Introduction
As a multi-bank financial holding company, we generate most of our revenue from interest on loans and investments, trust fees, and service charges. Our primary source of funding for our loans and investments are deposits held by our subsidiary banks. Our largest expenses are interest on these deposits and salaries and related employee benefits. We usually measure our performance by calculating our return on average assets, return on average equity, our regulatory leverage and risk based capital ratios, and our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis and noninterest income.
You should read the following discussion and analysis of the major elements of our consolidated balance sheets as of December 31, 2008 and 2007, and consolidated statements of earnings for the years 2006 through 2008 in conjunction with our consolidated financial statements, accompanying notes, and selected financial data presented elsewhere in this Form 10-K. Average share information and earnings per share data related to our common stock have been adjusted to give effect to all stock splits and stock dividends, including the four-for-three stock split in the form of a 33% stock dividend effective June 1, 2005.
Critical Accounting Policies
We prepare consolidated financial statements based on the selection of certain accounting policies, generally accepted accounting principles and customary practices in the banking industry. These policies, in certain areas, require us to make significant estimates and assumptions.
We deem a policy critical if (1) the accounting estimate required us to make assumptions about matters that are highly uncertain at the time we make the accounting estimate; and (2) different estimates that reasonably could have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the financial statements.
The following discussion addresses (1) our allowance for loan losses and its provision for loan losses and (2) our valuation of securities, which we deem to be our most critical accounting policies. We have other significant accounting policies and continue to evaluate the materiality of their impact on our consolidated financial statements, but we believe these other policies either do not generally require us to make estimates and judgments that are difficult or subjective, or it is less likely they would have a material impact on our reported results for a given period.
Allowance for Loan Losses:
The allowance for loan losses is an amount we believe will be adequate to absorb inherent estimated losses on existing loans in which full collectibility is unlikely based upon our review and evaluation of the loan portfolio. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries).
Our methodology is based on guidance provide in SEC Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues" and includes allowance allocations calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, and allowance allocations determined in accordance with SFAS No. 5, "Accounting for Contingencies." We also follow the guidance of the "Interagency Policy Statement on the Allowance for Loan and Lease Losses," issued jointly by the OCC, the Federal Reserve Board, the FDIC, the National Credit Union Administration and the Office of Thrift Supervision. We have developed a loan review methodology that includes allowances assigned to certain classified loans, allowances assigned based upon estimated loss factors and qualitative reserves. The level of the allowance reflects our periodic evaluation of general economic conditions, the financial condition of our borrowers, the value and liquidity of collateral, delinquencies, prior loan loss experience, and the results of periodic reviews of the portfolio by our independent loan review department and regulatory examiners.

Our allowance for loan losses is comprised of three elements: (i) specific reserves determined in accordance with SFAS 114 based on probable losses on specific classified loans; (ii) general reserves determined in accordance with SFAS 5 that consider historical loss rates; and (iii) a qualitative reserve determined in accordance with SFAS 5 based upon general economic conditions and other qualitative risk factors both internal and external to the Company. We regularly evaluate our allowance for loan losses to maintain an adequate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of specific reserves include the credit-worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All classified loans are specifically reviewed and a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the loan portfolio less cash secured loans, government guaranteed loans and classified loans is multiplied by the Company's historical loss rates. The qualitative reserves are determined by evaluating such things as current economic conditions and trends, changes in lending staff, policies or procedures, changes in credit concentrations, changes in the trends and severity of problem loans and changes in trends in volume and terms of loans.
Although we believe we use the best information available to make loan loss allowance determinations, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our initial determinations. A downturn in the economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The bank regulatory agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.
Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, the borrower's financial condition is such that collection of principal and interest is doubtful.
Our policy requires measurement of the allowance for an impaired collateral dependent loan based on the fair value of the collateral. Other loan impairments are measured based on the present value of expected future cash flows or the loan's observable market price.
Valuation of Securities:
The Company's available-for-sale and trading securities portfolio is recorded at fair value.
Effective January 1, 2008, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 157, "Fair Value Measurements". We also adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) No. FAS 157-3 which provided additional guidance on valuation and disclosures. Fair values are volatile and may be influenced by a number of factors, including market interest rates, prepayment speeds, discount rates, credit ratings and yield curves. Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on the quoted prices of similar instruments or an estimate of fair value by using a range of fair value estimates in the market place as a result of the illiquid market specific to the type of security.
When the fair value of a security is below its amortized cost, and depending on the length of time the condition exists and the extent the fair value is below amortized cost, additional analysis is performed to determine whether an other-than-temporary impairment condition exists. Available-for-sale and held-to-maturity securities are analyzed quarterly for possible other-than-temporary impairment. The analysis considers (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Often, the information available to conduct these assessments is limited and rapidly changing, making estimates of fair value subject to judgment. If actual information or conditions are different than estimated, the extent of the impairment of the security may be different than previously estimated, which could have a material effect on the Company's results of operations and financial condition.

Results of Operations
Performance Summary. Net earnings for 2008 were $53.2 million, an increase of $3.7 million, or 7.4%, over net earnings for 2007 of $49.5 million. Net earnings for 2006 were $46.0 million. The increase in net earnings for 2008 over 2007 was primarily attributable to growth in net interest income. The increase in net earnings for 2007 over 2006 was primarily attributable to growth in net interest income and noninterest income.
On a basic net earnings per share basis, net earnings were $2.56 for 2008 as compared to $2.38 for 2007 and $2.22 for 2006. The return on average assets was 1.74% for 2008 as compared to 1.72% for 2007 and 1.68% for 2006. The return on average equity was 15.27% for 2008 as compared to 15.87% for 2007 and 16.20% for 2006.
Net Interest Income. Net interest income is the difference between interest income on earning assets and interest expense on liabilities incurred to fund those assets. Our earning assets consist primarily of loans and investment securities. Our liabilities to fund those assets consist primarily of noninterest-bearing and interest-bearing deposits. Tax-equivalent net interest income was $131.0 million in 2008 as compared to $116.1 million in 2007 and $110.5 million in 2006. The increase in 2008 compared to 2007 was largely attributable to the decrease in the rate paid on interest-bearing liabilities in an amount greater than the decrease in rates earned on interest earning assets and an increase in the volume of earning assets. Average earning assets increased $178.3 million in 2008 with loans contributing $109.1 million of the increase. The yield on earning assets decreased 72 basis points in 2008, whereas the rate paid on interest-bearing liabilities decreased 129 basis points. The increase in 2007 compared to 2006 resulted primarily from an increase in the volume of earnings assets, which was partially reduced by increases in the rates paid on interest bearing liabilities. Average earning assets were $2.803 billion in 2008, as compared to $2.624 billion in 2007 and $2.483 billion in 2006. The 2008 increase in average earning assets was attributable to internally generated loan growth and purchases of investment securities. The 2007 increase in average earning assets was attributable primarily to internally generated loan growth. Table 1 allocates the change in tax-equivalent net interest income between the amount of change attributable to volume and to rate.
Table 1 - Changes in Interest Income and Interest Expense (in thousands):

                                         2008 Compared to 2007                                 2007 Compared to 2006
                                Change Attributable to              Total             Change Attributable to             Total
                               Volume              Rate            Change             Volume              Rate           Change

Short-term investments       $       207         $  (2,179 )      $  (1,972 )      $        568         $    213        $    781
Taxable investment
securities (1)                       854            (1,448 )           (594 )            (1,904 )          1,487            (417 )
Tax-exempt investment
securities (2)                     2,809               570            3,379               3,228             (603 )         2,625
Loans (1)                          8,765           (17,972 )         (9,207 )             9,345            3,152          12,497

Interest income                   12,635           (21,029 )         (8,394 )            11,237            4,249          15,486

Interest-bearing
deposits                           1,165           (20,035 )        (18,870 )               863            8,145           9,008
Short-term borrowings                695            (5,123 )         (4,428 )             2,181           (1,260 )           921

Interest expense                   1,860           (25,158 )        (23,298 )             3,044            6,885           9,929

Net interest income          $    10,775         $   4,129        $  14,904        $      8,193         $ (2,636 )      $  5,557

(1) Trading securities are included in taxable investment securities.

(2) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.

The net interest margin, which measures tax-equivalent net interest income as a percentage of average earning assets, is illustrated in Table 2 for the years 2006 through 2008. The net interest margin in 2008 was 4.67%, an increase of 24 basis points from 2007 and 21 basis points from 2006. The prime rate increased from 7.25% at January 1, 2006 to 8.25% at December 31, 2006 and returned to 7.25% at December 31, 2007. The prime rate decreased 400 basis points in 2008, finishing the year at 3.25%. Should interest rates remain at the current low levels in 2009, we anticipate that the impact of lower yields on loans and investment securities and competition for deposits will put pressure on our net interest margin.

Table 2 - Average Balances and Average Yields and Rates (in thousands, except percentages):

                                           2008                                            2007                                            2006
                           Average          Income/        Yield/          Average          Income/        Yield/          Average          Income/        Yield/
                           Balance          Expense         Rate           Balance          Expense         Rate           Balance          Expense         Rate
Assets
Short-term
investments              $    80,495       $   1,790          2.22 %     $    76,284       $   3,762          4.93 %     $    64,056       $   2,981          4.65 %
Taxable investment
securities (1)               851,099          38,286          4.50           832,807          38,881          4.67           875,247          39,298          4.49
Tax-exempt
investment
securities (2)               334,204          20,658          6.18           287,468          17,279          6.01           235,569          14,653          6.22
Loans (2)(3)               1,537,027         105,508          6.86         1,427,922         114,714          8.03         1,308,309         102,218          7.81

Total earning assets       2,802,825         166,242          5.93         2,624,481         174,636          6.66         2,483,181         159,150          6.41
Cash and due from
banks                        115,767                                         107,280                                         107,134
Bank premises and
equipment, net                64,289                                          61,036                                          60,827
Other assets                  35,776                                          34,075                                          35,283
Goodwill and other
intangible assets,
net                           64,598                                          65,942                                          67,555
Allowance for loan
losses                       (19,226 )                                       (16,621 )                                       (15,666 )

Total assets             $ 3,064,029                                     $ 2,876,193                                     $ 2,738,314

Liabilities and
Shareholders' Equity
Interest-bearing
deposits                 $ 1,775,158       $  33,110          1.87 %     $ 1,736,227       $  51,980          2.99 %     $ 1,702,051       $  42,972          2.52 %
Short-term
borrowings                   178,721           2,149          1.20           161,648           6,577          4.07           120,566           5,656          4.69

Total
interest-bearing
liabilities                1,953,879          35,259          1.80         1,897,875          58,557          3.09         1,822,617          48,628          2.67

Noninterest-bearing
deposits                     741,418                                         649,642                                         611,023
Other liabilities             20,461                                          16,878                                          20,557

Total liabilities          2,715,758                                       2,564,395                                       2,454,197
Shareholders' equity         348,271                                         311,798                                         284,117

Total liabilities
and shareholders'
equity                   $ 3,064,029                                     $ 2,876,193                                     $ 2,738,314

Net interest income                        $ 130,983                                       $ 116,079                                       $ 110,522

Rate Analysis:
Interest
income/earning
assets                                                        5.93 %                                          6.66 %                                          6.41 %
Interest
expense/earning
assets                                                        1.26                                            2.23                                            1.95

Net yield on earning
assets                                                        4.67 %                                          4.43 %                                          4.46 %

(1) Trading securities are included in taxable investment securities.

(2) Computed on a tax-equivalent basis assuming a marginal tax rate of 35%.

(3) Nonaccrual loans are included in loans.

Noninterest Income. Noninterest income for 2008 was $49.5 million, an increase of $1.2 million, or 2.4%, as compared to 2007. The increase is primarily attributable to (1) an increase of $1.4 million in ATM and credit card fees primarily as a result of increased use of debit cards, (2) an increase of $902 thousand in the net gain on securities transactions, and (3) an increase of $694 thousand in trust fees. The fair value of our trust assets, which are not reflected in our balance sheet, totaled $1.882 billion at December 31, 2008 compared to $1.803 billion at December 31, 2007. These increases were partially offset by (1) a decrease of $811 thousand in real estate mortgage fees, (2) a decrease of $323 thousand in service charges on deposit accounts and (3) a decrease of $238 thousand in the gain on sale of student loans. The decrease in real estate mortgage fees reflected the slowdown in residential lending activity. The decline in service charges on deposit accounts was the result of a decrease in customer overdraft fees. In 2008, we sold student loans totaling $63.0 million compared to $64 million in 2007. Due to changes in the market for student loans, the Company does not currently anticipate significant net revenues from the sale of such loans in 2009.
Noninterest income for 2007 was $48.3 million, an increase of $3.6 million, or 8.1%, as compared to 2006. The increase is primarily attributable to (1) an increase of $1.3 million in ATM and credit card fees primarily as a result of increased use of debit cards, (2) an increase of $1.1 million in trust fees,
(3) an increase in mortgage loan fees of $808 thousand, and (4) an increase in service charges on deposit accounts of $470 thousand. The fair value of our trust assets totaled $1.803 billion at December 31, 2007, compared to $1.693 billion at December 31, 2006. These increases were partially offset by a decrease of $228 thousand in the gain on the sale of student loans. In 2007, we sold student loans totaling $64 million compared to $72 million in 2006.

   Table 3 - Noninterest Income (in thousands):

                                                      Increase                           Increase
                                       2008          (Decrease)           2007          (Decrease)           2006

Trust fees                           $  9,441        $       694        $  8,747        $     1,082        $  7,665
Service charges on deposit
accounts                               22,597               (323 )        22,920                470          22,450
Real estate mortgage fees               2,536               (811 )         3,347                808           2,539
Gain on sale of student loans           1,675               (238 )         1,913               (228 )         2,141
ATM and credit card fees                8,904              1,383           7,521              1,307           6,214
Net gain on securities
transactions                            1,052                902             150                 88              62
Other:
Net gain (loss) on sale of
other real estate                           5               (103 )           108                118             (10 )
Check printing fees                       489               (106 )           595                (74 )           669
Safe deposit rental fees                  446                 (3 )           449                  5             444
Exchange fees                             135                (30 )           165                (24 )           189
Credit life and debt protection
fees                                      203                (60 )           263                 44             219
Data processing fees                       91                (18 )           109                (30 )           139
Brokerage commissions                     349                157             192                 (2 )           194
Interest on loan recoveries               347                 63             284                (18 )           302
Miscellaneous income                    1,183               (327 )         1,510                 59           1,451

Total other                             3,248               (427 )         3,675                 78           3,597

Total Noninterest Income             $ 49,453        $     1,180        $ 48,273        $     3,605        $ 44,668

Noninterest Expense. Total noninterest expense for 2008 was $91.6 million, an increase of $4.8 million, or 5.5%, as compared to 2007. Noninterest expense for 2007 amounted to $86.8 million, an increase of $3.8 million, or 4.6%, as compared to 2006. An important measure in determining whether a banking company effectively manages noninterest expenses is the efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income. Lower ratios indicate better efficiency since more income is generated with a lower noninterest expense total. Our efficiency ratio for 2008 was 50.76% compared to 52.83% for 2007, and 53.49% for 2006.
Salaries and employee benefits for 2008 totaled $49.3 million, an increase of $2.3 million, or 5.0%, as compared to 2007. The primary causes of this increase were higher levels of contributions to the Company's profit sharing plan, overall pay increases effective during the first quarter of 2008 and an increase in employee medical expenses.
All other categories of non interest expense for 2008 totaled $42.3 million, an increase of $2.4 million, or 6.1%, as compared to 2007. Net occupancy expense increased $842 thousand primarily as a result of higher utilities expense and three new branches. ATM and debit card interchange expenses increased $586 thousand reflecting increased debit card use by our customers, as seen in the increase in the related income above. Equipment expense increased $327 thousand reflecting ongoing investments in technology. Professional and service fees increased $305 thousand as a result of an increase in actuarial fees related to the Company's pension plan and higher expenses related to the treasury management services offered to Company's customers.
Salaries and employee benefits for 2007 totaled $46.9 million, an increase of $2.8 million, or 6.3%, as compared to 2006. The primary causes of this increase were higher levels of contributions to the Company's profit sharing plan and overall pay increases effective during the first quarter of 2007.
All other categories of non interest expense for 2007 totaled $39.9 million, an increase of $1.0 million, or 2.7%, as compared to 2006. ATM and debit card interchange expenses increased $465 thousand reflecting increased debit card use by our customers, as seen in the increase in the related income above. Legal fees increased $232 thousand. Operational and other losses were $220 thousand more in 2007 than in 2006. These losses come from increased charge-offs relating to demand accounts and other losses attributable to fraud. Partially offsetting the increase in noninterest expense were decreases in correspondent bank service charges as a result of maintaining higher compensating balances and in courier expense from the increased use of imaged check clearing and remote deposit capture.

   Table 4 - Noninterest Expense (in thousands):

                                                      Increase                           Increase
                                       2008          (Decrease)           2007          (Decrease)           2006
Salaries                             $ 38,263        $     1,619        $ 36,644        $     1,427        $ 35,217
Medical                                 3,335                605           2,730                 85           2,645
Profit sharing                          3,406                186           3,220              1,104           2,116
Pension                                   134               (176 )           310                (27 )           337
401(k) match expense                    1,133                  6           1,127                 86           1,041
Payroll taxes                           2,788                 95           2,693                 26           2,667
Stock option expense                      226                  6             220                 63             157

Total salaries and employee
benefits                               49,285              2,341          46,944              2,764          44,180

Net occupancy expense                   6,735                842           5,893                (93 )         5,986
Equipment expense                       7,547                327           7,220                181           7,039
Intangible amortization                 1,204               (291 )         1,495                  4           1,491

Other:
Data processing fees                      415                 24             391                 41             350
Postage                                 1,437                 22           1,415                 (4 )         1,419
Printing, stationery and
supplies                                1,891               (113 )         2,004                (63 )         2,067
Advertising                             1,201                 22           1,179                (45 )         1,224
. . .