RECENT MARKET DEVELOPMENTS

In response to the financial crisis affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law, giving the United States Department of the Treasury (Treasury Department) broad authority to implement certain actions to help restore confidence, stability and liquidity to U.S. financial markets and to encourage financial institutions to increase their lending to customers and to each other. The EESA authorized the Treasury Department to purchase from financial institutions and their holding companies up to $700.0 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (TARP). The Treasury Department has allocated $250.0 billion to the Voluntary Capital Purchase Program under the TARP (CPP). The TARP also includes direct purchases or guarantees of troubled assets of financial institutions by the U.S. government.

Under the CPP, the Treasury Department will purchase debt or equity securities from participating financial institutions in an amount equal to not less than 1% of the participating financial institution's risk-weighted assets and not more than the lesser of (i) $25.0 billion or (ii) 3% of the participating financial institution's risk-weighted assets. In connection therewith, each participating financial institution will be required to issue to the Treasury Department a warrant to purchase a number of shares of common stock having a market price equal to 15% of the senior preferred stock on the date of the Treasury Department's investment. During such time as the Treasury Department holds securities issued under the Voluntary Capital Purchase Program, the participating financial institutions will be required to comply with the Treasury Department's standards for executive compensation and will have limited ability to increase the amounts of dividends paid on, or to repurchase, their common stock.

The EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.

Following a systemic risk determination under the FDIC Improvement Act of 1991, on October 14, 2008, the FDIC established the Temporary Liquidity Guarantee Program (TLGP). The TLGP includes the Transaction Account Guarantee Program (TAGP), which provides unlimited deposit insurance coverage through December 31, 2009 for non-interest bearing transaction accounts (typically business checking accounts) and certain funds swept into non-interest bearing savings accounts. Institutions participating in the TAGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place. The TLGP also includes the Debt Guarantee Program (DGP), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies. The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012. The DGP coverage limit is generally 125% of the eligible entity's eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their total liabilities as of September 30, 2008. Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 50 to 100 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012. The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008. The Company has elected to participate in both guarantee programs.

OVERVIEW

Unprecedented market conditions during 2008 presented unforeseen challenges to the Company, the entire financial services sector and the economy in general. Decreased liquidity and declining market values have negatively affected all lending segments nationwide. The action taken on September 7, 2008 by the Treasury Department and the Federal Housing Finance Authority to place Fannie Mae and Freddie Mac into conservatorship caused a significant decrease in the market value of the securities issued by these government sponsored enterprises. Declining market interest rates to near zero negatively affected yields on interest-earning assets. These declining rates had a positive decrease on interest-bearing liabilities, although it was not as apparent due to increased competition for deposits throughout the industry. During 2008, it became significantly less costly for banks to strengthen their liquidity through certificate of deposit funding rather than issuing debt into illiquid credit markets.

The Company incurred a net loss for 2008 of $11.3 million, or $(1.10) per share compared to net income of $7.5 million, or $0.69 per diluted share for 2007. During 2008, the Company's financial results were negatively affected by provisions for losses on loans totaling $26.3 million, other-than-temporary impairments totaling $4.3 million on its investments in Fannie Mae and Freddie Mac preferred stock and a goodwill impairment of $1.2 million. Combined, these charges reduced 2008 net income by $19.9 million and reduced diluted earnings per share by $1.90.

The Bank's risk-based capital was 13.21% at December 31, 2008 compared to 13.93% at December 31, 2007 and continues to be in excess of the regulatory requirements of 10% to be considered "well-capitalized." At December 31, 2008, the Bank's risk-based capital was $27.2 million in excess of amounts required by regulatory agencies to be "well-capitalized."

The Bank's Tier 1 capital also continues to be in excess of the regulatory requirements of 5% to be considered "well-capitalized." At December 31, 2008, the Bank's Tier 1 capital was 9.07% and was $45.4 million in excess of the amounts required by regulatory agencies to be "well-capitalized."

The financial results of the Company for 2008 were negatively affected by $4.3 million of other-than-temporary impairment (OTTI) charges on its Fannie Mae and Freddie Mac preferred stock investments. The OTTI charge was a direct result of the actions taken by the U.S. Treasury relating to these government sponsored enterprises as previously discussed. In addition, the Company incurred a $1.2 million goodwill impairment as a result of the Company's year-end impairment analysis required under Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

The Company's provision for losses on loans increased to $26.3 million for the year ended December 31, 2008 compared to $2.3 million for the 2007 period. The increase in the 2008 provision reflects reduced collateral valuations on non-performing loans as well as increased general reserves. Net charge-offs for 2008 totaled $18.8 million as compared to $5.5 million for 2007. This increase primarily reflects the deteriorating market conditions, declines in collateral values and a lack of activity in residential housing and land development. During 2008, the Company realized $13.3 million of partial charge-offs related to impaired commercial construction and land development loans that previously totaled $34.1 million in the aggregate. Of these partial charge-offs, one was transferred to other real estate owned at $2.4 million. In addition, the Company realized $430,000 of partial charge-offs related to certain non-owner occupied commercial real estate loans that previously totaled $2.8 million. An additional $2.6 million was realized by the Company as full charge-offs related to certain non-owner occupied commercial real estate loans.

In conjunction with the hiring of an Executive Vice President - Business Banking, the Company reorganized its Business Banking group and during 2008 added ten new Business Banking Relationship Managers to accelerate the diversification of the commercial loan portfolio and to increase business deposits. This group has over 150 years of combined banking experience in the Company's existing markets and will focus on building market presence within the Business Banking segment. The group is responsible for rebalancing the Company's loan portfolio to reduce its exposure to commercial construction and land development by focusing on commercial and industrial, owner occupied commercial estate and multifamily loans. In addition, Business Bankers work with the borrowers to build the Company's deposit balances by pricing deals to include the operating and personal deposit accounts of the borrowers.

During the fourth quarter of 2008, the Company strengthened its Asset Management group by re-assigning a Business Banker with twenty years of experience and an Assistant Credit Manager with thirty years of experience in order to be proactive in this current economic environment. In addition, larger problem loans are being managed by the Bank's President and Chief Operating Officer and the Executive Vice President and two Senior Vice Presidents of Business Banking. The changes in this area have allowed the Bank to more proactively manage and resolve problem assets and potential problem assets while allowing management to keep up to date on the progress related to these loans.

CRITICAL ACCOUNTING POLICIES

The Company's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which require the Company to establish various accounting policies. Certain of these accounting policies require management to make estimates, judgments or assumptions that could have a material effect on the carrying value of certain assets and liabilities. The estimates, judgments and assumptions used by management are based on historical experience, projected results, internal cash flow modeling techniques and other factors which management believes are reasonable under the circumstances.

The Company's significant accounting policies are presented in Note 1 to the consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. These policies, along with the disclosures presented in other financial statement notes and in this management's discussion and analysis, provide information on the methodology used for the valuation of significant assets and liabilities in the Company's financial statements. Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the determination of the allowance for losses on loans, valuations and impairments of securities and the accounting for income taxes to be critical accounting policies.

One component of the allowance for losses on loans contains allocations for probable inherent but undetected losses within various pools of loans with similar characteristics pursuant to Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies. This component is based in part on certain loss factors applied to various loan pools as stratified by the Company. In determining the appropriate loss factors for these loan pools, management considers historical charge-offs and recoveries; levels of and trends in delinquencies, impaired loans and other classified loans; concentrations of credit within the commercial loan portfolios; volume and type of lending; and current and anticipated economic conditions.

The second component of the allowance for losses on loans contains allocations for probable losses that have been identified relating to specific borrowing relationships pursuant to SFAS No. 114, Accounting by Creditors for Impairment of a Loan. This component consists of expected losses resulting in specific credit allocations for individual loans not considered within the above mentioned loan pools. The analysis of each loan involves a high degree of judgment in estimating the amount of the loss associated with the loan, including the estimation of the amount and timing of future cash flows and collateral values.

Loan losses are charged off against the allowance when the loan balance or a portion of the loan balance is no longer covered by the paying capacity of the borrower based on an evaluation of available cash resources and collateral value, while recoveries of amounts previously charged off are credited to the allowance. The Company assesses the adequacy of the allowance for losses on loans on a quarterly basis and adjusts the allowance for losses on loans by recording a provision for losses on loans in an amount sufficient to maintain the allowance at a level deemed appropriate by management. The evaluation of the adequacy of the allowance for losses on loans is inherently subjective as it requires estimates that are susceptible to significant revision as additional information becomes available or as future events occur. To the extent that actual outcomes differ from management estimates, an additional provision for losses on loans could be required which could adversely affect earnings or the Company's financial position in future periods. In addition, various regulatory agencies, as an integral part of their examination processes, periodically review the allowance for losses on loans for the Bank and the carrying value of its other non-performing loans, based on information available to them at the time of their examinations. Any of these agencies could require the Bank to make additional provisions for losses on loans.

Securities. Under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, investment securities must be classified as held-to-maturity, available-for-sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not effect earnings until realized.

The fair values of the Company's securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs. Certain of the Company's fair values of securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the securities. These models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatilities.

The Company from time to time may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

Income Tax Accounting. Income tax expense recorded in the Company's consolidated statements of operations involves management's interpretation and application of certain accounting pronouncements and federal and state tax codes. As such, the Company has identified income tax accounting as a critical accounting policy. The Company is subject to examination by various regulatory taxing authorities. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management's current assessment of tax liabilities, the impact of which could be significant to the consolidated results of operations and reported earnings. Management believes the tax liabilities are adequately and properly recorded in the Company's consolidated financial statements.

In addition, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109 (FIN 48) effective January 1, 2007. FIN 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgment as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate and consequently, affect the Company's operating results. Management believes the tax liabilities are adequately and properly recorded in the Company's consolidated financial statements.

AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID

The following table provides information regarding: (i) the Company's interest income recognized from interest-earning assets and their related average yields; (ii) the amount of interest expense realized on interest-bearing liabilities and their related average rates; (iii) net interest income; (iv) interest rate spread; and (v) net interest margin. Information is based on average daily balances during the indicated periods.

                                                                                                       Year Ended December 31,
                                                                  2008                                          2007                                          2006
                                                  Average                       Average         Average                       Average         Average                       Average
                                                  Balance       Interest      Yield/Cost        Balance       Interest      Yield/Cost        Balance       Interest      Yield/Cost
                                                                                                       (Dollars in thousands)
Interest-earning assets:
     Loans receivable (1)                       $   753,500      $ 45,213          6.00 %     $   806,626      $ 56,678          7.03 %     $   854,268      $ 59,852          7.01 %
   Securities (2)                                   251,785        12,673          4.95           265,116        12,684          4.72           292,140        12,713          4.29
   Other interest-earning assets (3)                 45,330         1,653          3.65            59,215         2,879          4.86            59,753         2,982          4.99
     Total interest-earning assets                1,050,615        59,539          5.67         1,130,957        72,241          6.39         1,206,161        75,547          6.26
Non-interest earning assets                          85,178                                        79,370                                        74,433
Total assets                                    $ 1,135,793                                   $ 1,210,327                                   $ 1,280,594
Interest-bearing liabilities:
   Deposits:
     Checking accounts                          $   105,481           612          0.58       $   100,781           955          0.95       $   102,049         1,024          1.00
     Money market accounts                          181,852         3,768          2.07           176,538         5,947          3.37           145,756         4,306          2.95
     Savings accounts                               121,920           589          0.48           142,018           941          0.66           159,936           693          0.43
     Certificates of deposit                        374,834        13,130          3.50           400,607        18,379          4.59           391,844        16,140          4.12
        Total deposits                              784,087        18,099          2.31           819,944        26,222          3.20           799,585        22,163          2.77
   Borrowings:
     Other short-term
        borrowings (4)                               25,743           430          1.67            19,828           811          4.09            19,353           902          4.66
     FHLB borrowings (5)(6)(7)                      119,369         6,127          5.05           158,667        11,101          6.90           248,211        19,579          7.78
        Total borrowed money                        145,112         6,557          4.44           178,495        11,912          6.58           267,564        20,481          7.55
        Total interest-bearing
          liabilities                               929,199        24,656          2.65           998,439        38,134          3.82         1,067,149        42,644          4.00
Non-interest bearing deposits                        63,276                                        64,315                                        61,350
Non-interest bearing liabilities                     16,779                                        17,475                                        17,158
Total liabilities                                 1,009,254                                     1,080,229                                     1,145,657
Stockholders' equity                                126,539                                       130,098                                       134,937
Total liabilities and
   stockholders' equity                         $ 1,135,793                                   $ 1,210,327                                   $ 1,280,594
Net interest-earning assets                     $   121,416                                   $   132,518                                   $   139,012
Net interest income/ interest rate spread                        $ 34,883          3.02 %                      $ 34,107          2.57 %                      $ 32,903          2.26 %
Net interest margin                                                                3.32 %                                        3.02 %                                        2.73 %
Ratio of average interest-earning assets to
   average interest-bearing liabilities                                          113.07 %                                      113.27 %                                      113.03 %


____________________

(1) The average balance of loans receivable includes non-performing loans, interest on which is recognized on a cash basis.

(2) Average balances of securities are based on amortized cost.

(3) Includes FHLB stock, money market accounts, federal funds sold and interest-earning bank deposits.

(4) Includes federal funds purchased and Repo Sweeps.

(5) The 2008 period includes an average of $120.1 million of contractual FHLB borrowings reduced by an average of $763,000 of unamortized deferred premium on the early extinguishment of debt. Interest expense on borrowings for the 2008 period includes $1.5 million of amortization of the deferred premium on the early extinguishment of debt. The amortization of the deferred premium for the 2008 period increased the average cost of borrowed money as reported to 4.44% compared to an average contractual rate of 2.41%.

(6) The 2007 period includes an average of $162.4 million of contractual FHLB borrowings reduced by an average of $3.7 million of unamortized deferred premium on the early extinguishment of debt. Interest expense on borrowings for the 2007 period includes $4.5 million of amortization of the deferred premium on the early extinguishment of debt. The amortization of the deferred premium for the 2007 period increased the average cost of borrowed money as reported to 6.58% compared to an average contractual rate of 4.14%.

(7) The 2006 period includes an average of $259.1 million of contractual FHLB borrowings reduced by an average of $10.9 million of unamortized deferred premium on the early extinguishment of debt. Interest expense on borrowings for the 2006 period includes $9.6 million of amortization of the deferred premium on the early extinguishment of debt. The amortization of the deferred premium for the 2006 period increased the average cost of borrowed money as reported to 7.55% compared to an average contractual rate of 3.93%.

RATE/VOLUME ANALYSIS
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