The following is a discussion of the factors which significantly affected the consolidated results of operations and financial condition of Jeffersonville Bancorp ("the Parent Company") and its wholly-owned subsidiary, The First National Bank of Jeffersonville ("the Bank"). For purposes of this discussion, references to the Company include both the Bank and Parent Company, as the Bank is the Parent Company's only subsidiary. This discussion should be read in conjunction with the consolidated financial statements and notes thereto, and the other financial information appearing elsewhere in this annual report.

This document contains forward-looking statements, which are based on assumptions and describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," or similar words. The Company's ability to predict results and the actual effect of future plans or strategies is uncertain. Factors which could have a material adverse effect on operations include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market areas and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements. Actual results could differ materially from forward-looking statements.

The Parent Company is a bank holding company founded in 1982 and headquartered in Jeffersonville, New York. The Parent Company owns 100% of the outstanding shares of the Bank's common stock and derives substantially all of its income from the Bank's operations in the form of dividends paid to the Parent Company. The Bank is a New York commercial bank chartered in 1913 serving Sullivan County, New York with branch offices in Jeffersonville, Eldred, Liberty, Loch Sheldrake, Monticello (two), Livingston Manor, Narrowsburg, Callicoon and Wurtsboro. The Bank's administrative offices are located in Jeffersonville, New York.

The Company's mission is to serve the community banking needs of its borrowers and depositors, who predominantly are individuals, small businesses and local municipal governments. The Company believes it understands its local customer needs and provides quality service with a personal touch.

The financial results of the Company are influenced by economic events that affect the communities we serve as well as national economic conditions, primarily interest rates trends, affecting the entire banking industry. Changes in net interest income have the greatest impact on the Company's net income.

National economic performance deteriorated significantly in 2008. Subprime lending problems battered large banks and investment companies, leading to the disappearance of some and direct and indirect government support for others. The past year witnessed a material drop in market values of new and existing homes. Retail sales levels dropped despite heavy holiday discounting. Furthermore, the U.S.-based automobile industry has asked for significant government funding to stay afloat.

Locally, our economy is also suffering. Real estate values are declining as the inventory of unsold homes has increased. The construction industry is negatively affected by the decline in real estate sales and growing inventory of existing housing. Lack of commercial growth also impacts the construction industry, which in turn creates a decline in demand from suppliers of building materials as well as for construction workers. Nevertheless, there are reasons to believe that local economic conditions and employment prospects may not be so severe. A proposed "Entertainment City" development, a $1 billion dollar project that is expected to incorporate the current "racino" and harness racing track in Monticello, is currently under construction on the site of the former Concord Resort and may create thousands of construction and permanent jobs in Sullivan County. In addition, some Native American tribes have proposed casino gaming projects in Sullivan County. The forthcoming completion of the Millennium natural gas pipeline project will create a greatly expanded and bi-directional transportation route for local natural gas production and storage. Energy companies are exploring the possibility of drilling into previously unreachable natural gas reserves in western Sullivan County thought to contain up to 516 trillion cubic feet of natural gas. This project is expected to promote economic development in Sullivan County.

The Company has underwritten loans using the same conservative standards that have been the foundation of the Company since its inception. Our overall asset quality remains strong. Management believes the Company will weather this economic downturn, as it has survived many others in the past, with sound financial decisions.

Management of the Company considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent uncertainty in evaluating the levels of the allowance required to cover credit losses in the portfolio and the material effect that such judgments can have on the results of operations. The allowance for loan losses is maintained at a level deemed adequate by management based on an evaluation of such factors as economic conditions in the Company's market area, past loan loss experience, the financial condition of individual borrowers, and underlying collateral values based on independent appraisals. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions and values of real estate particularly in Sullivan County. Collateral underlying certain real estate loans could lose value which could lead to future additions to the allowance for loan losses. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Foreclosed real estate consists of properties acquired through foreclosure or by acceptance of a deed in lieu of foreclosure. These assets are recorded at the lower of fair value of the asset acquired less estimated costs to sell or "cost" (defined as the fair value at initial foreclosure). At the time of foreclosure, or when foreclosure occurs in-substance, the excess, if any, of the loan over the fair market value of the assets received, less estimated selling costs, is charged to the allowance for loan and lease losses and any subsequent valuation write-downs are charged to other expense. Operating costs associated with the properties are charged to expense as incurred. Gains on the sale of foreclosed real estate are included in income when title has passed and the sale has met the minimum down payment requirements prescribed by GAAP.

FASB Statement No. 141 (R) "Business Combinations" was issued in December of 2007. This Statement establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The Statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The guidance will become effective as of the beginning of a company's fiscal year beginning after December 15, 2008. This new pronouncement will impact the Company's accounting for business combinations completed beginning January 1, 2009.

In December 2008, the FASB issued FSP FAS 132(R)-1, "Employers' Disclosures about Postretirement Benefit Plan Assets". This FSP amends SFAS 132(R), "Employers' Disclosures about Pensions and Other Postretirement Benefits", to provide guidance on an employer's disclosures about plan assets of a defined benefit pension or other postretirement plan. The disclosures about plan assets required by this FSP shall be provided for fiscal years ending after December 15, 2009. The Company is currently reviewing the effect this new pronouncement will have on its consolidated financial statements.

Total assets increased by $11.2 million or 2.9% to $398.6 million at December 31, 2008 from $387.4 million at December 31, 2007. The increase was primarily due to a $14.8 million or 5.9% increase in loans, net of allowance, from $249.6 million at December 31, 2007 to $264.4 million at December 31, 2008 and a $3.3 million or 62.3% increase in other assets from $5.3 million to $8.6 million at December 31, 2008. Partially reducing these increases was a decrease in securities available for sale of $6.3 million or 6.8% from $92.1 at December 31, 2007 to $85.8 at December 31, 2008. Loan growth was funded by calls and maturities of securities available for sale and borrowings with the Federal Home Loan Bank (FHLB). Deposits decreased $2.5 million or 0.8% from $299.2 million at December 31, 2007 to $296.7 million at December 31, 2008. The decrease in deposits was due to $5.0 million of brokered deposits being paid off that were partially replaced with core deposits. Time deposits increased $15.1 million or 12.5% from $121.0 million at December 31, 2007 to $136.1 million at December 31, 2008. Savings and insured money market accounts decreased $14.2 million or 16.1% to $73.8 million at December 31, 2008 from $88.0 million at December 31, 2007. Non-deposit liabilities increased by 33.8% in 2008 from $44.2 million at December 31, 2007 to $59.2 million at December 31, 2008. The liabilities were primarily long- and short-term borrowings from the Federal Home Loan Bank of New York.

In 2008, total gross loans increased $14.6 million or 5.8% from $253.0 million to $267.6 million. Within the loan portfolio, residential real estate, commercial real estate and home equity loans increased by $6.6 million or 6.8%, $8.2 million or 9.6%, and $5.1 million or 19.7%, respectively. These increases were partially offset by construction loans which decreased by $2.8 million or 50.5% and decreases of $1.2 million and $1.4 million in commercial loans and consumer installment loans respectively at December 31, 2008. The growth in residential and commercial real estate loans and home equity loans reflects the Company's strategy to conservatively grow the real estate portfolio. The overall loan portfolio is structured in accordance with management's belief that loans secured by residential and commercial real estate generally result in lower loan loss levels compared to other types of loans because of the value of the underlying collateral. The Company remains committed to maintaining loan credit quality and sacrificing growth in the loan portfolio, if necessary.

There was a $1.2 million increase in foreclosed real estate at December 31, 2008, from $35,000 at December 31, 2007 as the result of a foreclosure on a commercial loan. The commercial property is under a lease agreement, with lease payments being recorded in income. Total nonperforming loans increased $1.5 million from $4.6 million at December 31, 2007 to $6.1 million at December 31, 2008 as a result of increases of $0.4 and $1.7 million in residential and commercial mortgages, respectively, partially offset by a decrease of $0.6 million in commercial loans, which includes a transfer of a $1.3 million commercial loan to foreclosed real estate. Net loan (charge-offs) recoveries increased from $206,000 in 2007 to $(447,000) in 2008 due to a recovery in 2007 as discussed below in "Provision for Loan Losses". At December 31, 2008, the allowance for loan losses equaled $3.2 million representing 1.18% of total gross loans outstanding and 51.8% of total nonperforming loans.

Total stockholders' equity was $42.6 million at December 31, 2008, a decrease of $1.3 million from December 31, 2007 of $44.0 million. This decrease was the result of cash dividends of $2.2 million, the cumulative effect of adopting EITF 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements in the amount of $255,000 and an increase in accumulated other comprehensive loss of $1.5 million partially offset by $2.7 million of net income.

Net Income

Net income for 2008 of $2.7 million decreased 36.8% or $1,573,000 from 2007 net income of $4.3 million. The lower earnings level in 2008 reflects the interaction of a number of factors. The most significant factor which reduced 2008 net income was a decrease in other non-interest income of $3.6 million partially offset by a reduction of income tax expense of $2.1 million. The $3.6 million decrease in other non-interest income was due primarily to impairment charges of Freddie Mac Preferred stock in the amount of $5.2 million partially offset by $1.5 million in insurance proceeds from bank owned life insurance. Other changes were an increase in net interest income of $861,000 offset by an increase in provision for loan losses of $635,000 and an increase in other non-interest expenses of $289,000. Net interest income increased $861,000 due to a decrease in interest expense of $1,387,000 partially offset by a decrease of $526,000 in interest income. The provision (credit) for loan losses increased $635,000, from $(370,000) in 2007, which was primarily the result of a large recovery that year, to $265,000 in 2008 as discussed in the "Summary of Loan Loss Experience" below. The increase in total non-interest expense of $289,000 was primarily the result of a $176,000 increase in other non-interest expense, composed mainly of $103,000 in consulting fees and $60,000 in FDIC assessment fees, and a $78,000 increase in salaries and employee benefits. Net interest income increased $0.9 million from $14.8 million in 2007 to $15.7 million in 2008. Interest expense on deposits decreased $1.8 million or 23.8% from $7.5 million to $5.7 million. Partially offsetting this was an increase in interest on Federal Home Loan Bank (FHLB) borrowings of $0.5 million or 50.3% due to increased levels of these borrowings, a decrease in loan interest and fees of $297,000 or 1.6% to $18.3 million from $18.6 million, and a decrease in interest on securities of $140,000 or 3.0%. Decreased interest rates on loans and decreased levels of both investment securities and federal funds sold accounted for the decrease in earnings. Interest expense on deposits decreased $1.8 million or 23.8% primarily due to falling interest rates and market pressure. Salary and employee benefit expense increased $78,000 or 1.0%. Occupancy and equipment expense increased $35,000. Other non-interest expense increased $176,000 due to increased FDIC assessments and consulting costs associated with staff training.

Interest Income and Interest Expense

Throughout the following discussion, net interest income and its components are expressed on a tax equivalent basis which means that, where appropriate, tax exempt income is shown as if it were earned on a fully taxable basis.

The largest source of income for the Company is net interest income, which represents interest earned on loans, securities and short-term investments, less interest paid on deposits and other interest bearing liabilities. Tax equivalent net interest income of $16.6 million for 2008 represented an increase of 5.2% over 2007. Net interest margin increased 17 basis points to 4.59% in 2008 compared to 4.42% in 2007, due to overall decreases in interest bearing liability rates.

Total tax equivalent interest income for 2008 was $23.8 million, compared to $24.4 million in 2007. The decrease in 2008 is largely the result of a decrease in the average yield on interest earning assets from 6.83% in 2007 to 6.59% in 2008. Total average securities (securities available for sale and securities held to maturity) decreased $3.6 million or 3.5% in 2008 to $101.1 million. The yield on total securities increased 1 basis point to 5.41% in 2008 from 5.40% in 2007. During 2008, total average securities and short-term investments decreased a total of $4.8 million. Average loans increased $9.4 million to $259.7 million from $250.3 million in 2007, with a 38 basis point decrease in yields from 7.45% in 2007 to 7.06% in 2008. Loan growth in real estate and fixed rate home equity loans amounted to $6.6 million and $3.3 million respectively. Due to falling interest rates, new fixed rate loans have brought the average loan yields down. Real estate and home equity loans yields decreased by 3 and 46 basis points respectively. Time and demand loans, which are tied to the Bank's prime rate, decreased 260 basis points in yield and $0.3 million in volume.

Total interest expense in 2008 decreased $1.4 million to $7.2 million from $8.6 million in 2007 primarily as a result of a decrease in average rates paid on total interest bearing liabilities from 3.17% in 2007 to 2.59% in 2008. The average balance of interest bearing liabilities increased from $272.0 million in 2007 to $278.7 million in 2008, an increase of 2.4%. The increase was result of an $18.9 million increase in average borrowings partially offset by a $12.3 million decrease in average interest bearing deposits. Brokered deposits of $5.0 million matured (an average balance of $3.3 million) during 2008 and were not replaced. During 2008, the average cost of total interest bearing liabilities decreased by 58 basis points from 3.17% to 2.59%. Average interest bearing deposits decreased $12.3 million to $238.7 million in 2008, a decrease of 4.9%. Interest rates on interest bearing deposits decreased by 59 basis points from an average rate paid of 3.00% in 2007 to 2.41% in 2008. Savings and insured money market interest rates decreased 134 basis points and time deposits decreased 45 basis points in response to falling rates. In 2008, average demand deposit balances decreased 4.3% over 2007.

Provision for Loan Losses

The provision (credit) for loan losses was $265,000 in 2008 as compared to $(370,000) in 2007 largely as a result of a $441,000 recovery in 2007 on a previously written-off loan and loans remaining well secured. Higher charge-off levels in 2008 resulted in the 2008 provision. Provisions for loan losses are recorded to maintain the allowance for loan losses at a level deemed adequate by management based on an evaluation of such factors as economic conditions in the Company's market area, past loan loss experience, the financial condition of individual borrowers, and underlying collateral values based on independent appraisals. The provision for loan losses was also reduced in 2007 due to the reduction in net charge-offs as noted below. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions, particularly in Sullivan County. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management's comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged-off against the allowance when management believes that the collectability of all or a portion of the principal is unlikely. Recoveries of loans previously charged-off are credited to the allowance when realized.

Total nonperforming loans increased $1.5 million from $4.6 million at December 31, 2007 to $6.1 million at December 31, 2008. Net loan recoveries (charge-offs) decreased from $206,000 in 2007 to $(447,000) in 2008 and gross charge-offs increased from $318,000 in 2007 to $647,000 in 2008.

Summary of Loan Loss Experience

The following table indicates the amount of charge-offs and recoveries in the loan portfolio by category.

ANALYSIS OF THE CHANGES IN ALLOWANCE FOR LOAN LOSSES FOR YEARS 2004 THROUGH 2008

                                    2008          2007           2006          2005          2004
                                                        (Dollars in thousands)

Balance at beginning of year      $   3,352     $   3,516      $   3,615     $   3,645         3,569
Charge-offs:
Commercial, financial and
agriculture                            (294 )        (106 )         (208 )          (2 )           -
Real estate - mortgage                  (21 )          (5 )          (66 )           -            (3 )
Installment loans                      (179 )        (118 )         (156 )        (308 )        (284 )
Other loans                            (153 )         (89 )         (103 )        (129 )        (146 )
Total charge-offs                      (647 )        (318 )         (533 )        (439 )        (433 )
Recoveries:
Commercial, financial and
agriculture                              80           388            187            59             1
Real estate - mortgage                    9             5              -             8            22
Installment loans                        47            72             98            83            59
Other loans                              64            59             59            79            67
Total recoveries                        200           524            344           229           149
Net recoveries (charge-offs)           (447 )         206           (189 )        (210 )        (284 )
Provision charged (credited) to
operations                              265          (370 )           90           180           360
Balance at end of year            $   3,170     $   3,352      $   3,516     $   3,615     $   3,645

Ratio of net (recoveries)
charge-offs to average
outstanding loans                      0.17 %       (0.08 )%        0.08 %        0.09 %        0.13 %

The Company manages asset quality with a review process which includes ongoing financial analysis of credits and both internal and external loan review of existing outstanding loans and delinquencies. Management strives to identify potential nonperforming loans in a timely basis; take charge-offs promptly based on a realistic assessment of probable losses; and maintain an adequate allowance for loan losses based on the inherent risk of loss in the existing portfolio.

The provision (credit) for loan losses was $265,000 for the year ended December 31, 2008 compared to a credit of $(370,000) for 2007. As disclosed in the Company's 2006 Form 10-K, the Company recovered $441,000 on a previously written-off loan. This recovery was for a loan made in 2002. The loan turned out to be fraudulent and the participants brought a legal suit against the Bank of New York. The participating lenders prevailed and received their settlements in the first quarter of 2007.

The allowance for loan losses was $3.2 million at December 31, 2008, $3.4 million at 2007, and $3.5 million at 2006. The allowance as a percentage of total loans was 1.18% at December 31, 2008, compared to 1.32% and 1.40% at December 31, 2007 and 2006, respectively. The allowance's coverage of nonperforming loans was 51.8% at December 31, 2008 compared to 72.2% and 187.0% at December 31, 2007 and 2006 respectively. Despite the continuing high levels of nonperforming loans and the downturn in local economic conditions, the Bank is and has been committed to common sense lending practices, sacrificing loan quantity for quality. This policy is reflected in the Banks net charge-off (recovery) history in the above table. While nonperforming loans have increased, the Bank's management believes that loans remain well collateralized. A specific reserve of $149,000 has been established to help reduce the risk of nonperforming loans.

No portion of the allowance for loan losses is restricted to any loan or group of loans, as the entire allowance is available to absorb charge-offs in any loan category. The amount and timing of future charge-offs and allowance allocations may vary from current estimates and will depend on local economic conditions. The following table shows the allocation of the allowance for loan losses to major portfolio categories and the percentage of each loan category to total loans outstanding.

Commercial nonperforming loans are evaluated individually for impairment in accordance with FAS 114. As of December 31, 2008, there were $5,191,000 in loans, compared to $3,394,000 as of December 31, 2007, which were considered to be impaired under SFAS No. 114. On the remaining loan portfolios, the Company applies reserve factors considering historical loan loss data and other subjective factors.

           DISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES AT DECEMBER 31,

                                       2008                           2007                           2006                           2005                           2004
                                             Percent                        Percent                        Percent                        Percent                        Percent
                                             of loans                       of loans                       of loans                       of loans                       of loans
                             Amount of       in each        Amount of       in each        Amount of       in each        Amount of       in each        Amount of       in each
                             allowance       Category       allowance       category       allowance       category       allowance       category       allowance       category
                             for loan        to total       for loan        to total       for loan        to total       for loan        to total       for loan        to total
                              losses          loans          losses          loans          losses          loans          losses          loans          losses          loans

                                                                                            (Dollars in thousands)

Residential mortgages (1)   $     1,036           51.2 %   $     1,048           51.4 %   $     1,048           50.2 %   $     1,048           48.5 %   $     1,039           48.4 %
Commercial mortgages                285           36.5             285           34.3             285           34.7             351           34.9             351           35.3
Commercial loans                  1,314            9.4           1,263           10.5           1,353           11.2           1,343           11.7           1,286            9.4
Installment loans                   473            2.8             604            3.7             650            3.9             648            4.8             753            6.3
. . .