an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. 

## Financial Condition 

During the year ended December 31, 2010, total assets decreased by $30.8 million (4.6%), to $631.1 million, with interest-earning assets decreasing by $25.3 million (4.1%). At December 31, 2010, interest earning assets totaled $586.0 million and represented 92.9% of total assets. Loans totaled $418.7 million and represented 71.4% of interest-earning assets, 66.3% of total assets and 80.5% of total deposits. 

The loan portfolio, which is the Bancorp’s largest asset, is a significant source of both interest and fee income. The Bancorp’s lending strategy emphasizes quality growth, product diversification, and competitive and profitable pricing. The loan portfolio includes $152.9 million (36.5%) in residential real estate loans, $138.5 million (33.1%) in commercial real estate loans, $46.4 million (11.1%) in construction and land development loans, $61.7 million (14.7%) in commercial business loans, $10.4 million (2.5%) in government and other loans, $7.6 million (1.8%) in multifamily loans, $0.8 million (0.2%) in consumer loans, and $0.4 million (0.1%) in loans held for sale. Adjustable rate loans comprised 40.7% of total loans at year-end. 

During 2010, loan balances decreased by $40.6 million (8.8%), with commercial real estate loan balances increasing, while construction and development, residential real estate, government, multifamily, consumer, and loans held for sale balances decreased. The decrease in loans during the year is partially the result of management’s interest rate risk reduction strategy of selling fixed rate mortgage loans to the secondary market. 

The Bancorp is primarily a portfolio lender. Mortgage banking activities are generally limited to the sale of fixed rate mortgage loans with contractual maturities greater than 15 years. However, as a result of the low interest rate envi- ronment, during 2010, management sold newly originated fixed rate mortgage loans with maturities ranging from 10 to 30 years in an effort to minimize future interest rate risk. These loans are identified as held for sale when originated and sold, on a case-by-case basis, in the secondary market. During 2010, the Bancorp sold $36.3 million in newly origi- nated fixed rate mortgage loans, compared to $49.4 million during 2009. During the current year, the continued loan sale activity was a result of the Federal Reserve’s sustained effort to maintain a low interest rate environment. Lower long-term interest rates also created mortgage loan refinance opportunities for borrowers within the Bancorp’s market area. In addition, during the fourth quarter of 2010, the Bancorp conducted a $5.1 million one-time sale of portfolio fixed rate mortgage loans, which were sold to reduce interest rate risk. Net gains realized from mortgage loan sales totaled $1.3 million for 2010, compared to $1.1 million for 2009. At December 31, 2010, the Bancorp had $422 thousand in loans that were classified as held for sale. 

The allowance for loan losses (ALL) is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses, and decreased by charge-offs, less recoveries. A loan is charged off against the allowance by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur. The determination of the amounts of the ALL and provi- sions for loan losses are based on management’s current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability as of the reporting date. The appropriateness of the current year provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that reviews the Bancorp’s current credit risk within the loan portfolio and identifies the required allowance for loan losses given the current risk estimates. 

Historically, the Bancorp has successfully originated commercial real estate loans within its primary lending area. 

However, beginning in the fourth quarter of 2005, in a response to a decrease in local loan demand and in an effort to reduce the potential credit risk associated with geographic concentrations, a strategy was implemented to purchase commercial real estate participation loans outside of the Bancorp’s primary lending area. The strategy to purchase these commercial real estate participation loans was limited to 10% of the Bancorp’s loan portfolio. The Bancorp’s management discontinued the strategy during the third quarter of 2007. As of December 31, 2010, the Bancorp’s commercial real estate participation loan portfolio carried an aggregate balance of $28.9 million. Of the $28.9 million in commercial real estate participation loans, $9.0 million has been purchased within the Bancorp’s primary lending area and $19.9 million outside of the primary lending area. 

At December 31, 2010, $14.5 million, or 50.2%, of the Bancorp’s commercial real estate participation loans have been internally classified as substandard and have been placed on non-accrual status. Of the $14.5 million in substandard commercial real estate participation loans placed on non-accrual status, $12.1 million are located outside of the Bancorp’s primary lending area. The discussion in the paragraphs that follow regarding non-performing loans, internally classified loans and impaired loans include loans from the Bancorp’s commercial real estate participation loan portfolio. 

For all of its commercial real estate participation loans, the Bancorp’s management requires that the lead lenders obtain external appraisals to determine the fair value of the underlying collateral for any collateral dependent loans. 

The Bancorp’s management requires current external appraisals when entering into a new lending relationship or when events have occurred that materially change the assumptions in the existing appraisal. The lead lenders receive external appraisals from qualified appraisal firms that have expertise in valuing commercial properties and are able to comply with the required scope of the engagement. After the lead lender receives the external appraisal and performs its compliance review, the appraisal is forwarded to the Bancorp for review. The Bancorp’s management validates the external appraisal by conducting an in-house review by 

