UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

(Mark One)

[X]		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934: For the fiscal year ended December 31, 2011
		OR
[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .

	Commission File No. 000-09785

TRI CITY BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Wisconsin	39-1158740
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

6400 South 27th Street
Oak Creek, Wisconsin	53154
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code	(414) 761-1610

Securities registered pursuant to Section 12(b) of the Act: NONE

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

$1.00 par value common stock

(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes [ ] No [ X ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes [ ] No [ X ]

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ X ]

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

Large accelerated filer __ Accelerated filer __ Non-accelerated filer [do not check if smaller reporting company] __

Smaller reporting company X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [ ] No [ X ]

The aggregate market value of the shares held by non-affiliates computed by reference to the price at which the common equity was last sold as of June 30, 2011 was approximately $56,589,884. As of March 18, 2012, 8,904,915 shares of common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Document	Incorporated in

Annual report to shareholders for fiscal year ended December 31, 2011	Parts II and IV
Proxy statement for annual meeting of shareholders to be held on June 13, 2012	Part III

Form 10-K Table of Contents

PART I		PAGE #

Item 1	Business	3
Item 1A	Risk Factors	10
Item 1B	Unresolved Staff Comments	15
Item 2	Properties	15
Item 3	Legal Proceedings	15
Item 4	Mine Safety Disclosures	15

PART II

Item 5	Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	16
Item 6	Selected Financial Data	16
Item 7	Management's Discussion and Analysis of Financial Condition and Results of Operation	16
Item 7A	Quantitative and Qualitative Disclosures About Market Risk	18
Item 8	Financial Statements and Supplementary Data	18
Item 9 Item 9A	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures	18 19
Item 9B	Other Information	19

PART III

Item 10	Directors, Executive Officers and Corporate Governance	20
Item 11	Executive Compensation	20
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	20
Item 13	Certain Relationships and Related Transactions, and Director Independence	20
Item 14	Principal Accountant Fees and Services	20

PART IV

Item 15	Exhibits and Financial Statement Schedules	21
	Signatures	25

PART I

Item 1.

BUSINESS

THE REGISTRANT

Tri City Bankshares Corporation (the “Registrant”), a Wisconsin corporation, was organized in 1970 for the purpose of acquiring the outstanding shares of Tri City National Bank (the “Bank”). The Bank is a wholly owned subsidiary of the Registrant.

At December 31, 2011, the Registrant had total assets of $1.2 billion and total stockholders’ equity of $122.0 million.

THE BANK

The Bank was organized as a Wisconsin state-chartered bank in 1963 and converted to a national bank charter in 1969. The Bank is supervised by the Office of the Comptroller of the Currency (“OCC”) and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). The Bank conducts business out of its main office located at 6400 South 27th Street, Oak Creek, Wisconsin. The Bank maintains 43 additional offices throughout Southeastern Wisconsin. Services are provided in person at the Bank’s offices and electronically using the Bank’s internet banking services.

The Bank provides a full range of consumer and commercial banking services to individuals and businesses. The basic services offered include demand deposit accounts, money market deposit accounts, NOW accounts, time deposits, safe deposit services, direct deposits, notary services, money orders, night depository, travelers’ checks, cashier’s checks, savings bonds and secured and unsecured consumer, commercial, installment, real estate and mortgage loans. The Bank offers automated teller machine (“ATM”) services and debit cards. In addition, the Bank maintains an investment portfolio consisting primarily of U.S. government sponsored agency and state and political subdivision securities.

As is the case with banking institutions generally, the Bank derives its revenues from interest on its loan and investment portfolios and fee income related to loans and deposits. The sale of alternative investment products provides additional fee income. The source of funds for the lending activities are deposits, repayment of loans, maturity of investment securities and short-term borrowing through correspondent banking relationships and the Federal Reserve Bank of Chicago. Principal expenses are the interest paid on deposits and borrowings, and operating and general administrative expenses.

THE ACQUISITION

Effective October 23, 2009 (the “Acquisition Date”), the Bank acquired substantially all of the assets and assumed substantially all of the liabilities, including the insured and uninsured deposits, of Bank of Elmwood (the “Acquired Bank”), a Wisconsin state-chartered bank headquartered in Racine, Wisconsin, from the FDIC as receiver for the Acquired Bank (the “Acquisition”).

LENDING ACTIVITIES

The Bank offers a range of lending services including secured and unsecured consumer, commercial, installment, real estate and mortgage loans to individuals, small businesses and other organizations that are located in or conduct a substantial portion of their business in the Bank’s market area. The Bank’s total loans as of December 31, 2011 were $707.8 million, or approximately 58.2% of total assets. Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan, and are further subject to competitive pressures, the cost and availability of funds and government policy.

The Bank maintains a comprehensive loan policy that establishes guidelines with respect to all categories of lending activity. The policy establishes lending authority for each individual loan officer, the officer loan committee and the Board of Directors. All loans to directors and executive officers are approved by the Board of Directors with the interested director abstaining. The Bank’s loans are concentrated in three major areas: real estate loans, commercial loans and consumer loans. The Bank’s lending strategy is focused on the development and maintenance of a high quality loan portfolio.

The Bank’s residential real estate loans are collateralized by mortgages and consist primarily of loans to individuals for the purchase and improvement of real estate and for the purchase of residential lots and construction of single-family residential units. The Bank’s residential real estate loans generally are repayable in monthly installments based on up to a thirty-year amortization schedule.

Commercial loans include loans to individuals and small businesses, including loans for working capital, machinery and equipment purchases, premises and equipment acquisitions, purchase, improvement and investment in real estate and real estate development, and other business needs. Commercial lines of credit are typically for a one-year term. Other commercial loans with terms or amortization schedules of longer than one year will normally carry interest rates that vary based on the term and will become payable in full, and are generally refinanced, in two to four years. Commercial loans typically entail a thorough analysis of the borrower, its industry, current and projected economic conditions and other factors. The Bank typically requires commercial borrowers to provide annual financial statements and requires appraisals or evaluations in connection with the loans collateralized by real estate. The Bank typically requires personal guarantees from principals involved with closely-held corporate borrowers.

The Bank’s consumer loan portfolio consists primarily of loans to individuals for various personal, household or family purposes, payable on an installment basis. The loans are generally for terms of five years or less and are collateralized by liens on various personal assets of the borrower. For additional information regarding the Bank’s loans, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loans” and Note 6 of Notes to Consolidated Financial Statements, both of which are contained in the Registrant’s 2011 Annual Report to Shareholders (“2011 Shareholder Report”), which discussion is incorporated herein by reference.

DEPOSIT ACTIVITIES

Deposits are the major source of the Bank’s funds for lending and other investment activities. The majority of the Bank’s deposits are generated from the Bank’s market area. Generally, the Bank attempts to maintain the rates paid on deposits at a competitive level in its market area. The Bank considers the majority of its regular savings, investor checking, demand, NOW and money market deposit accounts (which comprised 83.2% of the Bank’s total deposits at December 31, 2011) to be core deposits. Approximately 16.8% of the Bank’s deposits at December 31, 2011 were certificates of deposit (“CDs”). CDs of $100,000 and over made up approximately 40.3% of the Bank’s total CDs at December 31, 2011. For additional information regarding the Bank’s deposit accounts, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Deposits” and Note 14 of Notes to Consolidated Financial Statements, both of which are contained in the 2011 Shareholder Report, which discussion is incorporated herein by reference.

INVESTMENTS

The Bank invests a portion of its assets in obligations of U.S. government-sponsored entities, (the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Federal Home Loan Bank), state, county and municipal obligations and federal funds (“Fed Funds”) sold. While the Federal Home Loan Bank is a U.S. government-sponsored entity, the Bank’s investments in Federal Home Loan Bank securities are not guaranteed by the U.S. Government. The investments are managed in relation to the loan demand and deposit growth and are generally used to provide for the investment of excess funds at reduced yields and risks relative to yields and risks of the loan portfolio, while providing liquidity to fund increases in loan demand or to offset fluctuations in deposits. For additional information regarding the Bank’s investments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Investment Security Portfolio” and Note 5 of Notes to Consolidated Financial Statements, both of which are contained in the 2011 Shareholder Report to Shareholders (“2011 Shareholder Report”), which discussion is incorporated herein by reference.

SUPERVISION AND REGULATION

The Registrant and the Bank are subject to extensive supervision and regulation by federal and state agencies. The following is a summary of the regulatory agencies, statutes and related regulations that have, or could have, a material impact on the Registrant’s business. This discussion is qualified in its entirety by reference to such regulations and statutes.

Bank Holding Company

The Registrant is a legal entity separate and distinct from its subsidiaries and affiliated companies. As a registered bank holding company, the Registrant is subject to regulation under the Bank Holding Company Act of 1956, as amended (the “BHCA”), as amended by the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted on July 21, 2010, and other legislation The Registrant is further subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).

The Federal Reserve Board has extensive enforcement authority over bank holding companies. In general, the Federal Reserve Board may initiate enforcement actions for violations of laws and regulations and unsafe or unsound practices. The Registrant is also required to file reports and other information with the Federal Reserve Board regarding its business operations and those of its subsidiaries. Under Federal Reserve Board policy and regulations and the Dodd-Frank Act, a bank holding company must serve as a source of strength for its subsidiary banks. The Federal Reserve Board may require, and has required in the past, a holding company to contribute additional capital to an undercapitalized subsidiary bank.

Subsidiary Bank

The Bank is subject to regulation and examination primarily by the OCC and secondarily by the FDIC. The regulatory structure includes:

Real estate lending standards, which provide guidelines concerning loan-to-value ratios for various types of real estate loans;

Risk-based capital rules, including accounting for interest rate risk, concentration of credit risk and the risks posed by non-traditional activities;

Rules requiring depository institutions to develop and implement internal procedures to evaluate and control credit and settlement exposure to their correspondent banks;

Rules restricting types and amounts of equity investments; and

Rules addressing various safety and soundness issues, including operational and managerial standards for asset quality, earnings and compensation standards.

The Bank is subject to certain restrictions imposed by the Federal Reserve Act and Federal Reserve Board regulations regarding such matters as the maintenance of reserves against deposits, extensions of credit to the bank holding company or any of its subsidiaries, investments in the stock or other securities of the bank holding company or its subsidiaries and the taking of such stock or securities as collateral for loans to any borrower.

Non-Banking Subsidiaries

The Registrant’s non-banking subsidiaries are also subject to regulation by the Federal Reserve Board and other applicable federal and state agencies.

Other Regulatory Agencies

Securities and Exchange Commission (“SEC”). The Registrant is also under the jurisdiction of the SEC and certain state securities commissions for matters relating to the offering and sale of its securities. The Registrant is subject to disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as administered by the SEC.

The FDIC/Depository Insurance Fund. The FDIC is an independent federal agency which insures the deposits, up to prescribed statutory limits, of federally-insured banks and savings associations and safeguards the safety and soundness of the financial institution industry. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and subject to premium assessments to maintain the DIF.

The FDIC uses a risk-based assessment system that imposes insurance premiums on a four-tier risk matrix based upon a bank’s capital level and supervisory, or CAMELS, rating. Under the rules in effect through March 31, 2011, these rates were applied to the institution’s deposits. Well capitalized institutions that are financially sound with no more than a few minor weaknesses are assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risk to the DIF. A range of initial base assessment rates applies to each Risk Category, subject to adjustments based on an institution’s unsecured debt, secured liabilities and brokered deposits, such that the total base assessment rates after adjustments ranged from 7 to 24 basis points for Risk Category I, 17 to 43 basis points for Risk Category II, 27 to 58 basis points for Risk Category III, and 40 to 77.5 basis points for Risk Category IV.

As required by the Dodd-Frank Act, the FDIC has adopted rules effective April 1, 2011, under which insurance premium assessments are based on an institution’s total assets minus its tangible equity (defined as Tier 1 capital) instead of its deposits. Under these rules, an institution with total assets of less than $10 billion will be assigned to a Risk Category as described above, and a range of initial base assessment rates will apply to each category, subject to adjustment downward based on unsecured debt issued by the institution an, except for an institution in Risk Category I, adjusted upward if the institution’s brokered deposits exceed 10% of its domestic deposits, to produce total base assessment rates. Total base assessment rates range from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV, all subject to further adjustment upward if the institution holds more than a de minimis amount of unsecured debt issued by another FDIC-insured institution. The FDIC may increase or decrease its rates by 2 basis points without further rulemaking. In an emergency, the FDIC may also impose a special assessment.

On November 12, 2009, the FDIC issued new assessment regulations that required FDIC-insured institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. While the Bank’s full prepayment was made in December 2009, the quarterly amounts will not be reflected as a charge against earnings until the periods to which they apply.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to funds interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize a predecessor to the Deposit Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2019.

Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (“DRR”), that is, the ratio of the DIF to insured deposits. The FDIC has adopted a plan under which it will meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. The FDIC has not yet announced how it will implement this offset or how larger institutions will be affected by it.

On November 9, 2010 and January 18, 2011, the FDIC (as mandated by Section 343 of the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” as described below) adopted rules providing for unlimited deposit insurance for traditional noninterest-bearing transaction accounts and IOLTA accounts for two years starting December 31, 2010. This coverage applies to all insured deposit institutions, and there is no separate FDIC assessment for the insurance. Furthermore, this unlimited coverage is separate from, and in addition to, the coverage provided to depositors with respect to other accounts held at an insured depository institution.

The FDIC may terminate insurance coverage upon a finding that the insured institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition enacted or imposed by the institution’s regulatory agency.

The Dodd-Frank Act

On July 21, 2010, President Obama signed the Dodd-Frank Act into law, which resulted in sweeping changes in the regulation of financial institutions aimed at strengthening safety and soundness for the financial services sector. A summary of certain provisions of the Dodd-Frank Act is set forth below:

Increased Capital Standards and Enhanced Supervision. The federal banking agencies are required to establish minimum leverage and risk-based capital requirements for banks and bank holding companies. These new standards will be no lower than current regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, be higher when established by the agencies. The Dodd-Frank Act also increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.

Federal Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits and provides unlimited federal deposit insurance on non-interest bearing transaction accounts at all insured depository institutions until January 1, 2013. The Dodd-Frank Act also changes the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminates the ceiling on the size of the DIF and increases the floor of the size of the DIF.

The Consumer Financial Protection Bureau (“Bureau”). The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Bureau, responsible for implementing, examining and, for large financial institutions, enforcing compliance with federal consumer financial laws. Because the Bank has under $10 billion in total assets, however, the OCC will still continue to examine it at the federal level for compliance with such laws.

Interest on Demand Deposit Accounts. The Dodd-Frank Act repealed the prohibition on the payment of interest on demand deposit accounts effective July 21, 2011, thereby permitting depository institutions to pay interest on business checking and other accounts.

Branching. Allows de novo interstate branching by banks.

Source of Strength. Requires all bank holding companies to serve as a source of financial strength to their depository institution subsidiaries in the event such subsidiaries suffer from financial distress.

Mortgage Reform. The Dodd-Frank Act provides for mortgage reform addressing a customer’s ability to repay, restricts variable-rate lending by requiring the ability to repay to be determined for variable rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and makes more loans subject to requirement for higher-cost loans, new disclosures and certain other restrictions.

The Registrant expects that many of the requirements called for in the Dodd-Frank Act will be implemented over time, and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of the Registrant’s business activities, require changes to certain of its business practices, impose upon it more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect its business. These changes may also require the Registrant to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

Bank Holding Company Act

In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto.

The BHCA and other federal and state statutes regulate acquisitions of commercial banks. The BHCA requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition by a bank holding company of more than 5% of the voting shares of a commercial bank or its parent holding company. Under the Federal Bank Merger Act, the prior approval of the OCC is required for a national bank to merge with, or purchase the assets or assume the deposits of, another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, the applicant’s performance record under the Community Reinvestment Act and fair housing laws and the effectiveness of the subject organizations in combating money laundering activities.

In 1999, Congress enacted the GLB Act. Among other things, the GLB Act repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the BHCA to permit bank holding companies that qualify as “financial holding companies” to engage in a broad list of “financial activities,” and any non-financial activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines is “complementary” to a financial activity and poses no substantial risk to the safety and soundness of depository institutions or the financial system. The GLB Act treats various lending, insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities as financial in nature for this purpose. Under the GLB Act, a bank holding company may become certified as a financial holding company by filing a notice with the Federal Reserve Board, together with a certification that the bank holding company meets certain criteria, including capital, management, and Community Reinvestment Act requirements. The Registrant has chosen not to become certified as a financial holding company at this time. The Registrant may reconsider this determination in the future.

Capital Adequacy and Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, identifies five capital categories for insured depository institutions and requires the respective federal regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. The federal regulatory agencies, including the Federal Reserve Board and the OCC, have adopted substantially similar regulatory capital guidelines and regulations consistent with the requirements of FDICIA, as well as established a system of prompt corrective action to resolve certain of the problems of undercapitalized institutions. This system is based on five capital level categories for insured depository institutions: “well-capitalized,” “adequately capitalized,” “under capitalized,” “significantly under capitalized” and “critically under capitalized.”

The Federal Reserve Board’s risk-based capital guidelines establish a two-tier capital framework. Tier 1 capital generally consists of common stockholders’ equity, retained earnings, a limited amount of qualifying perpetual preferred stock, qualifying trust preferred securities and noncontrolling interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangibles. Tier 2 capital generally consists of certain hybrid capital instruments and perpetual debt, mandatory convertible debt securities and a limited amount of subordinated debt, qualifying perpetual preferred stock, loan loss allowance, and unrealized holding gains on certain equity securities. The sum of Tier 1 and Tier 2 capital represents qualifying total capital, at least 50% of which must consist of Tier 1 capital.

Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. For bank holding companies, generally the minimum Tier 1 risk-based capital ratio is 4% and the minimum total risk-based capital ratio is 8%. The Federal Reserve Board’s leverage capital guidelines establish a minimum leverage ratio determined by dividing Tier 1 capital by adjusted average total assets. The minimum leverage ratio is 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. From time to time, the regulatory agencies may require the Registrant and the Bank to maintain capital above these minimum levels should certain conditions exist, such as deterioration of their financial condition or growth in assets, either actual or expected. Both the Registrant and the Bank were “well capitalized” under applicable regulatory guidelines as of both December 31, 2011 and 2010.

The Dodd-Frank Act includes certain provisions concerning the capital regulations of the United States banking regulators, which are often referred to as the “Collins Amendment.” These provisions are intended to subject bank holding companies to the same capital requirements as their bank subsidiaries and to eliminate or significantly reduce the use of hybrid capital instruments, especially trust preferred securities, as regulatory capital. The banking regulators must develop regulations setting minimum risk-based and leverage capital requirements for holding companies and banks on a consolidated basis that are no less stringent than the generally applicable requirements in effect for depository institutions under the prompt corrective action regulations. The banking regulators must also seek to make capital standards countercyclical so that the required levels of capital increase in times of economic expansion and decrease in times of economic contraction. The Dodd-Frank Act required these new capital regulations to be adopted by the Federal Reserve Board in final form by January 10, 2012. To date, however, no proposed regulations have been issued.

In December 2010 and January 2011, the Basel Committee on Banking Supervisions (“Basel Committee”) published the final texts of reforms on capital and liquidity generally referred to as “Basel III.” Although Basel III is intended to be implemented by participating countries for large, internationally active banks, its provisions are likely to be considered by United States banking regulators in developing new regulations applicable to other banks in the United States, including the Bank.

For banks in the United States, among the most significant provisions of Basel III concerning capital are the following:

A minimum ratio of common equity to risk-weighted assets reaching 4.5%, plus an additional 2.5% as a capital conservation buffer, by 2019 after a phase-in period.

A minimum ratio of Tier 1 capital to risk-weighted assets reaching 6.0% by 2019 after a phase-in period.

A minimum ratio of total capital to risk-weighted assets, plus the additional 2.5% capital conservation buffer, reaching 10.5% by 2019 after a phase-in period.

An additional countercyclical capital buffer to be imposed by applicable national banking regulators periodically at their discretion, with advance notice.

Restrictions on capital distributions and discretionary bonuses applicable when capital ratios fall within the buffer zone.

Deduction from common equity of deferred tax assets that depend on future profitability to be realized.

Increased capital requirements for counterparty credit risk relating to OTC derivatives, repos and securities financing activities.

For capital instruments issued on or after January 13, 2013 (other than common equity), a loss-absorbency requirement such that the instrument must be written off or converted to common equity if a trigger event occurs, either pursuant to applicable law or at the direction of the banking regulator. A trigger event is an event under which the banking entity would become nonviable without the write-off or conversion, or without an injection of capital from the public sector. The issuer must maintain authorization to issue the requisite shares of common equity if conversion were required.

The Basel III provisions on liquidity include complex criteria establishing a liquidity coverage ratio (“LCR”) and a net stable funding ratio (“NSFR”). The purpose of the LCR is to ensure that a bank maintains adequate unencumbered, high quality liquid assets to meet its liquidity needs for 30 days under a severe liquidity stress scenario. The purpose of the NSFR is to promote more medium and long-term funding of assets and activities, using a one-year horizon. Although Basel III is described as a “final text,” it is subject to the resolution of certain issues and to further guidance and modification, as well as to adoption by United States banking regulators, including decisions as to whether and to what extent it will apply to United States banks that are not large, internationally active banks.

For additional information regarding the Bank’s capital, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital” and Note 21 of Notes to Consolidated Financial Statements, both of which are contained in the Registrant’s 2011 Annual Report to Shareholders (“2011 Shareholder Report”), which discussion is incorporated by reference in Item 8 below.

Community Reinvestment Act

The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to do so by, among other things, providing credit to low and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and assigned ratings. As of December 31, 2011, the most recent performance evaluation by the OCC (conducted in September 2011) resulted in an overall rating of “satisfactory” for the Bank.

Dividend Restrictions

Current federal banking regulations impose restrictions on the Bank’s ability to pay dividends to the Registrant. These restrictions include a limit on the amount of dividends that may be paid in a given year without prior approval of the OCC and a prohibition on paying dividends that would cause the Bank’s total capital to be less than the required minimum levels under the risk-based capital requirements. The Bank’s regulators may prohibit the payment of dividends at any time if the regulators determine the dividends represent unsafe and/or unsound banking practices or reduce the Bank’s total capital below adequate levels.

The Registrant’s ability to pay dividends to its shareholders may also be restricted. Under current Federal Reserve Board policy, the Registrant is expected to act as a source of financial strength to, and commit resources to support, the Bank. Under this policy, the Federal Reserve Board may require the Registrant to contribute additional capital to the Bank, which could restrict the amount of cash available for dividends.

Even when the legal ability exists, the Registrant or the Bank may decide to limit the payment of dividends in order to retain earnings for corporate use.

Customer Privacy and Other Consumer Protections

The Registrant is subject to regulations limiting the ability of financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated party. The Registrant is also subject to numerous federal and state laws aimed at protecting consumers, including the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Bank Secrecy Act, the Community Reinvestment Act and the Fair Credit Reporting Act.

USA PATRIOT Act

The Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”) and related regulations, among other things, require financial institutions to establish programs specifying procedures for obtaining identifying information from customers and establishing enhanced due diligence policies, procedures and controls designed to detect and report suspicious activity. The Bank has established policies and procedures that the Registrant believes comply with the requirements of the USA PATRIOT Act.

Monetary Policy

The Federal Reserve Board regulates money and credit conditions and interest rates in order to influence general economic conditions primarily through open market operations in U.S. government securities, changes in the discount rate on bank borrowings, and changes in the reserve requirements against depository institutions’ deposits. These policies and regulations significantly affect the overall growth and distribution of loans, investments and deposits, as well as interest rates charged on loans and paid on deposits.

The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of financial institutions in the past and are expected to continue to have significant effects in the future. In view of the changing conditions in the economy, the money markets and the activities of monetary and fiscal authorities, the Registrant can make no definitive predictions as to future changes in interest rates, credit availability or deposit levels.

Other Future Legislation and Changes in Regulations.

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

COMPETITION

The banking industry is highly competitive. The Bank competes for loans, deposits and other financial services in Southeastern Wisconsin. In addition to local, regional and national banking competition in the markets it serves, the Bank competes with other financial institutions, money market and other mutual funds, insurance companies, brokerage companies and other non-depository financial services companies, including certain governmental organizations that may offer subsidized financing at lower rates than those offered by the Bank.

For well over a decade, the banking industry has been undergoing a restructuring process that is contributing to greater competition within the industry which the Registrant expects to continue for the foreseeable future. The restructuring has been caused by product and technological innovations in the financial services industry, deregulation of interest rates, and increased competition from foreign and nontraditional banking competitors, and has been characterized principally by the gradual erosion of geographic barriers to intrastate and interstate banking and the gradual expansion of investment and lending authorities for bank institutions.

EMPLOYEES

As of December 31, 2011, the Registrant employed 392 full-time employees and 123 part-time employees. The employees are not represented by a collective bargaining unit. The Registrant considers relations with employees to be good.

AVAILABLE INFORMATION

The Registrant maintains a website at www.tcnb.com. The Registrant makes available through its website, free of charge, copies of its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to the reports (“SEC Reports”), as soon as reasonably practicable after the Registrant electronically files those materials with, or furnishes them to, the Securities and Exchange Commission (the “SEC”). Materials filed by the Registrant with the SEC, can be read and copied at the SEC public reference room located at 100 F Street, N.E. Washington, D.C. 20549. Please call the SEC at 800-SEC-0330 for further information on the public reference rooms. The Registrant’s SEC filings will also be available to the public on the SEC’s website at http:/www.sec.gov. The Registrant’s SEC reports can also be accessed through the “About TCNB” link of its website. The Registrant’s web address is included as an inactive textual reference only and the information thereon shall not be deemed to be incorporated by reference in this Report. Any reference to an SEC report available on the Registrant’s website is qualified with reference to any later-dated SEC report, regardless of whether such later-dated SEC report is immediately available on the Registrant’s website.

Item 1A.

RISK FACTORS

Cautionary Statements Relating To Forward-Looking Information And Risk Factors.

This 2011 Annual Report on Form 10-K (the “2011 Form 10-K”) and the documents and materials incorporated herein, as well as other SEC reports filed by the Registrant, contain forward-looking statements, and the Registrant and its representatives may, from time to time, make written or verbal forward-looking statements. Forward-looking statements relate to developments, results, conditions or other events the Registrant expects or anticipates will occur in the future. The Registrant intends words such as "believes," "anticipates," "plans," "expects" and similar expressions to identify forward-looking statements. Without limiting the foregoing, those statements may relate to future economic or interest rate conditions, loan losses and allowances, loan and deposit growth, new branches and the competitive environment. Forward-looking statements are based on management's then current views and assumptions and, as a result, are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Any such forward-looking statements are qualified by the following important risk factors that could cause actual results to differ materially from those predicted by the forward-looking statements.

An investment in the Registrant's common stock carries certain risks. Investors should carefully consider the risks described below and other risks, which may be disclosed from time to time in the Registrant's SEC reports, before investing in the Registrant's securities.

RISKS RELATED TO THE REGISTRANT’S AND THE BANK’S BUSINESS

The Registrant and the Bank are affected by conditions in the financial markets and economic conditions generally.

The United States economy has been in a downward cycle since the end of 2007, which has been marked by reduced business activity across a wide range of industries and regions. Many businesses are experiencing serious difficulty due to the lack of consumer spending and the lack of liquidity in the credit markets. In addition, unemployment continues to be significant.

The financial services industry and the securities markets generally have been materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the resulting impact on sub-prime mortgages but has since spread to all mortgage and real estate asset classes.

The economic downturn has also resulted in the failure of a number of prominent financial institutions, resulting in further losses as a consequence of defaults on securities issued by them and defaults under contracts with such entities as counterparties. In addition, declining asset values, defaults on mortgages and consumer loans, the lack of market and investor confidence and other factors have all combined to cause rating agencies to lower credit ratings and to otherwise increase the cost and decrease the availability of liquidity. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining collateral values. Although the U.S. government, the Federal Reserve Board and other regulators took numerous steps in 2008 and 2009 to increase liquidity and to restore investor confidence, including investing in the equity of other banking organizations, asset values have continued to decline and access to liquidity continues to be very limited.

The Registrant and the Bank are subject to credit risks associated with the Bank’s lending activities.

There are inherent risks associated with the Bank’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where it operates, as well as those across the United States and abroad. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Bank is also subject to various laws and regulations that affect the Bank’s lending activities. Failure to comply with applicable laws and regulations could subject the Bank to regulatory enforcement action that could result in the assessment of significant civil money penalties against it.

The Bank seeks to mitigate the risks in its loan portfolio by adhering to specific underwriting practices. Although it believes that its underwriting criteria are appropriate for the various kinds of loans it makes, the Bank may incur losses on loans that meet its underwriting criteria, and these loans may exceed the amounts the Bank sets aside as reserves in the allowance for loan losses. Due to recent economic conditions affecting the real estate market, many lending institutions, including the Bank, have experienced in recent years declines in the performance of their loans, including construction, land development loans and land loans and loans have declined and may continue to decline. Further negative developments in the financial industry and credit markets may continue to adversely impact the Registrant’s and the Bank’s financial condition and results of operations.

Fluctuating interest rates impact the Bank’s results of operations and equity.

The results of operations for financial institutions may be materially and adversely affected by changes in prevailing economic conditions, including rapid changes in interest rates and the policies of regulatory authorities, including the monetary and fiscal policies of the Federal Reserve Board. Changes in the economic environment may influence the growth rate of loans and deposits, the quality of the loan portfolio and loan and deposit pricing. While the Bank has taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that such measures will be effective in avoiding undue interest rate risk. The Bank is unable to predict fluctuations of market interest rates, which are affected by many factors, including inflation, recession, a rise in unemployment, tightening money supply, and domestic and international disorder and instability in domestic and foreign financial markets.

The Bank’s profitability depends to a large extent upon its net interest income, which is the difference (or “spread”) between interest income received on interest earning assets, such as loans and investments, and interest expense paid on interest-bearing liabilities, such as deposits and borrowings. The Bank’s net interest spread and margin will be affected by general economic conditions and other factors that influence market interest rates and the Bank’s ability to respond to changes in such rates. At any given time, the Bank’s assets and liabilities will be such that they are affected differently by a given change in interest rates. As a result, an increase or decrease in rates could have a positive or negative effect on the Bank’s net income, capital and liquidity.

The mismatch between maturities and interest rate sensitivities of balance sheet items (i.e., interest-earning assets and interest-bearing liabilities) results in interest rate risk, which risk will change as the level of interest rates changes. The Bank’s liabilities consist primarily of deposits, which are either of a short-term maturity or have no stated maturity. These latter deposits consist of NOW accounts, demand accounts, savings accounts and money market accounts. These accounts typically can react more quickly to changes in market interest rates than the Bank’s assets because of the shorter maturity (or lack of maturity) and repricing characteristics of these deposits. Consequently, sharp increases or decreases in market interest rates may impact the Bank’s earnings negatively or positively, respectively.

To manage vulnerability to interest rate changes, the Bank’s management monitors the Bank’s interest rate risks. The Bank’s officers have established investment policies and procedures, which ultimately are reported to the Board of Directors. Management and the Board of Directors generally meet quarterly and review the Bank’s interest rate risk position, loan and securities repricing, current interest rates and programs for raising deposit-based maturity gaps, including retail and non-brokered deposits, and loan origination pipeline. The Bank’s assets and liabilities maturing and repricing within one year generally result in a positive one-year gap, which occurs when the level of assets estimated to mature and reprice within one year is greater than the level of liabilities estimated to mature and reprice within that same time frame. If interest rates were to decline significantly, and for a prolonged period, the Bank’s operating results could be adversely affected. Gap analysis attempts to estimate the Bank’s earnings sensitivity based on many assumptions, including, but not limited to, the impact of contractual repricing and maturity characteristics for rate-sensitive assets and liabilities.

Changes in interest rates will also affect the level of voluntary prepayments on the Bank’s loans resulting in the receipt of proceeds that the Bank may have to reinvest at a lower rate than the loan being prepaid. Finally, changes in interest rates can result in the flow of funds away from the banking institutions into investments in U.S. government and corporate securities, and other investment vehicles that, because of the absence of federal insurance premiums and reserve requirements, among other reasons, generally can pay higher rates of return than banking institutions.

The Bank is vulnerable because of the concentration of its business in a limited geographic area, and because of its focus on providing certain types of loan products to small to medium business customers.

Most of the Bank’s loans are to businesses and individuals in Wisconsin (and primarily in Milwaukee, Ozaukee, Racine, Kenosha and Waukesha Counties), and any general adverse change in the economic conditions prevailing in these areas could reduce the Bank’s growth rate, impair its ability to collect loans or attract deposits, and generally have an adverse impact on the results of operations and financial condition of the Bank. If these areas experience adverse economic, political or business conditions, the Bank would likely experience higher rates of loss and delinquency on its loans than if its loans were more geographically diverse.

One of the primary focal points of the Bank’s business strategy is serving the banking and financial services needs of small to medium-sized businesses in the Bank’s geographic region. Small to medium-sized businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions deteriorate in the Milwaukee, Ozaukee, Racine, Kenosha and Waukesha County regions of Wisconsin, the businesses of the Bank’s lending clients and their ability to repay outstanding loans may be negatively affected. As a consequence, the Bank’s results of operations and financial condition may be adversely affected.

The Bank offers fixed and adjustable interest rates on loans, with terms of up to 30 years. Although the majority of the residential mortgage loans that the Bank originates are fixed-rate mortgages, adjustable-rate mortgage (“ARM”) loans increase the responsiveness of the Bank’s loan portfolio to changes in market interest rates. However, because ARM loans are more responsive to changes in market interest rates than fixed-rate loans, ARM loans also increase the possibility of delinquencies in periods of high interest rates.

The Bank also originates loans collateralized by mortgages on commercial real estate and multi-family residential real estate. Since these loans usually are larger than one-to-four family residential mortgage loans, they generally involve greater risks than one-to-four family residential mortgage loans. In addition, since customers’ ability to repay these loans often is dependent on operating and managing those properties successfully, adverse conditions in the real estate market or the economy generally can impact repayment more severely than loans collateralized by one-to-four family residential properties. Moreover, the commercial real estate business is subject to downturns, overbuilding and local economic conditions.

The Bank also makes construction loans for residences and commercial buildings, as well as on unimproved property. While these loans, because of their shorter (1-3 year) terms, enable the Bank to increase the interest rate sensitivity of its loan portfolios and receive higher yields than those obtainable on permanent residential mortgage loans, the higher yields correspond to higher risk construction lending. These include risks associated generally with loans on the type of property collateralizing the loan. Moreover, commercial construction lending often involves disbursing substantial funds with repayment dependent largely on the success of the ultimate project instead of the borrower’s or guarantor’s ability to repay. Again, adverse conditions in the real estate market or the economy generally can impact repayment of commercial construction loans more severely than loans collateralized by one-to-four family residential properties.

The Bank operates in a highly regulated environment, which could increase its cost structure or have other negative impacts on its operations.

The Registrant, primarily through the Bank, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not the Registrant’s stockholders. These regulations affect the Registrant’s lending practices, capital structure, investment practice, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Other changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Registrant in substantial and unpredictable ways. Such changes could subject the Registrant to additional costs, limit the types of financial services and products the Registrant may offer and/or increase the ability of onon-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Registrant’s business, financial condition and results of operations. See the section captioned “Supervision and Regulation” included in Item 1. Business, which is located elsewhere in this 2011 Form 10-K.

If the Bank has significant loan losses, it would need to further increase its allowance for loan losses and its earnings would decrease.

The Bank maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Registrant to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of the Registrant’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the Registrant’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Furthermore, if charge-offs in future periods exceed the allowance for loan losses, the Registrant will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Registrant’s financial condition and results of operations.

The Bank may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Bank routinely executes transactions with counterparties in the financial services industry. The primary relationship the Bank maintains are with several correspondent banks which include trading, clearing and federal funds lines of credit.

The Bank is subject to environmental liability risk associated with collateral securing its real estate lending.

Because a significant portion of its loan portfolio is secured by real property, the Bank from time to time may find it necessary to foreclose on and take title to properties securing such loans. In doing so, there is a risk that hazardous or toxic substances could be found on those properties. If such substances are found, the Bank could be held liable for remediation costs, as well as for personal injury and property damage. The Bank could also be required to incur substantial expenses that could materially reduce the affected property’s value or limit its ability to use or sell the affected property. In addition, future environmental laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability in such circumstances. Although the Bank is careful to perform environmental reviews on properties prior to loan closing, such reviews might not detect all environmental hazards.

An increase in the competition in markets the Bank serves could negatively impact financial results.

The financial services industry is highly competitive. The Bank faces intense competition from financial institutions in its market area and surrounding markets, and from non-bank financial institutions, such as mutual funds, brokerage firms and insurance companies that are aggressively expanding into markets traditionally served by banks. Many non-bank competitors are not subject to the same degree of regulation as applies to bank holding companies, federally insured banks and Wisconsin-chartered state banks. As a result, such non-bank competitors may have advantages over the Bank in providing certain services. The Bank also competes indirectly with regional and national financial institutions, many of which have greater liquidity, lending limits, access to capital and market recognition and resources than we do. Expanded interstate banking may increase competition from out-of-state banking organizations and other financial institutions. As a small bank relative to many of its competitors, the Bank may lack the resources to compete effectively in the financial services market.

The recent repeal of federal prohibitions on the payment of interest on demand deposits could increase the Registrant’s interest expense.

All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act beginning on July 21, 2011. As a result, some financial institutions have commenced offering interest on demand deposits to compete for customers. The Registrant does not yet know what interest rates other institutions may offer as market interest rates begin to increase. The Registrant’s interest expense will increase and its net interest margin will decrease if it begins offering interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on its business, financial condition and results of operations.

Uncertainty in the financial markets could result in lower fair values for investment securities held by the Registrant and the Bank.

The upheaval in the financial markets over the past four years has adversely impacted all classes of securities and has resulted in volatility in the fair values of the Bank’s investment securities. Issues with credit quality of the securities could result in lower fair values for these securities and may result in recognition of an other-than-temporary impairment charge, which would have a direct adverse impact on the Registrant’s and the Bank’s financial condition and results of operations.

The Registrant may not be able to effectively implement new technology, which could put it at a competitive disadvantage and negatively impact its results.

The banking industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. The Registrant’s future success will depend in part on its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands for convenience as well as create additional efficiencies in its operations. A number of the Registrant’s competitors may have substantially greater resources to invest in technological improvements. There can be no assurance that the Registrant will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to its customers.

The Registrant’s information systems may experience an interruption or breach in security.

The Registrant relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Registrant’s customer relationship management, general ledger, deposit, loan and other systems. While the Registrant has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of the Registrant’s information systems could damage the Registrant’s reputation, result in a loss of customer business, subject the Registrant to additional regulatory scrutiny, or expose the Registrant to civil litigation and possible financial liability, any of which could have a material adverse effect on the Registrant’s financial condition and results of operations.

Customers may decide not to use banks to complete their financial transactions, which could result in a loss of income to the Bank.

Technology and other changes are allowing customers to complete financial transactions that historically have involved banks at one or both ends of the transaction. For example, customers can now pay bills and transfer funds directly without going through a bank. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits.

The Registrant’s controls and procedures may fail or be circumvented.

Management regularly reviews and updates the Registrant’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable assurances that the objectives of the system are met. Any failure or circumvention of the Registrant’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on its business, financial condition and results of operations.

The Bank relies on the accuracy and completeness of information about customers or counterparties, and inaccurate or incomplete information could negatively impact its financial condition and results of operations.

In deciding whether to extend credit or enter into other transactions with customers and counterparties, the Bank may rely on information provided by such customers and counterparties, including financial statements and other financial information. It may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. The Bank’s and the Registrant’s financial condition and results of operations could be negatively impacted to the extent the Bank relies on financial statements that do not comply with generally accepted accounting principles or that are inaccurate or misleading.

The Bank may have underestimated the potential for losses in the loan portfolio that was acquired in the Acquisition.

The fair value estimates for loans acquired in the Acquisition were based on an expected cash flow methodology that considered factors including the type of loan, related collateral, classification status, fixed or variable interest rate, term of loan, whether the loan was amortizing, local market economic conditions and underwriting risk and methodology employed by the Acquired Bank. In calculating expected cash flows, Bank management made additional assumptions regarding prepayments, the timing of defaults and the loss severity of defaults. The loan valuations reflect the fact the Acquisition was completed as a whole bank purchase without any loss sharing provision on post acquisition loan losses between the Bank and the FDIC, such that the Bank bears all risk of future loan losses. The Bank could realize significant future losses if it receives less future cash flows on the acquired loans than were estimated.

RISKS ASSOCIATED WITH THE REGISTRANT’S COMMON STOCK

Shareholders may not be able to liquidate their holdings of Registrant’s common stock when desired.

The trading market for Registrant’s stock is limited and sporadic. Although the stock is quoted on the over-the-counter bulletin board, shareholders may nevertheless be unable to liquidate their stock quickly or on favorable terms should they desire to do so.

An investment in the Registrant’s common stock is not an insured deposit.

The Registrant’s common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in the Registrant’s common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this 2011 Form 10-K and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire the Registrant’s common stock, you could lose some or all of your investment.

Certain banking laws have an anti-takeover effect.

Provisions of federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire the Registrant, even if doing so would be perceived to be beneficial to the Registrant’s shareholders. These provisions effectively inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of the Registrant’s common stock.

Concentrated ownership of the Registrant’s common stock may have an adverse effect on the share price of the common stock and also can influence shareholder decisions.

As of February 29, 2012, executive officers, directors and shareholders of more than 5% of the Registrant’s common stock beneficially owned or controlled approximately ___% of its common stock. Investors who purchase the Registrant’s common stock may be subject to certain risks due to the concentrated ownership of the common stock. Such a concentration of ownership may have an adverse effect on the market price of the Registrant’s voting common stock. In addition, as a result of their ownership, executive officers, directors and shareholders of more than 5% of the Registrant’s common stock may have the ability to influence the outcome of any matter submitted to the Registrant’s shareholders for approval, including the election of directors.

Item 1B.

UNRESOLVED STAFF COMMENTS

None.

Item 2.

PROPERTIES

Tri City National Bank has forty-four locations in Southeastern Wisconsin, including four in Oak Creek, nine in Milwaukee, four in Brookfield, one in Menomonee Falls, two in Brown Deer, one in Franklin, one in Greenfield, four in West Allis, one in West Milwaukee, two in Hales Corners, two in Wauwatosa, one in Cedarburg, one in Grafton, one in Sturtevant, two in South Milwaukee, one in St. Francis, five in Racine, one in Kenosha and one in Waukesha. The Bank owns sixteen of its locations and leases twenty-eight locations; the leased locations include twenty-three full service banks located in grocery stores.

Registrant believes that its bank locations are in buildings that are attractive, efficient and adequate for their operations, with sufficient space for parking and drive-up facilities.

Item 3.

LEGAL PROCEEDINGS

The Registrant is not party to any material legal proceedings other than routine litigation arising in the ordinary course of conducting the Registrant’s and the Bank’s business.

Item 4.

MINE SAFETY DISCLOSURES

Not applicable.

PART II

Item 5.

MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

MARKET PRICE FOR AND DIVIDENDS ON COMMON STOCK

Information pertaining to the market price of and dividends on the Registrant’s common equity and related stockholder matters specified in Item 201 of Regulation S-K and required under Item 5(a) of Form 10-K is incorporated herein by reference to the 2011 Shareholder Report under the caption “Market for Corporation’s Common Stock and Related Stockholder Matters” (Page 30).

RECENT SALES OF UNREGISTERED SECURITIES

The Registrant did not sell any shares of its common stock during the last three years that were not registered under the Securities Act.

ISSUER PURCHASES OF EQUITY SECURITIES

The Registrant did not repurchase any shares of its common stock during the fourth quarter of 2011.

Item 6.

SELECTED FINANCIAL DATA

The information required by Item 6 is incorporated herein by reference to the 2011 Shareholder Report under the caption "Selected Financial Data" (Page 30).

Item 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The information required by Item 7 is incorporated herein by reference to the 2011 Shareholder Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operation" (Pages 4 to 31).

STATISTICAL PROFILE AND OTHER FINANCIAL DATA

The following statistical information relating to the Registrant and its subsidiaries on a consolidated basis, as required by Guide 3 of the Securities Act Industry Guides, is set forth in the Management’s Discussion and Analysis of Financial Position and Results of Operations (“MD&A”) section of the 2011 Shareholder Report:

(1)	Average Balances and Interest Rates for each of the last three fiscal years;

(2)	Interest Income and Expense Volume and Rate Change for each of the last two years;

(3)	Investment Securities Portfolio Maturity Distribution at December 31, 2011;

(4)	Investment Securities Portfolio for each of the last three years;

(5)	Loan Portfolio Composition for each of the last five years;

(6)	Summary of Loan Loss Experience for each of the last five years; and

(7)	Average Daily Balance of Deposits and Average Rate Paid on Deposits for each of the last three years.

The following additional tables set forth certain statistical information relating to the Registrant and its subsidiaries on a consolidated basis.

LOAN PORTFOLIO

The following table presents information concerning the aggregate amount of nonperforming loans. Nonperforming loans comprise (a) loans accounted for on a nonaccrual basis and (b) loans contractually past due 90 days or more as to interest or principal payments, for which interest continues to be accrued.

	(Dollars in Thousands)
	December 31,
	2011			2010			2009			2008			2007
Nonaccrual loans	$	20,055		$	23,182		$	5,937		$	2,930		$	2,024
Loans past due 90 days or more		2,350			1,433			9,391			5,684			3,703
Total nonperforming loans(1)	$	22,405		$	24,615		$	15,328		$	8,614		$	5,727

Ratio of nonaccrual loans to total loans		2.83	%		3.10	%		0.75	%		0.49	%		0.35	%
Ratio of nonperforming loans to total loans		3.17	%		3.30	%		1.95	%		1.44	%		0.98	%

(1)Amounts in 2010 and 2011 exclude purchased credit-impaired loans. Purchased credit-impaired loans had evidence of deterioration in credit quality prior to acquisition. Fair value of these loans as of the acquisition date included estimates of credit losses.

The accrual of interest income is generally discontinued when a loan becomes 90 days past due as to principal or interest. Management may continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balance and accrued interest.

There were 114 loans at December 31, 2011 classified as troubled debt restructuring whose terms had been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower. There were 65 loans classified as troubled debt restructuring at December 31, 2010 and three loans classified as troubled debt restructuring at December 31, 2009.

RETURN ON EQUITY AND ASSETS AND SELECTED CAPITAL RATIOS

The following table shows consolidated operating and capital ratios of the Registrant for each of the last three years:

	Year Ended December 31,
	2011			2010			2009
Percentage of net income to:
Average stockholders’ equity		8.10	%		11.69	%		20.16	%
Average total assets		0.85	%		1.32	%		2.67	%

Percentage of dividends declared per
common share to net income per
common share		19.65	%		149.07	%		43.56	%

Percentage of average stockholders’
equity to daily average total assets		10.50	%		11.26	%		13.24	%

SHORT-TERM BORROWINGS

(Dollars in Thousands)

Information relating to short-term borrowings follows:

	Federal Funds Purchased and Securities Sold Under Agreements to Repurchase			Other Short-term Borrowings
Balance at December 31:
2011	$	-		$	-
2010		-			4,816
2009		-			1,812

Weighted average interest rate at year end:
2011		0.05	%		0.00	%
2010		0.00	%		0.00	%
2009		0.00	%		0.07	%

Maximum amount outstanding at any month’s end:
2011	$	17,317		$	2,840
2010		-			4,816
2009		33,384			1,622

Average amount outstanding during the year:
2011	$	1,632		$	1,395
2010		235			1,340
2009		4,708			934

Average interest rate during the year:
2011		0.16	%		0.00	%
2010		0.35	%		0.00	%
2009		0.61	%		0.00	%

Fed Funds purchased and securities sold under agreements to repurchase generally mature within one to four days of the transaction date. Other short-term borrowings generally mature within 90 days.

Item 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by Item 7A is incorporated herein by reference to the 2011 Shareholder Report under the caption “Quantitative and Qualitative Disclosures About Market Risk” (Pages 24 to 27).

Item 8.

CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The information required by Item 8 is incorporated herein by reference to the 2011 Shareholder Report under the caption “Consolidated Financial Statements and Supplementary Data” (Pages 32 to 61).

Item 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

Item 9A.

CONTROLS AND PROCEDURES

The Registrant maintains a set of disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by it in the reports filed by it under the Securities Exchange Act of 1934, as amended, is recorded and processed, summarized and reported within the time periods specified in the SEC’s rules and forms. At year end, the Registrant carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer of the Registrant, of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer of the Registrant concluded that the Registrant’s disclosure controls and procedures were effective as of the end of the period covered by this report.

The Registrant’s management is responsible for establishing and maintaining adequate internal controls over financial reporting as defined in 13a-15(f) and 15d-15(f) under the Exchange Act. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail accurately and fairly reflect the acquisition, use and disposition of the assets of the Registrant; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Registrant are being made only in accordance with authorizations of management and directors of the Registrant; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Registrant’s assets that could have a material effect on interim or annual consolidated financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Registrant’s management, with the participation of its CEO and the CFO, conducted an evaluation of the effectiveness of the Registrant’s internal controls over financial reporting as of December 31, 2011 based on the framework and criteria established in Internal Controls – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission.

This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls, testing of the operating effectiveness of controls and a conclusion on this evaluation. Based on this evaluation, management concluded that the Registrant’s internal control over financial reporting is effective as of December 31, 2011.

This annual report on Form 10-K does not include an attestation of the Registrant’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Registrant’s independent registered public accounting firm pursuant to rules of the SEC that permit the Registrant to provide only management’s report in this annual report on Form 10-K.

There have been no changes in the Registrant’s internal control over financial reporting identified in connection with the evaluation discussed above that occurred during the Registrant’s last fiscal quarter that have materially affected, or are reasonable likely to materially affect, the Registrant’s internal control over financial reporting.

Item 9B.

OTHER INFORMATION

None.

PART III

Item 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by Item 10 is incorporated herein by reference to Registrant's definitive Proxy Statement for its annual meeting of stockholders on June 13, 2012 (“The 2011 Proxy Statement”) under the captions entitled "Election of Directors" and “Section 16(a) Beneficial Ownership Reporting Compliance”.

The Registrant has a Code of Ethics that applies to its principal executive officer, principal financial officer and principal accounting officer. Copies of the Registrant’s Code of Ethics are available upon request, free of charge, by contacting the Registrant at 6400 South 27th Street, Oak Creek, Wisconsin, 53154.

Item 11.

EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated herein by reference to the 2012 Proxy Statement under the caption entitled “Executive Compensation”.

Item 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by Item 12 is incorporated herein by reference to the 2012 Proxy Statement under the caption entitled “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information”.

Item 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by Item 13 is incorporated herein by reference to the 2012 Proxy Statement under the caption entitled “Loans and Other Transactions with Management”.

Item 14.

PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14 is incorporated herein by reference to the 2012 Proxy Statement under the caption entitled “Principal Accountant Fees and Services”.

PART IV

Item 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)

(1) and (2) Financial statements and financial statement schedules

The response to this portion of Item 15 is submitted as a separate section of this report.

(3) Listing of Exhibits

Exhibit 2.1 -

Purchase and Assumption Agreement Whole Bank All Deposits, among the Federal Deposit Insurance Corporation, receiver of the Bank of Elmwood, Racine, Wisconsin, the Federal Deposit Insurance Corporation and Tri City National Bank, dated as of October 23, 2009 (incorporated herein by reference to Exhibit 2.1 to Registrant’s current report on Form 8-K filed October 28, 2009)

Exhibit 3.1 -

Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.2 to Registrant’s current report on Form 8-K filed February 12, 2003)

Exhibit 3.2 -

By-Laws (incorporated herein by reference to Exhibit 3.2 to Registrant’s Annual Report on Form 10-K for the year ended December 31, 2000)

Exhibit 10.1* -

Summary of compensation arrangements with certain persons

Exhibit 10.2* -

Summary of director compensation

Exhibit 10.3* -

Summary of executive bonus arrangements

Exhibit 10.4

Exhibit 13 -

Annual Report to Stockholders for the year ended December 31, 2011

With the exception of the information incorporated by reference into Items 5, 6, 7, 7A, and 8 of this Form 10-K, the 2011 Annual Report to Stockholders is not deemed filed as part of this report

Exhibit 21 -

Subsidiaries of Registrant

Exhibit 31.1

Certification of Chief Executive Officer pursuant to Rule 13a -14(a) or 15d-14(a) under the Securities and Exchange Act of 1934, as amended

Exhibit 31.2

Certification of Chief Financial Officer pursuant to Rule 13a -14(a) or 15d-14(a) under the Securities and Exchange Act of 1934, as amended

Exhibit 32.1

Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350

Exhibit 32.2

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350

Exhibit 101.INS**

XBRL Instance

Exhibit 101.SCH**

XBRL Taxonomy Extension Schema

Exhibit 101.CAL**

XBRL Taxonomy Extension Calculation

Exhibit 101.DEF**

XBRL Taxonomy Extension Definition

Exhibit 101.LAB**

XBRL Taxonomy Extension Labels

Exhibit 101.PRE**

XBRL Taxonomy Extension Presentation

A Management contract or compensation plan or arrangement

XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

(b)

Exhibits

See Item 15(a)(3)

(C)

Financial Statement Schedules

The response to this portion of Item 15 is submitted as a separate section of this report.

PART IV

ANNUAL REPORT ON FORM 10-K

ITEM 15(a)(1), (2) and (b)

LIST OF FINANCIAL STATEMENTS AND FINANCIAL

STATEMENT SCHEDULES

CERTAIN EXHIBITS

Year Ended December 31, 2011

TRI CITY BANKSHARES CORPORATION

OAK CREEK, WISCONSIN

FORM 10-K-ITEM 15(a)(1) and (2)

TRI CITY BANKSHARES CORPORATION

LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES

The following consolidated financial statements and report of independent registered public accounting firm of Tri City Bankshares Corporation, included in the annual report of the Registrant to its stockholders for the year ended December 31, 2011, are incorporated by reference in Item 8:

Consolidated Balance Sheets-December 31, 2011 and 2010

Consolidated Statements of Income-Years ended December 31, 2011, 2010 and 2009

Consolidated Statements of Stockholders' Equity-Years ended December 31, 2011, 2010 and 2009.

Consolidated Statements of Cash Flows-Years ended December 31, 2011, 2010 and 2009.

Notes to Consolidated Financial Statements-Years ended December 31, 2011, 2010 and 2009.

Report of Independent Registered Public Accounting Firm

Schedules to the consolidated financial statements required by Article 9 of Regulation S-X are not required under the related instructions or are nonapplicable and, therefore, have been omitted.

SIGNATURES

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

	TRI CITY BANKSHARES CORPORATION

	BY: /s/ Ronald K. Puetz
	Ronald K. Puetz, President, Chairman and CEO
	Date: 3/16/2012

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

Name	Capacity	Date

/s/ Ronald K. Puetz Ronald K. Puetz	President, Chairman, Chief Executive Officer, and Director (Principal Executive Officer)	03/16/2012

/s/ Scott A. Wilson Scott A. Wilson	Executive Vice President, Treasurer and Director	03/16/2012

/s/ Robert W. Orth Robert W. Orth	Executive Vice President and Director	03/16/2012

/s/ Scott D. Gerardin Scott D. Gerardin	Senior Vice President, General Counsel and Director	03/16/2012

/s/ Frederick R. Klug Frederick R. Klug	Senior Vice President and Chief Financial Officer	03/16/2012

/s/ Frank J. Bauer Frank J. Bauer	Director	03/16/2012

/s/ William N. Beres William N. Beres	Director	03/16/2012

/s/ Sanford Fedderly Sanford Fedderly	Director	03/16/2012

/s/ William Gravitter William Gravitter	Director	03/16/2012


/s/ Brian T. McGarry Brian T. McGarry	Director	03/16/2012

/s/ Agatha T. Ulrich Agatha T. Ulrich	Director	03/16/2012

/s/ David A. Ulrich, Jr. David A. Ulrich, Jr.	Director	03/16/2012

/s/ William J. Werry William J. Werry	Director	03/16/2012

TRI CITY BANKSHARES CORPORATION

Dear Shareholders,

In February 2012, the Board of Directors was saddened by the loss of a long-time friend and member of the Board, Mr. Christ Krantz. Mr. Krantz served as a director since 1974 providing insight, knowledge and common sense acquired from running his own businesses in the Milwaukee area. A member of the audit and loan committees, his valuable contributions will be missed.

After two consecutive years in which the Corporation posted earnings which led banking companies of all sizes in the State of Wisconsin, I am pleased to report that Tri City Bankshares Corporation ended 2011 with continued strong net income of $9.5 million. The 2011 performance can and should be positively viewed in two ways.

First, examining those record years you will recall shareholders were pleased with the $12.9 million after-tax “bargain purchase gain” generated from the FDIC-assisted acquisition in 2009. Similarly, after-tax purchase accounting adjustments from the acquisition were $3.4 million greater in 2010 than 2011. The basis of our expectation for enhanced future earnings has always been improved core income from the larger $1.2 billion asset base the Corporation now enjoys.

Second, despite the largest ($5.4 million after-tax) expense ever taken by the Corporation as a provision for loan losses, 2011 income exceeded earnings posted by the Corporation for all years prior to the Acquisition except 2007 and 2008, two years in which loan loss expense was $0.3 million and $0.7 million after-tax respectively. Our franchise has performed well and profited from the events of the last few years and it is poised to profit in the future.

That said, there are always challenges to be overcome. After the second full year of converting Acquired loans into the Bank’s portfolio or eliminating them, there remains $101 million of such loans yet to be resolved. Originally estimated to be a three year project, this effort is likely to carry into 2013.

And certainly, not the least of challenges facing the Corporation is the economy. The Wisconsin Bankers Association recently stated “. . . while it would be nice to predict a strong U.S. and global economic recovery, a strong outlook for banking is necessarily tempered by relentless regulatory burdens, national and international dynamics and latent consumer confidence. . . expect to see slow positive improvement in the banking industry in 2012.”

We agree with that assessment and feel confident that your Corporation is prepared to take advantage of every opportunity in its market. Quality loan growth will remain our primary objective. The Board of Directors, management and every employee is prepared to hasten the projected “slow positive improvement” to enhance your shareholder value.

Very truly yours,

Tri City Bankshares Corporation

Ronald K. Puetz

Chairman of the Board

Chief Executive Officer

Directors and Officers of the Corporation

Directors

Frank J. Bauer	President of Frank Bauer Construction Company, Inc.

William N. Beres	Vice President of Structured Finance for the Global Energy Solutions division of Johnson Controls, Inc. since March 2010. Independent business and financial consultant from January 2009 through March 2010. Former Chief Financial Officer of Wisvest LLC and Vice President of Minergy LLC, both wholly owned subsidiaries of Wisconsin Energy Corporation, from January 1999 through December 2008

Sanford Fedderly	Retired Registered Pharmacist

Scott D. Gerardin	Senior Vice President and General Counsel of Tri City Bankshares Corporation and Senior Vice President and General Counsel of Tri City National Bank

William Gravitter	Retired President of Hy-View Mobile Home Court, Inc.

Brian T. McGarry	Retired Vice President of Tri City National Bank and Director of NDC LLC

Robert W. Orth	Executive Vice President of Tri City Bankshares Corporation and President of Tri City National Bank

Ronald K. Puetz	Chairman of the Board, President and Chief Executive Officer of Tri City Bankshares Corporation and Chairman of the Board and Chief Executive Officer of Tri City National Bank and Treasurer of NDC LLC

Agatha T. Ulrich	Chairman and Director of NDC LLC, President and Director of the David A. and Agatha T. Ulrich Foundation, Inc.

David A. Ulrich, Jr.	Independent Investor, Retired Vice President and Director of Mega Marts, Inc., Retired Vice President and Director of NDC, Inc., Director of NDC LLC and Director of the David A. and Agatha T. Ulrich Foundation, Inc.

William J. Werry	Retired Unit President of Tri City National Bank

Scott A. Wilson	Executive Vice President, Treasurer and Secretary of Tri City Bankshares Corporation, and Executive Vice President, CFO, Treasurer and Secretary of Tri City National Bank

Officers

Ronald K. Puetz	President, Chairman and Chief Executive Officer

Robert W. Orth	Executive Vice President

Scott A. Wilson	Executive Vice President, Treasurer and Secretary

Scott D. Gerardin	Senior Vice President and General Counsel

Frederick R. Klug	Senior Vice President and Chief Financial Officer

Thomas W. Vierthaler	Vice President and Comptroller

George E. Mikolajczak	Vice President – Human Resources

Gary J. Hafemann	Vice President and Auditor

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

The following discussion provides management’s analysis of the audited consolidated financial statements of Tri City Bankshares Corporation (the “Corporation”) and should be read in conjunction with those financial statements. This discussion focuses on significant factors that affected the Corporation’s financial performance in 2011 with comparisons to 2010 and to 2009 where applicable. For all periods presented, the operations of Tri City National Bank (the “Bank”) contributed substantially all of the Corporation’s revenue and expense for the year. Included in the operations of the Bank are the activities of its wholly-owned subsidiaries, Tri City Capital Corporation, Inc. and Title Service of Southeast Wisconsin, Inc.

Overview

On October 23, 2009 the Bank was the successful bidder for the Bank of Elmwood (“Acquired Bank”) through an FDIC-assisted purchase (the “Acquisition”). The Acquisition was the result of a competitive bidding process facilitated by the FDIC. The Bank bid negative $110.9 million and the FDIC estimated the net cost of the transaction to be $101.1 million, deemed to be the “least costly” resolution for the FDIC. Earnings performance at the Bank as a result of the Acquisition has been positively impacted. In 2009, the Bank posted record earnings of $22.1 million which included a $12.9 million after-tax “bargain purchase gain” on the FDIC transaction. In 2010, earnings of $14.3 million were buoyed by the first full year of enhanced core income of the larger $1.1 billion asset base and purchase accounting income of $7.2 million after-tax.

The Corporation posted after-tax earnings of $9.5 million in 2011, a decrease of $4.8 million or 33.5% compared to earnings of $14.3 million in 2010. Operating earnings in 2011 were negatively affected by a decline in net interest income, a higher provision for loan losses and a decrease in non-interest income which were partially offset by a decline in non-interest expenses. Total assets increased $73.5 million to $1.2 billion at December 31, 2011. In addition, total loans decreased $39.0 million during 2011, while deposits increased by $52.0 million during the same period. Thus, the Corporation has a very strong balance sheet and liquidity position moving into 2012

Forward-Looking Statements

This report contains statements that may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements other than historical facts contained or incorporated by reference in this report. These statements speak of the Corporation’s plans, goals, beliefs or expectations, refer to estimates or use similar terms. Future filings by the Corporation with the Securities and Exchange Commission, and statements other than historical facts contained in written material, press releases and oral statements issued by, or on behalf of the Corporation, may also contain forward-looking statements.

Forward-looking statements are subject to significant risks and uncertainties. The Corporation’s actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause actual results to differ from the results discussed in forward-looking statements include, but are not limited to the factors set forth in Item 1A of the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).

All forward-looking statements contained in this report or that may be contained in future statements made for or on behalf of the Corporation are based upon information available at the time the statement is made and the Corporation assumes no obligation to update any forward-looking statement.

Critical Accounting Policies

Consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) and reflect general practices in the banking industry. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates are based on information available to management as of the date of the consolidated financial statements. Accordingly, as this information changes, future financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported. The most significant accounting policies followed are presented in Note 1 of the Notes to Consolidated Financial Statements and in Item 8 Financial Statements and Supplementary Data, herein. These policies, along with the disclosures presented in the other financial statement notes and other information presented herein, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how these values are determined. Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates or assumptions, and where changes in those estimates and assumptions could have a significant impact on the consolidated financial statements. Management currently views the following items to be critical accounting policies.

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable and inherent losses incurred in the loan portfolio. Management maintains allowances for loan losses at levels that we believe to be adequate to absorb estimated probable credit losses inherent in the loan portfolio. The adequacy of the allowances is determined based on periodic evaluations of the loan portfolios and other relevant factors. The allowance is comprised of both a specific component and a general component. Even though the entire allowance is available to cover losses on any loan, specific allowances are provided on impaired loans pursuant to accounting standards. The general allowance is based on historical loss experience, adjusted for qualitative and environmental factors. Management reviews the assumptions and methodology related to the general allowance in an effort to update and refine the estimate on a quarterly basis.

In determining the general allowance management has segregated the loan portfolio by purpose. For each class of loan, we compute a historical loss factor. In determining the appropriate period of activity to use in computing the historical loss factor we look at trends in net charge-off ratios. It is management’s intention to utilize a period of activity that is most reflective of current experience. Changes in the historical period are made when there is a distinct change in the trend of net charge-off experience. Management adjusts the historical loss factors for the impact of the following qualitative factors: asset quality, changes in volume and terms, policy changes, ability of management, economic trends, industry conditions, changes in credit concentrations and competitive/legal factors. In determining the impact, if any, of an individual qualitative factor, management compares the current underlying facts and circumstances surrounding a particular factor with those in the historical periods, adjusting the historical loss factor in a directionally consistent manner with changes in the qualitative factor. Management separately evaluates both the Bank’s historical portfolio as well as Acquired loans that have renewed and are eligible to be considered as part of the general allowance. Management will continue to analyze the qualitative factors on a quarterly basis, adjusting the historical loss factor both up and down, to a factor we believe is appropriate for the probable and inherent risk of loss in its portfolio.

Specific allowances are determined as a result of our impairment process. When a loan is identified as impaired it is evaluated for loss using either the fair value of collateral method or the present value of cash flows method. If the present value of expected cash flows or the fair value of collateral exceeds the Bank’s carrying value of the loan no loss is anticipated and no specific reserve is established. However, if the Bank’s carrying value of the loan is greater than the present value of expected cash flows or fair value of collateral a specific reserve is established. In either situation, loans identified as impaired are excluded from the calculation of the general reserve.

The allowance for loan losses is increased by provisions charged to earnings and reduced by charge-offs, net of recoveries. The adequacy of the allowance for loan losses is reviewed and approved by the Bank's Board of Directors on a quarterly basis. The allowance for loan losses reflects management's best estimate of the probable and inherent losses on loans and is based on a risk model developed and implemented by management and approved by the Bank's Board of Directors.

In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may suggest additions to the allowance for loan losses based on their judgments of collectability based on information available to them at the time of their examination.

Loans Acquired Through Purchase

Loans acquired through the completion of a purchase, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Bank will be unable to collect all contractually- required payments receivable, are initially recorded at fair value with no valuation allowance. Loans are evaluated individually at the date of acquisition to determine if there is evidence of deterioration of credit quality since origination. Loans where there is evidence of deterioration of credit quality since origination may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. Contractually-required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” are not recognized as a yield adjustment, a loss accrual or a valuation allowance. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reclassification of the difference from non-accretable discount to accretable discount with a positive impact on interest income. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining life. Decreases in expected cash flows are recognized as provision for loan losses. If the Bank does not have the information necessary to reasonably estimate expected cash flows, it may use the cost recovery method or cash basis method of income recognition. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received).

Other Real Estate Owned

Other real estate owned (“OREO”) comprises real estate acquired in partial or full satisfaction of loans. OREO is recorded at the lower of carrying value or its estimated fair value less estimated selling costs at the date of transfer, with any excess of the related loan balance over the fair value less expected selling costs charged to the allowance for loan losses. Subsequently, properties are evaluated and any additional declines in value are recorded in current period earnings. The amount the Bank ultimately recovers on repossessed assets may differ substantially from the net carrying value of these assets because of future market factors beyond the Bank’s control.

Income Taxes

The Corporation files a consolidated federal income tax return and combined state income tax returns. Income tax expense is recorded based on the liability method. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The differences relate principally to the allowance for loan losses, mortgage servicing rights, deferred loan fees, and premises and equipment. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. The Corporation also accounts for the uncertainty in income taxes related to the recognition and measurement of a tax position taken or expected to be taken in an income tax return. The Corporation follows the applicable accounting guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition related to the uncertainty in these income tax positions. It is the Corporation’s policy to include interest and penalties in tax expense.

Performance Summary

While the banking industry as a whole continued to struggle for the fourth consecutive year, the Corporation is pleased to report that its results for 2011 continued to be strong. The Corporation posted after tax earnings of $9.5 million, a decrease of $4.8 million or 33.5% compared to earnings of $14.3 million in 2010 and earnings of $22.1 million in 2009. Operating earnings in 2011 were negatively affected by a decline in net interest income, a higher provision for loan losses and a decrease in non-interest income which was partially offset by a decline in non-interest expenses. The decrease from 2009 to 2010 was primarily due to the one-time bargain purchase gain of $12.9 million after tax recognized in 2009 which was partially offset in 2010 by increased core income and a significant increase in Acquisition-related purchase accounting income. Basic earnings per share for 2011 were $1.07, a 33.5% decrease from 2010 basic earnings per share of $1.61, while basic earnings per share in 2009 were $2.48. Return on average assets and return on equity for 2011 were 0.85% and 8.10%, respectively, compared to 1.32% and 11.69%, respectively, for 2010 and 2.67% and 20.16%, respectively, for 2009. No dividends were paid in 2011. However, a quarterly dividend of $0.21 per share was declared in December of 2011 and paid in January of 2012. Cash dividends of $2.40 per share were paid in 2010, which included a prepayment of 2011 dividends of $1.20 per share. Cash dividends were $1.08 per share in 2009. Total assets increased $73.5 million or 6.4% to $1.22 billion in 2011. The increase was primarily due to core deposit growth.

Income Statement Summary

Net interest income was $48.6 million for 2011 compared to $56.2 million in 2010 and $37.4 million in 2009 while tax-equivalent net interest income was $49.3 million for 2011 compared to $57.0 million in 2010 and $38.2 million in 2009. Growth in taxable investment securities more than offset a decline in loans which resulted in an increase in interest-earning assets in 2011 compared to 2010. However, tax-equivalent net interest income declined during the period as the yield on taxable investment securities is significantly less than the yield earned on loans and the yield on the loan portfolio decreased as maturing notes renewed at lower rates. In addition, interest expense on deposits declined in all areas but especially on fixed rate liabilities which continued to reprice downward during 2011. Included in the $7.7 million decrease in net interest income during 2011 was the effect of discount accretion associated with Acquisition-related purchase accounting adjustments of $5.6 million in 2011 compared to $11.2 million in 2010. The resulting taxable equivalent net interest margin for 2011 was 4.69% compared to 5.61% for 2010. The increase in tax-equivalent net interest income for 2010 compared to 2009 was largely due to the Acquisition. Included in the $18.8 million increase in net interest income was the effect of discount accretion associated with Acquisition-related purchase accounting adjustments that increased taxable equivalent net interest income by $11.2 million in 2010 compared to $1.9 million in 2009. As a result of the changes to yields on interest-earning assets and interest-bearing liabilities the tax-equivalent net interest margin for 2010 was 5.61% compared to 4.98% for 2009.

The provision for loan losses (“PLL”) represents the amount periodically added to the Bank’s allowance for loan losses (“ALL”) and charged to earnings in the relevant period. The PLL for 2011 was $8.4 million compared to $6.9 million in 2010 and $3.7 million in 2009. The increase in the PLL for 2011 compared to 2010 reflected the $3.4 million increase in net loans charged off between the years which was primarily due to the negative effect of the economic downturn on the Bank’s loan portfolio. The increase in the PLL for 2010 compared to 2009 reflected an increase in the ALL due to $26.2 million in non-credit impaired loans that were renewed since they were acquired in October of 2009. In the quarterly analysis of the ALL, these renewed loans exhibit a higher probability of loss, which is reflected in the ALL.

Non-interest income was $14.8 million in 2011, $16.5 million in 2010 and $36.1 million in 2009. The decrease in non-interest income during 2011was primarily due to a decrease of $1.3 million in the gain on sale of other real estate owned (“OREO”), net of carrying costs, compared to 2010. The non-accretable income, which is a result of the Acquisition related purchase accounting adjustments, was $2.3 million in 2011, $2.3 million in 2010 and $0.7 million in 2009. Non-interest income in 2009 was also significantly impacted by the Acquisition-related bargain purchase gain of $21.5 million.

Non-interest expense was $40.8 million in 2011, $43.1 million in 2010 and $34.1 million in 2009. The decrease in 2011 compared 2010 was primarily due to a $1.2 million decrease in FDIC premiums resulting from a change in the assessment methodology during 2010 and 2011. In addition, the Bank did not have any Acquisition-related expense during 2011 compared to $0.4 million incurred during 2010. The Acquisition on October 23, 2009 caused significant increases in many expense categories in 2010 compared to 2009, especially in salary and employee benefits. In addition, $0.4 million of expenses were associated with the purchase accounting adjustments related to the amortization of the core deposit intangible during 2011 compared to $0.6 million in 2010 and $0.1 million in 2009.

Income tax expense was $4.7 million in 2011 compared to $8.4 million in 2010 and $13.6 million in 2009. The Corporation’s effective tax rate was 33.0% in 2011, 36.9% in 2010 and 38.2 in 2009.

Balance Sheet Summary

Total loans were $707.8 million at December 31, 2011, a decrease of $39.0 million, or 5.2%, from $746.8 million at December 31, 2010. The decrease in total loans during 2011 was attributable to new business production not offsetting the continued reduction of the Acquired Bank’s loan portfolio. The strategy for acquired loans involves three options: renewal of loans conforming to the underwriting guidelines of the Bank, pay-out of loans not meeting those guidelines or final resolution of impaired loans through a short sale with a cooperative borrower or a foreclosure when other options fail. Renewals neither increase nor decrease the portfolio while the other two options reduce total loans. This strategy, while necessary to integrate or eliminate the acquired loans, limits the Bank’s opportunity for portfolio growth. New loan business must offset both amortization of performing loans and the planned elimination of substandard and non-performing acquired loan balances. The goal is to grow the loan portfolio but marketing efforts by the Bank’s lenders in 2011 were negatively impacted for the third straight year by the sluggish economy.

Asset quality in the Bank has been negatively affected by the difficult economic conditions from 2008 through 2011 as well as by the Acquired Bank’s loan portfolio. Nonperforming loans, not including purchased credit-impaired loans, were $22.4 million or 3.2% of total loans at December 31, 2011 compared to $24.6 million or 3.3% of total loans at December 31, 2010. Net charge offs were $6.9 million in 2011 and $3.4 million in 2010. Loans charged off are subject to continuous review and specific efforts are made to achieve maximum recovery of principal, accrued interest and related expenses. At December 31, 2011 the ALL was $11.0 million compared to $9.5 million at December 31, 2010. As of December 31, 2011 the ratio of the ALL to total loans was 1.56% compared to a ratio of 1.28% at December 31, 2010. As of December 31, 2011 the acquired credit impaired and non-credit impaired loans had contractually required payments of $138.5 million and a fair value of $101.1 million reflecting a discount of $37.4 million. This compares to contractually required payment of $195.9 million and a fair value of $139.3 million reflecting a discount of $56.6 million at December 31, 2010. The Bank held OREO of $7.4 million at December 31, 2011 compared to $5.4 million at December 31, 2010.

Deposits increased $52.0 million, or 5.1%, to $1.07 billion at December 31, 2011. The increase in total deposits during 2011 was attributable to organic growth as the Bank continued its significant marketing activities aimed toward both current customers and potential new customers, especially in the Acquired Bank’s markets of Racine and Kenosha Wisconsin.

As of December 31, 2011, the Corporation’s Tier 1 leverage ratio was 10.63%, the Tier 1 risk-based capital ratio was 15.84% and the total risk-based capital ratio was 17.08%. All ratios improved from 2010 levels due to the pre-payment of the 2011 dividend in 2010. All of the capital ratios significantly exceed minimum regulatory requirements for the Corporation to be deemed “well capitalized”. A bank is “well capitalized” if it maintains a minimum Tier 1 leverage ratio of 5.0%, a minimum Tier 1 risk based capital ratio of 6.0% and a minimum total risk based capital ratio of 10.0%.

INCOME STATEMENT ANALYSIS

Table 1 provides average balances of interest-earning assets and interest-bearing liabilities, the interest income and expense resulting from each, and the calculated interest rates earned and paid. The table further shows net interest income, interest rate spread, and the net interest margin on a tax-equivalent basis for the years ended December 31, 2011, 2010 and 2009.

Table 1

	AVERAGE BALANCES AND INTEREST RATES
	(Interest rates on a tax-equivalent basis)
	(Dollars in Thousands)

	2011						2010						2009
	Average				Yield or		Average				Yield or		Average				Yield or
	Balance		Interest		Cost		Balance		Interest		Cost		Balance		Interest		Cost
ASSETS
Interest earning assets:
Loans(1)	$	722,719	$	46,958	6.50	%	$	771,428	$	56,722	7.35	%	$	636,126	$	40,125	6.31	%
Taxable investment securities(2)		256,707		4,824	1.88	%		158,365		3,663	2.31	%		72,764		2,827	3.89	%
Non taxable investment securities		47,050		2,102	4.47	%		44,452		2,246	5.05	%		39,943		2,141	5.36	%
Fed funds sold		25,268		28	0.11	%		40,732		61	0.15	%		17,885		22	0.12	%
Total interest earning assets		1,051,744		53,912	5.13	%		1,014,977		62,692	6.18	%		766,718		45,115	5.88	%
Noninterest-earning assets:

Other assets		66,907						71,890						60,322

TOTAL ASSETS	$	1,118,651					$	1,086,867					$	827,040

LIABILITIES AND EQUITY
Interest-bearing liabilities:

Transaction accounts	$	256,241	$	485	0.19	%	$	247,950	$	860	0.35	%	$	171,761	$	981	0.57	%
Money market		199,816		1,011	0.51	%		155,195		1,313	0.85	%		101,811		1,272	1.25	%
Savings deposits		182,093		379	0.21	%		164,378		508	0.31	%		142,142		586	0.41	%
Other time deposits		193,147		2,696	1.40	%		229,011		3,030	1.32	%		165,088		4,084	2.47	%
Short-term borrowing		3,027		13	0.43	%		1,583		1	0.06	%		6,288		31	0.49	%
Total interest bearing liabilities		834,324		4,584	0.55	%		798,117		5,712	0.72	%		587,090		6,954	1.18	%
Noninterest bearing liabilities:
Demand deposits		161,355						156,011						127,301
Other		5,523						10,346						3,147
Stockholders’ equity		117,449						122,393						109,502
Total liabilities and stockholders’ equity	$	1,118,651					$	1,086,867					$	827,040

Net interest earnings and interest rate spread(3)			$	49,328	4.58	%			$	56,980	5.46	%			$	38,161	4.70	%

Net interest margin(4)					4.69	%					5.61	%					4.98	%

1.	The average loan balances and rates include non-accrual loans.

2.	The interest income on tax exempt securities is computed on a tax-equivalent basis using a tax rate of 34% for all periods presented.

3.	Interest rate spread represents the difference between the average yield earned on average interest-earning assets for the period and the average rate accrued on average interest-bearing liabilities for the period and is represented on a tax-equivalent basis.

4.	Net interest margin represents net interest income for a period divided by average interest-earning assets for the period and is represented on a tax-equivalent basis.

Net Interest Income

Interest income is the Corporation’s primary source of revenue. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing deposits and other borrowings, such as the Fed funds purchased through a correspondent bank. Net interest income is affected by increasing or decreasing interest rates, as well as by the mix and volume of both the interest-earning assets and interest-bearing liabilities. Additionally, the composition and characteristics of such assets and liabilities contribute to the sensitivity of the balance sheet to changes in interest rates. Examples of these characteristics include loans with floating rates tied to an index, such as the Bank’s reference rate, and the contractual maturities of loans. Similarly, on the deposit side, the ratio of time deposits to deposits with no stated investment term impacts balance sheet sensitivity.

Net interest income in the consolidated statements of operations (which excludes the tax-equivalent adjustment) was $48.6 million for 2011, compared to $56.2 million for 2010. The tax equivalent adjustments (adjustments needed to bring tax-exempt interest to a level that would yield the same after-tax income had that income been subject to taxation using a 34% tax rate) of $0.6 million for 2011 and $0.8 million for 2010 resulting in a tax-equivalent net interest income of $49.3 million and $57.0 million, respectively.

Table 1 shows tax-equivalent net interest income of $49.3 million for 2011, a decrease of $7.7 million or 13.4% from $57.0 million in 2010. Growth in taxable investment securities more than offset a decline in loans which resulted in an increase in interest-earning assets in 2011 compared to 2010. However, tax-equivalent net interest income declined during the period as the yield on taxable investment securities is significantly less than the yield earned on loans and the yield on the loan portfolio decreased as maturing notes renewed at lower rates. In addition, interest expense on deposits declined in all areas but especially on fixed rate liabilities which continued to reprice downward during 2011. Total interest income decreased $8.8 million to $53.9 million in 2011 from $62.7 million in 2010. Interest income as well as the yield on the loan portfolio was negatively impacted by $5.8 million of loan discount accretion recognized in 2011 compared to $9.8 million recognized in 2010, a decrease of $4.0 million. Management expects the loan discount accretion to continue to decline in future years as loans in the Acquired Bank’s loan portfolio continue to pay down, mature, renew or pay off. Interest expense decreased $1.1 million from $5.7 million in 2010 to $4.6 million in 2011. The interest expense and yield on time deposits during 2010 was positively impacted by the purchase accounting related to the amortization of deposit interest premium of $1.4 million All of the remaining benefit of this offset to interest expense was fully amortized during 2010 and therefore had no impact in reducing interest expense during 2011. The net effect of the Acquisition-related purchase accounting variances was a year-to-year decrease of $2.6 million in tax-equivalent net interest income between 2011 and 2010.

Interest income on loans decreased $9.8 million from $56.7 million in 2010 to $46.9 million in 2011, due to a $48.7 million decrease in average loans, declining yields on the remaining loan portfolio as good customers garner rate concessions on loan renewals during this historically low interest rate environment and a $4.0 million decrease in loan discount accretion income. When, in the opinion of management, serious doubt exists as to the collectability of a loan, the loan is placed on nonaccrual status and interest previously accrued but unpaid is deducted from interest income on loans. Nonaccrual loans are included in the calculations of both interest rate spread and net interest margin. Interest income on taxable investment securities increased $1.1 million in 2011 to $4.8 million from $3.7 million in 2010. The increase was due to a $98.3 million increase in the average balances of taxable investment securities from $158.4 million in 2010 to $256.7 million in 2011, which more than offset a decreased yield of 43 basis points (“bp,” equal to 1/100 of 1 percent) to 1.88% in 2011 from 2.31% in 2010. Interest income on tax-exempt investment securities decreased $0.1 million in 2011 to $1.4 million from $1.5 million in 2010. The decrease was due entirely to a 58bp decrease in yield on such securities as average balances of tax-exempt investment securities increase by $2.6 million from $44.4 million in 2010 to $47.0 million in 2011. For the fourth consecutive year variable rate deposits all re-priced at lower rates while maturing time deposits remained at relatively low levels. Overall funding yields on interest-bearing liabilities decreased 17 bp from 0.72% in 2010 to 0.55% in 2011. The change in yields for all five of the interest-bearing liability categories as shown in Table 1 are as follows:

Transaction account average yields decreased 16 bp to 0.19% in 2011 from 0.35% in 2010.

Money market deposit average yields decreased 34 bp to 0.51% in 2011 from 0.85% in 2010.

Savings deposit average yields including savings sweep accounts decreased 10 bp to 0.21% in 2011 from 0.31% in 2010.

Time deposit average yields increased 8 bp to 1.40% in 2011 from 1.32% in 2010. Interest expense on time deposits was reduced by $1.4 million during 2010 due to the amortization of the Acquired Bank’s deposit interest premium, which reduced the time deposit yield by 61 bp in 2010.

Short term rates on Fed funds borrowings continued to be insignificant as the Corporation had very small short-term borrowing balances during 2011.

All four of the deposit categories had a decrease in interest expense in 2011 compared to 2010 despite three out of four categories having increased average balances during the same period. Higher average balances were offset by the dramatic decrease in yields noted above, which caused the decrease in interest expense.

As a result of the changes to yields on interest-earning assets and interest-bearing liabilities the tax-equivalent net interest margin for 2011 was 4.69% compared to 5.61% for 2010. The change is attributable to an 88 bp contribution from a declining interest rate spread (the net effect of a 105 bp decrease on the yields of earning assets and a 17 bp decrease on the rates paid on deposits and borrowed funds) less a 4 bp increased contribution from net free funds. In addition, the benefit to the tax-equivalent net interest margin related to Acquisition-related purchase accounting adjustments decreased from 55 bp during 2011 compared to 110 bp during 2010.

Table 1 also shows tax-equivalent net interest income of $57.0 million for 2010, an increase of $18.8 million or 49.3% from $38.2 million in 2009. The Acquisition led to growth in interest-earning assets resulting in additional tax-equivalent net interest income. In addition, interest expense declined in most areas, but especially on fixed-rate liabilities which continued to reprice downward during 2010. As a result of the changes to yields on interest-earning assets and interest-bearing liabilities the tax-equivalent net interest margin for 2010 was 5.61% compared to 4.98% for 2009. The change is attributable to a 76 bp contribution from an improved interest rate spread (the net effect of a 30 bp increase on the yields of earning assets and a 46 bp decrease in the rates paid on deposits and borrowed funds) less a 13 bp decreased contribution from net free funds. In addition, the tax-equivalent net interest margin related to Acquisition-related purchase accounting adjustments was 110 bp during 2010 compared to 25 bp during 2009.

The following table sets forth, for the periods indicated, a summary of the changes in interest earned on a fully tax-equivalent basis and interest paid resulting from changes in volume and rates:

Table 2

NET INTEREST INCOME AND EXPENSE VOLUME AND RATE CHANGE

(Dollars in Thousands)

	2011 Compared to 2010 Increase (Decrease) Due to									2010 Compared to 2009 Increase (Decrease) Due to
	Volume			Rate(1)			Net			Volume			Rate(1)			Net
Interest earned on:
Loans	$	(3,582	)	$	(6,182	)		(9,764	)	$	8,534		$	8,064			16,598
Taxable investment securities		2,275			(1,114	)		1,161			3,326			(2,490	)		836
Non-taxable investment		131			(274	)		(143	)		242			(138	)		104
Fed funds sold		(23	)		(10	)		(33	)		28			11			39

Total interest-earning assets	$	(1,199	)	$	(7,580	)	$	(8,779	)	$	12,130		$	5,447		$	17,577

Interest paid on:
Transaction accounts	$	29		$	(404	)	$	(375	)	$	435		$	(556	)	$	(121	)
Money market		378			(680	)		(302	)		667			(626	)		41
Savings deposits		55			(184	)		(129	)		92			(170	)		(78	)
Time deposits		(480	)		146			(334	)		1,595			(2,649	)		(1,054	)
Short-term borrowings		1			11			12			(23	)		(7	)		(30	)

Total interest-bearing liabilities	$	(17	)	$	(1,111	)	$	(1,128	)	$	2,766		$	(4,008	)	$	(1,242	)

Increase (decrease) in net interest income							$	(7,651	)							$	18,819

(1) The change in interest due to both rate and volume has been allocated to rate changes.

Changes due to volume caused tax-equivalent net interest income to decrease by $1.2 million from 2010 to 2011 while changes due to rate caused a $7.6 million decrease for the same period, resulting in an aggregate $8.8 million decrease from 2010 to 2011 in tax equivalent interest earned on total interest-earning assets. For interest paid on total interest-bearing liabilities, there was a nominal decrease due to volume from 2010 to 2011, while changes due to rate decreased funding costs by $1.1 million, resulting in a decrease of $1.1 million interest paid on total interest-bearing liabilities. The net effect of the foregoing was a decrease in net interest income of $7.7 million.

A review of the changes to interest earned due to volume and rate for individual asset categories reveals a decrease due to loan volume of $3.6 million and a decrease of $6.2 million due to loan interest rates. From 2010 to 2011, interest earned on taxable investment securities increased $2.3 million due to volume and decreased $1.1 million due to rate. Non-taxable investment securities realized increases due to volume that were more than offset by decreases due to rate.

A review of the changes to interest paid on individual liability categories reveals the following trends.

Lower rates reduced interest paid on transaction accounts by $0.4 million which was partially offset by a nominal increase due to volume that resulted in a net decrease of $0.4 million in interest paid on transaction accounts.

Interest paid on money market accounts decreased $0.3 million as the decrease due to interest rates of $0.7 million was partially offset by additional interest of $0.4 million paid due to increased volume.

Lower interest rates reduced interest paid on savings accounts by $0.2 million, partially offset by an increase of $0.1 million due to volume which resulted in a net decrease of $0.1 million in interest paid on savings accounts.

A $0.2 million increase due to rates paid on time deposits was offset by a $0.5 million decrease due to volume, resulting in a $0.3 million net decrease to interest paid on time deposits.

Net interest paid on short term borrowings increased slightly due to both lower rates and decreased volume.

Changes due to volume caused tax-equivalent net interest income to increase by $12.1 million from 2009 to 2010 while changes due to rate caused a $5.5 million increase for the same period, resulting in a net $17.6 million increase from 2009 to 2010 in tax equivalent interest earned on total interest-earning assets. For interest paid on total interest-bearing liabilities, there was an increase of $2.8 million due to volume from 2009 to 2010, while changes due to rate decreased funding costs by $4.0 million, resulting in a net decrease of $1.2 million interest paid on total interest-bearing liabilities. The net effect of the foregoing was an increase in tax-equivalent net interest income of $18.8 million.

Provision for Loan Losses

The PLL represents the amount periodically added to the Bank’s ALL and charged to earnings in the relevant period. The PLL for 2011 was $8.4 million, a substantial increase from $6.9 million in 2010 and $3.7 million in 2009. The Bank does not engage in lease financing and the PLL expense is entirely the result of estimated loan losses. The increase in the PLL for 2011 compared to 2010 reflected the $3.4 million increase in net loans charged off which was primarily due to the negative effect of the economic downturn on the Bank’s loan portfolio. The increase in the PLL for 2010 compared to 2009 reflected an increase in the ALL due to $26.2 million in non-credit impaired loans that were renewed since they were acquired in October of 2009. In the quarterly analysis of the ALL, these renewed loans exhibit a higher probability of loss, which is reflected in the ALL.

Net loans charged off (total loans charged off less recoveries of prior loans charged off) for 2011 were $6.9 million compared to $3.4 million in 2010 and $3.6 million in 2009. A significant portion of the net loans charged off in 2010 and 2011 was related to charge-offs over and above the discount applied to the Acquired Bank’s loans as part of the purchase accounting fair value adjustments. Net loans charged off as a percent of average loans were 0.95%, 0.45% and 0.57% for 2011, 2010 and 2009, respectively. As of December 31, 2011 the ALL was $11.0 million compared to $9.5 million at December 31, 2010 and $6.0 million at year end 2009. The ratio of the ALL to total loans was 1.56% at December 31, 2011, up from 1.28% at December 31, 2010 and 0.77% at December 31, 2009. As of December 31, 2011 the remaining acquired credit-impaired and non-credit impaired loans had contractually required payments of $138.6 million and a carrying value of $101.2 million reflecting a discount of $37.4 million or 27.0% of the contractually required payments. As of December 31, 2010 the remaining acquired credit-impaired and non-credit impaired loans had contractually required payments of $195.9 million and a carrying value of $139.3 million reflecting a discount of $56.6 million or 28.9% of the contractually required payments. As of December 31, 2009 the acquired credit-impaired and non-credit impaired loans had contractually required payments of $266.0 million and a carrying value of $189.5 million reflecting a discount of $76.5 million or 28.8% of the contractually required payments. These acquired loans had ALL of $2.2 million and $1.4 million at December 31, 2011 and December 31, 2010, respectively, reflecting additional impairment over and above the discount. Nonperforming loans, excluding the acquired credit impaired nonperforming loans, at December 31, 2011 were $22.4 million compared to $24.6 million at December 31, 2010 and $15.3 million at December 31, 2009. The elevated levels of nonperforming loans during 2010 and 2011 was due primarily to the prolonged economic downturn.

Table 4 summarizes the ALL at the beginning and end of each of the last five years; changes in the ALL arising from loans charged off and recoveries on loans previously charged-off, by loan category; additions to the allowance that have been charged to expense; and selected performance ratios.

Table 3

SUMMARY OF LOAN CHARGE OFFS, RECOVERIES

AND PROVISIONS FOR LOAN LOSS

(Dollars in Thousands)

	For the Years Ended December 31,
	2011			2010			2009			2008			2007

Balance of allowance for loan losses at beginning of period	$	9,527		$	6,034		$	5,945		$	5,758		$	5,709
Loans charged-off:
Commercial		(300	)		(57	)		(626	)		(491	)		(143	)
Real Estate
Construction		(256	)		(300	)		(386	)		-			-
Commercial		(1,200	)		(964	)		(941	)		(309	)		(100	)
Residential		(4,972	)		(2,973	)		(1,357	)		(277	)		(178	)
Multifamily		(117	)		(48	)		(293	)		-			-
Installment & Consumer		(283	)		(209	)		(137	)		(152	)		(176	)
Total loans charged-off		(7,128	)		(4,551	)		(3,740	)		(1,229	)		(597	)

Recoveries of loans previously charged-off:
Commercial		10			428			20			22			24
Real Estate
Construction		37			9			-			-			-
Commercial		86			507			33			-			-
Residential		88			113			17			-			-
Multifamily		-			6			-			-			-
Installment & Consumer		22			51			53			94			142
Total Recoveries		243			1,114			123			116			166

Net loans charged-off		(6,885	)		(3,437	)		(3,617	)		(1,113	)		(431	)
Additions to allowance charged to expense		8,370			6,930			3,706			1,300			480

Balance at end of period	$	11,012		$	9,527		$	6,034		$	5,945		$	5,758

Ratio of net loans charged-off during theperiod to average loans outstanding		0.95	%		0.45	%		0.57	%		0.19	%		0.08	%
Ratio of allowance at end of year to total loans		1.56	%		1.28	%		0.77	%		0.99	%		0.98	%

The PLL results from the assessment of qualitative and quantitative factors to determine the required ALL. Factors considered are the size of the portfolio, levels of nonperforming loans, historical losses, risk inherent in certain categories of loans, concentrations of loans to certain borrowers or certain industry segments, economic trends, collateral pledged, and other factors that could affect loan losses as discussed in the paragraphs following Table 8.

Non-interest Income

A summary of non-interest income for the years ended December 31, 2009, 2010 and 2011 appears in Table 4 below:

Table 4

NON-INTEREST INCOME
(Dollars in Thousands)

	For the Years Ended December 31,
	2011		2010		2009
Service charges on deposits	$	9,987	$	10,181	$	9,921
Loan servicing income		318		350		(32	)
Net gain on sale of loans		1,249		1,421		2,321
Increase in cash surrender value of life insurance		467		472		505
Non-accretable loan discount		2,247		2,269		662
Other income		522		1,784		1,220
Total non-interest income	$	14,790	$	16,477	$	14,597

Total non-interest income was $14.8 million for 2011, a decrease of $1.7 million or 10.2% from $16.5 million in 2010. The decrease was primarily due to a $1.3 million decrease in other non-interest income resulting from lower gains on the sale of OREO, net of carrying costs, in 2011 compared to 2010. In addition, revenue from service charges and fees on business and retail deposit accounts decreased $0.2 million primarily driven by the number of accounts and the activity within those accounts. Net gain on sale of loans decreased $0.2 million to $1.2 million for 2011 as lower fixed-rate mortgage opportunities continued into 2011, but refinance activity in the secondary mortgage market was not as strong as in 2010. Non-accretable income, which is part of the Acquisition related purchase accounting, decreased $0.1 million in 2010. This is income related to loans acquired in the Acquisition that were specifically identified as credit impaired loans pursuant to applicable guidance for accounting for acquired loans and were paid or charged off during the year. In future years, non-accretable income will be dependent on the difference between future contractual payments received and the carrying amount of the loans specifically impaired.

Total non-interest income was $16.5 million for 2010, an increase of $1.9 million or 12.9% from $14.6 million in 2009, excluding the non-recurring bargain purchase gain of $21.5 million in 2009. The increase was primarily due to a $2.3 million increase in non-accretable income, which is part of the Acquisition-related purchase accounting, an increase of $0.6 million in other non-interest income and a $0.4 million increase in loan servicing income, comprising fees generated by payment collection, escrow collection and disbursement for loans serviced for the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal National Mortgage Association (“FNMA”). These increases were partially offset by a $0.3 million or 2.6% decrease in revenue from service charges and fees on business and retail deposit accounts and a $0.9 million decrease in the net gain on sale of loans for 2010, as lower fixed-rate mortgage opportunities continued into 2010, but refinance activity in the secondary mortgage market was not as strong as in 2009.

Non-interest Expense

A summary of non-interest expense for the years ended December 31, 2009, 2010 and 2011 appears in Table 5 below:

Table 5

NON-INTEREST EXPENSE
(Dollars in Thousands)

	For the Years Ended December 31,
	2011		2010		2009
Salaries and employee benefits	$	22,037	$	22,739	$	17,670
Occupancy		4,067		3,959		3,266
Furniture and equipment		1,887		2,201		1,896
Computer services		3,679		3,504		3,227
Advertising and promotional		1,033		1,173		976
Regulatory agency assessments		1,317		2,459		1,099
Office supplies		790		834		718
Acquisition expense		-		370		620
Core deposit intangible amortization		418		568		112
Other expenses		5,597		5,272		4,502
Total non-interest expense	$	40,825	$	43,079	$	34,086

Total non-interest expense for 2011 was $40.8 million, a decrease of $2.3 million or 5.2% over 2010, primarily resulting from a $1.1 million decrease in regulatory assessments resulting from lower FDIC premiums due to a change in the assessment methodology during 2010 and 2011. In addition, salaries employee benefits decreased $0.7 million or 3.1% due a decrease in bonus payments that was partially offset by both normal wage and salary increases as well as an increase in health insurance costs. Advertising expense decreased $0.1 million or 13.6% to $1.0 million in 2011 due to a reduction in special advertising during 2010 related to the integration of the acquisition in October of 2009. The Bank did not have any Acquisition-related expense during 2011 compared to $0.4 million incurred during 2010. Finally, the Bank had core deposit amortization expense of $0.4 million in 2011 compared to $0.6 million in 2010. The core deposit amortization expense will decrease annually until it is fully amortized in 2017. These decreases were partially offset by a $0.1 million increase in occupancy expenses and a $0.3 million decrease in equipment expenses in 2011 compared to 2010. In addition, computer service expense increased $0.2 million due to enhanced services for the Bank and additional new account volume. Finally, other non-interest expenses increased $0.3 million in 2011.

Total non-interest expense for 2010 was $43.1 million, an increase of $9.0 million or 26.4% over 2009. The Acquisition resulted in significant increases across most non-interest expenses in 2010 but had the most significant impact on salary and employee benefits. Salaries and employee benefits increased $5.1 million or 28.7% to $22.7 million for 2010 due to the Acquisition, normal wage and salary increases, and an increase in bonus payments. Occupancy expenses increased $0.7 million for 2010 primarily as a result of increased rent and utility expenses. Equipment expenses increased $0.3 million and computer service expense increased $0.3 million for 2010, due to the full-year impact of the Acquisition, enhanced services provided to the Bank and additional new account volume. Advertising expense was increased $0.2 million in 2010 as the Bank continued to utilize direct mail as its primary marketing vehicle. Regulatory assessments increased significantly from $1.1 million in 2009 to $2.5 million in 2010 due to the Acquisition and increased FDIC premium due to increased assessment rates, a special assessment and the run-off of assessment credits used in prior years. In addition, the Bank had core deposit amortization expense of $0.6 million in 2010 compared to $0.1 million in 2009. The core deposit amortization expense will decrease annually until it is fully amortized in 2017. Finally, other non-interest expenses increased $0.8 million in 2010. Nominally offsetting these increases, the Bank incurred lower Acquisition-related expenses of $0.4 million in 2010 compared to $0.6 million in 2009.

Income Taxes

Income tax expense was $4.7 million in 2011 compared to $8.4 million in 2010 and $13.6 million in 2009. The Corporation’s effective tax rate (income tax expense divided by income before income taxes) was 33.0% in 2011 compared to 36.9% in 2010 and 37.4% in 2009. The decrease in the effective tax rate in 2011 was due to both a true-up of taxes from prior years as well as a decrease in pre-tax income, which increases the effect of permanent non-taxable items on the effective tax rate.

BALANCE SHEET ANALYSIS

Loans

Loans originated by the Bank are generally loans to small businesses and individuals in the communities served in the Southeastern Wisconsin market. Although the legal lending limit of the Bank was $19.1 million per borrower as of December 31, 2011, the Bank’s larger customers are borrowers with credit needs of $10 million and less and, in fact, most borrowers’ credit relationships total less than $1 million. At December 31, 2011 there were three relationships in excess of $10 million with aggregate exposure totaling $33.8 million, fourteen relationships between $5.0 and $10 million with aggregate exposure totaling $95.9 million and thirty-one relationships between $2.0 and $5.0 million with aggregate exposure totaling $87.0 million. Of these forty-eight relationships with $216.7 million committed the balance outstanding at December 31, 2011 was $188.1 million. The remaining $28.6 million represented unfunded liability on lines of credit to 27 of the borrowers.

As of October 23, 2009 (the “Acquisition Date”) the Acquired Bank’s loan portfolio was discounted $85.1 million to reflect the estimated fair value of the acquired loans. Between the Acquisition Date and December 31, 2011 the discount has been significantly reduced as a result of activity in the Acquired Bank’s loan portfolio including renewals, amortization, pay-offs and charge-offs. Thus, the Bank’s total loans of $707.8 million at December 31, 2011 include a discount of $37.4 million reflecting the difference between cash flows expected to be received and contractually required payments on the acquired loans Credit management to ensure credit quality of the acquired loans as they are integrated into the Bank’s portfolio was a priority in 2011 and will remain so until the loans are completely transitioned. The aforementioned $85.1 million loan portfolio discount was originally allocated to $279.2 million of acquired (undiscounted) loans at the time of purchase. At December 31, 2011, the undiscounted loan total has been reduced by $101.6 million as a result of payment, foreclosure or charge-off. Of the remaining undiscounted $177.6 million, $39.0 million has been restructured or renewed into the Bank’s portfolio. Therefore to completely transition the acquired portfolio into the Bank’s portfolio requires resolving $138.5 million of undiscounted loans with $37.4 of remaining discount or $101.1 million of the Bank’s $707.8 portfolio. Management believes the remaining discount will be sufficient to cover the remaining credit losses related to the acquired loans.

The following table presents information concerning the composition of the loans held for investment by the Bank at the dates indicated.

Table 6

	LOAN PORTFOLIO COMPOSITION (Dollars in Thousands) December 31,
	2011			2010			2009			2008			2007
	Amount		% of Total	Amount		% of Total	Amount		% of Total	Amount		% of Total	Amount		% of Total
Commercial,	$	19,956	2.82%	$	25,451	3.41%	$	28,481	3.62%	$	23,552	3.93%	$	27,927	4.76%
Real estate
Construction		46,600	6.58%		55,974	7.49%		65,600	8.33%		47,726	7.96%		44,042	7.51%
Commercial		298,043	42.11%		285,863	38.28%		285,382	36.22%		246,660	41.13%		243,923	41.61%
Residential		288,609	40.78%		319,789	42.82%		349,904	44.41%		232,429	38.76%		227,362	38.78%
Multifamily		39,799	5.62%		41,074	5.50%		38,087	4.83%		35,306	5.89		28,871	4.93%
Total real estate		673,051	95.09%		702,700	94.09%		738,973	93.79%		562,121	93.74%		544,198	92.83%
Installment and other		14,790	2.09%		18,678	2.50%		20,426	2.59%		13,973	2.33%		14,153	2.41%
Total loans	$	707,797	100.00%	$	746,829	100.00%	$	787,880	100.00%	$	599,646	100.00%	$	586,278	100.00%

As Table 6 indicates, commercial loans were $20.0 million at December 31, 2011, down $5.5 million or 21.6% from December 31, 2010 and comprised 2.8% of the total loan portfolio compared to $25.5 million comprising 3.4% of the loan portfolio at December 31, 2010. Historically, commercial lending has been a small part of the Bank’s portfolio which continues to be the case in 2011. Commercial balances have decreased during these difficult economic times. Reductions of outstanding balances on lines of credit have occurred as well as the demand for term financing as businesses made little, if any, investment in new equipment. Commercial loans are collateralized by general business assets such as accounts receivable, inventory and equipment and have no real estate component. During weak economic periods the Bank can be exposed to heightened risk if a business is out of compliance with debtor covenants supporting commercial loans. The Bank was active in policing such requirements and this segment of loans presents minimal risk going forward.

Real estate construction loans decreased $9.4 million, or 16.8% to $46.6 million, representing 6.6% of the total loan portfolio at December 31, 2011, compared to $56.0 million or 7.5% of the total loan portfolio at December 31, 2010. The decrease from 2010 to 2011 was due primarily to repayment of the Bank’s pre-Acquisition construction loan portfolio. New loans to individuals for construction of owner-occupied single family residences and loans to developers that provide financing for the acquisition or development of commercial real estate and residential subdivisions lagged well behind the boom years leading up to 2008. In the challenging climate of today’s economy there were no significant new commercial real estate development loans financed by the Bank in 2011. Loans to residential real estate developers comprise most of the dollars outstanding in real estate construction loans. Historically, real estate construction loans have been made to developers who are well known to the Bank, have prior successful project experience and are well capitalized. Loans are made to customers in the Bank’s Southeastern Wisconsin market with experience and knowledge of the local economy. Real estate construction loans of this type are generally larger in size and involve greater risks than residential mortgage loans because payments depend on the success of the project or in the case of commercial development, successful management of the property. The Bank will generally make credit extensions to borrowers with adequate outside liquidity to support the project in the event the actual performance is less than projected. Developers with which the Bank does business have the ability to service the development debt personally or through their companies, however, these individuals are not immune to a prolonged weak economy such as the Bank has experienced. Most of the Bank’s real estate development loans are performing even three years into the economic downturn and borrowers’ inventories are decreasing. The greatest risk to the Bank within this segment are loans secured by raw land and condominium development loans. These two groups have been most severely affected by the prolonged economic downturn. In the case of loans secured by undeveloped acreage, the price per acre has decreased dramatically as other lenders liquidate the collateral on these raw land or “dirt” loans. The Bank has a few customers continuing to service the debt from free cash flow, but this becomes more problematic as the housing market continues a slow recovery or in some cases a non-recovery. In the case of condominium loans, risk factors the Bank inherits upon the failure of a developer include the existence and/or control of the condo association, the availability of term financing to initial buyers of units and partial project completion for common use areas. The Bank does have condominium exposure in several smaller projects to the second developers following foreclosures. These are the Bank’s customers who were able to buy incomplete developments at deep discounts from other banks that foreclosed on the original developer in 2010 and 2011. In all cases the selling banks also agreed to fixed-rate mortgage loans to qualified borrowers at prevailing rates to allow the second developer to sell units without the issue of term financing availability.

Commercial real estate loans increased $12.1 million or 4.3% to $298.0 million at December 31, 2011, compared to $285.9 million at December 31, 2010. The increase is due to new business exceeding the portfolio amortization, pay-offs and elimination of nonperforming loans from the Acquisition. This category of loans made up the largest component of the total loan portfolio at 42.1% at December 31 2011 and 38.3% at December 31, 2010. The increase is attributable to an influx of new relationships as well as new projects with current customers which outpaced any run-off from the Acquired loan portfolio. The Bank’s commercial real estate lending efforts are focused on owner occupied, improved property such as office buildings, warehouses, small manufacturing operations and retail facilities. The most significant risk factor in the third year of the financial crisis is occupancy. The fact that the Bank prefers owner occupied commercial real estate mitigates that risk, provided of course, the owner’s business survives. The Bank’s $19.1 million per-borrower legal lending limit would permit it to compete for activity in the middle market, but management prefers to seek small businesses as its target borrowers. Loans to such businesses are approved based on the creditworthiness, economic feasibility and cash flow abilities of the borrower.

Residential real estate loans which include single family, 2-4 family dwellings and home equity lines of credit or “HELOCs” secured by real estate decreased $31.2 million or 9.8% to $288.6 million comprising 40.8% of the Bank’s total loan portfolio at December 31, 2011 compared to $319.8 million comprising 42.8% of the Bank’s total loan portfolio at December 31, 2010. The decrease is primarily due to the elimination of nonperforming acquired loans. Loans in this segment of the portfolio have historically represented the lowest risk due to the large number of individual loans with relatively small average balances. The Bank considers owner-occupied one-to-four family loans to be low risk because underwriting has always required 20% equity and qualified borrowers with proper debt service coverage ratios. These loans provide a foundation for the sale of all other retail banking products and have always been a staple of the Bank’s portfolio. However, the Acquired Bank’s loan portfolio included a number of residential real estate loans that do not meet the Bank’s underwriting standards and these borrowers were encouraged to bring loans current, pay delinquent taxes, and comply with the Bank’s underwriting standards or refinance at another financial institution or face foreclosure. The greatest risks to the Bank in this segment are those one-to-four family residential real estate loans that are not owner occupied. Many of these scattered site owner’s loans were generated by the Acquired Bank through its “Rehab and Go” and “Equity is Cash” programs. Often rehab dollars were not invested in the property, the properties were over-appraised and rental property damage was prevalent but no replacement reserves were required, as would be the case in a commercial real estate loan. The Bank is working to eliminate this group of acquired loans. As a result, the significant portfolio decreases experienced in 2010 and 2011 will continue into 2012. These loans were deeply discounted in the Bank’s bid to the FDIC and the Bank believes the credit risk associated with these loans is mitigated by this discount.

Residential real estate loans in the portfolio have historically been originated with maturities of one, two or three years to provide a re-pricing opportunity to the Bank when rates change. Amortization periods offered to customers are 20-25 years depending on equity and loan-to-value ratios. Customers seeking long term rate locks choose the secondary market products offered by the Bank where rates can be fixed for 15, 20 or 30 years. These loans are then sold and as a result, do not impact the portfolio yields nor are they a factor in interest rate risk. Loans from the Acquisition are either one-, two- or three-year balloons or Adjustable Rate Mortgages (“ARMs”). While ARMs have not been the Bank’s vehicle of choice for rate management, they serve the purpose of providing annual rate adjustments after an initial fixed rate period of three to five years. ARM loans from the Acquired Bank residential real estate loan portfolio have been repriced in 2010 and 2011 at the margin (2.625%) prescribed by Freddie Mac over their assigned indices. A typical ARM index is the one year US Treasury note rate, which decreased to historic lows in 2011. This rate was near 0.25% during the first half of 2011 but decreased to 0.10% for most of the second half of the year resulting in adjusted rates below 3.0% for ARM mortgage customers. Of the variable rate mortgage loans repricable in Table 7, total ARM portfolio yields decreased 124 basis points to 4.78% at December 31, 2011 from 6.02% at December 31, 2010 as a result of these rate decreases. Even with today’s low funding costs extremely low rates negatively impact the Bank’s net interest margin.

Multi-family real estate loans decreased $1.3 million or 3.1% to $39.8 million, representing 5.6% of the total loan portfolio at December 31, 2011 compared to $41.1 million comprising 5.5% of the total loan portfolio at December 31, 2010. The loans in this category are collateralized by properties with more than four family dwelling units. The Bank has always been conservative in requiring borrowers to be well-qualified and to provide their personal guaranty, as well as insisting on proper debt service coverage ratios and equity sufficient to sustain reasonable debt service in the event of interest rate pressure. Loans in this category typically have maturities of 3, 4 or 5 years and are amortized over 15 to 20 years. While any loan presents risk to the Bank, loans in this segment are performing quite well in the downturn because of the Bank’s underwriting criteria and with significant foreclosure activity in the market, many former homeowners are back in the rental market.

In total real estate loans decreased $29.6 million or 4.2% to $673.1 million at December 31, 2011 compared to $702.7 at December 31, 2010 primarily as result of the continued reduction in the Acquired Bank’s nonperforming 1-4 family loans. Real estate loans accounted for 95.1% of the Bank’s total loan portfolio at December 31, 2011 and compared to 94.1% of the Bank’s total loan portfolio at December 31, 2010.

Installment loans decreased $3.9 million, or 20.8%, to $14.8 million at December 31, 2011 compared to $18.7 million at December 31, 2010 and $20.4 million at December 31, 2009 due to the elimination of acquired loans outpacing new business. These loans consist of auto loans, mobile home loans and unsecured consumer loans which have been decreasing at the Bank for several years. Auto loan volume decreased despite improved new car sales in 2011 because dealer incentive financing makes this non-competitive. The Bank has historically limited its exposure to mobile home loans and unsecured consumer loans. However, the Bank acquired a number of such consumer loans in the Acquisition, many of which continue to perform, despite not meeting the Bank’s historical underwriting standards.

To ensure credit quality, overall credit management of portfolio loans in the Bank requires sound loan underwriting and administration, systematic monitoring of existing loans, effective loan review, early identification of problem loans, an adequate ALL and valid non-accrual and charge off policies. As the economy weakened loan underwriting was strengthened at the Bank by reducing delegated authority for lenders in the branch locations to ensure that appropriate standards would be met on every credit request. These precautions were extended through 2011 and deemed necessary as management believed many marketing opportunities were the result of marginally qualified borrowers, both commercial and consumer, attempting to leave their existing bank due to rate pressure, new requirements such as additional collateral or other restrictive terms.

The Bank’s loan operations center occupies a facility in the lower level of the West Allis branch, which is centrally located for the suburban and metropolitan Milwaukee offices and provides support to lending officers and loan customers. Loan operations, documentation preparation, servicing and exception tracking take place in this facility. Remote distribution (print-back) of prepared documents to the Bank’s branch locations via its wide area telecommunications network has made a positive contribution to loan efficiency since its roll-out and is a key factor in servicing the lenders in the Bank’s Racine and Kenosha locations. Document preparation remains a centralized function, but electronic distribution eliminates the need for courier delivery of loan documents to the loan offices. The loan processing department of the Acquired Bank has been absorbed into the Bank’s loan operations center. Conversely, retail mortgage functions (other than underwriting, document preparation and data entry) for Freddie Mac and Fannie Mae are performed in Racine for the entire Bank. This post-closing activity fits nicely into a separate group managed by the Bank’s senior vice president in charge of loan operations.

The collection practices for the Bank were centralized to more efficiently handle increases in past dues, collection efforts, foreclosures and repossessions from both legacy loans and acquired loans. An executive vice president is now involved daily with debtors, attorneys, bankruptcy trustees, repossession companies, real estate agents and buyers of assets being liquidated. The Bank has three collection divisions reporting to the EVP; commercial loan workouts, retail loan collection and collection of the secondary market real estate loan portfolio serviced by the Bank. Loan losses and recoveries have been previously discussed in the narrative accompanying Table 3. However, it is worth noting the dramatic shift for the Corporation. At December 31, 2008, the Bank had no repossessed business assets, autos or trucks, boats or recreational vehicles in its possession and had only one parcel of foreclosed property, valued at $109,500. At December 31, 2009, primarily due to the Acquisition, the Bank had 46 properties in OREO with book values aggregating $4.7 million. At December 31, 2010, the Bank had 49 properties in OREO with book values of $5.4 million and had 67 properties in OREO with book values of $7.4 million at December 31, 2011. The increase of $2.0 million during 2011 is due to the addition of one property for $3.6 million. However, the effort to work through troubled loans continued at an aggressive pace during 2011, as 20 potential foreclosures/OREO were avoided with short sales of the underlying real estate collateral and 100 properties were liquidated from OREO during 2011. Indicative of the effort is the fact that of the 67 OREO properties at December 31, 2011, only 5 were also on the books as OREO at December 31, 2010. The current centralized structure is the reason collection, repossession and liquidation is efficient. The Bank’s goal is to minimize the delay in liquidation. The Bank has used its own officers as the best source for identifying buyers for OREO. A list complete with color photos and summary information is published to all 90 banking officers bi-weekly. Management believes that these officers know which of the Bank’s existing customers are in the market for real estate and thus far this strategy has proven successful, accounting for the majority of the properties sold. Management believes the significant number of foreclosure confirmations and OREO liquidation will continue in 2012.

The loan maturity distribution and interest rate sensitivity as of December 31, 2011 are displayed in Table 7 below. The table displays the maturity distribution by loan classification. Since commercial loans of $20.0 million and installment loans of $14.8 million account for only 2.8% and 2.1%, respectively, of the total selected loans, the majority of the Bank’s portfolio is collateralized by real estate. Although not displayed in Table 7, $648.4 million or 91.6% of the total $707.8 million loan portfolio will reprice within a three year period as a result of the Bank’s use of one, two and three year notes as its primary borrowing agreement. Real estate construction loans are typically floating rate loans with one year notes as evidenced by the fact that $23.1 million, or 49.6%, of loans in this class have maturities within one year. Other real estate mortgage loans are predominantly notes with maturities of five years or less with $246.5 million, or 34.8%, repricing in one year or less, and an additional $321.0 million, or 45.4%, maturing in more than one year but less than five years. The remaining $59.0 million, or 8.3%, of other real estate mortgage loans mature after five years however, most of these loans have a floating or variable rate structure that allows the Bank to reprice the loan after one year through five years.

Table 7

Maturities for Selected Loan Categories
(Dollars in Thousands)

	At December 31, 2011
			After
	Within		One year		After
	One		Through		Five
	Year		Five years		Years		Total

Selected loan maturities:
Commercial	$	11,059	$	8,880	$	17	$	19,956
Real estate construction		23,115		23,441		44		46,600
Other real estate mortgage		246,465		321,030		58,956		626,451
Installment and other loans		8,088		6,320		382		14,790

Total selected loans	$	288,727	$	359,671	$	59,399	$	707,797

Sensitivity of loans due after one year to changes in interest rates:
Loans to fixed interest rates			$	311,601	$	3,250
Loans at floating/variable interest rates				48,071		56,149

Total selected loans			$	359,672	$	59,399

Allowance for Loan Losses

The loan portfolio is the primary asset subject to credit risk. Credit risk is controlled and monitored through the use of lending standards, management’s strict underwriting of potential borrowers and on-going review of loan payment performance. Managing credit risk and minimizing loan losses is a high priority for management. Active asset quality administration, including early problem loan identification and timely resolution, aids in the management of credit risk and minimization of loan losses.

Table 8 summarizes the ALL balances at the beginning and end of each year from 2007 through 2011, changes in the ALL arising from loans charged off and recoveries on loans previously charged-off, additions to the allowance that have been charged to expense and selected performance ratios.

Table 8

SUMMARY OF ALLOWANCE FOR LOAN LOSSES
(Dollars in Thousands)

	For the Year Ended December 31,
	2011			2010			2009			2008			2007

Balance of allowance for loan losses at beginning of period	$	9,527		$	6,034		$	5,945		$	5,758		$	5,709
Total loans charged-off		(7,128	)		(4,551	)		(3,740	)		(1,229	)		(597	)
Total recoveries		243			1,114			123			116			166
Net loans charged-off		(6,885	)		(3,437	)		(3,617	)		(1,113	)		(431	)
Additions to allowance charged to expense		8,370			6,930			3,706			1,300			480
Balance of allowance for loan losses at end of period	$	11,012		$	9,527		$	6,034		$	5,945		$	5,758

Total loans	$	707,7987		$	746,829		$	787,880		$	599,646		$	586,278

Total nonperforming loans(1)	$	22,405		$	24,615		$	15,328		$	8,613		$	5,612

Ratio of allowance for loan losses to total nonperforming loans		49.15	%		38.70	%		39.37	%		69.02	%		102.60	%
Ratio of nonperforming loans to total loans		3.17	%		3.30	%		1.95	%		1.44	%		0.96	%
Ratio of nonperforming assets to total assets		2.49	%		2.63	%		1.78	%		1.10	%		0.71	%
Ratio of net loans charged-off during the period to average loans outstanding		0.95	%		0.45	%		0.57	%		0.19	%		0.07	%
Ratio of allowance at end of year to total loans		1.56	%		1.28	%		0.77	%		0.99	%		0.98	%

(1)This amount excludes purchased credit-impaired loans. Purchased credit-impaired loans have evidence of pre-Acquisition deterioration in credit quality. Fair value of these loans as of the Acquisition Date includes estimates of credit losses.

The ALL represents management’s estimate of an amount adequate to provide for probable and inherent credit losses in the loan portfolio. To assess the adequacy of the ALL, management uses significant judgment focusing on specific reserves applied to loans that are identified for evaluation on an individual loan basis. In addition, loans are analyzed on a group basis using risk characteristics that are common to groups of similar loans. The factors that are considered include changes in the size and character of the loan portfolio, changes in the levels of impaired and nonperforming loans, historical losses in each category, the risk inherent in specific loans, concentrations of loans to specific borrowers or industries, existing economic conditions, and the fair value of underlying collateral as well as changes to the fair value of underlying collateral.

At December 31, 2011, the ALL was $11.0 million, compared to $9.5 million at December 31, 2010. As of December 31, 2011, the ratio of the ALL to total loans was 1.56% and covered 49.2% of nonperforming loans, compared to a ratio of 1.28% covering 38.7% of nonperforming loans at December 31, 2010. The increase in the ratio of ALL to total loans during 2011 was due to both an increase in the ALL as well as a decrease in total loans. Nonperforming loans, not including the acquired credit impaired nonperforming loans, were $22.4 million, or 3.2% of total loans as of December 31, 2011, compared to $24.6 million, or 3.3% of total loans at December 31, 2010. Total interest income that was accrued but never recorded as income on loans on non-accrual was $2.7 million at December 31, 2011 and $3.2 million at December 31, 2010. Net charge offs were $6.9 million and $3.4 million for 2011 and 2010, respectively. Loans charged-off are subject to continuous review and specific efforts are taken to achieve maximum recovery of principal, accrued interest and related expenses.

Table 9 summarizes the components of the ALL at December 31, 2011, 2010 2009, 2008 and 2007. Because assumptions and conditions used to estimate the ALL are subject to change, the components shown in Table 9 are not necessarily indicative of the trend of future loan losses in any particular loan category. The Bank’s loans have historically been predominantly collateralized by real estate as shown in Table 6.

Table 9

ALLOWANCE FOR LOAN LOSS COMPONENTS
(Dollars in Thousands)

	December 31, 2011				December 31, 2010				December 31, 2009				December 31, 2008				December 31, 2007
			% of Loans				% of Loans				% of Loans				% of Loans				% of Loans
			in each				in each				in each				in each				in each
	Amount		Category		Amount		Category		Amount		Category		Amount		Category		Amount		Category

Commercial, industrial, agricultural	$	165		2.8%	$	413		3.4 %	$	340		3.6 %	$	242		3.9 %	$	467		4.8%
Real Estate
Construction		586		6.6 %		448		7.5 %		518		8.4 %		1,268		8.0 %		837		7.5 %
Commercial		3,730		42.1 %		2,738		38.3 %		1,712		36.2 %		2,231		41.1 %		2,756		41.6 %
Residential		5,776		40.8 %		4,594		42.8 %		3,159		44.4 %		2,134		38.8 %		1,627		38.8 %
Multifamily		595		5.6 %		1,011		5.5 %		245		4.8 %		-		5.9 %		-		4.9 %
Installment loans to individuals		160		2.1 %		242		2.5 %		60		2.3 %		70		2.3 %		71		2.4 %
Other Loans		-		- %		81		0.0 %		-		0.3 %		-		0.0 %		-		0.0 %
Total	$	11,012		100 %	$	9,527		100.0 %	$	6,034		100.0 %	$	5,945		100.0 %	$	5,758		100.0 %

At December 31, 2011, as can be seen in Table 9 above, $0.2 million of the ALL was allocated to potential losses on commercial, industrial or agricultural loans as a result of management’s analysis of commercial loans that comprise 2.8% of total loans in the Bank’s portfolio. This allocation represents a decrease of $0.2 million from $0.4 million at December 31, 2010 when the commercial category represented 3.4% of total loans. At December 31, 2011, $0.6 million of the ALL was allocated to potential losses on real estate construction financing, an increase of $0.1 million from $0.5 million at December 31, 2010. Real estate construction financing represents 6.6% of total loans at December 31, 2011 compared to 7.5% of total loans at December 31, 2010. At December 31, 2011, $3.7 million of the ALL was allocated to potential losses from commercial real estate loans, an increase of $1.0 million from $2.7 million at December 31, 2010. Commercial property in the market served by the Bank continued to struggle in 2011 warranting this increase. In addition, commercial real estate mortgage loans represented 42.1% of total loans at December 31, 2011, up from 38.3% at December 31, 2010. At December 31, 2011, $5.8 million of the ALL was allocated to potential losses on residential real estate loans comprising 40.8% of total loans in the Bank’s portfolio. This allocation represents an increase of $1.2 million from $4.6 million at December 31, 2010, when residential real estate mortgage loans represented 42.8% of total loans. As the economic slowdown persisted in 2011, management identified home mortgages requiring an additional reserve. The Bank works with borrowers where possible to restructure and avoid foreclosure. At December 31, 2011, $0.6 million of the ALL was allocated to potential losses from multifamily real estate loans, a decrease of $0.4 million from $1.0 million at December 31, 2010. Multifamily real estate mortgage loans represented 5.6% of total loans at December 31, 2011 up from 5.5% at December 31, 2010. At December 31, 2011 the reserve for installment loans to individuals remained at $0.2 million of the total ALL. Installment loans represented 2.1% of total loans at the Bank in 2011, down from 2.5% in 2010.

Total loans decreased during 2011 as the acquired loan portfolio issues were addressed and the bank maintained its historical conservative underwriting standards. Credit administration continues to remain a high priority, with management monitoring the Corporation’s loan portfolio to identify potential loan loss situations and to address any weaknesses promptly. This will continue to be important going forward given the historical weak underwriting standards implicit in the loan portfolio of the Acquired Bank. Management believes the ALL to be adequate at December 31, 2011.

Potential Problem Loans

Management uses an internal asset classification system as a means of reporting problem and potential problem assets. At the quarterly meetings, the Board of Directors of the Bank reviews trends for loans classified as “Special Mention,” “Substandard” and “Doubtful” for the previous thirteen months both as a total dollar volume in each classified category and as the percent of capital each classified category represents. A Special Mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date. An asset is classified Substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of current existing facts, conditions and values, highly questionable and improbable. Assets classified as Loss are those considered uncollectible and viewed as non-bankable assets, worthy of charge-off. Assets that do not currently expose the Bank to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses that may or may not be within the control of the customer are deemed to be Watch.

The determination as to the classification of assets and the amount of valuation allowance is subject to review by the Bank’s regulator, the Office of the Comptroller of the Currency (the “OCC”) ,which can order the establishment of additional general or specific loss allowances. There can be no assurance that regulators, in reviewing the Bank’s loan portfolio, will not request the Bank to materially adjust its allowance for loan losses. The OCC, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the ALLs. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that (1) institutions have effective systems and controls to identify, monitor and address asset quality problems; (2) management has analyzed all significant factors that affect the collectability of the portfolio in a reasonable manner; and (3) management has established acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Management believes it has established an adequate ALL. The Bank analyzes its process regularly, with modifications made if needed, and reports those results four times per year at meetings of the Board of Directors. Although management believes that adequate specific and general loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of specific and general loan loss allowances may become necessary.

Investment Securities Portfolio

The investment securities portfolio is intended to provide the Bank with liquidity, flexibility in asset/liability management, a source of stable income, and is structured to minimize the Corporation’s credit exposure. It is the practice of the Corporation to hold securities to maturity.

Table 10

INVESTMENT SECURITIES PORTFOLIO
(Dollars in Thousands)

	December 31,
	2011					2010					2009
	Amortized		Percentage			Amortized		Percentage			Amortized		Percentage
	Cost		of Total			Cost		of Total			Cost		of Total
Obligations of:
States and political subdivisions (tax exempt)	$	51,028		14.2	%	$	41,292		18.1	%	$	42,834		22.6	%
States and political subdivisions (taxable)		12,118		3.4	%		10,023		4.4	%		2,435		1.3	%
U.S. government sponsored entities		261,602		72.6	%		176,389		77.4	%		144,270		76.0	%
Collateralized mortgage obligations		17,069		4.7	%		-		-	%		-		-	%
Mortgage-backed securities		18,699		5.1	%		-		-	%		-		-	%
Other		50		-	%		100		0.1	%		250		0.1	%
Total investment securities	$	360,566		100.0	%	$	227,804		100.0	%	$	189,789		100.0	%

Fair value of investment securities	$	363,252				$	227,277				$	191,485

Total assets at year end	$	1,215,143				$	1,141,687				$	1,125,709

Average earning assets	$	1,051,744				$	1,014,977				$	766,717

The total investment securities portfolio increased $132.8 million or 58.3% to $360.6 million at December 31, 2011 compared to $227.8 million at December 31, 2010. At December 31, 2011, the total carrying value of investment securities represented 29.7% of total assets, compared to 20.0% at December 31, 2010. The increase in the investment securities portfolio during 2011 was due to the reinvestment of excess liquidity created by deposit growth and a decline in total loan balances during the year.

States and political subdivisions (tax-exempt) investment securities increased $9.7 million or 23.6% to $51.0 million at December 31, 2011 compared to $41.3 million at December 31, 2010. States and political subdivisions (taxable) investment securities increased $2.1 million or 20.9% to $12.1 million at December 31, 2011 compared to $10.0 million at year end 2010. Municipal investments (tax-exempt and taxable) represent 17.6% of total investment securities at December 31, 2011 compared to 22.5% at December 31, 2010. Management maintains overall quality as well as addresses its asset/liability management concerns by limiting purchases to rated investments of high quality or, on a limited basis, to well known local non-rated issues. Diversity in the securities portfolio is maintained by limiting the amount of investment to any single debtor in the municipal category. At December 31, 2011, the Bank’s securities portfolio did not contain any obligations of any single issuer that were payable by the same source of revenue or taxing authority where the aggregate carrying value of such securities exceeded 2.7% of stockholders’ equity.

Investments in securities of U.S. government sponsored entities (“GSEs”) increased $85.2 million to $261.6 million at December 31, 2011 compared to $176.4 million at year end 2010. Investments include four GSEs; the Federal Farm Credit Bank, the Federal Home Loan Bank, the Federal National Mortgage Association (“Fannie Mae”), and the Federal Home Loan Mortgage Corporation (“Freddie Mac”). Investments in GSE securities represented 72.6% of total investment securities at December 31, 2011 compared to 77.4% in 2010. Many of the GSEs purchased during 2011 represented relatively attractive yields initially with step-up features in which the yields are scheduled to increase in future periods. Step-up provides the Bank the advantage of increasing yields in a rising rate environment. The issuer receives the advantage of a call option in return and therefore the ability to reprice the security in a falling rate environment. In 2011 the Bank’s portfolio experienced numerous calls as rates declined during the year. GSEs such as Fannie Mae and Freddie Mac are not explicitly guaranteed by the U.S. government. The U.S. government has, however, provided unlimited support to both entities since 2009. The Federal Home Loan Bank and the Federal Farm Credit Bank are also GSEs. To date neither of these GSEs has required support from the U.S. Government.

The Corporation diversified the investment portfolio in 2011 through the purchase of $17.1 million of collateralized mortgage obligations and $18.7 million of mortgage-backed securities. These investments are guaranteed by Fannie Mae, Freddie Mac and the Government National Mortgage Association (“Ginnie Mae”). Investments in collateralized mortgage obligations and mortgage-backed securities represented 4.7% and 5.1%, respectively, of the investment portfolio as of December 31, 2011. These bonds are structured to return principal in a principal window significantly shorter than the maturity of the underlying mortgages. The average life of the securities purchased is four to six years. The cash flow will enhance the yield of the investment portfolio when interest rates rise as the economy strengthens.

The following table sets forth the maturities of investment securities at December 31, 2011, the weighted average yields of such securities (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security) and the tax-equivalent adjustment used in calculating the yields.

Table 11

INVESTMENT SECURITIES PORTFOLIO MATURITY DISTRIBUTION
(Dollars in Thousands)

					After One				More Than
	Within One Year				Within Five Years				Five Years
	Amount		Yield		Amount		Yield		Amount		Yield
Obligations of:
States and political subdivisions (tax-exempt)	$	5,824	5.28	%	$	29,301	4.41	%	$	15,903	3.72	%
States and political subdivision (taxable)		2,086	1.98	%		7,457	2.47	%		2,575	2.52	%
U.S. government sponsored entities		-	-	%		35,000	1.46	%		226,602	2.08	%
Collateralized mortgage obligations		-	-	%		14,975	2.07	%		2,094	2.37	%
Mortgage-backed securities		-	-			11,534	2.58	%		7,166	2.41	%
Corporate entities		50	2.57	%		-	-	%		-	-	%
	$	7,960			$	98,267			$	254,340

Tax equivalent adjustment for calculation of yield	$	118			$	446			$	196

Note: The weighted average yields on tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a tax rate of 34%.

As indicated in Table 11, $8.0 million or 2.2% of total investment securities mature within one year. An additional $98.3 million or 27.3% matures after one year and within five years. The remaining $254.3 million or 70.6% have stated maturities extending beyond 5 years. Expected maturities will differ from contractual maturities, as borrowers may have the right to call or repay obligations with or without call or prepayment penalties. Many of the GSEs purchased during 2011 have step-up features in which the interest rate paid on the security is scheduled to increase in future years. While these GSEs securities have an average stated maturity of 7.8 years, all of the GSEs securities are callable by the issuers. In addition, many of the collateralized mortgage obligations and mortgage backed securities have long stated maturities but have estimated average lives of 4.3 years and 3.9 years, respectively.

Deposits

Deposits are the Bank’s largest source of funds. The Bank competes in Southeastern Wisconsin with other financial institutions such as banks, thrifts and credit unions, as well as non-bank institutions, for retail and commercial deposits. The Bank continues to market its checking accounts and had continued success in 2011 with completely free checking (non-interest-bearing), several options for interest-bearing checking and for Investor Checking, a tiered product. The interest-bearing checking options offered are desirable to the Bank as low cost core deposit growth. Depositors earn interest, but the yields paid on these products are low compared to other funding costs.

Table 12

AVERAGE DAILY BALANCE OF DEPOSITS AND AVERAGE RATE PAID ON DEPOSITS
(Dollars in Thousands)

	2011				2010				2009
	Amount		Rate		Amount		Rate		Amount		Rate
Noninterest-bearing demand deposits	$	161,355	-	%	$	156,011	-	%	$	127,301	-	%
Transaction Accounts		256,241	0.19	%		247,950	0.35	%		171,761	0.57	%
Money Market Accounts		199,816	0.51	%		155,195	0.85	%		101,811	1.25	%
Savings		182,093	0.21	%		164,378	0.31	%		142,142	0.41	%
Time deposits (excluding time certificates of deposit of $100,000 or more)		120,793	1.41	%		124,966	1.35	%		65,039	4.47	%
Time deposits ($100,000 or more)		72,354	1.38	%		104,045	1.30	%		100,049	1.51	%
	$	992,652			$	952,545			$	708,103

For the year ended December 31, 2011 average daily deposits were $992.7 million, an increase of $40.1 million or 4.0% over $952.6 million at December 31, 2010. The Bank continued to have substantial organic deposit growth across most of the branches, including those that it acquired, due to a strong product line, convenient hours and locations, and successful marketing campaigns.

Average non-interest-bearing demand deposits increased $5.4 million or 3.4% to $161.4 million at December 31, 2011 compared to $156.0 million at December 31, 2010 as many customers opted for the safety of a fully guaranteed deposit solution over the nominal returns they would receive in an interest-bearing transaction account.

Transaction accounts consist of interest-bearing checking held by individuals, municipalities, non-profit organizations and sole proprietorships. Average transaction accounts increased $8.3 million or 3.3% to $256.2 million at December 31, 2011 compared to $247.9 million on December 31, 2010. The blended rate for all transaction accounts in 2011 was 0.19% a decrease of 16 bp from 0.35% in 2010.

The daily average balance of money market deposit accounts increased $44.6 million or 28.8% to $199.8 million for 2011 compared to $155.2 million in 2010. The increase in money market accounts during 2011 is due to the relatively attractive interest rates paid on this product compared to certain transaction accounts and longer term certificates of deposits. The yield on money market deposits decreased 34 bp to 0.51% for 2011 from 0.85% in 2010.

The daily average balance of savings accounts increased $17.7 million or 10.8% to $182.1 million for the year ended December 31, 2011 from $164.4 million at December 31, 2010. The yield on basic savings was 0.15% in 2011 and 0.20% in 2010. Savings sweep accounts for businesses increased the blended savings yields to 0.21% and 0.31% for 2011 and 2010, respectively. The sweep rates are tied to the Fed funds rate and vary as that index moves.

The daily average balance of time deposits decreased by $35.9 million, or 15.7% to $193.1 million at December 31, 2011, from $229.0 million at December 31, 2010. The decline was primarily due to deposits moving from fixed rate products with longer terms into floating interest rate products, such as money market accounts given the very low rates available in 2011. Within that total, time deposits $100,000 or more decreased $31.6 million or 30.5% to $72.4 million at year-end 2011 from $104.0 million at December 31, 2010. The yield on time deposits $100,000 or more was 1.38% in 2011, up from 1.30% in 2010. The average yields increased as there was a higher proportion of longer term CD’s with higher interest rates relative to the previous year. Time deposits less than $100,000 decreased $4.2 million or 3.3% to $120.8 million at year-end 2011 from $125.0 million at December 31, 2010. The yield on time deposits less than $100,000 was 1.41% in 2011, up from 1.35% in 2010. The increase in the yield on time deposits less than $100,000 was due to interest expense being reduced by $1.4 million in 2010 due to the amortization of the deposit premium associated with the Acquisition. The premium was fully amortized during 2010 and therefore did not reduce interest expense in 2011.

A total of $10.0 million or 13.8% of time deposits in amounts $100,000 or more mature in three months or less, an additional $17.1 million or 23.6% mature between 3 and 6 months, and $23.6 million or 32.6% mature between 6 and 12 months, making the total maturing in one year or less $50.7 million or 70.0%, as shown in Table 13 below. As a result, these investments earn a lower yield (being on the short end of a normal yield curve) and because they mature faster, renew at lower rates given the relatively low interest rate environment of 2010. As shown in Table 12 above, the yield on time deposits excluding time deposits of $100,000 or more was 1.41% in 2011, up from 1.30% in 2010. Certificate of deposits less than $100,000 have a more even maturity distribution from short term to 60 months, which is the longest investment term offered by the Bank. Therefore, these depositors earn higher rates as deposits are spread evenly throughout the yield curve and do not reprice at lower rates as quickly.

The Bank has no brokered certificates of deposit and does not participate in any CDars programs. Certificate of deposits of $100,000 or more are generally drawn from the Bank’s market and from its customers. Core deposits are crucial to the success of a financial institution and the Corporation considers these certificates of deposit in amounts of $100,000 or more to be core deposits.

Table 13

MATURITY DISTRIBUTION
TIME DEPOSITS IN AMOUNTS OF $100,000 AND OVER
(Dollars in Thousands)
	December 31, 2011
Three months or less	$	9,951
After 3 through 6 months		17,105
After 6 through 12 months		23,627
After 1 year through 2 years		10,811
After 2 years through 3 years		3,962
After 3 years through 4 years		4,342
After 4 years through 6 years		2,556
	$	72,354

Liquidity

The objective of liquidity management is to ensure that the Corporation and the Bank have the ability to generate sufficient cash or cash equivalents in a timely and cost efficient manner to meet commitments as they come due. Funds are available from a number of sources, primarily from core deposits and loan and security repayments and/or maturities. If needed, additional liquidity can be obtained from the sale of portfolio securities or loans, lines of credit with major banks and the acquisition of deposits.

It has been management’s practice not to sell portfolio loans or securities prior to maturity. The use of available credit facilities has been the principal source of liquidity when needed. At December 31, 2011, the Bank has a combined $50.0 million approved Fed funds purchased facility with two correspondent banks. There were no Fed funds purchased outstanding at December 31, 2011 or 2010. Management has avoided the use of brokered deposits; however the Bank has, through its normal day-to-day activity, developed deposit relationships with a number of local government entities and has pledged securities and loans to these depositors to meet their collateral requirements. The Bank continues to attract deposits by offering competitive deposit rates and by offering a high level of service with extended hours, seven days per week banking and forty-four locations in Southeastern Wisconsin.

Other sources of liquidity consist of accounts due to the Federal Reserve Bank under a $7,000,000 treasury, tax and loan depository agreement. Such borrowings bear interest at the lender bank’s announced daily federal funds rate and mature on demand. The Bank did not have any Treasury, tax and loan account balances outstanding as of December 31, 2011. Treasury, tax and loan account balances totaled $4.8 million at December 31, 2010. Such accounts generally are repaid within one to 120 days from the transaction date and are collateralized by a pledge of investment securities with a carrying value of $7.0 million and $7.2 million at December 31, 2011 and 2010, respectively.

The Bank may also borrow through securities sold under repurchase agreements (reverse repurchase agreements). Reverse repurchase agreements, which are classified as secured borrowings, generally mature within one to four days from the transaction date. They are reflected at the amount of cash received in connection with the transaction. The Bank had no borrowings outstanding under reverse repurchase agreements at December 31, 2011 and 2010, respectively and, accordingly, did not pledge any U.S. government -sponsored entity securities municipal obligations as collateral under its master repurchase agreement as of those dates. At December 31, 2011, however, the Bank could pledge up to $182.9 million of securities as collateral under the existing agreements if needed to obtain additional borrowings. The Bank may be required to provide additional collateral based on the fair value of the underlying securities. The Bank may also borrow through the Federal Reserve Bank Discount Window short term funds up to the amount of $52,708,500 and $74,412,000 as of December 31, 2011 and 2010, respectively. These funds are secured by U.S. government sponsored entity securities or qualified municipal securities totaling $58,565,000 and $82,680,000 as of December 31, 2011 and 2010, respectively.

Capital

The adequacy of the Corporation’s capital is regularly reviewed to ensure that sufficient capital is available for current and future needs and is in compliance with regulatory guidelines. The assessment of overall capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings stability, changing competitive forces, economic condition in markets served, and strength of management.

Table 14

	CAPITAL
	(Dollars and Share Numbers in Thousands)

	December 31,
	2011			2010			2009

Total stockholders’ equity	$	121,980		$	114,335		$	121,396
Tier 1 capital	$	120,816		$	112,741		$	119,226
Total capital	$	130,371		$	122,268		$	125,260
Book value per common share	$	13.70		$	12.84		$	13.63
Cash dividends declared per common share	$	0.21		$	2.40		$	1.08

Equity to assets ratio		10.50	%		10.01	%		10.78	%
Tier 1 leverage ratio		10.63	%		10.37	%		12.03	%
Tier 1 risk-based capital ratio		15.84	%		14.52	%		15.09	%
Total risk-based capital ratio		17.08	%		15.75	%		15.86	%

Shares outstanding (period end)		8,905			8,905			8,905
Basic shares outstanding (average)		8,905			8,905			8,905
Diluted shares outstanding (average)		8,905			8,905			8,905

Total stockholders’ equity at December 31, 2011 increased $7.7 million to $122.0 million, or $13.70 book value per common share compared with $114.3 million, or $12.84 book value per common share at December 31, 2010.

The increase in stockholders’ equity during 2011 was the result of only one regular quarterly dividend declaration being made during 2011, as the Corporation declared a special dividend of $1.20 per share paid on December 10, 2010 to shareholders of record date at November 30, 2010. This dividend was intended to prepay 2011 dividends due to the possibility of less favorable tax treatment of dividend income in 2011. As a result of the dividend paid in December 2010, the Board eliminated dividend payments for all of 2011. At the December 2011 meeting the Board resumed quarterly dividends by declaring a dividend of $0.21 per share payable January 13, 2012 to shareholders of record January 3, 2012. The Board will continue to review earnings, monitor regulatory developments and consider other appropriate factors relative to declaring future dividends. Stockholders’ equity to assets at December 31, 2011 was 10.50%, up from 10.01% at December 31, 2010. The increase was due to the growth in retained earnings exceeding dividends declared during 2011.

As previously discussed, there were no cash dividends paid during 2011 compared to $2.40 per share of cash dividends paid in 2010 which consisted of regular dividends of $1.20 per share and a special pre-paid dividend of $1.20 per share.

As of December 31, 2011 the Corporation’s Tier 1 leverage ratio was 10.63% compared to 10.37% at December 31, 2010. Tier 1 risk-based capital ratios were 15.84% and 14.52% at December 31, 2011 and 2010, respectively, and total risk-based capital ratios were 17.08% and 15.86% at December 31, 2011 and 2010, respectively. All ratios are significantly in excess of minimum regulatory requirements. A bank is “well capitalized” if it maintains a minimum Tier 1 leverage ratio of 5.0%, a minimum Tier 1 risk based capital ratio of 6.0% and a minimum total risk based capital ratio of 10.0%. Earnings continue to be stable and provide sufficient capital retention for anticipated growth. Management believes that the Corporation has a strong capital position and is positioned to take advantage of opportunities for profitable geographic and product expansion, and to provide depositor and investor confidence. Management actively reviews capital strategies for the Corporation and each of its subsidiaries in light of perceived business risks, future growth opportunities, industry standards and regulatory requirements.

Off-Balance Sheet Arrangements

The Bank uses certain derivative financial instruments to meet the ongoing credit needs of its customers and to manage the market exposure of its residential loans held for sale and its commitments to extend credit for residential loans. Derivative financial instruments include commitments to extend credit and forward loan sale commitments. The Bank does not use interest rate contracts (e.g. swaps, caps or floors) or other derivatives to manage interest rate risk and has none of these instruments outstanding at December 31, 2011 or 2010. The Bank, through its normal operations, does have loan commitments and standby letters of credit outstanding as of December 31, 2011 and December 31, 2010 in the amount of $109.9 million and $110.3 million, respectively. These items are further explained in Note 15 of Notes to Consolidated Financial Statements.

Table 15

CONTRACTUAL OBLIGATIONS
PAYMENTS DUE BY PERIOD AT DECEMBER 31, 2011
(Dollars in Thousands)

			Less One		One to		Three to		More than
	Total		One Year		Three Years		Five Years		Five Years

Certificates of Deposit and other time deposits	$	179,660	$	134,028	$	33,004	$	12,628	$	-
Short-term debt obligations		-		-		-		-		-
Minimum operating lease obligations		4,676		1,120		2,084		954		518

Total	$	184,336	$	135,148	$	35,088	$	13,582	$	518

Quantitative and Qualitative Disclosures about Market Risk

Market risk arises from exposure to changes in interest rates, exchange rates, commodity prices, and other relevant market rate or price risk. Market risk in the form of interest rate risk is measured and managed through the asset/liability management system. The Bank uses financial modeling techniques that measure the sensitivity of future earnings due to changing rate environments. Policies approved by the Board of Directors limit exposure of earnings at risk. General interest rate movements are used to develop sensitivity models and monitor earnings at risk. These limits are based on the Bank’s exposure to a 100 bp and 200 bp immediate and sustained parallel rate move, either upward or downward.

The Bank’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of the Bank’s transactions are denominated in U.S. dollars, with no specific foreign exchange exposure.

Interest Rate Risk

Financial institutions derive their income primarily from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and pays on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed to changes in profit margins (or losses) if it cannot adapt to interest rate changes. Interest Rate Risk (“IRR”) is the exposure of an organization’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and stockholder value. However, excessive levels of IRR could pose a significant threat to the Bank’s earnings and capital base. Accordingly, effective risk management that maintains IRR at prudent levels is essential to the Bank’s safety and soundness.

When assessing IRR, the Bank seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain IRR at prudent levels with consistency and continuity.

Evaluating the quantitative level of IRR exposure requires the Bank to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity and, where appropriate, asset quality.

Financial institutions are also subject to prepayment risk in falling rate environments. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refinance its obligations at new, lower rates. Prepayments of assets carrying higher rates reduce the Bank’s interest income and overall asset yields. Certain portions of an institution’s liabilities may be short-term or due on demand, while most of its assets may be invested in long-term loans or investments. Accordingly, the Bank seeks to have in place sources of cash to meet short-term demands. These funds can be obtained by increasing deposits, borrowing or selling assets. Also, short-term borrowings provide additional sources of liquidity for the Bank.

Several ways an institution can manage IRR include selling existing assets or repaying certain liabilities and matching repricing periods for new assets and liabilities by shortening terms of new loans or investments. The Bank has employed all these strategies in varying degrees. An institution might also invest in more complex financial instruments intended to hedge or otherwise mitigate IRR. Interest rate swaps, futures contracts, options on futures and other such derivative financial instruments are often used for this purpose. The Bank has never purchased any of these types of derivative financial instruments.

In order to measure earnings sensitivity to changing rates, the Bank uses two different measurement tools: static gap analysis, and simulation of earnings. The static gap analysis starts with contractual repricing information for assets and liabilities. These items are then combined with repricing estimations for administered rate (interest-bearing demand deposits, savings, and money market accounts) and non-rate related products (demand deposit accounts, other assets and other liabilities) to create a baseline repricing balance sheet. In addition to the contractual information, residential mortgage whole loan products are adjusted based on industry estimates of prepayment speeds that capture the expected prepayment of principal above the contractual amount.

At December 31, 2011, the Bank’s balance sheet was asset sensitive to interest rate movements for principal amounts maturing in one year. Asset sensitive means that assets will reprice faster than liabilities. In a rising rate environment, an asset sensitive bank will generally benefit. Liability sensitive means interest-bearing deposits will reprice faster than assets. In a rising rate environment a liability sensitive bank will generally not benefit.

Table 16

TRI CITY BANKSHARES CORPORATION

QUANTITATIVE DISCLOSURES OF MARKET RISK

December 31, 2011

(Dollars in Thousands)

	Principal Amount Maturing in:																					Fair Value
	2012			2013			2014			2015			2016			Thereafter			Total			12/31/11
Rate-sensitive assets:
Fixed interest rate loans	$	204,333		$	145,761		$	130,170		$	17,575		$	20,119		$	7,204		$	525,162		$	528,433
Average interest rate		5.53	%		6.01	%		5.89	%		5.75	%		5.04	%		5.75	%		5.74	%
Variable interest rate loans	$	87,523		$	23,107		$	21,928		$	1,423		$	1,613		$	47,421		$	183,015		$	184,155
Average interest rate		4.11	%		4.70	%		4.24	%		6.39	%		5.39	%		4.55	%		4.34	%
Fixed interest rate securities	$	7,958		$	27,151		$	8,923		$	18,260		$	33,934		$	108,590		$	204,816		$	207,395
Average interest rate		4.51	%		2.68	%		4.53	%		3.13	%		2.19	%		2.33	%		2.60	%
Variable interest rate securities	$	-		$	-		$	-		$	-		$	10,000		$	145,750		$	155,750		$	156,018
Average interest rate		-	%		-	%		-	%		-	%		.75	%		1.96	%		1.88	%
Other interest bearing assets	$	55,121		$	-		$	-		$	-		$	-		$	-		$	55,121		$	55,121
Average interest rate		.11	%		-	%		-	%		-	%		.-	%		-	%		.11	%

Rate –sensitive liabilities
Savings and interest bearing checking	$	714,052		$	-		$	-		$	-		$	-		$	-		$	714,052		$	714,052
Average interest rate		.30	%		-	%		-	%		-	%		.-	%		-	%		.30	%
Time deposits	$	134,028		$	25,630		$	7,374		$	6,907		$	5,721		$	-		$	179,660		$	178,237
Average interest rate		.89	%		2.17	%		1.87	%		2.09	%		1.81	%		-	%		1.19	%
Variable interest rate
Borrowings	$	-		$	-		$	-		$	-		$	-

TRI CITY BANKSHARES CORP 10-K