Introduction

The following discussion presents management's discussion and analysis of the consolidated financial condition and results of operations of the Company as of December 31, 2008 and 2007 and for the years ended December 31, 2008, 2007 and 2006. This discussion should be read in conjunction with our audited consolidated financial statements and the related notes appearing elsewhere in this report.

Forward-Looking Statements

This report includes "forward-looking statements." All statements regarding the Company's anticipated results or expectations, including its business plan and strategies are intended to be forward-looking statements within the meaning of the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Typically, forward-looking statements are predictive and are not statements of historical fact, and the words "anticipates," "believes," "estimates," "seeks," "expects," "plans," "intends," and similar expressions, as they relate to us, the Bank, the Trust Company, or our management, are intended to identify forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable and have based these expectations on our beliefs as well as assumptions we have made, these expectations may prove to be incorrect. Important factors that could cause actual results to differ materially from our expectations include, without limitation, the following:

· our dependence on a favorable local economy in the Bank's primary service area;

· the effect of general economic and monetary conditions on the Bank's ability to attract deposits, make loans and achieve satisfactory interest spreads;

· the risk of losses due to loan defaults by both commercial loan customers or a significant number of other borrowers;

· general changes in real estate, business and general property valuations underlying secured loans;

· the effect of banking regulation on the Bank's ability to grow and compete;

· restrictions imposed on us by regulators; and

· our dependence on key banking and management personnel.

Please also refer to the "Risk Factors" section of this report for a discussion of some of the principal risks and uncertainties inherent in our business.

Executive Overview

Net income for 2008 was $1.9 million compared to a net loss of $2.6 million in 2007. The increase in earnings from 2007 to 2008 was primarily due to a decrease in the amount of provision expense of $6.6 million recorded in 2008 compared to the previous year.

Net interest income decreased 2.7% from 2007 to 2008, along with a decrease in net interest margin from 3.34% to 3.30%. Net interest income decreased due to a decrease in net interest margin, a purposeful decrease in total loans, and the continuance of elevated levels of nonperforming assets. Net interest margin decreased in 2008 primarily due to a 400 basis point decrease in short-term interest rates throughout the year.

Non-interest income increased by 8.6% from 2007 to 2008, with an increase of $226,923, or 6.9%, in trust and brokerage fees and an increase of $226,719, or 23.2%, in service charges. The wealth management segment has continued to show strong revenue growth and asset growth for the 9th consecutive year. The gain on the sale of investments increased in 2008 by $69,054 from a loss of $3,213 in 2007.

Operating expenses increased by $257,330 or 1.2% from 2007 to 2008. The increase was due to an increase in FDIC insurance premiums of $212,248 or 43.8% due to the need to replenish the fund that was depleted by several large financial institutions failing in 2008. The FDIC also saw a need to increase the premiums due to the expectation of future bank failures, increasing the insured limit to $250,000 on interest bearing deposits and unlimited for non-interest bearing deposits, and the additional operating expenses that will be incurred with the increased resolution activity. Data processing expenses increased by $263,454 or 33.5% due to cost associated with our on-line banking conversion and upgrade. Legal and professional expenses also increased due to the outsourcing of our internal audit and loan review functions, along with increased costs associated with the workout of non-performing assets. The increases in operating expenses were offset by a decrease in employment expenses by $353,611 due to a workforce reduction that took place in April 2008.

Total assets decreased by $9.9 million or 1.4% from the prior year. The purposeful decrease in loans of $14.7 million and an increase in the allowance for loan loss of $2.4 million was the primary reason for the decrease in total assets and was offset by an increase in investments of $12.4 million. Asset quality and liquidity continues to be a major focus of the Bank, in the wake of the substantial charge-offs and the significant increase in non-performing assets the Bank sustained during 2007.

Core deposits grew $36.5 million and now comprise over 69.4% of total deposits, compared to approximately 61.6% in the prior year. While our cost of funds decreased in 2008 due to the growth in core deposits, net interest margin continued to decrease due to the significant decrease of 400 basis points in short-term interest rates. In a decreasing rate environment, deposits do not reprice as quickly as loans, so the lag causes a compression in the interest margin directly impacting net interest income as it did in 2008.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires that we make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions. 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. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. Our critical accounting policies are limited to those described below. For a detailed discussion on the application of these and other accounting policies, see Note 1-Summary of Significant Accounting Policies to the audited consolidated financial statements included in this report.

Allowance for Loan Losses. Our allowance for loan losses represents management's estimate of probable incurred losses inherent in the loan portfolio at the balance sheet date. Additions to the allowance may result from recording provision for loan losses and recoveries, while charge offs are deducted from the allowance. Allocation of the allowance is made for analytical purposes only, and the entire allowance is available to absorb any loan charged off.

We have an established process for determining the adequacy of the allowance for loan losses that relies on various procedures and pieces of information to arrive at a range of probable outcomes. No single statistic or measurement, in itself, determines the adequacy of the allowance. The allowance has two components: identified specific allocations and a percentage allocation based on loss history for different loan groups.

To determine the allocated component of the allowance, we combine estimated allowances required for specifically identified loans that are analyzed individually and loans that are analyzed on a group basis. First, management allocates specific portions of the allowance for loan losses based on identifiable problem loans. Problem loans are identified through a loan risk rating system and monitored through watchlist reporting. Specific allocations of allowance for loan losses are determined for each identified credit based on delinquency rates, collateral and other risk factors identified for that credit. Second, management's evaluation of the allowance for different loan groups is based on consideration of actual loss experience, the present and prospective financial condition of our borrowers, industry concentrations within the loan portfolio and general economic conditions. Absent the availability of some of these factors, we base our estimates upon peer industry data of comparable banks. Lastly, the unallocated component of the allowance is maintained to supplement the allocated component and to recognize the imprecision of estimating and measuring loss when evaluating loss allocations for individual loans or pools of loans. The allocated and the unallocated components represent the total allowance for loan losses that under normal circumstances should adequately cover probable incurred losses inherent in the loan portfolio.

Actual loan losses are charged against the allowance when management believes that a loan or a portion thereof is uncollectible. A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in the aggregate for smaller-balance loans of a similar nature such as residential mortgage and consumer loans, and on an individual loan basis for other loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of a borrower's operating results and financial condition indicates that underlying cash flows of the borrower's business are not adequate to meet its debt service requirements, the loan is evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing interest rate or at the fair value of collateral if repayment is expected solely from the collateral.

There are many factors affecting judgment calls relating to allowances for loan losses. Some are quantitative while others require qualitative judgment. Although we believe our process for determining the allowance adequately considers all of the factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect earnings or financial position in future periods.

Results of Operations

Summary. We reported net income of $1.9 million, or $0.46 per diluted share, for the year ended December 31, 2008. This reflects an increase of $4.5 million from a net loss of $2.6 million in 2007 and a decrease of $1.8 million from net income of $3.7 million posted in 2006. Net income per diluted share of $0.46 reflects a $1.10 increase from the $0.64 net loss reported in 2007 and a $0.43 decrease from the $0.89 net income posted in 2006.

The 2008 results reflected a $4.5 million growth in net income compared to a net loss of $2.6 million in 2007. Net interest income decreased by $572,948, or 2.7%, due to a drop in interest margin throughout the year, elevated levels of non-performing assets, and a purposeful decrease in total loans. Net interest margin decreased due to the reduction in interest rates throughout 2008. Noninterest income increased by $498,101, or 8.6%, primarily due to increases of $226,923 and $226,719 in Trust and Brokerage fees and Service Charges, respectively. Provision expense decreased significantly in 2008 by $6.6 million compared to 2007 due to lower loan charge-offs and less deterioration of asset quality issues. Noninterest expense increased by $257,330 due to an increase in data processing expenses by $263,454, marketing expenses by $208,860, and FDIC premiums by $212,248. The increases in noninterest expense were offset by a decrease in employment expenses by $353,611 and a decrease of $76,029 in business development expenses.

Net Interest Income. Net interest income, the difference between revenue generated from earning assets and the interest cost of funding those assets, is our primary source of earnings. Interest income and interest expense for the year ended December 31, 2008 were $37.8 million and $16.8 million, respectively, netting $21 million in net interest income. Interest income and interest expense for the year ended December 31, 2007 were $46.9 million and $25.4 million, respectively, resulting in $21.5 million in net interest income. Interest income and interest expense for the year ended December 31, 2006 totaled $41.1 million and $20.8 million, respectively, providing for net interest income of $20.3 million. The decrease of $572,948 in net interest income in 2008 from 2007 was due to a decrease in net interest margin, elevated levels of non-performing assets, and a purposeful decrease in total loans. We decided to lower our total loans outstanding to focus on improving asset quality and increasing liquidity through the purchase of investments. While the nonperforming assets remained high in 2008, they have decreased by $362,298 since December 31, 2007. The decrease in nonperforming assets and the purposeful decrease in loans reflect the Company's focus on improving asset quality, improving profitability, and recognizing the challenging economic environment.

The net yield on average earning assets during 2008 was 3.30% compared to 3.34% for 2007 and 3.58% for 2006. The decrease in net yield during 2008 was due to a 400 basis point drop in interest rates, specifically the fed funds rate which was down to 0.00% to 0.25% at December 31, 2008. The net yield on average earning assets was impacted by the change in the mix between higher yielding loans to lower yielding securities.

Deposit costs decreased as a result of a shift of certificate of deposits greater than $100,000 to lower-cost core deposits, such as non-interest bearing and interest bearing checking accounts which increased by $10.4 million and $18.5 million, respectively, since December 31, 2007. Health savings accounts were the primary increase in interest bearing checking as they increased by $13.0 million throughout the year.

The level of net interest income is primarily a function of asset size, as the weighted-average interest rate received on earning assets is greater than the weighted average interest cost of funding sources; however, factors such as types of assets and liabilities, interest rate risk, liquidity, asset quality, and customer behavior also impact net interest income as well as the net yield.

The following table reflects the average balance, interest earned or paid, and yields or costs of our assets, liabilities and stockholders' equity during 2008, 2007 and 2006.

Average Balance,
Interest and Yield/                              2008                                        2007                                        2006
Cost Analysis                                  Interest                                    Interest                                    Interest
                                 Average        Earned         Yield         Average        Earned         Yield         Average        Earned         Yield
($ in thousands)                 Balance       or Paid        or Cost        Balance       or Paid        or Cost        Balance       or Paid        or Cost
Assets
Short-term investments and
interest-earning deposits       $   7,169     $      184           2.57 %   $   4,238     $      245           5.78 %   $   5,731     $      282           4.92 %
Federal funds sold                  6,243            154           2.47 %       4,834            218           4.51 %       5,716            287           5.02 %
Securities - taxable               55,533          2,729           4.91 %      51,913          2,641           5.09 %      43,436          2,157           4.97 %
Securities - tax exempt (1)        21,067          1,339           6.36 %      19,367          1,199           6.19 %      16,165            974           6.03 %
Loans held for sale                   506              -           0.00 %          95              -           0.00 %           -              -
Loans                             559,794         33,808           6.04 %     576,417         43,006           7.46 %     502,666         37,649           7.49 %
Total interest-earning assets     650,312         38,214           5.88 %     656,864         47,309           7.20 %     573,714         41,349           7.21 %

Allowance for loan losses          (9,118 )                                    (7,700 )                                    (6,309 )
Cash and due from banks            14,255                                      12,347                                      16,286
Other assets                       33,199                                      30,340                                      22,581
Total assets                    $ 688,648                                   $ 691,851                                   $ 606,272

Liabilities and Stockholders'
Equity
Interest-bearing checking       $  66,085     $      791           1.20 %   $  45,360     $      674           1.49 %   $  31,112     $      339           1.09 %
Savings                            16,555            168           1.01 %      14,435            146           1.01 %      13,635            112           0.82 %
Money market                      137,747          3,203           2.33 %     125,488          4,649           3.70 %      98,482          3,295           3.35 %
Certificates of deposit           291,320         10,328           3.55 %     338,485         17,325           5.12 %     300,356         14,896           4.96 %
Short-term borrowings                 254              4           1.57 %          39              1           2.56 %           -              -           0.00 %
FHLB advances                      33,207          1,162           3.50 %      27,906          1,435           5.14 %      28,260          1,335           4.72 %
Junior subordinated debt           17,527          1,129           6.44 %      17,527          1,126           6.42 %      11,463            810           7.07 %
Total interest-bearing
liabilities                       562,695         16,785           2.98 %     569,240         25,356           4.45 %     483,308         20,787           4.30 %
                                        -                                           -                                           -
Noninterest-bearing checking       71,978                                      67,588                                      70,727
Other liabilities                   5,047                                       4,638                                       3,506
Stockholders' equity               48,928                                      50,385                                      48,731
Total liabilities and
stockholders' equity            $ 688,648                                   $ 691,851                                   $ 606,272

Net interest income                           $   21,429                                  $   21,953                                  $   20,562
Rate spread                                                        2.90 %                                      2.75 %                                      2.91 %
Net interest income as a
percent of average earning
assets                                                             3.30 %                                      3.34 %                                      3.58 %

(1) Computed on a tax equivalent bases for tax equivalent securities using a 34% statutory tax rate.

The following table shows the changes in interest income, interest expense, and net interest income due to variances in rate and volume of average earning assets and interest-bearing liabilities. The change in interest not solely due to changes in rate or volume has been allocated in proportion to the absolute dollar amounts of the change in each.

Changes in Net Interest Income Due
To Rate and Volume
                                                                 2008 over 2007
($ in thousands)                                         Rate        Volume       Total
Increase (decrease) in interest income:
Short-term investments and interest-earning deposits   $   (178 )   $    117     $    (61 )
Federal funds sold                                         (116 )         52          (64 )
Securities - taxable                                        (92 )        180           88
Securities - tax exempt                                      33          107          140
Loans                                                    (7,989 )     (1,209 )     (9,198 )
Net change in interest income                            (8,342 )       (753 )     (9,095 )
Increase (decrease) in interest expense:
Interest-bearing checking                                  (149 )        266          117
Savings                                                       -           22           22
Money market                                             (1,864 )        419       (1,445 )
Certificates of deposit                                  (4,814 )     (2,183 )     (6,997 )
Short-term borrowings                                        (1 )          4            3
FHLB advances                                              (513 )        240         (273 )
Trust preferred securities                                    3            -            3
Net change in interest expense                           (7,338 )     (1,232 )     (8,570 )
Net change in interest income and interest expense     $ (1,004 )   $    479     $   (525 )

                                                                 2007 over 2006
($ in thousands)                                         Rate        Volume       Total
Increase (decrease) in interest income:
Short-term investments and interest-earning deposits   $     47     $    (84 )   $    (37 )
Federal funds sold                                          (27 )        (42 )        (69 )
Securities - taxable                                         53          431          484
Securities - tax exempt                                      27          198          225
Loans                                                      (146 )      5,503        5,357
Net change in interest income                               (46 )      6,006        5,960
Increase (decrease) in interest expense:
Interest-bearing checking                                   133          202          335
Savings                                                      27            7           34
Money market                                                362          992        1,354
Certificates of deposit                                     481        1,948        2,429
Short-term borrowings                                         -            1            1
FHLB advances                                               117          (17 )        100
Trust preferred securities                                  (75 )        391          316
Net change in interest expense                            1,045        3,524        4,569
Net change in interest income and interest expense     $ (1,091 )   $  2,482     $  1,391

Interest income is primarily generated from the loan portfolio. Average loans comprised 86%, 88% and 88% of average earning assets during 2008, 2007 and 2006, respectively. During 2008, the loan portfolio had an average yield of 6.04%, and earned $33.8 million, or 89.5% of total interest income, a decrease of $9.2 million from 2007. The decrease in net interest income was mainly due to the decrease in net interest margin, but was also due to the purposeful decrease in average loans to be able to focus on asset quality and to improve liquidity and profitability. Short-term interest rates declined by 400 basis points in 2008, which negatively impacted net interest margin. During 2007, the loan portfolio had an average yield of 7.46% and earned $43.0 million, or 91.7% of total interest income while the loan portfolio had an average yield of 7.49% and earned $37.6 million, or 91.7% of total interest income during 2006.

The total securities portfolio and total short-term investments equaled 12.0% and 1.1%, respectively, of average earning assets during 2008. With an average tax-equivalent yield of 5.31%, total securities contributed $3.6 million, or 9.6% of total interest income in 2008, while total short-term investments had a combined average yield of 2.52% and earned $337,828, or 0.9% of total interest income, in 2008. During 2007, the total securities portfolio and total short-term investments equaled 10.9% and 1.4%, respectively, of average earning assets during 2007. With an average tax-equivalent yield of 5.39%, total securities contributed $3.8 million, or 8.1% of total interest income in 2007, while total short-term investments had a combined average yield of 5.1% and earned $463,231, or 1.0% of total interest income, in 2007. During 2006, the total securities portfolio and total short-term investments equaled 10.5% and 2.0%, respectively, of average earning assets. With an average yield of 5.26%, securities contributed $3.1 million, or 7.6% of total interest income in 2006, while total short-term investments had a combined average yield of 4.97% and earned $569,560, or 1.4% of total interest income in 2006.

Interest expense is primarily generated from money market deposits and certificates of deposit, which equaled 24.5% and 51.8%, respectively, of average interest-bearing liabilities during 2008; 22.0% and 59.5%, respectively, of average interest-bearing liabilities during 2007; and 20.4% and 62.1%, respectively, of average interest-bearing liabilities during 2006. Total borrowings were 9.1%, 8.0%, and 8.2% of average interest-bearing liabilities during 2008, 2007 and 2006, respectively.

Money market balances had an average rate of 2.33% and cost $3.2 million, or 19.1% of total interest expense, in 2008, compared to an average rate of 3.70% and cost $4.6 million, or 18.3% of total interest expense, in 2007. Certificates of deposit had an average rate of 3.55% and cost $10.3 million, or 61.5% of total interest expense, in 2008, compared to an average rate of 5.12% and cost $17.3 million, or 68.3% of total interest expense, in 2007. Interest expense on savings and interest-bearing checking totaled 5.7% of total interest expense during 2008 and 3.2% of total interest expense during 2007. The Company paid $2.3 million of interest expense on borrowings, or 13.6% of total interest expense, during 2008 and paid $2.6 million of interest expense on borrowings, or 10.1% of total interest expense, during 2007.

During 2006, money market accounts had an average rate of 3.35% and cost $3.3 million or 15.9% of total interest expense, while certificates of deposit had an average rate of 4.96% and cost $14.9 million, or 71.7% of total interest expense. Savings deposits and interest-bearing checking accounts totaled 9.3% of average interest-bearing liabilities during 2006 with an average rate of 1.0 %, or .22% of total interest expense in 2006. Total borrowings had an average rate of 5.40% during 2006.

Provision for Loan Losses. The provision for loan losses was $4.4 million for 2008, $11.0 million for 2007 and $2.2 million for 2006. In 2008, the amount recorded to provision expense was driven by a downturn in the economy. A portion of the 2008 provision expense was recorded due to further deterioriation requiring additional reserves from the residential real estate development loans identified in 2007. In 2007, the provision expense was primarily due to . . .