL Bank and Thrift Index and will use these as our peer groups going forward as we have determined that the companies included in these indices more closely match our Company characteristics than the companies included in the SIC Code Index. The graph assumes $100 invested on January 1, 2007 in Pinnacle Bankshares Corporation Common Stock and in each of the indices. In 2012, the financial holding companies in the SIC Code Index consisted of 237 banks with the same standard industry code of 6021 as Pinnacle Bankshares Corporation.

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	*Period Ending*
*Index*	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12
Pinnacle Bankshares Corporation		100.00		67.51		37.53		46.49		43.11		44.16
NASDAQ Market Index		100.00		60.02		87.24		103.08		102.26		120.42
SIC Code Index		100.00		59.82		59.05		66.18		48.94		67.37
S&P 500		100.00		63.00		79.68		91.68		93.61		108.59
SNL Bank and Thrift		100.00		57.51		56.74		63.34		49.25		66.14

Shareholder Information

Annual Meeting

The 2013 Annual Meeting of Shareholders will be held on April 9, 2013, at 11:00 a.m. at the Fellowship Hall of Altavista Presbyterian Church, located at 707 Broad Street, Altavista, Virginia.

Market for Common Equity and Related Stockholder Matters

The Company’s Common Stock is quoted on the OTC Bulletin Board. The following table presents the high and low bid prices per share of the Common Stock, as reported on the OTCQB marketplace, and dividend information of the Company for the quarters presented. The high and low bid prices of the Common Stock presented below reflect inter-dealer prices and do not include retail markups, markdowns or commissions, and may not represent actual transactions.


	2012						2011
	High		Low		Dividends		High		Low		Dividends

First Quarter	$	9.50	$	8.16	$	0.00	$	9.75	$	8.45	$	0.00

Second Quarter	$	10.50	$	9.10	$	0.00	$	8.50	$	6.75	$	0.00

Third Quarter	$	9.23	$	7.71	$	0.00	$	7.00	$	6.67	$	0.00

Fourth Quarter	$	9.10	$	8.02	$	0.05	$	8.50	$	6.70	$	0.00

The Company has filed Forms 15 with respect to the termination of registration under Section 12(g) of the Exchange Act, and the suspension of the duty to file reports under Section 15(d) of the Exchange Act. As a result, the Company expects that this annual report on Form 10-K and amendments, if any, thereto, will be the last report filed by the Company with the Securities and Exchange Commission pursuant to Section 13 of the Exchange Act for the foreseeable future.

Each share of Common Stock is entitled to participate equally in dividends, which are payable as and when determined by the Board of Directors after consideration of the earnings, general economic conditions, the financial condition of the business and other factors as might be appropriate. The Company’s ability to pay dividends is dependent upon its receipt of dividends from its subsidiary. Prior approval from the Comptroller of the Currency is required if the total of all dividends declared by a national bank, including the proposed dividend, in any calendar year will exceed the sum of the Bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. This limitation has not had a material impact on the Bank’s ability to declare dividends during 2012 and 2011 and is not expected to have a material impact during 2013.

As of March 1, 2013, there were approximately 355 shareholders of record of Bankshares’ Common Stock.

Requests for Information

Requests for information about the Company should be directed to Bryan M. Lemley, Secretary, Treasurer and Chief Financial Officer, P.O. Box 29, Altavista, Virginia 24517, telephone (434) 369-3000. A copy of the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, will be furnished without charge to shareholders upon written request.

Shareholders seeking information regarding lost certificates and dividends should contact Registrar and Transfer Company in Cranford, New Jersey, telephone (800) 368-5948. Please submit address changes in writing to:

Registrar and Transfer Company

Investor Relations Department

10 Commerce Drive

Cranford, New Jersey 07016-9982

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EXHIBIT 21

Subsidiaries of Registrant


Name		Type and Jurisdiction Of Organization

First National Bank		National banking association

FNB Property Corp.		Virginia corporation

First Properties, Inc.		Virginia corporation

Exhibit 31.1

CERTIFICATIONS

I, Aubrey H. Hall, III, certify that:

1. I have reviewed this annual report on Form 10-K of Pinnacle Bankshares Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


March 27, 2013
Date				/s/ Aubrey H. Hall, III
				Aubrey H. Hall, III, President and Chief Executive Officer
				(principal executive officer)

Exhibit 31.2

CERTIFICATIONS

I, Bryan M. Lemley, certify that:

1. I have reviewed this annual report on Form 10-K of Pinnacle Bankshares Corporation;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


March 27, 2013
Date				/s/ Bryan M. Lemley
				Bryan M. Lemley, Secretary, Treasurer and Chief Financial Officer
				(principal financial and accounting officer)

EXHIBIT 32.1

CEO/CFO Certification Pursuant to § 906 of the

Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350)

The undersigned, as the Chief Executive Officer and Chief Financial Officer of Pinnacle Bankshares Corporation, respectively, certify that, to the best of their knowledge and belief, the Annual Report on Form 10-K for the fiscal year ended December 31, 2012, which accompanies this certification, fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, and the information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of Pinnacle Bankshares Corporation and subsidiary at the dates and for the periods indicated. The foregoing certification is made pursuant to § 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350) and shall not be relied upon for any other purpose. The undersigned expressly disclaim any obligation to update the foregoing certification except as required by law.


March 27, 2013				/s/ Aubrey H. Hall, III
Date				Aubrey H. Hall, III, President and Chief Executive Officer
				(principal executive officer)

March 27, 2013				/s/ Bryan M. Lemley
Date				Bryan M. Lemley, Secretary, Treasurer and Chief Financial Officer
				(principal financial and accounting officer)