EXHIBIT 13

LOGO

LOGO

2006 ANNUAL REPORT



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LOGO

Front Row: John P. Erb, Robert H. Gilliam Jr., James E. Burton, IV and James P. Kent,
Jr.,

Back Row: A. Willard Arthur, Carroll E. Shelton, John L. Waller, R.B. Hancock, Jr.,

Michael E. Watson and William F. Overacre

BOARD OF DIRECTORS



|                                                                                     |  |                                                                                           
|------------------------------------------------------------------------------------ |  | ------------------------------------------------------------------------------------------
|A. Willard Arthur                                                                    |  | James P. Kent, Jr.                                                                        
|Chairman and Secretary Marvin V. Templeton & Sons, Inc.                              |  | Partner Kent & Kent, P.C.                                                                 
|                                                                                     | 
|James E. Burton, IV                                                                  |  | William F. Overacre                                                                       
|Vice President, Operations Marvin V. Templeton & Sons, Inc.                          |  | President & Owner RE/MAX 1st Olympic Inc. REALTORS                                        
|                                                                                     | 
|John P. Erb                                                                          |  | Carroll E. Shelton                                                                        
|Assistant Superintendent Campbell County Schools                                     |  | Senior Vice President The First National Bank of Altavista Pinnacle Bankshares Corporation
|                                                                                     | 
|Robert H. Gilliam, Jr.                                                               |  | John L. Waller                                                                            
|President & CEO The First National Bank of Altavista Pinnacle Bankshares Corporation |  | Owner &Operator Waller Farms, Inc.                                                        
|                                                                                     | 
|R. B. Hancock, Jr.                                                                   |  | Michael E. Watson                                                                         
|President & Owner R.B.H., Inc. d/b/a Napa Auto Parts                                 |  | Financial Manager Flippin, Bruce & Porter, Inc.                                           

Front Cover: Our new Timberlake Office



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Table of Contents



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|------------------------------------------------------------------------------------ |  | ----------
|                                                                                     |  | Page      
|                                                                                     | 
|Officers and Managers                                                                |  | 2         
|                                                                                     | 
|Office Locations                                                                     |  | 3         
|                                                                                     | 
|Presidents Letter                                                                   |  | 4         
|                                                                                     | 
|Selected Consolidated Financial Information                                          |  | 6         
|                                                                                     | 
|Managements Discussion and Analysis of Financial Condition and Results of Operation |  | 7         
|                                                                                     | 
|Quantitative and Qualitative Disclosures About Market Risk                           |  | 26        
|                                                                                     | 
|Consolidated Balance Sheets                                                          |  | 28        
|                                                                                     | 
|Consolidated Statements of Income                                                    |  | 29        
|                                                                                     | 
|Consolidated Statements of Changes in Stockholders Equity and Comprehensive Income  |  | 30        
|                                                                                     | 
|Consolidated Statements of Cash Flows                                                |  | 31        
|                                                                                     | 
|Notes to Consolidated Financial Statements                                           |  | 33        
|                                                                                     | 
|Report of Independent Registered Public Accounting Firm                              |  | 57        
|                                                                                     | 
|Shareholder Information                                                              |  | 60 and IBC



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY



|                                                              |  |                                                                           
|------------------------------------------------------------- |  | --------------------------------------------------------------------------
|Officers of Pinnacle Bankshares Corporation                  
|Robert H. Gilliam, Jr.                                        |  | President & Chief Executive Officer                                       
|Carroll E. Shelton                                            |  | Senior Vice President                                                     
|Bryan M. Lemley                                               |  | Secretary, Treasurer & Chief Financial Officer                            
|                                                             
|Officers and Managers of The First National Bank of
Altavista
|Robert H. Gilliam, Jr.                                        |  | President, Chief Executive Officer & Trust Officer                        
|Carroll E. Shelton                                            |  | Senior Vice President & Chief Lending Officer                             
|Lucy H. Johnson                                               |  | Senior Vice President & Data Processing Manager                           
|Bryan M. Lemley                                               |  | Vice President, Cashier & Chief Financial Officer                         
|William J. Sydnor, II                                         |  | Vice President & Branch Administration Officer                            
|Judith A. Clements                                            |  | Vice President & Director of Human Resources                              
|Pamela R. Adams                                               |  | Vice President & Mortgage Division Manager                                
|Thomas R. Burnett, Jr.                                        |  | Vice President & Commercial Lending Officer                               
|Aubrey H. Hall, III                                           |  | Vice President & Business Development Officer                             
|James M. Minear                                               |  | Vice President & Commercial Real Estate Lending Officer                   
|John E. Tucker                                                |  | Assistant Vice President & Investment Consultant                          
|Albert N. Fariss                                              |  | Assistant Vice President, Facilities/Purchasing Manager & Security Officer
|Ronald C. Clay                                                |  | Assistant Vice President & Recovery Manager                               
|Brenda M. Eades                                               |  | Assistant Vice President & Real Estate Loan Officer                       
|Tarry R. Pribble                                              |  | Assistant Vice President & Collection Manager                             
|Tony J. Bowling                                               |  | Assistant Vice President & Network Administrator                          
|Vicki G. Greer                                                |  | Assistant Vice President & Internal Auditor                               
|Marian E. Marshall                                            |  | Assistant Vice President & Branch Manager (Old Forest)                    
|Daniel R. Wheeler                                             |  | Assistant Vice President & Branch Manager (Airport)                       
|Shawn D. Stone                                                |  | Assistant Vice President & Branch Manager (Main)                          
|Tracie A. Robinson                                            |  | Assistant Vice President & Branch Manager (Forest)                        
|Nancy J. Holt                                                 |  | Assistant Vice President & Branch Manager (Vista)                         
|Vivian S. Brown                                               |  | Assistant Vice President & Branch Manager (Timberlake)                    
|Amanda M. Ramsey                                              |  | Assistant Vice President & Branch Manager (Amherst)                       
|Calvin R. Short                                               |  | Assistant Vice President & Dealer Finance Manager                         
|Doris N. Trent                                                |  | Loan Officer                                                              
|Gail B. Alexander                                             |  | Loan Production Officer                                                   
|Anita M. Jones                                                |  | Loan Production Officer                                                   
|Lauren R. Michael                                             |  | Compliance Officer & Bank Secrecy Act Officer                             
|Cynthia I. Gibson                                             |  | Bookkeeping Manager                                                       
|Barbara H. Caldwell                                           |  | Deposit Administration Manager & Assistant Branch Manager (Main)          
|Marion E. Clark                                               |  | Loan Administration Manager                                               
|Beth R. Starkey                                               |  | Assistant Branch Manager (Vista)                                          
|Janet H. Whitehead                                            |  | Assistant Branch Manager (Airport)                                        



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Office Locations

ALTAVISTA

MAIN OFFICE

622 Broad Street

Altavista, Virginia 24517

Telephone: (434) 369-3000

VISTA OFFICE

1301 N. Main Street

Altavista, Virginia 24517

Telephone: (434) 369-3001

LYNCHBURG

AIRPORT OFFICE

14580 Wards Road

Lynchburg, Virginia 24502

Telephone: (434) 237-3788

TIMBERLAKE OFFICE

20865 Timberlake Road

Lynchburg, Virginia 24502

Telephone: (434) 237-7936

OLD FOREST ROAD OFFICE

3309 Old Forest Road

Lynchburg, Virginia 24501

Telephone: (434) 385-4432

FOREST

FOREST OFFICE

14417 Forest Road

Forest, Virginia 24551

Telephone: (434) 534-0451

AMHERST

AMHERST OFFICE

193 Richmond Highway

Amherst, Virginia 24521

Telephone: (434) 946-7814

SMITH MOUNTAIN LAKE

LOAN PRODUCTION OFFICE

74 Scruggs Road, Suite 102

Moneta, Virginia 24121

Telephone: (540) 719-0193



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LOGO

TO OUR SHAREHOLDERS, CUSTOMERS AND FRIENDS:

Another record year of earnings was achieved by your Company in 2006, as net income after taxes amounted to $2,412,000, an increase of 14.48% over 2005. Basic net income per share for 2006 was $1.65 and the return on
average assets and the return on average equity reached levels of 1.00% or above and 10.00% or above, respectively, for the first time since 2000. Growth in net loans outstanding and higher yield on loans were the primary factors in the increase in
net income for 2006.

Total assets ended 2006 at $256,421,000, another record high. Deposits grew 10.31% to $230,817,000 in 2006. Time deposits reflected
the majority of the increase in deposits for the year and will likely contribute to higher cost of funds and potentially lower margins in 2007. Net loans grew 14.68% in 2006 to $207,861,000. The quality of the loan portfolio continues to be strong,
as net charge-offs to average net loans amounted to only 0.04% for 2006. Non-accrual loans and loans 30 days or more past due were collectively 0.34% of total gross loans as of December 31, 2006, historically low levels.

Stockholders equity at year-end 2006 was $24,492,000, an increase of $1,280,000 over the previous year. Book
value per share was $16.66 as of the end of 2006. Average equity to average assets for the year was 9.91% and the Company continues to be well capitalized by all regulatory standards. The cash dividend rate for 2006 increased 12.24% to
$0.55 per share and the dividend payout ratio for the year was 33.25%. 2006 marked the 30thconsecutive year of an
increase in the cash dividend rate.

In May, 2006 we relocated our in-store Brookville Kroger office one and one-half miles west to a more traditional
stand-alone branch facility on Timberlake Road in Campbell County. A picture of this office graces the cover of this Annual Report. Our decision to relocate this office has been substantiated by an increase of approximately 41.58% in the deposit
base for the Timberlake Branch as of the end of 2006 since opening in mid-May. Loan activity at this office is also appreciably stronger since the relocation.

Additional expansion occurred in November, 2006 with the opening of a new branch office in the Town of Amherst to serve the Amherst County market. The demographics of Amherst County are similar to those of our Campbell County base and we
sense a demand from Amherst for the services of an established community banking organization. We have been met with a warm reception in our temporary location and look forward to beginning construction of a permanent facility in 2007.

622 Broad Street  P.O. Box 29  Altavista, Virginia 24517  (434) 369-3000  Fax (434) 369-7190



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2006 saw the retirement of Betty S. Adkins, Vice President, after more than 45 years with First National Bank. With responsibility for deposit services,
Bettys customer knowledge and dedication and loyalty to the Company were unsurpassed. Betty is missed by her customers and co-workers, but we still benefit from her smiling face and positive attitude on drop-by visits to the bank.

Perhaps the most significant accomplishment of 2006 was formulation of a strategic plan outlining a direction for the Company for the next 5 years as we seek to
perpetuate our growth and profitability. The vision statement from the plan states that First National Bank of Altavista will be the premier community financial institution in our Region 2000 market. We will continually seek to leverage our strong
heritage, our exceptional personal service and our local decision making through our greatest asset, our people, recognizing that our ultimate purpose for being in business is to enhance the value of our shareholders investment.

We encourage your review of the wealth of information contained in this Annual Report and hope you will join us for our Annual Meeting of Shareholders to be held at
11:30 a.m., Tuesday, April 10, 2007 in the Fellowship Hall of Altavista Presbyterian Church, 707 Broad Street, Altavista, Virginia.

Thank you for
your support of Pinnacle Bankshares and for the business you share with First National Bank.



LOGORobert H. Gilliam, Jr.President and Chief Executive Officer


February 23, 2007

622 Broad Street·P.O. Box 29·Altavista, Virginia 24517·(434) 369-3000·Fax (434) 369-7190



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Selected Consolidated Financial Information

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



|                                                                          |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|------------------------------------------------------------------------- |  | ------------------------ | --------- | - | ---- | --------- | - | ---- | --------- | - | ---- | --------- | - | ---- | --------- | -
|                                                                          |  | Years ended December 31, |          
|                                                                          |  | 2006                     |           |   | 2005 |           |   | 2004 |           |   | 2003 |           |   | 2002 |          
|Income Statement Data:                                                    |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Net interest income                                                       |  | $                        | 9,192     |   |      | 7,983     |   |      | 7,400     |   |      | 7,083     |   |      | 7,096     |  
|Provision for loan losses                                                 |  |                          | 339       |   |      | 230       |   |      | 223       |   |      | 470       |   |      | 429       |  
|Noninterest income                                                        |  |                          | 2,500     |   |      | 2,396     |   |      | 2,255     |   |      | 2,578     |   |      | 1,756     |  
|Noninterest expenses                                                      |  |                          | 7,825     |   |      | 7,166     |   |      | 6,901     |   |      | 6,738     |   |      | 5,814     |  
|Income tax expense                                                        |  |                          | 1,116     |   |      | 876       |   |      | 712       |   |      | 681       |   |      | 723       |  
|Net income                                                                |  |                          | 2,412     |   |      | 2,107     |   |      | 1,819     |   |      | 1,772     |   |      | 1,886     |  
|Per Share Data:                                                           |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Basic net income                                                          |  | $                        | 1.65      |   |      | 1.44      |   |      | 1.25      |   |      | 1.22      |   |      | 1.30      |  
|Diluted net income                                                        |  |                          | 1.64      |   |      | 1.43      |   |      | 1.23      |   |      | 1.21      |   |      | 1.29      |  
|Cash dividends                                                            |  |                          | 0.55      |   |      | 0.49      |   |      | 0.45      |   |      | 0.44      |   |      | 0.41      |  
|Book value                                                                |  |                          | 16.66     |   |      | 15.91     |   |      | 15.24     |   |      | 14.71     |   |      | 14.02     |  
|Weighted-Average Shares Outstanding:                                      |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Basic                                                                     |  |                          | 1,459,007 |   |      | 1,458,706 |   |      | 1,457,406 |   |      | 1,455,530 |   |      | 1,453,013 |  
|Diluted                                                                   |  |                          | 1,478,128 |   |      | 1,476,288 |   |      | 1,473,442 |   |      | 1,469,739 |   |      | 1,461,300 |  
|Balance Sheet Data:                                                       |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Assets                                                                    |  | $                        | 256,421   |   |      | 233,490   |   |      | 219,813   |   |      | 206,344   |   |      | 199,899   |  
|Loans, net                                                                |  |                          | 207,861   |   |      | 181,268   |   |      | 158,846   |   |      | 147,883   |   |      | 129,999   |  
|Securities                                                                |  |                          | 24,866    |   |      | 29,261    |   |      | 34,224    |   |      | 37,108    |   |      | 42,731    |  
|Cash and cash equivalents                                                 |  |                          | 14,586    |   |      | 13,814    |   |      | 17,336    |   |      | 13,766    |   |      | 19,963    |  
|Deposits                                                                  |  |                          | 230,817   |   |      | 209,246   |   |      | 196,639   |   |      | 183,865   |   |      | 178,243   |  
|Stockholders equity                                                      |  |                          | 24,492    |   |      | 23,212    |   |      | 22,207    |   |      | 21,435    |   |      | 20,372    |  
|Performance Ratios:                                                       |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Return on average assets                                                  |  |                          | 1.00      | % |      | 0.94      | % |      | 0.86      | % |      | 0.87      | % |      | 0.94      | %
|Return on average equity                                                  |  |                          | 10.10     | % |      | 9.29      | % |      | 8.33      | % |      | 8.51      | % |      | 9.79      | %
|Dividend payout                                                           |  |                          | 33.25     | % |      | 33.93     | % |      | 36.06     | % |      | 36.07     | % |      | 31.54     | %
|Asset Quality Ratios:                                                     |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Allowance for loan losses to total loans, net of unearned income and fees |  |                          | 0.84      | % |      | 0.83      | % |      | 0.94      | % |      | 1.02      | % |      | 0.99      | %
|Net charge-offs to average loans, net of unearned income and fees         |  |                          | 0.04      | % |      | 0.13      | % |      | 0.16      | % |      | 0.16      | % |      | 0.24      | %
|Capital Ratios:                                                           |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Leverage                                                                  |  |                          | 9.80      | % |      | 9.88      | % |      | 9.85      | % |      | 9.79      | % |      | 9.44      | %
|Risk-based:                                                               |  |                          |           |   |      |           |   |      |           |   |      |           |   |      |           |  
|Tier 1 capital                                                            |  |                          | 9.92      | % |      | 10.54     | % |      | 10.98     | % |      | 11.57     | % |      | 12.37     | %
|Total capital                                                             |  |                          | 10.64     | % |      | 11.23     | % |      | 11.75     | % |      | 12.45     | % |      | 13.21     | %
|Average equity to average assets                                          |  |                          | 9.91      | % |      | 10.07     | % |      | 10.32     | % |      | 10.20     | % |      | 9.62      | %



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Managements Discussion and Analysis

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

The following discussion is qualified in its
entirety by the more detailed information and the consolidated financial statements and accompanying notes appearing elsewhere in this Annual Report. In addition to the historical information contained herein, this Annual Report contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of management, are
generally identifiable by use of words such as believe, expect, intend, anticipate, estimate, project, may, will or similar expressions. Although we
believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect
of future plans or strategies is inherently uncertain, and actual results, performance or achievements could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include,
but are not limited to, changes in: interest rates; general economic conditions; the legislative/regulatory climate; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Board of Governors of the
Federal Reserve System; the quality or composition of the loan and/or investment portfolios; demand for loan products; deposit flows; competition; demand for financial services in our market area; and accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating forward-looking statements contained herein. Bankshares bases its forward-looking statements on managements beliefs and assumptions based on information available as of the date
of this report. You should not place undue reliance on such statements, because the assumptions, beliefs, expectations and projections about future events on which they are based may, and often do, differ materially from actual results. We undertake
no obligation to update any forward-looking statement to reflect developments occurring after the statement is made.

Company Overview

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

The Bank was organized as a national bank in 1908 and commenced its general banking operations in December of that year, providing services to commercial and agricultural businesses and individuals in the Altavista area. With an emphasis on
personal service, the Bank today offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, merchant bankcard processing, residential and commercial
mortgages, home equity loans, consumer installment loans, agricultural loans, investment loans, small business loans, commercial lines of credit and letters of credit. The Bank also offers a full range of investment, insurance and annuity products
through its association with Bankers Investments, LLC, and Bankers Insurance, LLC. The Bank has two wholly-owned subsidiaries: FNB Property Corp., which holds title to Bank premises real estate, and First Properties, Inc., which holds
title to other real estate owned from foreclosures.

The following discussion supplements and provides information about the major components of the
results of operations and financial condition, liquidity and capital resources of Bankshares and its subsidiary (collectively the Company). This discussion and analysis should be read in conjunction with the Companys consolidated financial
statements and accompanying notes.



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Executive Summary

The Company serves a trade area consisting primarily of Campbell County, northern Pittsylvania County, eastern Bedford County, northern Franklin County, Amherst County and the city of Lynchburg from facilities located in the town of
Altavista and the city of Lynchburg, Virginia. In addition, in June 1999 the Company opened the Airport facility, located just outside the Lynchburg city limits. In August 2000, the Company opened the Old Forest Road facility, located on Old Forest
Road in Lynchburg, and the Brookville Plaza facility, located on Timberlake Road in Lynchburg. The Company opened these offices to better serve the Lynchburg and northern Campbell County areas. To better service eastern Bedford County, the Company
opened the Forest facility in August 2004 located at the intersection of Perrowville Road and Route 221. In July 2005, the Company opened the Smith Mountain Lake Loan Production Office located on Scruggs Road in Moneta. In May 2006, the Company
moved the Brookville Plaza facility on Timberlake Road in Lynchburg to a new full service facility approximately 1.5 miles away on Timberlake Road in Campbell County now referred to as the Timberlake facility. This move was completed to better
service our customers by providing a drive thru, safe deposit boxes, night depository and the same good service given at the previous facility. In November 2006, the Company opened the Amherst Office located on Richmond Highway in Amherst to extend
our services to Amherst County and further expand our footprint. The Company operates in a well-diversified industrial economic region that does not depend upon one or a few types of commerce.

The Company earns revenues on the interest margin between the interest it charges on loans it extends to customers and interest received on the Companys securities
portfolio net of the interest it pays on deposits to customers. The Company also earns revenues on service charges on deposit and loan products, gains on securities that are called or sold, fees on sales of mortgages, and other noninterest income
items including but not limited to overdraft fees, commissions from investment, insurance and annuity sales, safe deposit box rentals, and automated teller machine surcharges. The Companys revenue generating activities and related expenses are
outlined in the consolidated statements of income and consolidated statements of changes in stockholders equity and comprehensive income and accompanying notes and in Results of Operations below.

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

The Companys balance sheet experienced
strong growth in its loan and deposit portfolios and good growth overall in 2006 assisted by growth in the commercial loan portfolio, loan production at our Smith Mountain Lake loan production facility and continued deposit and loan growth at the
Forest facility. The overall growth of the Company is outlined in the consolidated balance sheets and accompanying notes and the Investment Portfolio, Loan Portfolio, Bank Premises and Equipment,
Deposits and Capital Resources discussions below.

The Company looks to continue growing in 2007 and plans to research further
expansion opportunities. While growing, the Company is continually striving to leverage efficiencies from our reporting and imaging systems. The Company is also striving to make our customers lives more convenient by offering innovative
products and services and providing many channels to bank with us including Internet banking, Internet bill pay, telephone banking, debit cards and real-time ATMs. The Company will continue to strive to identify and install convenient products and
services in 2007 with the goal to better enhance the customers experience with the Company.

Overview of 2006 and 2005

Total assets at December 31, 2006 were $256,421, up 9.82% from $233,490 at December 31, 2005. The principal components of the Companys assets at the end
of the year were $14,586 in cash and cash equivalents, $24,866 in securities and $207,861 in net loans. During the year ended December 31, 2006, gross loans increased 14.71% or $26,907. The Companys lending activities are a principal
source of income.

Total liabilities at December 31, 2006 were $231,929, up 10.30% from $210,278 at December 31, 2005, with the increase
reflective of an increase in total deposits of $21,571 or 10.31%. Noninterest-bearing demand deposits



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increased $1,717 or 7.84% and represented 10.24% of total deposits at December 31, 2006, compared to 10.47% at December 31, 2005. Savings and NOW
accounts increased $5,137 or 7.94% and represented 30.24% of total deposits at December 31, 2006, compared to 30.90% at December 31, 2005. Time deposits increased $14,717 or 12.00% at December 31, 2006 and represented 59.52% of total
deposits at December 31, 2006, compared to 58.63% at December 31, 2005. The Companys deposits are provided by individuals and businesses located within the communities served.

Total stockholders equity at December 31, 2006 was $24,492 compared to $23,212 at December 31, 2005.

The Company had net income of $2,412 for the year ended December 31, 2006, compared to net income of $2,107 for the year ended December 31, 2005, an increase
of 14.48%.

Profitability as measured by the Companys return on average assets (ROA) was 1.00% in 2006, compared to 0.94% in 2005. Another key
indicator of performance, the return on average equity (ROE), was 10.10% for 2006, compared to 9.29% for 2005.

Overview of 2005 and 2004

Total assets at December 31, 2005 were $233,490, up 6.22% from $219,813 at December 31, 2004. The principal components of the Companys
assets at the end of the year were $13,814 in cash and cash equivalents, $29,261 in securities and $181,268 in net loans. During the year ended December 31, 2005, gross loans increased 14.00% or $22,470. The Companys lending activities
are a principal source of income.

Total liabilities at December 31, 2005 were $210,278, up 6.41% from $197,606 at December 31, 2004, with the
increase reflective of an increase in total deposits of $12,607 or 6.41%. Noninterest-bearing demand deposits increased $2,150 or 10.88% and represented 10.47% of total deposits at December 31, 2005, compared to 10.05% at December 31,
2004. Savings and NOW accounts increased $4,852 or 8.11% and represented 30.90% of total deposits at December 31, 2005, compared to 30.42% at December 31, 2004. Time deposits increased $5,605 or 4.79% at December 31, 2005 and
represented 58.63% of total deposits at December 31, 2005, compared to 59.53% at December 31, 2004. The Companys deposits are provided by individuals and businesses located within the communities served.

Total stockholders equity at December 31, 2005 was $23,212 compared to $22,207 at December 31, 2004.

The Company had net income of $2,107 for the year ended December 31, 2005, compared to net income of $1,819 for the year ended December 31, 2004, an increase
of 15.83%.

Profitability as measured by the Companys return on average assets (ROA) was 0.94% in 2005, compared to 0.86% in 2004. Another key
indicator of performance, the return on average equity (ROE), was 9.29% for 2005, compared to 8.33% for 2004.

Results of Operations

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

The net interest spread increased to 3.54% for the year ended December 31, 2006 from 3.43% for the year ended December 31, 2005. Net interest income was $9,192
($9,287 on a tax-equivalent basis) for the year ended December 31, 2006, compared to $7,983 ($8,156 on a tax-equivalent basis) for the year ended December 31, 2005, and is attributable to interest income from loans, federal funds sold and
securities exceeding the cost



9



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associated with interest paid on deposits and other borrowings. In 2006, our loans repriced at higher rates more rapidly than did our deposits, therefore
increasing our interest rate spread. The Banks yield on interest-earning assets for the year ended December 31, 2006 was 0.82% higher than the year ended December 31, 2005 due to lower yielding assets being replaced by higher
yielding ones in 2006. The Banks cost of funds rate on interest-bearing liabilities in 2006 was 0.71% higher compared to 2005.

The net interest
spread decreased to 3.43% for the year ended December 31, 2005 from 3.50% for the year ended December 31, 2004. Net interest income was $7,983 ($8,156 on a tax-equivalent basis) for the year ended December 31, 2005, compared to $7,400
($7,605 on a tax-equivalent basis) for the year ended December 31, 2004, and is attributable to interest income from loans, federal funds sold and securities exceeding the cost associated with interest paid on deposits and other borrowings. In
2005, our deposits repriced at higher rates more rapidly than did our loans, therefore lowering our interest rate spread. The Banks yield on interest-earning assets for the year ended December 31, 2005 was 0.47% higher than the year ended
December 31, 2004 due to lower yielding assets being replaced by higher yielding ones in 2005. The Banks cost of funds rate on interest-bearing liabilities in 2005 was 0.54% higher compared to 2004.

The Companys net interest margin increased in 2006 from 2005 levels. The Company attempts to increase net interest margin by product pricing strategies. Many
economic forecasts of interest rates for 2007 predict that interest rates may decrease if the overall economy shows signs of sluggishness. On the contrary, rates may increase to combat increasing inflation. While there is no guarantee of how rates
may change in 2007, the Company will strive to price products that are competitive in the market, allow for growth and continue to improve the net interest margin. The Company also continues to strive to find new sources of noninterest income to
combat the effects of volatility in the interest rate environment.

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

ANALYSIS OF NET INTEREST INCOME



|                              |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|----------------------------- |  | ------------------------ | ------- | - | ---------------------- | ------ | --------------- | ---- | - | ----------------- | ------- | - | ---------------------- | ------ | --------------- | ---- | - | ----------------- | ------- | - | ---------------------- | ------ | --------------- | ---- | -
|                              |  | Years ended December 31, |        
|                              |  | 2006                     |         |   | 2005                   |        |                 | 2004 |  
|                              |  | Averagebalance(1)        |         |   | Interestincome/expense |        | Rateearned/paid |      |   | Averagebalance(1) |         |   | Interestincome/expense |        | Rateearned/paid |      |   | Averagebalance(1) |         |   | Interestincome/expense |        | Rateearned/paid |     
|Assets                        |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|Interest-earning assets:      |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|Loans (2)(3)                  |  | $                        | 194,819 |   |                        | 13,979 |                 | 7.18 | % |                   | 171,388 |   |                        | 10,847 |                 | 6.33 | % |                   | 153,902 |   |                        | 8,991  |                 | 5.87 | %
|Investment securities:        |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|Taxable                       |  |                          | 20,111  |   |                        | 988    |                 | 4.91 | % |                   | 23,540  |   |                        | 1,150  |                 | 4.89 | % |                   | 25,334  |   |                        | 1,301  |                 | 4.89 | %
|Tax-exempt (4)                |  |                          | 6,555   |   |                        | 372    |                 | 5.68 | % |                   | 8,501   |   |                        | 577    |                 | 6.79 | % |                   | 10,072  |   |                        | 679    |                 | 6.74 | %
|Interest-earning deposits     |  |                          | 91      |   |                        | 5      |                 | 5.49 | % |                   | 205     |   |                        | 6      |                 | 2.93 | % |                   | 79      |   |                        | 1      |                 | 1.79 | %
|Federal funds sold            |  |                          | 7,695   |   |                        | 368    |                 | 4.78 | % |                   | 9,227   |   |                        | 263    |                 | 2.85 | % |                   | 10,495  |   |                        | 135    |                 | 1.29 | %
|                              |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|Total interest-earning assets |  |                          | 229,271 |   |                        | 15,712 |                 | 6.85 | % |                   | 212,861 |   |                        | 12,843 |                 | 6.03 | % |                   | 199,882 |   |                        | 11,107 |                 | 5.56 | %
|Other assets:                 |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|Allowance for loan losses     |  |                          | (1,638  | ) |                        |        |                 |      |   |                   | (1,556  | ) |                        |        |                 |      |   |                   | (1,608  | ) |                        |        |                 |      |  
|Cash and due from banks       |  |                          | 4,929   |   |                        |        |                 |      |   |                   | 6,115   |   |                        |        |                 |      |   |                   | 4,300   |   |                        |        |                 |      |  
|Other assets, net             |  |                          | 8,367   |   |                        |        |                 |      |   |                   | 7,691   |   |                        |        |                 |      |   |                   | 9,022   |   |                        |        |                 |      |  
|                              |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  
|Total assets                  |  | $                        | 240,929 |   |                        |        |                 |      |   |                   | 225,111 |   |                        |        |                 |      |   |                   | 211,596 |   |                        |        |                 |      |  
|                              |  |                          |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |   |                   |         |   |                        |        |                 |      |  



10



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|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|------------------------------------ |  | ------------------------ | ------- | ---------------------- | ----- | --------------- | ---- | ---- | ----------------- | ------- | ---------------------- | ----- | --------------- | ---- | - | ----------------- | ------- | ---------------------- | ----- | --------------- | ---- | -
|                                     |  | Years ended December 31, |        
|                                     |  | 2006                     |         |                        | 2005  |                 |      | 2004 |                  
|                                     |  | Averagebalance(1)        |         | Interestincome/expense |       | Rateearned/paid |      |      | Averagebalance(1) |         | Interestincome/expense |       | Rateearned/paid |      |   | Averagebalance(1) |         | Interestincome/expense |       | Rateearned/paid |     
|Liabilities and Stockholders equity |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|Interest-bearing liabilities:        |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|Savings and NOW                      |  | $                        | 66,666  |                        | 1,048 |                 | 1.57 | %    |                   | 63,374  |                        | 549   |                 | 0.87 | % |                   | 62,195  |                        | 346   |                 | 0.56 | %
|Time                                 |  |                          | 127,185 |                        | 5,367 |                 | 4.22 | %    |                   | 116,895 |                        | 4,119 |                 | 3.52 | % |                   | 107,808 |                        | 3,134 |                 | 2.91 | %
|Other borrowings                     |  |                          | 158     |                        | 10    |                 | 6.33 | %    |                   | 260     |                        | 16    |                 | 6.15 | % |                   | 360     |                        | 22    |                 | 6.11 | %
|Federal Funds Purchased              |  |                          |        |                        |      |                 |     |      |                   | 75      |                        | 3     |                 | 4.00 | % |                   |        |                        |      |                 |     |  
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|                                     |  |                          | 194,009 |                        | 6,425 |                 | 3.31 | %    |                   | 180,604 |                        | 4,687 |                 | 2.60 | % |                   | 170,363 |                        | 3,502 |                 | 2.06 | %
|Noninterest-bearing liabilities:     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|Demand deposits                      |  |                          | 22,008  |                        |       |                 |      |      |                   | 21,169  |                        |       |                 |      |   |                   | 18,886  |                        |       |                 |      |  
|Other liabilities                    |  |                          | 1,054   |                        |       |                 |      |      |                   | 662     |                        |       |                 |      |   |                   | 506     |                        |       |                 |      |  
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|                                     |  |                          | 217,071 |                        |       |                 |      |      |                   | 202,435 |                        |       |                 |      |   |                   | 189,755 |                        |       |                 |      |  
|Stockholders equity                 |  |                          | 23,858  |                        |       |                 |      |      |                   | 22,676  |                        |       |                 |      |   |                   | 21,841  |                        |       |                 |      |  
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|                                     |  |                          | 240,929 |                        |       |                 |      |      |                   | 225,111 |                        |       |                 |      |   |                   | 211,596 |                        |       |                 |      |  
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|Net interest income                  |  |                          |         |                        | 9,287 |                 |      |      |                   |         |                        | 8,156 |                 |      |   |                   |         |                        | 7,605 |                 |      |  
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|Net interest margin (5)              |  |                          |         |                        |       |                 | 4.05 | %    |                   |         |                        |       |                 | 3.83 | % |                   |         |                        |       |                 | 3.80 | %
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  
|Net interest spread (6)              |  |                          |         |                        |       |                 | 3.54 | %    |                   |         |                        |       |                 | 3.43 | % |                   |         |                        |       |                 | 3.50 | %
|                                     |  |                          |         |                        |       |                 |      |      |                   |         |                        |       |                 |      |   |                   |         |                        |       |                 |      |  

---

|(1) | Averages are daily averages.
|--- | ----------------------------

|(2) | Loan interest income includes amortization of loan fees of $53 in 2006 and accretion of loan fees of $45 and $32 in 2005 and 2004 respectively.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------

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

|(4) | Tax-exempt income from investment securities is presented on a tax-equivalent basis assuming a 34% U.S. Federal tax rate for 2006, 2005 and 2004.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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



11



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RATE/VOLUME ANALYSIS



|                                                    |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|--------------------------------------------------- |  | ---------------------------------------- | ----- | - | ---------------------------------------- | ----- | - | --- | ----- | - | ------ | ----- | - | ---- | --- | - | --- | ----- | -
|                                                    |  | Years ended December 31,                 |      
|                                                    |  | 2006 compared to 2005Increase (decrease) |       |   | 2005 compared to 2004Increase (decrease) |      
|                                                    |  | Volume                                   |       |   | Rate                                     |       |   | Net |       |   | Volume |       |   | Rate |     |   | Net |      
|Interest earned on interest-earning assets:         |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Loans (1)                                           |  | $                                        | 1,601 |   |                                          | 1,531 |   |     | 3,132 |   |        | 1,087 |   |      | 769 |   |     | 1,856 |  
|Investment securities:                              |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Taxable                                             |  |                                          | (129  | ) |                                          | (29   | ) |     | (158  | ) |        | (147  | ) |      | (6  | ) |     | (153  | )
|Tax-exempt (2)                                      |  |                                          | (126  | ) |                                          | (54   | ) |     | (180  | ) |        | (111  | ) |      | 25  |   |     | (86   | )
|Interest-earning deposits                           |  |                                          | 2     |   |                                          | (3    | ) |     | (1    | ) |        | 2     |   |      | 1   |   |     | 3     |  
|Federal funds sold                                  |  |                                          | (34   | ) |                                          | 138   |   |     | 104   |   |        | (14   | ) |      | 142 |   |     | 128   |  
|                                                    |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Total interest earned on interest-earning assets    |  |                                          | 1,314 |   |                                          | 1,583 |   |     | 2,897 |   |        | 817   |   |      | 931 |   |     | 1,748 |  
|                                                    |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Interest paid on interest-bearing liabilities:      |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Savings and NOW                                     |  |                                          | 30    |   |                                          | 469   |   |     | 499   |   |        | 7     |   |      | 196 |   |     | 203   |  
|Time                                                |  |                                          | 383   |   |                                          | 865   |   |     | 1,248 |   |        | 281   |   |      | 704 |   |     | 985   |  
|Federal funds purchased                             |  |                                          | (3    | ) |                                          |      |   |     | (3    | ) |        | 3     |   |      |    |   |     | 3     |  
|Other borrowings                                    |  |                                          | (6    | ) |                                          |      |   |     | (6    | ) |        | (6    | ) |      |    |   |     | (6    | )
|                                                    |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Total interest paid on interest-bearing liabilities |  |                                          | 404   |   |                                          | 1,334 |   |     | 1,738 |   |        | 285   |   |      | 900 |   |     | 1,185 |  
|                                                    |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  
|Change in net interest income                       |  | $                                        | 910   |   |                                          | 249   |   |     | 1,159 |   |        | 532   |   |      | 31  |   |     | 563   |  
|                                                    |  |                                          |       |   |                                          |       |   |     |       |   |        |       |   |      |     |   |     |       |  

---

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

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

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

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

The provisions for loan losses for the years ended December 31, 2006, 2005 and 2004 were $339,
$230 and $223, respectively. See Allowance for Loan Losses for further discussion.

Noninterest Income.Total noninterest income
for the year ended December 31, 2006 increased $104, or 4.34% to $2,500 from $2,396 in 2005. The Companys principal source of noninterest income is service charges and fees on deposit accounts, particularly transaction accounts, fees on
sales of mortgage loans, and commissions and fees from investment, insurance, annuity and other bank products. The increase in 2006 is primarily attributable to an increase in service charges on deposits accounts and commissions on products sales.
Service charges on deposit accounts increased $64 and commissions on investment product sales increased $46 for the year ended December 31, 2006, compared to 2005.

Total noninterest income for the year ended December 31, 2005 increased $141, or 6.25% to $2,396 from $2,255 in 2004. The increase in 2005 is primarily attributable to an increase in commissions on investment
product sales. Commissions on investment product sales increased $131 for the year ended December 31, 2005, compared to 2004 resulting from the hiring of a new investment consultant in early 2005.

Noninterest Expense.Total noninterest expense for the year ended December 31, 2006 increased $659 or 9.20% to $7,825 from $7,166 in 2005. The
increase in noninterest expense is attributable to the effect of overall growth of the Company on personnel expenses and fixed asset costs. The Company has added six new branches and a



12



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loan production facility to its operations since June 1999 including relocating the Timberlake facility to a full-service branch from an in-store facility in
May 2006 and opening the Amherst branch in November 2006. The $108 increase in other expense is primarily due to a $48 increase in consultant expenses, a $7 increase in costs associated with our overdraft privilege program, an $8 increase in legal
fees, a $9 increase in fees paid to directors, and a $35 increase in indirect loan chargebacks.

Total noninterest expense for the year ended
December 31, 2005 increased $265 or 3.84% to $7,166 from $6,901 in 2004. The increase in noninterest expense is attributable to the effect of overall growth of the Company on personnel expenses and fixed asset costs associated with bank
premises additions. The decrease in other expense is primarily due to a $59 decrease in cost of foreclosures, a $42 decrease in consultant expenses, a $96 decrease in costs associated with our overdraft privilege program partially offset by a $41
increase in internal audit expenses associated with Sarbanes-Oxley compliance and a $37 increase in ATM network fees.

Income Tax
Expense. Applicable income taxes on 2006 earnings amounted to $1,116, resulting in an effective tax rate of 31.63% compared to $876, or 29.37% in 2005. The effective tax rate for 2006 is higher primarily because the level of
tax-exempt interest income for 2006 was lower compared to 2005.

Applicable income taxes on 2005 earnings amounted to $876, resulting in an effective tax
rate of 29.37% compared to $712, or 28.13% in 2004. The effective tax rate for 2005 is slightly higher primarily because the level of tax-exempt interest income for 2005 was lower compared to 2004.

Liquidity and Asset/Liability Management

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

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

The Companys operating activities for the year ended December 31, 2006 resulted in net cash provided of
$3,218, compared to net cash provided from operating activities of $2,711 in 2005. The overall increase is primarily attributable to the Companys cash received from net interest income of $9,164, which was $1,116 higher than the net interest
received in 2005 as a result of an increase in loan volume and yield received of $2,423. Partially offsetting this was cash received from noninterest income in 2006 that was $34 lower than the noninterest income amount received in 2005 and cash paid
for noninterest expenses of $7,935 that was $1,299 higher than 2005 primarily due to the Companys increased personnel and fixed asset expenses associated with its continued growth. Also, the Companys cash paid for income taxes totaled
$900 in 2006 compared to $688 in 2005. Management expects any changes in the Companys cash provided by operating activities to be partially offset through continued expansion of the Companys loan origination programs, changes in deposit
pricing strategies and continued focus on improving the efficiency of the Companys operations.

The Companys cash flows from investing
activities for the year ended December 31, 2006 resulted in net cash used of $23,135, compared to net cash used in investing activities of $18,044 in 2005. The overall increase is primarily attributable to a $4,788 increase in cash used to make
loans to customers as the Company increased its gross loans by 14.67%. The Company expects to continue to increase its loan portfolio in 2007. The Company also experienced fewer paydowns and maturities of available-for-sale mortgage-backed
securities due to a rising interest rate environment in 2006. The Company expects a slightly lower volume of paydowns in available-for-sale mortgage-backed securities in 2007 due to fewer mortgage-backed securities in the investment portfolio.

Net cash provided by financing activities for the year ended December 31, 2006 resulted in net cash provided of $20,689, compared to net cash
provided by financing activities of $11,811 in 2005. The overall increase in net



13



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cash provided is primarily attributable to the net increase in deposits. The Company had success in attracting all different types of deposits to fund the
growth in the loan portfolio although the cost of the deposits increased in 2006.

The Companys operating activities for the year ended
December 31, 2005 resulted in net cash provided of $2,711, compared to net cash provided from operating activities of $2,467 in 2004. The overall increase is primarily attributable to the Companys cash received of $2,458 from noninterest
income in 2005 and was $162 higher than the noninterest income amount received in 2004. The increase in noninterest income received in 2005 is primarily attributable to higher commission income from investment product sales. Additionally, the
Company received cash from net interest income of $8,048, which was $519 higher than the cash from net interest received in 2004 as a result of timing differences in the payment and collection of interest amounts. Partially offsetting this was cash
paid for noninterest expenses of $6,636 that was $134 higher than 2004 primarily due to the Companys increased personnel expenses associated with its continued growth. Also, the Companys cash paid for income taxes totaled $688 in 2005
compared to $914 in 2004.

The Companys cash flows from investing activities for the year ended December 31, 2005 resulted in net cash used of
$18,044, compared to net cash used in investing activities of $10,915 in 2004. The overall increase is primarily attributable to a $10,447 increase in cash used to make loans to customers as the Company increased its gross loans by 14.00%. The
Company also experienced fewer paydowns and maturities of available-for-sale mortgage-backed securities due to a rising interest rate environment in 2005.

Net cash provided by financing activities for the year ended December 31, 2005 resulted in net cash provided of $11,811, compared to net cash provided by financing activities of $12,018 in 2004. The overall decrease in net cash
provided is primarily attributable to the net decrease in time deposits offset by a net increase in demand, savings and NOW deposits. The Company had continued success in attracting low cost demand, savings and NOW deposits in 2005 with attractive
product offerings such as Internet banking, bill pay and overdraft privilege.

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

The Companys liquidity is provided by cash and due from banks, federal funds sold, investments available-for-sale, managing investment maturities, interest-earning deposits in other financial institutions and
loan repayments. The Companys ratio of liquid assets to deposits and short-term borrowings was 14.89% as of December 31, 2006 as compared to 17.62% as of December 31, 2005. The Company sells excess funds as overnight federal funds
sold to provide an immediate source of liquidity. Federal funds sold as of December 31, 2006 was $8,638 as compared to $7,223 as of December 31, 2005. The increase in federal funds sold in 2006 was primarily related to the net increase in
deposits and paydowns and maturities of securities in 2006. Cash and due from banks of $5,948 as of December 31, 2006 was $643 lower when compared to December 31, 2005.

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

As a result of the Companys
management of liquid assets and its ability to generate liquidity through alternative funding sources, management believes that the Company maintains overall liquidity that is sufficient to satisfy its



14



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depositors requirements and to meet customers credit needs. Additional sources of liquidity available to the Company include its capacity to
borrow funds through correspondent banks and the Federal Home Loan Bank.

The Company obtains sources of funds through growth in deposits, scheduled
payments and prepayments from the loan and investment portfolio, retained earnings growth, and may purchase or borrow funds through the Federal Reserves discount window. The Company also has sources of liquidity through three correspondent
banking relationships. The Company uses its funds to fund loan and investment growth. Excess funds are sold daily to other institutions. The Company had one borrowing with the Federal Home Loan Bank with a principal balance of $100 with an interest
rate of 6.13% as of December 31, 2006. The principal is reduced by $25 quarterly with final payment scheduled to be made in December of 2007.

Interest Rates

While no single measure can completely identify the impact of changes in interest rates on net interest income, one gauge of
interest rate sensitivity is to measure, over a variety of time periods, the differences in the amounts of the Companys rate-sensitive assets and rate-sensitive liabilities. These differences or gaps provide an indication of the
extent to which net interest income may be affected by future changes in interest rates. A positive gap exists when rate-sensitive assets exceed rate-sensitive liabilities and indicates that a greater volume of assets than liabilities
will reprice during a given period. This mismatch may enhance earnings in a rising interest rate environment and may inhibit earnings in a declining interest rate environment. Conversely, when rate-sensitive liabilities exceed rate-sensitive assets,
referred to as a negative gap, it indicates that a greater volume of liabilities than assets will reprice during the period. In this case, a rising interest rate environment may inhibit earnings and a declining interest rate environment
may enhance earnings. The cumulative one-year gap as of December 31, 2006 was $(41,160), representing 16.05% of total assets. This negative gap falls within the parameters set by the Company.

The following table illustrates the Companys interest rate sensitivity gap position at December 31, 2006.



|                                         |  |        |         |   |           |        |   |           |        |            |       
|---------------------------------------- |  | ------ | ------- | - | --------- | ------ | - | --------- | ------ | ---------- | ------
|                                         |  | 1 year |         |   | 1-3 years |        |   | 3-5 years |        | 5-15 years
|ASSET/(LIABILITY):                       |  |        |         |   |           |        |   |           |        |            |       
|Cumulative interest rate sensitivity gap |  | $      | (41,160 | ) |           | (5,540 | ) |           | 12,796 |            | 34,187

As of December 31, 2006, the Company was liability-sensitive in periods from one to three years and was
asset-sensitive beyond three years. The foregoing table does not necessarily indicate the impact of general interest rate movements on the Companys net interest yield, because the repricing of various categories of assets and liabilities is
discretionary and is subject to competition and other pressures. As a result, various assets and liabilities indicated as repricing within the same period may in fact price at different times and at different rate levels. Management attempts to
mitigate the impact of changing interest rates in several ways, one of which is to manage its interest rate-sensitivity gap. In addition to managing its asset/liability position, the Company has taken steps to mitigate the impact of changing
interest rates by generating noninterest income through service charges, and offering products that are not interest rate-sensitive.

Effects of
Inflation

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



15



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Investment Portfolio

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

Investment securities available-for-sale as of December 31, 2006 were $19,221, a decrease of $3,130 or 14.00% from $22,351 as of December 31, 2005. Investment
securities held-to-maturity decreased to $5,645 as of December 31, 2006 from $6,910 as of December 31, 2005, a decrease of $1,265 or 18.31%.

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



|                                                                                      |  |                |        |            |        |                |        |            |        |                |        |            |       
|------------------------------------------------------------------------------------- |  | -------------- | ------ | ---------- | ------ | -------------- | ------ | ---------- | ------ | -------------- | ------ | ---------- | ------
|                                                                                      |  | December 31,  
|                                                                                      |  | 2006           |        | 2005       |        | 2004          
|                                                                                      |  | Amortizedcosts |        | Fairvalues |        | Amortizedcosts |        | Fairvalues |        | Amortizedcosts |        | Fairvalues
|Available-for-Sale                                                                    |  |                |        |            |        |                |        |            |        |                |        |            |       
|U.S. Treasury securities and obligations of U.S. Government corporations and agencies |  | $              | 4,889  |            | 4,843  |                | 3,985  |            | 3,921  |                | 3,099  |            | 3,127 
|Obligations of states and political subdivisions                                      |  |                | 6,033  |            | 6,025  |                | 6,922  |            | 6,934  |                | 7,549  |            | 7,727 
|Corporate securities                                                                  |  |                | 3,502  |            | 3,451  |                | 6,055  |            | 5,985  |                | 8,577  |            | 8,726 
|Mortgage-backed securities  government                                               |  |                | 4,908  |            | 4,852  |                | 5,494  |            | 5,461  |                | 6,653  |            | 6,757 
|Other securities                                                                      |  |                | 50     |            | 50     |                | 50     |            | 50     |                | 50     |            | 50    
|                                                                                      |  |                |        |            |        |                |        |            |        |                |        |            |       
|Total available-for-sale                                                              |  | $              | 19,382 |            | 19,221 |                | 22,506 |            | 22,351 |                | 25,928 |            | 26,387
|                                                                                      |  |                |        |            |        |                |        |            |        |                |        |            |       



|                                                 |  |                |       |            |       |                |       |            |       |                |       |            |      
|------------------------------------------------ |  | -------------- | ----- | ---------- | ----- | -------------- | ----- | ---------- | ----- | -------------- | ----- | ---------- | -----
|                                                 |  | December 31,  
|                                                 |  | 2006           |       | 2005       |       | 2004          
|                                                 |  | Amortizedcosts |       | Fairvalues |       | Amortizedcosts |       | Fairvalues |       | Amortizedcosts |       | Fairvalues
|Held-to-Maturity                                 |  |                |       |            |       |                |       |            |       |                |       |            |      
|Obligations of states and political subdivisions |  |                | 5,645 |            | 5,673 |                | 6,910 |            | 6,982 |                | 7,837 |            | 8,102
|                                                 |  |                |       |            |       |                |       |            |       |                |       |            |      
|Total held-to-maturity                           |  | $              | 5,645 |            | 5,673 |                | 6,910 |            | 6,982 |                | 7,837 |            | 8,102
|                                                 |  |                |       |            |       |                |       |            |       |                |       |            |      



16



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

INVESTMENT PORTFOLIO  MATURITY DISTRIBUTION



|                                                 |  |                   |        |            |        |       |      |  
|------------------------------------------------ |  | ----------------- | ------ | ---------- | ------ | ----- | ---- | -
|                                                 |  | December 31, 2006 |       
|                                                 |  | Amortized Costs   |        | FairValues |        | Yield |     
|Available-for-Sale                               |  |                   |        |            |        |       |      |  
|U.S. Treasury securities and obligations of U.S. |  |                   |        |            |        |       |      |  
|Government corporations:                         |  |                   |        |            |        |       |      |  
|Within one year                                  |  | $                 | 2,200  |            | 2,188  |       | 3.98 | %
|After one but within five years                  |  |                   | 2,500  |            | 2,465  |       | 4.25 | %
|After five years through ten years               |  |                   | 189    |            | 189    |       | 5.01 | %
|Obligations of states and subdivisions (1):      |  |                   |        |            |        |       |      |  
|Within one year                                  |  |                   |        |            |        |       |      |  
|After one but within five years                  |  |                   | 4,199  |            | 4,159  |       | 4.65 | %
|After five years through ten years               |  |                   | 1,334  |            | 1,372  |       | 4.42 | %
|After ten years                                  |  |                   | 500    |            | 494    |       | 3.40 | %
|Corporate securities:                            |  |                   |        |            |        |       |      |  
|Within one year                                  |  |                   | 1,003  |            | 993    |       | 4.61 | %
|After one but within five years                  |  |                   | 2,499  |            | 2,458  |       | 4.32 | %
|Mortgage-backed securities  government          |  |                   | 4,908  |            | 4,853  |       | 5.12 | %
|Other securities (2)                             |  |                   | 50     |            | 50     |       |     |  
|                                                 |  |                   |        |            |        |       |      |  
|Total available-for-sale                         |  | $                 | 19,382 |            | 19,221 |       |      |  
|                                                 |  |                   |        |            |        |       |      |  
|Held-to-Maturity                                 |  |                   |        |            |        |       |      |  
|Obligations of states and subdivisions (1):      |  |                   |        |            |        |       |      |  
|Within one year                                  |  |                   | 1,470  |            | 1,474  |       | 5.12 | %
|After one but within five years                  |  |                   | 3,374  |            | 3,415  |       | 4.51 | %
|After five years through ten years               |  |                   | 801    |            | 784    |       | 4.18 | %
|                                                 |  |                   |        |            |        |       |      |  
|Total held-to-maturity                           |  | $                 | 5,645  |            | 5,673  |       |      |  
|                                                 |  |                   |        |            |        |       |      |  

---

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

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

Loan Portfolio

The Companys net loans were $207,861 as of December 31, 2006, an increase of $26,593 or 14.68% from $181,268 as
of December 31, 2005. This increase resulted primarily from increased volume of commercial loan originations during 2006 and loan volume from our loan production facility. The Companys ratio of net loans to total deposits was 90.05% as of
December 31, 2006 compared to 86.63% as of December 31, 2005.

Typically, the Company maintains a ratio of loans to deposits of between 70% and
90%. The loan portfolio primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate), and loans to individuals for household, family and other consumer expenditures.
However, the Company adjusts its mix of lending and the terms of its loan programs according to market conditions and other factors. The Companys loans are typically made to businesses and individuals located within the Companys market
area, most of who have account relationships with the Bank. There is no concentration of loans exceeding 10% of total loans that is not disclosed in the categories presented below. The Company has not made any loans to any foreign entities including
governments, banks, businesses or individuals. Commercial and construction loans in the Companys portfolio are primarily variable rate loans and have little interest rate risk.



17



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

LOAN PORTFOLIO



|                                                                           |  |             |         |   |      |         |   |        |         |   |      |         |   |      |         |  
|-------------------------------------------------------------------------- |  | ----------- | ------- | - | ---- | ------- | - | ------ | ------- | - | ---- | ------- | - | ---- | ------- | -
|                                                                           |  | December 31 |        
|                                                                           |  | 2006        |         |   | 2005 |         |   | , 2004 |         |   | 2003 |         |   | 2002 |        
|Real estate loans:                                                         |  |             |         |   |      |         |   |        |         |   |      |         |   |      |         |  
|Residential                                                                |  | $           | 51,876  |   |      | 55,936  |   |        | 52,470  |   |      | 52,264  |   |      | 51,134  |  
|Other                                                                      |  |             | 77,119  |   |      | 53,039  |   |        | 43,877  |   |      | 34,697  |   |      | 18,542  |  
|Loans to individuals for household, family and other consumer expenditures |  |             | 46,360  |   |      | 44,369  |   |        | 41,449  |   |      | 44,367  |   |      | 44,948  |  
|Commercial and industrial loans                                            |  |             | 34,036  |   |      | 28,659  |   |        | 21,680  |   |      | 17,635  |   |      | 16,672  |  
|All other loans                                                            |  |             | 454     |   |      | 935     |   |        | 992     |   |      | 533     |   |      | 146     |  
|                                                                           |  |             |         |   |      |         |   |        |         |   |      |         |   |      |         |  
|Total loans, gross                                                         |  |             | 209,845 |   |      | 182,938 |   |        | 160,468 |   |      | 149,496 |   |      | 131,442 |  
|Less unearned income and fees                                              |  |             | (214    | ) |      | (162    | ) |        | (120    | ) |      | (85     | ) |      | (145    | )
|                                                                           |  |             |         |   |      |         |   |        |         |   |      |         |   |      |         |  
|Loans, net of unearned income and fees                                     |  |             | 209,631 |   |      | 182,776 |   |        | 160,348 |   |      | 149,411 |   |      | 131,297 |  
|Less allowance for loan losses                                             |  |             | (1,770  | ) |      | (1,508  | ) |        | (1,502  | ) |      | (1,528  | ) |      | (1,298  | )
|                                                                           |  |             |         |   |      |         |   |        |         |   |      |         |   |      |         |  
|Loans, net                                                                 |  | $           | 207,861 |   |      | 181,268 |   |        | 158,846 |   |      | 147,883 |   |      | 129,999 |  
|                                                                           |  |             |         |   |      |         |   |        |         |   |      |         |   |      |         |  

Commercial Loans. Commercial and industrial loans accounted for 16.22% of the Companys
loan portfolio as of December 31, 2006 compared to 15.66% as of December 31, 2005. Such loans are generally made to provide operating lines of credit, to finance the purchase of inventory or equipment, and for other business purposes.
Commercial loans are primarily made at rates that adjust with changes in the prevailing prime interest rate, are generally made for a maximum term of five years (unless they are term loans), and generally require interest payments to be made
monthly. The creditworthiness of these borrowers is reviewed, analyzed and evaluated on a periodic basis. Most commercial loans are collateralized with business assets such as accounts receivable, inventory and equipment. Even with substantial
collateralization such as all of the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business.

Real Estate Loans.Real estate loans accounted for 61.47% of the Companys loan portfolio as of December 31, 2006 compared to 59.57% as of
December 31, 2005. The Company makes commercial and industrial real estate term loans that are typically secured by a first deed of trust. As of December 31, 2006, 40.22% of the real estate loans were secured by 1-4 family residential
properties compared to 51.33% at December 31, 2005. As of December 31, 2006, 1.10% of total real estate loans were construction loans compared to 1.77% at December 31, 2005. Real estate lending involves risk elements when there is
lack of timely payment and/or a decline in the value of the collateral. While it is difficult to predict the strength of the real estate market, management believes the real estate market in the Companys market area will continue to be strong
in 2007.

Installment Loans. Installment loans are represented by loans to individuals for household, family and other consumer
expenditures. Installment loans accounted for 22.09% of the Companys loan portfolio as of December 31, 2006 compared to 24.25% as of December 31, 2005.

Mortgage Loan Production.The mortgage loan production department makes mortgage loans and refinances existing mortgage loans. The production department sells these loans on the secondary market
through the Federal National Mortgage Association, General Motors Acceptance Corporation and other mortgage brokers. The department does not buy loans on the secondary market but services loans that are held in its loan portfolio and not sold in the
secondary market.

Loan Maturity and Interest Rate Sensitivity. The following table presents loan portfolio information related to
maturity distribution of commercial and industrial loans and real estate construction loans based on scheduled repayments at December 31, 2006.



18



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|                                |  |                    |        |                      |        |                     |       |       |       
|------------------------------- |  | ------------------ | ------ | -------------------- | ------ | ------------------- | ----- | ----- | ------
|                                |  | Due withinone year |        | Due one tofive years |        | Due afterfive years |       | Total
|Commercial and industrial loans |  | $                  | 16,041 |                      | 15,501 |                     | 2,494 |       | 34,036
|Real estate  construction      |  |                    | 1,406  |                      |       |                     | 14    |       | 1,420 

The following table presents the interest rate sensitivity of commercial and industrial loans and real estate
construction loans maturing after one year or longer as of December 31, 2006.

INTEREST RATE SENSITIVITY



|                              |  |   |       
|----------------------------- |  | - | ------
|Fixed interest rates          |  | $ | 16,208
|Variable interest rates       |  |   | 1,801 
|                              |  |   |       
|Total maturing after one year |  | $ | 18,009
|                              |  |   |       

Restructured loans.The Company had no restructured loans during the years ended December 31,
2006 and 2005.

Nonperforming Assets. Interest on loans is normally accrued from the date a disbursement is made and recognized as
income as it is accrued. Generally, the Company reviews any loan on which payment has not been made for 90 days for potential non-accrual. The loan is examined and the collateral is reviewed to determine loss potential. If the loan is placed on
non-accrual, any prior accrued interest that remains unpaid is reversed. Loans on non-accrual amounted to $255, $421 and $189 as of December 31, 2006, 2005 and 2004, respectively. Interest income that would have been earned on non-accrual loans
if they had been current in accordance with their original terms and the recorded interest that was included in income on these loans was not significant for 2006, 2005 or 2004. There were no commitments to lend additional funds to customers whose
loans were on non-accrual status at December 31, 2006. No foreclosed property was on hand as of December 31, 2006. Foreclosed property as of December 31, 2005 and 2004 consisted of one property totaling $150.

The following tables present information with respect to the Companys nonperforming assets and nonaccruing loans 90 days or more past due by type as of the dates
indicated.

NONPERFORMING ASSETS



|                           |  |              |     |      |     |      |    
|-------------------------- |  | ------------ | --- | ---- | --- | ---- | ---
|                           |  | December 31,
|                           |  | 2006         |     | 2005 |     | 2004
|Nonaccrual loans           |  | $            | 255 |      | 421 |      | 189
|Foreclosed properties      |  |              |    |      | 150 |      | 150
|                           |  |              |     |      |     |      |    
|Total nonperforming assets |  | $            | 255 |      | 571 |      | 339
|                           |  |              |     |      |     |      |    

Nonperforming assets totaled $255 or 0.12% of total gross loans as of December 31, 2006, compared to $571 or
0.31% as of December 31, 2005 and $339 or 0.21% as of December 31, 2004. The following table presents the balance of accruing loans 90 days or more past due by type as of the dates indicated.

ACCRUING LOANS 90 DAYS OR MORE

PAST
DUE BY TYPE



|                                              |  |              |    |      |    |      |   
|--------------------------------------------- |  | ------------ | -- | ---- | -- | ---- | --
|                                              |  | December 31,
|                                              |  | 2006         |    | 2005 |    | 2004
|Loans 90 days or more past due by type:       |  |              |    |      |    |      |   
|Real estate loans                             |  | $            |   |      | 17 |      | 19
|Loans to individuals                          |  |              | 15 |      |   |      | 2 
|Commercial loans                              |  |              |   |      | 51 |      | 2 
|                                              |  |              |    |      |    |      |   
|Total accruing loans 90 days or more past due |  | $            | 15 |      | 68 |      | 23
|                                              |  |              |    |      |    |      |   

Allowance for Loan Losses. The Company maintains an allowance for loan losses, which it
considers adequate to cover the risk of losses in the loan portfolio. The allowance is based upon managements ongoing evaluation of



19



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the quality of the loan portfolio, total outstanding and committed loans, previous charges against the allowance and current and anticipated economic
conditions. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance. The Companys management believes that as of
December 31, 2006, 2005 and 2004, the allowance was adequate. The amount of the provision for loan losses is a charge against earnings. Actual loan losses are charged against the allowance for loan losses.

Management evaluates the reasonableness of the allowance for loan losses on a quarterly basis and adjusts the provision as deemed necessary. As of December 31,
2006, the allowance for loan losses totaled $1,770 or 0.84% of total loans, net of unearned income and fees compared to $1,508 or 0.83% of total loans, net of unearned income and fees as of December 31, 2005. The provision for loan losses for
the years ended December 31, 2006 and 2005 was $339 and $230, respectively. Net charge-offs for the Company were $77 and $224 for the years ended December 31, 2006 and 2005, respectively. The ratio of net loan charge-offs during the period
to average loans outstanding for the period was 0.04% and 0.13% for the years ended December 31, 2006 and 2005, respectively.

As of December 31,
2005, the allowance for loan losses totaled $1,508 or 0.83% of total loans, net of unearned income and fees compared to 0.94% of total loans, net of unearned income and fees and $1,502 or 0.94% as of December 31, 2004. The provision for loan
losses for the years ended December 31, 2005 and 2004 was $230, $223, respectively. Net charge-offs for the Company were $224 and $249 for the years ended December 31, 2005 and 2004, respectively. The ratio of net loan charge-offs during
the period to average loans outstanding for the period was 0.13% and 0.16% for the years ended December 31, 2005 and 2004, respectively.

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

ANALYSIS OF ALLOWANCE FOR LOAN LOSSES



|                                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|-------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | ----- | - | ---------------------------- | ----- | - | ---- | ----- | - | ---- | ----- | -
|                                                                           |  | 2006 |       |   | 2005 |       |   | Years ended December 31,2004 |       |   | 2003 |       |   | 2002 |      
|Balance at beginning of year                                               |  | $    | 1,508 |   |      | 1,502 |   |                              | 1,528 |   |      | 1,298 |   |      | 1,176 |  
|Loan charge-offs:                                                          |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|Real estate loans  other                                                  |  |      |      |   |      |      |   |                              |      |   |      |      |   |      |      |  
|Real estate loans  commercial                                             |  |      |      |   |      |      |   |                              | (24   | ) |      |      |   |      | (37   | )
|Commercial and industrial loans                                            |  |      |      |   |      | (66   | ) |                              | (98   | ) |      |      |   |      | (20   | )
|Loans to individuals for household, family and other consumer expenditures |  |      | (206  | ) |      | (314  | ) |                              | (229  | ) |      | (367  | ) |      | (360  | )
|                                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|Total loan charge-offs                                                     |  |      | (206  | ) |      | (380  | ) |                              | (351  | ) |      | (367  | ) |      | (417  | )
|                                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|Loan recoveries:                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|Loans to individuals for household, family and other consumer expenditures |  |      | 129   |   |      | 156   |   |                              | 102   |   |      | 127   |   |      | 110   |  
|                                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|Net loan charge-offs                                                       |  |      | (77   | ) |      | (224  | ) |                              | (249  | ) |      | (240  | ) |      | (307  | )
|Provisions for loan losses                                                 |  |      | 339   |   |      | 230   |   |                              | 223   |   |      | 470   |   |      | 429   |  
|                                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  
|Balance at end of year                                                     |  | $    | 1,770 |   |      | 1,508 |   |                              | 1,502 |   |      | 1,528 |   |      | 1,298 |  
|                                                                           |  |      |       |   |      |       |   |                              |       |   |      |       |   |      |       |  

The primary risk element considered by management with respect to each installment and conventional real estate
loan is lack of timely payment and the value of the collateral. The primary risk elements with respect to real estate construction loans are fluctuations in real estate values in the Companys market areas, inaccurate estimates of construction
costs, fluctuations in interest rates, the availability of conventional financing, the demand for housing in the Companys market area and general economic conditions. The primary risk elements with respect to commercial loans are the financial
condition of the borrower, general economic conditions in the Companys market area, the sufficiency of collateral, the timeliness of payment and, with respect to adjustable rate loans,



20



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interest rate fluctuations. Management has a policy of requesting and reviewing annual financial statements from its commercial loan customers and
periodically reviews the existence of collateral and its value. Management also has a reporting system that monitors all past due loans and has adopted policies to pursue its creditors rights in order to preserve the Companys position.

Loans are charged against the allowance when, in managements opinion, they are deemed uncollectible, although the Bank continues to aggressively
pursue collection. The Company considers a number of factors to determine the need for and timing of charge-offs including the following: whenever any commercial loan becomes past due for 120 days for any scheduled principal or interest payment and
there is no recommendation to place the loan in non-accrual status; whenever foreclosure on real estate collateral or liquidation of other collateral does not result in full payment of the obligation and the deficiency or some portion thereof is
deemed uncollectible, the uncollectible portion shall be charged-off; whenever any installment loan becomes past due for 120 days and has not been placed in non-accrual status; whenever any repossessed vehicle remains unsold for 60 days after
repossession; whenever a bankruptcy notice is received on any installment loan and review of the facts results in an assessment that all or most of the balance will not be collected, the loan will be placed in non-accrual status; whenever a
bankruptcy notice is received on a small, unsecured, revolving installment account; and whenever any other small, unsecured, revolving installment account becomes past due for 180 days.

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

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



|                                                                            |  |                         |       |                                               |                   |   |                         |                   |                                               |        |                   |                         |       |                                               |        |   |                         |       |                                               |        |   |                         |       |                                               |        |  
|--------------------------------------------------------------------------- |  | ----------------------- | ----- | --------------------------------------------- | ----------------- | - | ----------------------- | ----------------- | --------------------------------------------- | ------ | ----------------- | ----------------------- | ----- | --------------------------------------------- | ------ | - | ----------------------- | ----- | --------------------------------------------- | ------ | - | ----------------------- | ----- | --------------------------------------------- | ------ | -
|                                                                            |  | December 31, 2006       |       |                                               | December 31, 2005 |   |                         | December 31, 2004 |                                               |        | December 31, 2003 |                         |       | December 31, 2002                             |       
|                                                                            |  | Allowancefor loanlosses |       | Percent ofloans in eachcategory tototal loans |                   |   | Allowancefor loanlosses |                   | Percent ofloans in eachcategory tototal loans |        |                   | Allowancefor loanlosses |       | Percent ofloans in eachcategory tototal loans |        |   | Allowancefor loanlosses |       | Percent ofloans in eachcategory tototal loans |        |   | Allowancefor loanlosses |       | Percent ofloans in eachcategory tototal loans |       
|Real estate loans:                                                          |  |                         |       |                                               |                   |   |                         |                   |                                               |        |                   |                         |       |                                               |        |   |                         |       |                                               |        |   |                         |       |                                               |        |  
|Residential                                                                 |  | $                       | 17    |                                               | 24.72             | % |                         | 75                |                                               | 30.58  | %                 |                         | 20    |                                               | 32.69  | % |                         | 71    |                                               | 34.96  | % |                         | 137   |                                               | 38.90  | %
|Other                                                                       |  |                         | 282   |                                               | 36.75             | % |                         | 173               |                                               | 28.99  | %                 |                         | 107   |                                               | 27.34  | % |                         | 366   |                                               | 23.21  | % |                         | 133   |                                               | 14.11  | %
|Loans to individuals for households, family and other consumer expenditures |  |                         | 502   |                                               | 22.09             | % |                         | 417               |                                               | 24.25  | %                 |                         | 333   |                                               | 25.84  | % |                         | 333   |                                               | 29.68  | % |                         | 210   |                                               | 34.20  | %
|Commercial and industrial loans                                             |  |                         | 509   |                                               | 16.22             | % |                         | 730               |                                               | 15.66  | %                 |                         | 951   |                                               | 13.52  | % |                         | 727   |                                               | 11.79  | % |                         | 721   |                                               | 12.68  | %
|All other loans                                                             |  |                         |      |                                               | 0.22              | % |                         |                  |                                               | 0.52   | %                 |                         | 43    |                                               | 0.61   | % |                         |      |                                               | 0.36   | % |                         |      |                                               | 0.11   | %
|Unallocated                                                                 |  |                         | 460   |                                               |                  |   |                         | 113               |                                               |       |                   |                         | 48    |                                               |       |   |                         | 31    |                                               |       |   |                         | 97    |                                               |       |  
|                                                                            |  |                         |       |                                               |                   |   |                         |                   |                                               |        |                   |                         |       |                                               |        |   |                         |       |                                               |        |   |                         |       |                                               |        |  
|Totals                                                                      |  | $                       | 1,770 |                                               | 100.00            | % |                         | 1,508             |                                               | 100.00 | %                 |                         | 1,502 |                                               | 100.00 | % |                         | 1,528 |                                               | 100.00 | % |                         | 1,298 |                                               | 100.00 | %
|                                                                            |  |                         |       |                                               |                   |   |                         |                   |                                               |        |                   |                         |       |                                               |        |   |                         |       |                                               |        |   |                         |       |                                               |        |  

While consumer related charge-offs represent a majority of total charge-offs over the last three years, they are
of a low dollar amount on an individual loan basis. Commercial loans on the other hand, though few in terms of the number of charge-offs over the past two years, have the potential to greatly impact the allowance if a particular loan defaults. The
Banks loan review team uses the principles of SFAS No. 5, Accounting for Contingencies and SFAS No. 114, Accounting by Creditors for Impairment of a Loan an amendment of FASB Statement No. 5 and 15 , when
determining the allowance for loan losses between loan categories. The determination of a loan



21



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categorys allowance is based on the probability of a loans default and the probability of loss in the event of a default.

CREDIT RISK MANAGEMENT.

The risk of nonpayment of loans is an
inherent aspect of commercial banking. The degree of perceived risk is taken into account in establishing the structure of, and interest rates and security for, specific loans and various types of loans. The Company strives to minimize its credit
risk exposure by its credit underwriting standards and loan policies and procedures. Management continually evaluates the credit risks of such loans and believes it has provided adequately for the credit risks associated with these loans. The
Company has implemented and expects to continue to implement and update new policies and procedures to maintain its credit risk management systems.

Bank Premises and Equipment

Bank premises and equipment decreased 2.64% in 2006 compared to a decrease of 4.50% in 2005 due to depreciation
and no major expenditures on new facilities or facility upgrades in 2006. The Company is leasing the new Timberlake and Amherst branch facilities opened in 2006.

Deposits

Average deposits were $215,859 for the year ended December 31, 2006, an increase of $14,421 or 7.16% from $201,438 of average
deposits for the year ended December 31, 2005. As of December 31, 2006, total deposits were $230,817 representing an increase of $21,571 or 10.31% from $209,246 in total deposits as of December 31, 2005. The change in deposits during
2006 was primarily due to changes in previously existing accounts and new accounts opened as a result of relationship changes, new locations, pricing and products offered in 2006.

For the year ended December 31, 2006, average noninterest-bearing demand deposits were $22,008 or 10.20% of average deposits. For the year ended December 31, 2005, average noninterest-bearing demand deposits
were $21,169 or 10.51% of average deposits. Average interest-bearing deposits were $193,851 for the year ended December 31, 2006, representing an increase of $13,582 or 7.53% over the $180,269 in average interest-bearing deposits for the year
ended December 31, 2005.

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

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



22



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AVERAGE DEPOSIT INFORMATION



|                                    |  |                             |         |                 |                             |   |                             |                             |                 |      |   |                             |         |                 |      |  
|----------------------------------- |  | --------------------------- | ------- | --------------- | --------------------------- | - | --------------------------- | --------------------------- | --------------- | ---- | - | --------------------------- | ------- | --------------- | ---- | -
|                                    |  | Year endedDecember 31, 2006 |         |                 | Year endedDecember 31, 2005 |   |                             | Year endedDecember 31, 2004 |                
|                                    |  | Averageamount ofdeposits(1) |         | Averageratepaid |                             |   | Averageamount ofdeposits(1) |                             | Averageratepaid |      |   | Averageamount ofdeposits(1) |         | Averageratepaid |     
|Noninterest-bearing demand deposits |  | $                           | 22,008  |                 | N/A                         |   |                             | 21,169                      |                 | N/A  |   |                             | 18,886  |                 | N/A  |  
|Interest-bearing demand deposits    |  |                             | 34,436  |                 | 0.45                        | % |                             | 28,218                      |                 | 0.55 | % |                             | 28,695  |                 | 0.52 | %
|Savings deposits                    |  |                             | 32,230  |                 | 2.77                        | % |                             | 35,156                      |                 | 1.12 | % |                             | 33,500  |                 | 0.59 | %
|Time deposits:                      |  |                             |         |                 |                             |   |                             |                             |                 |      |   |                             |         |                 |      |  
|Under $100,000                      |  |                             | 91,158  |                 | 4.51                        | % |                             | 86,010                      |                 | 3.66 | % |                             | 80,756  |                 | 3.00 | %
|$100,000 and over                   |  |                             | 36,027  |                 | 3.48                        | % |                             | 30,885                      |                 | 3.16 | % |                             | 27,052  |                 | 2.60 | %
|                                    |  |                             |         |                 |                             |   |                             |                             |                 |      |   |                             |         |                 |      |  
|Total average time deposits         |  |                             | 127,185 |                 |                             |   |                             | 116,895                     |                 |      |   |                             | 107,808 |                 |      |  
|                                    |  |                             |         |                 |                             |   |                             |                             |                 |      |   |                             |         |                 |      |  
|Total average deposits              |  | $                           | 215,859 |                 |                             |   |                             | 201,438                     |                 |      |   |                             | 188,889 |                 |      |  
|                                    |  |                             |         |                 |                             |   |                             |                             |                 |      |   |                             |         |                 |      |  

---

|(1) | Averages are daily averages.
|--- | ----------------------------

The following table presents the maturity
schedule of time certificates of deposit of $100,000 and over and other time deposits of $100,000 and over as of December 31, 2006.

TIME DEPOSITS OF $100,000 AND OVER



|                                         |  |                        |        |                    |       |       |       
|---------------------------------------- |  | ---------------------- | ------ | ------------------ | ----- | ----- | ------
|                                         |  | Certificatesof deposit |        | Other timedeposits |       | Total
|Three months or less                     |  | $                      | 4,420  |                    | 359   |       | 4,779 
|Over three through six months            |  |                        | 3,394  |                    | 294   |       | 3,688 
|Over six through 12 months               |  |                        | 13,264 |                    | 2,742 |       | 16,006
|Over 12 months                           |  |                        | 9,846  |                    | 4,739 |       | 14,585
|                                         |  |                        |        |                    |       |       |       
|Total time deposits of $100,000 and over |  | $                      | 30,924 |                    | 8,134 |       | 39,058
|                                         |  |                        |        |                    |       |       |       

Financial Ratios

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

RETURN ON EQUITY AND ASSETS



|                                 |  |                          |   |  |       |   |  |       |  
|-------------------------------- |  | ------------------------ | - |  | ----- | - |  | ----- | -
|                                 |  | Years ended December 31, |  
|                                 |  | 2006                     |   |  | 2005  |   |  | 2004  |  
|Return on average assets         |  | 1.00                     | % |  | 0.94  | % |  | 0.86  | %
|Return on average equity         |  | 10.10                    | % |  | 9.29  | % |  | 8.33  | %
|Dividend payout ratio            |  | 33.25                    | % |  | 33.93 | % |  | 36.06 | %
|Average equity to average assets |  | 9.91                     | % |  | 10.07 | % |  | 10.32 | %

Contractual Obligations

The Company has entered into certain contractual obligations including long-term debt and operating leases. The table does not include deposit liabilities entered into in the ordinary course of banking. The following
table summarizes the Companys contractual obligations as of December 31, 2006.



23



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|                                |  |                   |     |                 |   |          |  |          |     |                  |   |    |  |   |  
|------------------------------- |  | ----------------- | --- | --------------- | - | -------- |  | -------- | --- | ---------------- | - | -- |  | - | -
|                                |  | December 31, 2006
|                                |  | Total             |     | Less than1 Year |   | 1-3Years |  | 3-5Years |     | More than5 Years
|Federal Home Loan Bank Advances |  | $                 | 100 |                 | $ | 100      |  | $        |    |                  | $ |   |  | $ | 
|Operating Leases                |  |                   | 245 |                 |   | 72       |  |          | 104 |                  |   | 68 |  |   | 1
|                                |  |                   |     |                 |   |          |  |          |     |                  |   |    |  |   |  
|Total                           |  | $                 | 345 |                 | $ | 172      |  | $        | 104 |                  | $ | 68 |  | $ | 1

Capital Resources

The Companys financial position at December 31, 2006 reflects liquidity and capital levels currently adequate to fund anticipated future business expansion. Capital ratios are well in excess of required regulatory minimums for a
well-capitalized institution. The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the
Companys capital is reviewed by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

The Companys capital position continues to exceed regulatory requirements. The primary indicators relied on by bank regulators in measuring the capital position
are the Tier I capital, total risk-based capital and leverage ratios. Tier I capital consists generally of common and qualifying preferred stockholders equity less goodwill. Total capital generally consists of Tier I capital, qualifying
subordinated debt and a portion of the allowance for loan losses. Risk-based capital ratios are calculated with reference to risk-weighted assets. The Companys Tier I capital ratio was 9.92% at December 31, 2006 and 10.54% at
December 31, 2005. The total capital ratio was 10.64% at December 31, 2006 and 11.23% at December 31, 2005.

These ratios exceed the
mandated minimum requirements of 4% and 8%, respectively. As of December 31, 2006 and 2005, the Company met all regulatory capital ratio requirements and was considered well capitalized in accordance with FDICIA.

Stockholders equity reached $24,492 at December 31, 2006 compared to $23,212 at December 31, 2005. The leverage ratio consists of Tier I capital divided
by quarterly average assets. At December 31, 2006, the Companys leverage ratio was 9.80% compared to 9.88% at December 31, 2005. Each of these exceeds the required minimum leverage ratio of 4%. The dividend payout ratio was 33.25%
and 33.93% in 2006 and 2005, respectively. During 2006, the Company paid dividends of $0.55 per share, up 12.24% from $0.49 per share paid in 2005.

Off-Balance Sheet Arrangements

The Company did not use any financial derivatives during 2006 and 2005. However, the Company has off-balance
sheet arrangements that may have a material effect on the results of operations in the future. The Company, in the normal course of business, may at times be a party to financial instruments such as standby letters of credit. Standby letters of
credit as of December 31, 2006 equaled $2,014 compared with $1,684 as of December 31, 2005. Other commitments include commitments to lend money. Not all these commitments will be acted upon; therefore, the cash requirements will likely be
significantly less than the commitments themselves. As of December 31, 2006, the Company had unused loan commitments of $60,883 including $50,393 in unused commitments with an original maturity exceeding one year compared with $51,785 including
$42,096 in unused



24



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commitments with an original maturity exceeding one year as of December 31, 2005. See Note 9 of the Notes to Consolidated Financial Statements.

Critical Accounting Policies

The reporting policies
of the Company are in accordance with U.S. generally accepted accounting principles. Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. The
Companys single most critical accounting policy relates to the Companys allowance for loan losses, which reflects the estimated losses resulting from the inability of the Companys borrowers to make required loan payments. If the
financial condition of the Companys borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the Companys estimates would be updated, and additional provisions for loan losses may be required. Further
discussion of the estimates used in determining the allowance for loan losses is contained in the discussion on Allowance for Loan Losses on page 19 and Loans and Allowance for Loan Losses in Note 1 of the Notes to
Consolidated Financial Statements.

Impact of Recently Issued Accounting Standards

In February 2006, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standard (SFAS) No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB
Statements No. 133 and 140. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities and resolves issues in Statement No. 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. The provisions of this Statement are effective for all financial
instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 is not expected to have a material impact on the consolidated financial statements
of the Company.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement
No. 140.This Statement amends SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement 125with respect to the accounting for separately
recognized servicing assets and servicing liabilities. The provisions of this Statement are effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No. 156 is not expected to have a material impact on the
consolidated financial statements of the Company.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans  an amendment of FASB Statements No. 87, 88, 106, and 132(R).SFAS No. 158 and its impact on the Company are discussed in Note 1(k) of the Notes to Consolidated Financial Statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a framework for measuring fair value in generally
accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of
this new standard to have a material effect on the Companys consolidated results of operations or consolidated financial position.

In June 2006, the
FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, which establishes that the financial statement effects of a tax position taken or expected
to be taken in a tax return are to be recognized in the financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company does not expect the adoption of this new standard to have a material effect on the Companys consolidated results of operations or consolidated financial position.



25



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Quantitative and Qualitative Disclosures About Market Risk

MARKET RISK MANAGEMENT.

Market risk reflects the risk of
economic loss resulting from changes in interest rates and market prices. If the Bank is to achieve its financial goals, it must effectively manage this risk.

The primary market risk for a bank is interest rate risk and its impact on net interest income. This exposure results from differences between the amounts of interest earning assets and interest bearing liabilities that reprice within a
specified time period as a result of scheduled maturities and repayment and contractual interest rate changes.

The Banks Asset/Liability Management
Committee and the Investment Committee are primarily responsible for establishing strategies to monitor and control liquidity and interest rate risk. The primary goal for managing interest rate volatility is to maximize net interest income while
ensuring liquidity and managing interest rate risk within established guidelines. The Bank uses static gap analysis, earnings simulation analysis and economic value of equity (net present value estimation) to monitor interest rate risk. Each of
these models measure changes in a variety of interest rate scenarios. While each of the interest rate risk measures have limitations, taken together, management believes that they represent a reasonably comprehensive view of the magnitude of
interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap analysis, which measures aggregate
repricings, is less utilized since it does not effectively measure the earnings impact on the Company and, therefore, a static gap analysis is not presented here. However, earnings simulation and economic value models that more effectively measure
the earnings impact and are utilized by management on a regular basis are explained below.

EARNINGS SIMULATION ANALYSIS.

Management uses earnings simulation analysis to measure interest rate sensitivity and its impact on future earnings. The simulation uses current balance sheet volumes,
growth, repricings, changes in mix of assets and liabilities, prepayments and average rate paid and earned assumptions to project income under multiple interest rate scenarios. The model assumes changes in interest rates without any management
intervention to change the composition of the balance sheet. The analysis shows the effects of a hypothetical change in expected interest rates as of December 31, 2006 and the results of this change over a 1 year time period.

The following table represents the interest rate sensitivity on net income for the Company using different rate scenarios as of December 31, 2006.



|                     |  |                                    
|-------------------- |  | -----------------------------------
|Change in Prime Rate |  | Hypothetical % Change in Net Income
|                    
|+300 basis points    |  | +15%                               
|+200 basis points    |  | +10%                               
|+100 basis points    |  | +5%                                
|Level                |  | 0                                  
|-100 basis points    |  | -8%                                
|-200 basis points    |  | -17%                               
|-300 basis points    |  | -26%                               

ECONOMIC VALUE OF EQUITY SIMULATION.

Economic value of equity simulation is used to calculate the estimated fair value of assets and liabilities in different interest rate environments. Economic values are calculated based on discounted cash flow
analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the
balance sheet. The same assumptions are used in the economic value of equity simulation as in the earnings simulation.



26



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The following chart reflects the change in the net market value by using December 31, 2006 data, over different rate
environments with a one-year horizon.



|                     |  |                                                                        |       
|-------------------- |  | ---------------------------------------------------------------------- | ------
|Change in Prime Rate |  | Hypothetical Change in Economic Value of Equity (dollars in thousands)
|+300 basis points    |  | $                                                                      | -2,561
|+200 basis points    |  | $                                                                      | -1,600
|+100 basis points    |  | $                                                                      | -749  
|level                |  |                                                                        | 0     
|-100 basis points    |  | $                                                                      | 885   
|-200 basis points    |  | $                                                                      | 1,656 
|-300 basis points    |  | $                                                                      | 2,445 

There have been no material changes in quantitative and qualitative disclosures about market risk since this
information was developed using December 31, 2006 data.

The Bank cannot predict future interest rates or their exact effect on net interest income.
Certain limitations are inherent in any analysis. There is no guarantee that the risk management and balance sheet strategies management employs will be effective in periods of rapid rate movements. Furthermore, these analyses do not reflect actions
management might take in response to or in anticipation of changes in interest rates.



27



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PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

December 31, 2006 and 2005

(In thousands of dollars, except share data)



|                                                                                                                                      |  |      |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                                                                      |  | 2006 |         |   | 2005 |  
|Assets                                                                                                                                |  |      |         |   |      |   |         |  
|Cash and cash equivalents (note 2):                                                                                                   |  |      |         |   |      |   |         |  
|Cash and due from banks                                                                                                               |  | $    | 5,948   |   |      | $ | 6,591   |  
|Federal funds sold                                                                                                                    |  |      | 8,638   |   |      |   | 7,223   |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Total cash and cash equivalents                                                                                                       |  |      | 14,586  |   |      |   | 13,814  |  
|Securities (note 3):                                                                                                                  |  |      |         |   |      |   |         |  
|Available-for-sale, at fair value                                                                                                     |  |      | 19,221  |   |      |   | 22,351  |  
|Held-to-maturity, at amortized cost                                                                                                   |  |      | 5,645   |   |      |   | 6,910   |  
|Federal Reserve Bank stock, at cost (note 1(c))                                                                                       |  |      | 75      |   |      |   | 75      |  
|Federal Home Loan Bank stock, at cost (note 1(c))                                                                                     |  |      | 481     |   |      |   | 454     |  
|Loans, net (notes 4, 9 and 10)                                                                                                        |  |      | 207,861 |   |      |   | 181,268 |  
|Bank premises and equipment, net (note 5)                                                                                             |  |      | 5,264   |   |      |   | 5,407   |  
|Accrued interest receivable                                                                                                           |  |      | 1,250   |   |      |   | 1,075   |  
|Other assets (notes 7, 8 and 15)                                                                                                      |  |      | 2,038   |   |      |   | 2,136   |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Total assets                                                                                                                          |  | $    | 256,421 |   |      | $ | 233,490 |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Liabilities and Stockholders Equity                                                                                                  |  |      |         |   |      |   |         |  
|Liabilities:                                                                                                                          |  |      |         |   |      |   |         |  
|Deposits (note 6):                                                                                                                    |  |      |         |   |      |   |         |  
|Demand                                                                                                                                |  | $    | 23,631  |   |      | $ | 21,914  |  
|Savings and NOW accounts                                                                                                              |  |      | 69,798  |   |      |   | 64,661  |  
|Time                                                                                                                                  |  |      | 137,388 |   |      |   | 122,671 |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Total deposits                                                                                                                        |  |      | 230,817 |   |      |   | 209,246 |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Note payable to Federal Home Loan Bank (note 1(c))                                                                                    |  |      | 100     |   |      |   | 200     |  
|Accrued interest payable                                                                                                              |  |      | 764     |   |      |   | 601     |  
|Other liabilities (note 7)                                                                                                            |  |      | 248     |   |      |   | 231     |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Total liabilities                                                                                                                     |  |      | 231,929 |   |      |   | 210,278 |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Stockholders equity (notes 11 and 14):                                                                                               |  |      |         |   |      |   |         |  
|Common stock, $3 par value. Authorized 3,000,000 shares, issued and outstanding 1,459,589 shares in 2006 and 1,458,706 shares in
2005 |  |      | 4,379   |   |      |   | 4,376   |  
|Capital surplus                                                                                                                       |  |      | 605     |   |      |   | 577     |  
|Retained earnings                                                                                                                     |  |      | 19,972  |   |      |   | 18,362  |  
|Accumulated other comprehensive income (loss), net                                                                                    |  |      | (464    | ) |      |   | (103    | )
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Total stockholders equity                                                                                                            |  |      | 24,492  |   |      |   | 23,212  |  
|                                                                                                                                      |  |      |         |   |      |   |         |  
|Commitments, contingencies and other matters (notes 9, 10 and 11)                                                                     |  |      |         |   |      |   |         |  
|Total liabilities and stockholders equity                                                                                            |  | $    | 256,421 |   |      | $ | 233,490 |  
|                                                                                                                                      |  |      |         |   |      |   |         |  

See accompanying notes to consolidated financial statements.



28



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PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

Years
ended December 31, 2006, 2005 and 2004

(In thousands of dollars, except per share data)



|                                                    |  |      |        |      |   |        |  |   |       
|--------------------------------------------------- |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                                                    |  | 2006 |        | 2005 |   | 2004  
|Interest income:                                    |  |      |        |      |   |        |  |   |       
|Interest and fees on loans                          |  | $    | 13,979 |      | $ | 10,847 |  | $ | 8,991 
|Interest on securities:                             |  |      |        |      |   |        |  |   |       
|U.S. Government agencies                            |  |      | 469    |      |   | 455    |  |   | 494   
|Corporate                                           |  |      | 215    |      |   | 401    |  |   | 504   
|States and political subdivisions (taxable)         |  |      | 272    |      |   | 292    |  |   | 303   
|States and political subdivisions (tax exempt)      |  |      | 277    |      |   | 382    |  |   | 448   
|Other                                               |  |      | 37     |      |   | 30     |  |   | 27    
|Interest on federal funds sold                      |  |      | 368    |      |   | 263    |  |   | 135   
|                                                    |  |      |        |      |   |        |  |   |       
|Total interest income                               |  |      | 15,617 |      |   | 12,670 |  |   | 10,902
|                                                    |  |      |        |      |   |        |  |   |       
|Interest expense:                                   |  |      |        |      |   |        |  |   |       
|Interest on deposits:                               |  |      |        |      |   |        |  |   |       
|Savings and NOW accounts                            |  |      | 1,048  |      |   | 549    |  |   | 346   
|Time - under $100,000                               |  |      | 4,113  |      |   | 3,144  |  |   | 2,430 
|Time - $100,000 and over                            |  |      | 1,254  |      |   | 975    |  |   | 704   
|Other interest expense                              |  |      | 10     |      |   | 19     |  |   | 22    
|                                                    |  |      |        |      |   |        |  |   |       
|Total interest expense                              |  |      | 6,425  |      |   | 4,687  |  |   | 3,502 
|                                                    |  |      |        |      |   |        |  |   |       
|Net interest income                                 |  |      | 9,192  |      |   | 7,983  |  |   | 7,400 
|Provision for loan losses (note 4)                  |  |      | 339    |      |   | 230    |  |   | 223   
|                                                    |  |      |        |      |   |        |  |   |       
|Net interest income after provision for loan losses |  |      | 8,853  |      |   | 7,753  |  |   | 7,177 
|Noninterest income:                                 |  |      |        |      |   |        |  |   |       
|Service charges on deposit accounts                 |  |      | 1,357  |      |   | 1,293  |  |   | 1,286 
|Net realized gain on securities (note 3)            |  |      |       |      |   | 2      |  |   | 34    
|Commissions and fees                                |  |      | 378    |      |   | 332    |  |   | 176   
|Fees on sales of mortgage loans                     |  |      | 234    |      |   | 265    |  |   | 273   
|Service charges on loan accounts                    |  |      | 254    |      |   | 218    |  |   | 174   
|Other operating income                              |  |      | 277    |      |   | 286    |  |   | 312   
|                                                    |  |      |        |      |   |        |  |   |       
|Total noninterest income                            |  |      | 2,500  |      |   | 2,396  |  |   | 2,255 
|                                                    |  |      |        |      |   |        |  |   |       
|Noninterest expense:                                |  |      |        |      |   |        |  |   |       
|Salaries and employee benefits (note 7)             |  |      | 4,540  |      |   | 4,134  |  |   | 3,854 
|Occupancy expense                                   |  |      | 429    |      |   | 380    |  |   | 348   
|Furniture and equipment                             |  |      | 784    |      |   | 739    |  |   | 639   
|Office supplies and printing                        |  |      | 212    |      |   | 178    |  |   | 189   
|Capital stock tax                                   |  |      | 181    |      |   | 180    |  |   | 175   
|Advertising expense                                 |  |      | 121    |      |   | 105    |  |   | 133   
|Other operating expenses                            |  |      | 1,558  |      |   | 1,450  |  |   | 1,563 
|                                                    |  |      |        |      |   |        |  |   |       
|Total noninterest expense                           |  |      | 7,825  |      |   | 7,166  |  |   | 6,901 
|                                                    |  |      |        |      |   |        |  |   |       
|Income before income tax expense                    |  |      | 3,528  |      |   | 2,983  |  |   | 2,531 
|Income tax expense (note 8)                         |  |      | 1,116  |      |   | 876    |  |   | 712   
|                                                    |  |      |        |      |   |        |  |   |       
|Net income                                          |  | $    | 2,412  |      | $ | 2,107  |  | $ | 1,819 
|                                                    |  |      |        |      |   |        |  |   |       
|Basic net income per share (note 1(p))              |  | $    | 1.65   |      | $ | 1.44   |  | $ | 1.25  
|Diluted net income per share (note 1(p))            |  | $    | 1.64   |      | $ | 1.43   |  | $ | 1.23  

See accompanying notes to consolidated financial statements.



29



---

PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders Equity and Comprehensive Income

Years ended December 31, 2006, 2005 and 2004

(In thousands, except share and per
share data)



|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|---------------------------------------------------------------------------------------------- |  | ------------ |  | --------------- | ----- | ----------------- | - | --- | -------------------------------------------- | - | ------ | ----- |  | - | ---- | - |  | - | ------ | -
|                                                                                               |  | Common Stock |  | Capital Surplus |       | Retained Earnings |   |     | Accumulated Other ComprehensiveIncome
(Loss) |   |        | Total | 
|                                                                                               |  |              |  |                
|                                                                                               |  | Shares       |  | Par Value       |       |                   |   |    
|Balances, December 31, 2003                                                                    |  | 1,457,406    |  | $               | 4,372 |                   | $ | 562 |                                              | $ | 15,807 |       |  | $ | 694  |   |  | $ | 21,435 |  
|Net income                                                                                     |  |             |  |                 |      |                   |   |    |                                              |   | 1,819  |       |  |   |     |   |  |   | 1,819  |  
|Change in net unrealized gains on available-for-sale securities, net of deferred taxes of $201 |  |             |  |                 |      |                   |   |    |                                              |   |       |       |  |   | (369 | ) |  |   | (369   | )
|Reclassification adjustment for gains included in net income, net of income tax expense of $12 |  |             |  |                 |      |                   |   |    |                                              |   |       |       |  |   | (22  | ) |  |   | (22    | )
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Comprehensive income                                                                           |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   | 1,428  |  
|Cash dividends declared by Bankshares ($0.45 per share)                                        |  |             |  |                 |      |                   |   |    |                                              |   | (656   | )     |  |   |     |   |  |   | (656   | )
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Balances, December 31, 2004                                                                    |  | 1,457,406    |  | $               | 4,372 |                   | $ | 562 |                                              | $ | 16,970 |       |  | $ | 303  |   |  | $ | 22,207 |  
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Net income                                                                                     |  |             |  |                 |      |                   |   |    |                                              |   | 2,107  |       |  |   |     |   |  |   | 2,107  |  
|Change in net unrealized gains on available-for-sale securities, net of deferred taxes of $208 |  |             |  |                 |      |                   |   |    |                                              |   |       |       |  |   | (406 | ) |  |   | (406   | )
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Comprehensive income                                                                           |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   | 1,701  |  
|Cash dividends declared by Bankshares ($0.49 per share)                                        |  |             |  |                 |      |                   |   |    |                                              |   | (715   | )     |  |   |     |   |  |   | (715   | )
|Issuance of common stock, stock option exercise                                                |  | 1,300        |  |                 | 4     |                   |   | 15  |                                              |   |       |       |  |   |     |   |  |   | 19     |  
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Balances, December 31, 2005                                                                    |  | 1,458,706    |  | $               | 4,376 |                   | $ | 577 |                                              | $ | 18,362 |       |  | $ | (103 | ) |  | $ | 23,212 |  
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Net income                                                                                     |  |             |  |                 |      |                   |   |    |                                              |   | 2,412  |       |  |   |     |   |  |   | 2,412  |  
|Change in net unrealized gains on available-for-sale securities, net of deferred taxes of $2   |  |             |  |                 |      |                   |   |    |                                              |   |       |       |  |   | (4   | ) |  |   | (4     | )
|Adjustment to initially apply FASB Statement No. 158, net of tax of $183                       |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   | (357 | ) |  |   | (357   | )
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Comprehensive income                                                                           |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   | 2,051  |  
|Cash dividends declared by Bankshares ($0.55 per share)                                        |  |             |  |                 |      |                   |   |    |                                              |   | (802   | )     |  |   |     |   |  |   | (802   | )
|Issuance of common stock                                                                       |  | 883          |  |                 | 3     |                   |   | 19  |                                              |   |       |       |  |   |     |   |  |   | 22     |  
|Stock option expense                                                                           |  |              |  |                 |       |                   |   | 9   |                                              |   |        |       |  |   |      |   |  |   | 9      |  
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  
|Balances, December 31, 2006                                                                    |  | 1,459,589    |  | $               | 4,379 |                   | $ | 605 |                                              | $ | 19,972 |       |  | $ | (464 | ) |  | $ | 24,492 |  
|                                                                                               |  |              |  |                 |       |                   |   |     |                                              |   |        |       |  |   |      |   |  |   |        |  

See accompanying notes to consolidated financial statements.



30



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PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2006, 2005 and 2004

(In thousands of dollars)



|                                                                                       |  |      |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                       |  | 2006 |         |   | 2005 |   |         | 2004 | 
|Cash flows from operating activities:                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Net income                                                                             |  | $    | 2,412   |   |      | $ | 2,107   |      |  | $ | 1,819   |  
|                                                                                       |  |      |        
|Adjustments to reconcile net income to net cash provided by operating activities:      |  |      |         |   |      |   |         |      |  |   |         |  
|Depreciation of bank premises and equipment                                            |  |      | 435     |   |      |   | 473     |      |  |   | 440     |  
|Amortization of intangible assets                                                      |  |      | 3       |   |      |   | 11      |      |  |   | 12      |  
|Accretion (amortization) of unearned fees, net                                         |  |      | (53     | ) |      |   | 45      |      |  |   | 32      |  
|Net amortization of premiums and discounts on securities                               |  |      | 12      |   |      |   | 30      |      |  |   | 60      |  
|Provision for loan losses                                                              |  |      | 339     |   |      |   | 230     |      |  |   | 223     |  
|Provision for deferred income taxes                                                    |  |      | 161     |   |      |   | 184     |      |  |   | 43      |  
|Accrual of stock option vesting                                                        |  |      | 9       |   |      |   |        |      |  |   |        |  
|Originations of mortgage loans held for sale                                           |  |      | (9,751  | ) |      |   | (13,552 | )    |  |   | (1,604  | )
|Sales of mortgage loans held for sale                                                  |  |      | 10,208  |   |      |   | 13,095  |      |  |   | 1,657   |  
|Net realized gain on securities                                                        |  |      |        |   |      |   | (2      | )    |  |   | (34     | )
|Net decrease (increase) in:                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued income receivable                                                              |  |      | (175    | ) |      |   | (129    | )    |  |   | (38     | )
|Other assets                                                                           |  |      | (22     | ) |      |   | 54      |      |  |   | (166    | )
|Net increase (decrease) in:                                                            |  |      |         |   |      |   |         |      |  |   |         |  
|Accrued interest payable                                                               |  |      | 188     |   |      |   | 119     |      |  |   | 75      |  
|Other liabilities                                                                      |  |      | (548    | ) |      |   | 46      |      |  |   | (52     | )
|                                                                                       |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash provided by operating activities                                              |  |      | 3,218   |   |      |   | 2,711   |      |  |   | 2,467   |  
|                                                                                       |  |      |         |   |      |   |         |      |  |   |         |  
|Cash flows from investing activities:                                                  |  |      |         |   |      |   |         |      |  |   |         |  
|Purchases of held-to maturity securities                                               |  |      |        |   |      |   | (500    | )    |  |   | (301    | )
|Purchases of available-for sale securities                                             |  |      | (1,503  | ) |      |   | (2,989  | )    |  |   | (1,604  | )
|Purchases of available-for sale-mortgage backed securities                             |  |      | (500    | ) |      |   | (525    | )    |  |   | (2,881  | )
|Proceeds from maturities and calls of held-to-maturity securities                      |  |      | 1,265   |   |      |   | 1,427   |      |  |   | 2,282   |  
|Proceeds from maturities and calls of available-for-sale securities                    |  |      | 4,044   |   |      |   | 5,248   |      |  |   | 2,203   |  
|Proceeds from paydowns and maturities of available-for-sale mortgage-backed securities |  |      | 1,071   |   |      |   | 1,660   |      |  |   | 2,566   |  
|Sale (purchase) of Federal Home Loan Bank stock                                        |  |      | (27     | ) |      |   | (27     | )    |  |   | 171     |  
|Collections on loan participations                                                     |  |      | 493     |   |      |   | 751     |      |  |   | 1,108   |  
|Net increase in loans made to customers                                                |  |      | (27,815 | ) |      |   | (23,027 | )    |  |   | (12,580 | )
|Recoveries on loans charged off                                                        |  |      | 129     |   |      |   | 156     |      |  |   | 102     |  
|Purchases of bank premises and equipment                                               |  |      | (292    | ) |      |   | (218    | )    |  |   | (1,981  | )
|                                                                                       |  |      |         |   |      |   |         |      |  |   |         |  
|Net cash used in investing activities                                                  |  |      | (23,135 | ) |      |   | (18,044 | )    |  |   | (10,915 | )
|                                                                                       |  |      |         |   |      |   |         |      |  |   |         |  

Continued



31



---

PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2006, 2005 and 2004

(In thousands of dollars)



|                                                                                 |  |      |        |   |      |   |        |      |  |   |        |  
|-------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                 |  | 2006 |        |   | 2005 |   |        | 2004 | 
|Cash flows from financing activities:                                            |  |      |        |   |      |   |        |      |  |   |        |  
|Net increase in demand, savings and NOW deposits                                 |  |      | 6,854  |   |      |   | 7,002  |      |  |   | 237    |  
|Net increase in time deposits                                                    |  |      | 14,717 |   |      |   | 5,605  |      |  |   | 12,537 |  
|Repayments of note payable to Federal Home Loan Bank                             |  |      | (100   | ) |      |   | (100   | )    |  |   | (100   | )
|Proceeds from issuance of common stock                                           |  |      | 20     |   |      |   | 19     |      |  |   |       |  
|Cash dividends paid                                                              |  |      | (802   | ) |      |   | (715   | )    |  |   | (656   | )
|                                                                                 |  |      |        |   |      |   |        |      |  |   |        |  
|Net cash provided by financing activities                                        |  |      | 20,689 |   |      |   | 11,811 |      |  |   | 12,018 |  
|                                                                                 |  |      |        |   |      |   |        |      |  |   |        |  
|Net increase (decrease) in cash and cash equivalents                             |  |      | 772    |   |      |   | (3,522 | )    |  |   | 3,570  |  
|                                                                                 |  |      |       
|Cash and cash equivalents, beginning of period                                   |  |      | 13,814 |   |      |   | 17,336 |      |  |   | 13,766 |  
|                                                                                 |  |      |        |   |      |   |        |      |  |   |        |  
|Cash and cash equivalents, end of period                                         |  | $    | 14,586 |   |      | $ | 13,814 |      |  | $ | 17,336 |  
|                                                                                 |  |      |        |   |      |   |        |      |  |   |        |  
|Supplemental disclosure of cash flows information Cash paid during the year for: |  |      |        |   |      |   |        |      |  |   |        |  
|Income taxes                                                                     |  | $    | 900    |   |      | $ | 688    |      |  | $ | 914    |  
|Interest                                                                         |  |      | 6,237  |   |      |   | 4,568  |      |  |   | 3,427  |  
|Supplemental schedule of noncash investing and financing activities:             |  |      |        |   |      |   |        |      |  |   |        |  
|Transfer of loans to repossessed properties                                      |  | $    | 81     |   |      | $ | 120    |      |  | $ | 254    |  
|Loans charged against the allowance for loan losses                              |  |      | 206    |   |      |   | 380    |      |  |   | 351    |  
|Unrealized gains (losses) on available-for-sale securities                       |  |      | (6     | ) |      |   | (614   | )    |  |   | (592   | )
|Adjustment to initially adopt FASB Statement No. 158                             |  |      | (540   | ) |      |   |       |      |  |   |       |  

See accompanying notes to consolidated financial statements.



32



---

PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Notes to Consolidated Financial Statements

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



|(1) | Summary of Significant Accounting Policies and Practices
|--- | --------------------------------------------------------

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

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



| | (a) | Consolidation
| | --- | -------------

The consolidated financial
statements include the accounts of Pinnacle Bankshares Corporation and its wholly owned subsidiary. All material intercompany balances and transactions have been eliminated.



| | (b) | Securities
| | --- | ----------

The Bank classifies its
securities in three categories: (1) debt securities that the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; (2) debt and equity
securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in net income; and (3) debt
and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from net income and
reported in accumulated other comprehensive income, a separate component of stockholders equity. Fair value is determined from quoted prices obtained from FT (Financial Times) Interactive Data in cooperation with Compass Bank, our
thirdparty bond accountant. Held-to-maturity securities are stated at cost, adjusted for amortization of premiums and accretion of discounts on a basis, which approximates the level yield method. The Bank does not maintain trading securities.
Gains or losses on disposition are based on the net proceeds and adjusted carrying values of the securities called or sold, using the specific identification method on a trade date basis. If a decline below cost in the market value of any
available-for-sale or held-to-maturity security is deemed other than temporary, the decline is charged to net income, resulting in the establishment of a new cost basis for the security.



| | (c) | Required Investments and Note Payable to FHLB
| | --- | ---------------------------------------------

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

In addition, the Bank is eligible to borrow
from the FHLB with borrowings collateralized by qualifying assets, primarily residential mortgage loans, and the Banks capital stock investment in the FHLB. At December 31, 2006, the Banks available borrowing limit was approximately
$33,311. The Bank had $100 and $200 in borrowings outstanding at December 31, 2006 and 2005, respectively.



33



---

The note payable to the FHLB, due in December 2007, is payable in annual installments of $100 and bears
interest at a fixed rate of 6.13%.



| | (d) | Mortgage Loans Held for Sale
| | --- | ----------------------------

Mortgage loans
originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value.

Pursuant to an
agreement with the Federal National Mortgage Association (FNMA), during the second quarter of 2003, the Company began a program to originate mortgage loans for sale to FNMA. At December 31, 2006 and 2005, the Company had no originated loans
that were subsequently sold to FNMA.

Pursuant to an agreement with the General Motors Acceptance Corporation (GMAC), during the second
quarter of 2005, the Company began a program to originate mortgage loans for sale to GMAC. At December 31, 2006, the Company had no originated loans that were subsequently sold to GMAC. At December 31, 2005, the Company had originated
loans of $457 that were subsequently sold to GMAC.



| | (e) | Loans and Allowance for Loan Losses
| | --- | -----------------------------------

Loans
are stated at the amount of unpaid principal, reduced by unearned income and fees on loans, and an allowance for loan losses. Income is recognized over the terms of the loans using methods that approximate the level yield method. The allowance for
loan losses is a valuation allowance consisting of the cumulative effect of the provision for loan losses, plus any amounts recovered on loans previously charged off, minus loans charged off. The provision for loan losses charged to operating
expenses is the amount necessary in managements judgment to maintain the allowance for loan losses at a level it believes sufficient to cover losses in the collection of the Banks loans. Management determines the adequacy of the
allowance based upon reviews of individual credits, recent loss experience, delinquencies, current economic conditions, the risk characteristics of the various categories of loans and other pertinent factors. Loans are charged against the allowance
for loan losses when management believes the collectibility of the principal is unlikely. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes
in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Banks allowance for loan losses. Such agencies may require the Bank to recognize additions to the
allowance for loan losses based on their judgments about information available to them at the time of their examinations.

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

Interest related to non-accrual loans is recognized on the cash basis. Loans are generally placed in non-accrual status when the collection of principal
and interest is 90 days or more past due, unless the obligation relates to a consumer or residential real estate loan or is both well-secured and in the process of collection.



34



---

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



| | (f) | Loan Origination and Commitment Fees and Certain Related Direct Costs
| | --- | ---------------------------------------------------------------------

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



| | (g) | Bank Premises and Equipment
| | --- | ---------------------------

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



| | (h) | Foreclosed Properties
| | --- | ---------------------

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



| | (i) | Impairment or Disposal of Long-Lived Assets
| | --- | -------------------------------------------

The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used, such as bank premises and equipment, is measured by a comparison of the carrying amount
of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset
exceeds the fair value of the asset. Assets to be disposed of, such as foreclosed properties, are reported at the lower of the carrying amount or fair value less costs to sell.



| | (j) | Test for Impairment of Investment in Bankers Investments Group, LLC
| | --- | -------------------------------------------------------------------

The Banks investment of $219 in Bankers Investments Group, LLC as of December 31, 2006 has been evaluated for other-than-temporary impairment. The impairment test evaluated the performance, the liquidity
and future cash flows of Bankers Investments Group, LLC. Management has determined the investment impairment is of a temporary nature and is carrying the investment at its cost as of December 31, 2006. Management will continue to evaluate the
asset for impairment in future periods.



35



---

| | (k) | Pension Plan
| | --- | ------------

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

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans - an
amendment of FASB Statements No. 87, 88, 106, and 132(R), which requires a business entity to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement
of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 also requires a business entity to measure the funded status of a plan as of the date of its
year-end statement of financial position, with limited exceptions. SFAS 158 was adopted by the Bank beginning with the year ended December 31, 2006. The incremental effect of the adoption of SFAS No. 158 is as follows:



|                                              |  |                                  |         |   |             |   |      |                                 |  |   |         |  
|--------------------------------------------- |  | -------------------------------- | ------- | - | ----------- | - | ---- | ------------------------------- |  | - | ------- | -
|                                              |  | BeforeApplication ofSFAS No. 158 |         |   | Adjustments |   |      | AfterApplication ofSFAS No. 158 | 
|Other assets                                  |  | $                                | 1,855   |   |             | $ | 183  |                                 |  | $ | 2,038   |  
|Total assets                                  |  |                                  | 256,238 |   |             |   | 183  |                                 |  |   | 256,421 |  
|Other liabilities                             |  |                                  | (292    | ) |             |   | 540  |                                 |  |   | 248     |  
|Total Liabilities                             |  |                                  | 231,389 |   |             |   | 540  |                                 |  |   | 231,929 |  
|Accumulated other comprehensive income (loss) |  |                                  | (107    | ) |             |   | (357 | )                               |  |   | (464    | )
|Total stockholders equity                    |  | $                                | 24,849  |   |             | $ | (357 | )                               |  | $ | 24,492  |  



| | (l) | Advertising
| | --- | -----------

The Bank expenses advertising
expenses as incurred.



| | (m) | Income Taxes
| | --- | ------------

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



| | (n) | Stock Options
| | --- | -------------

Stock Based Compensation
In October 1995, the FASB issued SFAS No. 123, Accounting for Stock-Based Compensation, which encouraged companies to recognize expense for stock-based awards based on their estimated value on the date of grant. SFAS 123
permitted companies to account for stock-based compensation based on provisions prescribed in SFAS 123, or based on the



36



---

authoritative guidance in Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. The Company elected to
account for its stock-based compensation in accordance with APB 25, which used the intrinsic value method; however, as required by SFAS 123, the Company disclosed the pro forma impact on the financial statements assuming the measurement provisions
of SFAS 123 had been adopted.

In December 2004, the FASB issued SFAS No. 123R, Shared-Based Payment (SFAS 123R). SFAS 123R is a
revision of SFAS No. 123, Accounting for Stock Based Compensation, supersedes APB Opinion No. 25 and amends FASB Statement No. 95, Statement of Cash Flows. SFAS 123R eliminates the ability to account for share-based
compensation using APB Opinion No. 25 and requires that all share-based payments to employees, including grants of employee stock options, to be recognized as compensation in the financial statements using a fair value-based method. SFAS 123R
is effective for nonpublic companies as of the beginning of the first annual reporting period that begins after December 15, 2005. SFAS 123R was adopted by the Bank beginning with the year ended December 31, 2006.

SFAS 123R requires public companies to adopt the recognition requirements using either a modified prospective method or a modified
retrospective method. Under the modified prospective method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS 123R for all shared-based payments
granted after that date, and based on the requirements of SFAS 123R for all unvested awards granted prior to the effective date of SFAS 123R. Under the modified retrospective method, the requirements are the same as under the
modified prospective method, but also permits entities to restate financial statements of previous periods based on pro forma disclosures made in accordance with SFAS 123.

The Company adopted SFAS 123R under the modified prospective method effective January 1, 2006. The Company has begun to recognize
compensation expense for options that have been issued but not yet vested as of January 1, 2006. In addition, options issued after January 1, 2006 will increase compensation expense for 2006 and afterward. Options that were issued prior to
January 1, 2006 and vested during the year resulted in additional compensation expense of $6,000. There were no options granted in 2006. Future levels of compensation cost recognized related to share-based compensation awards may be impacted by
new awards and/or modification, repurchases and cancellations of existing awards after the adoption of this standard.

The following table
illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123 to options granted under the Companys stock option plan. For the purposes of this pro forma disclosure,
the value of the options is estimated using a Black-Scholes option-pricing formula and amortized to expense over the options vesting periods.



|                                                                                                                  |  |      |       |   |      |       |  
|----------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | - | ---- | ----- | -
|                                                                                                                  |  | 2005 |       |   | 2004 |      
|Net income, as reported                                                                                           |  | $    | 2,107 |   |      | 1,819 |  
|Deduct: Total stock-based employee compensation expense determined under SFAS No. 123, net of related tax effects |  |      | (9    | ) |      | (9    | )
|                                                                                                                  |  |      |       |   |      |       |  
|Pro forma net income                                                                                              |  | $    | 2,098 |   |      | 1,810 |  
|                                                                                                                  |  |      |       |   |      |       |  
|Basic net income per share:                                                                                       |  |      |       |   |      |       |  
|As reported                                                                                                       |  | $    | 1.44  |   |      | 1.25  |  
|Pro forma                                                                                                         |  |      | 1.44  |   |      | 1.24  |  
|                                                                                                                  |  |     
|Diluted net income per share:                                                                                     |  |      |       |   |      |       |  
|As reported                                                                                                       |  | $    | 1.43  |   |      | 1.23  |  
|Pro forma                                                                                                         |  |      | 1.42  |   |      | 1.23  |  



37



---

The fair value of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions used; dividend yield of 4.00%, expected volatility of 27.30%, a risk-free interest rate of 4.63%, and expected lives of 7 years.



| | (o) | Net Income Per Share
| | --- | --------------------

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

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



|                                 |  |                       |       |                     |           |                 |   |     
|-------------------------------- |  | --------------------- | ----- | ------------------- | --------- | --------------- | - | ----
|Year ended December 31, 2006     |  | Net income(numerator) |       | Shares(denominator) |           | Per shareamount
|Basic net income per share       |  | $                     | 2,412 |                     | 1,459,007 |                 | $ | 1.65
|                                 |  |                       |       |                     |           |                 |   |     
|Effect of dilutive stock options |  |                       |      |                     | 12,799    |                 |   |     
|                                 |  |                       |       |                     |           |                 |   |     
|Diluted net income per share     |  | $                     | 2,412 |                     | 1,471,806 |                 | $ | 1.64
|                                 |  |                       |       |                     |           |                 |   |     



|                                 |  |                       |       |                     |           |                 |   |     
|-------------------------------- |  | --------------------- | ----- | ------------------- | --------- | --------------- | - | ----
|Year ended December 31, 2005     |  | Net income(numerator) |       | Shares(denominator) |           | Per shareamount
|Basic net income per share       |  | $                     | 2,107 |                     | 1,458,615 |                 | $ | 1.44
|                                 |  |                       |       |                     |           |                 |   |     
|Effect of dilutive stock options |  |                       |      |                     | 17,673    |                 |   |     
|                                 |  |                       |       |                     |           |                 |   |     
|Diluted net income per share     |  | $                     | 2,107 |                     | 1,476,288 |                 | $ | 1.43
|                                 |  |                       |       |                     |           |                 |   |     



|                                 |  |                       |       |                     |           |                 |   |     
|-------------------------------- |  | --------------------- | ----- | ------------------- | --------- | --------------- | - | ----
|Year ended December 31, 2004     |  | Net income(numerator) |       | Shares(denominator) |           | Per shareamount
|Basic net income per share       |  | $                     | 1,819 |                     | 1,457,406 |                 | $ | 1.25
|                                 |  |                       |       |                     |           |                 |   |     
|Effect of dilutive stock options |  |                       |      |                     | 16,036    |                 |   |     
|                                 |  |                       |       |                     |           |                 |   |     
|Diluted net income per share     |  | $                     | 1,819 |                     | 1,473,442 |                 | $ | 1.23
|                                 |  |                       |       |                     |           |                 |   |     



| | (p) | Consolidated Statements of Cash Flows
| | --- | -------------------------------------

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



| | (q) | Comprehensive Income
| | --- | --------------------

SFAS No. 130,
Reporting Comprehensive Income, requires the Company to classify items of Other Comprehensive Income (such as net unrealized gains (losses) on available-for-sale securities) by their nature in a financial statement and present the
accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The Companys other comprehensive income consists of net income and
net unrealized gains (losses) on securities available-for-sale, net of income taxes.

SFAS No. 158, Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R), requires a business entity to recognize the overfunded or underfunded status of a single-employer defined benefit
postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 also



38



---

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



| | (r) | Use of Estimates
| | --- | ----------------

In preparing the
consolidated financial statements in accordance with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the
consolidated balance sheets and revenues and expenses for the years ended December 31, 2006, 2005 and 2004. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the
near term relate to the determination of the allowance for loan losses.



| | (s) | Impact of Recently Issued Accounting Standards
| | --- | ----------------------------------------------

In February 2006, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standard (SFAS) No. 155, Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements
No. 133 and 140. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
and resolves issues in Statement No. 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. The provisions of this Statement are effective for all financial instruments
acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 is not expected to have a material impact on the consolidated financial statements of the
Company.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement
No. 140.This Statement amends SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement 125with respect to the accounting for separately
recognized servicing assets and servicing liabilities. The provisions of this Statement are effective for fiscal years beginning after September 15, 2006. The adoption of SFAS No. 156 is not expected to have a material impact on the
consolidated financial statements of the Company.

In September 2006, the FASB issued SFAS No. 158, Employers Accounting for
Defined Benefit Pension and Other Postretirement Plans  an amendment of FASB Statements No. 87, 88, 106, and 132(R).SFAS No. 158 and its impact on the Company are discussed in Note 1(k) of the Notes to Consolidated Financial
Statements.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which establishes a framework for
measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The
Company does not expect the adoption of this new standard to have a material effect on the Companys consolidated results of operations or consolidated financial position.

In June 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109, which establishes that the financial statement effects of a tax position taken or expected to be taken in a tax return are to be recognized in the financial statements when it is more likely than not, based on the
technical merits, that the position will be sustained upon examination. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of this new standard to have a



39



---

material effect on the Companys consolidated results of operations or consolidated financial position.



|(2) | Restrictions on Cash
|--- | --------------------

To comply with Federal
Reserve regulations, the Bank is required to maintain certain average reserve balances. The daily average reserve requirements were approximately $1,304, and $1,349 for the weeks including December 31, 2006 and 2005, respectively.



|(3) | Securities
|--- | ----------

The amortized costs, gross unrealized
gains, gross unrealized losses and fair values for securities at December 31, 2006 and 2005 are as follows:



|                                                                                      |  |                 |        |                       |     |                        |      |   |            |       
|------------------------------------------------------------------------------------- |  | --------------- | ------ | --------------------- | --- | ---------------------- | ---- | - | ---------- | ------
|                                                                                      |  | 2006           
|                                                                                      |  | Amortized costs |        | Gross unrealizedgains |     | Gross unrealizedlosses |      |   | Fairvalues
|Available-for-Sale                                                                    |  |                 |        |                       |     |                        |      |   |            |       
|U.S. Treasury securities and obligations of U.S. Government corporations and agencies |  | $               | 4,889  |                       | 1   |                        | (47  | ) |            | 4,843 
|Obligations of states and political subdivisions                                      |  |                 | 6,033  |                       | 74  |                        | (82  | ) |            | 6,025 
|Corporate securities                                                                  |  |                 | 3,502  |                       |    |                        | (51  | ) |            | 3,451 
|Mortgage-backed securities - government                                               |  |                 | 4,908  |                       | 27  |                        | (83  | ) |            | 4,852 
|Other securities                                                                      |  |                 | 50     |                       |    |                        |     |   |            | 50    
|                                                                                      |  |                 |        |                       |     |                        |      |   |            |       
|Total available-for-sale                                                              |  | $               | 19,382 |                       | 102 |                        | (263 | ) |            | 19,221
|                                                                                      |  |                 |        |                       |     |                        |      |   |            |       



|                                                 |  |                 |       |                      |    |                       |     |   |            |      
|------------------------------------------------ |  | --------------- | ----- | -------------------- | -- | --------------------- | --- | - | ---------- | -----
|                                                 |  | 2006           
|                                                 |  | Amortized costs |       | Grossunrealizedgains |    | Grossunrealizedlosses |     |   | Fairvalues
|Held-to-Maturity                                 |  |                 |       |                      |    |                       |     |   |            |      
|Obligations of states and political subdivisions |  | $               | 5,645 |                      | 70 |                       | (42 | ) |            | 5,673
|                                                 |  |                 |       |                      |    |                       |     |   |            |      



|                                                                                      |  |                |        |                      |     |                       |      |   |            |       
|------------------------------------------------------------------------------------- |  | -------------- | ------ | -------------------- | --- | --------------------- | ---- | - | ---------- | ------
|                                                                                      |  | 2005          
|                                                                                      |  | Amortizedcosts |        | Grossunrealizedgains |     | Grossunrealizedlosses |      |   | Fairvalues
|Available-for-Sale                                                                    |  |                |        |                      |     |                       |      |   |            |       
|U.S. Treasury securities and obligations of U.S. Government corporations and agencies |  | $              | 3,985  |                      | 3   |                       | (67  | ) |            | 3,921 
|Obligations of states and political subdivisions                                      |  |                | 6,922  |                      | 97  |                       | (85  | ) |            | 6,934 
|Corporate securities                                                                  |  |                | 6,055  |                      | 8   |                       | (78  | ) |            | 5,985 
|Mortgage-backed securities - government                                               |  |                | 5,494  |                      | 54  |                       | (87  | ) |            | 5,461 
|Other securities                                                                      |  |                | 50     |                      |    |                       |     |   |            | 50    
|                                                                                      |  |                |        |                      |     |                       |      |   |            |       
|Total available-for-sale                                                              |  | $              | 22,506 |                      | 162 |                       | (317 | ) |            | 22,351
|                                                                                      |  |                |        |                      |     |                       |      |   |            |       



|                                                 |  |                |       |                      |     |                       |     |   |            |      
|------------------------------------------------ |  | -------------- | ----- | -------------------- | --- | --------------------- | --- | - | ---------- | -----
|                                                 |  | 2005          
|                                                 |  | Amortizedcosts |       | Grossunrealizedgains |     | Grossunrealizedlosses |     |   | Fairvalues
|Held-to-Maturity                                 |  |                |       |                      |     |                       |     |   |            |      
|Obligations of states and political subdivisions |  | $              | 6,910 |                      | 125 |                       | (53 | ) |            | 6,982
|                                                 |  |                |       |                      |     |                       |     |   |            |      



40



---

The following table shows the gross unrealized losses and fair value of the Companys investments,
aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2006:



|                                                                                      |  |                     |       |                       |   |           |        |                       |     |           |        |                       |    
|------------------------------------------------------------------------------------- |  | ------------------- | ----- | --------------------- | - | --------- | ------ | --------------------- | --- | --------- | ------ | --------------------- | ---
|                                                                                      |  | Less than 12 months |       | 12 months or more     |   | Total    
|Description of Securities                                                             |  | Fairvalue           |       | Grossunrealizedlosses |   | Fairvalue |        | Grossunrealizedlosses |     | Fairvalue |        | GrossUnrealizedlosses
|U.S. Treasury securities and obligations of U.S. Government corporations and agencies |  | $                   | 999   |                       | 1 |           | 3,654  |                       | 46  |           | 4,653  |                       | 47 
|Obligations of states and political subdivisions                                      |  |                     | 631   |                       | 1 |           | 5,119  |                       | 123 |           | 5,750  |                       | 124
|Corporate securities                                                                  |  |                     |      |                       |  |           | 3,451  |                       | 51  |           | 3,451  |                       | 51 
|Mortgage-backed securities-government                                                 |  |                     | 561   |                       | 1 |           | 2,804  |                       | 82  |           | 3,365  |                       | 83 
|                                                                                      |  |                     |       |                       |   |           |        |                       |     |           |        |                       |    
|Total temporarily impaired securities                                                 |  | $                   | 2,191 |                       | 3 |           | 15,028 |                       | 302 |           | 17,219 |                       | 305
|                                                                                      |  |                     |       |                       |   |           |        |                       |     |           |        |                       |    

The Company does not consider the unrealized losses other-than-temporary losses based on the
volatility of the securities market price involved, the credit quality of the securities, and the Companys ability to hold the securities until maturity. The securities include 6 bonds that have continuous losses for less than 12 months and 33
bonds that have continuous losses for more than 12 months. The $17,219 in securities in which there is an unrealized loss of $305 includes unrealized losses ranging from $1 to $22 or from 0.01% to 4.12% of the original cost of the investment.

The following table shows the gross unrealized losses and fair value of the Companys investments, aggregated by investment category
and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2005:



|                                                                                      |  |                     |        |                       |     |           |       |                       |     |           |        |                       |    
|------------------------------------------------------------------------------------- |  | ------------------- | ------ | --------------------- | --- | --------- | ----- | --------------------- | --- | --------- | ------ | --------------------- | ---
|                                                                                      |  | Less than 12 months |        | 12 months or more     |     | Total    
|Description of Securities                                                             |  | Fairvalue           |        | Grossunrealizedlosses |     | Fairvalue |       | Grossunrealizedlosses |     | Fairvalue |        | Grossunrealizedlosses
|U.S. Treasury securities and obligations of U.S. Government corporations and agencies |  | $                   | 2,462  |                       | 38  |           | 1,171 |                       | 29  |           | 3,633  |                       | 67 
|Obligations of states and political subdivisions                                      |  |                     | 2,279  |                       | 29  |           | 3,442 |                       | 109 |           | 5,721  |                       | 138
|Corporate securities                                                                  |  |                     | 3,937  |                       | 70  |           | 492   |                       | 8   |           | 4,429  |                       | 78 
|Mortgage-backed securities-government                                                 |  |                     | 1,353  |                       | 25  |           | 2,039 |                       | 62  |           | 3,392  |                       | 87 
|                                                                                      |  |                     |        |                       |     |           |       |                       |     |           |        |                       |    
|Total temporarily impaired securities                                                 |  | $                   | 10,031 |                       | 162 |           | 7,144 |                       | 208 |           | 17,175 |                       | 370
|                                                                                      |  |                     |        |                       |     |           |       |                       |     |           |        |                       |    



41



---

The Company does not consider the unrealized losses other-than-temporary losses based on the volatility
of the securities market price involved, the credit quality of the securities, and the Companys ability to hold the securities until maturity. The securities include 24 bonds that have continuous losses for less than 12 months and 12 bonds
that have continuous losses for more than 12 months. The $17,175 in securities in which there is an unrealized loss of $370 includes unrealized losses ranging from $1 to $21 or from 0.05% to 4.19% of the original cost of the investment.

The amortized costs and fair values of available-for-sale and held-to-maturity securities at December 31, 2006, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



|                                       |  |                    |        |                  |        |                 |       |             |      
|-------------------------------------- |  | ------------------ | ------ | ---------------- | ------ | --------------- | ----- | ----------- | -----
|                                       |  | 2006              
|                                       |  | Available-for-Sale |        | Held-to-Maturity
|                                       |  | Amortized costs    |        | Fair values      |        | Amortized costs |       | Fair values
|Due in one year or less                |  | $                  | 3,253  |                  | 3,231  |                 | 1,470 |             | 1,473
|Due after one year through five years  |  |                    | 9,198  |                  | 9,083  |                 | 3,374 |             | 3,416
|Due after five years through ten years |  |                    | 1,523  |                  | 1,561  |                 | 801   |             | 784  
|Due after ten years                    |  |                    | 500    |                  | 494    |                 |      |             |     
|                                       |  |                    |        |                  |        |                 |       |             |      
|                                       |  |                    | 14,474 |                  | 14,369 |                 | 5,645 |             | 5,673
|                                       |  |                    |        |                 
|Mortgage-backed securities             |  |                    | 4,908  |                  | 4,852  |                 |      |             |     
|                                       |  |                    |        |                  |        |                 |       |             |      
|Totals                                 |  | $                  | 19,382 |                  | 19,221 |                 | 5,645 |             | 5,673
|                                       |  |                    |        |                  |        |                 |       |             |      

Securities with amortized costs of approximately $4,160 and $2,915 (fair values of $4,122 and
$2,947, respectively) as of December 31, 2006 and 2005, respectively, were pledged as collateral for public deposits.



|(4) | Loans
|--- | -----

A summary of loans at December 31, 2006
and 2005 follows:



|                                                                           |  |      |         |   |      |         |  
|-------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | ------- | -
|                                                                           |  | 2006 |         |   | 2005 |        
|Real estate loans:                                                         |  |      |         |   |      |         |  
|Residential                                                                |  | $    | 51,876  |   |      | 55,936  |  
|Other                                                                      |  |      | 77,119  |   |      | 53,039  |  
|Loans to individuals for household, family and other consumer expenditures |  |      | 46,360  |   |      | 44,369  |  
|Commercial and industrial loans                                            |  |      | 34,036  |   |      | 28,659  |  
|All other loans                                                            |  |      | 454     |   |      | 935     |  
|                                                                           |  |      |         |   |      |         |  
|Total loans, gross                                                         |  |      | 209,845 |   |      | 182,938 |  
|                                                                           |  |     
|Less unearned income and fees                                              |  |      | (214    | ) |      | (162    | )
|                                                                           |  |      |         |   |      |         |  
|Loans, net of unearned income and fees                                     |  |      | 209,631 |   |      | 182,776 |  
|                                                                           |  |     
|Less allowance for loan losses                                             |  |      | (1,770  | ) |      | (1,508  | )
|                                                                           |  |      |         |   |      |         |  
|Loans, net                                                                 |  | $    | 207,861 |   |      | 181,268 |  
|                                                                           |  |      |         |   |      |         |  

Non-accrual loans amounted to approximately $255, $421 and $189 at December 31, 2006, 2005
and 2004 respectively. Interest income that would have been earned on non-accrual loans if they had been current in accordance with their original terms and the recorded interest that was included in income on these loans was not significant for
2006, 2005 and 2004. There were no commitments to lend additional funds to customers whose loans were on non-accrual status at December 31, 2006.

In the normal course of business, the Bank has made loans to executive officers and directors. At December 31, 2006, loans to executive officers and directors were approximately $507 compared to $120 at



42



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December 31, 2005. During 2006, new loans to executive officers and directors amounted to
approximately $470 and repayments amounted to approximately $84. Loans to companies in which executive officers and directors have an interest amounted to approximately $1,190 and $1,283 at December 31, 2006 and 2005, respectively. All such
loans were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unrelated persons, and, in the opinion
of management, do not involve more than normal risk or present other unfavorable features.

Activity in the allowance for loan losses for
the years ended December 31, 2006 and 2005 is summarized as follows:



|                              |  |      |       |   |      |       |   |      |       |  
|----------------------------- |  | ---- | ----- | - | ---- | ----- | - | ---- | ----- | -
|                              |  | 2006 |       |   | 2005 |       |   | 2004 |      
|Balances at beginning of year |  | $    | 1,508 |   |      | 1,502 |   |      | 1,528 |  
|Provision for loan losses     |  |      | 339   |   |      | 230   |   |      | 223   |  
|Loans charged off             |  |      | (206  | ) |      | (380  | ) |      | (351  | )
|Loan recoveries               |  |      | 129   |   |      | 156   |   |      | 102   |  
|                              |  |      |       |   |      |       |   |      |       |  
|Balances at end of year       |  | $    | 1,770 |   |      | 1,508 |   |      | 1,502 |  
|                              |  |      |       |   |      |       |   |      |       |  

At December 31, 2006, 2005 and 2004, the recorded investment in loans for which impairment
has been identified totaled approximately $255, $421 and $189, respectively, with corresponding valuation allowances of approximately $3, $66 and $100, respectively. The average recorded investment in impaired loans receivable during 2006, 2005 and
2004 was approximately $333, $389 and $349, respectively. Interest income recognized on a cash basis on impaired loans during 2006, 2005 and 2004 was approximately $15, $3 and $2 respectively.



|(5) | Bank Premises and Equipment
|--- | ---------------------------

Bank premises and
equipment, net were comprised of the following as of December 31, 2006 and 2005:



|                                  |  |      |        |   |      |        |  
|--------------------------------- |  | ---- | ------ | - | ---- | ------ | -
|                                  |  | 2006 |        |   | 2005 |       
|Land improvements                 |  | $    | 420    |   |      | 420    |  
|Buildings                         |  |      | 4,628  |   |      | 4,611  |  
|Equipment, furniture and fixtures |  |      | 3,002  |   |      | 4,599  |  
|                                  |  |      |        |   |      |        |  
|                                  |  |      | 8,050  |   |      | 9,630  |  
|Less accumulated depreciation     |  |      | (3,937 | ) |      | (5,374 | )
|                                  |  |      |        |   |      |        |  
|                                  |  |      | 4,113  |   |      | 4,256  |  
|Land                              |  |      | 1,151  |   |      | 1,151  |  
|                                  |  |      |        |   |      |        |  
|Bank premises and equipment, net  |  | $    | 5,264  |   |      | 5,407  |  
|                                  |  |      |        |   |      |        |  



|(6) | Deposits
|--- | --------

A summary of deposits at
December 31, 2006 and 2005 follows:



|                                    |  |      |         |      |        
|----------------------------------- |  | ---- | ------- | ---- | -------
|                                    |  | 2006 |         | 2005
|Noninterest-bearing demand deposits |  | $    | 23,631  |      | 21,914 
|Interest-bearing:                   |  |      |         |      |        
|Savings                             |  |      | 44,794  |      | 36,627 
|NOW accounts                        |  |      | 25,004  |      | 28,034 
|Time deposits - under $100,000      |  |      | 98,330  |      | 89,676 
|Time deposits - $100,000 and over   |  |      | 39,058  |      | 32,995 
|                                    |  |      |         |      |        
|Total interest-bearing deposits     |  |      | 207,186 |      | 187,332
|                                    |  |      |         |      |        
|Total deposits                      |  | $    | 230,817 |      | 209,246
|                                    |  |      |         |      |        

At December 31, 2006, the scheduled maturity of time deposits is as follows: $84,583 in 2007;
$16,563 in 2008; $17,498 in 2009; $13,974 in 2010 and $4,770 in 2011.



43



---

In the normal course of business, the Bank has received deposits from executive officers and directors.
At December 31, 2006 and 2005, deposits from executive officers and directors were approximately $2,426 and $1,867, respectively. All such deposits were received in the ordinary course of business on substantially the same terms and conditions,
including interest rates, as those prevailing at the same time for comparable transactions with unrelated persons.



|(7) | Employee Benefit Plans
|--- | ----------------------

The Bank maintains a
noncontributory defined benefit pension plan that covers substantially all of its employees. Benefits are computed based on employees average final compensation and years of credited service. Pension expense amounted to approximately $244,
$293 and $393 in 2006, 2005 and 2004, respectively. The change in benefit obligation, change in plan assets and funded status of the pension plan at September 30, 2006, 2005 and 2004 (most recent information available) and pertinent assumptions
are as follows:



|                                                                               |  |                  |       |   |      |       |   |      |       |  
|------------------------------------------------------------------------------ |  | ---------------- | ----- | - | ---- | ----- | - | ---- | ----- | -
|                                                                               |  | Pension Benefits |      
|                                                                               |  | 2006             |       |   | 2005 |       |   | 2004 |      
|Change in Benefit Obligation                                                   |  |                  |       |   |      |       |   |      |       |  
|Benefit obligation at beginning of year                                        |  | $                | 5,111 |   |      | 4,571 |   |      | 4,201 |  
|Service cost                                                                   |  |                  | 299   |   |      | 301   |   |      | 310   |  
|Interest cost                                                                  |  |                  | 294   |   |      | 274   |   |      | 252   |  
|Actuarial (gain) loss                                                          |  |                  | (109  | ) |      | 72    |   |      | (183  | )
|Benefits paid                                                                  |  |                  | (688  | ) |      | (107  | ) |      | (9    | )
|                                                                               |  |                  |       |   |      |       |   |      |       |  
|Benefit obligation at end of year                                              |  |                  | 4,907 |   |      | 5,111 |   |      | 4,571 |  
|                                                                               |  |                  |       |   |      |       |   |      |       |  
|Change in Plan Assets                                                          |  |                  |       |   |      |       |   |      |       |  
|                                                                               |  |                  |      
|Fair value of plan assets at beginning of year                                 |  |                  | 4,383 |   |      | 3,741 |   |      | 2,891 |  
|Actual return on plan assets                                                   |  |                  | 416   |   |      | 553   |   |      | 309   |  
|Employer contribution                                                          |  |                  | 800   |   |      | 196   |   |      | 747   |  
|Benefit paid                                                                   |  |                  | (688  | ) |      | (107  | ) |      | (10   | )
|                                                                               |  |                  |       |   |      |       |   |      |       |  
|Fair value of plan assets at end of year                                       |  |                  | 4,911 |   |      | 4,383 |   |      | 3,937 |  
|                                                                               |  |                  |       |   |      |       |   |      |       |  
|Funded status                                                                  |  |                  | 4     |   |      | (728  | ) |      | (634  | )
|                                                                               |  |                  |      
|Unrecognized net actuarial loss                                                |  |                  | 505   |   |      | 667   |   |      | 852   |  
|Unrecognized prior service cost                                                |  |                  | 35    |   |      | 45    |   |      | 54    |  
|                                                                               |  |                  |       |   |      |       |   |      |       |  
|Prepaid (accrued) pension benefit cost, include din other assets (liabilities) |  | $                | 544   |   |      | (16   | ) |      | 272   |  
|                                                                               |  |                  |       |   |      |       |   |      |       |  



|                                                 |  |                  |   |  |      |   |  |      |  
|------------------------------------------------ |  | ---------------- | - |  | ---- | - |  | ---- | -
|                                                 |  | Pension Benefits |  
|                                                 |  | 2006             |   |  | 2005 |   |  | 2004 |  
|Weighted Average Assumptions as of September 30: |  |                  |   |  |      |   |  |      |  
|Discount rate                                    |  | 6.00             | % |  | 5.75 | % |  | 6.00 | %
|                                                 |  |                  |  
|Expected long-term return on plan assets         |  | 8.50             | % |  | 8.50 | % |  | 8.50 | %
|                                                 |  |                  |  
|Rate of compensation increase                    |  | 5.00             | % |  | 5.00 | % |  | 5.00 | %

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

Because assets are
held in a qualified trust, anticipated returns are not reduced for taxes. Further  solely for this purpose  the plan is assumed to continue in force and not terminate during the period during which assets are invested. However,
consideration is given to the potential impact of current and future investment



44



---

policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses
are not explicitly estimated within periodic cost).

The components of net pension benefit cost under the plan for the years ended
December 31, 2006, 2005 and 2004 is summarized as follows:



|                               |  |                  |      |   |      |      |   |      |      |  
|------------------------------ |  | ---------------- | ---- | - | ---- | ---- | - | ---- | ---- | -
|                               |  | Pension Benefits |     
|                               |  | 2006             |      |   | 2005 |      |   | 2004 |     
|Service cost                   |  | $                | 299  |   |      | 301  |   |      | 310  |  
|Interest cost                  |  |                  | 294  |   |      | 274  |   |      | 252  |  
|Expected return on plan assets |  |                  | (372 | ) |      | (317 | ) |      | (228 | )
|Net amortization               |  |                  | 8    |   |      | 9    |   |      | 9    |  
|Recognized net actuarial loss  |  |                  | 10   |   |      | 22   |   |      | 43   |  
|                               |  |                  |      |   |      |      |   |      |      |  
|Net pension benefit cost       |  | $                | 239  |   |      | 289  |   |      | 386  |  
|                               |  |                  |      |   |      |      |   |      |      |  

Projected Benefit Payments

The projected benefit payments under the plan are summarized as follows for the years ending September 30:



|          |  |   |      
|--------- |  | - | -----
|2007      |  | $ | 36   
|          | 
|2008      |  |   | 47   
|          | 
|2009      |  |   | 47   
|          | 
|2010      |  |   | 50   
|          | 
|2011      |  |   | 174  
|          | 
|2012-2016 |  |   | 1,270

Plan Asset Allocation

The pension plans weighted-average asset allocations at September 30, 2006, 2005 and 2004, by asset category, are as follows:



|                            |  |                              |   |  |      |   |  |      |  
|--------------------------- |  | ---------------------------- | - |  | ---- | - |  | ---- | -
|                            |  | Plan Assets at September 30, |  
|                            |  | 2006                         |   |  | 2005 |   |  | 2004 |  
|Asset Category:             |  |                              |   |  |      |   |  |      |  
|Mutual funds  fixed income |  | 21                           | % |  | 19   | % |  | 35   | %
|Mutual funds  equity       |  | 71                           | % |  | 81   | % |  | 65   | %
|Cash and Equivalents        |  | 8                            | % |  | 0    | % |  | 0    | %
|                            |  |                              |   |  |      |   |  |      |  
|Total                       |  | 100                          | % |  | 100  | % |  | 100  | %
|                            |  |                              |   |  |      |   |  |      |  

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



45



---

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

Contributions

The Company expects to
contribute $318 to its pension plan in 2007.

The Company also has a 401(k) plan for which the Company does not currently match employee
contributions to the plan.



|(8) | Income Taxes
|--- | ------------

Income tax expense attributable to
income before income tax expense for the years ended December 31, 2006 and 2005 is summarized as follows:



|                         |  |      |       |      |     |      |    
|------------------------ |  | ---- | ----- | ---- | --- | ---- | ---
|                         |  | 2006 |       | 2005 |     | 2004
|Current                  |  | $    | 955   |      | 692 |      | 669
|Deferred                 |  |      | 161   |      | 184 |      | 43 
|                         |  |      |       |      |     |      |    
|Total income tax expense |  | $    | 1,116 |      | 876 |      | 712
|                         |  |      |       |      |     |      |    

Reported income tax expense for the years ended December 31, 2006 and 2005 differed from the
amounts computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense as a result of the following:



|                                                           |  |      |       |   |      |       |   |      |      |  
|---------------------------------------------------------- |  | ---- | ----- | - | ---- | ----- | - | ---- | ---- | -
|                                                           |  | 2006 |       |   | 2005 |       |   | 2004 |     
|Computed expected income tax expense                     |  | $    | 1,199 |   |      | 1,014 |   |      | 860  |  
|Increase (reduction) in income tax expense resulting from: |  |      |       |   |      |       |   |      |      |  
|Tax-exempt interest                                        |  |      | (102  | ) |      | (138  | ) |      | (162 | )
|Disallowance of interest expense                           |  |      | 13    |   |      | 13    |   |      | 12   |  
|Other, net                                                 |  |      | 6     |   |      | (13   | ) |      | 2    |  
|                                                           |  |      |       |   |      |       |   |      |      |  
|Reported income tax expense                                |  | $    | 1,116 |   |      | 876   |   |      | 712  |  
|                                                           |  |      |       |   |      |       |   |      |      |  



46



---

The tax effects of temporary differences that give rise to significant portions of the deferred tax
assets and deferred tax liabilities at December 31, 2006, 2005 and 2004 are as follows:



|                                                                                                           |  |      |      |   |      |      |  
|---------------------------------------------------------------------------------------------------------- |  | ---- | ---- | - | ---- | ---- | -
|                                                                                                           |  | 2006 |      |   | 2005 |     
|Deferred tax assets:                                                                                       |  |      |      |   |      |      |  
|Loans, principally due to allowance for loan losses                                                        |  | $    | 481  |   |      | 391  |  
|Accrued pension, due to accrual for financial reporting purposes in excess of actual pension contributions |  |      |     |   |      | 6    |  
|Net unrealized losses on available-for-sale securities                                                     |  |      | 55   |   |      | 53   |  
|Unrecognized net actuarial loss and prior service cost                                                     |  |      | 183  |   |      |     |  
|Loans, due to unearned fees, net                                                                           |  |      | 39   |   |      | 43   |  
|Other                                                                                                      |  |      | 69   |   |      | 60   |  
|                                                                                                           |  |      |      |   |      |      |  
|Total gross deferred tax assets                                                                            |  |      | 827  |   |      | 553  |  
|                                                                                                           |  |      |      |   |      |      |  
|Deferred tax liabilities:                                                                                  |  |      |      |   |      |      |  
|Bank premises and equipment, due to differences in depreciation                                            |  |      | (153 | ) |      | (104 | )
|Accrued pension, due to actual pension contributions in excess of accrual for financial reporting purposes |  |      | (183 | ) |      |     |  
|Net unrealized gains on available-for-sale securities                                                      |  |      |     |   |      |     |  
|Other                                                                                                      |  |      | (86  | ) |      | (70  | )
|                                                                                                           |  |      |      |   |      |      |  
|Total gross deferred tax liabilities                                                                       |  |      | (422 | ) |      | (174 | )
|                                                                                                           |  |      |      |   |      |      |  
|Net deferred tax asset, included in other assets                                                           |  | $    | 405  |   |      | 379  |  
|                                                                                                           |  |      |      |   |      |      |  

The Bank has determined that a valuation allowance for the gross deferred tax assets is not
necessary at December 31, 2006, 2005 and 2004, since realization of the entire gross deferred tax assets can be supported by the amounts of taxes paid during the carryback periods available under current tax laws.



|(9) | Financial Instruments with Off-Balance-Sheet Risk
|--- | -------------------------------------------------

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

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

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

Financial instruments whose contract amounts represent credit risk:



|                             |  |                                  |        |      |       
|---------------------------- |  | -------------------------------- | ------ | ---- | ------
|                             |  | Contract amounts at December 31,
|                             |  | 2006                             |        | 2005
|Commitments to extend credit |  | $                                | 60,883 |      | 51,785
|                             |  |                                  |        |      |       
|Standby letters of credit    |  | $                                | 2,014  |      | 1,684 
|                             |  |                                  |        |      |       



47



---

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

Standby letters of credit are conditional commitments issued by
the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions. Unless renewed, substantially all of
the Banks standby letters of credit commitments at December 31, 2006 will expire within one year. Management does not anticipate any material losses as a result of these transactions. The credit risk involved in issuing letters of credit
is essentially the same as that involved in extending loans to customers.

(10) Concentrations of Credit Risk

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

The Banks commercial loan portfolio is diversified, with no significant concentrations of credit. The real estate loan portfolio consists
principally of 1-4 family residential property. The installment loan portfolio consists of consumer loans primarily for automobiles and other personal property. Overall, the Banks loan portfolio is not concentrated within a single industry or
group of industries, the loss of any one or more of which would generate a materially adverse impact on the business of the Bank.

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

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

(11) Dividend Restrictions and Capital Requirements

Bankshares principal source of funds for dividend payments is dividends received from its subsidiary Bank. For the years ended December 31, 2006 and 2005, dividends from the subsidiary Bank totaled $855 and
$780, respectively.

Substantially all of Bankshares retained earnings consist of undistributed earnings of its subsidiary Bank, which
are restricted by various regulations administered by federal banking regulatory agencies. Under applicable federal laws, the Comptroller of the Currency restricts, without prior approval, the total dividend payments of the Bank in any calendar year
to the net profits of that year, as defined, combined with the retained net profits for the two preceding years. At December 31, 2006, retained net profits of the Bank that were free of such restriction approximated $6,338.

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



48



---

Quantitative measures established by regulation to ensure capital adequacy require Bankshares and the
Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).
Management believes, as of December 31, 2006, that Bankshares and the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2006, the most recent notification from Office of the Comptroller of the Currency categorized Bankshares and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be
categorized as well capitalized, Bankshares and the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table below. There are no conditions or events since that notification that
management believes have changed Bankshares and the Banks category.

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



|                           |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|-------------------------- |  | ------ | ------ | ----- | ---------------------------- | - | ------ | --------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                           |  | Actual |        |       | For CapitalAdequacy Purposes |   |        | To Be WellCapitalized UnderPrompt CorrectiveAction Provisions |       
|                           |  | Amount |        | Ratio |                              |   | Amount |                                                                 | Ratio  |  |     | Amount |  | Ratio |       
|As of December 31, 2006:   |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|Total Capital              |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|(to Risk Weighted Assets): |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|Bankshares consolidated    |  | $      | 26,197 |       | 10.64                        | % |        | $                                                               | 19,824 |  | 8.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                       |  |        | 25,979 |       | 10.55                        | % |        |                                                                 | 19,706 |  | 8.0 | %      |  |       | 24,633 |  | 10.0 | %
|Tier I Capital             |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|(to Risk Weighted Assets): |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|Bankshares consolidated    |  |        | 24,427 |       | 9.92                         | % |        |                                                                 | 9,864  |  | 4.0 | %      |  |       | N/A    |  | N/A  |  
|Bank                       |  |        | 24,209 |       | 9.83                         | % |        |                                                                 | 9,853  |  | 4.0 | %      |  |       | 14,780 |  | 6.0  | %
|Tier I Capital (Leverage)  |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|(to Average Assets):       |  |        |        |       |                              |   |        |                                                                 |        |  |     |        |  |       |        |  |      |  
|Bankshares consolidated    |  |        | 24,427 |       | 9.80                         | % |        |                                                                 | 9,980  |  | 4.0 | %      |  |       | N/A    |  | N/A  |  
|Bank                       |  |        | 24,209 |       | 9.71                         | % |        |                                                                 | 9,977  |  | 4.0 | %      |  |       | 12,471 |  | 5.0  | %



|                           |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|-------------------------- |  | ------ | ------ | ----- | ----------------------------- | - | ------ | -------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                           |  | Actual |        |       | For Capital Adequacy Purposes |   |        | To Be WellCapitalizedUnder PromptCorrective ActionProvisions |       
|                           |  | Amount |        | Ratio |                               |   | Amount |                                                                | Ratio  |  |     | Amount |  | Ratio |       
|As of December 31, 2005:   |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|Total Capital              |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|(to Risk Weighted Assets): |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|Bankshares consolidated    |  | $      | 24,280 |       | 11.23                         | % |        | $                                                              | 17,297 |  | 8.0 | %      |  | $     | N/A    |  | N/A  |  
|Bank                       |  |        | 24,092 |       | 11.15                         | % |        |                                                                | 17,280 |  | 8.0 | %      |  |       | 21,600 |  | 10.0 | %
|Tier I Capital             |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|(to Risk Weighted Assets): |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|Bankshares consolidated    |  |        | 22,772 |       | 10.54                         | % |        |                                                                | 8,651  |  | 4.0 | %      |  |       | N/A    |  | N/A  |  
|Bank                       |  |        | 22,584 |       | 10.46                         | % |        |                                                                | 8,640  |  | 4.0 | %      |  |       | 12,960 |  | 6.0  | %
|Tier I Capital (Leverage)  |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|(to Average Assets):       |  |        |        |       |                               |   |        |                                                                |        |  |     |        |  |       |        |  |      |  
|Bankshares consolidated    |  |        | 22,772 |       | 9.88                          | % |        |                                                                | 9,220  |  | 4.0 | %      |  |       | N/A    |  | N/A  |  
|Bank                       |  |        | 22,584 |       | 9.80                          | % |        |                                                                | 9,217  |  | 4.0 | %      |  |       | 11,521 |  | 5.0  | %



49



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|(12) | Disclosures About Fair Value of Financial Instruments
|---- | -----------------------------------------------------

SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires the Company to disclose estimated fair values of its financial instruments.

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



| | (a) | Cash and Due from Banks and Federal Funds Sold
| | --- | ----------------------------------------------

The carrying amounts are a reasonable estimate of fair value.



| | (b) | Securities
| | --- | ----------

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



| | (c) | Mortgage Loans Held for Sale
| | --- | ----------------------------

Fair values of
mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.



| | (d) | Loans
| | --- | -----

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

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



| | (e) | Deposits and Note Payable to Federal Home Loan Bank
| | --- | ---------------------------------------------------

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



| | (f) | Commitments to Extend Credit and Standby Letters of Credit
| | --- | ----------------------------------------------------------

The only amounts recorded for commitments to extend credit and standby letters of credit are the deferred fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant at
December 31, 2006 and 2005, and as such, the related fair values have not been estimated.



50



---

The carrying amounts and approximate fair values of the Companys financial instruments are as
follows at December 31, 2006 and 2005:



|                                       |  |                 |         |                        |         |                 |         |                        |        
|-------------------------------------- |  | --------------- | ------- | ---------------------- | ------- | --------------- | ------- | ---------------------- | -------
|                                       |  | 2006            |         | 2005                  
|                                       |  | Carryingamounts |         | Approximatefair values |         | Carryingamounts |         | Approximatefair values
|Financial assets:                      |  |                 |         |                        |         |                 |         |                        |        
|Cash and due from banks                |  | $               | 5,948   |                        | 5,948   |                 | 6,591   |                        | 6,591  
|Federal funds sold                     |  |                 | 8,638   |                        | 8,638   |                 | 7,223   |                        | 7,223  
|Securities:                            |  |                 |         |                        |         |                 |         |                        |        
|Available-for-sale                     |  |                 | 19,221  |                        | 19,221  |                 | 22,351  |                        | 22,351 
|Held-to-maturity                       |  |                 | 5,645   |                        | 5,673   |                 | 6,910   |                        | 6,982  
|Federal Reserve Bank Stock             |  |                 | 75      |                        | 75      |                 | 75      |                        | 75     
|Federal Home Loan Bank Stock           |  |                 | 481     |                        | 481     |                 | 454     |                        | 454    
|Loans, net of unearned income and fees |  |                 | 209,631 |                        | 206,740 |                 | 182,776 |                        | 180,598
|                                       |  |                 |         |                        |         |                 |         |                        |        
|Total financial assets                 |  | $               | 249,639 |                        | 246,776 |                 | 226,380 |                        | 224,274
|                                       |  |                 |         |                        |         |                 |         |                        |        
|Financial liabilities:                 |  |                 |         |                        |         |                 |         |                        |        
|Deposits                               |  | $               | 230,817 |                        | 230,615 |                 | 209,246 |                        | 209,343
|Note payable to Federal Home Loan Bank |  |                 | 100     |                        | 100     |                 | 200     |                        | 204    
|                                       |  |                 |         |                        |         |                 |         |                        |        
|Total financial liabilities            |  | $               | 230,917 |                        | 230,715 |                 | 209,446 |                        | 209,547
|                                       |  |                 |         |                        |         |                 |         |                        |        

Fair value estimates are made at a specific point in time, based on relevant market information
and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Companys entire holdings of a particular financial instrument. Because no market
exists for a significant portion of the Companys financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments
and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

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



51



---

(13) Parent Company Financial Information

Condensed financial information of Bankshares (Parent) is presented below:

Condensed Balance Sheets



|                                                                                                                                        |  |              |        |   |      |        |  
|--------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------ | - | ---- | ------ | -
|                                                                                                                                        |  | December 31, |       
|                                                                                                                                        |  | 2006         |        |   | 2005 |       
|Assets                                                                                                                                  |  |              |        |   |      |        |  
|Cash due from subsidiary                                                                                                                |  | $            | 30     |   |      | 22     |  
|Investment in subsidiary, at equity                                                                                                     |  |              | 24,642 |   |      | 23,023 |  
|Other assets                                                                                                                            |  |              | 218    |   |      | 187    |  
|                                                                                                                                        |  |              |        |   |      |        |  
|Total assets                                                                                                                            |  | $            | 24,890 |   |      | 23,232 |  
|                                                                                                                                        |  |              |        |   |      |        |  
|Liabilities and Stockholders Equity                                                                                                    |  |              |        |   |      |        |  
|Other liabilities                                                                                                                       |  | $            | 40     |   |      | 20     |  
|                                                                                                                                        |  |              |        |   |      |        |  
|Stockholders equity (notes 11 and 14):                                                                                                 |  |              |        |   |      |        |  
|Common stock of $3 par value. Authorized 3,000,000 shares; issued and outstanding 1,459,589 shares in 2006 and 1,458,706 shares in
2005 |  |              | 4,379  |   |      | 4,376  |  
|Capital surplus                                                                                                                         |  |              | 604    |   |      | 577    |  
|Retained earnings                                                                                                                       |  |              | 19,973 |   |      | 18,362 |  
|Accumulated other comprehensive income (loss), net                                                                                      |  |              | (106   | ) |      | (103   | )
|                                                                                                                                        |  |              |        |   |      |        |  
|Total stockholders equity                                                                                                              |  |              | 24,850 |   |      | 23,212 |  
|Commitments, contingencies and other matters (notes 9, 10 and 11)                                                                       |  |              |       |   |      |       |  
|                                                                                                                                        |  |              |        |   |      |        |  
|Total liabilities and stockholders equity                                                                                              |  | $            | 24,890 |   |      | 23,232 |  
|                                                                                                                                        |  |              |        |   |      |        |  

Condensed Statements of Income



|                                                                                      |  |                          |       |      |       |      |      
|------------------------------------------------------------------------------------- |  | ------------------------ | ----- | ---- | ----- | ---- | -----
|                                                                                      |  | Years ended December 31,
|                                                                                      |  | 2006                     |       | 2005 |       | 2004
|Income:                                                                               |  |                          |       |      |       |      |      
|Dividends from subsidiary (note 11)                                                   |  | $                        | 855   |      | 780   |      | 705  
|Expenses:                                                                             |  |                          |       |      |       |      |      
|Other expenses                                                                        |  |                          | 85    |      | 68    |      | 88   
|                                                                                      |  |                          |       |      |       |      |      
|Income before income tax benefit and equity in undistributed net income of subsidiary |  |                          | 770   |      | 712   |      | 617  
|Applicable income tax benefit                                                         |  |                          | 29    |      | 34    |      | 32   
|                                                                                      |  |                          |       |      |       |      |      
|Income before equity in undistributed net income of subsidiary                        |  |                          | 799   |      | 746   |      | 649  
|Equity in undistributed net income of subsidiary                                      |  |                          | 1,613 |      | 1,361 |      | 1,170
|                                                                                      |  |                          |       |      |       |      |      
|Net income                                                                            |  | $                        | 2,412 |      | 2,107 |      | 1,819
|                                                                                      |  |                          |       |      |       |      |      



52



---

Condensed Statements of Cash Flows



|                                                                                  |  |                          |        |   |      |        |   |      |        |  
|--------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | ------ | - | ---- | ------ | -
|                                                                                  |  | Years ended December 31, |       
|                                                                                  |  | 2006                     |        |   | 2005 |        |   | 2004 |       
|Cash flows from operating activities:                                             |  |                          |        |   |      |        |   |      |        |  
|Net income                                                                        |  | $                        | 2,412  |   |      | 2,107  |   |      | 1,819  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |        |   |      |        |   |      |        |  
|Equity in undistributed net income of subsidiary                                  |  |                          | (1,613 | ) |      | (1,361 | ) |      | (1,170 | )
|Increase in other assets                                                          |  |                          | (38    | ) |      | (34    | ) |      | (30    | )
|                                                                                  |  |                          |        |   |      |        |   |      |        |  
|Net cash provided by operating activities                                         |  |                          | 761    |   |      | 712    |   |      | 619    |  
|                                                                                  |  |                          |        |   |      |        |   |      |        |  
|Cash flows from financing activities:                                             |  |                          |        |   |      |        |   |      |        |  
|Proceeds from issuance of common stock                                            |  |                          | 30     |   |      | 19     |   |      |       |  
|Cash dividends paid                                                               |  |                          | (803   | ) |      | (715   | ) |      | (659   | )
|Increase (decrease) in other liabilities                                          |  |                          | 20     |   |      | (1     | ) |      | 4      |  
|                                                                                  |  |                          |        |   |      |        |   |      |        |  
|Net cash used in financing activities                                             |  |                          | (753   | ) |      | (697   | ) |      | (655   | )
|                                                                                  |  |                          |        |   |      |        |   |      |        |  
|Net increase (decrease) in cash due from subsidiary                               |  |                          | 8      |   |      | 15     |   |      | (36    | )
|Cash due from subsidiary, beginning of year                                       |  |                          | 22     |   |      | 7      |   |      | 43     |  
|                                                                                  |  |                          |        |   |      |        |   |      |        |  
|Cash due from subsidiary, end of year                                             |  | $                        | 30     |   |      | 22     |   |      | 7      |  
|                                                                                  |  |                          |        |   |      |        |   |      |        |  

(14) Stock Options

The Company has two incentive stock option plans. The 1997 Incentive Stock Plan (the 1997 Plan), pursuant to which the Companys Board of Directors may grant stock options to officers and key employees, was
effective as of May 1, 1997. The 1997 Plan authorizes grants of options to purchase up to 50,000 shares of the Companys authorized, but unissued common stock. Accordingly, 50,000 shares of authorized, but unissued common stock are
reserved for use in the 1997 Plan. All stock options are granted with an exercise price equal to the stocks fair market value at the date of grant. At December 31, 2006, there were 5,000 additional shares available for grant under the
1997 Plan.

The 2004 Incentive Stock Plan (the 2004 Plan), pursuant to which the Companys Board of Directors may grant stock options
to officers and key employees, was approved by shareholders on April 13, 2004 and became effective as of May 1, 2004. The 2004 Plan authorizes grants of options to purchase up to 100,000 shares of the Companys authorized, but
unissued common stock. Accordingly, 100,000 shares of authorized, but unissued common stock are reserved for use in the 2004 Plan. All stock options are granted with an exercise price equal to the stocks fair market value at the date of the
grant. At December 31, 2006, there were 100,000 additional shares available for grant under the 2004 Plan.

Stock options generally
have 10-year terms, vest at the rate of 20% per year, and become fully exercisable five years from the date of grant.

During 2006, no
stock options were exercised. During 2005, 1,300 stock options were exercised. During 2004, no stock options were exercised. During 2006, 2005 and 2004, there were no options granted to employees.

A summary of the status of the Banks unvested stock awards as of December 31, 2006 and changes during the year then ended is presented below:



53



---

|                              |  |        |   |  |                                       |     
|----------------------------- |  | ------ | - |  | ------------------------------------- | ----
|Unvested Stock Awards         |  | Shares |   |  | Weighted AverageGrant Date Fair Value
|Unvested at January 1, 2006   |  | 5,000  |   |  | $                                     | 3.29
|Granted                       |  |       |   |  |                                       |    
|Vested                        |  | (3,500 | ) |  |                                       | 3.39
|Forefeitures                  |  |       |   |  |                                       |    
|                              |  |        |   |  |                                       |     
|Unvested at December 31, 2006 |  | 1,500  |   |  | $                                     | 3.08

At December 31, 2006, options for 25,000 shares were exercisable at an exercise price of
$10.00 per share, options for 10,000 shares were exercisable at an exercise price of $14.00 per share, and 6,000 shares were exercisable at an exercise price of $14.75 per share. As of December 31, 2006, there was $3 of total unrecognized
compensation costs related to unvested stock options. The cost is expected to be recognized over a weighted-average of 0.61 years.

Stock
option activity during the years ended December 31, 2006 and 2005 is as follows:



|                             |  |                |  |                               |      
|---------------------------- |  | -------------- |  | ----------------------------- | -----
|                             |  | Numberofshares |  | Weightedaverageexercise price
|Balance at December 31, 2004 |  | 45,000         |  | $                             | 11.92
|                             |  |                |  |                               |      
|Forfeited                    |  | 1,200          |  |                               | 14.38
|Exercised                    |  | 1,300          |  | $                             | 14.23
|Granted                      |  |               |  |                               |     
|                             |  |                |  |                               |      
|Balance at December 31, 2005 |  | 42,500         |  | $                             | 11.78
|                             |  |                |  |                               |      
|Forfeited/Exercised          |  |               |  |                               |     
|Granted                      |  |               |  |                               |     
|                             |  |                |  |                               |      
|Balance at December 31, 2006 |  | 42,500         |  | $                             | 11.78
|                             |  |                |  |                               |      

The following table summarizes information about stock options outstanding at December 31,
2006:



|               |  |                              |  |                                                     |  |                               |       |                                |        |                               |   |      
|-------------- |  | ---------------------------- |  | --------------------------------------------------- |  | ----------------------------- | ----- | ------------------------------ | ------ | ----------------------------- | - | -----
|               |  | Options Outstanding          |  | Options Exercisable                                
|Exercise Price |  | NumberOutstandingat 12/31/06 |  | Weighted-AverageRemainingContractualLife
(in years) |  | Weighted-AverageExercisePrice |       | NumberExercisable at12/31/2006 |        | Weighted-AverageExercisePrice
|$10.00         |  | 25,000                       |  | 0.4                                                 |  | $                             | 10.00 |                                | 25,000 |                               |   | 10.00
|14.00          |  | 10,000                       |  | 4.5                                                 |  |                               | 14.00 |                                | 10,000 |                               |   | 14.00
|14.75          |  | 7,500                        |  | 5.6                                                 |  |                               | 14.75 |                                | 6,000  |                               |   | 14.75
|               |  |                              |  |                                                     |  |                               |       |                                |        |                               |   |      
|               |  | 42,500                       |  | 2.3                                                 |  | $                             | 11.78 |                                | 41,000 |                               | $ | 11.67
|               |  |                              |  |                                                     |  |                               |       |                                |        |                               |   |      



54



---

The aggregate intrinsic value of options outstanding was approximately $441, options exercisable was
approximately $430, and options unvested and expected to vest was approximately $11 at December 31, 2006.

The total intrinsic value
(market value on date of exercise less exercise price) of options exercised during the years ended December 31, 2006, 2005 and 2004 totaled $0, $4 and $0 respectively.

(15) Goodwill and Other Intangible Assets

Included in other assets is goodwill of $539 as of
December 31, 2006 and 2005, and other amortizing intangible assets of $0 and $3 as of December 31, 2006 and 2005, respectively. There was no change in the carrying amount of goodwill of $539 for the years ended December 31, 2006 and
2005.

(16) Quarterly Results of Operations (Unaudited)

The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2006 and 2005:



55



---

|                             |  |              |       |               |       |              |       |               |      
|---------------------------- |  | ------------ | ----- | ------------- | ----- | ------------ | ----- | ------------- | -----
|                             |  | 2006        
|                             |  | Firstquarter |       | Secondquarter |       | Thirdquarter |       | Fourthquarter
|Income statement data:       |  |              |       |               |       |              |       |               |      
|Interest income              |  | $            | 3,578 |               | 3,781 |              | 4,015 |               | 4,243
|Interest expense             |  |              | 1,412 |               | 1,498 |              | 1,675 |               | 1,840
|                             |  |              |       |               |       |              |       |               |      
|Net interest income          |  |              | 2,166 |               | 2,283 |              | 2,340 |               | 2,403
|Provision for loan losses    |  |              | 65    |               | 81    |              | 94    |               | 99   
|Noninterest income           |  |              | 561   |               | 666   |              | 628   |               | 645  
|Noninterest expense          |  |              | 1,823 |               | 1,949 |              | 1,955 |               | 2,098
|Income tax expense           |  |              | 263   |               | 295   |              | 290   |               | 268  
|                             |  |              |       |               |       |              |       |               |      
|Net income                   |  | $            | 576   |               | 624   |              | 629   |               | 583  
|                             |  |              |       |               |       |              |       |               |      
|Per share data:              |  |              |       |               |       |              |       |               |      
|Basic net income per share   |  | $            | 0.39  |               | 0.43  |              | 0.43  |               | 0.40 
|Diluted net income per share |  |              | 0.39  |               | 0.42  |              | 0.43  |               | 0.40 
|Cash dividends per share     |  |              | 0.13  |               | 0.13  |              | 0.14  |               | 0.15 
|Book value per share         |  |              | 16.14 |               | 16.30 |              | 16.75 |               | 16.78
|                             | 
|                             |  | 2005        
|                             |  | Firstquarter |       | Secondquarter |       | Thirdquarter |       | Fourthquarter
|Income statement data:       |  |              |       |               |       |              |       |               |      
|Interest income              |  | $            | 2,933 |               | 3,061 |              | 3,207 |               | 3,469
|Interest expense             |  |              | 1,053 |               | 1,074 |              | 1,209 |               | 1,352
|                             |  |              |       |               |       |              |       |               |      
|Net interest income          |  |              | 1,880 |               | 1,987 |              | 1,998 |               | 2,117
|Provision for loan losses    |  |              | 60    |               | 82    |              | 65    |               | 23   
|Noninterest income           |  |              | 549   |               | 637   |              | 655   |               | 555  
|Noninterest expense          |  |              | 1,699 |               | 1,781 |              | 1,831 |               | 1,855
|Income tax expense           |  |              | 193   |               | 224   |              | 229   |               | 230  
|                             |  |              |       |               |       |              |       |               |      
|Net income                   |  | $            | 477   |               | 537   |              | 528   |               | 564  
|                             |  |              |       |               |       |              |       |               |      
|Per share data:              |  |              |       |               |       |              |       |               |      
|Basic net income per share   |  | $            | 0.33  |               | 0.37  |              | 0.36  |               | 0.39 
|Diluted net income per share |  |              | 0.32  |               | 0.36  |              | 0.36  |               | 0.38 
|Cash dividends per share     |  |              | 0.12  |               | 0.12  |              | 0.12  |               | 0.13 
|Book value per share         |  |              | 15.25 |               | 15.60 |              | 15.75 |               | 15.91
|                             | 
|                             |  | 2004        
|                             |  | Firstquarter |       | Secondquarter |       | Thirdquarter |       | Fourthquarter
|Income statement data:       |  |              |       |               |       |              |       |               |      
|Interest income              |  | $            | 2,657 |               | 2,637 |              | 2,761 |               | 2,847
|Interest expense             |  |              | 849   |               | 829   |              | 852   |               | 972  
|                             |  |              |       |               |       |              |       |               |      
|Net interest income          |  |              | 1,808 |               | 1,808 |              | 1,909 |               | 1,875
|Provision for loan losses    |  |              | 108   |               | 55    |              | 40    |               | 20   
|Noninterest income           |  |              | 570   |               | 565   |              | 592   |               | 528  
|Noninterest expense          |  |              | 1,658 |               | 1,622 |              | 1,817 |               | 1,804
|Income tax expense           |  |              | 172   |               | 201   |              | 185   |               | 154  
|                             |  |              |       |               |       |              |       |               |      
|Net income                   |  | $            | 440   |               | 495   |              | 459   |               | 425  
|                             |  |              |       |               |       |              |       |               |      
|Per share data:              |  |              |       |               |       |              |       |               |      
|Basic net income per share   |  | $            | 0.30  |               | 0.35  |              | 0.31  |               | 0.29 
|Diluted net income per share |  |              | 0.30  |               | 0.34  |              | 0.31  |               | 0.28 
|Cash dividends per share     |  |              | 0.11  |               | 0.11  |              | 0.11  |               | 0.12 
|Book value per share         |  |              | 14.98 |               | 14.82 |              | 15.18 |               | 15.24



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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Pinnacle Bankshares Corporation

Altavista, Virginia

We have audited the accompanying
consolidated balance sheets of Pinnacle Bankshares Corporation and subsidiary as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in stockholders equity and comprehensive income, and cash flows for
each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Banks management. Our responsibility is to express an opinion on these consolidated financial
statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material
respects, the financial position of Pinnacle Bankshares Corporation and subsidiary as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,
2006, in conformity with accounting principles generally accepted in the United States of America.

LOGO

Raleigh, North Carolina

February 23, 2007



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Shareholder Information

PERFORMANCE GRAPH

The graph below
compares total returns assuming reinvestment of dividends of Pinnacle Bankshares Common Stock, the NASDAQ Market Index, and an Industry Peer Group Index. The graph assumes $100 invested on December 31, 2001 in Pinnacle Bankshares Corporation
Common Stock and in each of the indices. In 2006, the financial holding companies in the SIC Code Index consisted of 245 banks with the same standard industry code of 6022 as Pinnacle Bankshares Corporation.

COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN*

AMONG PINNACLE BANKSHARES CORPORATION,

NASDAQ MARKET INDEX AND SIC CODE INDEX

LOGO

*ASSUMES $100 INVESTED ON DEC. 31, 2001

ASSUMES DIVIDEND REINVESTED

FISCAL YEAR ENDING DEC. 31, 2006



|                         |  |                                                 |  |        |  |        |  |        |  |        |  |       
|------------------------ |  | ----------------------------------------------- |  | ------ |  | ------ |  | ------ |  | ------ |  | ------
|                         |  | Cumulative Total Returns For Fiscal Year Ending
|                         |  | 2001                                            |  | 2002   |  | 2003   |  | 2004   |  | 2005   |  | 2006  
|Pinnacle Bankshares Corp |  | 100.00                                          |  | 118.11 |  | 145.33 |  | 162.20 |  | 174.57 |  | 188.83
|SIC Code Index 6022      |  | 100.00                                          |  | 93.67  |  | 122.15 |  | 132.84 |  | 130.62 |  | 148.64
|NASDAQ Market Index      |  | 100.00                                          |  | 69.75  |  | 104.88 |  | 113.70 |  | 116.19 |  | 128.12



60



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PINNACLE BANKSHARES CORPORATION

AND SUBSIDIARY

Shareholder Information

Annual Meeting

The 2007
Annual Meeting of Shareholders will be held on April 10, 2007, at 11:30 a.m. at the Fellowship Hall of Altavista Presbyterian Church, located at 707 Broad Street, Altavista, Virginia.

Market for Common Equity and Related Stockholder Matters

The Companys Common Stock is quoted on the OTC Bulletin Board. The following table presents the high and low bid prices per share of the Common Stock, as reported on the OTC Bulletin Board, and dividend
information of the Company for the quarters presented. The high and low bid prices of the Common Stock presented below reflect inter-dealer prices and do not include retail markups, markdowns or commissions, and may not represent actual
transactions.



|               |  |      |       |      |   |           |  |      |      |     |   |           |  |   |       |  |   |     
|-------------- |  | ---- | ----- | ---- | - | --------- |  | ---- | ---- | --- | - | --------- |  | - | ----- |  | - | ----
|               |  | 2006 |       | 2005
|               |  | High |       | Low  |   | Dividends |  | High |      | Low |   | Dividends
|First Quarter  |  | $    | 22.00 |      | $ | 21.00     |  | $    | 0.13 |     | $ | 23.00     |  | $ | 19.10 |  | $ | 0.12
|               |  |      |       |      |   |          
|Second Quarter |  | $    | 23.00 |      | $ | 21.05     |  | $    | 0.13 |     | $ | 22.00     |  | $ | 19.25 |  | $ | 0.12
|               |  |      |       |      |   |          
|Third Quarter  |  | $    | 22.00 |      | $ | 20.05     |  | $    | 0.14 |     | $ | 21.00     |  | $ | 19.00 |  | $ | 0.12
|               |  |      |       |      |   |          
|Fourth Quarter |  | $    | 25.40 |      | $ | 20.75     |  | $    | 0.15 |     | $ | 21.00     |  | $ | 19.01 |  | $ | 0.13

Each share of Common Stock is entitled to participate equally in dividends, which are payable as
and when determined by the Board of Directors after consideration of the earnings, general economic conditions, the financial condition of the business and other factors as might be appropriate. The Companys ability to pay dividends is
dependent upon its receipt of dividends from its subsidiary. Prior approval from the Comptroller of the Currency is required if the total of all dividends declared by a national bank, including the proposed dividend, in any calendar year will exceed
the sum of the Banks net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. This limitation has not had a material impact on the Banks ability to declare
dividends during 2006 and 2005 and is not expected to have a material impact during 2007.

As of December 31, 2006, there were
approximately 384 shareholders of record of Bankshares Common Stock.

Requests for Information

Requests for information about the Company should be directed to Bryan M. Lemley, Secretary, Treasurer and Chief Financial Officer, P.O. Box 29,
Altavista, Virginia 24517, telephone (434) 369-3000. A copy of the Companys Annual Report on Form 10-K for the year ended December 31, 2006, will be furnished without charge to shareholders upon written request after
March 31, 2007.

Shareholders seeking information regarding lost certificates and dividends should contact Registrar and Transfer
Company in Cranford, New Jersey, telephone (800) 368-5948. Please submit address changes in writing to:



| |  |                                 |  | 
| |  | ------------------------------- |  | 
| |  | Registrar and Transfer Company  |  | 
| |  | Investor Relations Department   |  | 
| |  | 10 Commerce Drive               |  | 
| |  | Cranford, New Jersey 07016-9982 |  | 



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LOGO

622 Broad Street

Post Office Box 29

Altavista, Virginia 24517

(434) 369-3000