This discussion should be read in conjunction with the consolidated financial statements, notes and tables included elsewhere in this report. Throughout the following sections, the "Company" refers to 1st Constitution Bancorp and its wholly owned subsidiaries, 1st Constitution Bank, 1st Constitution Capital Trust I, and 1st Constitution Capital Trust II, the "Bank" refers to 1st Constitution Bank, and the "Trusts" refers to 1st Constitution Capital Trust I and 1st Constitution Capital Trust II, collectively. The purpose of this discussion and analysis is to assist in the understanding and evaluation of the Company's financial condition, changes in financial condition and results of operations.

Critical Accounting Policies and Estimates

"Management's Discussion and Analysis of Financial Condition and Results of Operation" is based upon the Company's 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 the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company's Consolidated Financial Statements for the year ended December 31, 2008 contains a summary of the Company's significant accounting policies. Management believes the Company's policies with respect to the methodologies for the determination of the allowance for loan losses and for determining other-than-temporary security impairment involve a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. These critical policies and their application are periodically reviewed with the Audit Committee and the Board of Directors. The provision for loan losses is based upon management's evaluation of the adequacy of the allowance, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectibility may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available to it, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of the Company's loans are secured by real estate in the State of New Jersey. Accordingly, the collectibility of a substantial portion of the carrying value of the Company's loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the Central New Jersey area experience an adverse economic shock. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company's control.

Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets (level 1) or quoted prices on similar assets (level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of quoted prices, valuation techniques would be used to determine fair value of any investments that require inputs that are both significant to the fair value measurement and unobservable (level 3). Valuation techniques are based on various assumptions, including, but not limited to cash flows, discount rates, rate of return, adjustments for nonperformance and liquidity, and liquidation values. A significant degree of judgment is involved in valuing investments using level 3 inputs. The use of different assumptions could have a positive or negative effect on consolidated financial condition or results of operations.

Management must periodically evaluate if unrealized losses (as determined based on the securities valuation methodologies discussed above) on individual securities classified as held to maturity or available for sale in the investment portfolio are considered to be other-than-temporary. The analysis of other-than-temporary impairment requires the use of various assumptions, including, but not limited to, the length of time an investment's book value is greater than fair value, the severity of the investment's decline, as well as any credit deterioration of the investment. If the decline in value of an investment is deemed to be other-than-temporary, the investment is written down to fair value and a non-cash impairment charge is recognized in the period of such evaluation.

Results of Operations

The Company reported net income for the 12 months ended December 31, 2008 of $2,759,458, a decrease of 49.3% from the $5,442,782 reported for the 12 months ended December 31, 2007. The decrease is due primarily to the effects of the declining level of market interest rates during 2008 plus the higher level of nonperforming assets compared to the prior year, both resulting in a lower level of net interest income for the year ended December 31, 2008 compared with the year ended December 31, 2007. Diluted net income per share was $0.65 for the year ended December 31, 2008 compared to $1.29 reported for the year ended December 31, 2007. Basic net income per share for the year ended December 31, 2008 was $0.66 as compared to the $1.31 reported for the year ended December 31, 2007. All share information has been restated for the effect of a 5% stock dividend declared on December 18, 2008 and paid on February 2, 2009 to shareholders of record on January 20, 2009.

Return on average assets ("ROA") and return on average equity ("ROE") were 0.56% and 6.52%, respectively, for the year ended December 31, 2008, compared to 1.29% and 14.32%, respectively, for the year ended December 31, 2007. Key performance ratios declined for the 2008 fiscal year as compared to the prior year due to the lower net income for the year ended December 31, 2008 as compared to the year ended December 31, 2007.

A significant factor impacting the Company's net interest income has been the declining level of market interest rates and the resulting compression of the Company's net interest margin. The net interest margin for the year ended December 31, 2008 was 3.64% as compared to the 4.57% net interest margin recorded for the year ended December 31, 2007, a reduction of 93 basis points. The Federal Reserve has decreased the level of market interest rates by 400 basis points since January 1, 2008. Since the majority of the Company's interest earning assets earn at floating rates, these interest rate reductions have resulted in a decreased level of interest income. The Company will continue to closely monitor the mix of earning assets and funding sources to maximize net interest income during this challenging interest rate environment.

The Company has a significant investment in federal agency-backed collateralized mortgage obligations and trust preferred securities. The Company does not invest in any private issuer collateralized mortgage obligations. At December 31, 2008, the Company held collateralized mortgage obligations in the available for sale and held to maturity portfolios with aggregate fair values of $6,777,632 and $8,767,537, respectively. These securities had a net unrealized loss of $196,418. The Company also held trust preferred securities in the available for sale and held to maturity portfolios with aggregate fair values of $1,281,806 and $346,988, respectively, and a net unrealized loss of $1,808,335 at December 31, 2008. Several financial institutions have reported significant write-downs of the value of mortgage-related and trust preferred securities. Management has considered the severity and duration of the unrealized losses within the Company's collateralized mortgage obligations and trust preferred securities portfolios, and evaluated recent events specific to the issuers of these securities and their industries, as well as external credit ratings and downgrades thereto. Based on these considerations and evaluations, management does not believe that any of the Company's collateralized mortgage obligations or trust preferred securities are other-than-temporarily impaired as of December 31, 2008. Certain of these types of securities may also not be marketable except at significant discounts. While management of the Company is, as of the date of this report, unaware of any other-than-temporarily impairment in the Company's portfolio of these securities, market, entity or industry conditions could further deteriorate and result in the recognition of future impairment losses related to these securities.

Net Interest Income

Net interest income, the Company's largest and most significant component of operating income, is the difference between interest and fees earned on loans and other earning assets, and interest paid on deposits and borrowed funds. This component represented 83.2% of the Company's net revenues for the year ended December 31, 2008. Net interest income also depends upon the relative amount of interest earning assets, interest-bearing liabilities, and the interest rate earned or paid on them.

The following tables set forth the Company's consolidated average balances of assets and liabilities and shareholders' equity as well as interest income and expense on related items, and the Company's average yield or rate for the years ended December 31, 2008, 2007 and 2006. The average rates are derived by dividing interest income and expense by the average balance of assets and liabilities, respectively.

Average Balance Sheets with Resultant Interest and Rates

(yields on a tax-equivalent
basis)                                                 2008                                            2007                                            2006
                                      Average                          Average         Average                         Average         Average                         Average
                                      Balance          Interest         Rate           Balance          Interest         Rate          Balance          Interest         Rate

Assets:
Federal Funds Sold/Short-Term
     Investments                   $   4,667,073     $    112,427          2.41 %   $   1,653,896     $    101,171         6.12 %   $   1,457,568     $     85,012         5.14 %
Investment Securities:
  Taxable                             84,611,384        4,158,923          4.92 %      80,876,181        4,278,288         5.29 %      70,048,748        3,448,780         4.92 %

  Tax-exempt (4)                      14,471,144          829,249          5.73 %      22,968,401        1,296,032         5.64 %      16,198,497          895,172         5.53 %

  Total                               99,082,528        4,988,172          5.03 %     103,844,582        5,574,320         5.37 %      86,247,245        4,343,952         5.04 %

Loan Portfolio:
  Construction                       115,517,676        8,090,444          7.00 %     129,285,776       11,486,481         8.88 %     125,022,769       11,129,600         8.90 %
  Residential Real Estate             10,376,822          652,728          6.29 %       8,878,427          657,928         7.41 %       8,072,109          517,146         6.41 %
   Home Equity                        15,490,320          986,117          6.37 %      14,118,025        1,063,025         7.53 %      14,604,243        1,109,996         7.60 %
  Commercial and Commercial
    Real Estate                      127,377,980        9,302,815          7.30 %     117,463,693        9,140,693         7.78 %      99,521,245        7,706,864         7.74 %
   Mortgage warehouse lines           57,477,364        2,755,003          4.79 %               -                -            -                 -                -            -
   Installment                         1,204,297           96,375          8.00 %       1,542,082          129,483         8.40 %       2,013,438          167,126         8.30 %
   All Other Loans                    26,660,793        2,405,176          9.02 %      21,083,348        2,635,877        12.50 %      22,506,843        2,535,812        11.27 %
  Total (1)                          354,105,252       24,288,658          6.86 %     292,371,351       25,113,487         8.59 %     271,740,647       23,166,544         8.53 %

Total Interest-Earning Assets        457,854,853       29,389,257          6.42 %     397,869,829       30,788,978         7.74 %     359,445,460       27,595,508         7.68 %

Allowance for Loan Losses             (3,612,156 )                                     (3,270,810 )                                    (2,662,370 )
Cash and Due From Banks               12,446,849                                       10,254,911                                       9,391,415
Other Assets                          22,180,579                                       17,648,099                                      15,422,593
Total Assets                       $ 488,870,125                                    $ 425,502,029                                   $ 381,597,098

Liabilities and Shareholders'
Equity:
Interest-Bearing Liabilities:
  Money Market and NOW Accounts    $  89,274,785     $  2,164,369          2.42 %   $  83,597,940     $  1,737,487         2.08 %   $  87,135,125     $  1,455,755         1.67 %
  Savings Accounts                    79,864,816        1,990,479          2.49 %      64,408,442        2,017,580         3.13 %      44,867,384          939,324         2.09 %
  Certificates of Deposit under
$100,000                              76,921,495        3,096,986          4.03 %      67,236,813        3,170,322         4.72 %      58,183,657        2,907,883         5.00 %
  Certificates of Deposit of
     $100,000 and Over                70,297,311        2,855,024          4.06 %      54,252,087        2,711,467         5.00 %      43,870,647        1,385,119         3.16 %
  Other Borrowed Funds                37,111,612        1,556,238          4.19 %      29,580,685        1,514,907         5.12 %      32,539,699        1,687,749         5.19 %
  Trust Preferred Securities          18,000,000        1,069,351          5.94 %      19,534,247        1,438,876         7.37 %      14,863,014        1,141,667         7.68 %

Total Interest-Bearing
Liabilities                          371,470,019       12,732,447          3.43 %     318,610,214       12,590,639         3.95 %     281,459,526        9,517,497         3.38 %

Net Interest Spread (2)                                                    2.99 %                                          3.79 %                                          3.80 %

Non-interest Bearing
  Demand Deposits                     69,907,048                                       60,892,433                                      63,040,519
Other Liabilities                      5,165,108                                        4,989,809                                       5,013,813
Total Liabilities                    446,542,175                                      384,492,456                                     349,513,858
Shareholders' Equity                  42,327,950                                       38,009,573                                      32,083,240
Total Liabilities and
Shareholders' Equity               $ 488,870,125                                    $ 422,502,029                                   $ 381,597,098

        Net Interest Margin (3)                      $ 16,656,810          3.64 %                     $ 18,198,339         4.57 %                     $ 18,078,001         5.03 %

(1) Loan origination fees are considered an adjustment to interest income. For the purpose of calculating loan yields, average loan balances include nonaccrual loans with no related interest income.

(2) The interest rate spread is the difference between the average yield on interest earning assets and the average rate paid on interest bearing liabilities.

(3) The net interest margin is equal to net interest income divided by average interest earning assets.

(4) Tax equivalent basis.

Changes in net interest income and margin result from the interaction between the volume and composition of interest earning assets, interest bearing liabilities, related yields, and associated funding costs. The Rate/Volume Table demonstrates the impact on net interest income of changes in the volume of interest earning assets and interest bearing liabilities and changes in interest rates earned and paid.

The Company's net interest income decreased on a tax equivalent basis by $1,541,529, or 8.5%, to $16,656,810 for the year ended December 31, 2008, from the $18,198,339 reported for the year ended December 31, 2007. As indicated in the Rate/Volume Table, the principal factor contributing to the decrease in net interest income for the year ended December 31, 2008 was a decrease in the interest income of $1,399,721, resulting from decreased rates on the earning assets components. This was combined with an increase in interest expense resulting from increases in the balances of the deposit components.

The Company's net interest income on a tax-equivalent basis increased by $120,328, or 0.6%, to $18,198,339 for the year ended December 31, 2007, from the $18,078,001 reported for the year ended December 31, 2006. As indicated in the Rate/Volume Table, the principal factor contributing to the 2007 increase in net interest income was an increase in the interest income of $3,193,470, resulting from increased balances in the earning assets components. This was partially offset by an increase in interest expense resulting from increases in the rates paid on deposit components.

 Rate/Volume Table                                                Amount of Increase (Decrease)
                                             Year Ended December 31,                            Year Ended December 31,
                                                 2008 versus 2007                                  2007 versus 2006
                                                Due to Change in:                                  Due to Change in:
(Tax-equivalent basis)              Volume            Rate              Total           Volume           Rate            Total

Interest Income:
  Loans:
    Construction                 $ (1,094,267 )   $ (2,302,233 )    $  (3,396,500 )   $   382,349     $   (25,005 )   $   357,344
    Residential Real Estate            94,238          (99,438 )           (5,200 )        55,873          84,909         140,782
    Home Equity                        95,054         (172,050 )          (76,996 )       (36,807 )       (10,076 )       (46,883 )
    Commercial and Commercial
Real Estate                           748,916         (586,243 )          162,673       1,393,469          39,808       1,433,278
    Mortgage Warehouse Lines        2,755,003                0          2,755,003               -               -               -
    Installment                       (26,940 )         (6,168 )          (33,108 )       (39,657 )         2,013         (37,643 )
    All Other Loans                   600,091         (830,792 )         (230,791 )      (158,402 )       258,466         100,064
Total Loans                         3,172,095       (3,996,924 )         (824,829 )     1,596,826         350,117       1,946,942
  Investment Securities :
    Taxable                           188,735         (308,100 )         (119,365 )       551,519         277,989         829,508
    Tax-exempt                       (483,349 )         16,566           (466,783 )       378,709          22,151         400,860
Total Investment Securities          (294,614 )       (291,534 )         (586,148 )       930,227         300,141       1,230,368
  Federal Funds Sold /
Short-Term Investments                128,512         (117,256 )           11,256          15,721             438          16,159

Total Interest Income               3,005,993       (4,405,714 )       (1,399,721 )     2,542,775         650,695       3,193,470

Interest Expense :
    Money Market and NOW
Accounts                              130,364          296,518      $     426,882         (67,296 )       349,028         281,732
    Savings Accounts                  434,450         (461,551 )          (27,101 )       510,021         568,235       1,078,256
    Certificates of Deposit
under $100,000                        423,858         (497,194 )          (73,336 )       439,006        (176,567 )       262,439
    Certificates of Deposit of
$100,000 and Over                     727,894         (584,337 )          143,557         423,591         902,757       1,326,347
    Other Borrowed Funds              351,007         (309,676 )           41,331        (151,819 )       (21,023 )      (172,842 )
    Trust Preferred Securities        (84,797 )       (284,728 )         (369,525 )       364,138         (66,929 )       297,209
Total Interest Expense              1,982,776       (1,840,968 )          141,808       1,517,640       1,555,501       3,073,142

Net Interest Income              $  1,023,217     $ (2,564,746 )     $ (1,541,529 )   $ 1,025,134     $  (904,806 )   $   120,328

Average interest earning assets increased by $59,985,025, or 15.1%, to $457,854,853 for the year ended December 31, 2008 from $397,869,829 for the year ended December 31, 2007, consisting primarily of an increase of $61,733,901 in loans for 2008 as compared to 2007. Led by the mortgage warehouse lines component, the Bank's average total loan portfolio grew by 21.1%. However, due to the declining level of market interest rates during 2008, loan yields averaged 6.86% for the year ended December 31, 2008, 173 basis points lower than for the year ended December 31, 2007. The Bank's average investment securities portfolio decreased 4.6%, and the yield on that portfolio decreased 34 basis points for the year ended December 31, 2008 compared to the year ended December 31, 2007. Overall, the yield on interest earning assets decreased 132 basis points to 6.42% in the 2008 fiscal year from 7.74% in the 2007 fiscal year.

Average interest earning assets increased by $38,424,369, or 10.7%, to $397,869,829 for the year ended December 31, 2007 from $359,445,460 for the year ended December 31, 2006, consisting primarily of increases in 2007 of $20,630,704 in loans and $17,597,337 in investment securities compared to 2006. Led by the construction loans component, the Bank's average total loan portfolio grew by 7.6% and loan yields averaged 8.59% for the year ended December 31, 2007, 6 basis points higher than for the year ended December 31, 2006. The Bank's average investment securities portfolio increased 20.4%, and the yield on that portfolio increased 33 basis points for the year ended December 31, 2007 compared to the year ended December 31, 2006. Overall, the yield on interest earning assets increased 6 basis points to 7.74% in the 2007 fiscal year from 7.68% in the 2006 fiscal year.

Interest expense increased by $141,808, or 1.1%, to $12,732,447 for the year ended December 31, 2008, from $12,590,639 for the year ended December 31, 2007. This increase in interest expense is principally attributable to higher levels of interest-bearing liabilities priced at a lower market interest rate level. Certificates of deposit of $100,000 and over increased on average by $16,045,224 in 2008, or 29.6%, as compared to 2007, contributing to the funding of loan portfolio growth. The cost on these deposits decreased 94 basis points in 2008 as compared to 2007. Average interest bearing liabilities rose 16.6% in 2008 from 2007. The cost of total interest-bearing liabilities decreased 52 basis points to 3.43% in 2008 from 3.95% in 2007.

Interest expense increased by $3,073,142, or 32.3%, to $12,590,639 for the year ended December 31, 2007, from $9,517,497 for the year ended December 31, 2006. This increase in interest expense is principally attributable to higher levels of interest-bearing liabilities priced at a higher market interest rate level. Savings accounts increased on average by $19,541,058 in 2007, or 43.6%, as compared to 2006, contributing to the funding of loans and investments portfolio growth. The cost on these deposits increased 104 basis points in 2007 as compared to 2006. Average interest bearing liabilities rose 13.2% in 2007 from 2006. The cost of total interest-bearing liabilities increased 57 basis points to 3.95% in 2007 from 3.38% in 2006.

Average non-interest bearing demand deposits increased by $9,014,615, or 14.8%, to $69,907,048 for the year ended December 31, 2008 from $60,892,433 for the year ended December 31, 2007. The primary cause of this increase for 2008 was the requirement for customers of the new Warehouse Line of Credit to maintain deposit relationships with the Bank that, on average, represent 10% to 15% of the loan balances.

Non-Interest Income

Non-interest income increased by $743,630, or 29.1%, to $3,301,959 for the year ended December 31, 2008 from $2,258,329 for the year ended December 31, 2007.

Service charges on deposit accounts represent a significant source of non-interest income. Service charge revenues increased by $210,056, or 31.2%, to $883,882 for the year ended December 31, 2008 compared to $673,826 for the year ended December 31, 2007. This increase was the result of a higher volume of uncollected funds and overdraft fees collected on deposit accounts during 2008 compared to 2007. This component of non-interest income represented 26.8% and 26.3% of the total non-interest income for the years ended December 31, 2008 and 2007, respectively.

Gains on sales of loans held for sale increased by $279,912, or 36.8%, to $1,040,916 for the year ended December 31, 2008, from $761,004 for the year ended December 31, 2007. The Bank sells both residential mortgage loans and Small Business Administration ("SBA") loans in the secondary market. The lower interest rate environment that continued into 2008 has positively impacted the volume of sales transactions in the mortgage loan and SBA loan markets and the resultant gains from these sales transactions.

Non-interest income also includes income from bank-owned life insurance ("BOLI") which amounted to $378,852 for the year ended December 31, 2008 compared to $365,601 for the year ended December 31, 2007. The Bank purchased tax-free BOLI assets to partially offset the cost of employee benefit plans and reduce the Company's overall effective tax rate.

The Bank also generates non-interest income from a variety of fee-based services. These include safe deposit rentals, wire transfer service fees and Automated Teller Machine fees for non-Bank customers. Deposit and service fee charges are reviewed and adjusted as needed from time to time by management to reflect current costs incurred by the Bank in offering these products or services and prices charged by competitor financial institutions amid the Bank's competitive market.

Non-Interest Expenses

Non-interest expenses increased by $2,949,756, or 24.4%, to $15,051,024 for the year ended December 31, 2008 from $12,101,268 for the year ended December 31, 2007. The largest increase in non-interest expenses for 2008 compared to 2007 was in salaries and employee benefits. To a lesser extent, occupancy expense . . .