FIRST NATIONAL COMMUNITY BANCORP INC – 10-K/A – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Edgar Online, Inc.

 Management's discussion and analysis represents an overview of the financial condition and results of operations and should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report and Risk Factors detailed in Item 1A of Part I of this report.    

We are in the business of providing customary retail and commercial banking services to individuals and businesses. Our core market is northeastern Pennsylvania.

    FORWARD-LOOKING STATEMENTS    The Company may from time to time make written or oral "forward-looking statements," including statements contained in the Company's filings with the SEC (including this Amendment and the exhibits hereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995.    These forward-looking statements include statements with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Company's control).  The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements.  The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in the Company's markets; the effects of, and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services; the impact of the Company's ability to comply with its regulatory agreements and orders; the effectiveness of the Company's revised system of internal controls; the ability of the Company to attract additional capital investment; the impact of changes in financial services' laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; acquisitions; changes in consumer spending and saving habits; the nature, extent, and timing of governmental actions and reforms, and the success of the Company at managing the risks involved in the foregoing.    The Company cautions that the foregoing list of important factors is not exclusive.  Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management's analysis only as of the date of this report, even if subsequently made available by the Company on its website or otherwise.  The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company to reflect events or circumstances occurring after the date of this report.    

CRITICAL ACCOUNTING POLICIES

    In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods indicated.  Actual results could differ significantly from those estimates.    The Company's accounting policies are fundamental to understanding management's discussion and analysis of its financial condition and results of operations. The Company's significant accounting policies are presented in Note 2 to the consolidated financial statements.  Management has identified the policies on the Allowance for Loan and Lease Losses ("ALLL"), securities valuation, goodwill and other intangible assets and income taxes to be critical as management is required to make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available.    The judgments used by management in applying the critical accounting policies discussed below may be affected by a further and prolonged deterioration in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in the Company's investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to further impairment losses.    

In connection with regulatory reviews of the Company's operations, financial statements and SEC filings, the Company determined that certain of its accounting and reporting policies did not conform to U.S. GAAP and were not being applied properly or should otherwise be revised. During 2009 and as reflected in this Amendment, the Company made the following changes to its accounting and reporting policies:

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    †          In its preparation of the financial statements included in the Original Report, the Company did not properly formulate and evaluate its ALLL as a result of the timing of charge-offs and the recognition of TDRs.  In determining the ALLL included in the Original Report, the Company increased the specific reserve component of the ALLL when it determined a loan had impairment rather than timely recognizing the loss and reducing the reserve.  As reflected in this Amendment, the Company changed its ALLL policy to timely recognize charge-offs in the appropriate accounting period.  As revised, when a loan is determined to be impaired and collection of the entire amount of the loan is unlikely, the loan is charged off or charged down to the fair market value of the collateral, thus reducing the carrying value of the loan and the ALLL.  The change in policy led to an increase in the provision for loan and lease losses in the Original Report of $32.0 million to a provision of $42.1 million in this Amendment.  Additionally, the general reserve component of the ALLL, previously based on one aggregated pool of unimpaired loans, was increased after assigning these loans to one of three pools of "Pass", "Special Mention" or "Accruing and Substandard" and applying historical loss factors and varied qualitative factor basis point allocations based on the risk profile in each pool to determine the appropriate reserve related to those loans.  The general reserve component of the ALLL also increased because of higher historical loss experience resulting from the increased loan charge-offs of impaired loans.    As a result of the change in ALLL policy reflected herein, the ALLL, which was $22.5 million in the Original Report and was comprised of a specific reserve of $12.4 million and a general reserve of $10.1 million, was restated to reduce the ALLL by charging off an additional $10.2 million in loans and recording an additional provision for loan and lease losses of $10.1 million. The change reallocated the reserve by reducing the specific reserves by $8.4 million, from $12.4 million to $4.0 million.  Included in the $4.0 million specific reserve allocation is $2.0 million in reserve for TDR impairments which were not previously identified by the Company.  The addition of the risk pools, along with higher historical loss experience as a result of increased charge-offs, resulted in the general reserves increasing by $8.4 million, from $10.1 to $18.5 million.  As a result the restated ALLL was $22.5 million.    †          In connection with determining the appropriate ALLL, the Company also revised its loan impairment measurement process.  In the Original Report, the Company employed a policy of impairing or charging off impaired collateral-dependent loans upon receipt of a certified appraisal of the collateral and only used alternative valuation sources for the purposes of writing down loans if the receipt of a certified appraisal was significantly delayed, the timing of receipt was uncertain and an alternative methodology could be derived that produced logical results such as an available appraisal for a similar property in a similar location.  As a result of input received from the Company's regulators, the Company revised its valuation policy to record downward adjustments on impaired collateral-dependent loans based on a variety of valuation sources, including, but not limited to, certified appraisals, broker price opinions, letters of intent and executed sale agreements.    Additional loan charge-offs reflected in this report resulted from the change in policy to timely recognize charge-offs in the appropriate accounting period.  As a result of this change in policy, this report reflects an additional $10.2 million of loan charge-offs from the amount of charge-offs reflected in the Original Report.    The Company also determined that it had calculated its provision for off-balance sheet commitments incorrectly in the Original Report.  The reserve for off-balance sheet commitments was previously calculated using all commitments and assumed these commitments would be fully funded.  This methodology was revised to provide a reserve on letters of credit and construction commitments. The Company also performs individual analyses on the aforementioned commitments to borrowers considered to be impaired. As a result, the Company reduced the related liability by $1.0 million.    †          The Company also revised its policy for determining and calculating the value of the pooled trust preferred collateralized debt obligations securities ("PreTSLs") in its securities portfolio and the amount of related credit impairment to employ more severe assumptions. In changing the methodology, the Company adopted a policy that is more consistent with those used by other market participants and that uses the same approach to value all of the PreTSLs in the Company's portfolio. In the Original Report, the Company had assumed that 50% of issuers who had deferred payments would recover, including by paying previously deferred amounts, within two years of deferral. However, as reflected in this Amendment, the Company changed its policy to cause to be produced cash flow models for each security that assumes all deferring issuers default immediately, with no recovery assumed. The Company did not change its policy with respect to defaulted securities: credit impairment in the Original Report and in this Amendment both reflect the assumption that defaulted issuers default immediately with no recovery. As reflected in the Original Report, the Company had not determined whether factors, other than existing deferrals or defaults, indicated that an impairment loss had been incurred with respect to performing issuers, but rather, it had assumed a 0.375% default rate for all securities and relied on market data provided by a third party. As reflected in this Amendment, we changed our policy to evaluate each bank issuer based upon its financial trends, such as earnings, net interest margin, operating efficiency, liquidity, capital position, level of non-performing loans to total loans, apparent sufficiency of loan loss reserves, Texas ratio and whether the issuer received TARP monies. Based on this analysis of historical experience and assumptions of future events for each bank issuer, we developed annual expected default rates specific to each bank issuer rather than using the same expected default rate of 0.375% for each issuer. Furthermore, we had previously relied on two outside service providers, including a third party who sold us the PreTSLs included in its securities portfolio to provide us with fair values for our                                           29 

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    PreTSLs.However, under our revised methodology, fair value was calculated by a third party valuation service unaffiliated with the PreTSLs based on our estimates of future cash flows and the assumption that an investor would require a 15% return on investment for PreTSL XIX and PreTSL XXVI and a 20% return on investment for the remaining PreTSLs to be willing to purchase the cash flows. This change in methodology resulted in an additional impairment charge to earnings of $8.7 million.    The Company recognized additional other than temporary impairment ("OTTI") charges of $4.9 million on PreTSL securities the issuers of which defaulted or deferred payments between the first quarter of 2010 and the date of this Amendment, after the Company reviewed its subsequent events analysis and determined that these events reflected issuer credit impairments that existed as of the fourth quarter of 2009. Also, as a result of its subsequent events analysis, the Company recognized additional OTTI of $800 thousand in the fourth quarter of 2009 on its PLCMOs.    †          In the Original Report, the Company accounted for loan fees and costs inconsistently across loan types.  The Company engaged a third party to review its methodology, assist in the calculation of the actual deferred fees and costs and the applicable amortization period and to provide a consistent approach. This analysis has been incorporated into the Company's methodology.  This change in methodology resulted in an additional deferral of $497 thousand.    

Allowance for Loan and Lease Losses

    The ALLL represents management's estimate of probable loan losses inherent in the loan portfolio.  Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on qualitative factors and historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Various banking regulators, as an integral part of their examination of the Company, also review the ALLL.  Such regulators may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL.  Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio.    As previously noted, the Company changed its policy for determining the ALLL effective for 2009.  The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired.  For such loans an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers loans that are performing as agreed and is based on historical loss experience adjusted by qualitative factors.  The general reserve component of the ALLL, previously based on one aggregated pool of unimpaired loans, was increased after assigning these loans to one of three pools of "Pass", "Special Mention" or "Accruing and Substandard" and applying historical loss factors and varied qualitative factor basis point allocations based on the risk profile in each pool to determine the appropriate reserve related to those loans.  The general reserve component of the ALLL also increased because of higher historical loss experience resulting from the increased loan charge-offs of impaired loans.    Securities Valuation    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 or models using inputs that are observable, either directly or indirectly (level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of observable inputs or if markets are illiquid, valuation techniques would be used to determine fair value of any investments that require inputs that are both unobservable and significant to the fair value measurement (level 3).  For level 3 inputs, 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.  See Note 5 of the consolidated financial statements included in Item 8 hereof for more details on our securities valuation techniques.    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 OTTI. The analysis of OTTI 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, any credit deterioration of the investment, whether management intends to sell the security, and whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. As a result of our adoption of new authoritative guidance under Accounting Standards Codification ("ASC") Topic 320, "Investments-Debt and Equity Securities" on June 30, 2009, debt investment securities deemed to be OTTI are written down by the impairment related to the estimated credit loss and the non-credit related impairment is recognized in other comprehensive income. Prior to the adoption of the new authoritative guidance and unchanged for equity securities, if the decline in value of an investment was deemed to be other-than-temporary, the investment was written down to fair value and a non-cash impairment charge was recognized in the period of such evaluation. 

The

 Company recognized OTTI charges on securities of $20.6 million, $0, and $ 0 in 2009, 2008, and 2007, respectively, within the net OTTI losses on securities on the consolidated statements of operations. For 2009, the OTTI charges relate mainly to estimated credit losses on pooled trust preferred securities. See - "Securities" section below and Note 18 Fair Value Measurements to the consolidated financial statements for additional analysis of our OTTI charges.                                           30 

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Goodwill and Intangible Assets

    The Company records all assets, liabilities, and non-controlling interests in the acquiree in purchase acquisitions, including goodwill and other intangible assets, at fair value as of the acquisition date, and expenses all acquisition related costs as incurred as required by ASC Topic 805, "Business Combination." Goodwill is not amortized but is subject to annual tests for impairment or more often if events or circumstances indicate it may be impaired. Other intangible assets are amortized over their estimated useful lives and are subject to impairment tests if events or circumstances indicate a possible inability to realize the carrying amount. The initial recording of goodwill and other intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets.    On an annual basis, the Company evaluates whether circumstances are present that would indicate potential impairment of its goodwill. These circumstances include the trading value of the Company's common shares relative to its book value, adverse changes in the business or legal climate, actions by regulators, or loss of key personnel.  When the Company determines that these or other circumstances are present, the Company tests the carrying value of goodwill for impairment at an interim date.    The goodwill impairment test is performed in two phases. The first step compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, an additional procedure must be performed.    In the second step, the Company calculates the implied value of goodwill by simulating a business combination for each reporting unit. This step subtracts the estimated fair value of net assets in the reporting unit from the step one estimated fair value to determine the implied value of goodwill. If the implied value of goodwill exceeds the carrying value of goodwill allocated to the reporting unit, goodwill is not impaired, but if the implied value of goodwill is less than the carrying value of the goodwill allocated to the reporting unit, a goodwill impairment charge for the difference is recognized in the consolidated statement of operations with a corresponding reduction to goodwill on the consolidated balance sheet.    In performing its evaluation of goodwill impairment, the Company makes significant judgments, particularly with respect to estimating the fair value of each reporting unit and if the second step test is required, estimating the fair value of net assets. The Company utilizes a third-party specialist who assists with valuation techniques to evaluate each reporting unit and estimate a fair value as though it were an acquirer. The estimates utilize historical data, cash flows, and market and industry data. Industry and market data is used to develop material assumptions such as transaction multiples, required rates of return, control premiums, transaction costs and synergies of a transaction, and capitalization.    

The step two test resulted in $8.1 million of impairment, which eliminated goodwill as of December 31, 2009. Our 2009 net income was also reduced by $8.1 million as a result of the impairment.

    Intangible assets which are subject to amortization include core deposit intangible assets related to the Bank's Honesdale branch acquisition during November 2006 and $2.6 million of mortgage servicing rights related to loans originated by the Bank and sold in the secondary market where servicing rights have been retained.  These assets subject to amortization are reviewed by management at least annually for potential impairment and whenever events or circumstances indicate that carrying amounts may not be recoverable.    Fair value may be determined using: market prices, comparison to similar assets, market multiples, discounted cash flow analyses and other determinants. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates, terminal values and specific industry or market sector conditions.    Income Taxes    The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity's financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated financial condition or results of operations.    We record income tax expense based on the amount of tax currently payable or receivable and the change in deferred tax assets and liabilities.  Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes.  We conduct quarterly assessments of all available evidence to determine the amount of deferred tax assets that are more-likely-than-not to be realized.  The available evidence used in connection with these assessments includes taxable income in current and prior periods, cumulative losses in prior periods, projected future taxable income, potential tax-planning strategies, and projected future reversals of deferred tax items.  These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.                                           31 

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    In connection with determining our income tax provision, the Company considers maintaining liabilities for uncertain tax positions and tax strategies that management believes contain an element of uncertainty. Periodically, the Company evaluates each of our tax positions and strategies to determine whether the liability for uncertain tax benefits continues to be appropriate. Notes 2 and 13 to the consolidated financial statements include additional discussion on the accounting for income taxes.    

New Authoritative Accounting Guidance

    On July 1, 2009, the ASC became the FASB's officially recognized source of authoritative U.S. GAAP applicable to all public and non-public non-governmental entities, superseding all existing FASB, American Institute of Certified Public Accountants ("AICPA"), Emerging Issues Task Force ("EITF") and related literature. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative guidance for SEC registrants. All other accounting literature is considered non-authoritative. The issuance of the ASC affects the way companies refer to U.S. GAAP in financial statements and other disclosures. See Note 2 of the consolidated financial statements for a description of recent accounting pronouncements including the dates of adoption and the effect on the results of operations and financial condition.    SUMMARY OF PERFORMANCE   

The Company reported a net loss of $44.3 million in 2009 compared to $15.1 million in net income for fiscal year 2008. Basic earnings/(loss) per share decreased from the $0.95 per share reported in 2008 to $(2.74) in 2009.

    The deterioration in general economic conditions and declining real estate values severely impacted borrowers' ability to make scheduled payments on their loans, resulting in the Company recording $42.1 million of provision for loan and lease losses to state the ALLL at the amount the Company believes is adequate to absorb probable loan losses. Other key items contributing to the 2009 results included OTTI losses incurred on investment securities totaling $20.6 million, a goodwill impairment charge of $8.1 million, a $5.4 million increase in operating expenses which includes a $2.1 million increase in FDIC insurance premiums and a $1.3 million increase in the expenses of other real estate owned.   

The Company's return on assets for the years ended December 31, 2009 and 2008 was (3.29)%, and 1.17%, respectively while the return on average equity was (47.78)% and 14.35%, respectively.

   Goodwill Impairment    In connection with the purchase of the Honesdale branch during 2006, the Company acquired intangible assets of $9.8 million. Of that amount, $1.7 million results from core deposit premium subject to periodic amortization over the useful life of 10 years. Goodwill of $8.1 million, which is not subject to amortization, arose in connection with the acquisition.  In response to the significant loss reported by the Company in 2009 and the reduction in the market capitalization of the Company's common shares, the Company's goodwill was evaluated for impairment as of December 31, 2009.  The analysis included a combination of a market approach based analysis of comparable transactions, change of control premium to peer market price approach, a discounted cash flow analysis of the potential dividends of the company and the assessment of the fair value of the Company's balance sheet as of the measurement date. As a result of the analysis, the $8.1 million was charged off as of December 31, 2009.    

The following table displays the changes in the carrying amount of goodwill during the period (in thousands):

                                                   Accumulated                                    Goodwill     Impairment Balance as of January1, 2009      $    8,134   $           -  Impairment write-off                  (8,134 )        (8,134 )

Balance as of December 31, 2009 $ - $ (8,134 )

    Net Interest Income    Net interest income consists of interest income and fees on interest-earning assets less interest expense on deposits and borrowed funds.  It represents the largest component of the Company's operating income and as such is the primary determinant of profitability. The net interest margin on a fully tax equivalent basis is calculated by dividing tax equivalent net interest income by average interest earning assets and is a key measurement used in the banking industry to measure income from earning assets. The net interest margin was 3.44 % for the year ended December 31, 2009, a decrease of 15 basis points compared to the same period in 2008.  This decrease in net interest margin was due to a 17% increase in non-earning assets.  Rate spread, the difference between the average yield on                                           32 

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    interest earning assets and the average cost of interest bearing liabilities shown on a fully tax equivalent basis was 3.28% for 2009, a decrease of 2 basis points versus 2008.  Management was able to maintain the rate spread by altering the balance and mix of interest earning assets and interest bearing liabilities to offset the changes in their corresponding interest yields and costs. However, the Company cannot guarantee that these actions and other asset/liability management strategies will prevent future declines in rate spread, net interest margin or net interest income.    Net interest income on a tax equivalent basis, decreased $374 thousand to $43.1 million for 2009 compared with $43.5 million for 2008. During 2009, an 87 basis point decline in interest rates paid on average interest bearing liabilities and higher loan balances positively impacted our net interest income, but were offset by a 112 basis point decline in the yield on average loans and investments and higher average interest bearing liabilities as compared to 2008. After reducing the Federal Funds rate throughout 2008, the Federal Reserve kept interest rates stable during 2009 leaving the Federal Funds rate at an historic low of 25 basis points. Because the Company's floating rate loans are largely indexed to the national prime rate they reset lower as the prime rate followed the Federal Funds rate lower in 2008. Many of these loans are now at their floors and will remain there until the prime rate moves up enough for their rates to move above their floors. In addition, most of the time deposits in the Company's funding portfolio matured and renewed at lower market rates in 2009.    Average loans totaling $938.3 million for the year ended December 31, 2009 increased $11.5 million or 1.25% in 2009 compared to the same period for 2008 primarily due to organic loan growth of $35.3 million in installment indirect auto loans, partly offset by a net decrease of $21.2 million in commercial loans. Interest income on a tax equivalent basis for loans decreased $7.4 million due to an 86 basis point decrease in average loan yield as loan rates reset lower and new business was originated at lower market rates compared with the same period in 2008, despite an increase of $612 thousand due to loan volumes. Average investment securities totaling $275.4 million declined $7.1 million or 2.5 percent in 2009 compared to the same period in 2008. Interest income on a tax equivalent basis for investment securities decreased $1.2 million primarily due to reinvestment of pay downs and maturities into more liquid lower yielding securities and the loss of dividends on stock in the Federal Home Loan Bank of Pittsburgh. Average federal funds sold increased $38.1 million as the Company increased its holdings of liquid assets.  Interest income on federal funds sold increased $86 thousand as the increase in volume more than offset the 142 basis point decline in yield earned.    The interest income that would have been earned on nonaccrual and restructured loans outstanding at December 31, 2009, 2008 and 2007 in accordance with their original terms approximated $4.1 million, $1.1 million and $227 thousand, respectively.  Interest income on impaired loans of $1 thousand, $166 thousand and $0 was recognized for cash payments received in 2009, 2008 and 2007, respectively.    Average interest bearing liabilities totaled $1.2 billion for the year ended December 31, 2009 an increase of $67.2 million or 6.2% during 2009 compared to the same period in 2008 primarily due to increases in interest bearing demand deposits of $24.1 million or 8.3%, increases in time deposits over $100 thousand of $76.1 million or 41.7% and savings deposits increases of $6.8 million or 9.1%.  These increases were partly offset by a decrease in other time deposits of $37.6 million or 12.1%. The cost of interest-bearing demand deposits, savings deposits, time deposits over $100 thousand, and other time deposits decreased 21, 20, 167, and 87 basis points respectively, from the same period in 2008. Average borrowed funds and other interest-bearing liabilities totaled $235.6 million for the year ended December 31, 2009 a decrease of $2.1 million or 1% compared to 2008.    In 2008, tax-equivalent net interest income improved $1.3 million, or 3.2%, when compared to the prior year. Growth of the balance sheet, effective asset-liability management strategies and the positive impact due to re-pricing all contributed to earnings improvement.    Average loans outstanding increased $39.4 million, or 4.4% in 2008 compared to 2007. The average yield earned on the loan portfolio decreased one hundred twenty one basis points as a result of the Federal Reserve monetary policy which reduced the prime interest rate by 4% to help a struggling economy. This strategy had a significant impact on our variable rate loans, resulting in an $8.2 million decrease in income earned on total loans. Commercial loans were most severely impacted by the lower interest rate environment due to the high volume of variable rate credits. Interest income decreased $9.1 million on this group of loans in spite of a $23.8 million increase in average loans outstanding. Included in this total is over $16 million of commercial loan balances which were transferred to nonaccrual status during 2008, and this transfer combined with balances previously placed in this non-earning category, resulted in a $1.2 million loss of earnings on those assets. Retail loans outstanding grew $15.7 million on average due primarily to a $9.8 million increase in average indirect auto loans. Earnings on retail loans improved $946 thousand when compared to 2007.    Average securities decreased $3.4 million in 2008 as liquidity was utilized to fund loan growth. Investment in higher yielding mortgage-back securities and tax- free municipal bonds led to a fourteen basis point improvement in the yield earned which resulted in an additional $206 thousand of interest income over the prior year. Money market balances were limited to $717 thousand on average as funds were utilized in higher earning assets. Earnings on this category of assets decreased $16 thousand in 2008 due to the lower interest rate environment.                                           33 

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    Average interest-bearing deposit balances decreased $17.5 million in 2008 due to certificate of deposit maturities that were not replaced. Interest-bearing demand deposits decreased $3.9 million during the year due to activity in large commercial accounts and municipal relationships while average savings deposits increased $2.9 million. Average time deposits decreased $16.5 million as many customers withdrew funds as interest rates paid on certificates of deposit decreased. The average cost of interest-bearing deposits decreased 1.10% from the 2007 rate which helped to offset the earnings lost on assets. Average borrowed funds outstanding increased $60.1 million in 2008 to offset the deposits lost, and the average rate paid on these borrowings was ninety eight basis points lower than the rate paid in 2007.    Overall, an increase in interest-earning assets combined with a fourteen basis point increase in the spread earned resulted in the $1.3 million increase in tax-equivalent net interest income. The net interest margin remained stable at 3.59%. Investment leveraging transactions continued to add to the profitability of the company in 2008, contributing almost $1.4 million to pre-tax earnings, but the average spread earned on the transactions was 1.69% which negatively impacted the net interest margin.    

The following table reflects the components of net interest income for each of the three years ended December 31, 2009, 2008 and 2007:

        Analysis of Average Assets, Liabilities and Shareholders' Equity and Net                    Interest Income on a Tax-Equivalent Basis                                 (in thousands) (1)                                     December 31, 2009                                    (as restated)                       December 31, 2008                     December 31, 2007                                        Interest     Average                  Interest    Average                   Interest    Average                            Average      Income/    Interest      Average      Income/    Interest      Average      Income/    Interest                            Balance      Expense      Rate        Balance      Expense      Rate        Balance      Expense      Rate ASSETS: Earning Assets:(2) Commercial loans-taxable            $   640,241   $  33,945       5.30 %  $   664,333   $  42,523       6.40 %  $   650,679   $  52,276       8.03 % Commercial loans-tax free                          51,206       3,520       6.87 %       48,325       3,494       7.23 %       38,229       2,874       7.52 % Mortgage loans                34,369       2,576       7.50 %       36,890       2,619       7.10 %       34,695       2,352       6.78 % Installment loans            212,501      12,494       5.88 %      177,228      11,253       6.35 %      163,729      10,574       6.46 % Total Loans(1)(2)            938,317      52,535       5.60 %      926,776      59,889       6.46 %      887,332      68,076       7.67 % Securities-taxable           161,094       7,759       4.82 %      194,162      11,020       5.68 %      211,139      11,446       5.42 % Securities-tax free          114,298       7,883       6.90 %       88,376       5,774       6.53 %       74,817       5,142       6.87 % Total Securities(1)(3)       275,392      15,642       5.68 %      282,538      16,794       5.94 %      285,956      16,588       5.80 % Interest-bearing deposits with banks                0           0       0.00 %            0           0       0.00 %            0           0       0.00 % Federal funds sold            38,863          98       0.25 %          717          12       1.67 %          544          28       5.15 % Total Money Market Assets                        38,863          98       0.25 %          717          12       1.67 %          544          28       5.15 % Total Earning Assets       1,252,572      68,275       5.45 %    1,210,031      76,695       6.34 %    1,173,832      84,692       7.22 % Non-earning assets           106,360                                90,921                                81,529 Allowance for loan and lease losses                 (12,770 )                              (6,861 )                              (8,357 ) Total Assets             $ 1,346,162                           $ 1,294,091                           $ 1,247,004  LIABILITIES AND SHAREHOLDERS' EQUITY: Interest-Bearing Liabilities: Interest-bearing demand deposits          $   312,285   $   3,725       1.19 %  $   288,226   $   4,025       1.40 %  $   292,134   $   8,064       2.76 % Savings deposits              81,149         589       0.73 %       74,349         692       0.93 %       71,444         868       1.21 % Time deposits over $100,000                     258,275       5,097       1.97 %      182,205       6,633       3.64 %      193,834       9,271       4.78 % Other time deposits          272,001       8,010       2.94 %      309,585      12,240       3.95 %      314,469      15,413       4.90 % Total Interest-Bearing Deposits                     923,710      17,421       1.89 %      854,365      23,590       2.76 %      871,881      33,616       3.86 % Interest-bearing liabilities                  235,559       7,775       3.30 %      237,631       9,652       4.06 %      177,537       8,956       5.04 % Total Interest-Bearing Liabilities                1,159,269      25,196       2.17 %    1,091,996      33,242       3.04 %    1,049,418      42,572       4.06 % Demand deposits               81,081                                81,772                                80,515 Other liabilities             13,070                                15,194                                14,429 Shareholders' equity          92,742                               105,129                               102,642 Total Liabilities and Shareholders' Equity     $ 1,346,162                           $ 1,294,091                           $ 1,247,004  Net Interest Income/Interest Rate Spread (4)                             $  43,079       3.28 %                $  43,453       3.30 %                $  42,120       3.16 % Net Interest Margin (5)                                                    3.44 %                                3.59 %                                3.59 %                                            34 

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(1) Interest income is presented on a tax equivalent basis using a 34% tax rate for 2009 and a 35% tax rate for 2008 and 2007.

(2) Loans are stated net of unearned income and exclude non-performing loans.

(3) The yield for securities that are classified as available for sale is based on the average historical amortized cost.

  (4) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.  

(5) Net interest income as a percentage of total average interest earning assets.

    Rate Volume Analysis    The most significant impact on net income between periods is derived from the interaction of changes in the volume and rates earned or paid on interest-earning assets and interest-bearing liabilities. The volume of earning dollars in loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in net interest income between periods. Components of interest income and interest expense are presented on a tax-equivalent basis using the statutory federal income tax rate of 34% for 2009 and a 35% tax rate for 2008 and 2007.   

The following table shows the effect of changes in volume and interest rates on net interest income. The variance in interest income or expense due to the combination of rate and volume has been allocated proportionately.

                            Rate/Volume Variance Report(1)                      (in thousands-taxable equivalent basis)                                          2009 vs. 2008                              2008 vs. 2007                                          Increase (Decrease)                        Increase (Decrease)                            Total       Due to                         Total       Due to                           Change       Volume        Due to Rate     Change       Volume       Due to Rate  Interest Income: Commercial loans-taxable            $  (8,578 ) $    (1,538 )  $      (7,040 ) $  (9,753 ) $    1,807    $     (11,560 ) Commercial loans-tax free                            26           152             (126 )       620          771             (151 ) Mortgage loans                 (43 )        (179 )            136         267          147              120 Installment loans            1,241         2,177             (936 )       679          847             (168 ) Total Loans                 (7,354 )         612           (7,966 )   

(8,187 ) 3,572 (11,759 ) Securities-taxable (3,261 ) (1,695 ) (1,566 ) (426 ) (1,245 )

            819 Securities-tax free          2,109         1,694              415         632          932             (300 ) Total Securities            (1,152 )          (1 )         (1,151 )       206         (313 )            519 Interest-bearing deposits with banks              0             0                0           0            0                0 Federal funds sold              86           638             (552 )       (16 )          9              (25 ) Total Money Market Assets                          86           638             (552 )       (16 )          9              (25 ) Total Interest Income       (8,420 )       1,249           (9,669 )    

(7,997 ) 3,268 (11,265 )

  Interest Expense: Interest-bearing demand deposits               (300 )         335             (635 )    (4,039 )       (130 )         (3,909 ) Savings deposits              (103 )          63             (166 )      (176 )         29             (205 ) Time deposits over $100,000                    (1,536 )       2,769           (4,305 )    (2,638 )       (600 )         (2,038 ) Other time deposits         (4,229 )      (1,436 )         (2,793 )    (3,174 )       (192 )         (2,982 ) Total Interest-Bearing Deposits                    (6,168 )       1,731           (7,899 )   (10,027 )       (893 )         (9,134 ) Borrowed funds and other interest-bearing liabilities                 (1,878 )         (84 )         (1,794 )       697        3,002           (2,305 ) Total Interest Expense      (8,046 )       1,647           (9,693 )    (9,330 )      2,109          (11,439 ) Net Interest Income      $    (374 ) $      (398 )  $          24   $   1,333   $    1,159    $         174                                            35 

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(1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated proportionately to changes due to volume and changes due to rate.

    During 2009, tax-equivalent net interest income decreased $374 thousand over the prior year total. The re-pricing of interest sensitive assets and liabilities combined with growth at current market levels generated a positive variance due to rate in the amount of $24 thousand.    Interest income recognized on loans decreased $7.4 million in 2009. The $11.5 million increase in average loans outstanding led to a $612 thousand increase in interest income, but earnings lost due to transferring loans to nonaccrual status led to a negative variance.    Investment securities interest income during 2009 decreased $1.2 million when compared to 2008 due primarily to a 0.30% decrease in the yield earned and the addition of lower yielding securities. Earnings from money market assets were $86 thousand higher than the prior year as deposit growth increased balances significantly.    Deposit growth resulted in a $1.7 million increase in interest expense in 2009, however declining interest rates led to a $7.9 million reduction of interest expense. The $6.2 million decrease in the cost of deposits combined with a $1.9 million decrease in the cost of borrowings resulted in an $8.0 million reduction in total interest expense which offset the $8.4 million decrease in interest income for the year.    During 2008, tax-equivalent net interest income increased $1.3 million over the 2007 total. Balance sheet growth was profitable as evidenced by the $1.2 million of improvement related to volume. The repricing of interest sensitive assets and liabilities combined with growth at current market levels contributed to a positive variance due to rate in the amount of $174 thousand.    Interest income recognized on loans decreased $8.2 million in 2008 compared to 2007. The $39 million increase in average loans outstanding led to a $3.6 million increase in interest income, but re-pricing resulting from Federal Reserve interest rate cuts contributed to the $11.8 million decrease due to rate. Included in the negative variance due to rate is the $1.2 million of lost earnings on nonaccrual loans. Investment securities added $200 thousand more interest income in 2008 compared to 2007 in spite of lower balances due to the repositioning of the securities portfolio into higher earning assets. Earnings from money market assets were $16 thousand less than the prior year as funds were utilized in higher earning asset categories.    Deposits runoff resulted in an $893 thousand decrease in interest expense in 2008 compared to 2007, while declining interest rates led to an additional $9.1 million reduction of interest expense. The $10 million decrease in the cost of deposits combined with a $700 thousand increase in the cost of borrowings due to increased balances resulted in a $9.3 million reduction in total interest expense which more than offset the $8.0 million decrease in interest income and resulted in the $1.3 million improvement in net interest income recorded for the year.   

Provision for Loan and Lease Losses

    Management closely monitors the loan portfolio and the adequacy of the ALLL considering underlying borrower financial performance and collateral values and increasing credit risks.  Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management used in making its evaluation of the ALLL.  The provision for loan and lease losses is an expense charged against net interest income to provide for estimated losses attributable to uncollectible loans and is based on management's analysis of the adequacy of the ALLL.  The provision for loan and lease losses was $42.1 million in 2009 as compared to $1.8 million in 2008.  The increase was primarily related to increased charge offs due to the decline in the real estate market and the prolonged deterioration in the economy as well as our change in policy for determining the ALLL, including an enhanced loan impairment measurement process and historical loss analysis, described in more detail under "-Critical Accounting Policies" and "Financial Condition - Allowance for Loan and Lease Losses. "                                           36 

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     Table of Contents    Other Income (Loss)                                                      2009                                               (as restated)           2008             2007                                                                  (in thousands) Service charges                              $         2,863    $          3,118    $     2,840 Net gain on the sale of securities                       890               1,156            721 Other-than-temporary-impairment loss on securities                                           (20,649 )                 -              - Net gain on the sale of loans                          1,481                 414            310 Net gain on the sale of other real estate                309                 520              - Net gain on the sale of other assets                       -                   3             26 Other                                                  3,255               2,601          2,448 Total Other Income (Loss)                    $       (11,851 )  $          7,812    $     6,345     During 2009, total other income (loss) decreased $19.7 million from the 2008 total primarily due to the recognition of OTTI charges on investment securities, in the amount of $20.6 million. Gains from the sale of loans increased $1.1 million over 2008 as residential mortgages were sold to Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") or Federal Home Loan Bank ("FHLB") in the secondary mortgage market.    The credit loss component of an OTTI write-down is recorded in earnings, while the remaining portion of the impairment loss is recognized in other comprehensive income, provided that the Company does not intend to sell, or that it is more likely than not that the Company will not be required to sell, the underlying debt security.    During 2009, the Company recorded a $20.6 million OTTI charge on debt securities. The charge includes $18.4 million in credit related OTTI on seven pooled trust preferred collateralized debt obligations and $2.2 million on eight private label mortgage-backed securities. All of the securities for which OTTI was recorded were classified as available-for-sale. Additionally, $15 million in noncredit related OTTI was recorded in other comprehensive income on the fifteen securities which were classified as impaired.    

During 2008, total other income increased $1.5 million, or 23.1%, over 2007.

  Service charges improved $278 thousand, or 9.8%, due to a $293 thousand increase in overdraft privilege fees. Income generated from the sale of assets increased $1.0 million compared to 2007. Securities were sold to reposition the portfolio for future benefits and residential mortgages were sold to reduce the Company's exposure to interest rate risk. Additionally, a $520 thousand gain was recognized from the sale of several properties which were previously classified as OREO. Other fee income also increased $153 thousand, or 6.3%, due to increased fees recognized on asset management services and Bank Owned Life Insurance.    Other Expenses                                                        2009                                                 (as restated)          2008             2007                                                                   (in thousands) Salary expense                                 $         9,960    $        10,469    $     9,628 Employee benefit expense                                 2,195              2,276          2,289 Occupancy expense                                        2,218              2,349          2,116 Equipment expense                                        1,828              1,811          1,577 Advertising expense                                        713                988            890 Data processing expense                                  1,928              1,610          1,682 Goodwill Impairment                                      8,134                  -              - FDIC assessment                                          2,782                720            375 Bank shares tax                                            898                643            677 Expenses of other real estate owned                      1,250                 (4 )            1 Provision for off-balance sheet commitments                604                896              - Legal expense                                              591                257            159 Other operating expenses                                 5,071              4,515          4,403 Total Other Expenses                           $        38,172    $        26,530    $    23,797     In 2009, total other expenses increased $11.6 million, or 43.9%, from the 2008 total primarily due to the goodwill impairment charge of $8.1 million, a $2.1 million, or 286.4% increase in FDIC insurance premiums, and an increase in OREO expenses of $1.3 million primarily due to the increase from one property in 2008 to fourteen properties in 2009. These increases were partly offset by a                                           37  --------------------------------------------------------------------------------

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    decrease of $292 thousand in the provision for off balance sheet commitments and a decrease of $509 thousand in salary and benefit costs compared to 2008 primarily due to a decrease in incentive compensation.  Refer to discussion of goodwill impairment in Note 9 to our consolidated financial statements included in Item 8 hereof.    On February 27, 2009, The Board of Directors of the FDIC voted to amend the restoration plan for the Deposit Insurance Fund ("DIF"). Under the current restoration plan, the FDIC Board set a rate schedule to raise the DIF reserve ratio to 1.15% within seven years. The amended restoration plan was accompanied by a final rule that sets assessment rates and makes adjustments that improve how the assessment system differentiates for risk.    Prior to the final rule, most banks were in the best risk category and paid anywhere from 12 cents per $100 of deposits to 14 cents per $100 for insurance. On April 1, 2009, banks in this category are required to pay initial base rates ranging from 12 cents per $100 to 16 cents per $100 on an annual basis. Changes to the assessment system include higher rates for institutions that rely significantly on secured liabilities, which may increase the FDIC's loss in the event of failure without providing additional assessment revenue. Under the final rule, assessments are higher for institutions that rely significantly on brokered deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid asset growth. Brokered deposits combined with rapid asset growth have played a role in a number of costly failures, including recent failures. The final rule also provided incentives in the form of a reduction in assessment rates for institutions to hold long-term unsecured debt and, for smaller institutions, high levels of Tier 1 capital.    The FDIC Board also adopted a rule imposing a 5 basis point emergency special assessment on the industry on June 30, 2009. The assessment was collected on September 30, 2009. For the Bank, based upon our deposit levels at June 30, 2009, the additional amount of 2009 FDIC insurance expense related to this special assessment was $603 thousand. This adjustment was recognized during the second quarter of 2009. On September 29, 2009, the FDIC Board adopted a proposed rulemaking that would require banks to prepay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. Prepaid assessments for the fourth quarter of 2009 amounted to $385 thousand, $1.6 million in 2010, $2 million in 2011 and $2.1 million in 2012. Under the new rule, banks would be assessed through 2010 according to the risk-based premium schedule adopted earlier this year. Beginning January 1, 2011, the base rate will increase by 3 basis points.    Provision for off-balance sheet commitments was reclassified to other expense for the years 2009 and 2008. In previous periods, it was included in the provision for loan and lease losses on the statement of operations. The provision for off-balance sheet commitments was previously calculated using all commitments and assumed these commitments would be fully funded.  This methodology was revised to provide a reserve on letters of credit and construction commitments.  In addition, individual analyses are performed on the aforementioned commitments to borrowers considered to be impaired.  As a result, the Company reduced the related liability by $1.0 million.    In 2008, total other expenses increased $2.7 million, or 11.5%, from the prior year total. Employee costs rose $828 thousand or 6.9% while occupancy and equipment costs increased $467 thousand or 12.6%. All other expenses increased $1.4 million, or 17.6% primarily due to a higher provision for off-balance sheet commitments and FDIC assessment costs. The Company's overhead ratio was 1.98% in 2008 compared to 1.91% in 2007.    

Salary and benefit costs accounted for 48% of total operating expenses in 2008. The increase in employee costs includes an $841 thousand increase in salaries which reflects the cost of merit increases as well as the cost of the new Stroudsburg and Honesdale Route 6 offices opened in 2007 and the new Marshalls Creek office opened in May, 2008. As of December 31, 2008, the Company had 280 full-time equivalent employees on staff compared to 276 on December 31, 2007.

Occupancy and equipment costs increased $467 thousand in 2008 compared to 2007 primarily due to the addition of branch offices.

Provision for Income Taxes

    For the year ended December 31, 2009, the Company recorded an income tax benefit of $(8.6) million, in contrast to an income tax expense of $4.6 million in 2008. The income tax benefit is the result of net losses from operations in 2009, primarily from the provision for loan and lease losses and other than temporary impairment losses, offset by the establishment of a $12.1 million valuation allowance against deferred tax assets. In future periods, the Company anticipates that it will have a minimal tax provision or benefit until such time as it is able to reverse the deferred tax asset valuation allowance.  The effective tax rate for the years ended December 31, 2009 and 2008 was 35% and 23.4%, respectively.    The Company calculates its current and deferred tax provision based on estimates and assumptions that could differ from actual results reflected in income tax returns filed during the subsequent year. Any adjustments required based on filed returns are recorded when identified in the subsequent year.    Federal income tax expense decreased $362 thousand in 2008 compared to 2007 due primarily to the benefits derived from higher tax-exempt income.  The Company's effective tax rate was 23.4% in 2008 and 25.3% in 2007.                                           38  --------------------------------------------------------------------------------

   Table of Contents    FINANCIAL CONDITION    Total assets increased $52.6 million during 2009, due to significant growth in deposits, which were deployed into cash and cash equivalents and investment securities, while net loans decreased $39.2 million due to the Company charging off additional credits and the slowing economy. Cash dividends were reduced from 46 cents per share in 2008  to 17 cents per share in 2009  to conserve capital and comply with regulatory requirements. The Company subsequently suspended paying dividends.    Securities    The Company holds debt securities primarily for liquidity, interest rate risk management needs and to provide a source of interest income. Securities are classified as held to maturity and carried at amortized cost when the Company has the positive intent and ability to hold them to maturity.  Securities not classified as held to maturity are classified as available-for-sale and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.  The Company determines the appropriate classification of securities at the time of purchase. The decision to purchase or sell securities is based upon the current assessment of long and short-term economic and financial conditions, including the interest rate environment and other statement of financial condition components. Securities with limited marketability and/or restrictions, such as Federal Home Loan Bank and Federal Reserve Bank stocks, are carried at cost in other assets.    At December 31, 2009, the Company's investment portfolio was comprised of U.S Government agency securities, tax-exempt obligations of states and political subdivisions, government sponsored agency and private label collateralized mortgage obligations ("PLCMOs"), residential mortgage-backed securities, pooled trust preferred securities ("PreTSLs") principally collateralized by bank holding companies ("bank issuers"), corporate debt and equity securities.    Among other securities, the Company's investments in the private label mortgage-backed securities, trust preferred securities, and equity securities may pose a higher risk of future impairment charges by the Company as a result of the current downturn in the U.S. economy and its potential negative effect on the future performance of these bank issuers and/or the underlying mortgage loan collateral. Many of the bank issuers of trust preferred securities within the Company's investment portfolio remain participants in the U.S. Treasury's TARP CPP.  For TARP participants, dividend payments to trust preferred security holders are currently senior to and payable before dividends can be paid on the preferred stock issued under the TARP CPP.  Some bank issuers may elect to defer future payments of interest on such securities either based upon recommendations by the U.S. Treasury and the banking regulators or management decisions driven by potential liquidity needs. Such elections by issuers of securities within our investment portfolio could adversely affect securities valuations and result in future impairment charges if collection of deferred and accrued interest (or principal upon maturity) is deemed unlikely by management.  See the "Other-Than-Temporary-Impairment Analysis" section below for further details.    

The following table sets forth the carrying value of available-for-sale securities, which are carried at fair value, and held to maturity securities, which are carried at amortized cost, at the dates indicated:

                                                                     December 31,                                                      2009                                                  (as restated)           2008             2007                                                                     (in thousands) U.S. Treasury securities and obligations of U.S. government agencies                        $        27,089    $         32,233    $   52,504 Obligations of state and political subdivisions                                            120,569             101,451        74,627 Collateralized mortgage obligations: Government sponsored agency                              53,495              29,223        43,251 Private label                                            21,059              31,840        35,620 Residential mortgage-backed securities                   27,442              30,061        62,143 Pooled Trust Preferred Senior Class                       1,391               2,775             - Pooled Trust Preferred Mezzanine Class                    2,419              14,877        22,436 Corporate debt securities                                   356               4,274         5,872 Equity securities                                         1,025                 974           996 Total                                           $       254,845    $        247,708    $  297,449     The following table sets forth the maturities of available for sale securities, based on amortized cost, at December 31, 2009 (in thousands) and the weighted average yields of such securities calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security.                                           39  --------------------------------------------------------------------------------    Table of Contents                                                                           Mortgage-                           Within     > 1 - 5    6 - 10      Over         Backed       No Fixed                          One Year     Years      Years    10 Years     Securities     Maturity      Total U.S. Treasury securities              $        -   $      -   $     -   $       -   $          -   $        -   $       - Yield Obligations of U.S. government agencies                                       $  28,734                               $  28,734 Yield                                                         4.588 %                                 4.588 % Obligations of state and political subdivisions (1)                        4,404     4,981     112,667                                 122,052 Yield                                   5.784 %   6.291 %     6.849 %                                 6.788 % Corporate debt securities                                                      500                                     500 Yield                                                         0.899 %                                 0.899 % CMOs: Government sponsored agencies                                                                    52,968                   52,968 Yield                                                                        4.066 %                  4.066 % Private label                                                               24,154                   24,154 Yield                                                                        6.032 %                  6.032 % Residential mortgage-backed securities                                                                  26,152                   26,152 Yield                                                                        5.406 %                  5.406 % Pooled Trust Preferred Senior Class                                                         3,848                                   3,848 Yield                                                         1.174 %                                 1.174 % Pooled Trust Preferred Mezzanine Class                                                        12,459                                  12,459 Yield                                                         1.742 %                                 1.742 % Equity securities (2)                                                                     1,010       1,010 Yield                                                                                     0.743 %     0.743 % 

Total maturities $ - $ 4,404$ 4,981$ 158,208$ 103,274$ 1,010$ 271,877 Weighted yield

                   - %    5.784 %   6.291 %     5.879 %        4.865 %      0.743 %     5.481 %    

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(1) Yields on state and municipal securities have been adjusted to a tax-equivalent basis using a 35% federal income tax rate.

(2) Yield presented represents 2009 actual return.

Other-Than-Temporary Impairment ("OTTI")

    Effective June 30, 2009 management adopted ASC Topic 320, "Investments-Debt and Equity Securities." Under this guidance, if management has no intent to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost, then other-than-temporary declines in the fair value of the debt security that are related to credit losses must be recognized in earnings as realized losses and those that are related to other factors are recognized in other comprehensive income. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio and may result in OTTI on the Company's investment securities in future periods.    On a quarterly basis, the Company evaluates its investment securities for OTTI. Unrealized losses on securities are considered to be OTTI when the Company believes the security's impairment is due to factors that could include the security issuer's inability to pay interest or dividends, the security issuer's potential for default, and/or other factors. As a result of the adoption of the new authoritative guidance, when a held to maturity or available for sale debt security is assessed for OTTI, the Company must first consider (a) whether management intends to sell the security, and (b) whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. If one of these circumstances applies to a security, an OTTI loss is recognized in the statement of operations equal to the full amount of the decline in fair value below amortized cost. If neither of these circumstances applies to a security, but the Company does not expect to recover the entire amortized cost basis, an OTTI loss has                                           40  --------------------------------------------------------------------------------

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    occurred that must be separated into two categories: (a) the amount related to credit loss, and (b) the amount related to other factors. In assessing the level of OTTI attributable to credit loss, the Company compares the present value of cash flows expected to be collected with the amortized cost basis of the security. As discussed above, the portion of the total OTTI related to credit loss is recognized in earnings, while the amount related to other factors is recognized in other comprehensive income. The total OTTI loss is presented in the statement of operations, less the portion recognized in other comprehensive income. When a debt security becomes other than temporarily impaired, its amortized cost basis is reduced to reflect the portion of the total impairment related to credit loss.   

To determine whether a security's impairment is other than temporary, management considers factors that include:

† the causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility.

   †          the severity and duration of the decline.    †          the Company's ability and intent to hold equity security investments until they recover in value, as well as the likelihood of such a recovery in the near term.    †          the Company's intent to sell security investments, or if it is more likely than not that the Company will be required to sell such securities before recovery of their individual amortized cost basis less any current-period credit loss.    For debt securities, the primary consideration in determining whether impairment is other-than-temporary is whether or not it is probable that current or future contractual cash flows have or may be impaired.    Based on the Company's evaluation at December 31, 2009, the Company has determined that the decreases in estimated fair value are temporary with the exception of eight PLCMOs and seven bank-issued PreTSLs.  The Company's estimate of projected cash flows it expected to receive was less than the securities' carrying value, resulting in a net credit impairment charge to earnings for the year ending December 31, 2009 of $20.6 million.    OTTI of Private Label CMOs:   

The following PLCMOs were determined to be credit impaired as of December 31, 2009 resulting in a charge to earnings (in thousands): (as restated)

                                                                S&P                     Credit          Credit                           Book      Fair      Unrealized    credit   Collateral    Impairment,     Impairment, Security                 value      Value     gain/loss     rating      type       this period     cumulative RAST 2006 - A10 A5      $  1,000   $   690   $       (310 )  CCC      ALT-A30     $         277   $         277 RAST 2006 - A8 2A2           898       782           (116 )  CCC      ALT-A30               414             414 CWALT 2007 - 7T2 A12       1,988     1,692           (296 )  CCC      ALT-A30               282             282 RALI 2006 - QS 16 A10        985       802           (183 )  CCC      ALT-A30               354             354 RALI 2006 - QS4 A2         1,516       983           (533 )  CCC      ALT-A30               379             379 HALO 2007 - 1 3A6          1,468       636           (832 )  CCC        WH30                 79              79 WMALT 2006 - 2 2CB           872       884             12    CCC      ALT-A30               434             434 PRIME 2006 - 1 1A1         2,016     1,736           (280 )  CCC        WH30                 41              41         Total           $ 10,743   $ 8,205   $     (2,538 )                       $       2,260   $       2,260     The OTTI analysis relies on a review of the individual loans that provide the collateral for each security. This information is then used to develop default and severity assumptions over a future horizon for each security. The factors involved in constructing these assumptions are:    †          MSA (Metropolitan statistical area), Geographic location  †          HPI (Home Price Index) of specific MSAs  †          Loan Balance  †          Rate Premium  †          LTV (both individual and combined if there are other loans)  †          FICO  †          Loan Purpose (cash-out versus purchase)  †          Documentation  †          Loan Structure  †          Occupancy Status  †          Property Type                                           41 

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   †          Borrower Payment History  †          Historical delinquency and roll/curve rates    Adjustments are made to the default/severity vectors that may be warranted given the current environment. The Company then applies a fairness check to each vector to review whether future default/severity assumptions are "in line" with current observable performance. The data used to perform this analysis is provided by a third party provider and the individual loan performance.    Once the Company has default/severity assumptions for the underlying collateral (on a deal specific basis), the Company then has to understand how the timing of losses impacts each specific bond/tranche and how each cash flow changes over time. The default and severity vectors are modeled using a third party cash flow model and both total collateral and tranche specific cash flows are established. The Company then computes various metrics based on the resulting tranche cash flows:    †          Total Collateral Principal Loss  †          Total Tranche Loss  †          Lifetime Tranche Yield  †          Tranche Loss Timing    A security is considered to be other-than-temporarily-impaired if the expected cash flow analysis results in a change of cash flow from the original expectation which indicates that there is the potential that all principal and/or interest may not be received. Information affecting cash flows and the impact on the collectability of principal and interest are evaluated on a monthly basis as received from service providers. The results are recognized through earnings as they become available.  Information discovered subsequent to the balance sheet date but prior to the filing date is included in the OTTI analysis.  As a result, the Company recorded $2.2 million in credit losses related to OTTI for PLCMOs for the full year period ended December 31, 2009.    The table below illustrates the percentage of the current balance of each identified PLCMO that was delinquent, in foreclosure, in OREO and the trailing 3 month loss severity that was used in the Company's December 31, 2009 OTTI calculations.                                                                                    Projected                       60-89 Days    90+ Days                         3 Month     Default Security              Delinquent   Delinquent   Foreclosure   OREO  

Severity   Severity RAST 2006-A10 A5            2.09 %       4.85 %       14.81 % 3.01 %    56.53 %     36.85 % RAST 2006-A8 2A2            4.04 %       4.88 %       13.92 % 3.54 %    61.29 %     58.07 % CWALT 2007-7T2 A12          3.81 %      14.50 %       12.37 % 0.91 %    66.55 %     57.79 % RALI 2006-QS 16 A10         2.92 %       8.46 %       17.45 % 1.22 %    55.22 %     63.15 % RALI 2006-QS4 A2            3.56 %       6.21 %       11.74 % 0.97 %    64.10 %     47.47 % HALO 2007-1 3A6             2.95 %       9.09 %        7.09 % 0.93 %    60.87 %     48.32 % WMALT 2006-2 2CB            3.11 %       7.98 %       11.10 % 1.25 %    21.85 %     72.05 % PRIME 2006-1 1A1            1.55 %       9.50 %        4.55 % 1.69 %    39.38 %     50.00 %    

OTTI of Pooled Trust Preferred Collateralized Debt Obligations:

    As of December 31, 2009, the book value of our PreTSLs totaled $16.3 million with an estimated fair value of $3.8 million and is comprised of seven securities each of which is collateralized by debt issued by bank holding companies and insurance companies. The Company holds one senior tranche and six mezzanine tranches and the mezzanine tranches all possess credit ratings below investment grade.  During 2009, all of the pooled issues were downgraded by Moody's Investor Services. At the time of initial issue, no more than 5% of any pooled security consisted of a security issued by any one institution.  As of December 31, 2009, five of these securities had no excess subordination and two had excess subordination which ranged from 0.8% to 9.0% of the current performing collateral.  Excess subordination is the amount by which the underlying performing collateral exceeds the outstanding bonds in the current class plus all senior classes.  It can also be referred to as credit enhancement. As deferrals and defaults of underlying issuers occur, the excess subordination is reduced or eliminated, increasing the risk of the security experiencing principal or interest shortfalls.  Conversely, subordination can be increased as collateral transitions from non-performing to performing. The coverage ratio, or overcollateralization, of a specific security measures the rate of performing collateral to a given class of notes. It is calculated by dividing the performing collateral in a transaction by the current balance of the class of notes plus all classes senior to that class.    

The following table presents information about the Company's collateral and subordination for its PreTSLs as of December 31, 2009 (as restated):

                                       42  --------------------------------------------------------------------------------    Table of Contents                                                                                                                Actual                                                                                             Current       Deferrals /     Expected                                                   Excess/                                  Number of    Defaults as a %    Future                  Performing        Bonds        Insufficient    Coverage      Excess       Performing     of Current      Default Security         Collateral     Outstanding      Collateral      Ratio     Subordination    Issuers       Collateral        Rate                                (in thousands) PreTSL VIII     $    239,300   $     395,835   $     (156,535 )     60.5 %           N/A           24              43.7 %     2.88 % PreTSL IX            313,520         339,943          (26,423 )     92.2 %           N/A           36              30.3 %     1.40 % PreTSL X             289,750         386,273          (96,523 )     75.0 %           N/A           38              42.1 %     1.54 % PreTSL XI            458,995         483,756          (24,761 )     94.9 %           N/A           50              23.7 %     1.97 % PreTSL XIX           558,035         553,623            4,412      100.8 %           0.8 %         62              20.3 %     1.84 % PreTSL XXVI          702,700         644,439           58,261      109.0 %           9.0 %         58              27.1 %     1.10 % PreTSL XXVIII        292,850         310,160          (17,310 )     94.4 %           N/A           43              18.8 %     2.03 %    

The following list details information for each of the Company's investments in PreTSLs as of December 31, 2009:

                                                                    Moody's /      Credit          Credit                                Book      Fair      Unrealized      Fitch      Impairment,     Impairment, Security           Class      Value      Value     Gain/Loss      Ratings     the period      cumulative  PreTSL VIII      Mezzanine   $     80   $     2   $        (78 )  Ca / CC    $       2,920   $       2,920 PreTSL IX        Mezzanine      1,320       253         (1,067 )  Ca / CC            1,680           1,680 PreTSL X         Mezzanine        355        12           (343 )  Ca / CC            2,645           2,645 PreTSL XI        Mezzanine      2,214       392         (1,822 )  Ca / CC            2,786           2,786 PreTSL XIX       Mezzanine      6,111     1,712         (4,399 )  B3 / B-            1,064           1,064 PreTSL XXVI      Senior         3,848     1,391         (2,457 ) Ba1 / BBB             251             251 PreTSL XXVIII    Mezzanine      2,379        48         (2,331 )  Ca / CC            7,043           7,043 Total                        $ 16,307   $ 3,810   $    (12,497 )             $      18,389   $      18,389     The Company's PreTSLs are measured for OTTI within the scope of ASC Topic 325 by determining whether an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows from the cash flows previously projected involves comparing the present value of remaining cash flows previously projected against the present value of the cash flows estimated at December 31, 2009. The Company considers the discounted cash flow analysis to be our primary evidence when determining whether credit related OTTI exists.    Results of a discounted cash flow test are significantly affected by variables such as the estimate of the probability of default, estimates of future cash flows, discount rates, prepayment rates and the creditworthiness of the underlying banks. The following provides additional information for each of these variables:                                           43 

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†

  †          Probability of Default - An issuer level approach is used to analyze each security and default and recovery assumptions are based on the credit quality of the underlying issuers (generally, bank holding companies or insurance companies).  Each bank issuer is evaluated based upon an examination of the trends in its earnings, net interest margin, operating efficiency, liquidity, capital position, level of nonperforming loans to total loans, apparent sufficiency of loan loss reserves, Texas ratio, and whether the bank received TARP monies. From this information, each issuer bank that is currently performing is assigned a category of Good, Average, Weak, or Troubled. Default rates are then assigned based upon the historical performance of each category. Additionally, because the information available to the Company regarding the underlying insurance company issuers is more limited than for bank issuers, rather than performing an analysis of each such issuer's results and assigning insurance company issuers to these same categories, the Company uses the Moody's one year long-terms default rate assumption for insurance companies. The historical default rates used in this analysis are:                            Default Rate Category    Year 1   Year 2   Year 3   Thereafter Good           0.5 %    0.6 %    0.6 %        0.4 % Average        1.8 %    2.3 %    2.3 %        1.5 % Insurance      1.0 %    1.2 %    1.2 %        0.8 % Weak           5.8 %    7.2 %    7.2 %        4.8 % Troubled       9.7 %   12.2 %   12.2 %        8.1 %     Each issuer in the collateral pool is assigned a probability of default for each year until maturity.  Banks currently in default or deferring interest payments thus far are assumed to default immediately. A zero percent projected recovery rate is applied to both deferring and defaulted issues.  The probability of default is updated quarterly based upon changes in the creditworthiness of each underlying issuer.  Timing of defaults and deferrals has a substantial impact on each valuation.  As a result of this analysis, each issuer is assigned an expected default rate specific to that issuer.    †          Estimates of Future Cash Flows - While understanding the composition and characteristics of each bank issuer is important in evaluating the security, certain issuers have a disproportionate impact (both positive and negative) based upon other attributes, such as the interest rate payable by each issuer. Each credit is assessed independently, and the timing and nature of each issuer's performance is assessed.  Once assessed, the expected performance of each issuer is applied to a structural cash flow model.  Due to the complexity of these transactions, the expected performance of each unique issuer requires an adherence to the governing documents of the securitization to derive a cash flow.  A model produced by third party is utilized to assist in determining cash flows.  Utilization of third party cash flow modeling to derive cash flows from assumptions is a market convention for these types of securities.                                           44  --------------------------------------------------------------------------------

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    †          Discount Rate - The Company is discounting projected cash flows based upon its discount margin defined at the time of purchase, which constitutes a spread over 3-month LIBOR plus credit premium, consistent with our pre-purchase yield.    †          Prepayment Rate - Lack of liquidity in the market for PreTSL securities, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment on these securities.  During the early years of PreTSL securities, prepayments were common as issuers were able to refinance into lower cost borrowings.  Since the middle of 2007, however, this option has all but disappeared and the Company is operating in an environment which makes early redemption of these instruments unlikely.  Accordingly, the Company has assumed zero prepayments when modeling the cash flows of these securities.  The Company will reevaluate its prepayment assumptions from time to time as appropriate.  The Company performed a sensitivity analysis using 1% and 3% prepayment assumptions.  As a result of this analysis, the Company determined that employing a 1% and a 3% prepayment assumption rather than assuming zero prepayments would have resulted in an additional credit loss of approximately $558 thousand and $883 thousand, respectively, to the $20.6 million impairment charge taken during 2009.  Credit losses would increase as a result of an increase in the prepayment assumption because prepayments reduce the amount of excess subordination that would be available to absorb expected losses.    †          Credit Analysis - A quarterly credit evaluation is performed for each of the securities.  While the underlying core component of these securities are the credit characteristics of the underlying 'issuers', typically banks, other characteristics of the securities and issuers are evaluated and stressed to determine cash flow.  These include but are not limited to interest rate of each issuer, certain derivative contracts, default timing, and interest rate volatility are all addressed.  Issuer level credit considers all evidence available to us and includes the nature of the issuer's business, its years of operating history, corporate structure, loan composition, loan concentrations, deposit mix, asset growth rates, geographic footprint and local environment. Depending upon the security, and its place in the capital structure, certain analytical assumptions are isolated with greater scrutiny.  The core analysis for each specific issuer focuses on profitability, return on assets, shareholders' equity, net interest margin, credit quality ratios, operating efficiency, capital adequacy and liquidity.    The Company has evaluated its PreTSL and PLCMO securities considering all available evidence, including information received after the balance sheet date but before the filing date, and determined that the discounted estimated projected cash flows are less than the securities' carrying value, resulting in an impairment charge to earnings for the year ended December 31, 2009 of $18.4 million and $2.2 million, respectively, for a total impairment charge of $20.6 million.    The table below provides a cumulative roll forward of credit losses recognized (in thousands):                       Other-Than-Temporarily Impaired Securities                                                                     For the Year Ended December 31,                                                                               2009 Beginning Balance                                         $                      -      $             -

Credit losses on debt securities for which OTTI was not previously recognized

20,649

Additional credit losses on debt securities for which OTTI was previously recognized

     - Ending Balance                                            $                 20,649                                            45 

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Investments in FHLB and FRB stock, which have limited marketability, are carried at cost in Other Assets and totaled $11.8 million and $11.1 million at December 31, 2009 and 2008, respectively. Management noted no indicators of impairment for the FHLB of Pittsburgh during 2009.

   Loans    The net loan balance declined in 2009 primarily as a result of charge-offs, higher ALLL, large payoffs and transfers to OREO.  Net loans declined $39.2 million, or 4.1%, to $917.5 million as of December 31, 2009 from $956.7 million as of December 31, 2008. Net loans represented 67.2% of total assets as of December 31, 2009, compared to 72.8% as of December 31, 2008. The Company noted increases in installment loans and other loans. Increases in these categories were offset by decreases in commercial and industrial loans and commercial and residential real estate loans. Historically, commercial lending activities have represented a significant portion of the Company's loan portfolio. This includes commercial and industrial loans and commercial real estate loans.  Furthermore, from a collateral standpoint, a majority of the Company's loan portfolio consisted of loans secured by real estate. Real estate secured loans as of percentage of total net loans has declined from 61.7% as of December 31, 2008 to 60.3% of the loan portfolio as of December 31, 2009.    Commercial and industrial loans decreased $177 thousand, or .08%, during the year from $221.0 million as of December 31, 2008 to $220.8 million as of December 31, 2009. Commercial loans consist primarily of equipment loans, permanent working capital financing, revolving lines of credit and loans secured by cash and marketable securities. The decrease was primarily a reduction in borrowings under revolving line of credit facilities within the portfolio. Loans secured by commercial real estate decreased $29.5 million, or 6.7%, from $440.8 million as of December 31, 2008 to $411.3 million as of December 31, 2009. Commercial real estate loans include long-term commercial mortgage financing, construction loans and land development loans, and are primarily secured by first or second lien mortgages. The decrease in commercial real estate loans is primarily attributable to some large payoffs, along with significant charge-offs and transfers to OREO.    Residential real estate loans totaled $142.1 million as of December 31, 2009. This represents a decrease of $7.2 million, or 4.8%, from $149.3 million as of December 31, 2008. The components of residential real estate loans include fixed rate mortgage loans primarily held for sale in the secondary market, which represent less than one percent of the overall loan portfolio, and home equity loans and lines of credit. The Company continues to adhere to a philosophy of underwriting fixed rate purchase and refinance residential mortgage loans that are generally then sold in the secondary market to reduce interest rate risk and provide funding for additional loans. Installment loans increased $8.9 million during the year, or 7.4%, from $119.5 million as of December 31, 2008 to $128.4 million as of December 31, 2009. The increase in installment loans is due primarily to growth in the Company's indirect auto loan portfolio. During the first half of 2009, a government sponsored stimulus program led to increased auto sales. Additionally, many auto manufacturers terminated the operations of their finance arms, or severely limited the lending activity of these entities. These two factors led to an increase in the demand for automobile financing from banks and other traditional lending sources. All other loans, which include obligations of state and municipal governments, totaled $37.0 million as of December 31, 2009, an increase of $2.6 million, or 7.5%, from $34.4 million as of December 31, 2008.    

Details regarding the loan portfolio for each of the last five years ended December 31 are as follows:

                                  Loans Outstanding                                   (in thousands)                                                             December 31,                                    2009                                (as restated)       2008         2007         2006         2005 Commercial and Industrial     $       220,849    $ 221,026    $ 202,665    $ 157,837    $ 132,838 Commercial Real Estate                411,256      440,753      436,861      418,844      369,106 Residential Real Estate               142,055      149,259      142,807      147,980      108,973 Installment                           128,392      119,501       91,052       80,770       73,217 Other                                  37,013       34,440       32,136       31,591       30,139 Total Loans Gross                     939,565      964,979      905,521      837,022      714,273 Unearned Discount                        (298 )       (380 )       (470 )       (569 )          - Loan Fees                                 707          329          183          206          503 Allowance for Loan and Lease Losses                          (22,458 )     (8,254 )     (7,569 )     (7,538 )     (7,528 ) Net Loans                     $       917,516    $ 956,674    $ 897,665    $ 829,121    $ 707,248     The following schedule shows the re-pricing distribution of loans outstanding as of December 31, 2009. Also provided are these amounts classified according to sensitivity to changes in interest rates.                                           46  --------------------------------------------------------------------------------      Table of Contents                      Loans Outstanding - Re-pricing Distribution                                   (in thousands)                                                         December 31, 2009                                                        (as restated)                                    Within          One to        Over Five                                   One Year       Five Years        Years           Total Commercial and Industrial        $   160,750    $     52,210    $      7,889    $   220,849 Commercial Real Estate               307,097          95,537           8,622        411,256 Residential Real Estate               66,930          28,630          46,495        142,055 Installment                            2,556         108,091          17,745        128,392 Other                                  7,618           4,435          24,960         37,013 Total                            $   544,951    $    288,903    $    105,711    $   939,565  Loans with predetermined interest rates                   $    22,836    $    162,488    $    100,372    $   285,696 Loans with floating rates            522,115         126,415           5,339        653,869 Total                            $   544,951    $    288,903    $    105,711    $   939,565     Loan Concentrations: At December 31, 2009 and 2008, the Bank's loan portfolio was concentrated in loans in the following industries. All loans included in the Solid Waste Landfills are fully secured by cash collateral on deposit at the Bank.                                     December 31, 2009 (as                                        restated)                   December 31, 2008                                   Amount        % of Loans       Amount       % of Loans Land subdivision              $       74,959          7.98 %  $     89,040           9.23 % Shopping centers/complexes            36,184          3.85 %        41,404           4.29 % Gas stations                          26,627          2.83 %        27,982           2.90 % Office complexes/units                25,864          2.75 %        19,067           1.98 % Solid waste landfills                 46,325          4.93 %        35,132           3.64 %     Asset Quality    The Company manages credit risk through the efforts of loan officers, the loan review function, and the Loan Quality as well as the ALLL management committees and oversight from the board of directors, along with the application of policies and procedures designed to foster sound underwriting and credit monitoring practices. The Company continually evaluates this process to ensure it is reacting to problems in the loan portfolio in a timely manner. Although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond the Company's control.    Under the Company's risk rating system, loans rated as special mention, substandard, doubtful or loss are reviewed regularly as part of the Company's risk management practices. The Company's Loan Quality Committee, which consists of key members of senior management and credit administration, meets monthly or more often, as necessary, to review individual problem credits and workout strategies and makes reports to the Board of Directors.    A loan is considered impaired when it is probable that the Bank will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement.  For purposes of the Company's analysis, loans which are identified as troubled debt restructures ("TDRs") or are non-accrual substandard or doubtful loans are considered impaired.  Impaired loans are analyzed individually for the amount of impairment.  The Company generally utilizes the fair value of collateral method for collateral dependent loans, which make up the majority of the Company's impaired loans.  A loan is considered to be collateral dependent when repayment of the loan is anticipated to come from the liquidation of the collateral held.  For loans that are secured by real estate, external appraisals are obtained annually, or more frequently as warranted, to ascertain a current market value so that the impairment analysis can be updated.  Should a current appraisal not be available at the time of impairment analysis, other sources of valuation such as current letters of intent, broker price opinions or executed agreements of sale may be used.  For non-collateral dependent loans, the Company measures impairment based on the present value of expected future cash flows, net of disposal costs, discounted at the loan's original effective interest rate.    Non-performing loans and OREO are monitored on an ongoing basis as part of the Company's loan review process and through the Loan Quality Committee. Additionally, work-out efforts continue and are actively monitored for non-performing loans and OREO.  Potential loss on non-performing assets is generally evaluated by comparing the outstanding loan balance to the fair market value of the pledged collateral.    Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell. For the Company's calculations on real estate secured loans, a factor of 10% is generally utilized to estimate costs to sell, which is based                                           47 

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    on typical cost factors, such as a 6% broker commission, 2% transfer taxes, and 2% various other miscellaneous costs associated with the sales process.  If the valuation indicates that the market value has deteriorated below the carrying value of the loan, either the entire loan is written off or the difference between the market value and the principal balance is charged off unless there are material mitigating factors to the contrary. For loans which are considered to be impaired, but for which the value of the collateral less costs to sell exceeds the loan value, the impairment is considered to be zero.    

The following schedule reflects non-performing assets and performing TDRs as of December 31 for each of the last five years:

                                                             December 31,                                       2009                                   (as restated)       2008        2007        2006        2005                                                          (in thousands) Nonaccrual loans                 $        25,865    $ 22,263    $  3,106    $  2,299    $     70 Loans past due 90 days or more and still accruing                      117       1,151         904         412         721 Total Non-Performing Loans       $        25,982    $ 23,414    $  4,010    $  2,711    $    791 Other Real Estate Owned                   11,184       2,308       2,588       2,188           - 

Total Non-Performing Assets $ 37,166 $ 25,722$ 6,598$ 4,899$ 791 Performing TDRs

                  $        10,743    $      -    $      -    $      -    $      - Non-performing loans as a percentage of gross loans                    2.8 %       2.4 %       0.4 %       0.3 %       0.1 % Non-performing assets as a percentage of total assets                   2.7 %       2.0 %       0.5 %       0.4 %       0.1 %     In 2009, total non-performing assets increased $11.4 million, from $25.7 million as of December 31, 2008 to $37.2 million as of December 31, 2009, as the effects of the severe and prolonged economic downturn continued to impact individual and business customers of the Company. Non-performing assets represented 58.9% of shareholders' equity as of December 31, 2009, as compared to 25.6% of shareholders' equity as of December 31, 2008. Included in non-performing assets are nonaccrual loans which increased $3.6 million during the year. The increase in nonaccrual loans is primarily centered in commercial real estate loans, including a concentration in land development and construction loans. Continued downturn in the real estate market could lead to additional increases in impaired loans.    The Company has historically participated in loans with other financial institutions, the majority of which have been loans originated by financial institutions located in the Company's general market area. Over the past six years, the Company has participated in seven (7) commercial real estate loans with a financial institution that was headquartered in Minneapolis, Minnesota. The majority of these loans were for out of market commercial real estate projects. Two (2) projects were located in Pennsylvania, one (1) project was located in New York and the remaining four (4) projects were located in Florida. The Company's original aggregate commitment for these various loans totaled approximately $34 million. Two of these loans, one local Pennsylvania project and the New York project, have been paid in full. The remaining Pennsylvania loan continues to pay as agreed but is rated as "Substandard". During 2009, the Company recognized charge offs in excess of $11.3 million against the four Florida credits. This amount represents 40% of the Company's total charge offs that were recognized in fiscal 2009. The remaining outstanding balance under these Florida participations totals $7.3 million. These credits are all classified as either non-performing or as OREO. All of these credits have been written down to the current fair market value of each respective property.    Non-performing loans increased $2.6 million from $23.4 million as of December 31, 2008 to $26.0 million as of December 31, 2009. This increase was primarily the result of the re-classification of loans from accruing to non-accrual, net of payments on non-accrual loans, amounting to $41.7 million over the course of the year, and payoffs of non-accrual loans offset by $27.9 million in charge-offs and the transfer of $11.2 million in loans to OREO. The increase in non-performing loans is centered in a few large credits, all of which are secured by real estate collateral.    Loans to borrowers that are experiencing financial difficulty that are modified and result in the Company granting concessions to the borrower are classified as troubled debt restructurings ("TDRs") and are considered to be impaired. Concessions granted under a troubled debt restructuring generally involve a reduction of the rate or an extension of a loan's stated maturity date. Nonaccrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification.  The Bank was committed to lend additional funds to one of the loans classified as a troubled debt restructuring which was performing according to terms in 2009.    Six credits totaling $27.8 million at the time of re-classification and subsequently written down to $18.1 million represented the majority of loans re-classified as impaired during 2009. Additionally, these six credits, plus three other credits re-classified in previous years, represent 87.1% of total non-performing loans as of December 31, 2009. A majority of non-performing loans as of                                           48 

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December 31, 2009 are concentrated in land development loans. Four of these credits totaling $10.1 million are located outside of the Company's primary market area. Two of the credits in the combined amount of $4.2 million are secured by real estate located in Florida.

    The six credits representing the majority of loans re-classified during 2009 are:    †          $5.0 million - This credit represents a land development loan secured by a residential subdivision located outside of the Company's primary market area; this credit was written down to $2.6 million as of December 31, 2009. Further, $260 thousand of the ALLL is allocated to this credit.  

†

  †          $4.8 million - This credit represents a land development loan secured by a residential subdivision located outside of the Company's general market area; this credit was written down to $3.3 million as of December 31, 2009. Further, $328 thousand of the ALLL is allocated to this credit.  

†

† $11.1 million - This credit represents a land development loan secured by a residential subdivision. This credit was written down to $5.3 million as of December 31, 2009. Further, $534 thousand of the ALLL is allocated to this credit.

†

  †          $2.5 million - This credit represents a participation in an out of area real estate bridge loan made to a non-Bank related customer, secured by real estate.  Due to sufficient collateral value, no allocation is provided for this credit in the ALLL.  † 

† $3.2 million - This credit represents a commercial construction loan secured by real estate. ALLL of $319 thousand is allocated to this credit. This credit is guaranteed by two former members of the Company's Board of Directors.

†

† $1.2 million - This credit represents a commercial mortgage loan secured by commercial real estate. Due to sufficient collateral value, no allocation is provided for this credit in the ALLL.

The three remaining credits re-classified prior to 2009 are:

† $1.2 million - This credit represents a commercial mortgage loan secured by commercial real estate. Due to sufficient collateral value, no allocation is provided for this credit in the ALLL.

†

  †          $1.7 million - This credit represents a participation in an out of area real estate bridge loan made to a non-Bank related customer, secured by real estate.  Due to sufficient collateral value, no allocation is provided for this credit in the ALLL.  †  †          $1.6 million - This credit represents a commercial mortgage loan secured by commercial real estate.  ALLL of $160 thousand of is allocated to this credit.      In 2008, total non-performing assets increased $19.1 million as the effects of the economic crisis impacted borrowers' ability to make scheduled payments and reduced the value of real estate collateral securing many loans. Nonaccrual loans increased $19.2 million during the year due primarily to the addition of four credits which represent construction projects in which the Bank is a participating lender. Construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. Workout efforts continue on each of these credits, but declining real estate values are expected to hamper the Bank's ability to receive full recovery on these credits. At December 31, 2008, the Bank evaluated the recovery of its recorded investment in these impaired loans and established a specific valuation allowance under ASC 310 guidance totaling $900 thousand for potential losses on these loans. This valuation allowance resulted from market declines in the underlying value of the collateral securing these loans.    During 2008, three large credits totaling $14.1 million as of December 31, 2008, were classified non-performing, which led to the increase for the period. All three credits represent shared participation loans in Florida. The collateral securing the loan was a first lien mortgage on the property. As of December 31, 2007, non-performing loans were comprised of four credits.    The following table outlines delinquency within the Company's loan portfolio is provided below.                              2009                       (as restated)   2008   2007 30-59 days                      .35 %  .89 %  .60 % 60-89 days                      .05 %  .64 %  .61 % 90 + days                       .01 %  .12 %  .10 % Non-Accrual                    2.75 % 1.79 %  .34 % Total Delinquencies            3.16 % 3.44 % 1.65 %                                            49 

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    Delinquencies for accruing loans declined in 2009 due to transfers of loans to nonaccrual and more rigorous collection activity.  In its evaluation for the ALLL, management considers a variety of qualitative factors including changes in the volume and severity of delinquencies.    As of December 31, 2009, the Company's ratio of nonperforming loans to total gross loans was 2.8% compared to the 2.4% reported as of December 31, 2008. The Company continues to acknowledge the weakness in local real estate markets, emphasizing strict underwriting standards to minimize the negative impact of the current environment.    OREO totaled $11.2 million as of December 31, 2009, which is an increase of $8.9 million, from $2.3 million as of December 31, 2008. As of December 31, 2009, OREO consists of fourteen properties compared to one property as of December 31, 2008. Six of the properties held in OREO as of December 31, 2009 represent approximately 95% of the total. Included in OREO are two properties totaling $3.1 million, or 28%, of OREO, located outside of the Company's general market area. Additionally, $7.7 million, or 69%, of OREO is located in the Pocono region located within the Company's primary market area that has been particularly hard hit during the current economic recession.    The Company is actively marketing these properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 2% transfer taxes, and 2% various other miscellaneous costs associated with the sales process.  This market value is updated on an annual basis or more frequently if new valuation information is available. Further deterioration in the real estate market could result in additional losses on these properties.    The following schedule reflects a breakdown of OREO for the periods reviewed.                                                     December 31,                                   2009      2008      2007      2006     2005                                                 (in thousands) Land / Lots                     $  5,887   $     -   $     -   $     -   $   - Commercial Real Estate             4,852     2,308     2,588     2,188       - Residential Real Estate              445         -         -         -       - Total Other Real Estate Owned   $ 11,184   $ 2,308   $ 2,588   $ 2,188   $   -     There were two properties in OREO at the end of 2007.  The Company sold one property in 2008.  OREO decreased $280 thousand in 2008 and consisted of one property on which the Bank had assumed title during 2008. Current expenses associated with the property were being recovered through a short-term occupancy arrangement.   

Allowance for Loan and Lease Losses

    The ALLL represents management's estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and varies from year to year based on management's evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio. Effective for 2009, the ALLL methodology was revised to include an enhanced impairment measurement process.  Enhancements were also made to the historical loss analysis including an expanded and a more comprehensive loan pool analysis and developing a more detailed qualitative adjustment factors analysis.    In its evaluation, management considers qualitative factors such as changes in lending policies and procedures, changes in concentrations of credit, the nature and volume of the portfolio, the volume and severity of delinquencies, classified and non-accrual loans, competition and legal and regulatory environments, management capabilities, current local and national economic trends, loan review methodology and Board of Directors oversight, as well as various other factors. Consideration is also given to examinations performed by regulatory authorities and loan review.    The downturn in the economy has resulted in increased loan delinquencies, defaults, foreclosures and charge offs primarily in the commercial real estate portfolio. Nonaccrual loans increased to $25.9 million at December 31, 2009 from $22.3 million at December 31, 2008. During the year, several large commercial real estate credits were moved to nonaccrual status. The decline in the economy and resulting decline in the real estate markets were primarily responsible for over $25.3 million of net charge-offs for the year. The Company recorded a provision for loan and lease losses of $42.1 million for 2009 in order to adequately provide for probable losses, compared to a provision of $1.8 million in 2008.  The increase in the ALLL was primarily a result of the decline in the real estate market and the prolonged deterioration in the economy along with a variety of other factors. These factors contributed significantly to                                           50  --------------------------------------------------------------------------------

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    an increase in non-performing assets and net charge-offs primarily in the commercial real estate portfolio concentrated in land development loans.  In each case, real estate collateral provides for an alternate source of repayment in the event of default by the borrower. Management continues to monitor real estate values, which may further deteriorate in this real estate market and result in an increase in impairment in loans and potential increase in charge-offs.    All doubtful, non-accrual substandard loans and troubled debt restructurings are considered to be impaired and are analyzed individually to determine the amount of impairment.  Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired.  The fair value of collateral method is generally used for this measurement unless the loan is non-collateral dependent in which case, a discounted cash flow analysis is performed.  Appraisals are received at least annually to ensure that impairment measurements reflect current market conditions.  Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, Broker Price Opinions or executed agreements of sale may be used.  Only downward adjustments are made based on these supporting values.  Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 2% transfer taxes and 2% various other miscellaneous costs associated with the sales process.  The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed.    Some of the charge-offs resulted from participations in a small number of out of area real estate loans made to non-Bank customers.  At the time these loans were issued, the Bank was looking to expand into other market areas and spread risk. The decision to participate in these credit facilities was based upon perceived favorable market conditions, substantial equity positions, excellent loan to value ratios, fee income, and above average interest rates at the time these loans were approved. Management has since made a decision to discontinue participation in out of area loans.  See further discussion under "Asset Quality".    The Company's ALLL consists of both specific and general components.  At December 31, 2009, the ALLL that related to impaired loans, the guidance for which is provided by ASC 310 "Impairment of a Loan" ("ASC 310"), was $4.0 million or 17.8% of total ALLL.  A general allocation of $18.5 million was calculated for loans analyzed under ASC 450 "Contingencies" ("ASC 450"), which represented 82.2% of the total ALLL of $22.5 million.  The ratio of the ALLL to total loans at December 31, 2009 and 2008 was 2.4% and 0.86%, respectively, based on total loans of $939.6 million and $965.0 million, respectively. The ALLL increased to $22.5 million at December 31, 2009 from $8.3 million at December 31, 2008 due primarily to the market conditions and other items noted above.    Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL.  The ALLL is established through a provision for loan losses charged to earnings.  Interest on loans is recognized using the effective interest method in accordance with GAAP and credited to income from operations based upon principal amounts outstanding.    Loans are placed on nonaccrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This is generally when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. When the interest accrual is discontinued, all unpaid interest is reversed and charged back against current earnings. Any cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of lost interest.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.    Management actively manages impaired loans in an effort to reduce loan balances by working with customers to develop strategies to resolve borrower issues, through sale or liquidation of collateral, foreclosure, and other appropriate means. If real estate values continue to decline, it is more likely that we would be required to further increase our provision for loan and lease losses, which in turn, could result in reduced earnings.    

The following table presents an allocation of the ALLL as of the end of each of the last five years (in thousands):

                                       51  --------------------------------------------------------------------------------    Table of Contents                      Allocation of the Allowance for Loan Losses                              Years Ended December 31,                              2009                       (as restated)                2008                     2007                    2006                    2005                    Amount    Percentage     Amount    Percentage    Amount    Percentage    Amount    Percentage    Amount    Percentage Commercial and Industrial        $  4,467           20 %  $  7,462           90 %  $ 7,019           93 %  $ 6,995           93 %  $ 6,933           92 % Commercial Real Estate (1)          14,640           65 %         -            -          -            -          -            -          -            - Residential Real Estate          1,212            5 %       259            3 %       91            1 %      114            1 %       55            1 % Installment          1,537            7 %       481            6 %      405            5 %      377            5 %      427            6 % Other                  602            3 %        52            1 %       54            1 %       52            1 %      113            1 % Allowance for loan and lease losses            $ 22,458          100 %  $  8,254          100 %  $ 7,569          100 %  $ 7,538          100 %  $ 7,528          100 %    

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(1) Prior to December 31, 2009, the commercial real estate allowance for loan and lease losses was combined with commercial and industrial loans.

    In the Company's historical loss analysis, loans are analyzed by industry concentration, loan type and risk rating. Management measures the effects of various qualitative factors on each of these loan segments. The factors include changes in lending policies and procedures, changes in concentrations of credit, changes in the nature and volume of the portfolio, changes in the volume and severity of delinquencies, classified and nonaccrual loans, changes in competition and legal and regulatory environments, management capabilities, current local and national economic trends, knowledge of customer base and changes in loan review methodology/board of director oversight.  Consideration is also given to examinations performed by regulatory authorities.    Evaluations are intrinsically subjective, as the results are estimated based on management knowledge and experience and are subject to interpretation and modification as information becomes available or as future events occur. Management monitors the loan portfolio on an ongoing basis with emphasis on the declining real estate market and a weakened economy and its effect on repayment. Adjustments to the ALLL are made based on management's assessment of the factors noted above.    The following schedule presents an analysis of ALLL for each of the last five years (in thousands):                                                        Years Ended December 31,                                       2009                                   (as restated)       2008        2007        2006        2005 Balance, January 1,              $         8,254    $  7,569    $  7,538    $  7,528    $  7,100 Charge-Offs: Commercial and Industrial                  2,247         466         329          83          64 Commercial Real Estate                    24,980         262       1,663       1,802       1,523 Residential Real Estate                      307          51         952           -           - Installment                                  449         499         452         535         435 Other Loans                                   34          49           -           -           - Total Charge-Offs                         28,017       1,327       3,396       2,420       2,022 Recoveries on Charged-Off Loans: Commercial and Industrial                     22           6           6           8         257 Commercial Real Estate                        33          17       1,018         110          57 Residential Real Estate                        -           -           5           -          51 Installment                                   70         177         198         232         225 Other Loans                                    7           8           -           -           - Total Recoveries                             132         208       1,227         350         590 Net Charge-Offs                           27,885       1,119       2,169       2,070       1,432 Provision for loan and lease losses                                    42,089       1,804       2,200       2,080       1,860 Balance, December 31,            $        22,458    $  8,254    $  7,569    $  7,538    $  7,528  Net Charge-Offs during the period as a percentage of average loans outstanding during the period                           2.97 %      0.12 %      0.24 %      0.27 %      0.21 % Allowance for loan and lease losses as a percentage of gross loans outstanding at end of period                               2.39 %      0.86 %      0.84 %      0.90 %      1.05 %                                            52 

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    The ratio of the loan loss reserve to total gross loans at December 31, 2009 and 2008 was 2.39% and 0.86%, respectively. Net loans fell from $956.7 million at December 31, 2008 to $917.5 million at December 31, 2009.  The allowance for loan and lease losses increased from $8.3 million at December 31, 2008 to $22.5 million at December 31, 2009.  Net charge-offs totaled $27.9 million in 2009. As a result of these charge-offs, an increase in nonaccrual loans and an increase in troubled debt restructurings, the Company added provisions of $42.1 million in 2009.    Charge-off activity increased in 2009 from $1.1 million in net charge offs in 2008 to $27.9 million in 2009. The majority of the charge-offs resulted from the out of area real estate loans made to non-Bank customers. Severe real estate value declines in the Florida markets necessitated these charge downs, which totaled $11.3 million or 40.5% of the year's net charge offs.  Another $9.7 million in charge-offs of real estate loans resulted from three land subdivision credits in Pennsylvania All other charge-off and recovery activity is consistent with the normal course of business. Management is actively pursuing work out and collections efforts to collect on these loans.    Funding Sources    The Company utilizes traditional deposit products, such as demand, savings, negotiable order of withdrawal ("NOW"), money market, and time as its primary funding sources to support the earning asset base and future growth. Other sources, such as short-term FHLB advances, federal funds purchased, brokered time deposits and long-term FHLB borrowings may be utilized as necessary to support the Company's growth in assets and to achieve interest rate sensitivity objectives. The average balance of interest-bearing liabilities increased $67.0 million, totaling $1.2 billion in 2009 from $1.1 billion in 2008. The rate paid on interest-bearing liabilities decreased from 3.04% in 2008 to 2.17% in 2009. This decrease caused a reduction in interest expense of $8.0 million, or 24%, from $33.2 million in 2008 to $25.2 million in 2009.    Deposits    Average interest-bearing deposits increased $68.7 million, or 8.0% during 2009 compared to 2008. The increase resulted primarily from increases in time deposits and interest-bearing demand accounts. Average time deposits increased $38.5 million or 7.8% during 2009 as compared to 2008. Average interest-bearing demand accounts increased $24.1 million or 8.3% during 2009 when compared to 2008. The increase in average interest-bearing demand deposits resulted primarily from an increase in personal money market deposits and municipal NOW accounts. The average balance of savings accounts increased $6.8 million or 9.1% during 2009 when compared to 2008. The rate paid on average interest-bearing deposits decreased from 2.76% during 2008 to 1.89% in 2009. The decrease in the rate on interest-bearing deposits was driven primarily by pricing decreases from money markets and time deposits, which are sensitive to interest rate changes. The pricing decreases for these products resulted from decreases in short-term rates by the FRB during 2009 combined with an overall decrease in market rates. The rate paid on average interest bearing demand deposits decreased from 1.40% during 2008 to 1.19% in 2009.  The rate paid for savings deposits decreased from 0.93% in 2008 to 0.73% in 2009 and the rate paid on time deposits decreased from 3.84% during 2008 to 2.47% during 2009.    

The average daily amount of deposits and rates paid on such deposits is summarized for the periods indicated in the following table (in thousands):

                                                Year Ended December 31,                                   2009                  2008                 2007                             Amount       Rate     Amount      Rate     Amount      Rate                                               (dollars in thousands) Noninterest-bearing demand deposits           $    81,081            $  81,772            $  80,515 Interest-bearing demand deposits                      312,285     1.19 %   288,226     1.40 %   292,134     2.76 % Savings deposits               81,149     0.73 %    74,349     0.93 %    71,444     1.21 % Time deposits                 530,276     2.47 %   491,790     3.84 %   508,303     4.86 % Total                     $ 1,004,791            $ 936,137            $ 952,396    

The following table presents the maturity distribution of time deposits of $100,000 or more at December 31, 2009 and December 31, 2008 (in thousands):

                               December 31, 2009     December 31, 2008 3 months or less           $           136,948   $           100,824 Over 3 through 6 months                 23,624                23,589 Over 6 through 12 months                48,868                42,300 Over 12 months                          29,399                24,339 Total                      $           238,839   $           191,052                                            53 

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   Table of Contents    Borrowings    Average short-term borrowings decreased $16.4 million to $7.7 million in 2009. The average rate paid on short-term borrowings decreased from 2.63% in 2008 to 0.68% in 2009, which was primarily driven by the FRB decreasing the Fed Funds target rate (which directly impacts short-term borrowing rates) in 2008. Average long-term debt increased from $202 million in 2008 to $210 million in 2009 which was primarily due to the Company's issuance of $23.1 million of subordinated debt of the Company in the fourth quarter of 2009. - See Note 11 to our consolidated financial statements included in Item 8 hereof.    The average balance of trust preferred debentures remained at $10.3 million in 2009 compared to 2008. The average rate paid for trust preferred debentures in 2009 was 2.69%, down from 4.97% in 2008. The decrease in rate on the trust preferred debentures is due primarily to the previously mentioned decrease in short-term rates during 2009.    Short-term borrowings consist of Federal funds purchased which generally represent overnight borrowing transactions, and other short-term borrowings, primarily FHLB advances, with original maturities of one year or less. The Company has unused lines of credit and access to brokered deposits available for short-term financing of approximately $143 million and $72 million at December 31, 2009 and 2008, respectively. Long-term debt, which is comprised primarily of FHLB advances, are collateralized by the FHLB stock owned by the Company, certain of its mortgage-backed securities and a blanket lien on its residential and commercial real estate mortgage loans.    The maximum amount of borrowings outstanding at any month end during the years ended December 31, 2009 and 2008 were $262.9 million and $260.1 million, respectively.  Federal funds purchased represent overnight borrowings providing for the short-term funding requirements of the Company's banking subsidiary and generally mature within one business day of the transaction. During 2009 the average outstanding balance on these credit lines amounted to $3.4 million and the weighted average rate paid in 2009 was 2.25%. Federal Reserve Discount Window borrowings also represent overnight funding to meet the short-term liquidity requirements of the Bank and are fully collateralized with investment securities. During 2009, the average outstanding balance at the Discount Window was $3.5 million and the average rate paid was 0.50%.    Capital    A strong capital base is essential to the continued growth and profitability of the Company and is therefore a management priority. The Company's principal capital planning goals are to provide an adequate return to shareholders while retaining a sufficient base from which to provide for future growth, while at the same time complying with all regulatory standards. As more fully described in Note 17 to the consolidated financial statements, regulatory authorities have prescribed specified minimum capital ratios as guidelines for determining capital adequacy to help assure the safety and soundness of financial institutions.    The following schedules present information regarding the Company's risk-based capital at December 31, 2009, 2008 and 2007 and selected other capital ratios:                                    CAPITAL ANALYSIS                                   (in thousands)                                                                     December 31                                                      2009 Company                                          (as restated)        2008           2007 Tier I Capital: Total Tier I Capital                            $        84,365    $   117,285    $   109,732 Tier II Capital: Subordinated notes                              $        23,100    $         -    $         - Allowable portion of allowance for loan and lease losses                                             14,594          9,150          7,569 Total Tier II Capital                           $        37,694    $     9,150    $     7,569 Total Risk-Based Capital                        $       122,059    $   126,435    $   117,301 Total Risk-Weighted Assets                      $     1,158,157    $ 1,130,824    $ 1,045,008  Bank Tier I Capital: Total Tier I Capital                            $       103,453    $   117,069    $   109,397 Tier II Capital: Allowable portion of allowance for loan and lease losses                                             14,590          9,150          7,569 Total Tier II Capital                           $        14,590    $     9,150    $     7,569 Total Risk-Based Capital                        $       118,043    $   126,219    $   116,966 Total Risk-Weighted Assets                      $     1,157,823    $ 1,130,490    $ 1,044,676                                            54 

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   Table of Contents                                                                                 To Be Well                                                                              Capitalized                                                                             Under Prompt                                                    For Capital               Corrective                              Actual             Adequacy Purposes         Action Provision As of December 31, 2009 (as restated):     Amount      Ratio        Amount       Ratio       Amount      Ratio Total Capital (to Risk Weighted Assets) Company                $ 122,059     10.54 %  $    >92,653     >8.00 %         N/A        N/A Bank                   $ 118,043     10.20 %  $    >92,626     >8.00 %  $ >115,782     >10.00 % Tier I Capital (to Risk Weighted Assets) Company                $  84,365      7.28 %  $    >46,326     >4.00 %         N/A        N/A Bank                   $ 103,453      8.94 %  $     46,313     >4.00 %  $  >69,469      >6.00 % Tier I Capital (to Average Assets) Company                $  84,365      5.94 %  $    >56,853     >4.00 %         N/A        N/A Bank                   $ 103,453      7.28 %  $    >56,853     >4.00 %  $  >71,067      >5.00 %                                                                                To Be Well                                                                            Capitalized                                                                           Under Prompt                                                     For Capital            Corrective                                  Actual          Adequacy Purposes      Action Provision As of December 31, 2008:     Amount     Ratio      Amount      Ratio     Amount     Ratio Total Capital (to Risk Weighted Assets) Company                     $ 126,435   11.18 % $    >90,466   >8.00 %        N/A      N/A Bank                        $ 126,219   11.16 % $    >90,439   >8.00 % $ >113,049   >10.00 % Tier I Capital (to Risk Weighted Assets) Company                     $ 117,285   10.37 % $    >45,233   >4.00 %        N/A      N/A Bank                        $ 117,069   10.36 % $    >45,220   >4.00 % $  >67,829    >6.00 % Tier I Capital (to Average Assets) Company                     $ 117,285    8.99 % $    >52,184   >4.00 %        N/A      N/A Bank                        $ 117,069    8.95 % $    >52,340   >4.00 % $  >65,425    >5.00 %                                            55 

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   Table of Contents                                      December 31,                              2009                          (as restated)    2008    2007 Return on Assets                 (3.29 )%  1.17 %  1.18 % Return on Equity                (47.78 )% 14.35 % 14.32 % Equity to Assets Ratio            4.62 %   9.18 %  8.43 % Dividend Payout Ratio            (6.18 )% 48.36 % 45.01 %     During 1999, the Company implemented a Dividend Reinvestment Plan ("DRIP") which permits participants to automatically reinvest cash dividends on all of their shares and to make voluntary cash contributions under terms of the plan.  Under the DRIP, participants purchase, at a 10% discount to the 10-day trading average, common shares that are either newly-issued by the Company or acquired by the plan administrator in the open market or privately.    

In 2009, new capital generated from shares issued under the DRIP totaled $1.7 million. The Company has subsequently suspended the operation of the DRIP Plan.

    In 2009, regulatory capital decreased $4.4 million, comprised of a $47.1 million decrease in retained earnings due to a net loss of $44.3 million and payment of cash dividends of $2.7 million, offset by a $1.7 million increase due to the Company's dividend reinvestment plan and a $93 thousand increase due to the issuance of shares from the Company's stock option plans. As of December 31, 2009, there were 33,710,030 common shares available for future sale or share dividends. The number of shareholders of record at December 31, 2009 was approximately 1,650.  Quarterly market highs and lows, dividends paid and known market makers are highlighted in Part I, Item 5 of this report.  Refer to Note 17 to the consolidated financial statements for further discussion of our capital requirements and dividend limitations.  As a result of the Order, the Bank is required to achieve a total capital ratio of 13% and Tier I capital to average assets ratio of 9% by November 30, 2010.  As of August 4, 2011, the Bank has not yet achieved these ratios.  Furthermore, pursuant to the Order and the Agreement, the Bank and the Company are currently prohibited from declaring or paying any dividends without prior regulatory approval.    The Board of Directors (the "Board") has voted to suspend payment of the Company's quarterly dividend indefinitely in an effort to conserve capital. The Board recognizes the importance of preserving cash and, given the challenging economic conditions that continue to impact the health and stability of many businesses within the region we serve, believes dividends should not be paid from current and anticipated earnings to prudently fund fiscal 2010 operations. Suspending the $0.02 per share dividend will save the Company approximately $1.3 million annually. The Board will reevaluate the policy in the future.    The suspension is among several initiatives in place to conserve cash reserves during the nation's protracted economic slump. The Company recently announced it had raised more than $23 million through the sale of subordinated notes which will mature on September 1, 2019. A substantial portion of the net proceeds of the completed sale will be used to strengthen the institution's capital position, improve liquidity, increase lending capacity and support the Company's continuing growth objectives. 

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