UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended June 30, 2012

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

For the Transition Period from to

Commission file number 000-53655

TOUCHMARK BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Georgia		20-8746061
(State or other jurisdiction		(I.R.S. Employer
of incorporation)		Identification No.)

3651 Old Milton Parkway

Alpharetta, Georgia 30005

(Address of principal executive offices)

(770) 407-6700

(Registrant’s telephone number)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x YES o NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer o

Non-accelerated filer o		Smaller reporting company x
(Do not check if a smaller reporting company)

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

Indicate the number of shares outstanding of each of the registrant’s classes of common equity, as of the latest practicable date: 3,465,391 shares of common stock, par value $.01 per share, outstanding as of August 14, 2012.

Table of Contents

INDEX

			Page

Part I. Financial Information

	Item 1. Financial Statements (unaudited)		3

		Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011	3

		Condensed Consolidated Statements of Income (Loss) for the Three and Six Months Ended June 30, 2012 and 2011	4

		Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011	5

		Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011	6

		Notes to Condensed Consolidated Financial Statements	8

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		31

	Item 3. Quantitative and Qualitative Disclosures About Market Risk		40

	Item 4. Controls and Procedures		40

Part II. Other Information			41

	Item 6. Exhibits		41

	SIGNATURES		42

	EXHIBIT INDEX		43

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

JUNE 30, 2012 AND DECEMBER 31, 2011

	(Unaudited)
	June 30,			December 31,
	2012			2011
ASSETS

Cash and due from banks	$	5,310,259		$	2,509,157
Federal funds sold	—			325,000
Interest-bearing accounts with other banks	7,029,785			6,729,905
Investment securities	27,643,388			36,134,645
Restricted stock	1,710,100			1,478,500
Loans held for sale	248,658			248,658
Loans, less allowance for loan losses of $1,830,086 and $1,745,400, respectively	78,608,189			74,268,936
Accrued interest receivable	388,708			434,178
Premises and equipment	2,409,026			2,486,685
Foreclosed real estate	4,922,300			5,375,473
Land held for sale	2,409,023			2,409,023
Other assets	218,084			200,806
Total assets	$	130,897,520		$	132,600,966

LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities:
Deposits:
Non-interest bearing demand	$	7,106,627		$	9,119,354
Interest-bearing	82,281,566			85,197,277
Total deposits	89,388,193			94,316,631
Accrued interest payable	29,979			36,011
Federal Home Loan Bank advances	15,250,000			12,500,000
Other liabilities	465,953			523,263
Total liabilities	105,134,125			107,375,905

Shareholders’ Equity:
Preferred stock, no par value, 10,000,000 shares authorized, none issued	—			—
Common stock, $.01 par value, 50,000,000 shares authorized, 3,465,391 issued and outstanding	34,654			34,654
Paid in capital	36,215,170			36,189,165
Accumulated deficit	(10,813,456		)	(11,428,518		)
Accumulated other comprehensive income	327,027			429,760
Total shareholders’ equity	25,763,395			25,225,061

Total liabilities and shareholders’ equity	$	130,897,520		$	132,600,966

See accompanying notes to the condensed consolidated financial statements

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

(UNAUDITED)

	Three Months			Three Months			Six Months			Six Months
	Ended			Ended			Ended			Ended
	June 30,			June 30,			June 30,			June 30,
	2012			2011			2012			2011
Interest income:
Loans, including fees	$	1,244,334		$	1,200,574		$	2,455,780		$	2,388,372
Investment income	181,018			369,850			397,519			760,347
Federal funds sold	341			349			521			606
Total interest income	1,425,693			1,570,773			2,853,820			3,149,325

Interest expense:
Deposits	191,092			305,580			403,137			663,089
Federal Home Loan Bank advances	80,542			69,704			148,660			139,566
Other borrowings	—			869			521			4,484
Total interest expense	271,634			376,153			552,318			807,139

Net interest income	1,154,059			1,194,620			2,301,502			2,342,186
Provision for loan losses	300,000			209,563			375,000			209,563
Net interest income after provision for loan losses	854,059			985,057			1,926,502			2,132,623

Noninterest income:
Service charges on deposit accounts and other fees	9,909			12,832			19,679			26,754
Gain (loss) on sale of securities available for sale	157,348			(3,485		)	197,533			60,073
Gain on sale of foreclosed real estate	14,400			—			54,988			—
Gain on sale of SBA loans	245,104			191,575			721,700			479,789
Loss on fair value mark of derivative instrument	(1,451		)	(51,510		)	(8,759		)	(42,454		)
Other noninterest income	91,807			11,954			170,621			22,845
Total noninterest income	517,117			161,366			1,155,762			547,007

Noninterest expense:
Salaries and employee benefits	624,377			708,730			1,246,878			1,411,637
Occupancy and equipment	157,047			152,037			309,304			304,538
Other operating expense	494,783			536,626			911,020			1,023,349
Total noninterest expense	1,276,207			1,397,393			2,467,202			2,739,524

Net income (loss)	$	94,969		$	(250,970	)	$	615,062		$	(59,894	)

Basic earnings (loss) per share	$	0.03		$	(0.07	)	$	0.18		$	(0.02	)
Diluted earnings (loss) per share	$	0.03		$	(0.07	)	$	0.18		$	(0.02	)
Dividends per share	$	—		$	—		$	—		$	—

See accompanying notes to the condensed consolidated financial statements

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011

(UNAUDITED)

	Three Months			Three Months			Six Months			Six Months
	Ended			Ended			Ended			Ended
	June 30,			June 30,			June 30,			June 30,
	2012			2011			2012			2011
Net income (loss)	$	94,969		$	(250,970	)	$	615,062		$	(59,894	)
Other comprehensive income (loss):
Unrealized holding gains arising during the period	141,560			1,073,612			44,200			1,041,424
Reclassification adjustment for (gain) loss realized in net income (loss)	(157,348		)	3,485			(197,533		)	(60,073		)
Tax effect	5,210			(355,441		)	50,600			(323,845		)
Other comprehensive income (loss):	(10,578		)	721,656			(102,733		)	657,506
Comprehensive income	$	84,391		$	470,686		$	512,329		$	597,612

See accompanying notes to the condensed consolidated financial statements

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2012 AND 2011

(UNAUDITED)

	Six Months			Six Months
	Ended			Ended
	June 30,			June 30,
	2012			2011
Cash flow from operating activities:
Net income (loss)	$	615,062		$	(59,894	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	131,541			142,199
Net amortization	277,013			125,892
Provision for loan losses	375,000			209,563
Gain on sale of securities available for sale	(197,533		)	(60,073		)
Gain on sale of SBA loans	(721,700		)	(479,789		)
Gain on sale of foreclosed real estate	(54,988		)	—
Stock compensation expense	26,005			50,280
Decrease in interest receivable	45,470			102,681
Decrease in interest payable	(6,032		)	(40,980		)
Decrease (increase) in other assets	(17,278		)	154,514
Increase (decrease) in other liabilities	(6,710		)	278,147

Net cash provided by operating activities	465,850			422,540

Cash flow from investing activities:
Decrease (increase) in federal funds sold, net	325,000			(125,000		)
Increase in interest bearing accounts	(299,880		)	(1,531,937		)
Purchase of securities available for sale	(7,054,977		)	(9,728,675		)
Proceeds from paydowns, calls and maturities of securities available for sale	6,813,307			4,640,936
Proceeds from sales of securities available for sale	8,500,114			11,274,281
Purchase of restricted stock	(231,600		)	(750		)
Proceeds from sale of foreclosed real estate	1,566,004			17,713
Loan originations and collections, net	(5,050,396		)	8,305,488
Purchase of premises and equipment	(53,882		)	(16,263		)

Net cash provided by investing activities	4,513,690			12,835,793

See accompanying notes to the condensed consolidated financial statements

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2012 AND 2011

(UNAUDITED)

	Six Months			Six Months
	Ended			Ended
	June 30,			June 30,
	2012			2011
Cash flow from financing activities:
Net decrease in deposits	(4,928,438		)	(11,667,293		)
Repayment of secured borrowings	—			(2,027,311		)
Proceeds from Federal Home Loan Bank advances	2,750,000			1,100,000

Net cash used by financing activities	(2,178,438		)	(12,594,604		)

Net change in cash	2,801,102			663,729

Cash at the beginning of the period	2,509,157			1,220,785

Cash at the end of the period	$	5,310,259		$	1,884,514

Supplemental disclosures of cash flow information - Interest paid	$	558,350		$	848,119

Non cash activities:
Transfer of loan principal to foreclosed real estate	$	1,057,843		$	3,185,000

See accompanying notes to the condensed consolidated financial statements

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. BASIS OF PRESENTATION:

The consolidated financial information included for Touchmark Bancshares, Inc. herein is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods. These statements should be read in conjunction with the financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

The results of operations for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year.

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Reporting Entity and Nature of Operations

Touchmark Bancshares, Inc. (the “Company”, “we”, “us” or “our”), a Georgia corporation, was established on April 3, 2007 for the purpose of organizing and managing Touchmark National Bank, (the “Bank”). The Company is a one-bank holding company with respect to its subsidiary, Touchmark National Bank, which is organized as a national bank. The Bank, which is headquartered in Fulton County, Georgia, began operations on January 28, 2008 with the purpose of providing community banking services to Gwinnett County, Dekalb, north Fulton and south Forsyth counties and surrounding areas in the State of Georgia.

Basis of Accounting: The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, shareholders’ equity and net income. Actual results may differ significantly from those estimates. The Company uses the accrual basis of accounting by recognizing revenues when they are earned and expenses in the period incurred, without regard to the time of receipt or payment of cash.

Allowance for Loan Losses: Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The Company’s allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio. Due to our limited operating history, the loans in our loan portfolio and our lending relationships are of relatively recent origin. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process known as seasoning. As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio is relatively new, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher or lower than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition. The allowance for loan losses is increased by provisions for loan losses and by recoveries of loans previously charged-off and reduced by loans charged-off.

The process of reviewing the adequacy of the allowance for loan losses requires management to make numerous judgments and assumptions about current events and subjective judgments, including the likelihood of loan repayment, risk evaluation, historical losses, extrapolation of historical losses of similar banks, and similar judgments and assumptions. If these assumptions prove to be incorrect, charge-offs in future periods could exceed the allowance for loan losses.

See accompanying notes to the condensed consolidated financial statements

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

The allowance for loan losses may consist of specific, general, and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the collateral value, discounted cash flows or the observable market price of the impaired loan is lower than the carrying value of the loan. General allowances are established for non-impaired loans. These loans are assigned a loan category, and the allocated allowance for loan losses is determined based upon the loss percentage factors that correspond to each loan category.

The general reserves are determined based on consideration of historic and peer loss data, and the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

Construction and development loans — Loans in this segment primarily include real estate development loans for which payment is derived from sale of the property as well as construction projects in which the property will ultimately be used by the borrower. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.

Real estate - mortgage — The Company generally does not originate loans with a loan-to-value ratio greater than 85 percent and does not make subprime loans. Loans in this segment are dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates, will have an effect on the credit quality in the segment.

Commercial real estate — Loans in this segment are primarily income-producing properties. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Management monitors the cash flows of these loans.

Commercial and industrial loans — Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

Other loans — Loans in this segment are made to individuals and are generally secured by personal property and/or personal guaranties. Repayment is expected from the cash flows of the individual which is affected by the overall economy with specific regards to the unemployment rate.

Stock Based Compensation: The Company has adopted the fair value recognition provisions of Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) 718, Stock Compensation. Upon issuance of the Director and Organizer warrants, compensation cost was recognized in the consolidated financial statements of the Company for all share-based payments granted, based on the grant date fair value as estimated in accordance with the provisions of FASB ASC 718, which requires recognition of expense equal to the fair value of the warrant over the vesting period of the warrant. There were no options or warrants granted during the first six months of 2012.

The fair value of each warrant grant is estimated on the date of grant using the Black-Scholes option-pricing model. Expected volatility for the period has been determined based on expected volatility of similar entities. The expected term of warrants granted is based on the short-cut method and represents the period of time that the warrants are expected to be outstanding. Expected dividends are based on dividend trends and the market price of the Company’s stock at grant date. The risk-free rate for periods within the contractual life of the warrant is based on the U.S. Treasury yield curve in effect at the time of grant.

The Company recorded no compensation expense related to the warrants for the six months ended June 30, 2012 and 2011, respectively.

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

At June 30, 2012, there was no unrecognized compensation cost related to warrants. The weighted average remaining contractual life of the warrants outstanding as of June 30, 2012 was approximately 5.51 years. The Company had 469,167 warrants exercisable as of June 30, 2012.

Through June 30, 2012, the Company has issued 219,822 options to purchase common stock to employees of the Company or the Bank and the Company has issued 10,000 options to purchase common stock to a new director. There were no options issued during the first six months of 2012. During the first six months of 2011, 11,500 options were issued. Upon issuance of options, compensation cost is recognized in the consolidated financial statements of the Company for all options granted, based on the grant date fair value as estimated in accordance with the provisions of FASB ASC 718, which requires recognition of expense equal to the fair value of the options over the vesting period of the options.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the assumptions listed in the table below. Expected volatility for the period has been determined based on expected volatility of similar entities. The expected term of options granted is based on the short-cut method and represents the period of time that the options are expected to be outstanding. Expected dividends are based on dividend trends and the market price of the Company’s stock at grant date. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

	Six Months Ended
	June 30, 2011
Risk-free interest rate	2.53		%
Expected life (years)	6.50
Expected volatility	56.10		%
Expected dividends	0.00		%
Expected forfeiture rate	28.99		%
Weighted average fair value of options granted	$	2.85

The Company recorded stock-based compensation expense related to the options of $26,005 and $50,280 during the six months ended June 30, 2012 and 2011, respectively.

At June 30, 2012, there was $26,006 of unrecognized compensation cost related to options outstanding, which is expected to be recognized over a weighted-average period of 0.72 years. The weighted average remaining contractual life of the options outstanding as of June 30, 2012 was approximately 7.46 years. The Company had 95,283 options exercisable as of June 30, 2012.

Income Taxes: Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the differences between the book and tax bases of the various balance sheet assets and liabilities, and gives current recognition to changes in tax rates and laws. A valuation allowance for deferred tax assets is required when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realization of the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income (in the near-term based on current projections), and tax planning strategies.

Statement of Cash Flows: The statement of cash flows was prepared using the indirect method. Under this method, net income was reconciled to net cash flows provided by operating activities by adjusting for the effects of operating activities.

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

2. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Cash and Cash Equivalents: For purposes of presentation in the statement of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption “cash and due from banks.” Cash flows from interest-bearing accounts with other banks, deposits, federal funds purchased and sold, and originations, renewals and extensions of loans are reported net.

Loans Purchased: Discounts and premiums on loans purchased by the Company are amortized based upon specific identification over the contractual life of the loan.

3. INVESTMENT SECURITIES:

The amortized cost, gross unrealized gains and losses, and estimated fair value of investment securities at June 30, 2012 and December 31, 2011, are summarized as follows:

	Amortized		Unrealized		Unrealized			Fair
June 30, 2012:	Cost		Gains		Losses			Value
State and municipal securities	$	4,194,881	$	149,369	$	—		$	4,344,250
Mortgage-backed Government- sponsored enterprise (GSE)* residential	22,960,407		371,395		(32,664		)	23,299,138

	$	27,155,288	$	520,764	$	(32,664	)	$	27,643,388

	Amortized		Unrealized		Unrealized			Fair
December 31, 2011:	Cost		Gains		Losses			Value
U.S. Government-sponsored enterprises (GSEs)*	$	2,000,000	$	12,163	$	—		$	2,012,163
State and municipal securities	4,140,071		233,654		—			4,373,725
Mortgage-backed GSE residential	29,353,141		420,639		(25,023		)	29,748,757

	$	35,493,212	$	666,456	$	(25,023	)	$	36,134,645

* Such as Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Federal Home Loan Banks

The amortized cost and estimated fair value of investment securities at June 30, 2012, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

3. INVESTMENT SECURITIES:

	Amortized		Fair
	Cost		Value

Due in one year or less	$	7,604,228	$	7,693,471
Due after one year but less than five years	12,501,618		12,684,036
Due after five years but less than ten years	4,569,412		4,659,638
Due after ten years	2,480,030		2,606,243
	$	27,155,288	$	27,643,388

For the purpose of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

During the period ended June 30, 2012, the Company had gross gains on sales of securities of $200,589 and gross losses on sales of securities of $3,056. The Company had gross gains on sales of securities of $89,323 and gross losses on sales of securities of $29,250 during the period ended June 30, 2011.

Information pertaining to securities with gross unrealized losses at June 30, 2012 and December 31, 2011 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

	Less than					More than
	Twelve Months					Twelve Months				Total
	Gross			Estimated		Gross		Estimated		Gross			Estimated
	Unrealized			Fair		Unrealized		Fair		Unrealized			Fair
June 30, 2012:	Losses			Value		Losses		Value		Losses			Value
Mortgage-backed GSE residential	$	(32,664	)	$	6,830,416	$	—	$	—	$	(32,664	)	$	6,830,416

	$	(32,664	)	$	6,830,416	$	—	$	—	$	(32,664	)	$	6,830,416

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

	Less than					More than
	Twelve Months					Twelve Months				Total
	Gross			Estimated		Gross		Estimated		Gross			Estimated
	Unrealized			Fair		Unrealized		Fair		Unrealized			Fair
December 31, 2011:	Losses			Value		Losses		Value		Losses			Value
Mortgage-backed GSE residential	$	(25,023	)	$	6,383,330	$	—	$	—	$	(25,023	)	$	6,383,330

	$	(25,023	)	$	6,383,330	$	—	$	—	$	(25,023	)	$	6,383,330

3. INVESTMENT SECURITIES:

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

At June 30, 2012, eight debt securities have unrealized losses with aggregate depreciation of 0.48% from the Company’s amortized cost basis. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. Although some of the issuers have shown declines in earnings and/or a weakened financial condition as a result of the weakened economy, no credit issues have been identified that cause management to believe the declines in market value are other than temporary. As management has the ability to hold debt securities until maturity, or for the foreseeable future, no declines are deemed to be other than temporary.

Mortgage-backed securities GSE residential. The unrealized losses on the Company’s investment in eight mortgage-backed securities GSE residential were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost bases of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and because it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

The composition of loans as of June 30, 2012 and December 31, 2011 is summarized as follows:

	June 30, 2012			December 31, 2011
Construction and development	$	8,009,368		$	9,255,356
Real estate - mortgage	7,389,638			7,676,754
Commercial real estate	59,859,995			51,405,126
Commercial and industrial	4,972,875			7,282,319
Other	304,720			516,849

	80,536,596			76,136,404

Unearned loan origination income	(98,321		)	(122,068		)
Allowance for loan losses	(1,830,086		)	(1,745,400		)

Loans, net	$	78,608,189		$	74,268,936

For purposes of the disclosures required pursuant to the adoption of amendments to ASC 310, the loan portfolio was disaggregated into segments. A portfolio segment is defined as the level at which an entity develops and documents a systematic method for determining its allowance for loan losses. There are five loan portfolio segments that include construction and development, real estate — mortgage, commercial real estate, commercial and industrial, and other.

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

Construction and Development

Loans in this segment include real estate development loans for which the source of repayment is the sale of the property as well as construction projects in which the property will ultimately be used by the borrower. Total construction and development loans as of June 30, 2012 were 9.9% of the total loan portfolio.

Real Estate - Mortgage

These are loans secured by real estate mortgages. Total real estate mortgage loans as of June 30, 2012 were 9.2% of the total loan portfolio.

Commercial Real Estate

The commercial real estate portfolio represents the largest category of the Company’s loan portfolio. These loans are primarily income-producing properties and are dependent upon the borrower’s cash flow. Total commercial real estate loans as of June 30, 2012 were 74.3% of the total loan portfolio.

Commercial and Industrial

Loans in this segment are made to businesses and are generally secured by business assets. Total commercial and industrial loans as of June 30, 2012 were 6.2% of the total loan portfolio.

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

Other

Loans in this segment are made to individuals and are secured by personal assets or unsecured. Total other loans as of June 30, 2012 were 0.4% of the total loan portfolio.

Changes in the allowance for loan losses for the periods ended June 30, 2012 and 2011 are as follows:

	June 30,			June 30,
	2012			2011
Balance, beginning of period	$	1,745,400		$	3,462,375
Provision for loan losses	375,000			209,563
Loans charged off	(290,314		)	(206,162		)
Recoveries	—			—

Balance, end of period	$	1,830,086		$	3,465,776

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

The allowance for loan losses as of June 30, 2012, by portfolio segment, is as follows:

	Construction						Commercial		Commercial
	and			Real Estate -			Real		and
	Development			Mortgage			Estate		Industrial			Other			Unallocated			Total
Allowance for loan losses:
For the three months ended June 30, 2012
Beginning balance	$	704,602		$	129,552		$	647,548	$	82,375		$	4,459		$	83,811		$	1,652,347
Charge-offs	—			(122,261		)	—		—			—			—			(122,261		)
Recoveries	—			—			—		—			—			—			—
Provision	(254,632		)	128,668			475,074		27,266			(178		)	(76,198		)	300,000
Ending balance	$	449,970		$	135,959		$	1,122,622	$	109,641		$	4,281		$	7,613		$	1,830,086

For the six months ended June 30, 2012
Beginning balance	$	564,176		$	145,288		$	572,763	$	145,418		$	28,438		$	289,317		$	1,745,400
Charge-offs	—			(122,261		)	—		—			(168,053		)	—			(290,314		)
Recoveries	—			—			—		—			—			—			—
Provision	(114,206		)	112,932			549,859		(35,777		)	143,896			(281,704		)	375,000
Ending balance	$	449,970		$	135,959		$	1,122,622	$	109,641		$	4,281		$	7,613		$	1,830,086

Ending balance: individually evaluated for impairment	$	—		$	—		$	227,710	$	—		$	—		$	—		$	227,710

Ending balance: collectively evaluated for impairment	$	449,970		$	135,959		$	894,912	$	109,641		$	4,281		$	7,613		$	1,602,376

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—	$	—		$	—		$	—		$	—

Loans:
Ending Balance	$	8,009,368		$	7,389,638		$	59,859,995	$	4,972,875		$	304,720		$	—		$	80,536,596

Ending balance: individually evaluated for impairment	$	—		$	—		$	986,127	$	—		$	—		$	—		$	986,127

Ending balance: collectively evaluated for impairment	$	8,009,368		$	7,389,638		$	58,873,868	$	4,972,875		$	304,720		$	—		$	79,550,469

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—	$	—		$	—		$	—		$	—

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

The allowance for loan losses as of December 31, 2011, by portfolio segment, is as follows:

	Construction					Commercial			Commercial
	and			Real Estate -		Real			and
	Development			Mortgage		Estate			Industrial			Other			Unallocated		Total
Allowance for loan losses:
Beginning balance	$	1,259,996		$	68,905	$	1,933,810		$	156,457		$	43,207		$	—	$	3,462,375
Charge-offs	(93,190		)	—		(1,833,348		)	—			—			—		(1,926,538		)
Recoveries	—			—		—			—			—			—		—
Provision	(602,630		)	76,383		472,301			(11,039		)	(14,769		)	289,317		209,563
Ending balance	$	564,176		$	145,288	$	572,763		$	145,418		$	28,438		$	289,317	$	1,745,400

Ending balance: individually evaluated for impairment	$	—		$	—	$	—		$	—		$	—		$	—	$	—

Ending balance: collectively evaluated for impairment	$	564,176		$	145,288	$	572,763		$	145,418		$	28,438		$	289,317	$	1,745,400

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—	$	—		$	—		$	—		$	—	$	—

Loans:
Ending Balance	$	9,255,356		$	7,676,754	$	51,405,126		$	7,282,319		$	516,849		$	—	$	76,136,404

Ending balance: individually evaluated for impairment	$	—		$	—	$	1,251,803		$	—		$	—		$	—	$	1,251,803

Ending balance: collectively evaluated for impairment	$	9,255,356		$	7,676,754	$	50,153,323		$	7,282,319		$	516,849		$	—	$	74,884,601

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—	$	—		$	—		$	—		$	—	$	—

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

The allowance for loan losses as of June 30, 2011, by portfolio segment, is as follows:

	Construction						Commercial			Commercial
	and			Real Estate -			Real			and
	Development			Mortgage			Estate			Industrial			Other			Total
Allowance for loan losses:
For the three months ended June 30, 2011
Beginning balance	$	1,178,351		$	27,494		$	1,469,584		$	740,424		$	46,522		$	3,462,375
Charge-offs	(93,300		)	—			(112,862		)	—			—			(206,162		)
Recoveries	—			—			—			—			—			—
Provision	(24,439		)	(20,969		)	272,734			(16,428		)	(1,335		)	209,563
Reallocation	(99,130		)	48,253			44,565			47,183			(40,871		)	—
Ending balance	$	961,482		$	54,778		$	1,674,021		$	771,179		$	4,316		$	3,465,776

For the six months ended June 30, 2011
Beginning balance	$	1,259,996		$	68,905		$	1,933,810		$	156,457		$	43,207		$	3,462,375
Charge-offs	(93,300		)	—			(112,862		)	—			—			(206,162		)
Recoveries	—			—			—			—			—			—
Provision	(24,439		)	(20,969		)	272,734			(16,428		)	(1,335		)	209,563
Reallocation	(180,775		)	6,842			(419,661		)	631,150			(37,556		)	—
Ending balance	$	961,482		$	54,778		$	1,674,021		$	771,179		$	4,316		$	3,465,776

Ending balance: individually evaluated for impairment	$	—		$	—		$	1,346,653		$	—		$	—		$	1,346,653

Ending balance: collectively evaluated for impairment	$	961,482		$	54,778		$	327,368		$	771,179		$	4,316		$	2,119,123

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—

Loans:
Ending Balance	$	9,005,401		$	8,299,559		$	51,351,381		$	6,502,254		$	528,382		$	75,686,977

Ending balance: individually evaluated for impairment	$	—		$	—		$	4,552,903		$	—		$	—		$	4,552,903

Ending balance: collectively evaluated for impairment	$	9,005,401		$	8,299,559		$	46,798,478		$	6,502,254		$	528,382		$	71,134,074

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	518,995		$	—		$	—		$	518,995

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

Historically, the Company used a combination of peer loss history and its own loss history for its various loan types in arriving at its allowance for loan and lease loss (ALLL). Management revisited the Company’s methodology after the second quarter of 2011 for the purposes of determining the most effective means for arriving at an appropriate allowance for loan loss balance commensurate with the Company’s size and level of complexity.

Management concluded that a loss migration analysis based on the Company’s internal loan risk rating system provides a more precise and accurate estimate of potential losses within the loan portfolio. The basis for determining the appropriateness of the allowance for loan losses under the revised methodology focuses on the Company’s internal risk rated loss experience over a rolling eight quarter period as opposed to reliance on peer group data.

Impaired loans as of June 30, 2012 and December 31, 2011, by portfolio segment, are as follows:

	Unpaid		Recorded		Recorded
	Total		Investment		Investment		Total
	Principal		With No		With		Recorded		Related
As of June 30, 2012	Balance		Allowance		Allowance		Investment		Allowance

Construction and development	$	—	$	—	$	—	$	—	$	—
Real estate - mortgage	—		—		—		—		—
Commercial real estate	1,244,922		158,417		827,710		986,127		227,710
Commercial and industrial	—		—		—		—		—
Other	—		—		—		—		—
Total	$	1,244,922	$	158,417	$	827,710	$	986,127	$	227,710

As of December 31, 2011

Construction and development	$	—	$	—	$	—	$	—	$	—
Real estate - mortgage	—		—		—		—		—
Commercial real estate	3,925,636		1,251,803		—		1,251,803		—
Commercial and industrial	—		—		—		—		—
Other	—		—		—		—		—
Total	$	3,925,636	$	1,251,803	$	—	$	1,251,803	$	—

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

	Three Months Ended				Six Months Ended				Year Ended
	June 30, 2012				June 30, 2012				December 31, 2011
	Average				Average				Average
	Recorded		Income		Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized		Investment		Recognized

Construction and development	$	—	$	—	$	—	$	—	$	—	$	—
Real estate - mortgage	—		—		—		—		—		—
Commercial real estate	572,273		—		798,783		—		1,495,372		—
Commercial and industrial	—		—		—		—		—		—
Other	—		—		—		—		—		—

Total	$	572,273	$	—	$	798,783	$	—	$	1,495,372	$	—

	Three Months Ended				Six Months Ended
	June 30, 2011				June 30, 2011
	Average				Average
	Recorded		Income		Recorded		Income
	Investment		Recognized		Investment		Recognized

Construction and development	$	1,021,650	$	—	$	1,021,650	$	—
Real estate - mortgage	—		—		—		—
Commercial real estate	5,236,834		—		5,342,959		—
Commercial and industrial	—		—		—		—
Other	—		—		—		—

Total	$	6,258,484	$	—	$	6,364,609	$	—

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

A primary credit quality indicator for financial institutions is delinquent balances. Following are the delinquent amounts, by portfolio segment, as of June 30, 2012 and December 31, 2011:

					Accruing
					Greater						Total
					Than 90		Total Accruing				Financing
June 30, 2012	Current		30 - 89 Days		Days		Past Due		Non-accrual		Receivables

Construction and development	$	8,009,368	$	—	$	—	$	—	$	—	$	8,009,368
Real estate - mortgage	7,389,638		—		—		—		—		7,389,638
Commercial real estate	58,873,868		—		—		—		986,127		59,859,995
Commercial and industrial	4,955,590		17,285		—		17,285		—		4,972,875
Other	304,720		—		—		—		—		304,720

December 31, 2011

Construction and development	$	9,255,356	$	—	$	—	$	—	$	—	$	9,255,356
Real estate - mortgage	7,676,754		—		—		—		—		7,676,754
Commercial real estate	50,153,323		—		—		—		1,251,803		51,405,126
Commercial and industrial	7,282,319		—		—		—		—		7,282,319
Other	516,849		—		—		—		—		516,849

The Company utilizes a nine grade internal loan rating system for its loan portfolio as follows:

· Loans rated 1-4 (Pass) - Loans in these categories have low to average risk.

· Loans rated 5 (Internal Watch List) - These assets raise some concern due to either prior financial or collateral problems, or recent developing conditions, and thus warrant closer monitoring and review than “pass” assets.

· Loans rated 6 (Special Mention) - These assets constitute an undue and unwarranted credit risk but not to the point of justifying a substandard classification.

· Loans rated 7 (Substandard) - A substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.

· Loans rated 8 (Doubtful) - An asset classified as doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

· Loans rated 9 (Loss) - Assets classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

The following presents the Company’s loans by risk rating as of June 30, 2012 and December 31, 2011:

	Construction
	and		Real Estate -		Commercial		Commercial
June 30, 2012	Development		Mortgage		Real Estate		and Industrial		Other		Total
Rating:
1-4 (Pass)	$	1,021,539	$	7,389,638	$	58,873,867	$	4,955,590	$	289,801	$	72,530,435
5 (Internal Watch List)	4,047,829		—		—		17,285		14,919		4,080,033
6 (Special Mention)	2,940,000		—		—		—		—		2,940,000
7 (Substandard)	—		—		986,128		—		—		986,128
8 (Doubtful)	—		—		—		—		—		—
9 (Loss)	—		—		—		—		—		—
Total	$	8,009,368	$	7,389,638	$	59,859,995	$	4,972,875	$	304,720	$	80,536,596

	Construction
	and		Real Estate -		Commercial		Commercial
December 31, 2011	Development		Mortgage		Real Estate		and Industrial		Other		Total
Rating:
1-4 (Pass)	$	5,437,275	$	7,676,754	$	49,305,957	$	7,243,622	$	335,130	$	69,998,738
5 (Internal Watch List)	3,818,081		—		—		38,697		181,719		4,038,497
6 (Special Mention)	—		—		847,366		—		—		847,366
7 (Substandard)	—		—		1,251,803		—		—		1,251,803
8 (Doubtful)	—		—		—		—		—		—
9 (Loss)	—		—		—		—		—		—
Total	$	9,255,356	$	7,676,754	$	51,405,126	$	7,282,319	$	516,849	$	76,136,404

In this current real estate environment it has become more common to restructure or modify the terms of certain loans under certain conditions (i.e. troubled debt restructures or “TDRs”). In those circumstances it may be beneficial to restructure the terms of a loan and work with the borrower for the benefit of both parties, versus forcing the property into foreclosure and having to dispose of it in an unfavorable real estate market. When we have modified the terms of a loan, we usually either reduce or defer payments for a period of time. We have not forgiven any material principal amounts on any loan modifications to date. We have approximately $158,418 of TDRs, and $158,418 have been placed on nonaccrual status. There were no troubled debt restructurings which occurred during the six months ended June 30, 2012.

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

Our TDRs which are performing in accordance with the restructured terms are presented below.

	June 30,
Toubled debt restructured loans (“TDRs”)	2012

Performing TDRs	$	—
Non-performing TDRs	158,418

Total TDRs	$	158,418

TDRs as of June 30, 2012 quantified by loan type classified separately as accruing and non-accrual are presented in the table below.

TDRs	Accruing		Non-Accrual		Total

Construction and development	$	—	$	—	$	—
Real estate - mortgage	—		—		—
Commercial real estate	—		158,418		158,418
Commercial and industrial	—		—		—
Other	—		—		—

Total TDRs	$	—	$	158,418	$	158,418

Our policy is to return non-accrual TDR loans to accrual status when all the principal and interest amounts contractually due, pursuant to its modified terms, are brought current and future payments are reasonably assured. Our policy also considers payment history of the borrower, but is not dependent upon a specific number of payments. The Company recorded no specific reserve as of June 30, 2012 and recognized no partial charge offs on the TDR loan described above during the period ended June 30, 2012.

Loans are modified to minimize loan losses when we believe the modification will improve the borrower’s financial condition and ability to repay the loan. We typically do not forgive principal. We generally either defer, or decrease monthly payments for a temporary period of time. A summary of the types of concessions made are presented in the table below.

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

	June 30,
Type of Concession	2012

Deferred payments for 90 days	$	158,418

Total TDRs	$	158,418

4. LOANS AND ALLOWANCE FOR LOAN LOSSES:

There have been no loans modified as TDRs within the past twelve months for which there was a payment default within the six month period ended June 30, 2012.

During the six months ended June 30, 2012, the Company purchased loans with outstanding principal balances at the time of purchase of $8,085,324. The Company paid a premium of $343,626 at the time of the purchase which will be amortized over the contractual lives of the individual loans. The unamortized premium as of June 30, 2012 was $318,067.

5. FAIR VALUE:

Financial Instruments Measured at Fair Value

ASC Topic 820, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FASB ASC 820-10 applies reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

ASC 820-10 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, GAAP establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchanges rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Table of Contents

TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

5. FAIR VALUE:

Financial Instruments Measured at Fair Value (continued)

The tables below present the Company’s assets measured at fair value on a recurring basis as of June 30, 2012 and December 31, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable
Assets as of	Identical Assets		Inputs		Inputs
June 30, 2012:	(Level 1)		(Level 2)		(Level 3)		Total

Investment securities available-for-sale	$	—	$	27,643,388	$	—	$	27,643,388
Derivative instruments	—		—		681		681
Loans held for sale	—		—		248,658		248,658
	$	—	$	27,643,388	$	249,339	$	27,892,727

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable
Assets as of	Identical Assets		Inputs		Inputs
December 31, 2011:	(Level 1)		(Level 2)		(Level 3)		Total

Investment securities available-for-sale	$	—	$	36,134,645	$	—	$	36,134,645
Derivative instruments	—		—		9,440		9,440
Loans held for sale	—		—		248,658		248,658
	$	—	$	36,134,645	$	258,098	$	36,392,743

Securities classified as available-for-sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. The investments in the Company’s portfolio are generally not quoted on an exchange but are actively traded in the secondary institutional markets.

The Company’s policy is to recognize transfers between levels as of the actual date of the event or change in circumstances. For the period ended June 30, 2012 and year ended December 31, 2011, there were no transfers between Level 1 and Level 2.

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

5. FAIR VALUE:

Financial Instruments Measured at Fair Value (continued)

The derivative instrument held by the Company is reported at fair value utilizing Level 3 inputs. The valuation of this instrument is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual term of the derivative, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates fell below (or rise above) the strike rate of the floors (or caps). The variable interest rates used in the calculation of projected receipts on the floor (cap) are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. To comply with the provisions of ASC 820, the Company incorporates unobservable credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Loans held-for-sale are measured at the lower of cost or fair value. On loans held for sale, collateral includes commercial real estate. The fair value of loans held for sale is evaluated on an on-going basis by monitoring what secondary markets are offering for loans and portfolios with similar characteristics. The unobservable inputs considered in the valuation of loans held for sale are the marketability of the loans held and probability of default.

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs.

	Loans Held		Derivative
	For Sale		Instruments
Balance, December 31, 2011	$	248,658	$	9,440
Mark to market loss included in noninterest income	—		(8,759		)
Balance, June 30, 2012	$	248,658	$	681

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

5. FAIR VALUE:

Financial Instruments Measured at Fair Value (continued)

The following table presents the assets that are measured at fair value on a non-recurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial position at June 30, 2012 and December 31, 2011.

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Total
	Identical Assets		Inputs		Inputs		Gains
	(Level 1)		(Level 2)		(Level 3)		(Losses)

Assets as of June 30, 2012
Impaired loans	$	—	$	—	$	600,000	$	(227,710	)
Foreclosed assets	$	—	$	—	$	—	$	—

Assets as of December 31, 2011

Impaired loans	$	—	$	—	$	1,251,803	$	(503,833	)
Foreclosed assets	$	—	$	—	$	1,995,000	$	—

Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. Fair value is measured based on the value of the collateral securing these loans and is classified as Level 3 in the fair value hierarchy. Collateral may include real estate, or business assets including equipment, inventory and accounts receivable. The value of real estate collateral is determined based on an appraisal by qualified licensed appraisers hired by the Company. The value of business equipment is based on an appraisal by qualified licensed appraisers hired by the Company, if significant, or the equipment’s net book value on the business’s financial statements. Inventory and accounts receivable collateral are valued based on independent field examiner review or aging reports. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and the client’s business. Such considerations and adjustments constitute the unobservable inputs for valuation. These unobservable inputs based on changes in market conditions and knowledge of collateral can vary widely. Impaired loans are evaluated on at least a quarterly basis for additional impairment and adjusted accordingly.

Foreclosed real estate is adjusted to fair value upon transfer of the loans to foreclosed real estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the collateral value. When the fair value of the collateral is based on an observable market price or a current appraised value, the foreclosed asset is recorded as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed real estate as nonrecurring Level 3. The valuation of foreclosed real estate is currently based on the unobservable input of management’s evaluation of market conditions and the resulting impact on real estate values. This input can

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

range widely depending on the underlying evaluation of market conditions.

5. FAIR VALUE:

Fair Value of Financial Instruments

The following methods and assumptions that were used by the Company in estimating fair values of financial instruments are disclosed herein:

Cash, federal funds sold, and interest bearing deposits with other banks. The carrying amounts of cash and short-term instruments approximate their fair value due to the relatively short period to maturity of instruments.

Investment securities. Fair values for securities, excluding restricted equity securities, are based predominately on quoted market prices. If quoted market prices are not available, fair values are based on quoted market prices of similar instruments.

Restricted stock. The carrying values of restricted equity securities approximate fair values.

Loans held for sale. Loans held for sale are carried at the lower of cost or market value. Fair value is based on what secondary markets are offering for loans with similar characteristics.

Loans receivable. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Deposit liabilities. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal Home Loan Bank (“FHLB”) advances and other borrowings. Fair values of fixed rate FHLB advances and other borrowings are estimated using discounted cash flow analyses based on the Bank’s current incremental borrowing rates for similar types of borrowing arrangements. The carrying values of variable rate FHLB advances and other borrowings approximate fair value.

Accrued interest. The carrying amounts of accrued interest approximate their fair values.

Derivative instruments. The fair values of these instruments are determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.

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TOUCHMARK BANCSHARES, INC.

AND SUBSIDIARY

Notes to Condensed Consolidated Financial Statements

(unaudited)

5. FAIR VALUE:

Fair Value of Financial Instruments (continued)

The Company’s carrying amounts and estimated fair values of financial instruments as of June 30, 2012 and December 31, 2011 (in thousands) were as follows:

	June 30, 2012				December 31, 2011
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Assets:
Cash and due from banks	$	5,310	$	5,310	$	2,509	$	2,509
Federal funds sold	—		—		325		325
Interest-bearing accounts with other banks	7,030		7,030		6,730		6,730
Securities	27,643		27,643		36,135		36,135
Restricted stock	1,710		1,710		1,479		1,479
Loans held for sale	249		249		249		249
Loans receivable	78,608		78,837		74,269		75,602
Accrued interest receivable	389		389		434		434
Derivative instruments	1

Touchmark Bancshares, Inc. 10-Q