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 affect 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 Company 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 securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) we intend to sell the security or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more-likely-than-not that we will be required to sell the security before recovery, we must determine what portion of the impairment is attributable to a

credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary 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, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we would be required to sell the security before recovery.

Results of Operations

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.

During the three months ended June 30, 2009, the Company recorded $1,050,000 in other-than-temporary impairment charges, net of tax $693,000. This non-cash charge to earnings is related to Collateralized Debt Obligation (CDO) investment securities and was previously discussed in Note 2. Also on May 22, 2009, the FDIC levied a special assessment on insured institutions as part of the agency's effort to rebuild the Deposit Insurance Fund (DIF). The final rule established a special assessment of five basis points on each FDIC-insured depository institution's assets, minus its Tier 1 capital as of June 30, 2009. The special assessment will be collected by the FDIC on September 30, 2009. The Bank accrued $225,000 during the second quarter of 2009 in accordance with the FDIC's ruling.

For the quarter ended June 30, 2009, the Company reported a loss of $95,356 compared to earnings of $909,577 in the quarter ended June 30, 2008. The decline in net income is $1,004,933 or 110.5 percent when compared to earnings in the second quarter of 2008. Net income available to common shareholders was a loss of $255,943 after accrued dividends and accretion of discount on preferred stock totaling $160,588. Basic and diluted earnings on a per share basis were ($0.10), a decrease of $0.45 or 128.6 percent. For the six-month period in 2009, net income was $165,780 compared to earnings of $1,805,082 for the same period in 2008. Net income available to common shareholders for the six-month period of 2009 was a loss of $103,447 after accrued dividends and accretion of discount on preferred stock totaling $269,227. Basic and diluted earnings on a per share basis were ($0.04), a decrease of $0.74 or 105.7 percent for basic earnings per share and a decrease of $0.73 or 105.8 percent for diluted earnings per share compared to the same period in 2008.

The decrease during the second quarter is the result of net interest margin compression, which was impacted by the loss of interest income from the decline in earning assets of over $18 million due to the non-cash write-down of perpetual preferred stock issued by Fannie Mae and Freddie Mac (collectively, "the GSE") during the third quarter of 2008, an additional loss of interest income from the $11.5 million of non-accrual loans and other real estate, the non-cash write-down of $1,050,000 in Collateralized Debt Obligation (CDO) securities during the second quarter of 2009, an industry wide FDIC special assessment of $225,000, and contributions to the Bank's provision for loan losses of $550,000 compared to $300,000 for the second quarter of 2008.

The return on average assets for the second quarter was (0.08) percent and excluding the write-down and special assessment would have been 0.60 percent versus the prior year's 0.72 percent. The return on shareholders' equity was
(1.33) percent and exclusive of the write-down and special assessment would have been 10.42 percent, compared to 10.14 percent in 2008.

Not withstanding the impact of the non-cash impairment write-down, the FDIC special assessment and the increase in the provision for loan losses, the decrease in net income for the quarter is due to net interest margin compression. Primary factors impacting the net interest margin include earning assets with variable interest rates tied to prime outweighing corresponding variable funding sources; the loss of $19 million in earning assets due to the aforementioned write-off of Fannie Mae and Freddie Mac preferred stock and CDO investments during the last two quarters of 2008 and first two quarters of 2009, respectively; 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 Federal Funds rate target at 5.25 percent and continued through December 2008 when the Federal Funds target range was set to 0 percent to 0.25 percent, where it remained at June 30, 2009. 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 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 at a slower rate than total interest income.

Excluding the loss on the write-down of CDO securities, the net gains on sale of securities and the special assessment from the FDIC during the second quarter of 2009, net income available to common shareholders for the six-month period was $523,091 or $.20 per basic and diluted shares. For the six-month period ended June 30, 2008 comparable net income available to common shareholders, net of gains of sale of securities, was $1,151,000 or $0.45 and $0.44 per basic and diluted shares respectively.

This decline in net income available to common shareholders exclusive of the write-down of securities and the special assessment from the FDIC, in 2009 of $627,909 or 54.6 percent is the result of the previously noted factors that affected the Company's net interest margin during 2009.

Net Interest Income. The Company's net interest income was $3,374,437 in the second quarter of 2009, compared to $3,754,869 for the second quarter of 2008, a decrease of $380,432 or 10.1 percent. This decrease is primarily the result of the effect of shrinking interest margins. The net interest margin for the second quarter of 2009 was 2.93 percent compared to 3.29 percent in the second quarter of 2008. Factors that were present during the latter part of 2008 continued to impact net interest margin during the first and second quarters of 2009. These factors include the absence of earning assets totaling over $19 million from the write off of Fannie Mae and Freddie Mac preferred stock and CDO 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. Average earning assets were $474.0 million at June 30, 2009, a decrease of $4.3 million or 0.9 percent from $478.3 million in the second quarter of 2008. The tax-equivalent yield on total interest earning assets dropped to 5.61 percent in 2009 from 6.50 percent in 2008 resulting in a decrease of $1.1 million in total interest income. Interest expense also decreased as the yield on interest-bearing liabilities decreased to 2.95 percent in the second quarter of 2009 compared to 3.61 percent in 2008 resulting in a decrease of $648,952 in total interest expense to $3.2 million compared to $3.8 million in the second quarter of 2008. This decrease in total interest expense occurred in spite of an increase in average interest-bearing liabilities of $7.0 million or 1.7 percent to $431.2 million in the second quarter of 2009 compared to $424.1 million in the second quarter of 2008. The changes in average interest-bearing liabilities were in interest-bearing deposits, up $9.4 million or 2.9 percent; FHLB advances down $5.5 million or 9.3 percent; federal funds purchased and repurchase agreements up $3.1 million or 9.5 percent. These additional funds were utilized to fund loan growth, the average of which was up $17.4 million or 6.1 percent.

For the six-month period ended June 30, 2009, net interest income totaled $6,393,910, a decrease of 14.8 percent or $1.1 million compared to $7,509,355 for the same period in 2008. The net interest margin for the 2009 period was 2.77 percent compared to 3.35 percent in 2008. Interest and fees on loans decreased $1,106,922 or 11.1 percent as the volume of loans increased $5,527,328 million, or 1.9 percent, from December 31, 2008 to June 30, 2009. Interest on securities decreased $1,247,661 and interest on federal funds sold increased $7,596. Combined, total interest income was down $2,346,987 or 15.3 percent. Total interest expense decreased 15.7 percent as interest on deposits decreased $919,873 or 14.8 percent as the volume of deposits increased 8.5 percent. Interest on borrowings decreased $311,669, or 18.7 percent.

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 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.

During the second quarter of 2009, average loans totaled $300.4 million, an increase of $17.5 million or 6.1 percent from $282.9 million in the second quarter of 2008, while average investment securities totaled $166.8 million, a decrease of $28.5 million from $195.3 million in the second quarter of 2008. The fully taxable equivalent annualized yield on loans decreased to 6.03 percent from 6.90 percent in the comparable quarter of 2008, while investment securities in the second quarter of 2009 yielded 5.08 percent, compared to 5.92 percent in the second quarter of 2008. 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 its current level of 3.25 percent during the second quarter of 2009. Like the yield on the loan portfolio, security yields have been affected by the declining rate environment as reinvestment of $42.2 million in called securities have been at lower yields, and the reduction in higher yielding assets from the write-down of the CDO security investments in 2009 and Fannie Mae and Freddie Mac preferred stock security investments in 2008. Average total deposits for the second quarter of 2009 increased by $6.2 million or 1.7 percent, to $373.4 million from $367.2 million in the second quarter of 2008. Total interest bearing deposits in the second quarter averaged $336.2 million, an increase of $9.4 million or 2.8 percent as compared to $326.8 million in the second quarter of 2008. Total borrowings averaged $95.0 million in the second quarter of 2009 compared to $97.3 million in the comparable quarter of 2008.

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
                                                June 30, 2009              June 30, 2008
                                           Average           Yield/   Average          Yield/
                                           Balance Interest   Rate    Balance Interest  Rate
Interest-earning assets:                                ($ amounts in thousands)
Federal funds sold                             $ 6,881   $ 3  0.17%      $ 44    $ 0.2  2.13%
Securities:
U. S. government agencies and corporations      93,903 1,102  4.69%   100,868    1,363  5.41%
States and political subdivisions               16,434   273  6.64%    19,875      316  6.36%
Other securities                                56,491   745  5.28%    74,556    1,211  6.50%
Total securities                               166,828 2,120  5.08%   195,299    2,890  5.92%
Loans                                          300,356 4,528  6.03%   282,970    4,879  6.90%

Total interest-earning assets                       474,065 $ 6,651  5.61%     478,313 $ 7,769 6.50%
Allowance for loan losses                           (3,904)                    (3,203)
Total non-earning assets                             29,570                     28,414
Total Assets                                      $ 499,731                  $ 503,524

Interest-bearing liabilities:
Deposits:
Interest bearing demand and MMDA                   $ 70,425   $ 224  1.27%    $ 63,835   $ 280 1.75%
Savings                                              33,285      95  1.15%      32,642     122 1.50%
Other time                                          232,498   2,256 3.88 %     230,327   2,628 4.56%
Total deposits                                      336,208   2,575  3.06%     326,804   3,030 3.71%

Federal funds purchased and securities sold under
repurchase agreements                                36,157      72  0.80%      33,012     197 3.52%
FHLB Term advances                                   41,923     472  4.50%      45,000     451 4.01%
FHLB Overnight advances                              11,725      13  0.44%      14,178      85  2.40
Capital trust preferred securities                    5,155      51  3.96%       5,155      70 5.43%
Total borrowings                                     94,960     608  2.56%      97,345     803 3.30%
Total interest-bearing liabilities                  431,168   3,183  2.95%     424,149   3,833 3.61%
Demand deposits                                      37,227                     40,411
Other non interest bearing liabilities                2,682                      3,093
Total Liabilities                                   471,077                    467,653
Stockholders' Equity                                 28,654                     35,871
Total Liabilities and Stockholders' Equity        $ 499,731                  $ 503,524
Net interest spread                                         $ 3,468  2.66%             $ 3,936 2.88%
Net interest margin                                                  2.93%                     3.29%

                                               Six Months ended             Six Months ended
                                                 June 30, 2009                June 30, 2008
                                            Average           Yield/    Average           Yield/
                                            Balance  Interest  Rate     Balance  Interest  Rate

Interest earning assets:
Federal funds sold                           $ 9,747      $ 9  0.18%       $ 116      $ 2  2.77%
Securities:
U. S. government agencies and corporations    94,140    2,275  4.83%     100,140    2,718  5.43%
States and political subdivisions             16,214      540  6.66%      19,121      613  6.41%
Other securities                              56,717    1,505  5.31%      72,810    2,416  6.64%
Total securities                             167,071    4,320  5.17%     192,071    5,747  5.98%
Loans                                        297,874    8,879  5.96%     277,330    9,987  7.20%
Total interest-earning assets                474,692  $13,208  5.56%     469,517 $ 15,736  6.70%
Allowance for loan losses                    (3,855)                     (3,092)
Total non-earning assets                      33,734                      29,403
Total assets                               $ 504,571                   $ 495,828


Interest bearing liabilities:
Deposits:
Interest bearing demand                     $ 68,240    $ 480  1.41%    $ 61,241    $ 560  1.83%
Savings                                       31,949      200  1.25%      32,340      243  1.50%

Other time                                   231,395   4,593 3.97%     230,356   5,390 4.68%
Total deposits                               331,584   5,273 3.18%     323,937   6,193 3.82%
Federal funds purchased and securities
sold under repurchase agreements              36,974     156 0.84%      30,839     449 2.91%
FHLB advances
Term                                          43,453     948 4.36%      45,000     911 4.05%
Overnight                                     13,105      33 0.50%      10,396     141 2.71%
Loan                                           3,403     116 6.82%           -       -     -
Capital trust preferred securities             5,155     105 4.07%       5,155     167 6.48%
Total borrowings                             102,090   1,358 2.66%      91,390   1,668 3.65%
Total interest-bearing liabilities           433,674   6,631 3.06%     415,327   7,861 3.79%
Demand deposits                               40,346                    40,615
Other liabilities                              2,922                     3,042
Total liabilities                            476,942                   458,984
Stockholders' equity                          27,629                    36,844
Total liabilities and stockholders' equity $ 504,571                 $ 495,828

Net interest spread                                  $ 6,579 2.51%             $ 7,875 2.92%

Net interest margin                                          2.77%                     3.35%

Non-Interest Income. The Company's non-interest income for the second quarter of 2009 was $1,394,056, an increase of $530,737 or 61.5 percent from $863,319 in the same period of 2008. Deposit fees and charges increased 0.22 percent or $1,009 to $457,727 as the number of overdraft fees remained steady. Bank card fees fell slightly by $3,536 to $130,224 in 2009. Income recognized on the increase in cash surrender value of life insurance increased by 10.4 percent or $9,923 to $105,593. Secondary market mortgage loan fees increased $61,898 to $73,852. Securities gains increased $476,151 to $531,946, due largely to the sale of certain securities in the ordinary course of business and the increase in the number of agency securities called at par. These agency securities had been purchased at a discount and, despite accretion, were still carried at a book value below par, which resulted in a gain when they were called by the issuer. Investment and insurance commissions declined $20,960 or 36.2 percent to $36,980 in the second quarter of 2009 due to a significant reduction in transaction levels given the existing investment environment. Other income was up $6,252 percent to $57,734 largely due to lower earnings from an investment in a title company, which was negatively affected by the slowdown in mortgage loan originations.

Year to date 2009 non-interest income totaled $2,342,190, an increase of $546,733 or 30.5 percent when compared to $1,795,457 in the first six months of 2008. The categories with the most significant year to date increases or decreases were deposit fees and charges, down 6.9 percent; secondary market mortgage fees, up 178.4 percent due to an increase in purchasing activity within the local housing market during the second quarter; net gains on sales of securities was up 501.7 percent due to a higher volume of sales as well as a high volume of calls at par of agency securities originally purchased at a discount; other income was down 6.2 percent largely due to lower earnings from an investment in a title company which was negatively affected by the slowdown in mortgage loan originations.

Non-Interest Expenses. Total non-interest expense for the second quarter of 2009 was $4,330,557, an increase of $1,172,984 compared to $3,157,573 in the comparable period in 2008. Excluding the write-down of securities previously discussed of $1,050,000 during the second quarter and the FDIC special assessment accrual of $225,000, non-interest expenses were $3,055,557, a decrease of $102,016, or 3.2 percent as cost control and efficiency continue to be stressed by the Company wherever possible and practicable. Salaries and benefits totaled $1,658,668, a decrease of $120,222 or 6.8 percent compared to $1,778,890 in second quarter 2008. The decrease reflects lower staffing levels and a freeze on normal annual increases during 2009 combined with lower benefit accruals. Legal and professional fees totaled $73,472, an increase of $15,567 or 26.9 percent from the second quarter of last year's total of $57,905 due to accounting and legal expense associated with the Company's participation in the Capital Purchase Program and testing of the Bank's compliance with Section 404 of the Sarbanes-Oxley Act. Equipment repairs and maintenance expense decreased $40,146 or 43.5 percent to $52,080 reflecting reduced costs from software and equipment maintenance contracts due to the outsourcing of our data and item processing units in the fourth quarter of 2008. Consulting fees decreased $23,697 or 27.7 percent as the Company continues to reduce its use of outside consultants. Equipment depreciation decreased by $28,882 or 17.4 percent to $137,351 as management has deferred capital purchases. Advertising and public relations expense decreased by $17,716 or 22.7 percent for the quarter as management has reduced costs by selectively identifying advertising opportunities that provide the best value for exposure within our marketplace. Insurance premiums for FDIC insurance increased to $295,149, an increase of $230,262 or 354.9 percent from $64,887 in second quarter of 2008 primarily due to the FDIC's industry wide special deposit insurance assessment that the Bank accrued $225,000 to be paid during the third quarter of 2009. Office supplies, telephone, and postage expense decreased to $114,907, a decrease of $14,649 or 11.3 percent from $129,556 in the second quarter 2008. Data processing was $86,800 and is associated with the outsourcing of our data and item processing units in the fourth quarter of 2008 there was no expense in the second quarter of 2008.

For year to date 2009, total non-interest expense was $7,563,643, an increase of $1,118,720 or 17.4 percent compared to $6,444,923 for the year to date 2008. Again, excluding the loss on write-down of securities and the FDIC special assessment accrual of $225,000, non-interest expenses in 2009 was $6,135,688, a decrease of $309,235 or 4.8%. For the first six months of 2009, the categories with the most significant increases or decreases were salaries and benefits, down 10.5 percent or $391,122; occupancy expense was up 5.3 percent or $16,844; equipment depreciation is down 16.0 percent or $53,902; equipment repairs and maintenance is down 44.7 percent; advertising and public relations is down $47,611 or 30.4 percent; office supplies, telephone, and postage expense was down 6.2 percent; legal and professional fees were up $37,836 or 34.7 percent; and federal insurance premiums were up 385.1 percent for the reasons stated above.

. . .