UNITED
STATES SECURITITES AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q


(Mark
One)


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





For
      the quarterly period ended September 30,
2009





o
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE EXCHANGE
ACT





For
      the transition period from _____________________ to
      __________________________





Commission
File Number: 000-30515





Weststar
Financial Services Corporation


(Exact
name of registrant as specified in its charter)





North
      Carolina
            56-2181423(State
      or other jurisdiction of incorporation or organization)
            (IRS
      Employer Identification No.)





79
Woodfin Place, Asheville NC 28801


(Address
of principal executive offices)





828.252.1735


(Registrant’s
telephone number)


(Former
      name, former address and former fiscal year, if changed since last
      report)


Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the of the Exchange Act 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.  x
Yes   o 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).  o
Yes   o No




Indicate
by checkmark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act: (Check one): Large
accelerated filer o   Accelerated
filer o   Non-accelerated
filer o (Do
not check if a smaller company)   Smaller reporting company x




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




APPLICABLE
ONLY TO CORPORATE ISSUERS:





State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date: Common stock, $1.00 par value – 2,147,132
shares outstanding as of November 12, 2009.












INDEX
            PagePart
      I – FINANCIAL INFORMATIONFinancial
      Statements:Consolidated Balance SheetsSeptember 30, 2009 and December 31, 2008
            2Consolidated Statements of OperationsThree and Nine Months Ended September 30, 2009 and
      2008
            3Consolidated Statements of Comprehensive Income
      (Loss)Three and Nine Months Ended September 30, 2009 and
      2008
            4Consolidated Statements of Changes in Shareholders’
      EquityNine Months Ended September 30, 2009 and
    2008
            5Consolidated Statements of Cash FlowsNine Months Ended September 30, 2009 and
    2008
            6Notes to Consolidated Financial
    Statements
            7Item 2 -Management’s Discussion and
AnalysisFinancial Condition and Results of
    Operations
            14Item 4T – Controls and Procedures
            27Part
      II – OTHER INFORMATIONItem 4 – Submission of Matters to a Vote of Security
      Holders
            28Item 5 – Other Information
            28Item 6 –Exhibits
            28Signatures
            29


Index


Part
      I.
            FINANCIAL
      INFORMATION





Item
      I.
            Financial
      Statements





Weststar Financial Services Corporation &
Subsidiary


Consolidated
Balance Sheets





(unaudited)September 30,
            
            
            December 31,2009
            
            
            2008*ASSETS:Cash
      and cash equivalents:Cash
      and due from banks
            
            $
            3,585,203
            
            
            $
            4,200,866Interest-bearing
      deposits
            
            
            9,030,999
            
            
            
            218,912Total
      cash and cash equivalents
            
            
            12,616,202
            
            
            
            4,419,778Investment
      securities- available for sale, at fair value(amortized
      cost of $21,640,438 and $23,750,009, atSeptember
      30, 2009 and December 31, 2008, respectively)
            
            
            22,414,711
            
            
            
            23,778,449Loans
            
            
            185,441,835
            
            
            
            171,239,692Allowance
      for loan losses
            
            
            (3,519,884
            )
            
            
            (2,529,981
            )Net
      loans
            
            
            181,921,951
            
            
            
            168,709,711Premises
      and equipment, net
            
            
            2,489,124
            
            
            
            2,652,007Accrued
      interest receivable
            
            
            1,161,549
            
            
            
            1,030,460Federal
      Home Loan Bank stock, at cost
            
            
            592,300
            
            
            
            585,600Deferred
      income taxes
            
            
            1,031,054
            
            
            
            810,921Foreclosed
      properties
            
            
            636,219
            
            
            
            205,006Other
      assets
            
            
            724,352
            
            
            
            667,040TOTAL
            
            $
            223,587,462
            
            
            $
            202,858,972LIABILITIES
      AND SHAREHOLDERS’ EQUITYLiabilities:Deposits:Demand
            
            $
            23,971,160
            
            
            $
            22,251,288NOW
      accounts
            
            
            38,885,373
            
            
            
            18,319,836Money
      market accounts
            
            
            30,421,234
            
            
            
            31,416,333Savings
            
            
            2,277,461
            
            
            
            2,207,173Time
      deposits of $100,000 or more
            
            
            22,859,848
            
            
            
            26,799,682Other
      time deposits
            
            
            77,340,981
            
            
            
            69,819,794Total
      deposits
            
            
            195,756,057
            
            
            
            170,814,106Short-term
      borrowings
            
            
            4,429,141
            
            
            
            5,919,140Accrued
      interest payable
            
            
            389,638
            
            
            
            565,105Other
      liabilities
            
            
            1,043,169
            
            
            
            926,050Long-term
      debt
            
            
            4,124,000
            
            
            
            8,124,000Total
      liabilities
            
            
            205,742,005
            
            
            
            186,348,401SHAREHOLDERS’
      EQUITY:Preferred
      stock, authorized $1,000,000 shares;No
      shares issued and outstanding
            
            
            -
            
            
            
            -Common
      stock, $1 par value, authorized- 9,000,000 shares;outstanding
      shares- and 2,147,132 at September 30, 2009and
      2,125,747 at December 31, 2008, respectively
            
            
            2,147,132
            
            
            
            2,125,747Additional
      paid-in capital
            
            
            6,218,619
            
            
            
            6,152,868Retained
      earnings
            
            
            9,003,915
            
            
            
            8,214,480Accumulated
      other comprehensive income
            
            
            475,791
            
            
            
            17,476Total
      shareholders’ equity
            
            
            17,845,457
            
            
            
            16,510,571Total
            
            $
            223,587,462
            
            
            $
            202,858,972





*Derived
from audited consolidated financial statements.


See notes
to consolidated financial statements.


2
 Index


Weststar FinancialServices Corporation &
Subsidiary


Consolidated Statements of Operations(unaudited)





Three
      Months
            
            
            Nine
      MonthsEnded
      September 30,
            
            
            Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008INTEREST
      INCOME:Interest
      and fees on loans
            
            $
            2,941,802
            
            
            $
            2,780,707
            
            
            $
            8,701,003
            
            
            $
            8,096,225Federal
      funds sold
            
            
            53
            
            
            
            3,416
            
            
            
            1,185
            
            
            
            44,592Interest-bearing
      deposits
            
            
            6,790
            
            
            
            336
            
            
            
            10,795
            
            
            
            1,552Investments:Taxable
      interest income
            
            
            162,448
            
            
            
            196,594
            
            
            
            511,521
            
            
            
            625,533Nontaxable
      interest income
            
            
            95,373
            
            
            
            91,704
            
            
            
            282,230
            
            
            
            266,425Corporate
      dividends
            
            
            1,242
            
            
            
            7,451
            
            
            
            1,242
            
            
            
            21,672Total
      interest income
            
            
            3,207,708
            
            
            
            3,080,208
            
            
            
            9,507,976
            
            
            
            9,055,999INTEREST
      EXPENSE:Time
      deposits of $100,000 or more
            
            
            170,615
            
            
            
            271,069
            
            
            
            619,427
            
            
            
            930,663Other
      time and savings deposits
            
            
            781,818
            
            
            
            791,346
            
            
            
            2,483,581
            
            
            
            2,412,338Short-term
      borrowings
            
            
            51,074
            
            
            
            5,661
            
            
            
            111,188
            
            
            
            17,478Long-term
      debt
            
            
            39,065
            
            
            
            112,921
            
            
            
            174,703
            
            
            
            352,942Total
      interest expense
            
            
            1,042,572
            
            
            
            1,180,997
            
            
            
            3,388,899
            
            
            
            3,713,421NET
      INTEREST INCOME
            
            
            2,165,136
            
            
            
            1,899,211
            
            
            
            6,119,077
            
            
            
            5,342,578PROVISION
      FOR LOAN LOSSES
            
            
            869,015
            
            
            
            320,635
            
            
            
            1,344,905
            
            
            
            508,760NET
      INTEREST INCOME AFTER PROVISIONFOR
      LOAN LOSSES
            
            
            1,296,121
            
            
            
            1,578,576
            
            
            
            4,774,173
            
            
            
            4,833,818OTHER
      INCOME:Services
      charges on deposit accounts
            
            
            306,610
            
            
            
            291,527
            
            
            
            858,945
            
            
            
            859,546Other
      service fees and commissions
            
            
            146,009
            
            
            
            119,278
            
            
            
            446,621
            
            
            
            324,082Equity
      in income (loss) of Bank of Asheville MortgageCompany,
      LLC
            
            
            -
            
            
            
            814
            
            
            
            -
            
            
            
            (15,295
            )Other
            
            
            10,847
            
            
            
            13,999
            
            
            
            30,698
            
            
            
            48,168Total
      other income
            
            
            463,466
            
            
            
            425,618
            
            
            
            1,336,264
            
            
            
            1,216,501OTHER
      EXPENSES:Salaries
      and wages
            
            
            703,476
            
            
            
            659,449
            
            
            
            2,094,747
            
            
            
            1,945,752Employee
      benefits
            
            
            84,483
            
            
            
            125,736
            
            
            
            298,618
            
            
            
            362,507Occupancy
      expense, net
            
            
            124,016
            
            
            
            120,455
            
            
            
            431,145
            
            
            
            370,194Equipment
      rentals, depreciation andmaintenance
            
            
            86,420
            
            
            
            95,626
            
            
            
            287,795
            
            
            
            328,962Supplies
            
            
            64,901
            
            
            
            57,850
            
            
            
            196,759
            
            
            
            196,352Professional
      fees
            
            
            102,789
            
            
            
            75,398
            
            
            
            254,182
            
            
            
            224,730Data
      processing fees
            
            
            168,761
            
            
            
            134,019
            
            
            
            479,709
            
            
            
            411,764FDIC
      insurance premiums
            
            
            76,968
            
            
            
            23,987
            
            
            
            323,180
            
            
            
            72,146Audit,
      tax and accounting
            
            
            24,219
            
            
            
            12,070
            
            
            
            103,841
            
            
            
            85,059Marketing
            
            
            65,431
            
            
            
            86,569
            
            
            
            238,553
            
            
            
            219,555Expenses
      from foreclosed properties
            
            
            20,343
            
            
            
            1,523
            
            
            
            20,413
            
            
            
            42,744Other
            
            
            94,471
            
            
            
            85,699
            
            
            
            272,100
            
            
            
            251,596Total
      other expenses
            
            
            1,616,278
            
            
            
            1,478,381
            
            
            
            5,001,042
            
            
            
            4,511,361INCOME
      BEFORE INCOME TAXES
            
            
            143,309
            
            
            
            525,813
            
            
            
            1,109,394
            
            
            
            1,538,958INCOME
      TAX PROVISION
            
            
            11,686
            
            
            
            176,809
            
            
            
            319,959
            
            
            
            519,334NET
      INCOME
            
            $
            131,623
            
            
            $
            349,004
            
            
            
            789,435
            
            
            
            1,019,624EARNINGS
      PER SHARE:Basic
            
            $
            .06
            
            
            $
            .16
            
            
            $
            .37
            
            
            $
            .48Diluted
            
            $
            .06
            
            
            $
            .15
            
            
            $
            .35
            
            
            $
            .45





See notes
to consolidated financial statements.


3
 Index


Weststar Financial ServicesCorporation &
Subsidiary


Consolidated Statements of
Comprehensive Income (Loss)(unaudited)





Three
      Months
            
            
            Nine
      MonthsEnded
      September 30,
            
            
            Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008NET
      INCOME
            
            $
            131,623
            
            
            $
            349,004
            
            
            $
            789,435
            
            
            $
            1,019,624OTHER
      COMPREHENSIVE INCOMEUnrealized
      holding income (losses) on securitiesavailable
      for sale
            
            
            502,156
            
            
            
            (590,969
            )
            
            
            745,833
            
            
            
            (708,462
            )Tax
      effect
            
            
            (193,581
            )
            
            
            227,818
            
            
            
            (287,518
            )
            
            
            273,112OTHER
      COMPREHENSIVE INCOME (LOSS), NET OF TAX
            
            
            308,575
            
            
            
            (363,151
            )
            
            
            458,315
            
            
            
            (435,350
            )COMPREHENSIVE
      INCOME (LOSS)
            
            $
            440,198
            
            
            $
            (14,147
            )
            
            $
            1,247,750
            
            
            $
            584,274





See notes to consolidated financial
statements.


4
 Index


Weststar FinancialServices Corporation &
Subsidiary


Consolidated
Statements of Changes in Shareholders’ Equity(unaudited)


For
the Nine Months Ended September 30, 2009 and 2008





AccumulatedAdditional
            
            
            
            
            
            Other
            
            
            TotalCommon Stock
            
            
            Paid-In
            
            
            Retained
            
            
            Comprehensive
            
            
            Shareholders’Shares
            
            
            Amount
            
            
            Capital
            
            
            Earnings
            
            
            Income (Loss)
            
            
            EquityBalance
      December 31, 2007
            
            
            2,118,437
            
            
            $
            2,118,437
            
            
            $
            6,133,773
            
            
            $
            6,913,168
            
            
            $
            13,861
            
            
            $
            15,179,239Net
      change in unrealizedlosses
      on securities held for sale
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (435,350
            )
            
            
            (435,350
            )Issuance
      of common stock pursuantto
      the exercise of stock options
            
            
            5,810
            
            
            
            5,810
            
            
            
            9,197
            
            
            
            -
            
            
            
            -
            
            
            
            15,007Tax
      benefit on exercise of nonqualifiedstock
      options
            
            
            -
            
            
            
            -
            
            
            
            4,628
            
            
            
            -
            
            
            
            -
            
            
            
            4,628Net
      Income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,019,624
            
            
            
            -
            
            
            
            1,019,624Balance
      September 30, 2008
            
            
            2,124,247
            
            
            $
            2,124,247
            
            
            $
            6,147,598
            
            
            $
            7,932,792
            
            
            $
            (421,489
            )
            
            $
            15,783,148Balance
      December 31, 2008
            
            
            2,125,747
            
            
            $
            2,125,747
            
            
            $
            6,152,868
            
            
            $
            8,214,480
            
            
            $
            17,476
            
            
            $
            16,510,571Net
      change in unrealizedgains
      on securities held for sale
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            458,315
            
            
            
            458,315Issuance
      of common stock pursuantto
      the exercise of stock options
            
            
            21,385
            
            
            
            21,385
            
            
            
            48,330
            
            
            
            -
            
            
            
            -
            
            
            
            69,715Tax
      benefit on exercise of non-qualified
      stock options
            
            
            -
            
            
            
            -
            
            
            
            17,421
            
            
            
            -
            
            
            
            -
            
            
            
            17,421Net
      Income
            
            
            -
            
            
            
            -
            
            
            
            789,435
            
            
            
            -
            
            
            
            789,435Balance
      September 30, 2009
            
            
            2,147,132
            
            
            $
            2,147,132
            
            
            $
            6,218,619
            
            
            $
            9,003,915
            
            
            $
            475,791
            
            
            $
            17,845,457





See notes
to consolidated financial statements.


5
 Index


WeststarFinancial Services Corporation &
Subsidiary


Consolidated
Statements of Cash Flows (unaudited)


For
the Nine Months Ended September 30,





2009
            
            
            2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      Income
            
            $
            789,435
            
            
            $
            1,019,624Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
            
            
            248,978
            
            
            
            289,812Provision
      for loan losses
            
            
            1,344,905
            
            
            
            508,760Premium
      amortization and discount accretion, net
            
            
            (24,641
            )
            
            
            (18,408
            )Deferred
      income tax provision
            
            
            (507,651
            )
            
            
            (197,077
            )Expense
      from foreclosed properties
            
            
            17,809
            
            
            
            36,781(Increase)
      decrease in accrued interest receivable
            
            
            (131,089
            )
            
            
            51,576(Increase)
      decrease in other assets
            
            
            (57,312
            )
            
            
            122,793Decrease
      in accrued interest payable
            
            
            (175,467
            )
            
            
            (97,340
            )Increase
      in other liabilities
            
            
            117,119
            
            
            
            145,217Net
      cash provided by operating activities
            
            
            1,622,086
            
            
            
            1,861,738CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of securities available for sale
            
            
            (1,597,260
            )
            
            
            (1,530,893
            )Maturities
      of securities available for sale
            
            
            3,731,472
            
            
            
            3,272,839Net
      increase in loans
            
            
            (15,026,358
            )
            
            
            (22,470,684
            )FHLB
      stock purchase
            
            
            (54,200
            )
            
            
            (122,300
            )FHLB
      stock redemption
            
            
            47,500
            
            
            
            -Proceeds
      from the sales of foreclosed properties
            
            
            20,191
            
            
            
            60,300Additions
      to premises and equipment
            
            
            (86,095
            )
            
            
            (44,774
            )Net
      cash used in investing activities
            
            
            (12,964,750
            )
            
            
            (20,835,512
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      increase in demand deposits, NOW Accounts, MMDA and savings
      accounts
            
            
            21,360,598
            
            
            
            3,260,518Net
      increase in time deposits
            
            
            3,581,353
            
            
            
            14,067,952Issuance
      of common stock
            
            
            69,715
            
            
            
            15,007Proceeds
      of FHLB advances
            
            
            1,110,000
            
            
            
            2,550,000Repayment
      of FHLB advances
            
            
            (2,110,000
            )
            
            
            (2,550,000
            )Tax
      benefit from exercise of non-qualified stock options
            
            
            17,421
            
            
            
            4,628Net
      increase (decrease) in short-term borrowing
            
            
            (4,489,999
            )
            
            
            834,808Net
      cash provided by financing activities
            
            
            19,539,088
            
            
            
            18,182,913NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            8,196,424
            
            
            
            (790,861
            )CASH
      AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
            
            
            4,419,778
            
            
            
            8,527,456CASH
      AND CASH EQUIVALENTS AT END OF PERIOD
            
            $
            12,616,202
            
            
            $
            7,736,595





See notes
to consolidated financial statements.


6
 Index


WESTSTAR FINANCIAL SERVICES CORPORTION &
SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




1.
            Weststar
      Financial Services Corporation (the “Company”) is a holding company with
      one subsidiary, The Bank of Asheville (the “Bank”).  The Bank is
      a state chartered commercial bank, which was incorporated in North
      Carolina on October 29, 1997.  The Bank provides consumer and
      commercial banking services in Buncombe County and surrounding
      area.  Common shares of The Bank of Asheville were exchanged for
      common shares of Weststar Financial Services Corporation on April 29,
      2000.  Weststar Financial Services Corporation formed Weststar
      Financial Services Corporation I (the “Trust”) during October 2003 in
      order to facilitate the issuance of trust preferred
      securities.  The Trust is a statutory business trust formed
      under the laws of the state of Delaware, of which all common securities
      are owned by Weststar Financial Services
  Corporation.





In the
opinion of management, the accompanying consolidated financial statements
contain all adjustments necessary to present fairly the consolidated financial
position of the Company as of September 30, 2009 and December 31, 2008, and the
consolidated results of their operations for the three and nine-month periods
ended September 30, 2009 and 2008 and their cash flows for the nine-month
periods ended September 30 2009 and 2008.  Operating results for the
three and nine-month periods ended September 30, 2009 are not necessarily
indicative of the results that may be expected for the fiscal year ending
December 31, 2009.





The
accounting policies followed are set forth in Note 1 to the 2008 Annual Report
to Shareholders (Form 10-K) on file with the Securities and Exchange
Commission.





2.
            In
      the normal course of business there are various commitments and contingent
      liabilities such as commitments to extend credit, which are not reflected
      on the financial statements.  The unused portions of commitments
      to extend credit were $26,826,955 and $31,886,835 at September 30, 2009
      and December 31, 2008,
respectively.





3.
            Basic
      earnings per common share represents income available to common
      stockholders divided by the weighted average number of common shares
      outstanding during the period.  Diluted earnings per common
      share reflect additional common shares that would have been outstanding if
      dilutive potential common shares had been issued, as well as any
      adjustments to income that would result from the assumed
      issuance.  Potential common shares that may be issued by the
      Company relate solely to outstanding stock options and are determined
      using the treasury stock method.  During 2009 and 2008, there
      were no shares excluded due to
antidultion.





Basic and
diluted net income per share have been computed based upon net income as
presented in the accompanying statements of operations divided by the weighted
average number of common shares outstanding or assumed to be outstanding as
summarized below:


7
 Index




Three
      Months
            
            
            Nine
      MonthsEnded
      September 30,
            
            
            Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Weighted
      average number ofcommon
      shares used incomputing
      basic net incomeper
      share
            
            
            2,146,817
            
            
            
            2,122,147
            
            
            
            2,142,534
            
            
            
            2,120,195Effect
      of dilutive stock options
            
            
            97,212
            
            
            
            151,241
            
            
            
            99,464
            
            
            
            157,877Weighted
      average number ofcommon
      shares and dilutivepotential
      common sharesused
      in computing diluted netincome
      per common share
            
            
            2,244,029
            
            
            
            2,273,388
            
            
            
            2,241,998
            
            
            
            2,278,072





4.
            The
      Company groups assets and liabilities at fair value in three levels, based
      on the markets in which the assets and liabilities are traded and the
      reliability of the assumptions used to determine fair
      values.  These levels
are:





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





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





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





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





Investment
Securities Available-for-Sale


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





Impaired
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 a
specific reserve 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, the fair value is estimated using
one of several methods, including collateral value, market value of similar
debt, enterprise value, liquidation value and discounted cash
flow.  Those impaired loans not requiring an allowance represent loans
for which the fair value of the expected repayments or collateral exceed the
recorded investment in such loans.  At September 30, 2009 and December
31, 2008, substantially all of the total impaired loans were evaluated based on
the fair value of the collateral.  For impaired loans,  an
allowance is established


8
 Index


based on
the fair value of collateral within the fair value hierarchy.  When
the fair value of the collateral is based on an observable market price or a
current appraised value, the Company records the impaired loan as nonrecurring
Level 2.  When an appraised value is not available or management
determines the fair value of the collateral is further impaired below the
appraised value and there is no observable market price, the Company records the
impaired loan as nonrecurring Level 3.





Foreclosed
Properties


Other
real estate owned by the Company resulting from foreclosures is estimated at the
fair value of the collateral based on a current appraised value is recorded as a
Level 2.  If no current appraisal is available, other management
estimates are utilized, and the asset is recorded as a Level 3.  At
September 30, 2009 and December 31, 2008, no foreclosures were carried at fair
value.




Assets
measured at fair value on a recurring basis are summarized below:








Fair Value Measurements at September 30,
      2009Description
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              Identical
              Assets
              (Level 1)
            
            
            Significant
              Other
              Observable
              Inputs
              (Level 2)
            
            
            Significant
              Unobservable
              Inputs
              (Level 3)
            
            
            Assets/
              Liabilities
              at Fair ValueAvailable-for-salesecurities
            
            
            -
            
            
            $
            22,414,711
            
            
            
            -
            
            
            $
            22,414,711Fair Value Measurements at December 31,
      2008Available-for-salesecurities
            
            
            -
            
            
            $
            23,778,449
            
            
            
            -
            
            
            $
            23,778,449








Assets
measured at fair value on a non-recurring basis are summarized
below:





Fair Value Measurements at September 30,
      2009Description
            
            Quoted
      Prices
              in
      Active
              Markets
      for
              Identical
              Assets
              (Level 1)
            
            
            Significant
              Other
              Observable
              Inputs
              (Level 2)
            
            
            Significant
              Unobservable
              Inputs
              (Level 3)
            
            
            Assets/
              Liabilities
              at Fair ValueImpaired
      loans(1)
            
            
            -
            
            
            $
            3,758,601
            
            
            $
            156,723
            
            
            $
            3,915,325





(1) Net
of deferred fees/costs, reserves and loans carried at cost.







Fair
Value of Financial Instruments





The fair
value estimates presented herein are based on pertinent information available to
management as of September 30, 2009 and December 31, 2008.  These fair
values estimates are based on relevant market information and information about
the financial instruments.  Fair value estimates are intended
to


9
 Index


represent
the price an asset could be sold at or the price a liability could be settled
for.  However, given there is no active market or observable market
transaction for many of the Company’s financial instruments, the Company has
made estimates of many of these fair values, which are subjective in nature,
involve uncertainties and matters of significant judgment and therefore cannot
be determined with precision.  Changes in assumptions could
significantly affect the estimated values.








September 30, 2009
            
            
            December 31, 2008Carrying
              amount
            
            
            Estimated
              fair value
            
            
            Carrying
              amount
            
            
            Estimated
              fair value(In
      thousands)Assets:Cash
      and cash equivalents
            
            $
            12,616
            
            
            $
            12,616
            
            
            $
            4,420
            
            
            $
            4,420Investment
      securities
            
            
            22,415
            
            
            
            22,415
            
            
            
            23,778
            
            
            
            23,778Federal
      Home Loan Bank stock
            
            
            592
            
            
            
            592
            
            
            
            586
            
            
            
            586Loans,
      net
            
            
            181,922
            
            
            
            184,066
            
            
            
            168,710
            
            
            
            171,856Interest
      receivable
            
            
            1,162
            
            
            
            1,162
            
            
            
            1,030
            
            
            
            1,030Bank
      owned life insurance
            
            
            312
            
            
            
            312
            
            
            
            225
            
            
            
            225Liabilities:Demand
      deposits, NOW accounts,money market accounts, savings
            
            
            95,555
            
            
            
            95,555
            
            
            
            74,195
            
            
            
            74,195Time
      deposits
            
            
            100,201
            
            
            
            100,443
            
            
            
            96,619
            
            
            
            97,039Short-term
      borrowings
            
            
            4,429
            
            
            
            4,515
            
            
            
            5,919
            
            
            
            5,919Interest
      payable
            
            
            390
            
            
            
            390
            
            
            
            565
            
            
            
            565Long-term
      debt
            
            
            4,124
            
            
            
            4,041
            
            
            
            8,124
            
            
            
            8,297







Cash and
Cash Equivalents, Accrued Interest Receivable, and Accrued Interest Payable -
The carrying amounts approximate their fair value because of the short maturity
of these financial instruments.




Investment
Securities - Investment securities available-for-sale are recorded at fair value
on a recurring basis.  Fair value measurement is based upon quoted
prices, if available.  If quoted prices are not available, fair values
are measured using independent pricing modes or other model-based valuation
techniques such as present value of future cash flows, adjusted for the
security’s credit rating, prepayment assumptions and other factors such as
credit loss assumptions.    The carrying value of Federal
Home Loan Bank stock approximates fair value based on the historic redemption
policies and practices of the Federal Home Loan Bank.





Loans -
Fair value of loans are estimated based on discounted expected cash
flows.  These cash flows include assumptions for prepayment estimates
over the loans remaining life, considerations for the current interest rate
environment compared to the weighted average rate of each portfolio credit, a
credit risk component based on historical and expected performance of each
portfolio.





Bank
Owned Life Insurance – Fair value of bank owned life insurance is based upon
quoted prices of underlying investments, if available.  If quoted
prices are not available, fair values are measured using independent pricing
modes or other model-based valuation techniques such as present value of future
cash flows, adjusted for the security’s credit rating, prepayment assumptions
and other factors such as credit loss assumptions.





Deposits
- The fair value of deposits with no stated maturity, such as
non-interest-bearing demand deposits, savings, NOW, and money market accounts,
is equal to the amount payable on demand as of the valuation date. The fair
value of certificates of deposit is based on the discounted value of
contractual




10
 Index


cash
flows. The discount rate is estimated using the rates currently offered for
deposits of similar remaining maturities.




Short-term
borrowings and long-term debt – The fair values are based on discounting
expected cash flows at the interest rate for debt with same or similar remaining
maturities and collateral requirements.






INVESTMENT
PORTFOLIO





The
amortized cost, gross unrealized gains and losses and fair values of investment
securities at September 30, 2009 are as follows:





Available-for-sale
securities consist of the following at September 30, 2009:





Amortized
              cost
            
            
            Gross
              unrealized
              gains
            
            
            Gross
              unrealized
              losses
            
            
            Fair
              valueType
      and Maturity GroupResidential
      mortgage-backedsecurities
      --Within
      1 year
            
            $
            507,574
            
            
            $
            -
            
            
            $
            (532
            )
            
            $
            507,042Residential
      mortgage-backedsecurities
      due -Within
      1 to 5 years
            
            
            1,321,967
            
            
            
            30,322
            
            
            
            -
            
            
            
            1,352,289Municipal
      bonds due –Within
      1 to 5 years
            
            
            1,551,887
            
            
            
            67,095
            
            
            
            -
            
            
            
            1,618,982Total
      due within 1 to 5 years
            
            
            2,873,854
            
            
            
            97,417
            
            
            
            -
            
            
            
            2,971,271U.S.
      Government agencies due -Within
      5 to 10 years
            
            
            2,370,806
            
            
            
            169,263
            
            
            
            -
            
            
            
            2,540,069Residential
      mortgage-backedsecurities
      due -Within
      5 to 10 years
            
            
            773,313
            
            
            
            42,702
            
            
            
            -
            
            
            
            816,015Municipal
      bonds due –Within
      5 to 10 years
            
            
            716,364
            
            
            
            10,746
            
            
            
            -
            
            
            
            727,110Total
      due within 5 to 10 years
            
            
            3,860,483
            
            
            
            222,711
            
            
            
            -
            
            
            
            4,083,194Residential
      mortgage-backedsecurities
      due -after
      10 years
            
            
            6,997,524
            
            
            
            367,250
            
            
            
            -
            
            
            
            7,364,774Municipal
      bonds due –after
      10 years
            
            
            7,401,003
            
            
            
            152,109
            
            
            
            (64,682
            )
            
            
            7,488,430Total
      due after years
            
            
            14,398,527
            
            
            
            519,359
            
            
            
            (64,682
            )
            
            
            14,853,204Total
      at September 30, 2009
            
            $
            21,640,438
            
            
            $
            839,487
            
            
            $
            (65,214
            )
            
            $
            22,414,711





The
following tables show investments’ gross unrealized losses and fair value,
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at


11
 Index


September
30, 2009.  These investments represent securities that the Company has
the positive intent and ability to hold to maturity.  The unrealized
losses on investment securities as of September 30, 2009 are a result of
volatility in the market during 2009 and relate to three Municipal bonds and two
Mortgage-backed securities.  All unrealized losses on investment
securities resulted from changes in interest rates and are considered by
management to be temporary given the credit ratings on these investment
securities, the duration of the unrealized loss, and our intent and ability to
retain our investment in a security for a period of time sufficient to allow for
any anticipated recovery in market value.  Since the Company intends
to hold all of its investment securities until maturity, and it is more likely
than not that the Company will not have to sell any of its investment securities
before unrealized losses have been recovered, and the company expects to recover
the entire amount of the amortized cost basis of all its securities, none of the
securities are deemed other than temporarily impaired.








Less Than 12 Months
            
            
            12 Months or More
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealizedvalue
            
            
            losses
            
            
            value
            
            
            losses
            
            
            value
            
            
            lossesSecurities
      available for sale:Residential
      mortgage-backedsecurities
            
            $
            278,884
            
            
            $
            (532
            )
            
            $
            -
            
            
            $
            -
            
            
            $
            278,884
            
            
            $
            (532
            )Municipal
      bonds
            
            
            -
            
            
            
            -
            
            
            
            1,422,689
            
            
            
            (64,682
            )
            
            
            1,422,689
            
            
            
            (64,682
            )Total
      temporarily impairedsecurities
            
            $
            278,884
            
            
            $
            (532
            )
            
            $
            1,422,689
            
            
            $
            (64,682
            )
            
            $
            1,701,573
            
            
            $
            (65,214
            )







The
aggregate cost of the Company’s cost method investment, Federal Home Loan Bank -
Atlanta stock, totaled $592,300 at September 30, 2009.  The Company
estimated that the fair value equaled the cost of the investment (that is, the
investment was not impaired).  The investment in Federal Home Loan
Bank stock is not reflected in investment securities; the investment is carried
as a separate line item in the financial statements.




5.
            In
      preparing these financial statements, the Company has evaluated events and
      transactions for potential recognition or disclosure through November 12,
      2009, the date the financial statements were
  issued.





6.
            An
      update to FASB Staff Position (“FSP”) Accounting Standards Code (“ASC”)
      ASC 820, “Determining Fair Value,” was effective for interim and annual
      reporting periods ending after June 15, 2009, with early adoption
      permitted for periods ending after March 15, 2009.  This
      position provides guidelines for making fair value measurements when the
      volume and level of activity for assets or liabilities have significantly
      decreased. The update addresses determining fair values when there is no
      active market or where the price inputs being used represent distressed
      sales. It reaffirms the objective of fair value measurement – to reflect
      how much an asset would be sold for in an orderly transaction (as opposed
      to a distressed or forced transaction) at the date of the financial
      statements under current market conditions. Specifically, it reaffirms the
      need to use judgment to ascertain if a formerly active market has become
      inactive and in determining fair values when markets have become inactive.
      In such cases, management would use valuation techniques such as market
      approach, income approach or cost approach or a weighted probably of each
      to determine the fair value.  The adoption of this new guidance
      did not have material effect on its financial position and results of
      operations.





An update
to FSP ASC 320, “Investments in Debt and Equity Securities,” was effective for
interim and annual reporting periods ending after June 15, 2009, with early
adoption permitted for periods ending after March 15, 2009.  The
update provides further guidance on Other-Than-Temporary Impairment and effects
improved presentation and disclosure of other-than-temporary impairment on debt
and equity securities in the financial statements. This amendment is intended to
bring greater consistency to the timing of impairment recognition, and provide
greater clarity to investors about the credit and noncredit
components


12
 Index


of
impaired debt securities that are not expected to be sold. The measure of
other-than-temporary impairment is the difference between a security’s amortized
cost basis and fair value. The FSP also requires increased and more timely
disclosures sought by investors regarding expected cash flows, credit losses,
and an aging of securities with unrealized losses. The adoption of this new
guidance did not have a material effect on its financial position and results of
operations.





An update
to FSP ASC 825, “Financial Instruments,” was effective for interim and annual
reporting periods ending after June 15, 2009, with early adoption permitted for
periods ending after March 15, 2009.  The amendment requires
disclosures about fair value of financial instruments for interim reporting
periods of publicly traded companies as well as in annual financial
statements.  The Company’s adoption of this new guidance did not have
a material effect on its financial position and results of
operations.





In May
2009, FASB issued ASC 855, “Subsequent Events.”  This statement sets
forth the circumstances under which an entity should recognize events occurring
after the balance sheet date and the disclosures that should be
made.  Also, this statement requires disclosure of the date through
which the entity has evaluated subsequent events (for public companies, and
other companies that expect to widely distribute their financial statements,
this date is the date of financial statement issuance, and for nonpublic
companies, the date the financial statements are available to be
issued).  The effective date is for interim and annual periods ending
after June 15, 2009. The adoption of this FAS did not have a material effect on
its financial position and results of operations.





In June
2009, FASB issued ASC 860, “Transfers and Servicing,” which eliminates the
concept of a qualifying special purpose entity (QSPE), changes the requirements
for derecognizing financial assets, and requires additional disclosures,
including information about continuing exposure to risks related to transferred
financial assets.  This standard is effective for financial asset
transfers occurring after the beginning of fiscal years beginning after November
15, 2009.  The disclosure requirements must be applied to transfers
that occurred before and after the effective date.The Company does not
anticipate the adoption of this statement as of January 1, 2010 to have a
material effect on its financial position and results of
operations.





In June
2009, FASB issued ASC 810, “Consolidation,” which contains new criteria for
determining the primary beneficiary, eliminates the exception to consolidating
QSPEs, requires continual reconsideration of conclusions reached in determining
the primary beneficiary, and requires additional disclosures.  This
standard is effective as of the beginning of fiscal years beginning after
November 15, 2009 and is applied using a cumulative effect adjustment to
retained earnings for any carrying amount adjustments (e.g., for
newly-consolidated VIEs).The Company does not
anticipate the adoption of this statement as of January 1, 2010 to have a
material effect on its financial position and results of
operations.





In June
2009, FASB ASC 105, “Generally Accepted Accounting Principles,” effective for
financial statements issued for interim and annual financial statements ending
after September 15, 2009.  The Codification will become the source of
authoritative US GAAP recognized by the FASB to be applied by nongovernmental
entities and will supersede all non-SEC accounting and reporting
standards.  The adoption of this statement did not have a material
effect on its financial position and results of operations.


13
 Index


Item 2.
                  Management’s
      Discussion and
Analysis


FinancialCondition and Results of
Operations





Weststar
Financial Services Corporation & Subsidiaries


Management’s
Discussion and Analysis





Management’s
Discussion and Analysis is provided to assist in understanding and evaluating
the Company’s results of operations and financial condition. The following
discussion should be read in conjunction with the consolidated financial
statements and related notes included elsewhere herein. Weststar Financial
Services Corporation (the “Company”) is a holding company for The Bank of
Asheville (the “Bank”), a state chartered commercial bank incorporated in North
Carolina on October 29, 1997.  The Bank provides consumer and
commercial banking services in Buncombe County and surrounding
areas.  Common shares of the Bank were exchanged for common shares of
Weststar Financial Services Corporation on April 29, 2000.  Weststar
Financial Services Corporation formed Weststar Financial Services Corporation I
(the “Trust”) during October 2003 in order to facilitate the issuance of trust
preferred securities.  The Trust is a statutory business trust formed
under the laws of the state of Delaware, of which all common securities are
owned by Weststar Financial Services Corporation.  On October 19,
2004, the Company formed Bank of Asheville Mortgage Company, LLC (the “Mortgage
Company”), a mortgage broker, of which the Company owned a 50%
interest.  During 2008, the Company and its partner in the Mortgage
Company elected to dissolve the partnership and closed the Mortgage Company on
October 31, 2008.  Because Weststar Financial Services Corporation has
no material operations and conducts no business on its own other than owning the
Bank, the discussion contained in Management’s Discussion and Analysis concerns
primarily the business of the Bank.  However, for ease of reading and
because the financial statements are presented on a consolidated basis, Weststar
Financial Services Corporation and the Bank are collectively referred to herein
as the Company.





EXECUTIVE
OVERVIEW





During
2009, the Company continued its focus on asset quality, liquidity and core
deposit growth.  Management emphasized prudent underwriting standards,
periodic reviews of loans of $100,000 or more, and monitoring loan
quality.  While there was an increase in non-performing assets,
overall asset quality remained strong during the
period.  Non-performing assets totaled $6,809,269 at September 30,
2009 compared to $521,108 at December 31, 2008.  Net charge-offs for
the period totaled $355,002 compared to $243,641 for the nine-month period ended
September 30, 2008.  Loans outstanding grew by 8.29% to $185,441,835
compared to December 31, 2008.  Deposits increased 14.60% to
$195,756,057.  The increase was attributable to marketing campaigns,
sales call efforts and product development.





Net
interest income increased by 14.00% during the three-month period due to growth
in net earning assets.  As a result of loan growth, net charge-offs
and a continued deterioration in the national and regional economic conditions,
the Company added $869,015 to allowance for loan losses compared to $320,635
during the comparable period in 2008.  Other non-interest income for
the September 30, 2009 and 2008 quarters totaled $463,466 and $425,618,
respectively.  The increase in other income primarily reflects
increased fees from the origination of mortgage loans at the Bank level and
increased revenue from debit/credit card interchange
transactions.  During the second quarter of 2008, the Company and its
partner in the Mortgage Company mutually agreed to terminate their relationship,
and began the process to close the Mortgage Company.  The Company then
shifted originating mortgage loans through the Bank.  Bank of
Asheville Mortgage Company, LLC posted net operating losses of $1,628 during the
third quarter of 2008 of which $814 was the Company’s
portion.  Non-interest expenses increased from $1,478,381 to
$1,616,278 or 9.33%.  The increase was primarily attributable to
operating expenses associated with personnel, professional fees, data processing
fees, FDIC insurance premiums and expenses associated with foreclosed
properties.




Net
income totaled $131,623 and $349,004 for the quarters ended September 30, 2009
and 2008, respectively – a decrease of 62.29%.


14
 Index


The
Company’s net interest income increased by 14.53% during the nine-month period
due to growth in net earnings assets.  As a result of loan growth, net
charge-offs and a continued deterioration in the national and regional economic
conditions, the Company added $1,344,905 to the loan loss reserve compared to
$508,760 during the comparable period in 2008.  Other non-interest
income for the September 30, 2009 and 2008 periods totaled $1,336,264 and
$1,216,501 respectively.  The increase in other income primarily
reflects increased fees from the origination of mortgage loans at the Bank level
and increased revenue from debit/credit card interchange
transactions.  During the second quarter of 2008, the Company and its
partner in the Mortgage Company mutually agreed to terminate their relationship,
and began the process to close the Mortgage Company.  The Company then
shifted originating mortgage loans through the Bank.  Bank of
Asheville Mortgage Company, LLC posted net operating losses of $30,410 during
the nine month period of 2008 of which $15,295 was the Company’s
portion.  Non-interest expenses increased from $4,511,361 to
$5,001,042 or 10.85%.  The increase was primarily attributable to
operating expenses associated with personnel, data processing fees, FDIC
insurance premiums and marketing expenses incurred to support loan and deposit
servicing and growth.




Net
income totaled $789,435 and $1,019,624 for the periods ended September 30, 2009
and 2008, respectively – a decrease of 22.58%.





CHANGES
IN FINANCIAL CONDITION


SEPTEMBER
30, 2009 COMPARED TO DECEMBER 31, 2008





During
the period from December 31, 2008 to September 30, 2009, total assets increased
$20,728,490 or 10.22%.  This increase, reflected primarily in the cash
and cash equivalents and loans, resulted from an increase in
deposits.





Securities
and interest-bearing balances with other financial institutions at September 30,
2009 totaled $31,445,710 compared to $23,997,361 at December 31,
2008.  Through an investment in the Federal Home Loan Bank, the
Company gained access to the Federal Home Loan Bank system.  This
access grants the Company sources of funds for lending and
liquidity.  Investments in Federal Home Loan Bank stock to date total
$592,300.





At
September 30, 2009, the loan portfolio constituted 82.94% of the Company’s total
assets.  Loans increased $14,202,143 from December 31, 2008 to
September 30, 2009 or 8.29%.  Continued growth in real estate secured
lending resulted in the majority of the growth.  Management places a
strong emphasis on loan quality.





During
the period, the loan portfolio reflected increased deterioration in asset
quality.  The Company evaluates loans for impairment on a monthly
basis.  A loan is considered impaired when it is probable that the
Company will be unable to collect all amounts due (including both principal and
interest) according to the contractual terms of the loan
agreement.  Generally, a loan is impaired if it exhibits the same
level of weakness and probability of loss as loan classified as doubtful or
loss.  All nonaccrual and most troubled debt restructured loans are
considered impaired.





The
recorded investment, which includes accrued interest and is net of deferred
fees/costs, in loans that are considered to be impaired was $7,664,640, $83,892,
and $349,976 at September 30, 2009 and 2008, and December 31, 2008,
respectively.  The average recorded balance of impaired loans for the
nine months ended September 30, 2009 and 2008 totaled $3,141,102 and $199,511,
respectively and $195,935 for the year ended December 31, 2008.  The
related allowance for loan losses determined for impaired loans was $372,237,
none and none at September 30, 2009 and 2008, and December 31, 2008
respectively.  For the nine-month periods ended September 30, 2009 and
2008, Weststar recognized interest income from impaired loans of approximately
$40,224 and $350, respectively.  See “Asset Quality” for discussion
for an analysis of loan loss reserves.





Non-performing
assets consist of loans on which interest is no longer accrued, certain
restructured loans where the borrower has failed to comply with the terms of the
original note due to financial difficulties and real estate acquired in
foreclosure.  The accrual of interest is discontinued on loans when
management believes there is reasonable uncertainty about the full amount of the
collection of principal and interest or when the loan is contractually past due
90 days or more.  Once a loan is placed on nonaccrual status, it
remains as such until the


15
 Index


loan is
charged-off or until a reasonable payment history (generally 6 months) has been
demonstrated and the borrower’s financial condition supports a probable
likelihood of continued future payments.  Interest income on
nonaccrual loans is subsequently recognized only in periods in which actual
payments are received.  If a loan is returned to a performing status,
interest recognition resumes under the accrual method of
accounting.  The following table sets forth non-performing assets at
September 30, 2009 and December 31, 2008.








September 30,
            
            
            December 31,2009
            
            
            2008Nonaccrual
      loans
            
            $
            6,078,050
            
            
            $
            316,102Restructured
      loans
            
            
            95,000
            
            
            
            -Total
      non-performing loans
            
            $
            6,173,050
            
            
            $
            316,102Foreclosed
      properties
            
            
            636,219
            
            
            
            205,006Total
            
            $
            6,809,269
            
            
            $
            521,108Restructured
      loans not listed above
            
            $
            1,136,527
            
            
            $
            -





Nonaccrual
loans as of September 30, 2009 were comprised of 23 loans, the majority of which
are secured by real estate in the form of real estate construction properties or
mortgages.  Of the total loans on nonaccrual status, approximately
$1.2 million had maintained a regular payment status, but have not yet been
returned to accrual status.





Restructured
loans, which are in compliance with restructured terms, totaled $1,136,527 at
September 30, 2009.  The majority of these loans are secured by real
estate in the form of construction properties or mortgages.  The
Company did not reduce interest rates on restructured loan below the then
existing market rates.  Rather, restructuring generally involved a
concession in the form of extending the term of the loan and deferring accrued
interest to the end of the loan period.  Given the current economic
conditions and the accumulated real estate inventory, management has chosen to
work with borrowers by providing some flexibility in payment terms.





Potential
problem loans consist of loans that are performing in accordance with
contractual terms, but for which management has concerns about the ability of an
obligor to continue to comply with repayment terms, because of the obligor’s
potential operating or financial difficulties.  Management monitors
these loans closely and reviews their performance on a regular
basis.  These loans do not meet the standards for, and are therefore
not included in, non-performing assets.  At September 30, 2009, the
Company identified 14 potential problem loans totaling $13,767,385 as compared
to one loan totaling $400,756 at December 31, 2008.  Potential problem
loans at September 30, 2009 and December 31, 2008 were primarily from the
Company’s commercial real estate segment of the loan portfolio.





Potential
problem loans at September 30, 2009, consisted of six
relationships.  One relationship consisted of a single note secured by
a vehicle in the amount of $3,659.  The borrower has declared
bankruptcy, but continues to make payments.  The second relationship,
which consisted of two loans totaling $3,060,000, is secured by a first deed of
trust on a twenty-seven lot residential development.  This
relationship is being included as a potential problem loan due to the fact that
the delays in completion of the project have added concerns about the
principal’s ability to continue interest payments until the lots
sale.  Management anticipates working with the developer during the
next 30 days regarding his ability to resume payments.  A third
relationship consisted of two notes totaling $3,025,050.  Both notes
are current; however, the borrower was previously part owner of a business
entity, which recently declared bankruptcy.  The smaller of the two
notes is secured by a first deed of trust on a residential lot in a subdivision,
which has recently filed for Chapter 11 protection.  The larger of the
two notes is secured by a first deed of trust on 32 completed building lots, and
additional acreage in a well established subdivision.  The borrower
continues to make payments on the notes.  A fourth relationship
consisted of two notes totaling $2,337,500 to two individual
borrowers.  The first note is a lot loan for $637,500 in a
development, which has filed for Chapter 11 protection.  The second
note for $1,700,000 is made to the same individual, who is the borrower on the
first note, plus an  additional borrower..  The note is
secured by a first deed of trust and improvements, including a 58,000 square
foot building on a 21.94 acre tract not located in, but adjoining, a
subdivision, which has filed for Chapter


16
 Index


11
protection.  The note is also collateralized by an unsecured note with
a face amount of $3,000,000.  The notes are current, and borrowers
continue to make payments.  A fifth relationship consisted of two
notes to an individual totaling $2,493,222, who was previously part owner in a
business entity, which recently filed for Chapter 11 protection.  The
two loans are secured by an assignment of unsecured notes.  The loans
are current, and the borrower continues to make payments.  The sixth
relationship consisted of four notes totaling $2,847,954 to an individual, who
is principal owner/developer in a subdivision, which recently filed for Chapter
11, protection.  These notes are secured by a second deed of trust in
a viable and growing subdivision, a first deed of trust on two residential
building lots in a growing subdivision and by an airplane.   A
general loans loss reserve approximately $437,000 has been established for the
loans.





Deposits
increased 14.60% or $24,941,951 during the nine months ended September 30,
2009.  The increase in deposits was primarily attributable to growth
in NOW accounts and certificates of deposit.  In an effort to increase
core deposits, during 2008, the Company introduced a new NOW account,
eZchecking, which pays an above market interest rate on balances up to
$25,000.  Qualifiers for the account included a minimum of 10 debit
card transactions, one direct deposit and receipt of electronic statement each
month.  The Company earns interchange revenue from debit card usage
and can deliver electronic statements more efficiently than through standard
U.S. mail; these two factors effectively minimize the cost of funds on the
product.  At September 30, 2009, the Company had 1,647 eZchecking
accounts totaling $26,458,470 compared to 789 accounts totaling $9,283,769 at
December 31, 2008.  Other increases in NOW accounts resulted from
fluctuation in Interest on Lawyers Trust Accounts (commonly referred to as
IOLTA), primarily escrow accounts for real estate transactions, which increased
from $1,521,560 at December 31, 2008 to $2,641,755 at September 30, 2009, and
general growth in other NOW accounts.  Time deposits increased from
$96,619,476 to $100,200,829 or 3.71%.  Growth in time deposits stemmed
from interest-rate sensitive customers choosing to lock in fixed rates to
protect themselves from further interest rate declines as well as customers
choosing to transfer funds from the stock market into FDIC insured fixed rate
time deposit accounts.  Demand, money market and savings accounts
increased by $795,061during the period.  As noted previously, during
the second quarter, a single commercial account increased its balance in a
demand deposit account by over $4 million; these funds were considered to be
temporary and were expected to be depleted over the next six
months.  During the third quarter, over $3 million had been withdrawn
from that account.





Short-term
borrowings consisted of one advance from the FHLB, which totaled $4,000,000 and
securities sold under agreements to repurchase in the amount of
$429,141.  At December 31, 2008, the $4,000,000 FHLB borrowing was
considered long-term debt, but has been reclassified to short-term debut for the
current period due to remaining length of maturity.  The interest rate
on the FHLB advance was 5.01% and matures on March 23, 2010.  Advances
from the FHLB are secured by a blanket lien on 1-4 family real estate loans and
certain commercial real estate loans.  Securities sold under
agreements to repurchase bear a variable rate of interest and mature
daily.  At September 30, 2009, the rate on these borrowings was
..25%.





Long-term
borrowings consisted of trust preferred securities totaling
$4,124,000.  The trust preferred securities bear a rate of LIBOR plus
315 basis points (3.66% at September 30, 2009) and pay dividends
quarterly.  The rate is subject to quarterly resets.  The
trust preferred securities mature October 7, 2033, and became callable on or
after October 7, 2008.  All of the trust preferred securities were
eligible for inclusion as Tier I capital.  The Company continues to
use the capital to support growth and branch expansion..




The
Company’s capital at September 30, 2009 to risk weighted assets totaled
12.26%.  Current regulations require a minimum ratio of total capital
to risk weighted assets of 8%, with at least 4% being in the form of Tier 1
capital, as defined in the regulation.  As of September 30, 2009, the
Company’s capital exceeded the current regulatory capital requirements, and is
categorized as well-capitalized under regulatory requirements.


17
 Index


RESULTS
OF OPERATIONS


FOR THE
THREE-MONTH AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2009 AND
2008





Net
interest income, the principal source of the Company’s earnings, is the amount
of income generated by earning assets (primarily loans and investment
securities) less the total interest cost of the funds obtained to carry them
(primarily deposits and other borrowings).  The volume, rate and mix
of both earning assets and related funding sources determine net interest
income.





COMPARATIVE
THREE MONTHS





Net
interest income for the quarter ended September 30, 2009 totaled $2,165,136
compared to $1,899,211 in 2008.  The increase was attributable to
growth in net earning assets.  The Company’s net interest margin was
approximately 3.91% and 4.16% for the quarters ended September 30, 2009 and
2008, respectively.





Weststar
recorded a provision for loan losses of $869,015 and $320,260 for the quarters
ended September 30, 2009 and 2008, respectively.  The provision for
loan losses is charged to operations to bring the allowance to a level deemed
appropriate by management based on the factors discussed under “Asset
Quality.”





Other
non-interest income for the September 30, 2009 and 2008 quarters totaled
$463,466 and $425,618, respectively.  The increase in other income
primarily reflects increased fees from debit/credit card interchange
transactions and fees from the origination of mortgage loans at the Bank
level.  Interchange revenue increased from $75,335 to $90,475 for the
periods ended September 30, 2008 and 2009, respectively; fees from the
originations of mortgage loans produced $26,335 during 2009 compared to $14,728
during 2008.  During the second quarter of 2008, the Company and its
partner in the Mortgage Company mutually agreed to terminate their relationship,
and began the process to close the Mortgage Company.  The Company then
shifted originating mortgage loans through the Bank.  Bank of
Asheville Mortgage Company, LLC posted net operating losses of $1,628 during the
September 2008 quarter, of which $814 was the Company’s
portion.  Other income decreased from $13,999 during 2008 to $10,847
during 2009.  The decrease primarily reflects lower revenue earned
from balances maintained at a correspondent bank.





Other
non-interest expense totaled $1,616,278 compared to $1,478,381 in
2008.  The increase was primarily attributable to personnel and
overhead incurred to support loan and deposit servicing and growth, increased
professional fees for services rendered, and increased FDIC insurance premiums.
Occupancy expense remained relatively flat at $124,016.  Equipment
expenses decreased by $9,206 primarily as a result of lower amounts of
depreciation.  Data processing fees increased by $34,742 as a result
of growth in loans and deposits.  FDIC insurance premiums increased
from $23,987 to $76,968 in 2009 as a result of increased premium rates, which
increased from an annualized 5 cents per $100 of deposits for the September 30,
2008 quarter to an estimated annualized 13.49 cents per $100 for the September
30, 2009 quarter.  As a result of banking failures during 2008, 2009
and projected future failures, the FDIC increased the premium to ensure adequate
funding for the depository insurance fund.  FDIC’s Treasury borrowing
authority was increased to $100 billion, which allowed the agency to cut its
planned assessment from 20 to 5 basis points for institutions as well
capitalized as Bank of Asheville.  The FDIC imposed a 5 basis point
assessment during the second quarter of 2009, and reserves the right to impose
another special assessment in subsequent quarters up to a maximum of 5 basis
points of assets less Tier 1 capital, which could have a significant impact on
the results of operations of the Company for 2009.  Based on current
assets less Tier 1 capital, the assessment would be approximately
$101,000.  At this point, however, it appears the FDIC will move
toward a three year prepaid structure rather than assessing fees in
arrears.  If the FDIC moves toward this direction, the Company will
owe an estimated $1.1 million for prepaid FDIC insurance
coverage.  Marketing expenses decreased from $86,569 to $65,431, which
reflects a shift in timing for marketing efforts.  Expenses from the
foreclosures of properties increased from $1,523 during 2008 to $20,343 during
2009.  The increase reflects the levels of foreclosure related
activities.  Other expenses totaled $94,471 in 2009 compared to
$85,699 in 2008.  Income before income tax provision totaled $143,309
and $525,813 for the quarters ended September 30, 2009 and 2008,
respectively.  Income tax provision totaled $11,686 and $176,809 for
the quarters ended September 30, 2009 and 2008, respectively, which equated to
an effective tax rate of


18
 Index


8.15% and
33.63%, respectively.  The decrease in the effective tax rate was
primarily attributable to higher relative tax-exempt income to total taxable
income in 2009. Net income totaled $131,623 and $349,004 for the quarters ended
September 30, 2009 and 2008, respectively.





Other
comprehensive income/(loss) totaled $308,575 and $(363,151) in 2009 and 2008,
respectively.  Comprehensive income/(loss), which is the change in
shareholders’ equity excluding transactions with shareholders, totaled $440,198
and $(14,147) for the quarters ended September 30, 2009 and 2008,
respectively.





COMPARATIVE
NINE MONTHS





Net
interest income for the nine-month period September 30, 2009 totaled $6,119,077
compared to $5,342,578 in 2008.  The increase was attributable to
growth in net earning assets.  The Company’s net interest margin was
approximately 3.87% and 4.07% for the nine months ended September 30, 2009 and
2008, respectively.





Weststar
recorded a provision for loan losses of $1,344,905 and $508,760 for the nine
months ended September 30, 2009 and 2008, respectively.  The provision
for loan losses is charged to operations to bring the allowance to a level
deemed appropriate by management based on the factors discussed under “Asset
Quality.”





Other
non-interest income for the September 30, 2009 and 2008 quarters totaled
$1,336,264 and $1,216,501, respectively.  The increase in other income
primarily reflects increased fees from debit/credit card interchange
transactions and fees from the origination of mortgage loans at the Bank
level.  Interchange revenue increased from $212,393 to $251,103 for
the periods ended September 30, 2008 and 2009, respectively; fees from the
originations of mortgage loans produced $114,185 during 2009 compared to $37,724
during 2008.  During the second quarter of 2008, the Company and its
partner in the Mortgage Company mutually agreed to terminate their relationship,
and began the process to close the Mortgage Company.  The Company then
shifted originating mortgage loans through the Bank.  Bank of
Asheville Mortgage Company, LLC posted net operating losses of $30,590 during
the September 2008 period, of which $15,295 was the Company’s
portion.  Other income decreased from $48,168 during 2008 to $30,698
during 2009.  The decrease primarily reflects lower revenue earned
from balances maintained at a correspondent banks.





Other
non-interest expense totaled $5,001,042 compared to $4,511,361 in
2008.  The increase was primarily attributable to personnel and
overhead incurred to support loan and deposit servicing and growth and increased
FDIC insurance premiums. Occupancy expense increased by $60,951 to $431,145
primarily as a result of a finder’s fee paid to secure a permanent branch
location.  Equipment expenses decreased by $41,167 primarily as a
result of lower amounts of depreciation.  Professional fees increased
by 13.11% to $254,182 as a result of increased services.  Data
processing fees increased by $67,945 as a result of growth in loans and
deposits.  FDIC insurance premiums increased from $72,146 to $323,180
in 2009 as a result of increased premium rates, which increased from an
annualized 5 cents per $100 of deposits for the September 30, 2008 period to an
estimated annualized 13.34 cents per $100 for the September 30, 2009 period and
as a result of a 5 basis point special assessment during the second
quarter.  As a result of banking failures during 2008 and projected
failures during 2009, the FDIC increased the premium to ensure adequate funding
for the depository insurance fund.  FDIC’s Treasury borrowing
authority was increased to $100 billion, which allowed the agency to cut its
planned assessment from 20 to 5 basis points for institutions as well
capitalized as Bank of Asheville.  The FDIC reserves the right to
impose another special assessment in subsequent quarters up to a maximum of 5
basis points of assets less Tier 1 capital, which could have a significant
impact on the results of operations of the Company for 2009.  At this
point, however, it appears the FDIC will move toward a three year prepaid
structure rather than assessing fees in arrears.  If the FDIC moves
toward this direction, the Company will owe an estimated $1.1 million for
prepaid FDIC insurance coverage.  Marketing expenses increased from
$219,555 to $238,553, which reflects increased marketing efforts for products
and services.  Expenses from the foreclosures of properties decreased
from $42,744 during 2008 to $20,413 during 2009.  The decrease
reflects the levels of foreclosure related activities.  Other expenses
totaled $272,100 in 2009 compared to $251,596 in 2008.  Income before
income tax provision totaled $1,109,394 and $1,538,958 for the periods ended
September 30, 2009 and 2008, respectively.  Income tax provision
totaled $319,959 and $519,334 for the periods ended September 30,
2009


19
 Index


and 2008,
respectively, which equated to an effective tax rate of 28.84% and 33.75%,
respectively.  The decrease in the effective tax rate was primarily
attributable to higher relative tax-exempt income to taxable income in
2009.  Net income totaled $789,435 and $1,019,624 for the periods
ended September 30, 2009 and 2008, respectively.





Other
comprehensive income (loss) totaled $458,315 and $(435,350) in 2009 and 2008,
respectively.  Comprehensive income, which is the change in
shareholders’ equity excluding transactions with shareholders, totaled
$1,247,750 and $584,274 for the periods ended September 30, 2009 and 2008,
respectively.





ASSET/LIABILITY
MANAGEMENT





The
Company’s asset/liability management, or interest rate risk management, program
is focused primarily on evaluating and managing the composition of its assets
and liabilities in view of various interest rate scenarios. Factors beyond the
Company’s control, such as market interest rates and competition, may also have
an impact on the Company’s interest income and interest expense.





Interest Rate Gap Analysis.As
a part of its interest rate risk management policy, the Company calculates an
interest rate “gap.” Interest rate “gap” analysis is a common, though imperfect,
measure of interest rate risk, which measures the relative dollar amounts of
interest-earning assets and interest-bearing liabilities which reprice within a
specific time period, either through maturity or rate adjustment. The “gap” is
the difference between the amounts of such assets and liabilities that are
subject to repricing. A “positive” gap for a given period means that the amount
of interest-earning assets maturing or otherwise repricing within that period
exceeds the amount of interest-bearing liabilities maturing or otherwise
repricing within the same period. Accordingly, in a declining interest rate
environment, an institution with a positive gap would generally be expected,
absent the effects of other factors, to experience a decrease in the yield on
its assets greater than the decrease in the cost of its liabilities and its
income should be negatively affected. Conversely, the cost of funds for an
institution with a positive gap would generally be expected to increase more
slowly than the yield on its assets in a rising interest rate environment, and
such institution’s net interest income generally would be expected to be
positively affected by rising interest rates. Changes in interest rates
generally have the opposite effect on an institution with a “negative
gap.”





The
majority of the Company’s deposits are rate-sensitive instruments with rates
that tend to fluctuate with market rates. These deposits, coupled with the
Company’s short-term certificates of deposit, have increased the opportunities
for deposit repricing. The Company places great significance on monitoring and
managing the Company’s asset/liability position. The Company’s policy of
managing its interest margin (or net yield on interest-earning assets) is to
maximize net interest income while maintaining a stable deposit base. The
Company’s deposit base is not generally subject to the level of volatility
experienced in national financial markets in recent years; however, the Company
does realize the importance of minimizing such volatility while at the same time
maintaining and improving earnings. Therefore, management prepares on a regular
basis earnings projections based on a range of interest rate scenarios of
rising, flat and declining rates in order to more accurately measure interest
rate risk.





Interest-bearing
liabilities and variable rate loans are generally repriced to current market
rates. Based on its analysis, the Company believes that its balance sheet is
currently liability-sensitive; meaning that in a given period there will be more
liabilities than assets subject to immediate repricing as the market rates
change. Because a significant portion of the Company’s deposits are either
variable rate or have short-term maturities, they reprice more rapidly than rate
sensitive interest-earnings assets. During periods of rising rates, this results
in decreased net interest income, assuming similar growth rates and stable
product mixes in loans and deposits. The opposite occurs during periods of
declining rates.





The
Company uses interest sensitivity analysis to measure the sensitivity of
projected earnings to changes in interest rates. The sensitivity analysis takes
into account the current contractual agreements that the Company has on
deposits, borrowings, loans, investments and any commitments to enter into those
transactions. The Company monitors interest sensitivity by means of computer
models that incorporate the current volumes, average rates, scheduled maturities
and payments and repricing opportunities of asset and liability portfolios.
Using this


20
 Index


information,
the model estimates earnings based on projected portfolio balances under
multiple interest rate scenarios. In an effort to estimate the effects of pure
interest-rate risk, the Company assumes no growth in its balance sheet, because
to do so could have the effect of distorting the balance sheet’s sensitivity to
changing interest rates. The Company simulates the effects of interest rate
changes on its earnings by assuming no change in interest rates as its base case
scenario and either (1) gradually increasing or decreasing interest rates by
over a twelve-month period or (2) immediately increasing or decreasing interest
rates by .25%, .50%, 1% and 2%. Although these methods are subject to the
accuracy of the assumptions that underlie the process and do not take into
account the pricing strategies that management would undertake in response to
sudden interest rate changes, the Company believes that these methods provide a
better indication of the sensitivity of earnings to changes in interest rates
than other analyses.





Income
simulation through modeling is one tool that the Company uses in the
asset/liability management process. The Company also considers a number of other
factors in determining its asset/liability and interest rate sensitivity
management strategies. Management strives to determine the most likely outlook
for the economy and interest rates by analyzing external factors, including
published economic projections and data, the effects of likely monetary and
fiscal policies as well as any enacted or prospective regulatory changes. The
Company’s current and prospective liquidity position, current balance sheet
volumes and projected growth, accessibility of funds for short-term needs and
capital maintenance are also considered. This data is combined with various
interest rate scenarios to provide management with information necessary to
analyze interest sensitivity and to aid in the development of strategies to
manage the Company’s balance sheet.





The
following table sets forth the amounts of interest-earning assets and
interest-bearing liabilities outstanding at September 30, 2009, which are
projected to reprice or mature in each of the future time periods shown. Except
as stated below, the amounts of assets and liabilities shown which reprice or
mature within a particular period were determined in accordance with the
contractual terms of the assets or liabilities. Loans with adjustable rates are
shown as being due at the end of the next upcoming adjustment
period.  The interest rate sensitivity of the Company’s assets and
liabilities illustrated in the following table would vary substantially if
different assumptions were used or if actual experience differs from that
indicated by such assumptions.


21
 Index




TERMS
      TO REPRICING AT SEPTEMBER 30, 20091-90
      Days
            
            
            91-180
      Days
            
            
            181-365
      Days
            
            
            Total
      One
            
            
            Non-
            
            
            TotalYear
            
            
            SensitiveInterest-earning
      assets:Interest
      bearing deposits
            
            
            
            
            $
            9,030,999
            
            
            $
            9,030,999
            
            
            $
            9,030,999Investment
      securities
            
            
            468,538
            
            
            $
            348,236
            
            
            $
            491,468
            
            
            
            1,308,242
            
            
            $
            20,332,196
            
            
            
            21,640,438Federal
      Home Loan Bankstock
            
            
            592,300
            
            
            
            -
            
            
            
            -
            
            
            
            592,300
            
            
            
            -
            
            
            
            592,300Loans
      (1)
            
            
            131,524,475
            
            
            
            10,134,671
            
            
            
            10,490,733
            
            
            
            152,149,879
            
            
            
            33,291,956
            
            
            
            185,441,835Total
      Interest-earning assets
            
            
            141,616,312
            
            
            
            10,482,907
            
            
            
            10,981,201
            
            
            
            163,081,420
            
            
            
            53,624,152
            
            
            
            216,705,572Interest-bearing
      liabilities:Time
      deposits
            
            
            29,193,441
            
            
            
            33,013,827
            
            
            
            36,872,894
            
            
            
            99,081,162
            
            
            
            1,119,667
            
            
            
            100,200,829All
      other deposits
            
            
            71,584,068
            
            
            
            -
            
            
            
            -
            
            
            
            71,584,068
            
            
            
            -
            
            
            
            71,584,068Short-term
      debt
            
            
            429,141
            
            
            
            4,000,000
            
            
            
            0
            
            
            
            4,429,141
            
            
            
            -
            
            
            
            4,429,141Long-term
      debt
            
            
            4,124,000
            
            
            
            -
            
            
            
            -
            
            
            
            4,124,000
            
            
            
            -
            
            
            
            4,124,000Total
      interest-bearing liabilities
            
            
            105,330,650
            
            
            
            37,013,827
            
            
            
            36,872,894
            
            
            
            179,218,371
            
            
            
            1,119,667
            
            
            
            180,338,038Interest
      sensitivity gap
            
            $
            36,285,662
            
            
            $
            (26,530,920
            )
            
            $
            (25,891,693
            )
            
            $
            (16,136,951
            )
            
            $
            52,504,485Cumulative
      interest sensitivityGap
            
            $
            36,285,662
            
            
            $
            9,754,742
            
            
            $
            (16,136,951
            )Interest-earning
      assets as A percent of interest sensitiveliabilities*
            
            
            134.4
            %
            
            
            28.3
            %
            
            
            29.8
            %
            
            
            91.0
            %





*Percentages
shown are not cumulative.





Weststar
has established an acceptable range of 80% to 120% for interest-earning assets
as a percent of interest sensitive liabilities for the total one year
horizon.





ASSET
QUALITY





Management
considers Weststar’s asset quality to be of primary importance.  We
maintain an allowance for loan losses to absorb probable losses inherent in the
loan portfolio. The loan portfolio is analyzed monthly in an effort to identify
potential problems before they actually occur.  The allowance for loan
losses is established as losses are estimated to have occurred through a
provision for loan losses charged to earnings. The provision for loan losses is
based upon management’s best estimate of the amount needed to maintain the
allowance for loan losses at an adequate level. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the
allowance.





The
allowance for loan losses is evaluated on a regular basis by management and is
based upon management’s periodic review of the collectibility of the loans in
light of the current status of the portfolio, historical experience, the nature
and volume of the loan portfolio, adverse situations that may affect the
borrower’s ability to repay, estimated value of any underlying collateral, and
prevailing economic conditions.





Higher
risk loans are factored into the calculation of the allowance for loan
losses.  For example, junior liens on real estate properties are a
higher risk than first lien positions, and owner occupied real estate is a
lesser risk than non-owner occupied real estate properties.  Home
equity lines of credit are reviewed annually for credit quality, payment history
and collateral value.  All MSA (Asheville & Buncombe County) loans
are coded to census tracts to assist in tracking any
concentrations.  Fluctuation in real estate values are taken into
consideration when preparing annual in-house appraisal
reviews.  Inspections of collateral, updates in tax values, and data
provided by local appraisers are reviewed when determining current market prices
for collateral.





All loans
are reviewed periodically for delinquency by category, collateral code, and loan
grade ratings.  On a quarterly basis qualitative analytics including
credit, delinquency trends, economic and business trends, external factors,
lending management and staff, lending policies and procedures, loss/recovery
trends, nature and volume of


22
 Index


portfolio,
nonaccrual trends, problem loan trends and quality of loan review systems are
utilized in estimating the adequacy of the allowance for loan
losses.





This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available.
Therefore, while management uses the best information available to make
evaluations, future adjustments to the allowance may be necessary if conditions
differ substantially from the assumptions used in making the evaluations. In
addition, regulatory examiners may require the Company to recognize changes to
the allowance for loan losses based on their judgments about information
available to them at the time of their examination.





The
provision for loan losses represents a charge against income in an amount
necessary to maintain the allowance at an appropriate level.  The
monthly provision for loan losses may fluctuate based on the results of this
analysis.  The allowance for loan losses at September 30, 2009 and
2008, and December 31, 2008 was $3,519,884, $2,355,244 and $2,529,981 or 1.90%,
1.49% and 1.48%, respectively, of gross loans outstanding.   The
ratio of net charge-offs to average loans outstanding was .27%, .23% and .18%
during the periods ended September 30, 2009 and 2008, and December 31, 2008,
respectively.





The
following table contains an analysis of the allowance for loan losses, including
the amount of charge-offs and recoveries by loan type, for the nine months ended
September 30, 2009 and 2008, and for the year ended December 31,
2008.





Summary
of Allowance for Loan Losses





For
      the nine months
            
            
            For
      the year endedEnded
      September 30,
            
            
            December 31,2009
            
            
            2008
            
            
            2008Balance,
      beginning of period
            
            $
            2,529,981
            
            
            $
            2,090,125
            
            
            $
            2,090,125Charge-offs:Commercial,
      financial and agricultural
            
            
            (236,392
            )
            
            
            (200,091
            )
            
            
            (203,524
            )Real
      Estate:Construction
            
            
            (9,211
            )
            
            
            -
            
            
            
            -Mortgage
            
            
            (78,877
            )
            
            
            -
            
            
            
            -Consumer
            
            
            (55,914
            )
            
            
            (83,083
            )
            
            
            (116,409
            )Total
      charge-offs
            
            
            (380,394
            )
            
            
            (283,174
            )
            
            
            (319,933
            )RecoveriesCommercial,
      financial, and agricultural
            
            
            28
            
            
            
            13,415
            
            
            
            13,415Real
      Estate:Construction
            
            
            -
            
            
            
            -
            
            
            
            -Mortgage
            
            
            -
            
            
            
            -
            
            
            
            -Consumer
            
            
            25,364
            
            
            
            26,118
            
            
            
            35,089Total
      Recoveries
            
            
            25,392
            
            
            
            39,533
            
            
            
            48,504Net
      (charge-offs) recoveries
            
            
            (355,002
            )
            
            
            (243,641
            )
            
            
            (271,429
            )Provision
      charged to operations
            
            
            1,344,905
            
            
            
            508,760
            
            
            
            711,285Balance,
      end of period
            
            $
            3,519,884
            
            
            $
            2,355,244
            
            
            $
            2,529,981Percentage
      of net charge-offs toaverage
      loans
            
            
            .27
            %
            
            
            .23
            %
            
            
            .18
            %Percentage
      of allowance toperiod-end
      loans
            
            
            1.90
            %
            
            
            1.49
            %
            
            
            1.48
            %





The Bank
operates in a well diversified market.  Major economic drivers include
tourism, medical industry and light manufacturing.  While the
Company’s market has not experienced some of the extreme hardships as portrayed
nationally, the Bank and its market are not totally
isolated.  Residential mortgage sales in the market have
slowed


23
 Index


down;
however, the Bank has not experienced the same magnitude as the national
market.  While the Bank’s losses related to real estate lending have
been low historically, the volatility of the real estate development market
loans in our market could result in additional increases in our exposure to
losses if the economy continues to experience a downward trend.





The Bank
mitigates its exposure to real estate construction lending by limiting the
number of unsold houses to four per developer.  Currently, home
developer loans have an average balance of approximately $300,000 per
unit.  The Bank uses third party building inspectors to evaluate
construction progress.  Based upon reports provided by the inspectors
the Bank stands better equipped to monitor and distribute loan draws according
to percent of project completed.  Approximately 30% of commercial real
estate mortgage loans are owner-occupied.  In general, owner-occupied
loans pose lower risks than non-owner-occupied loans as there is lower risk of
the borrower-tenant leaving the building for a better lease and generally there
are business-related cash flows which provide debt service
capacity.  Additionally, in the normal owner-occupied loan situation,
personal guarantees for the loan are present.





Nonaccrual
and restructured loans increased from $316,102 at December 31, 2008 to
$7,309,577 at September 30, 2009.  Current non-accrual loans represent
23 loans with 20 customers; restructured loans represent 10 loans with eight
customers.  Although some of the customers have resumed payments,
management has continued to classify the relationships until such time as the
borrowers demonstrate a consistent and consecutive payment
history.  Lost interest on nonaccrual loans amounted to $78,992 during
2009.  Management has reviewed each non-performing loan, supporting
collateral, financial stability of each borrower and the relevant loan loss
allowance.  During 2009, management continued its in-depth
underwriting analysis, training and loan monitoring.  Management
continued its engagement of third party loan review services to supplement and
validate overall loan review analytics and portfolio risk
assessments.  Based upon this analysis, management believes the
allowance is adequate to support current loans outstanding.





The
following table identifies management’s specific allocation of the allowance for
loan losses for impaired loans.





Impaired
      loans without a related allowance
            
            $
            3,325,844Impaired
      loans with a related allowance for loan losses
            
            
            4,213,251Total
      impaired loans
            
            $
            7,539,095Allowance
      for loan loss related to impaired loans
            
            $
            372,236





A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired.  Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower’s
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed.  Impairment is measured on a loan by loan
basis for commercial and construction loans by either the present value of
expected future cash flows discounted at the loan’s effective interest rate, the
loan’s obtainable market price, or the fair value of the collateral if the loan
is collateral dependent.  Large groups of smaller balance homogeneous
loans are collectively evaluated for impairment.  Accordingly, the
Company does not separately identify individual consumer and residential loans
for impairment disclosures.





During
2009, there were no changes in estimation methods or assumptions that affected
our methodology for assessing the appropriateness of the general and specific
allowance for credit losses.  Changes in estimates and assumptions
regarding the effect of economic and business conditions on borrowers affect the
assessment of the allowance.


24
 Index


The
following table allocates the allowance for loan losses by loan category at the
dates indicated.  The allocation of the allowance to each category is
not necessarily indicative of future losses and does not restrict the use of the
allowance to absorb losses in any category.





September 30,
      2009
            
            
            December 31,
      2008Amount
      of Allowance
            
            
            Percent
      of Total
      Loans
            
            
            Amount
      of Allowance
            
            
            Percent
      of Total
      LoansTYPE
      OF LOAN:Real
      Estate
            
            $
            2,731,110
            
            
            
            85
            %
            
            $
            2,001,660
            
            
            
            82
            %Commercial
      and industrialloans
            
            
            712,828
            
            
            
            14
            %
            
            
            465,388
            
            
            
            16
            %Consumer
            
            
            75,946
            
            
            
            1
            %
            
            
            50,786
            
            
            
            2
            %Unallocated
            
            
            -
            
            
            
            -
            
            
            
            12,147
            
            
            
            -Total
      Allowance
            
            $
            3,519,884
            
            
            
            100
            %
            
            $
            2,529,981
            
            
            
            100
            %








CAPITAL
RESOURCES





Banks and
bank holding companies, as regulated institutions, must meet required levels of
capital. The Federal Deposit Insurance Corporation (“FDIC”) and the Federal
Reserve, the primary regulators of The Bank of Asheville and Weststar,
respectively, have adopted minimum capital regulations or guidelines that
categorize components and the level of risk associated with various types of
assets. Financial institutions are expected to maintain a level of capital
commensurate with the risk profile assigned to its assets in accordance with
these guidelines. As shown in the following table, Weststar and The Bank of
Asheville both maintained capital levels exceeding the minimum levels for "well
capitalized" banks and bank holding companies.





REGULATORY
CAPITAL





Actual
                
                
                For
      Capital
                  Adequacy
                  Purposes
                
                
                To
      Be Well Capitalized
                  Under
      Prompt Corrective
                  Action
      ProvisionsAmount
                
                
                Ratio
                
                
                Amount
                
                
                Ratio
                
                
                Amount
                
                
                Ratio(Dollars
      in Thousands)As
      of September 30, 2009Total
      Capital (to Risk Weighted
                  Assets)Consolidated
                
                $
                23,810
                
                
                
                12.26
                %
                
                $
                15,533
                
                
                
                8.00
                %
                
                $
                19,417
                
                
                
                10.00
                %Bank
                
                $
                22,568
                
                
                
                11.64
                %
                
                $
                15,514
                
                
                
                8.00
                %
                
                $
                19,393
                
                
                
                10.00
                %Tier
      1 Capital (to Risk WeightedAssets)Consolidated
                
                $
                21,369
                
                
                
                11.01
                %
                
                $
                7,767
                
                
                
                4.00
                %
                
                $
                11,650
                
                
                
                6.00
                %Bank
                
                $
                20,130
                
                
                
                10.38
                %
                
                $
                7,757
                
                
                
                4.00
                %
                
                $
                11,636
                
                
                
                6.00
                %Tier
      1 Capital (to Average Assets)Consolidated
                
                $
                21,369
                
                
                
                9.53
                %
                
                $
                8,970
                
                
                
                4.00
                %
                
                $
                11,212
                
                
                
                5.00
                %Bank
                
                $
                20,130
                
                
                
                8.99
                %
                
                $
                8,960
                
                
                
                4.00
                %
                
                $
                11,200
                
                
                
                5.00
                %


25
 Index


LIQUIDITY





Maintaining
adequate liquidity while managing interest rate risk is the primary goal of
Weststar’s asset and liability management strategy. Liquidity is the ability to
fund the needs of the Company’s borrowers and depositors, pay operating
expenses, and meet regulatory liquidity requirements. Loan repayments, deposit
growth, federal funds purchased and borrowings from the Federal Home Loan Bank
are presently the main sources of the Company’s liquidity. The Company’s primary
uses of liquidity are to fund loans and to make investments.





As of
September 30, 2009 liquid assets (cash and due from banks and interest-earning
bank deposits) were approximately $12.6 million, which represents 5.64% of total
assets and 6.44% of total deposits. Supplementing this liquidity, Weststar has
available lines of credit from correspondent banks of approximately $20.3
million; and unpledged investment securities of $19.1 million. At September 30,
2009, outstanding commitments to extend credit and available lines of credit
were $26.8 million. The Company has the ability to access brokered
deposits and Certificate of Deposit Account Registry Service, more commonly
referred to as CDARS, for additional liquidity, but does not currently have any
of either in its certificates of deposit portfolio.  Management
believes that the combined aggregate liquidity position of the Company is
sufficient to meet the funding requirements of loan demand and deposit
maturities and withdrawals in the near term.





Certificates
of deposit represented approximately 51.19% of Weststar’s total deposits at
September 30, 2009. The Company’s growth strategy includes efforts focused on
increasing the relative volume of transaction deposit accounts, as the branch
network is expanded, making it more convenient for our banking customers.
Certificates of deposit of $100,000 or more represented 11.68% of the Company’s
total deposits at September 30, 2009.  These deposits are generally
considered rate sensitive, but management believes most of them are
relationship-oriented. While the Company will need to pay competitive rates to
retain these deposits at maturity, there are other subjective factors that will
determine the Company’s continued retention of these deposits.


26
 Index


IMPACT
OF INFLATION AND CHANGING PRICES





A
financial institution has assets and liabilities that are distinctly different
from those of a company with substantial investments in plant and inventory
because the major portion of its assets is monetary in nature. As a result, a
bank’s performance may be significantly influenced by changes in interest rates.
Although the banking industry is more affected by changes in interest rates than
by inflation in the prices of goods and services, inflation is a factor, which
may influence interest rates. However, the frequency and magnitude of interest
rate fluctuations do not necessarily coincide with changes in the general
inflation rate. Inflation does affect operating expenses in that personnel
expenses, cost of supplies and outside services tend to increase more during
periods of high inflation.





Item 4T.
            Controls
      and Procedures





At the
end of the period covered by this report, the Company carried out an evaluation,
under the supervision and with the participation of the Company’s management,
including the Company’s Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of the Company’s disclosure
controls and procedures pursuant to Securities Exchange Act Rule
13a-14.





Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures were effective
(1) to provide reasonable assurance that information required to be disclosed by
the Company in the reports filed or submitted by it under the Securities
Exchange Act was recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms, and (2) to provide reasonable
assurance that information required to be disclosed by the Company in such
reports is accumulated and communicated to the
Company’s   management, including its Chief Executive Officer and
Chief Financial Officer, as appropriate to allow for timely decisions regarding
required disclosure.





There
were no changes in the Company’s internal control over financial reporting
during the period covered by this report that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over
financial reporting. The Company reviews its disclosure controls and procedures,
which may include its internal control over financial reporting, on an ongoing
basis, and may from time to time make changes aimed at enhancing their
effectiveness and to ensure that the Company’s systems evolve with its
business.


27
 Index


Part
      II.
            OTHER
      INFORMATION





Item 4.
            Submission
      of Matters to a Vote of Security
Holders





None.








Item 5.
            Other
      Information


(a)  None.


(b)  None.





Item 6.
            Exhibits





(a)  Exhibits.





31.1 –
            Certification
      of the Chief Executive Officer pursuant to Rule 13a-14(a) under the
      Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002





31.2 –
            Certification
      of the Chief Financial Officer pursuant to Rule 13a-14(a) under the
      Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002





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





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


28
 Index


SIGNATURES








Under the
requirements 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.








WESTSTAR
      FINANCIAL SERVICES CORPORATIONDate:
      November 12, 2009
            
            By:
            /s/ G. Gordon GreenwoodG.
      Gordon GreenwoodPresident
      and Chief Executive OfficerDate:
      November 12, 2009
            
            By:
            /s/ Randall C. HallRandall
      C. HallExecutive
      Vice President and Chief Financialand
      Principal Accounting Officer





29