Critical Accounting Policies

General. The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, we may use historical loss factors as one of the many factors and estimates utilized in determining the inherent losses that may be present in our loan portfolio. Actual losses could differ substantially from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. A summary of the significant accounting policies of the Company is set forth in Note 1 to the Company's consolidated financial statements.

Allowance for Loan Losses: We establish the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be appropriate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectibility of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available.

Impairment of Loans: We measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan (or, as a practical expedient, at the loan's observable market price) or the fair value of the collateral if the loan is collateral dependent. We consider a loan impaired when it is probable that the Corporation will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment.

Impairment of Securities: Impairment of investment securities results in a write-down that must be included in net income when a market decline below cost is other-than-temporary. We regularly review each investment security for impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer and our ability and intention with regard to holding the security to maturity.

The following discussion is intended to assist in understanding the results of operations and financial condition of the Company. This discussion should be read in conjunction with the accompanying consolidated financial statements.

For the quarter ended March 31, 2009, the Company reported earnings of $261,136. This compares to earnings of $895,505 in the quarter ended March 31, 2008. The decline in net income is $634,369 or 70.8 percent when compared to earnings in the first quarter of 2008. Net income available to common shareholders was $152,497 after accrued dividends and accretion of discount on preferred stock totaling $108,639. Basic earnings on a per share basis were $0.06, a decrease of $0.29 or 82.9 percent and diluted shares were $0.06, a decline of $0.28 or 82.4 percent. The decrease is the result of net interest margin compression impacted by the loss of over $18 million in earning assets and related interest income associated and the non-cash write-down of perpetual preferred stock issued by Fannie Mae and Freddie Mac (collectively, "the GSE") during 2008, an additional loss of interest income from the $13.2 million of non-accural loans and other real estate, the non-cash write-down of $152,955 in Collateralized Debt Obligation (CDO) securities during the first quarter of 2009, and additional contributions to the Bank's provision for loan losses of $95,000 compared to the first quarter of 2008.

The return on average assets for the first quarter was 0.21 percent and excluding the write-down would have been 0.28 percent versus the prior year's 0.73 percent. The return on shareholders' equity was 3.93 percent and exclusive of the write-down would have been 5.45 percent, compared to 9.47 percent in 2008. Additionally, included in the first quarter of 2009 was a provision for loan losses expense of $375,000 compared to expense of only $280,000 in 2008.

Notwithstanding the impact of the non-cash impairment write-down and the $95,000 increase in the provision for loan losses, the decrease in net income is due to net interest margin compression. Primary factors impacting the net interest margin include the higher amount of earning assets with variable interest rates tied to prime than corresponding variable funding sources; the loss of $18 million in earning assets due to the aforementioned write-off of GSE investments during the last two quarters of 2008; significant competition for retail deposits in our markets; all of which have been further exacerbated by interest rate cuts by the Federal Reserve that started in September 2007 with the Fed Funds rate target at 5.25 percent and continued through December 2008 when the Fed Funds target range was set to 0 percent to 0.25 percent. As a result, the cost of funding asset growth declined at a slower rate than did income on all earning assets, particularly interest sensitive earning assets. As the Company is largely asset sensitive, and in a period of declining rates, the income from earning assets will decline more than will the interest expense on deposits. In addition, the company has historically relied on higher cost retail certificates of deposit for funding. However, growth in loans coupled with a decline in deposits, required increased use of lower cost borrowings and resulted in total interest expense declining, but as noted at a slower rate than total interest income. As a result the Company's net interest income prior to the loan loss provision declined by $735,091, to $3.0 million in the first quarter of 2009, from $3.8 million during the first quarter of 2008. The Company's net interest income after provision for loan losses declined by $830,091 from $2.6 million during the first quarter of 2009 compared to $3.5 million during the same period in 2008, as the Company contributed $375,000 in loan loss expense for the first quarter of 2009 versus $280,000 in 2008. The Company's net interest margin accordingly declined from 3.42 percent for the first quarter of 2008, to 2.62% for the first quarter of 2009. Excluding the write-off of the CDO the Company reduced its non-interest expense by $207,220 during the first quarter of 2009 compared to the same period in 2008.

At March 2009, total assets were $504.6 million, growth of $5.0 million or 1.01 percent from $499.5 million at the comparable quarter of 2008. Comparing the major components of the Company's balance sheet at quarter end 2009 and 2008 finds cash and funds sold were $12.8 million versus $10.5 million; investment securities were $150.2 million versus $180.7 million; loans were $293.4 million versus

Net Interest Income. The Company's net interest income was $3,019,396 in the first quarter of 2009, compared to $3,754,487 for the first quarter of 2008, a decrease of $735,091 or 19.6 percent. The fully tax equivalent (FTE) net interest income in the first quarter of 2009 was $3,109,326, a decrease of $827,794 or 21.0 percent versus $3,937,119 in the first quarter of 2008. The net interest margin for the first quarter of 2009 was 2.62 percent compared to 3.42 percent in the first quarter of 2008. This decrease is primarily the result of the effect of shrinking interest margins. Net interest margin continued to be compressed during the first quarter of 2009. Factors that were present during the latter part of 2008 continued to impact net interest margin during the first quarter of 2009. These factors include the absence of earning assets totaling over $18 million from the write off of GSE investments, the effect on non-accruing loans and other real estate that are no longer earning income due to their status, and the prevailing low market rate environment.

Total interest income was $6.5 million in the first quarter of 2009 compared to $7.8 million in the comparable period in 2008. Interest and fees on loans declined $757,209 or 14.8 percent even though the volume of loans increased $19.5 million, or 7.0 percent, at March 31, 2009 from March 31, 2008. Additionally there was a $565,453 decrease in interest on securities and a $4,981 increase in interest on federal funds sold. Combined, total interest income was down $1,317,681 or 16.9 percent. Average interest earning assets totaled $475.3 million in the first quarter of 2009, an increase of $14.6 million or 3.2 percent from $460.7 million in the first quarter of 2008. During the first quarter of 2009, average loans totaled $294.5 million, an increase of $24.3 million or 9.0 percent from $270.2 million in the first quarter of 2008, while average investment securities totaled $167.3 million, a decrease of $21.5 million from $188.8 million in the first quarter of 2008. The fully taxable equivalent annualized yield on loans decreased to 5.89 percent from 7.52 percent in the comparable quarter of 2008, while investment securities in the first quarter of 2009 yielded 5.26 percent, compared to 6.05 percent in the first quarter of 2008. However, the tax-equivalent yield on total interest earning assets dropped to 5.52 percent in 2009 from 6.92 percent in 2008 resulting in a decrease of $560,472 in total interest income. The decrease in loan yields reflects the effects of a reduction in the prime interest rate from 5.0 percent during the first quarter of 2008 to 3.25 percent during the first quarter of 2009. Like the yield on the loan portfolio, security yields have been affected by the declining rate environment as reinvestment of $23.3 million in called securities have been at lower yields, and the reduction in higher yielding assets from the write-down of the GSE security investments in 2008. Total interest expense decreased 14.5 percent as interest on deposits decreased $465,073 or 14.7 percent as the volume of deposits increased 1.0 percent. Interest on borrowings declined $117,516, or 13.6 percent because of the lower interest rate environment and the decision to utilize lower cost short-term wholesale borrowings compared to higher rate retail deposits to fund the growth in loans.

The yield on interest-bearing liabilities decreased to 3.16 percent in the first quarter of 2009 compared to 3.97 percent in 2008 resulting in a decrease of $582,589 in total interest expense to $3.4 million compared to $4.0 million in the first quarter of 2009. This decrease in total interest expense occurred in spite of an increase in average interest-bearing liabilities of $29.7 million or 7.3 percent to $436.2 million in the first quarter of 2009 compared to $406.5 million in the first quarter of 2008. The changes in average interest-bearing liabilities were in interest-bearing deposits, up $5.8 million or 1.8 percent; FHLB advances up $7.9 million or 15.3 percent; federal funds purchased down $6.2 million or 79.7 percent; short-term note payable up $6.8 million and repurchase agreements up $15.3 million or 73.3 percent. These additional funds were utilized to fund loan growth, the average of which was up $23.7

The net interest margin is a measure of net interest income performance. It represents the difference between interest income, including net loan fees earned, and interest expense, reflected as a percentage of average interest earning assets. The Company's tax equivalent net interest margin decreased to 2.62 percent in the first quarter of 2009 from 3.42 percent in the first quarter of 2008. The Company continues to be asset sensitive, although less so than in the past, as many of its loans are tied to prime or other indices and have repriced down faster than the interest rates on its deposits and other funding sources resulting in compression of the net interest margin. The Company has allowed the higher rate retail deposits to run off and replaced this funding source with variable rate overnight borrowings, which will more closely match the future changes in the prime rate, thereby minimizing the extent of margin compression.

The following table sets forth the Company's average interest earning assets (on a taxable equivalent basis) and average interest bearing liabilities, the average yields earned on such assets and rates paid on such liabilities, and the net interest margin, for the periods indicated.

                                                      Three Months ended          Three Months ended
                                                        March 31, 2009              March 31, 2008
                                                   Average            Yield/    Average           Yield/
                                                   Balance  Interest   Rate     Balance  Interest  Rate
Interest-earning assets:                                         ($ amounts in thousands)
Federal funds sold                                   $ 12,646     $ 6  0.19%       $ 188      $ 1  2.13%
Securities:
U. S. government agencies and corporations             94,389   1,173  4.97%      99,412    1,355  5.45%
States and political subdivisions                      15,992     266  6.65%      18,366      297  6.47%
Other securities                                       56,945     760  5.34%      71,066    1,204  6.78%
Total securities                                      167,326   2,199  5.26%     188,844    2,856  6.05%
Loans                                                 295,365   4,351  5.89%     271,689    5,108  7.52%
Total interest-earning assets                         475,337 $ 6,556  5.52%     460,721  $ 7,965  6.92%
Allowance for loan losses                             (3,806)                    (2,980)
Cash and other non interest-earning assets             37,933                     30,390
Total Assets                                        $ 509,464                  $ 488,131

Interest-bearing liabilities:
Deposits:
Interest bearing demand and MMDA                     $ 66,030   $ 256  1.55%    $ 58,646    $ 281  1.92%
Savings                                                30,599     105  1.38%      32,039      120  1.50%
Other time                                            230,280   2,337  4.06%     230,385    2,762  4.80%
Total deposits                                        326,909   2,698  3.30%     321,070    3,163  3.94%

Fed funds purchased and securities sold under REPO     37,800      84  0.89%      28,666      252  3.52%
FHLB Term advances                                     45,000     475  4.23%      45,000      461  4.10%
FHLB Overnight advances                                14,500      20  0.55%       6,614       57   3.45
Loan payable                                            6,844     116  6.78%           -        -      -
Capital trust preferred securities                      5,155      54  4.19%       5,155       97  7.53%
Total borrowings                                      109,299     749  2.74%      85,435      867  4.06%