Overview

Management's discussion and analysis represents an overview of the results of operations and financial condition, and highlights the significant changes in the results of operations and financial condition, as presented in the accompanying consolidated financial statements for Union National Financial Corporation ("Union National"), a bank holding company, and its wholly-owned subsidiary, Union National Community Bank (the "Bank"). Union National's consolidated financial condition and results of operations consist primarily of the Bank's financial condition and results of operations. Union National's trust subsidiaries, Union National Capital Trust I and Union National Capital Trust II, were established for the purpose of issuing $11,000,000 of trust capital securities during 2003 and 2004.

Forward Looking Statements

This quarterly report contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results and trends could differ materially from those set forth in such statements due to various risks, uncertainties and other factors. Such risks, uncertainties and other factors that could cause actual results and experience to differ include, but are not limited to, the following: the strategic initiatives and business plans may not be satisfactorily completed or executed, if at all; increased demand or prices for the Corporation's financial services and products may not occur; changing economic and competitive conditions; technological developments; the effectiveness of the Corporation's business strategy due to changes in current or future market conditions; actions of the U.S. government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets; effects of deterioration of economic conditions on customers specifically the effect on loan customers to repay loans; inability of the Corporation to raise or achieve desired or required levels of capital; paying significantly higher Federal Deposit Insurance Corporation (FDIC) premiums in the future; the effects of competition, and of changes in laws and regulations, including industry consolidation and development of competing financial products and services; interest rate movements; relationships with customers and employees; challenges in establishing and maintaining operations; volatilities in the securities markets and related potential impairments of investment securities; and deteriorating economic conditions and declines in housing prices and real estate values and other risks and uncertainties, including those detailed in the Corporation's filings with the Securities and Exchange Commission. When we use words such as "believes", "expects", "anticipates", or similar expressions, we are making forward-looking statements. Union National undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.

Readers should carefully review the risk factors described in the Annual Report and other documents that we periodically file with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2008.

Critical Accounting Policies

The reporting of our financial condition and results of operations is impacted by the application of accounting policies by management, some of which are particularly sensitive and require significant judgments, estimates and assumptions to be made in matters that are inherently uncertain. These accounting policies, along with the disclosures presented in other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the consolidated financial statements. Management currently views the determination of the allowance for credit losses and the fair value of investment securities to be critical accounting policies.

Determination of the Allowance for Credit Losses The provision for credit losses and the level of the allowance for credit losses involve significant estimates by management. In evaluating the adequacy of the allowance for credit losses, management considers past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect borrowers ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant qualitative factors. While we use available information to make such evaluations, future adjustments to the allowance for credit losses and the provision for credit losses may be necessary if economic conditions or loan credit quality differ substantially from the factors and assumptions used in making the evaluation.

Fair Value of Investment Securities
All investments are carried at fair value with any unrealized gains and losses, considered to be temporary, reported net of tax as an adjustment to stockholders' equity. In order to determine whether unrealized losses in the fair value of investment securities are other-than-temporary (OTTI), management regularly reviews the entire portfolio of investment securities for possible impairment, analyzing factors including but not limited to the underlying creditworthiness of the issuing organization, the length of time for which the fair value of the investment securities has been less than cost, and independent analysts' opinions about circumstances that could affect the performance of the investment securities. In assessing potential OTTI for debt securities, other considerations include (1) whether management intends to sell the security, or
(2) if it is more likely than not that management will be required to sell the security before recovery, or (3) if management does not expect to recover the entire amortized cost basis. In assessing potential OTTI for equity securities, consideration is given to management's intention and ability to hold the securities until recovery of unrealized losses. After considering such factors, it is a matter of judgment on the part of management to make the determination of whether or not the decline in market value is other-than-temporary.

Federal Home Loan Bank ("FHLB") Stock Impairment Analysis Investment in FHLB stock is required for membership in the organization and is carried at cost since there is no market value available. The amount Union National is required to invest is dependent upon the relative size of outstanding borrowings it has with the FHLB. Excess stock is typically repurchased from Union National at par if the borrowings decline to a predetermined level. Throughout most of 2008, Union National earned a return or dividend on the amount invested. In late December 2008, the FHLB announced that it had suspended the payment of dividends and the repurchase of excess capital stock to preserve its capital level. That decision was based on FHLB's analysis and consideration of certain negative market trends and the impact those trends had on their financial condition. Based on the financial results of the FHLB for the year-ended December 31, 2008 and for the nine months ended September 30, 2009, management believes that the suspension of both the dividend payments and excess capital stock repurchase is temporary in nature. Management further believes that the FHLB will continue to be a primary source of wholesale liquidity for both short- and long-term funding and has concluded that its investment in FHLB stock is not other-than-temporarily impaired. Union National will continue to monitor the financial condition of the FHLB quarterly.

Financial Condition

Total assets increased by $15,592,000 or 3% to $500,701,000 at September 30, 2009 from $485,109,000 at December 31, 2008. The increase was primarily the result of strong retail deposit generation, which further strengthened Union National's liquidity position. The proceeds received from the deposit growth were used to purchase short-term investments. Total deposits grew by $31,385,000 or 8% to $414,962,000 at September 30, 2009 from $383,577,000 at December 31, 2008.

Investment Securities
Investment securities were $46,374,000 at September 30, 2009 as compared to $64,289,000 at December 31, 2008. All of Union National's investment securities were classified as available for sale at September 30, 2009 and December 31, 2008. Securities classified as available for sale are marketable equity securities, and those debt securities that we intend to hold for an indefinite period of time, but not necessarily to maturity. In addition to the investment portfolio generating interest income, it serves other primary financial management functions such as an ultimate source of liquidity and a tool to manage interest rate risk. In order to support these functions, we have designated our entire portfolio of investment securities as being available for sale. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in maturity mix of our assets and liabilities, liquidity needs, regulatory capital considerations, changes in the creditworthiness of the issuing entity, changes in investment strategy and portfolio mix, and other similar factors. Changes in unrealized gains or losses on available-for-sale securities, net of taxes, are recorded as other comprehensive income (loss), a component of stockholders' equity.

Union National purchases certain types of mortgage-backed and asset-backed securities to better position our investment portfolio for a subsequent increase or decrease in interest rates, as aligned with our interest rate risk position. These securities may be purchased at premiums or discounts, with short-, mid-, or long-term average expected lives or maturities. Overall yields on these securities will increase or decrease based on changes in prepayment speeds and subsequent cash flow reinvestments. Cash flows from these securities and changes in market interest rates are considered in our net interest income simulation model (see related discussion titled Market Risk - Interest Rate Risk on page 40).

Union National sold $183,337,000 of investment securities and recognized $1,791,000 in net gains, and purchased $185,007,000 of investment securities in 2009. We periodically assess the strategy of selling mortgage-backed securities and other available for sale securities. Investment security purchases and sales generally occur to manage the Bank's liquidity requirements, pledging requirements, interest rate risk, and to enhance our net interest margin. We regularly evaluate our available-for-sale portfolio for possible opportunities to increase earnings through potential investment security sales or portfolio repositioning. Investment securities (including some short-term investments) carried at $58,858,000 at September 30, 2009, and $59,646,000 at December 31, 2008 were pledged to secure public, trust, and government deposits and for other purposes.

In addition to the credit risk present in the loan portfolio, we also have credit risk associated with our investment security holdings. Based on recent national economic trends and other factors, we have increased our monitoring of our non-agency mortgage-backed securities and corporate debt securities and changes in their credit ratings as published by national statistical rating organizations.

As of September 30, 2009 and December 31, 2008, Union National had a portfolio of investment securities as follows (in thousands):

                                                  September 30,       December 31,
                                                      2009                2008
   Market Value of Debt Securities               $        46,290     $       64,083
   Market Value of Equity Securities                          84                206
   Total Market Value of Investment Securities   $        46,374     $       64,289

Debt securities include government agencies, mortgage-backed securities, collateralized mortgage obligations and corporate securities. At September 30, 2009, there were nine debt securities with unrealized losses of $139,000 that amounted to 0.7% of their amortized cost, as compared to December 31, 2008, when there were twenty-three debt securities with unrealized losses of $607,000 that amounted to 3.2% of their amortized cost. We believe that the unrealized losses reflect temporary declines primarily due to changes in interest rates subsequent to the acquisition of specific securities. These temporary declines in investment securities' fair value below amortized cost have been provided for in other comprehensive income (loss).

Equity securities held are comprised primarily of common stock holdings in other financial institutions. The market values include net unrealized gains of $1,000 as of September 30, 2009 as compared to net unrealized losses of $21,000 as of December 31, 2008. Union National sold $105,000 of these equity securities in 2009 and recognized losses of $39,000.

As of September 30, 2009, $14,000 of the fair value of total investment securities were measured using Level 1 inputs as defined by fair value measurement and disclosure guidance, $42,928,000 or 93% of the fair value were measured using Level 2 inputs, and $3,432,000 or 7% of the fair value were measured using Level 3 inputs (see definitions and related discussion in Note 10 to the consolidated financial statements).

The fair value of Level 3 investment securities decreased to $3,432,000 at September 30, 2009 from $4,437,000 at December 31, 2008. Of the decrease in value, $1,471,000 was related to impairment charges that were included in net income and $555,000 was related to principal and interest payments received (net of accretion), which were fully applied to principal, offset by $1,021,000 of unrealized gains (with a corresponding after-tax increase to stockholders' equity of $674,000 recorded as other comprehensive income).

In order to determine whether unrealized losses in the fair value of investment securities are other-than-temporary, management regularly reviews the entire portfolio of investment securities for possible impairment, analyzing factors including but not limited to the underlying creditworthiness of the issuing organization, the length of time for which the fair value of the investment securities has been less than cost, and independent analysts' opinions about circumstances that could affect the performance of the investment securities. In assessing potential OTTI for debt securities, other considerations include (i) whether management intends to sell the security, or (ii) if it is more likely than not that management will be required to sell the security before recovery, or (iii) if management does not expect to recover the entire amortized cost basis. In assessing potential OTTI for equity securities, consideration is given to management's intention and ability to hold the securities until recovery of unrealized losses.

As of September 30, 2009, Union National maintains five investment securities with recorded impairments. The fair value of the five impaired investments is $3,432,000 at of September 30, 2009, as compared to an original amortized cost of $8,950,000. All payments received on impaired investment securities are fully applied to principal.

ASC Topic 320, "Investments - Debt and Equity Securities" provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with fair value measurement and disclosure guidance. Further, fair value measurement and disclosure guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly, and the Corporation must evaluate the weight of evidence to determine whether the transactions are orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

As discussed in Note 12 to the consolidated financial statements, the fair value of these investment securities was determined by calculating the net present value of the expected future cash flows of each security, with qualitative risk-adjusted discounting for potential credit risks and nonperformance in the underlying issuers, and market sector illiquidity concerns. Under ASC Topic 320, "Investments - Debt and Equity Securities" when an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable. Management's judgment was that, as of September 30, 2009, the facts and circumstances indicated significant illiquidity and an inactive market for these types of investments when other relevant observable inputs were not available; therefore, expected cash flows were a reasonable basis in determining the fair value of the corporate investment securities. Prior to September 30, 2008, management used other observable inputs to determine the fair value of the corporate investment securities including broker indicated prices and quoted prices in limited trading activity of the issuances.

During the first nine months of 2009, four of the Bank's five private-issuer securities were downgraded to below investment grade. The fifth private-issuer security was downgraded to below-investment-grade in December 2008. Accordingly, the Bank recorded $1,471,000 of other-than-temporary impairment charges in the first nine months of 2009 including (i) $859,000 related to three pooled trust-preferred debt securities supported primarily by obligations from other banks, and (ii) $612,000 related to a mortgage-backed security not guaranteed by the U.S. government. Management determined that, due to severe illiquidity and distress in the financial markets, the unrealized declines in the value of these investments were other-than-temporary, requiring the write-down. For the securities with impairment charges recorded, interest income payments received subsequent to impairment are fully applied to principal further reducing the amortized cost of these investments. (See Note 5 to the unaudited consolidated financial statements.)

Management determined that further impairments as of September 30, 2009 were not warranted on these five securities based upon the following considerations:

· The financial condition and near-term prospects of the issuers reflect only one probable default, which was fully considered when determining the other-than-temporary impairment of the respective security.

· Four of the five impaired investment securities were current, as of September 30, 2009, for scheduled investment interest payments, and principal repayments for the two private issuer mortgage-backed securities, have occurred regularly since issuance. Based upon the information reviewed by management in preparing the financial statements, the financial condition and near-term prospects of the issuers do not reflect any specific events which may have influenced the operations of the issuers, such as changes in technology or a discontinuance of a business segment, that may have further impaired the earnings potential of the investments.

· The securities experienced very limited trading activity during the last 12 months being in a market sector with a high degree of illiquidity and dislocation; therefore, determining fair value based upon discounted cash flows is considered reasonable.

· Management does not intend to sell the securities, and it is not likely that management will be required to sell the securities before recovery, and though management does not expect to recover the amortized cost of the securities, management expects to hold the securities until a reasonable recovery towards the current carrying value.

Loans and Leases, Credit Quality and Credit Risk Loans and leases at September 30, 2009 were $342,506,000 as compared to $358,280,000 at December 31, 2008. Outstanding loans decreased by $15,774,000 from December 31, 2008 to September 30, 2009 due to (i) reduced loan demand from creditworthy borrowers, and (ii) the impact of nearly $10 million of loan participations sold for capital and risk management purposes. Union National continues to focus lending on creditworthy consumers and businesses, with necessary consideration given to increased credit risks posed by the weak economy and the housing market. The economy and housing market, and increased unemployment, has affected some of Union National's borrowers, resulting in increased nonperforming loans and credit losses.

Allowance for Credit Losses. The allowance for credit losses is maintained at a level believed adequate by management to absorb estimated probable loan and lease losses. Management is responsible for the adequacy of the allowance for credit losses, which is formally reviewed by management on a quarterly basis. The allowance is increased by provisions charged against net interest income and reduced by net charge-offs. Our evaluation of the adequacy of the allowance is based on our past loan and lease loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant qualitative factors. While we use available information to make such evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, review our allowance for credit losses. Such agencies may require us to recognize additions to the allowance based on their judgment of information available to them at the time of their examination. We determined that no adjustment to the allowance for credit losses was necessary as a result of the Office of the Comptroller of the Currency's ("OCC's") most recent examination.

The allowance for credit losses is evaluated based on an assessment of the losses inherent in the loan and lease portfolio. This assessment results in an allowance that consists of specific, general and unallocated components. The specific component relates to loans and leases that are classified as impaired. For such loans and leases, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan or lease is lower than the carrying value. The general component covers all other loans and leases, including criticized loans that are not impaired, and is based on historical loss experience adjusted for qualitative factors. Separate qualitative adjustments are made for higher-risk criticized loans that are not impaired. An unallocated component is maintained to cover uncertainties that could affect our estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Union National continues to closely monitor the loan portfolio, and the underlying borrower financial performance and collateral values, identifying credit concerns and risks, including those resulting from the current weak economy. Future adjustments may be necessary to the allowance for credit losses, and consequently the provision for credit losses, if economic conditions or loan credit quality differ substantially from the assumptions we used in making our evaluation of the level of the allowance as compared to the balance of outstanding loans and leases. The allowance for credit losses was $4,798,000 at September 30, 2009, as compared to $4,358,000 at December 31, 2008. The provision for credit losses for the three and nine months ended September 30, 2009, was significantly higher than the provision for credit losses for the same periods in 2008 (see related discussion on Provision for Credit Losses on pages 29 and 32) given the increased credit risks in the loan portfolio, including those resulting from the current weak economy and real estate markets, and due to loan charge-offs being significantly higher for the three and nine months ended September 30, 2009, as compared to the same periods in 2008. A provision for credit losses of $1,446,000 was made for the first nine months of 2009. With the higher provision exceeding net loan charge-offs of $1,006,000 for the first nine months of 2009, the allowance for credit losses increased to 1.40% of loans at September 30, 2009 as compared to 1.22% of loans at December 31, 2008. Management believes, based on information currently available, that the allowance for credit losses as of September 30, 2009 of $4,798,000 is adequate to meet potential credit losses.

The following table summarizes the changes in the allowance for credit losses for of the three and nine months ended September 30, 2009 and 2008 (dollars in thousands):

                                             Three Months Ended           Nine Months Ended
                                                September 30,               September 30,
                                             2009          2008          2009          2008
Allowance for Credit Losses, Beginning
of Period                                  $   4,364     $   3,831     $   4,358     $   3,675
Charge-Offs                                     (132 )           -        (1,065 )        (134 )
Recoveries                                        44             8            59            19
Net (Charge-Offs) Recoveries                     (88 )           8        (1,006 )        (115 )
Addition to Provision for Credit Losses          522            47         1,446           326
Allowance for Credit Losses, End of
Period                                     $   4,798     $   3,886     $   4,798     $   3,886

Loans and Leases - Average                 $ 351,446     $ 376,415     $ 352,401     $ 370,380

Gross Loans and Leases - Actual                                        $ 342,506     $ 370,549

Ratio of Gross Loans and Leases Charged
Off to Average Loans and Leases
(Annualized)                                    0.15 %        0.00 %        0.40 %        0.05 %

Ratio of Allowance for Credit Losses to
Gross Loans and Leases                                                      1.40 %        1.05 %

Impaired Loans. Other than as described herein, we do not believe there are any trends, events or uncertainties that are reasonably expected to have a material impact on our loan and lease portfolio to affect future results of operations, liquidity or capital resources. However, based on known information, we believe that the effects of current and past economic conditions and other unfavorable . . .