Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of the Company. The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and accompanying notes thereto.

Forward-Looking Statements

This Form 10-Q contains certain "forward-looking statements" which may be identified by the use of words such as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors that could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, the effect of the current severe disruption in financial markets and the United States government programs introduced to restore stability and liquidity, changes in interest rates, general economic conditions and the weakening state of the United States economy, deposit flows, demand for mortgage and other loans, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing of products and services.

Critical Accounting Policies

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in preparing its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. Management believes the following discussion on the allowance for loan losses addresses our most critical accounting policy, which is most important to the portrayal of our financial condition and results and require management's most difficult, subjective and complex judgements, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Allowance for Loan Losses - The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses. The allowance is based upon past loan experience and other factors which, in management's judgement, deserve current recognition in estimating loan losses. The evaluation includes a review of all loans on which full collectibility may not be reasonably assured. Other factors considered by management include the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions and historical losses on each portfolio category. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties, which collateralize loans. Management uses the available information to make such determinations. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. While we believe we have established our existing allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request an increase in the allowance for loan losses. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary if loan quality deteriorates.

New Accounting Standards Adopted During First Quarter 2008

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). FAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. FAS 157 has been applied prospectively as of the beginning of the period.

Federal Deposit Insurance Corporation Insurance Coverage

As with all banks insured by the Federal Deposit Insurance Corporation ("FDIC"), the Company's depositors are protected against the loss of their insured deposits by the FDIC. The FDIC recently made two changes to the rules that broadened the FDIC insurance. On October 3, 2008, the FDIC temporarily increased basic FDIC insurance coverage from $100,000 to $250,000 per depositor until December 31, 2009. In addition, on October 14, 2008 the FDIC instituted a Temporary Liquidity Guaranty Program ("TLGP") which provides full deposit coverage for non-interest bearing transaction deposit accounts, regardless of dollar amount. The TLGP fully insures these accounts automatically for 30 days. After the 30 day period a bank may elect to opt out of the program. The FDIC defines a "non-interest bearing transaction account" as a transaction account on which the insured depository institution pays no interest and does not reserve the right to require advance notice of intended withdrawals. This coverage is over and above the $250,000 in coverage otherwise provided to a customer.

The Company intends to stay in the TLGP. The additional cost of this program, assessed on a quarterly basis, is a 10 basis point annualized surcharge (2.5 basis points quarterly) on balances in non-interest bearing transaction accounts that exceed $250,000. The Company does not believe this amount will have a material effect on its consolidated financial statements.

Financial Condition

September 30, 2008 Compared to December 31, 2007

Total assets increased $6.1 million to $294.6 million at September 30, 2008 from $288.5 million at December 31, 2007. Net loans increased $3.4 million to $179.3 million at September 30, 2008. Available-for-sale investment securities decreased $12.8 million primarily due to $46.0 million in calls of U.S. agency bonds, partially offset by purchases of $15.7 million of U.S. agency bonds and $21.8 million of tax-free municipal bonds. Mortgage-backed securities increased $19.5 million during the nine-month time frame, mostly due to purchases of $23.7 million, partially offset by principal payments. Deposits decreased $7.3 million during this same time period, reflecting decreases in time deposits. Other borrowings increased $13.3 million primarily due to an increase in advances from the Federal Home Loan Bank.

Stockholders' equity increased $304,000 to $22.9 million at September 30, 2008. Changes in stockholders' equity reflect net income of $1.3 million and the receipt of $13,000 from the exercise of stock options during the first nine months of 2008, partially offset by dividend payments of $214,000 to stockholders and an increase of $781,000 in unrealized losses, net of tax, on available-for-sale securities. The change in unrealized gains or losses on securities classified as available-for-sale is affected by market conditions, which can fluctuate daily. The receipt of $13,000 reflects $11,000 received from the exercise of stock options and a $2,000 compensation expense related to options.

Results of Operations

Comparison of Operating Results for the Three Months Ended September 30, 2008 and 2007

General: The Company reported net income for the three months ended September 30, 2008, of $499,000, or $0.25 per share of common stock, basic and diluted, compared to net income of $138,000, or $0.07 per share of common stock, basic and diluted, for the three months ended September 30, 2007. The increase of $361,000 in net income is due to increases of $477,000 in net interest income and $229,000 in other income, partially offset by increases of $128,000 in other expenses, $85,000 in the provision for loan losses, and $132,000 in income taxes. The Company's operations benefited from the steepening of the yield curve, as the Federal Reserve has aggressively lowered short-term rates. In addition, earnings have benefited from the stable level of nonperforming assets.

Interest Income: Total interest income for the three months ended September 30, 2008 decreased $47,000 from the same period of 2007. The decrease in interest income reflects decreases in interest income of $56,000 on loans and $297,000 on investment securities, partially offset by increases of $298,000 on mortgage-backed securities and $8,000 on other investments.

The decrease in interest income on loans is primarily due to a decrease of 45 basis points in the average yield of the loan portfolio to 6.68% during the third quarter of 2008. The decrease was partially offset by an $8.1 million increase in the average balance of the loan portfolio to $178.0 million during the third quarter of 2008 compared to the third quarter of 2007. The growth in the average balance of loans reflects an increase in commercial real estate lending. This increase in commercial real estate loans is mostly due to the origination of two large lines to local, well-established businesses expanding their operations.

The $297,000 decrease in interest income on investment securities reflects a decrease of $25.9 million in the average balance of the portfolio to $55.3 million during the third quarter of 2008, as compared to the third quarter of 2007. The decrease in the average balance reflects an increase in calls, a portion of which have been reinvested into tax-free municipal bonds, as well as mortgage-backed securities. The average balance of municipal securities increased $19.6 million during the third quarter. The average yield of investment securities decreased to 3.86% from 4.09% during the third quarter of 2008 and 2007, respectively. This average yield does not reflect the benefit of the higher tax-equivalent yield of the municipal bonds, which is reflected as a reduction in income tax expense.

Interest income on mortgage-backed securities increased $298,000 during the third quarter of 2008 compared to the third quarter of 2007. The increased interest income on mortgage-backed securities reflects an increase of $23.6 million in the average balance of mortgage-backed securities to $35.9 million during the third quarter of 2008. The increase in mortgage-backed securities reflects the reinvestment of funds from calls of investment securities. Interest income also benefited from an increase in the average yield to 5.00% from 4.90% during the three months ended September 30, 2008 and 2007, respectively.

Interest income on other interest earning assets, which consist of interest-earning deposit accounts and federal funds sold, increased during the third quarter of 2008 primarily due to a higher average balance. The average balance of these accounts increased $2.5 million to $3.2 million for the three months ended September 30, 2008 compared to the three months ended September 30, 2007. The increase in the average balance is primarily due to funds provided by investment calls. The average yield on these accounts decreased to 2.01% from 4.59% during the third quarter of 2008 and 2007, respectively, reflecting the decreases in short-term interest rates during the fourth quarter of 2007 through 2008.

Interest Expense: Total interest expense for the three months ended September 30, 2008 decreased $524,000 compared to the three months ended September 30, 2007. The decrease in interest expense is due to decreases of $441,000 in the cost of deposits and $83,000 in the cost of borrowed funds.

The $441,000 decrease in the cost of deposits was primarily due to a decrease in the average rate. The average rate decreased to 3.01% during the three months ended September 30, 2008 from 3.89% during the three months ended September 30, 2007. The 88 basis point decrease reflects the decrease in short-term market rates of interest. The decreased cost was partially offset by an increase of $5.8 million in the average balance of deposits to $226.5 million during the comparative three month period.

Interest paid on borrowed funds decreased $83,000 due to a decrease in the average cost to 3.19% from 4.99% during the third quarter of 2008 and 2007, respectively. The average balance of borrowed funds increased $180,000 to $18.8 million during this same period. The borrowed funds consist of advances from the Federal Home Loan Bank and securities sold under agreements to repurchase.

Provision for Loan Losses: The provision for loan losses is determined by management as the amount needed to replenish the allowance for loan losses, after net charge-offs have been deducted, to a level considered adequate to absorb probable losses in the loan portfolio, in accordance with accounting principles generally accepted in the United States of America.

The allowance for loan losses increased to $1.9 million at September 30, 2008 from $1.8 million at December 31, 2007. The increase is the result of the provision for loan losses exceeding net charge-offs during 2008. Net charge-offs decreased to a net recovery of $6,000 during the third quarter of 2008 compared to net charge-offs of $42,000 during the third quarter of 2007. The $85,000 increase in the provision for loan losses reflects an increase in the average balance of the loan portfolio, primarily in commercial real estate, and an increase in watch list credits. The provisions for loan losses have been made to bring the allowance for loan losses to a level deemed adequate following management's evaluation of the repayment capacity and collateral protection afforded by each problem credit identified by management. This review also considered the local economy and the level of bankruptcies and foreclosures in the Company's market area. The following table sets forth information regarding nonperforming assets at the dates indicated.

                                               September 30, 2008       December 31, 2007
                                                         (Dollars in thousands)
Non-accruing loans:
One-to-four family residential                 $               419     $               310
Commerical and agricultural real estate                         35                     218
Multi-family residential                                       155                       -
Commercial and agricultural business                            62                      82
Home equity/Home improvement                                   249                      89
Automobile                                                       5                      12
Other consumer                                                   4                      12
Total                                          $               929     $               723

Accruing loans delinquent more than 90 days:
One-to-four family residential                 $                 -     $               203
Commercial and agricultural real estate                          -                     156
Other consumer                                                  26                       9
Total                                          $                26     $               368

Foreclosed assets:
One-to-four family residential                 $                54     $               115
Commercial and agricultural real estate                        230                     249
Automobile                                                       -                      23
Total                                          $               284     $               387

Total nonperforming assets                     $             1,239     $             1,478

Total as a percentage of total assets                         0.42 %                  0.51 %

The decrease in commercial and agricultural real estate non-accruing loans reflects the payoff of two non-accruing loans totaling $177,000 during 2008. The increase in multi-family residential real estate reflects the delinquency of one loan, which is both well secured and in the process of collection. The following table shows the aggregate principal amount of potential problem credits on the Company's watch list at September 30, 2008 and December 31, 2007. The increase in Special Mention credits reflects the addition of four large commercial and commercial real estate borrowers. Each of the credits is current and well secured, and no loss is expected. All nonaccruing loans are automatically placed on the watch list.

                                   September 30, 2008       December 31, 2007
                                                 (In thousands)

       Special Mention credits    $              7,791     $             2,649
       Substandard credits                       2,661                   3,338
       Total watch list credits   $             10,452     $             5,987

Other Income: Total other income for the three months ended September 30, 2008 increased $229,000 from the comparable period in 2007. The increase in other income is primarily attributable to increases of $69,000 in net income from mortgage banking operations, $59,000 in commission income, $42,000 in earnings on cash surrender value of life insurance, and $30,000 in trust income. The increase in mortgage banking income is due to a higher volume of loan sales to the secondary market. The higher earnings on cash surrender value reflect a $3.4 million increase in bank-owned life insurance during the past twelve months. The increases in commission and trust income are due to continued growth in brokerage and trust accounts.

Other Expenses: Total other expenses for the three months ended September 30, 2008 increased $128,000 from the same period in 2007. The increase in other expenses reflects increases of $102,000 in salaries and benefits expense, $31,000 in professional fees, and $25,000 in occupancy expenses, partially offset by a decrease of $41,000 in other expenses, including amortization of intangible assets. The increase in salaries and benefits expense reflects annual wage and cost increases and higher commissions. Occupancy expenses increased mostly due to higher maintenance and utility costs.

Income Taxes: The provision for income taxes increased $132,000 during the three months ended September 30, 2008, compared to the three months ended September 30, 2007. The provision reflects an increase in taxable income due to higher income, net of an increase in the benefit of tax-exempt investment income.

Comparison of Operating Results for the Nine Months Ended September 30, 2008 and 2007

General: The Company reported net income for the nine months ended September 30, 2008 of $1,286,000, or $0.65 per share, basic and diluted, compared to net income of $444,000, or $0.22 per share, basic and diluted, for the nine months ended September 30, 2007. Net income increased $842,000 during the nine months ended September 30, 2008 compared to the same period of 2007, due to increases of $1.0 million in net interest income and $566,000 in other income, partially offset by increases of $336,000 in other expenses, $115,000 in the provision for loan losses, and $311,000 in income taxes.

Interest Income: Total interest income increased $398,000 during the nine months ended September 30, 2008, compared to the same period in 2007. The increase in interest income was due to increases of $397,000 on loans, $750,000 on mortgage-backed securities, and $160,000 on other investments, partially offset by a decrease of $909,000 in interest on investment securities.

The increase of $397,000 in interest income on loans was due to an increase in the average balance, partially offset by a decrease in the average yield of the loan portfolio. The average balance of loans increased $14.4 million to $176.8 million during the first nine months of 2008 compared to the same period of 2007. The increase in the average balance of loans is primarily due to an increase in commercial and commercial real estate lending, including participations purchased from other institutions. The increase in the average balance was partially offset by a decrease in the average yield of the loan portfolio to 6.78% from 7.03% for the nine months ended September 30, 2008 and 2007, respectively.

The $909,000 decrease in interest income on investment securities reflects a decrease of $27.9 million in the average balance of the portfolio to $54.1 million during the first nine months of 2008, as compared to the same period of 2007. The decrease in the average balance reflects an increase in calls, a portion of which have been reinvested into tax-free municipal bonds, as well as mortgage-backed securities. The average balance of municipal securities increased $16.4 million during the 2008 period. The average yield of investment securities decreased to 3.87% from 4.03% during the first nine months of 2008 and 2007, respectively. This average yield does not reflect the benefit of the higher tax-equivalent yield of the municipal bonds, which is reflected as a reduction in income tax expense.

The $750,000 increase in interest income on mortgage-backed securities was mostly due to an increase in the average balance of these securities. The average balance of mortgage-backed securities increased $16.4 million to $28.0 million during the nine months ended September 30, 2008 compared to the same period in 2007. Interest income also benefited from an increase of 77 basis points in the average yield of mortgage-backed securities to 5.56% during this same time frame.

Interest income on other investments, consisting of interest bearing deposit accounts and federal funds sold, increased $160,000 during the first nine months of 2008 compared to the first nine months of 2007. The increase in interest income was due to an increase in the average balance, partially offset by a decrease in the average yield of these accounts. The average balance increased $10.3 million to $12.1 million during this same time frame, primarily due to investment calls. The average yield on these accounts decreased to 2.50% from 5.02% during the nine months ended September 30, 2008 and 2007, respectively.

Interest Expense: Total interest expense decreased $640,000 for the nine months ended September 30, 2008 compared to the same period in 2007. The decrease in interest expense was due to a decrease of $642,000 in the cost of deposits partially offset by an increase of $2,000 in the cost of borrowed funds.

The $642,000 decrease in the cost of deposits was primarily due to a decrease in the average rate. The average rate decreased to 3.25% during the nine months ended September 30, 2008 from 3.80% during the nine months ended September 30, 2007. The 55 basis point decrease reflects the decrease in short-term market rates of interest. The decreased cost was partially offset by an increase of $11.0 million in the average balance of deposits to $231.7 million, which reflects growth in both time deposits and transaction accounts.

Interest expense on borrowed funds increased $2,000 primarily due to a $4.3 million increase in the average balance to $16.6 million during the first nine months of 2008. The increased cost was partially offset by a decrease in the average rate to 3.61% from 4.86% during this same time frame. The borrowed funds consist of advances from the Federal Home Loan Bank and securities sold under agreements to repurchase.

Provision for Loan Losses: The provision for loan losses is determined by management as the amount needed to replenish the allowance for loan losses, after net charge-offs have been deducted, to a level considered adequate to absorb probable losses in the loan portfolio, in accordance with accounting principles generally accepted in the United States of America.

                                                        9 Months Ended
                                          September 30, 2008      September 30, 2007
                                                        (In thousands)
Balance at beginning of period            $             1,766     $             1,864
Charge-offs:
One-to-four family residential                             56                      63
Commercial and agricultural business                        -                       8
Home equity/home improvement                                -                      49
Automobile                                                  5                       -
Other Consumer                                              3                      38
Total                                                      64                     158

Recoveries:
One-to-four family residential                              1                       5
Commercial and agricultural real estate                     3                       -
Home equity/home improvement                                3                       2
Automobile                                                  5                       7
Other Consumer                                              9                      19
Total                                                      21                      33

Net loans charged off                                      43                     125
Provision expense                                         165                      50
Balance at end of period                  $             1,888     $             1,789

The allowance for loan losses increased $122,000 to $1.9 million at September 30, 2008 from December 31, 2007. The increase is the result of the provision for loan losses exceeding net charge-offs. The provision for loan losses increased to $165,000 during the nine months ended September 30, 2008 from $50,000 during the first nine months of 2007. Net charge-offs decreased to $43,000 during the first nine months of 2008. The increase in the provision during 2008 reflects the changing mix of the loan portfolio and an increase in watch list credits, partially offset by a decrease in nonperforming assets.

Other Income: Total other income for the nine months ended September 30, 2008 increased $566,000 from the comparable period in 2007. The increase in other income is primarily attributed to increases of $202,000 in net income from mortgage banking operations, $182,000 in commission income, $107,000 in earnings on cash surrender value of life insurance, and $75,000 in trust income. The increases in commission and trust income are due to continued growth in brokerage and trust accounts. The increase in mortgage banking income is due to a higher volume of loan sales of $24.7 million to the secondary market during 2008. The higher earnings on cash surrender value reflect a $3.4 million increase in bank-owned life insurance, which was purchased to fund new benefit plans, during the past twelve months.

Other Expense: Total other expense for the nine months ended September 30, 2008 increased $336,000 from the same period of 2007. The increase in other expense is mainly comprised of increases of $304,000 in salaries and benefits, $42,000 in occupancy expenses, and $27,000 in professional fees, partially offset by a decrease of $70,000 in other expenses, including amortization of intangible assets. The increase in salaries and benefits expense reflects annual wage and cost increases and higher commissions, as well as expenses associated with new . . .