UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC 20549





FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
Quarterly Period Ended June 30,
2010





OR





 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
transition period from 
to





Commission
file number 0-19214





UNION NATIONAL FINANCIAL
CORPORATION


(Exact
Name of Registrant as Specified in its Charter)





Pennsylvania
              
              23-2415179(State or Other Jurisdiction of
                Incorporation or Organization)
              
              (I.R.S. Employer Identification
                Number)570 Lausch Lane, Suite 300
                Lancaster, Pennsylvania
              
              17601(Address
      of Principal Executive
                Offices)
              
              (Zip
      Code)





(717)
492-2222


(Registrant's
Telephone Number, Including Area Code)





Indicate
by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.





Yes x No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).





Yes  ̈ No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See definition of “accelerated filer, large accelerated
filer and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
One):





Large
accelerated filer  ̈    Accelerated
filer  ̈    Non-accelerated
filer  ̈    Smaller
reporting company x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).





Yes  ̈ No x





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.





3,011,144 shares of $0.25 (par) common
stock were outstanding as of August 12, 2010.









UNION
NATIONAL FINANCIAL CORPORATION


FORM
10-Q


INDEX





PAGE NO.PART I – FINANCIAL INFORMATIONItem
      1.
                                                        Financial
      Statements (Unaudited)Consolidated
      Statements of Financial ConditionAs
      of June 30, 2010 and December 31, 2009
                                                        1Consolidated
      Statements of OperationsFor
      the Three and Six Months Ended June 30, 2010 and 2009
                                                        2Consolidated
      Statements of Changes in Stockholders’ EquityFor
      the Six Months Ended June 30, 2010 and 2009
                                                        3Consolidated
      Statements of Cash FlowsFor
      the Six Months Ended June 30, 2010 and 2009
                                                        4Notes
      to Unaudited Consolidated Financial Statements
                                                        5 -
      26Item
      2.
                                                        Management’s
      Discussion and Analysis ofFinancial
      Condition and Results of Operations
                                                        27
      - 47Item
      3.
                                                        Quantitative
      and Qualitative Disclosures about Market Risk
                                                        47Item
      4.
                                                        Controls
      and Procedures
                                                        47PART
      II – OTHER
      INFORMATIONItem
      1.
                                                        Legal
      Proceedings
                                                        48Item
      1A.
                                                        Risk
      Factors
                                                        48Item
      2.
                                                        Unregistered
      Sales of Equity Securities and Use of Proceeds
                                                        48Item
      3.
                                                        Defaults
      upon Senior Securities
                                                        48Item
      4.
                                                        (Removed
      and Reserved)
                                                        48Item
      5.
                                                        Other
      Information
                                                        48Item
      6.
                                                        Exhibits
                                                        49Signatures
                                                        52





Unless
the context otherwise requires, the terms “Union National,” “we,” “us,” and
“our” refer to Union National Financial Corporation and its consolidated
subsidiary.





PART I — FINANCIAL
INFORMATION





Item
1.  Financial Statements


Union
National Financial Corporation


Consolidated
Statements of Financial Condition


(Unaudited;
Dollars in thousands, except share and per share data)





June 30,
                                        2010
                                      
                                      
                                      December 31,
                                        2009AssetsCash
      and Due from Banks
                                      
                                      $
                                      8,697
                                      
                                      
                                      $
                                      8,807Interest-Bearing
      Demand Deposits in Other Banks
                                      
                                      
                                      60,329
                                      
                                      
                                      
                                      34,533Total
      Cash and Cash Equivalents
                                      
                                      
                                      69,026
                                      
                                      
                                      
                                      43,340Interest-Bearing
      Time Deposits in Other Banks
                                      
                                      
                                      5,309
                                      
                                      
                                      
                                      9,229Investment
      Securities Available for Sale
                                      
                                      
                                      54,765
                                      
                                      
                                      
                                      60,546Loans
      and Leases, Net of Unearned Income
                                      
                                      
                                      332,735
                                      
                                      
                                      
                                      339,274Less:  Allowance
      for Credit Losses
                                      
                                      
                                      (5,989
                                      )
                                      
                                      
                                      (5,858
                                      )Net
      Loans and Leases
                                      
                                      
                                      326,746
                                      
                                      
                                      
                                      333,416Premises
      and Equipment, Net
                                      
                                      
                                      10,961
                                      
                                      
                                      
                                      11,403Restricted
      Investment in Bank Stocks
                                      
                                      
                                      3,727
                                      
                                      
                                      
                                      3,727Bank-Owned
      Life Insurance
                                      
                                      
                                      11,743
                                      
                                      
                                      
                                      11,539Other
      Real Estate Owned
                                      
                                      
                                      8,694
                                      
                                      
                                      
                                      5,383Other
      Assets
                                      
                                      
                                      10,909
                                      
                                      
                                      
                                      11,061Total
      Assets
                                      
                                      $
                                      501,880
                                      
                                      
                                      $
                                      489,644LiabilitiesDeposits:Noninterest-Bearing
                                      
                                      $
                                      66,611
                                      
                                      
                                      $
                                      54,331Interest-Bearing
                                      
                                      
                                      347,074
                                      
                                      
                                      
                                      350,434Total
      Deposits
                                      
                                      
                                      413,685
                                      
                                      
                                      
                                      404,765Long-Term
      Debt
                                      
                                      
                                      30,834
                                      
                                      
                                      
                                      33,334Junior
      Subordinated Debentures
                                      
                                      
                                      17,341
                                      
                                      
                                      
                                      17,341Other
      Liabilities
                                      
                                      
                                      9,499
                                      
                                      
                                      
                                      2,868Total
      Liabilities
                                      
                                      
                                      471,359
                                      
                                      
                                      
                                      458,308Stockholders’
      EquityPreferred
      Stock (Series A), liquidation value $1,000 per shareShares
      authorized - 5,000; Issued – 1,275 at June 30, 2010 and December 31,
      2009
                                      
                                      
                                      1,275
                                      
                                      
                                      
                                      1,275Common
      Stock, par value $0.25 per shareShares
      authorized - 20,000,000; Issued – 3,110,584 and 3,109,105 at June 30, 2010
      and December 31, 2009, respectively; Outstanding - 2,742,395 and 2,740,916
      at June 30, 2010 and December 31, 2009, respectively
                                      
                                      
                                      778
                                      
                                      
                                      
                                      777Surplus
                                      
                                      
                                      13,896
                                      
                                      
                                      
                                      13,891Retained
      Earnings
                                      
                                      
                                      21,885
                                      
                                      
                                      
                                      22,921Accumulated
      Other Comprehensive Income (Loss)
                                      
                                      
                                      20
                                      
                                      
                                      
                                      (195
                                      )Treasury
      Stock, at cost;  368,189 at June 30, 2010 and December 31,
      2009
                                      
                                      
                                      (7,333
                                      )
                                      
                                      
                                      (7,333
                                      )Total
      Stockholders’ Equity
                                      
                                      
                                      30,521
                                      
                                      
                                      
                                      31,336Total
      Liabilities and Stockholders’ Equity
                                      
                                      $
                                      501,880
                                      
                                      
                                      $
                                      489,644





See
accompanying notes to unaudited consolidated financial
statements.


1


Union
National Financial Corporation


Consolidated
Statements of Operations


(Unaudited;
Dollars in thousands, except per share data)





Three Months Ended June 30,
                
                
                Six Months Ended June 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Interest
      IncomeInterest
      and Fees on Loans and Leases
                
                $
                4,998
                
                
                $
                5,496
                
                
                $
                10,007
                
                
                $
                10,881Investment
      Securities:Taxable
      Interest
                
                
                396
                
                
                
                372
                
                
                
                834
                
                
                
                967Tax-Exempt
      Interest
                
                
                15
                
                
                
                67
                
                
                
                15
                
                
                
                89Dividends
                
                
                9
                
                
                
                9
                
                
                
                18
                
                
                
                22Other
                
                
                62
                
                
                
                53
                
                
                
                128
                
                
                
                87Total
      Interest Income
                
                
                5,480
                
                
                
                5,997
                
                
                
                11,002
                
                
                
                12,046Interest
      ExpenseDeposits
                
                
                1,494
                
                
                
                2,216
                
                
                
                3,175
                
                
                
                4,518Long-Term
      Debt
                
                
                391
                
                
                
                516
                
                
                
                784
                
                
                
                1,161Junior
      Subordinated Debentures
                
                
                192
                
                
                
                213
                
                
                
                381
                
                
                
                444Total
      Interest Expense
                
                
                2,077
                
                
                
                2,945
                
                
                
                4,340
                
                
                
                6,123Net
      Interest Income
                
                
                3,403
                
                
                
                3,052
                
                
                
                6,662
                
                
                
                5,923Provision
      for Credit Losses
                
                
                628
                
                
                
                611
                
                
                
                1,124
                
                
                
                924Net
      Interest Income after Provision for Credit Losses
                
                
                2,775
                
                
                
                2,441
                
                
                
                5,538
                
                
                
                4,999Non-Interest
      IncomeService
      Charges on Deposit Accounts
                
                
                498
                
                
                
                540
                
                
                
                956
                
                
                
                1,013Other
      Service Charges, Commissions, Fees
                
                
                316
                
                
                
                297
                
                
                
                604
                
                
                
                564Alternative
      Investment Sales Commissions
                
                
                167
                
                
                
                193
                
                
                
                334
                
                
                
                303Income
      from Fiduciary Activities
                
                
                41
                
                
                
                47
                
                
                
                88
                
                
                
                93Earnings
      from Bank-Owned Life Insurance
                
                
                102
                
                
                
                107
                
                
                
                204
                
                
                
                215Other
      Income
                
                
                42
                
                
                
                333
                
                
                
                83
                
                
                
                376Net
      Gain on Sale of Investment Securities
                
                
                289
                
                
                
                983
                
                
                
                366
                
                
                
                1,394Other-than-temporary
      Impairments (“OTTI”) of Securities
                
                
                (1,560
                )
                
                
                (462
                )
                
                
                (1,560
                )
                
                
                (1,301
                )Portion
      of OTTI Recognized in Other Comprehensive Income
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Net
      OTTI Losses on Securities
                
                
                (1,560
                )
                
                
                (462
                )
                
                
                (1,560
                )
                
                
                (1,301
                )Total
      Non-Interest (Loss) Income
                
                
                (105
                )
                
                
                2,038
                
                
                
                1,075
                
                
                
                2,657Non-Interest
      ExpenseSalaries,
      Wages, and Employee Benefits
                
                
                1,663
                
                
                
                1,671
                
                
                
                3,461
                
                
                
                3,617Net
      Occupancy
                
                
                442
                
                
                
                421
                
                
                
                904
                
                
                
                899Data
      and ATM Processing
                
                
                461
                
                
                
                426
                
                
                
                867
                
                
                
                830Professional
      Fees and Regulatory Assessments
                
                
                206
                
                
                
                244
                
                
                
                412
                
                
                
                501Furniture
      and Equipment
                
                
                220
                
                
                
                240
                
                
                
                438
                
                
                
                486FDIC
      Insurance
                
                
                239
                
                
                
                540
                
                
                
                467
                
                
                
                660Pennsylvania
      Shares Tax
                
                
                96
                
                
                
                89
                
                
                
                191
                
                
                
                178Advertising
      and Marketing
                
                
                52
                
                
                
                50
                
                
                
                90
                
                
                
                117Supplies
      and Postage
                
                
                59
                
                
                
                74
                
                
                
                119
                
                
                
                148Merger
      and Acquisition Expense
                
                
                436
                
                
                
                —
                
                
                
                436
                
                
                
                —Other
      Expense
                
                
                410
                
                
                
                725
                
                
                
                921
                
                
                
                1,058Total
      Non-Interest Expense
                
                
                4,284
                
                
                
                4,480
                
                
                
                8,306
                
                
                
                8,494Loss
      Before Benefit from Income Taxes
                
                
                (1,614
                )
                
                
                (1
                )
                
                
                (1,693
                )
                
                
                (838
                )Benefit
      from Income Taxes
                
                
                (610
                )
                
                
                (106
                )
                
                
                (692
                )
                
                
                (434
                )Net
      (Loss) Income
                
                
                (1,004
                )
                
                
                105
                
                
                
                (1,001
                )
                
                
                (404
                )Preferred
      Stock Dividends
                
                
                17
                
                
                
                —
                
                
                
                35
                
                
                
                —Net
      (Loss) Income Available to Common Stockholders
                
                $
                (1,021
                )
                
                $
                105
                
                
                $
                (1,036
                )
                
                $
                (404
                )(Loss)
      Income Per Common ShareBasic
      and Diluted
                
                $
                (0.37
                )
                
                $
                0.04
                
                
                $
                (0.38
                )
                
                $
                (0.15
                )Cash
      Dividends Paid Per Common Share
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —




See
accompanying notes to unaudited consolidated financial
statements.


2


Union
National Financial Corporation


Consolidated
Statements of Changes in Stockholders’ Equity


(Unaudited;
Dollars in thousands, except share data)





Six Months Ended June 30, 2010Shares of
                      Common
                      Stock
                      Outstanding
                    
                    
                    Preferred
                      Stock
                    
                    
                    Common
                      Stock
                    
                    
                    Surplus
                    
                    
                    Retained
                      Earnings
                    
                    
                    Accumulated
                      Other
                      Comprehensive
                      (Loss) Income
                    
                    
                    Treasury
                      Stock
                    
                    
                    TotalBalance
      at December 31, 2009
                    
                    
                    2,740,916
                    
                    
                    $
                    1,275
                    
                    
                    $
                    777
                    
                    
                    $
                    13,891
                    
                    
                    $
                    22,921
                    
                    
                    $
                    (195
                    )
                    
                    $
                    (7,333
                    )
                    
                    $
                    31,336Comprehensive
      Loss:Net
      Loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (1,001
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (1,001
                    )Net
      Change in Unrealized Gains on Available- for-Sale Securities, Net of
      Tax
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    215
                    
                    
                    
                    —
                    
                    
                    
                    215Total
      Comprehensive Loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (786
                    )Issuance
      of Common Stock under Dividend Reinvestment Plan
                    
                    
                    1,479
                    
                    
                    
                    —
                    
                    
                    
                    1
                    
                    
                    
                    5
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    6Cash
      Dividends Paid to Preferred Stockholders
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (35
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (35
                    )Balance
      at June 30, 2010
                    
                    
                    2,742,395
                    
                    
                    $
                    1,275
                    
                    
                    $
                    778
                    
                    
                    $
                    13,896
                    
                    
                    $
                    21,885
                    
                    
                    $
                    20
                    
                    
                    $
                    (7,333
                    )
                    
                    $
                    30,521





Six Months Ended June 30, 2009Shares of
                      Common
                      Stock
                      Outstanding
                    
                    
                    Preferred
                      Stock
                    
                    
                    Common
                      Stock
                    
                    
                    Surplus
                    
                    
                    Retained
                      Earnings
                    
                    
                    Accumulated
                      Other
                      Comprehensive
                      Income (Loss)
                    
                    
                    Treasury
                      Stock
                    
                    
                    TotalBalance
      at December 31, 2008
                    
                    
                    2,720,076
                    
                    
                    $
                    —
                    
                    
                    $
                    785
                    
                    
                    $
                    14,868
                    
                    
                    $
                    23,434
                    
                    
                    $
                    36
                    
                    
                    $
                    (8,329
                    )
                    
                    $
                    30,794Comprehensive
      Loss:Net
      Loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (404
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (404
                    )Reclassification
      Adjustment for Cumulative Effect of ASC Topic 320, “Investments – Debt and
      Equity Securities”, Net of Tax
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    202
                    
                    
                    
                    (202
                    )
                    
                    
                    —
                    
                    
                    
                    —Net
      Change in Unrealized Gains on Available-for-Sale Securities, Net of
      Tax
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    165
                    
                    
                    
                    —
                    
                    
                    
                    165Total
      Comprehensive Loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (239
                    )Issuance
      of Common Stock under Dividend Reinvestment Plan
                    
                    
                    14,580
                    
                    
                    
                    —
                    
                    
                    
                    3
                    
                    
                    
                    44
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    47Balance
      at June 30, 2009
                    
                    
                    2,734,656
                    
                    
                    $
                    —
                    
                    
                    $
                    788
                    
                    
                    $
                    14,912
                    
                    
                    $
                    23,232
                    
                    
                    $
                    (1
                    )
                    
                    $
                    (8,329
                    )
                    
                    $
                    30,602





See
accompanying notes to unaudited consolidated financial
statements.


3


Union
      National Financial Corporation


Consolidated
      Statements of Cash Flows


(Unaudited;
      Dollars in thousands)





Six Months Ended June 30,2010
                    
                    
                    2009Cash
      Flows from Operating ActivitiesNet
      Loss
                    
                    $
                    (1,001
                    )
                    
                    $
                    (404
                    )Adjustments
      to Reconcile Net Loss to Net Cash Provided by (Used In) Operating
      Activities:Depreciation
      and Amortization
                    
                    
                    533
                    
                    
                    
                    608Provision
      for Credit Losses
                    
                    
                    1,124
                    
                    
                    
                    924Net
      Amortization of Investment Securities Premiums
                    
                    
                    235
                    
                    
                    
                    181Net
      Investment Securities Gains on Sales
                    
                    
                    (366
                    )
                    
                    
                    (1,394
                    )OTTI
      Losses on Investment Securities
                    
                    
                    1,560
                    
                    
                    
                    1,301Benefit
      from Deferred Income Taxes
                    
                    
                    (731
                    )
                    
                    
                    —Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (204
                    )
                    
                    
                    (215
                    )Decrease
      (Increase) in Accrued Interest Receivable
                    
                    
                    82
                    
                    
                    
                    (211
                    )Decrease
      (Increase) in Other Assets
                    
                    
                    669
                    
                    
                    
                    (1,751
                    )Increase
      in Other Liabilities
                    
                    
                    6,631
                    
                    
                    
                    729Net
      Cash Provided by (Used in) Operating Activities
                    
                    
                    8,532
                    
                    
                    
                    (232
                    )Cash
      Flows from Investing ActivitiesProceeds
      from Sales of Available-for-Sale Securities
                    
                    
                    61,398
                    
                    
                    
                    71,195Proceeds
      from Maturities and Principal Repayments on Available-for-Sale
      Securities
                    
                    
                    4,820
                    
                    
                    
                    14,664Purchases
      of Available-for-Sale Securities
                    
                    
                    (61,538
                    )
                    
                    
                    (100,581
                    )Proceeds
      from Calls, Maturities and Sales (Purchases) of Time Deposits in Other
      Banks
                    
                    
                    3,920
                    
                    
                    
                    (10,673
                    )Net
      Decrease in Loans and Leases
                    
                    
                    2,235
                    
                    
                    
                    7,055Purchases
      of Premises, Equipment and Software
                    
                    
                    (72
                    )
                    
                    
                    (331
                    )Net
      Increase of Restricted Investments in Bank Stocks
                    
                    
                    —
                    
                    
                    
                    (2
                    )Net
      Cash Provided by (Used in) Investing Activities
                    
                    
                    10,763
                    
                    
                    
                    (18,673
                    )Cash
      Flows from Financing ActivitiesNet
      Increase in Demand Deposits and Savings Accounts
                    
                    
                    587
                    
                    
                    
                    28,310Net
      Increase in Time Deposits
                    
                    
                    8,333
                    
                    
                    
                    13,781Payments
      on Long-Term Debt
                    
                    
                    (2,500
                    )
                    
                    
                    (12,000
                    )Issuance
      of Common Stock, Net of Costs
                    
                    
                    6
                    
                    
                    
                    47Cash
      Dividends Paid to Preferred Stockholders
                    
                    
                    (35
                    )
                    
                    
                    —Net
      Cash Provided by Financing Activities
                    
                    
                    6,391
                    
                    
                    
                    30,138Net
      Increase in Cash and Cash Equivalents
                    
                    
                    25,686
                    
                    
                    
                    11,233Cash
      and Cash Equivalents at Beginning of Period
                    
                    
                    43,340
                    
                    
                    
                    31,837Cash
      and Cash Equivalents at End of Period
                    
                    $
                    69,026
                    
                    
                    $
                    43,070Supplemental
      Disclosures of Cash Flow InformationInterest
      Paid
                    
                    $
                    4,507
                    
                    
                    $
                    6,281Income
      Tax Paid
                    
                    
                    —
                    
                    
                    
                    750Supplemental
      Schedule of Noncash ActivitiesTransfers
      to Other Real Estate Owned
                    
                    $
                    3,311
                    
                    
                    $
                    349





See
accompanying notes to unaudited consolidated financial
statements.


4


Union
National Financial Corporation


Notes
to Unaudited Consolidated Financial Statements





Note
1 — Basis of Presentation





The
accompanying unaudited consolidated financial statements include the accounts of
Union National Financial Corporation (“Union National”) and its subsidiary Union
National Community Bank (the “Bank”).   All material intercompany
accounts and transactions have been eliminated in consolidation.  Union
National’s trust subsidiaries, Union National Capital Trust I and Union National
Capital Trust II, which were established during 2003 and 2004 for the purpose of
issuing $11,000,000 of trust capital securities, are not
consolidated.





Certain
information and footnote disclosures normally included in consolidated financial
statements prepared in accordance with generally accepted accounting principles
in the United States of America (“GAAP”) have been condensed or omitted pursuant
to the rules and regulations of the Securities and Exchange Commission
(“SEC”).  The consolidated financial statements contain all adjustments
(consisting only of normal recurring accruals and adjustments) necessary to
present fairly our financial position as of June 30, 2010 and December 31, 2009,
and the related consolidated statements of operations, changes in stockholders’
equity and cash flows for each of the periods ended June 30, 2010 and
2009.  The results of operations for interim periods are not necessarily
indicative of operating results expected for the full year.  These interim
consolidated financial statements should be read in conjunction with the audited
financial statements and notes thereto included in Union National’s Annual
Report on Form 10-K for the year ended December 31, 2009, and with Union
National’s Forms 8-K, and other reports, that were filed during 2010 with the
SEC.





Union
National has evaluated events and transactions occurring subsequent to the
balance sheet date of June 30, 2010, for items that should potentially be
recognized or disclosed in the consolidated financial statements. The evaluation
was conducted through the date these consolidated financial statements were
issued.





Note
2 — Use of Estimates





The
process of preparing consolidated financial statements in conformity with GAAP
requires the use of estimates and assumptions that affect the reported amounts
of certain types of assets, liabilities, revenues and expenses. 
Accordingly, actual results may differ from estimated amounts.  Material
estimates that are particularly susceptible to significant change in the near
term relate to the determination of the allowance for credit losses, the
valuation of deferred tax assets, the assessment of other-than-temporary
impairment of investment securities, the potential impairment of restricted
stock and fair value disclosures.





Note
3 — Recent Accounting Pronouncements





ASU
2009-16. In
October 2009, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Update (“ASU”) 2009-16, “Transfers and Servicing
(Accounting Standards Codification (“ASC”) Topic 860) - Accounting for Transfers
of Financial Assets”. This ASU amends the Codification for the issuance of FASB
Statement No. 166, Accounting for Transfers of Financial Assets - an amendment
of FASB Statement No. 140.





The
amendments in this ASU improve financial reporting by eliminating the exceptions
for qualifying special-purpose entities from the consolidation guidance and the
exception that permitted sale accounting for certain mortgage securitizations
when a transferor has not surrendered control over the transferred financial
assets. In addition, the amendments require enhanced disclosures about the risks
that a transferor continues to be exposed to because of its continuing
involvement in transferred financial assets.  Comparability and consistency
in accounting for transferred financial assets will also be improved through
clarifications of the requirements for isolation and limitations on portions of
financial assets that are eligible for sale accounting.


5


This
guidance became effective January 1, 2010, and did not have a significant impact
on Union National’s financial condition or results of operations.





ASU
2009-17.  In
October 2009, the FASB issued ASU 2009-17, “Consolidations (ASC Topic 810) -
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities”.  This Update amends the Codification for the issuance
of FASB Statement No. 167, “Amendments to FASB Interpretation No.
46(R)”.





The
amendments in this ASU replace the quantitative-based risks and rewards
calculation for determining which reporting entity, if any, has a controlling
financial interest in a variable interest entity with an approach focused on
identifying which reporting entity has the power to direct the activities of a
variable interest entity that most significantly impact the entity’s economic
performance and (1) the obligation to absorb losses of the entity or (2) the
right to receive benefits from the entity. An approach that is expected to be
primarily qualitative will be more effective for identifying which reporting
entity has a controlling financial interest in a variable interest entity. 
The amendments in this ASU also require additional disclosures about a reporting
entity’s involvement in variable interest entities, which will enhance the
information provided to users of financial statements.





This
guidance became effective January 1, 2010, and did not have a significant impact
on Union National’s financial condition or results of operations.





ASU
2010-18.  ASU 2010-18, “Receivables (ASC Topic 310): Effect of a
Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a
Single Asset”, codifies the consensus reached in EITF Issue No. 09-I, “Effect of
a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a
Single Asset.” The amendments to the Codification provide that modifications of
loans that are accounted for within a pool under Subtopic 310-30 do not result
in the removal of those loans from the pool even if the modification of those
loans would otherwise be considered a troubled debt restructuring. An entity
will continue to be required to consider whether the pool of assets in which the
loan is included is impaired if expected cash flows for the pool change. ASU
2010-18 does not affect the accounting for loans under the scope of Subtopic
310-30 that are not accounted for within pools. Loans accounted for individually
under Subtopic 310-30 continue to be subject to the troubled debt restructuring
accounting provisions within Subtopic 310-40.





ASU
2010-18 is effective prospectively for modifications of loans accounted for
within pools under Subtopic 310-30 occurring in the first interim or annual
period ending on or after July 15, 2010. Early application is permitted. Upon
initial adoption of ASU 2010-18, an entity may make a one-time election to
terminate accounting for loans as a pool under ASC Subtopic 310-30. This
election may be applied on a pool-by-pool basis and does not preclude an entity
from applying pool accounting to subsequent acquisitions of loans with credit
deterioration.  Union National’s adoption of this new pronouncement will
not have a significant impact on Union National’s consolidated financial
statements.





ASU
2010-20.  ASU 2010-20, “Receivables (ASC Topic 310): Disclosures
about the Credit Quality of Financing Receivables and the Allowance for Credit
Losses”, will help investors assess the credit risk of a company’s receivables
portfolio and the adequacy of its allowance for credit losses held against the
portfolios by expanding credit risk disclosures.





This ASU
requires more information about the credit quality of financing receivables in
the disclosures to financial statements, such as aging information and credit
quality indicators.  Both new and existing disclosures must be
disaggregated by portfolio segment or class.  The disaggregation of
information is based on how a company develops its allowance for credit losses
and how it manages its credit exposure.


6


The
amendments in this Update apply to all public and nonpublic entities with
financing receivables.  Financing receivables include loans and trade
accounts receivable.  However, short-term trade accounts receivable,
receivables measured at fair value or lower of cost or fair value, and debt
securities are exempt from these disclosure amendments.





For
public companies, the amendments that require disclosures as of the end of a
reporting period are effective for periods ending on or after December 15,
2010.  The amendments that require disclosures about activity that occurs
during a reporting period are effective for periods beginning on or after
December 15, 2010.  Union National is assessing the impact of this new ASC,
but believes the adoption of this new pronouncement will not have a material
impact on its consolidated financial statements.





Note
4 — Earnings (Loss) Per Common Share





Basic
earnings (loss) per common share is computed by dividing net income (loss)
available to common shareholders by the weighted-average number of common shares
outstanding during the period.  Diluted earnings (loss) per common share
reflects the potential dilution that could occur if (i) preferred stock shares
were converted to common stock shares, and (ii) options to issue common stock
were exercised.  The terms of the potential conversion of preferred stock
to common stock shares are discussed in Note 8 — Stock Issued Under Private
Placement Offerings and Dividend Reinvestment Plan.Potential common
shares that may be issued related to outstanding stock options are determined
using the treasury stock method.  For the three and six months ended June
30, 2010, there were no preferred stock conversions, which potentially would
have a dilutive effect.  The dilutive earnings (loss) per common share for
each period was not affected by the impact of stock options.  At June 30,
2010 and 2009, there were 77,517 and 91,958 stock options outstanding,
respectively, which had no intrinsic value.





The
computation of basic and diluted earnings (loss) per common share, net income
(loss) available to common shareholders, and weighted-average number of shares
outstanding for the three and six months ended June 30, 2010 and 2009, are
presented below (amounts, except earnings (loss) per share, in
thousands):





Three Months Ended June 30,
                    
                    
                    Six Months Ended June 30,2010
                    
                    
                    2009
                    
                    
                    2010
                    
                    
                    2009Net
      (Loss) Income Available to Common Stockholders
                    
                    $
                    (1,021
                    )
                    
                    $
                    105
                    
                    
                    $
                    (1,036
                    )
                    
                    $
                    (404
                    )Weighted-average
      Common Shares Outstanding
                    
                    
                    2,742
                    
                    
                    
                    2,721
                    
                    
                    
                    2,742
                    
                    
                    
                    2,721Basic
      (Loss) Earnings Per Common Share
                    
                    $
                    (0.37
                    )
                    
                    $
                    0.04
                    
                    
                    $
                    (0.38
                    )
                    
                    $
                    (0.15
                    )Weighted-average Common Shares Outstanding
                    
                    
                    2,742
                    
                    
                    
                    2,721
                    
                    
                    
                    2,742
                    
                    
                    
                    2,721Effect
      of Diluted Securities:Convertible
      Preferred Stock (1)
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Stock
      Options
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Total
      Weighted-average Common Shares and Equivalents
                    
                    
                    2,742
                    
                    
                    
                    2,721
                    
                    
                    
                    2,742
                    
                    
                    
                    2,721Diluted
      (Loss) Earnings Per Common Share
                    
                    $
                    (0.37
                    )
                    
                    $
                    0.04
                    
                    
                    $
                    (0.38
                    )
                    
                    $
                    (0.15
                    )


(1)   Had Union
National not been in a loss position for the three and six months ended June 30,
2010, the impact on diluted loss per common share would have been an additional
319,000 weighted-average common shares outstanding for convertible preferred
stock that was issued beginning in September 2009.  This would reflect the
potential dilution that could occur if preferred stock shares were converted to
common stock shares.  There were no shares of preferred stock outstanding
at June 30, 2009.


7


Note
5 — Investment Securities Available For Sale





The
amortized cost and fair value of investment securities are presented in the
tables below as of June 30, 2010 and December 31, 2009 (in thousands).  The
unrealized gains (losses) for these investment securities have been recorded in
accumulated other comprehensive income (loss), net of related tax expense
(benefit), which amounted to a net unrealized gain of $20,000 at June 30, 2010,
as compared to a net unrealized loss of ($195,000) at December 31, 2009,
recorded in accumulated other comprehensive income (loss).  At June 30,
2010, the amortized cost of the private issuer mortgage-backed securities and
corporate securities reflect cumulative reductions for other-than-temporary
impairment charges of $2,642,000 and $639,000, respectively. During 2009,
other-than-temporary impairment charges on the private issuer mortgage-backed
securities were adjusted accordingly for the cumulative effect of the adoption
of ASC Topic 320, “Investments – Debt and Equity Securities”, as discussed on
page 11 under the section of Note 5 titled “Other-Than-Temporary Impairment of
Investment Securities”.





At June 30, 2010Gross
                  
                  
                  GrossAmortized
                  
                  
                  Unrealized
                  
                  
                  Unrealized
                  
                  
                  FairCost
                  
                  
                  Gains
                  
                  
                  Losses
                  
                  
                  ValueObligations
      of State and Political Subdivisions
                  
                  $
                  24,202
                  
                  
                  $
                  25
                  
                  
                  $
                  (175
                  )
                  
                  $
                  24,052U.S.
      Agency Mortgage-Backed Securities
                  
                  
                  17,110
                  
                  
                  
                  160
                  
                  
                  
                  (28
                  )
                  
                  
                  17,242U.S.
      Agency Bonds and Structured Notes
                  
                  
                  12,516
                  
                  
                  
                  55
                  
                  
                  
                  —
                  
                  
                  
                  12,571Private
      Issuer Mortgage-Backed Securities
                  
                  
                  706
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  706Corporate
      Securities
                  
                  
                  129
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  129Equity
      Securities
                  
                  
                  70
                  
                  
                  
                  8
                  
                  
                  
                  (13
                  )
                  
                  
                  65Total
      Investment Securities
                  
                  $
                  54,733
                  
                  
                  $
                  248
                  
                  
                  $
                  (216
                  )
                  
                  $
                  54,765





At December 31, 2009Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    53,752
                    
                    
                    $
                    26
                    
                    
                    $
                    (384
                    )
                    
                    $
                    53,394Private
      Issuer Mortgage-Backed Securities
                    
                    
                    2,468
                    
                    
                    
                    170
                    
                    
                    
                    —
                    
                    
                    
                    2,638Obligations
      of State and Political Subdivisions
                    
                    
                    4,016
                    
                    
                    
                    —
                    
                    
                    
                    (201
                    )
                    
                    
                    3,815Corporate
      Securities
                    
                    
                    535
                    
                    
                    
                    96
                    
                    
                    
                    —
                    
                    
                    
                    631Equity
      Securities
                    
                    
                    71
                    
                    
                    
                    8
                    
                    
                    
                    (11
                    )
                    
                    
                    68Total
      Investment Securities
                    
                    $
                    60,842
                    
                    
                    $
                    300
                    
                    
                    $
                    (596
                    )
                    
                    $
                    60,546





Investment
securities carried at fair value of $47,034,000 and $57,209,000 at June 30, 2010
and December 31, 2009, respectively, were pledged to secure public and
government entity deposits, trust deposits, and as collateral for the Bank’s
borrowing availability at the Federal Reserve Bank.


8


The
amortized cost and fair value of investment securities at June 30, 2010 and
December 31, 2009, by contractual maturity, are shown below (in
thousands).  Expected maturities may differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without penalties.





June 30, 2010
                  
                  
                  December 31, 2009Maturity
                  
                  Amortized
                    Cost
                  
                  
                  Fair Value
                  
                  
                  Amortized
                    Cost
                  
                  
                  Fair ValueDue
      in One Year or Less
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —Due
      After One Year Through Five Years
                  
                  
                  9,518
                  
                  
                  
                  9,546
                  
                  
                  
                  —
                  
                  
                  
                  —Due
      After Five Years Through Ten Years
                  
                  
                  7,781
                  
                  
                  
                  7,828
                  
                  
                  
                  —
                  
                  
                  
                  —Due
      After Ten Years
                  
                  
                  19,548
                  
                  
                  
                  19,378
                  
                  
                  
                  4,551
                  
                  
                  
                  4,44636,847
                  
                  
                  
                  36,752
                  
                  
                  
                  4,551
                  
                  
                  
                  4,446U.S.
      Agency Mortgage-Backed Securities
                  
                  
                  17,110
                  
                  
                  
                  17,242
                  
                  
                  
                  53,752
                  
                  
                  
                  53,394Private
      Issuer Mortgage-Backed Securities
                  
                  
                  706
                  
                  
                  
                  706
                  
                  
                  
                  2,468
                  
                  
                  
                  2,638Equity
      Securities
                  
                  
                  70
                  
                  
                  
                  65
                  
                  
                  
                  71
                  
                  
                  
                  68Total
      Investment Securities
                  
                  $
                  54,733
                  
                  
                  $
                  54,765
                  
                  
                  $
                  60,842
                  
                  
                  $
                  60,546





The
following tables present investment securities with gross unrealized losses that
are not deemed to be other-than-temporarily impaired.  These securities are
aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at June 30, 2010 and
December 31, 2009 (in thousands):





At June 30, 2010Less than 12 Months
                  
                  
                  12 Months or More
                  
                  
                  TotalFair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    LossesObligations
      of State and Political Subdivisions
                  
                  $
                  12,477
                  
                  
                  $
                  (175
                  )
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  12,477
                  
                  
                  $
                  (175
                  )U.S.
      Agency Mortgage-Backed Securities
                  
                  
                  2,102
                  
                  
                  
                  (28
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,102
                  
                  
                  
                  (28
                  )Equity
      Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  16
                  
                  
                  
                  (13
                  )
                  
                  
                  16
                  
                  
                  
                  (13
                  )Temporarily
      Impaired Securities
                  
                  $
                  14,579
                  
                  
                  $
                  (203
                  )
                  
                  $
                  16
                  
                  
                  $
                  (13
                  )
                  
                  $
                  14,595
                  
                  
                  $
                  (216
                  )





At December 31, 2009Less than 12 Months
                  
                  
                  12 Months or More
                  
                  
                  TotalFair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    Losses
                  
                  
                  Fair
                    Value
                  
                  
                  Unrealized
                    LossesU.S.
      Agency Mortgage-Backed Securities
                  
                  $
                  41,565
                  
                  
                  $
                  (384
                  )
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  41,565
                  
                  
                  $
                  (384
                  )Obligations
      of State and Political Subdivisions
                  
                  
                  3,815
                  
                  
                  
                  (201
                  )
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  3,815
                  
                  
                  
                  (201
                  )Equity
      Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  18
                  
                  
                  
                  (11
                  )
                  
                  
                  18
                  
                  
                  
                  (11
                  )Temporarily
      Impaired Securities
                  
                  $
                  45,380
                  
                  
                  $
                  (585
                  )
                  
                  $
                  18
                  
                  
                  $
                  (11
                  )
                  
                  $
                  45,398
                  
                  
                  $
                  (596
                  )





Debt
securities include mortgage-backed securities, obligations of state and
political subdivisions, obligations of U.S. government agencies, structured
notes and corporate securities. At June 30, 2010, there were fourteen debt
securities with unrealized losses of $203,000 that amounted to 1.4% of their
amortized cost, as compared to December 31, 2009, when there were twenty-seven
debt securities with unrealized losses of $585,000 that amounted to 1.3% of
their amortized cost.  Management believes that the unrealized losses
reflect temporary declines primarily due to changes in interest rates subsequent
to the acquisition of specific securities.  These temporary declines have
been accounted for in other comprehensive income (loss).


9


Equity
securities held are comprised primarily of common stock holdings in other
financial institutions.  There were nine and ten equity securities with
unrealized losses of $13,000 and $11,000 at June 30, 2010 and December 31, 2009,
respectively.  Union National has the ability and intent to hold these
investments for a reasonable period of time sufficient for each security to
increase in value to Union National’s cost, and none are in companies with known
debt defaults or deferrals.  Management does not consider the equity
securities to be other-than-temporarily impaired at June 30, 2010.





For the
three months ended June 30, 2010 and 2009, Union National received gross
proceeds of $44,919,000 and $48,043,000, respectively, on the sale of investment
securities.  The following tables present information related to the
realized gains and losses on the sales of investment securities, and losses
recognized on the other-than-temporary impairment of investment securities, for
the three months ended June 30, 2010 and 2009 (in thousands):





Three Months Ended June 30, 2010Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)U.S.
      Agency Mortgage-Backed Securities
                
                $
                270
                
                
                $
                —
                
                
                $
                —
                
                
                $
                270U.S.
      Agency Bonds
                
                
                19
                
                
                
                —
                
                
                
                —
                
                
                
                19Private
      Issuer Mortgage-Backed Securities
                
                
                —
                
                
                
                —
                
                
                
                (1,451
                )
                
                
                (1,451
                )Corporate
      Securities
                
                
                —
                
                
                
                —
                
                
                
                (109
                )
                
                
                (109
                )Total
                
                $
                289
                
                
                $
                —
                
                
                $
                (1,560
                )
                
                $
                (1,271
                )





Three Months Ended June 30, 2009Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)U.S.
      Agency Mortgage-Backed Securities
                
                $
                1,023
                
                
                $
                (11
                )
                
                $
                —
                
                
                $
                1,012Private
      Issuer Mortgage-Backed Securities
                
                
                —
                
                
                
                —
                
                
                
                (452
                )
                
                
                (452
                )Corporate
      Securities
                
                
                —
                
                
                
                —
                
                
                
                (10
                )
                
                
                (10
                )Obligations
      of U.S. Government Agencies
                
                
                10
                
                
                
                —
                
                
                
                —
                
                
                
                10Equity
      Securities
                
                
                —
                
                
                
                (39
                )
                
                
                —
                
                
                
                (39
                )Total
                
                $
                1,033
                
                
                $
                (50
                )
                
                $
                (462
                )
                
                $
                521


10


For the
six months ended June 30, 2010 and 2009, Union National received gross proceeds
of $61,398,000 and $71,195,000, respectively, on the sale of investment
securities.  The following tables present information related to the
realized gains and losses on the sales of investment securities, and losses
recognized on the other-than-temporary impairment of investment securities, for
the six months ended June 30, 2010 and 2009 (in thousands):





Six Months Ended June 30, 2010Gross
                    Realized
                    Gains
                  
                  
                  Gross
                    Realized
                    Losses
                  
                  
                  Other-than-
                    temporary
                    Impairment
                    Losses
                  
                  
                  Net Gains
                    (Losses)U.S.
      Agency Mortgage-Backed Securities
                  
                  $
                  317
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  317Obligations
      of State and Political Subdivisions
                  
                  
                  24
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  24U.S.
      Agency Bonds
                  
                  
                  19
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  19Private
      Issuer Mortgage-Backed Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (1,451
                  )
                  
                  
                  (1,451
                  )Corporate
      Securities
                  
                  
                  5
                  
                  
                  
                  —
                  
                  
                  
                  (109
                  )
                  
                  
                  (104
                  )Equity
      Securities
                  
                  
                  1
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1Total
                  
                  $
                  366
                  
                  
                  $
                  —
                  
                  
                  $
                  (1,560
                  )
                  
                  $
                  (1,194
                  )





Six Months Ended June 30, 2009Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)U.S.
      Agency Mortgage-Backed Securities
                
                $
                1,466
                
                
                $
                (43
                )
                
                $
                —
                
                
                $
                1,423Private
      Issuer Mortgage-Backed Securities
                
                
                —
                
                
                
                —
                
                
                
                (452
                )
                
                
                (452
                )Corporate
      Securities
                
                
                —
                
                
                
                —
                
                
                
                (849
                )
                
                
                (849
                )Obligations
      of U.S. Government Agencies
                
                
                10
                
                
                
                —
                
                
                
                —
                
                
                
                10Equity
      Securities
                
                
                —
                
                
                
                (39
                )
                
                
                —
                
                
                
                (39
                )Total
                
                $
                1,476
                
                
                $
                (82
                )
                
                $
                (1,301
                )
                
                $
                93





Other-Than-Temporary
Impairment of Investment Securities


In
determining fair value and assessing the potential for other-than-temporary
impairment (“OTTI”) of investment securities  as of June 30, 2010,
management primarily considered accounting principles and guidance from ASC
Topic 320, “Investments – Debt and Equity Securities”, and ASC Topic 820, “Fair
Value Measurements and Disclosures”.  Additionally, management considered
SEC guidance including SAB Topic 5M, “Miscellaneous Accounting – Other Than
Temporary Impairment of Certain Investments in Debt and Equity Securities”, and
additional interpretive guidance SEC Press Release #2008-234, “SEC Office of the
Chief Accountant and FASB Staff Clarifications on Fair Value
Accounting”.





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


11


In
assessing potential OTTI for equity securities, consideration is given tomanagement’s intention and
ability to hold the securities until recovery of any unrealized
losses.





Effective
April 1, 2009, the accounting principles and guidance referenced above requires
that the credit-related portion of OTTI on debt securities be recognized in
earnings, while the noncredit-related portion of OTTI on debt securities not
expected by management to be sold be recognized in other comprehensive
income.  Management determined that OTTI recorded in 2008 against a
private-issuer mortgage-backed security, not expected to be sold, had both
credit-related and noncredit-related portions of OTTI; however, in 2008, the
entire OTTI charge on this investment security was recognized in earnings. 
The noncredit-related portion was determined to be $306,000 pre-tax. 
Accordingly, on April 1, 2009, a cumulative effect adjustment was recorded in
the after-tax amount of $202,000 to increase retained earnings and decrease
unrealized gains (losses) in accumulated other comprehensive income (loss) for
the noncredit-related portion of the OTTI recorded in 2008.





During
2009, one of the previously impaired corporate securities (USCap Funding V) was
fully impaired, completely written off and declared as a worthless asset for tax
purposes.  This impaired corporate security had a cumulative credit related
OTTI of $936,000 at December 31, 2009.  The following table (in thousands)
summarizes the cumulative credit related OTTI charges recognized as components
of earnings for investment securities held with a recorded fair value at June
30, 2010 (the beginning balance on January 1, 2010, was adjusted to reflect the
elimination of the worthless security discussed above):





Cumulative
      OTTI charges at January 1, 2010
                  
                  $
                  2,352Sale
      of impaired securities (as of June 30, 2010)
                  
                  
                  (631
                  )Additional
      OTTI taken for credit losses during 2010
                  
                  
                  1,560Cumulative
      OTTI charges at June 30, 2010
                  
                  $
                  3,281





As of
June 30, 2010, Union National’s investment balances include three securities
with recorded impairments. The fair value of these impaired investments was
$835,000 as compared to an original amortized cost of $6,950,000. The following
table provides additional information related to these three investment
securities(in
thousands):





At June 30, 2010Original
                        Amortized
                      
                      Investment Rating
                      
                      
                      Current
                        Amortized
                      
                      
                      Fair
                      
                      
                      OTTIDescription of Investment Security
                      
                      Cost
                      
                      Original
                      
                      Current
                      
                      
                      Cost
                      
                      
                      Value
                      
                      
                      TakenCountrywide
      Alt Ln 2005-83CB A3
                      
                      $
                      3,018
                      
                      AAA
                      
                      C
                      
                      
                      $
                      235
                      
                      
                      $
                      235
                      
                      
                      $
                      1,550Countrywide
      Alt Ln 2005-75CB A4
                      
                      
                      2,932
                      
                      AAA
                      
                      CCC
                      
                      
                      
                      471
                      
                      
                      
                      471
                      
                      
                      
                      1,092InCaps
      Funding II Junior Note
                      
                      
                      1,000
                      
                      BBB
                      
                      CCC-
                      
                      
                      
                      129
                      
                      
                      
                      129
                      
                      
                      
                      639Total
      Securities with OTTI
                      
                      $
                      6,950
                      
                      
                      
                      
                      
                      
                      
                      $
                      835
                      
                      
                      $
                      835
                      
                      
                      $
                      3,281





During
the second quarter of 2010, the three remaining impaired securities experienced
further downgrades and/or a reduction in cash flows.  As a result,
management made the determination to sell the securities, and valued the
securities based upon current distressed market trading values.





As
discussed more thoroughly in Note 12 — Fair Value Measurements of
Assets and Liabilities and Fair Value of Financial Instruments, the fair
value of these investment securities for quarters ended prior to June 30, 2010,
was determined by calculating the net present value of the expected future cash
flows of each security, with qualitative risk-adjusted discounting for potential
credit risks and nonperformance in the underlying issuers, and market sector
illiquidity concerns. In accordance with ASC Topic 820, when an active market
for a security does not exist, the use of management estimates that incorporate
current market participant expectations of future cash flows, and include
appropriate risk premiums, is acceptable.  For quarters ended prior to June
30, 2010, management’s judgment was that the facts and circumstances indicated
significant illiquidity and an inactive market for these types of investments
when other relevant observable inputs were not available; therefore, expected
cash flows were used as a reasonable basis in determining the fair value of the
corporate investment securities.


12


During
2009, four of the Bank’s private issuer securities were downgraded to below
investment grade (another private issuer mortgage-backed security was downgraded
to below investment grade in 2008).  Accordingly, the Bank recorded
$1,504,000 of other-than-temporary impairment charges for the year ended
December 31, 2009 including (i) $859,000 related to three corporate securities
supported primarily by obligations from other financial industry entities, and
(ii) $645,000 related to two private issuer mortgage-backed securities not
guaranteed by the U.S. government ($462,000 of the $1,504,000
other-than-temporary impairment charges for the year ended December 31, 2009,
were recorded in the second quarter of 2009).  Management determined that,
due to severe illiquidity and distress in the financial markets, the unrealized
declines in the value of these investments were other-than-temporary and credit
related, requiring the write-down and related impairment charge to
earnings.  For the securities with impairment charges recorded, interest
income payments received subsequent to impairment are fully applied to principal
further reducing the amortized cost of these investments.





During
2009, one of the previously impaired corporate securities (USCap Funding V) was
fully impaired, completely written-off and declared as a worthless asset for tax
purposes. This impaired corporate security had a cumulative credit related OTTI
of $936,000 at December 31, 2009. At December 31, 2009, the Bank had four
impaired securities remaining.





During
the first quarter of 2010, one of the impaired corporate securities (InCaps
Funding II Senior Note) held at December 31, 2009, was sold for $277,000. 
At the time of the sale, the security had $631,000 of previously recorded
impairments, and an adjusted amortized cost of $272,000, which resulted in a
$5,000 gain recorded on the sale.





During
the second quarter of 2010, the three remaining impaired securities experienced
further downgrades and/or a reduction in cash flows.  As a result,
management made the determination to sell the securities, and valued the
securities based upon current distressed market trading values.  The Bank
recorded $1,560,000 of other-than-temporary impairment charges for the six
months ended June 30, 2010, including (i) $1,451,000 related to the two private
issuer mortgage-backed securities not guaranteed by the U.S. government, and
(ii) $109,000 related to one corporate security supported primarily by
obligations from other financial industry entities.





Subsequent
to June 30, 2010, the last corporate security (InCaps Funding II Junior Note)
was sold for $129,000. Additionally, one of the private issuer mortgage-backed
securities (Countrywide Alt Ln 2005-75CB A4) was sold.  The sales proceeds
plus estimated principal and interest proceeds yet to be received on the private
issuer mortgage-backed security, approximate $471,000, which was the recorded
impaired value at June 30, 2010. At the time of the sales, the impaired
securities had $639,000 and $1,092,000, respectively, of previously recorded
impairments.





As of
June 30, 2010, Union National’s recorded investment balances include three
securities with previously recorded impairments, two of which were subsequently
sold.  The fair value of the three impaired investments was $835,000 at
June 30, 2010, as compared to an original amortized cost of $6,950,000. All
principal and interest payments received on impaired investment securities are
fully applied to principal.





As of
June 30, 2010, management determined that further impairments were not warranted
on the three remaining impaired investment securities as two securities were
sold subsequent to June 30, 2010, and because the value for the third security
was written-down to distressed trading levels.


13


Note
6 — De-Leveraging and Restructuring Activities





In 2010,
the Bank continued with de-leveraging activities by prepaying $2,500,000 of FHLB
advances, which had a fixed weighted average interest cost of 4.67%, incurring
$96,000 of debt prepayment penalties, which were included in other non-interest
expense. The balance of long-term debt was reduced to $30,834,000 at June 30,
2010 from $33,334,000 at December 31, 2009.





Subsequent
to June 30, 2010, the Bank prepaid an additional $10,000,000 of FHLB advances,
which had a fixed weighted average interest cost of 5.55%.  In conjunction
with the prepayments, the Bank incurred $136,000 of prepayment penalties, which
was recognized in July 2010.





During
the second quarter of 2009, the Bank prepaid $12,000,000 of FHLB advances, which
had a fixed weighted average interest cost of 5.67%, incurring $393,000 of debt
prepayment penalties.  For the year ended December 31, 2009, the Bank
prepaid $17,000,000 of FHLB advances, which had a fixed weighted average
interest cost of 5.36%, incurring $536,000 of debt prepayment penalties. 
During 2009, the Bank also repaid a $5,241,000 brokered CD with an interest cost
of 3.90% that matured on October 15, 2009.





Note
7 — Junior Subordinated Debentures





Union
National had three issuances of junior subordinated debentures, totaling
$17,341,000, outstanding as of June 30, 2010 and December 31, 2009.





On July
28, 2006, the Bank issued $6,000,000 of subordinated debentures due September
15, 2021 with a five-year initial fixed rate of 7.17%, and then an annual coupon
rate, reset quarterly, based on three-month London Interbank Offered Rate
(“LIBOR”) plus 1.65%.





In
December 2003, Union National Capital Trust I (“UNCT I”) issued $8,248,000 of
floating-rate debentures due January 23, 2034, of which $248,000 is related to
Union National’s capital contribution.  UNCT I provides for quarterly
distributions at a variable annual coupon rate that is reset quarterly, based on
three-month LIBOR plus 2.85%.  The coupon rate was 3.19% and 3.13% at June
30, 2010 and December 31, 2009, respectively.





In
October 2004, Union National Capital Trust II (“UNCT II”) issued $3,093,000 of
debentures due November 23, 2034, of which $93,000 is related to Union
National’s capital contribution.  UNCT II provides for quarterly
distributions at a variable annual coupon rate that is reset quarterly, based on
three-month LIBOR plus 2.00%. The coupon rate was 2.48% and 2.27% at June 30,
2010 and December 31, 2009, respectively.





All of
the junior subordinated debentures are callable at Union National’s option
beginning at five years from the date of issuance.  These debentures do not
have to be called in full.  UNCT I became callable in December 2008, UNCT
II became callable in October 2009, and the Bank’s junior subordinated debenture
will become callable in July 2011.  All three issuances of junior
subordinated debentures qualify as a component of risk-based capital for
regulatory capital purposes.





Interest
expense on junior subordinated debentures was $192,000 and $213,000 for the
three months ended June 30, 2010 and 2009, respectively.  For the six
months ended June 30, 2010 and 2009, interest expense on junior subordinated
debentures was $381,000 and $444,000, respectively.





Union
National, as directed by the Federal Reserve, has deferred making interest
payments on the UNCT I and UNCT II debentures beginning on July 23, 2010 and
August 23, 2010, respectively.  Interest expense continues to accrue on
these debentures.  For additional information related to Federal Reserve
requirements and actions related to interest payments on UNCT I and UNCT II,
refer to the section Memorandum of Understanding with the
Federal Reserve Bank in Note 9 — Enforcement Actions with
Bank Regulatory Agencies.


14


Note
8 — Stock Issued Under Private Placement Offerings and Dividend Reinvestment
Plan





Preferred Stock Private
Placement Offering


On
September 15, 2009, Union National filed with the Pennsylvania Department
of State two Statements with
Respect to Shares which, effective upon filing, designated two series of
preferred stock as “5% Non-Cumulative Non-Voting Convertible Perpetual Preferred
Stock, Series A” (“Series A Preferred Stock”), and “6% Non-Cumulative Non-Voting
Non-Convertible Perpetual Preferred Stock, Series B” (“Series B Preferred
Stock”), and set forth the voting and other powers, designations, preferences
and relative, participating, optional or other rights, and the qualifications,
limitations or restrictions of the Series A Preferred Stock and Series B
Preferred Stock. On March 1, 2010, Union National terminated the offering of
both series of its Convertible Perpetual Preferred Stock.





Sales of Preferred
Stock:


Union
National has sold shares of its Non-Cumulative Non-Voting Convertible Perpetual
Preferred Stock, Series A (“Series A Preferred Stock”), in transactions exempt
from registration under the Securities Act of 1933, pursuant to Section 4(2)
thereof.





During
the offering, Union National sold 1,275 shares of its Series A Preferred Stock
for total gross proceeds of $1,275,000, which were offset by issuance costs of
$57,000.  At June 30, 2010, there were no Series B Preferred stock shares
outstanding as there were no Series B Preferred stock shares sold or issued
during the offering.





The
following table summarizes the Series A Preferred Stock shares sold and the
gross proceeds received through the private placement offering (dollars in
thousands):





Period
                    
                    Shares
                    
                    
                    Gross
                      ProceedsSeptember
      25, 2009 – September 30, 2009
                    
                    
                    700
                    
                    
                    $
                    700October
      1, 2009 – December 31, 2009
                    
                    
                    575
                    
                    
                    
                    575January
      1, 2010 – February 28, 2010 (1)
                    
                    
                    —
                    
                    
                    
                    —Total
                    
                    
                    1,275
                    
                    
                    $
                    1,275





(1) 
 On March 1, 2010, Union National terminated the offering of both series of
its Preferred Stock.





As of
June 30, 2010, none of the 1,275 Series A Preferred Stock Shares issued
converted to common stock.





Subsequent
to June 30, 2010, 1,075 shares of Series A Preferred Stock converted to common
stock at $4.00 per share, representing an increase of 268,750 common stock
shares outstanding.





Terms of the Series A
Preferred Stock:


Dividends
on the Series A Preferred Stock are payable quarterly in arrears if, when,
and as declared by Union National’s Board of Directors, at a rate of 5.00% per
year on the liquidation preference of $1,000 per share. Dividends, if declared,
will be payable quarterly on January 31, April 30, July 31, and October 31 of
each year (each a “Dividend Payment Date”).  In 2010, a dividend was paid
on January 31 and April 30, however, the next dividend due to be paid on July 31
was not paid.  For additional information related to Federal Reserve
pre-approval requirements related to dividend payments on Preferred Stock, refer
to the sectionMemorandum of Understanding with the
Federal Reserve Bank in Note 9 — Enforcement Actions with
Bank Regulatory Agencies.  In the case of the dividend payable on
January 31, 2010, such dividend was prorated based on the number of days elapsed
from the date of purchase to January 31, 2010 over a quarterly dividend period
of ninety (90) days.  Dividends on the Series A Preferred Stock are
non-cumulative.





Holders
of the Series A Preferred Stock may convert their shares into common stock
at any time upon approval of the Board of Governors of the Federal Reserve
System (the “Federal Reserve”), if required, at the conversion prices listed
below:


15





Conversion Date:
                  
                  Conversion Price
                    per ShareSeptember
      15, 2009 through September 14, 2010
                  
                  $
                  4.00September
      15, 2010 through September 14, 2011
                  
                  $
                  6.25September
      15, 2011 through September 14, 2012
                  
                  $
                  7.50September
      15, 2012 through September 14, 2013
                  
                  $
                  8.75On
      or After September 15, 2013
                  
                  $
                  10.00





The
Series A Preferred Stock only may be redeemed by Union National upon prior
approval of the Federal Reserve. If Union National redeems the Series A
Preferred Stock on or prior to September 14, 2014, the redemption price will
include a premium decreasing over time from 2.5% to 0.5% of the liquidation
preference. The holders of the Series A Preferred Stock do not have voting
rights except as required by Pennsylvania Business Corporation Law of 1988, as
amended.





Dividend Reinvestment
Plan


Union
National maintains a Dividend Reinvestment Plan (“DRIP”) for record holders of
Union National’s common stock to provide a convenient method of investing cash
dividends payable upon their common stock and to provide participants with the
opportunity to make voluntary cash payments, from a minimum of $500 to a maximum
of $50,000 per calendar quarter, to purchase additional common shares at a 10%
discount to the fair market value of the shares on the effective purchase date
as defined by the DRIP.  There were no common dividends paid by Union
National during 2010; however, eligible stockholders made voluntary cash
payments totaling $6,000, which were used to purchase 1,479 common shares. 
Union National reserved 200,000 common stock shares to be issued under the DRIP,
of which, 24,471 shares have been issued as of June 30, 2010.  As part of
the proposed merger, as discussed in Note 14 — Proposed Merger Agreement, the
ability of stockholders to make direct cash purchases was suspended effective
June 30, 2010.





Note
9 — Enforcement Actions with Bank Regulatory Agencies





Formal Written Agreement
with the Office of the Comptroller of the Currency
(“OCC”)


On August
27, 2009, the Bank, the wholly-owned banking subsidiary of Union National,
entered into a formal written agreement (the “Agreement”) with the OCC. 
Specifically, the Agreement requires the Bank to (1) establish a compliance
committee to monitor and coordinate the Bank’s adherence to the provisions of
the Agreement, (2) have the Board of Directors evaluate and monitor executive
management performance, (3) update its three year strategic plan in accordance
with specific guidelines set forth in the Agreement, (4) update its three year
capital program, (5) develop and implement systems to provide for effective loan
portfolio management, (6) take action to protect criticized assets and implement
a written program to eliminate the basis of criticism of assets criticized by
the OCC, (7) strengthen the Bank’s contingency funding plan, (8) implement a
written consumer compliance program, and (9) not exceed the level of brokered
deposits as of the date of the Agreement without prior OCC
approval.




The
Agreement supersedes the previous Memorandum of Understanding (“MOU”) entered
into between the Bank and the OCC on June 20, 2007.  The Agreement
effectively extends several of the provisions under the MOU, including requiring
a three year strategic plan and three year capital plan, improving the Bank’s
loan portfolio management, implementing an effective risk-based consumer
compliance audit program, and establishing a compliance committee.




Separate
from the Agreement, the OCC established individual minimum capital requirements
for the Bank requiring Tier 1 Capital to Average Total Assets of at least eight
percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine and one-half
percent (9.5%), and Total Capital to Risk-Based Assets of at least twelve
percent (12%) effective beginning September 30, 2009.  These minimum
capital ratios are similar to the capital ratio targets agreed to between the
Bank and the OCC under the MOU which were Tier I Capital to Average Total Assets
of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital to
Risk-Based Assets of 12%.  At June 30, 2010, the Bank’s measure of Tier I
Capital to Average Total Assets was 8.09%, Tier I Capital to Risk-Based Assets
was 10.17%, and Total Capital to Risk-Based Assets was 12.94%.  At June 30,
2010, all three ratios exceeded the respective OCC individual minimum capital
requirements.  The Bank capital ratios reflect the infusion to the Bank
subsidiary of $700,000 of the $1,275,000 proceeds raised in Union National’s
preferred stock private placement.


16


Management
and the Board of Directors are committed to taking the necessary actions to
fully maintain the new minimum capital ratios and address the provisions of the
Agreement, and believe that the Bank has already made measurable progress in
addressing these requirements.  If the Bank does not continue to meet the
OCC’s requirements, the OCC could subject the Bank to such administrative
actions or sanctions as the OCC considers necessary.





Memorandum of Understanding
with the Federal Reserve Bank


On
January 28, 2010, Union National entered into an informal Memorandum of
Understanding with the Federal Reserve Bank (“FRB”).  Union National is the
registered bank holding company that wholly owns the Bank (the Bank subsidiary
is separately supervised by the Office of the Comptroller of the
Currency).  The Memorandum of Understanding, which is not a “written
agreement” for purposes of Section 8 of the Federal Deposit Insurance Act,
requires, among other things, Union National to seek prior approval by the FRB
before (i) declaring or paying dividends to stockholders, (ii) distributing
interest, principal or other sums on UNCT I and UNCT II junior subordinated
debentures, and (iii) incurring, increasing or guaranteeing any additional
debt.





The FRB approved Union National’s
request to pay preferred stock dividends and distributions on its two issuances
of trust-preferred securities for the first and second quarters of 2010. 
Union National made a similar request for the third quarter of 2010, but the FRB
denied the request.  Accordingly, Union National has acted to suspend the
preferred stock dividend and to defer distributions on its trust-preferred
securities indefinitely.  Distributions on one class of trust preferred
securities, issued by UNCT I, were next scheduled for July 23, 2010 and
distributions on the other class, issued by UNCT II, were next scheduled for
August 23, 2010.  Dividend payments on the preferred stock were next
scheduled for July 31, 2010.  Union National’s preferred stock is
non-cumulative so the suspension of dividends will not result in any accrued
dividend liability.  The deferral of distributions on the trust-preferred
securities will continue to accrue as interest expense payable by Union
National.  Union National is prohibited from declaring or paying any
dividends on its common stock or preferred stock while distributions on the
trust-preferred securities are in arrears.





Note
10 — Commitments, Guarantees and Contingencies





Credit
Commitments


In the
ordinary course of business, Union National makes commitments to extend credit
to its customers through letters of credit, loan commitments and lines of
credit.  As of June 30, 2010, the Bank had $110,316,000 outstanding in loan
commitments and other unused lines of credit extended to its customers, as
compared to $110,791,000 at December 31, 2009.  The Bank does not issue any
guarantees that would require liability recognition or disclosure, other than
its standby letters of credit. Standby letters of credit written are conditional
commitments issued by Union National to guarantee the performance of a customer
to a third party.  Generally, all letters of credit, when issued, have
expiration dates within one year. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to
customers.  The Bank generally holds collateral and/or personal guarantees
supporting these commitments.  There were $5,925,000 and $6,199,000 of
standby letters of credit outstanding as of June 30, 2010 and December 31, 2009,
respectively.





Management
believes that the proceeds obtained through a liquidation of collateral and the
enforcement of guarantees would be sufficient to cover the potential amount of
future payments required under the corresponding standby letters of
credit.  The current amount of the liability at June 30, 2010 and December
31, 2009, for Bank guarantees under standby letters of credit issued is not
considered to be material.


17


Health Care
Consortium


Effective
July 1, 2008, the Bank joined a health care expense management consortium with
other Pennsylvania banks.  The purpose of the consortium is to pool the
risks of covered groups of employees, and to provide effective claims-based
expense management, administrative efficiencies, and use of high-dollar claim
stop loss insurance coverage, to reduce the overall health care costs to the
consortium member banks, while maintaining high quality coverage for
employees.  Through June 30, 2010, the Bank’s payments to the consortium to
cover estimated claims expenses, administrative expenses, and stop loss
insurance premiums exceeded the actual processed expenses by $366,000. 
However, the Bank reduced the amount of this prepaid benefit by a contingent
reserve of $65,000 reflecting an actuarial estimate by the consortium of the
Bank’s unpaid claim liability as of June 30, 2010 to include potential (i)
unreported claims, (ii) reported but unprocessed claims, and (iii) processed but
unpaid claims, related to both medical and drug coverage.





Proposed
Merger


Union
National entered into an Agreement and Plan of Merger (the “Merger Agreement”)
on April 19, 2010, as amended and restated as of May 20, 2010, with Donegal
Financial Services Corporation (“DFSC”), the parent company of Province Bank FSB
(“Province”), and certain affiliated entities of DFSC, pursuant to which Union
National will merge with and into DFSC. DFSC is wholly owned by Donegal Mutual
Insurance Company and Donegal Group Inc (For additional information on the
proposed merger, refer to Note
14 — Proposed Merger Agreement).





On June
16, 2010, Union National, Donegal Financial Services Corporation ("DFSC"), an
affiliate of Donegal Group Inc. and Donegal Mutual Insurance Company, became
aware of a filing of a complaint on June 14, 2010 in the Court of Common Pleas
of Lancaster County, Pennsylvania against Union National, each of the Directors
of Union National, DFSC and certain affiliated entities of DFSC (collectively,
the "Donegal Parties"). The complaint purports to be a class action filed on
behalf of the holders of Union National common stock arising from certain
alleged actions by Union National and its Board of Directors in connection with
the previously announced proposed merger of Union National with and into DFSC.
Union National and the Donegal Parties believe the factual allegations in the
complaint are without merit and intend to defend vigorously against the
allegations in the complaint.   Accordingly, Union National has not
accrued a contingent liability related to this litigation.





Other
than above, management is not aware of any other litigation that would have a
material adverse effect on the consolidated financial position of Union
National.





Note
11 — Stock-Based Compensation





In
accordance with ASC Topic 718, “Compensation – Stock Compensation”, Union
National recognizes compensation expense for share-based awards based upon an
assessment of the fair value on the grant date.  The fair value of each
option is estimated on the date of grant using the Black-Scholes option-pricing
model.  Stock compensation expense is recognized on a straight-line basis
over the vesting period of the award.





Union
National had two plans with stock options outstanding as of June 30, 2010: (i)
the Employee Stock Incentive Plan (“SIP”); and, (ii) the Independent Directors’
Stock Option Plan (“IDSOP”).  Neither of these plans had remaining options
available for grant as of June 30, 2010.  Options granted under the SIP are
incentive stock options with terms up to 10 years and option prices equal to the
fair value of the shares on the date of the grant.  SIP options vest over
six months, become exercisable nine months after the grant date, and generally
lapse 90 days after termination of employment.  Options granted under the
IDSOP consist of non-qualified stock options with terms up to 10 years. 
IDSOP options have exercise prices equal to the fair value of the shares on the
date of the grant and expire one year after departure from the Board of
Directors.  It is Union National’s policy to issue new shares from its
authorized shares upon the exercise of stock options.





No
share-based awards were granted or vested during the three and six months ended
June 30, 2010 and 2009; accordingly, no compensation expense was recorded for
these periods.  There were 77,517 and 78,674 stock options outstanding at
June 30, 2010 and December 31, 2009, respectively, with exercise prices ranging
from $11.52 to $22.14 for both of these periods.


18


Stock
option activity for the six months ended June 30, 2010, is summarized
below:





Shares
                  
                  
                  Weighted-
                    Average
                    Exercise PriceBeginning
      of Period
                  
                  
                  78,674
                  
                  
                  $
                  18.83Granted
                  
                  
                  —
                  
                  
                  
                  —Exercised
                  
                  
                  —
                  
                  
                  
                  —Forfeited
                  
                  
                  (1,157
                  )
                  
                  
                  15.42Expired
                  
                  
                  —
                  
                  
                  
                  —End
      of Period
                  
                  
                  77,517
                  
                  
                  $
                  18.88





All stock
options outstanding at June 30, 2010, had no intrinsic value (the amount by
which the market price exceeds the exercise price) and were fully vested and
exercisable, and consisted of the following:





Number
      of options
                  
                  
                  77,517Weighted-average
      contractual remaining term
                  
                  4.0
      YearsWeighted-average
      exercise price
                  
                  $
                  18.88Aggregate
      intrinsic value
                  
                  $
                  —





Note
12 — Fair Value Measurement of Assets and Liabilities and Fair Value of
Financial Instruments





ASC Topic
820, “Fair Value Measurements and Disclosures” defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles, and expands disclosures about fair value
measurements.  This guidance defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. A fair value measurement assumes that a
transaction to sell an asset or transfer a liability occurs in the principal
market for the asset or liability or, in the absence of a principal market, the
most advantageous market for the asset or liability.  The price in the
principal (or most advantageous) market used to measure the fair value of the
asset or liability shall not be adjusted for transaction costs.  An orderly
transaction is not a forced transaction, but rather a transction that assumes
exposure to the market for a period prior to the measurement date to allow for
marketing activities that are usual and customary for transactions involving
such assets and liabilities.





Market
participants are buyers and sellers in the principal market that are (i)
independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to
transact.  ASC Topic 820 requires the use of valuation techniques that are
consistent with the market approach, the income approach and/or the cost
approach.  The market approach uses prices and other relevant information
generated by market transactions involving identical or comparable assets and
liabilities.  The income approach uses valuation techniques to convert
future amounts such as cash flows or earnings, to a single present amount on a
discounted basis.  The cost approach is based on the amount that currently
would be required to replace the service capacity of an asset (replacement
cost).  Valuation techniques should be consistently applied. Inputs to
valuation techniques refer to the assumptions that market participants would use
in pricing the asset or liability.  Inputs may be observable, meaning those
that reflect the assumptions market participants would use in pricing the asset
or liability developed based on market data obtained from independent sources,
or unobservable, meaning those that reflect the reporting entity’s own
assumptions about the assumptions market participants would use in pricing the
asset or liability based upon the best information available in the
circumstances.  In that regard, ASC Topic 820 establishes a fair value
hierarchy for valuation inputs that gives the highest priority to quoted prices
in active markets for identical assets or liabilities and the lowest priority to
unobservable inputs.


19


The fair
value hierarchy is as follows:





Level
      1
            -
            Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or liabilities;Level
      2
            -
            Quoted
      prices in markets that are not active, or inputs that are observable
      either directly or indirectly, for substantially the full term of the
      asset or liability;Level
      3
            -
            Prices
      or valuation techniques that require inputs that are both significant to
      the fair value measurement and unobservable (i.e., supported by little or
      no market activity).





ASC Topic
820 provides a list of factors that a reporting entity should evaluate to
determine whether there has been a significant decrease in the volume and level
of activity for the asset or liability in relation to normal market activity for
the asset or liability. When the reporting entity concludes there has been a
significant decrease in the volume and level of activity for the asset or
liability, further analysis of the information from that market is needed and
significant adjustments to the related prices may be necessary to estimate fair
value in accordance with fair value measurement and disclosure guidance. 
Further, ASC Topic 820 clarifies that when there has been a significant decrease
in the volume and level of activity for the asset or liability, some
transactions may not be orderly, and Union National must evaluate the weight of
evidence to determine whether the transactions are orderly. It provides a list
of circumstances that may indicate that a transaction is not orderly. A
transaction price that is not associated with an orderly transaction is given
little, if any, weight when estimating fair value.





A
description of the valuation methodologies used for instruments measured at fair
value, as well as the general classification of such instruments pursuant to the
valuation hierarchy, is set forth below.  The valuation methodologies were
applied to all of Union National’s financial assets and financial liabilities
carried at fair value, effective January 1, 2008.  In addition, Union
National adopted fair value measurement and disclosure guidance for
non-financial assets and non-financial liabilities on January 1,
2009.





Securities Available for
Sale


Equity
securities, comprised mostly of financial institutions, traded on a national
securities exchange are reported at fair value using the Level 1 valuation
hierarchy because these securities tend to trade frequently, and quoted prices
are considered active.  Other equity securities, comprised mostly of
smaller financial institutions, traded on the OTC Bulletin Board (“OTCBB”) or
privately are reported at fair value using the Level 2 valuation hierarchy
because these securities tend to trade infrequently, and quoted prices are not
considered active.  Debt securities classified as available for sale are
generally reported at fair value utilizing Level 2 inputs.  For these
securities, Union National obtained fair value measurements from an independent
pricing service.  The fair value measurements consider observable data that
may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield
curve, live trading levels, trade execution data, market consensus prepayment
speeds, credit information and the bond’s terms and conditions, among other
things.





Level 3
inputs are for certain corporate investment security positions that are not
traded in active markets or are subject to transfer restrictions, and/or where
valuations are adjusted to reflect illiquidity and/or non-transferability. 
Such adjustments are generally based on available market evidence.  In the
absence of such evidence, management’s best estimate is used.  Management’s
best estimate consists of both internal and external support on certain Level 3
investments.  Management only changes Level 3 inputs and assumptions when
corroborated by evidence such as transactions in similar instruments, completed
or pending third-party transactions in the underlying investment or comparable
entities, subsequent transactions or rounds of financing, recapitalizations and
other transactions across the capital structure, offerings in the equity or debt
markets, and changes in financial ratios or cash flows.  During the second
quarter of 2010, the three remaining impaired securities experienced further
downgrades and/or a reduction in cash flows.  As a result, management made
the determination to sell the securities, and valued the securities based upon
current distressed market trading values.


20


For
quarters ended prior to June 30, 2010, the fair value of these securities valued
using Level 3 inputs was determined by calculating the net present value of the
expected future cash flows of each security, with qualitative risk-adjusted
discounting for potential credit risks and nonperformance in the underlying
issuers, and market sector illiquidity concerns.





The
following tables present available-for-sale investment securities measured at
fair value on a recurring basis as of June 30, 2010 and December 31, 2009,
segregated by the level of the valuation inputs within the hierarchy utilized to
measure fair value (in thousands).  There were no transfers of assets
between fair value Level 1 and Level 2 for the six months ended June 30,
2010.





At June 30, 2010Level 1
                  
                  
                  Level 2
                  
                  
                  Level 3
                  
                  
                  TotalU.S.
      Agency Mortgage-Backed Securities
                  
                  $
                  —
                  
                  
                  $
                  17,242
                  
                  
                  $
                  —
                  
                  
                  $
                  17,242U.S.
      Agency Bonds and Structured Notes
                  
                  
                  —
                  
                  
                  
                  12,571
                  
                  
                  
                  —
                  
                  
                  
                  12,571Obligations
      of State and Political Subdivisions
                  
                  
                  —
                  
                  
                  
                  24,052
                  
                  
                  
                  —
                  
                  
                  
                  24,052Private
      Issuer Mortgage-Backed Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  706
                  
                  
                  
                  706Corporate
      Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  129
                  
                  
                  
                  129Equity
      Securities
                  
                  
                  10
                  
                  
                  
                  55
                  
                  
                  
                  —
                  
                  
                  
                  65Total
      Investment Securities
                  
                  $
                  10
                  
                  
                  $
                  53,920
                  
                  
                  $
                  835
                  
                  
                  $
                  54,765





At December 31, 2009Level 1
                  
                  
                  Level 2
                  
                  
                  Level 3
                  
                  
                  TotalU.S.
      Agency Mortgage-Backed Securities
                  
                  $
                  —
                  
                  
                  $
                  53,394
                  
                  
                  $
                  —
                  
                  
                  $
                  53,394Obligations
      of State and Political Subdivisions
                  
                  
                  —
                  
                  
                  
                  3,815
                  
                  
                  
                  —
                  
                  
                  
                  3,815Private
      Issuer Mortgage-Backed Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,638
                  
                  
                  
                  2,638Corporate
      Securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  631
                  
                  
                  
                  631Equity
      Securities
                  
                  
                  13
                  
                  
                  
                  55
                  
                  
                  
                  —
                  
                  
                  
                  68Total
      Investment Securities
                  
                  $
                  13
                  
                  
                  $
                  57,264
                  
                  
                  $
                  3,269
                  
                  
                  $
                  60,546





The
following is a reconciliation of the beginning and ending balances of recurring
fair value measurements of certain available-for-sale securities using
significant unobservable (Level 3) inputs (in thousands):





Available-For-
                    Sale
                    SecuritiesBeginning
      Balance at January 1, 2010
                  
                  $
                  3,269Payments
      received (applied to principal), net of accretion
                  
                  
                  (336
                  )Net
      proceeds received on sale of impaired security
                  
                  
                  (272
                  )Total
      realized and unrealized lossesIncluded
      in net loss
                  
                  
                  (1,560
                  )Included
      in other comprehensive loss
                  
                  
                  (266
                  )Ending
      Balance at June 30, 2010
                  
                  $
                  835





Certain
financial assets and financial liabilities are measured at fair value on a
nonrecurring basis; that is, the instruments are not measured at fair value on
an ongoing basis, but are subject to fair value adjustments in certain
circumstances (for example, when there is evidence of impairment).





Impaired Loans.Certain impaired loans
are reported at the fair value of the underlying collateral if repayment is
expected solely from the collateral.  Collateral values are estimated using
Level 3 inputs based upon customized discounting criteria.


21


The
balance of loans and leases that were considered to be impaired under GAAP was
$4,976,000 and $8,715,000, which consisted of seven and ten loan and lease
relationships to unrelated borrowers, at June 30, 2010 and December 31, 2009,
respectively.  At June 30, 2010, three of the relationships represented 88%
of the total impaired loans and leases of $4,976,000.  The decrease in
impaired loans and leases during the first six months of 2010 resulted primarily
from several loans, with a related allowance, that were either charged-off
and/or foreclosed on and transferred into other real estate owned during
2010.  Management continues to diligently monitor and evaluate the existing
portfolio, and identify credit concerns and risks, including those resulting
from the current weak economy.The
measure of impairment is based primarily on the fair value of collateral
securing these loans, which is primarily real estate and equipment.





Impaired Loans With a
Related Allowance.  Union National had $4,581,000 and $5,916,000 of
impaired loans and leases with a related allowance for credit losses at June 30,
2010 and December 31, 2009, respectively. These consisted of five loan and lease
relationships to unrelated borrowers, with a related allowance for credit losses
of $860,000 and $1,458,000 at both June 30, 2010 and December 31, 2009,
respectively.  This group of impaired loans and leases has a related
allowance due to the probability that the borrower is not able to continue to
make principal and interest payments due under the contractual terms of the loan
or lease.  These loans and leases appear to have insufficient collateral
and Union National’s principal may be at risk; as a result, a related allowance
is necessary to cover future potential principal losses.





Repossessed
Assets.Assets included in repossessed assets are reported at fair value on a
non-recurring basis. Values are estimated using Level 3 inputs, based on
appraisals that consider the sales prices of similar assets.





Other Real Estate
Owned.Assets included in other real estate owned are reported at fair value on
a non-recurring basis.  Values are estimated using Level 3 inputs, based on
appraisals that consider the sales prices of properties in the proximate
vicinity, and estimated liquidation costs.





The
following table summarizes financial assets and financial liabilities measured
at fair value on a nonrecurring basis as of June 30, 2010 and December 31, 2009,
segregated by the level of the valuation inputs within the fair value hierarchy
utilized to measure fair value (in thousands):





June 30, 2010Level 1
                        Inputs
                      
                      
                      Level 2
                        Inputs
                      
                      
                      Level 3
                        Inputs
                      
                      
                      Total Fair
                        ValueAssets:Impaired
      Loans
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      3,721
                      
                      
                      $
                      3,721Repossessed
      Assets
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      167
                      
                      
                      
                      167Other
      Real Estate Owned
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      8,694
                      
                      
                      
                      8,694Total
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      12,582
                      
                      
                      $
                      12,582





December 31, 2009Level 1
                        Inputs
                      
                      
                      Level 2
                        Inputs
                      
                      
                      Level 3
                        Inputs
                      
                      
                      Total Fair
                        ValueAssets:Impaired
      Loans
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      4,458
                      
                      
                      $
                      4,458Repossessed
      Assets
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      436
                      
                      
                      
                      436Other
      Real Estate Owned
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      5,383
                      
                      
                      
                      5,383Total
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      10,277
                      
                      
                      $
                      10,277


22


ASC Topic
825, “Financial Instruments” requires disclosures about fair value of financial
instruments for interim reporting periods of publicly traded companies as well
as in annual financial statements.  The estimated fair values of financial
instruments as of June 30, 2010 and December 31, 2009, are set forth in the
table below (in thousands).  The information in the table should not be
interpreted as an estimate of the fair value of Union National in its entirety
since a fair value calculation is only provided for a limited portion of Union
National’s assets and liabilities.  Due to a wide range of valuation
techniques and the degree of subjectivity used in making the estimates,
comparisons between Union National’s disclosures and those of other companies
may not be meaningful.





June 30, 2010
                    
                    
                    December 31, 2009Carrying
                      Amount
                    
                    
                    Fair
                      Value
                    
                    
                    Carrying
                      Amount
                    
                    
                    Fair
                      ValueAssets:Cash
      and Cash Equivalents
                    
                    $
                    69,026
                    
                    
                    $
                    69,026
                    
                    
                    $
                    43,340
                    
                    
                    $
                    43,340Interest-Bearing
      Time Deposits in Other Banks
                    
                    
                    5,309
                    
                    
                    
                    5,373
                    
                    
                    
                    9,229
                    
                    
                    
                    9,252Investment
      Securities Available for Sale
                    
                    
                    54,765
                    
                    
                    
                    54,765
                    
                    
                    
                    60,546
                    
                    
                    
                    60,546Loans
      and Leases, Net
                    
                    
                    326,746
                    
                    
                    
                    316,905
                    
                    
                    
                    333,416
                    
                    
                    
                    317,459Restricted
      Investment in Bank Stocks
                    
                    
                    3,727
                    
                    
                    
                    3,727
                    
                    
                    
                    3,727
                    
                    
                    
                    3,727Accrued
      Interest Receivable
                    
                    
                    1,487
                    
                    
                    
                    1,487
                    
                    
                    
                    1,569
                    
                    
                    
                    1,569Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                    
                    
                    48
                    
                    
                    
                    247
                    
                    
                    
                    48
                    
                    
                    
                    267Liabilities:Demand
      and Savings Deposits
                    
                    
                    213,044
                    
                    
                    
                    213,044
                    
                    
                    
                    212,457
                    
                    
                    
                    212,457Time
      Deposits
                    
                    
                    200,641
                    
                    
                    
                    202,533
                    
                    
                    
                    192,308
                    
                    
                    
                    194,218Long-Term
      Debt
                    
                    
                    30,834
                    
                    
                    
                    31,901
                    
                    
                    
                    33,334
                    
                    
                    
                    34,798Junior
      Subordinated Debentures
                    
                    
                    17,341
                    
                    
                    
                    17,194
                    
                    
                    
                    17,341
                    
                    
                    
                    17,017Accrued
      Interest Payable
                    
                    
                    771
                    
                    
                    
                    771
                    
                    
                    
                    938
                    
                    
                    
                    938Off-balance-sheet
      Items:Commitments
      to Extend Credit and Standby Letters of Credit
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —





The
following methods and assumptions were used by Union National to estimate the
fair value of its financial instruments at June 30, 2010 and December 31,
2009:





Cash and
cash equivalents:
The carrying amounts of cash and short-term investments (U.S. Treasury Bills
with a maturity of less than 60 days) approximate their fair
values.





Interest-bearing
time deposits in other banks:The carrying amounts of
interest-bearing time deposits in other banks approximate their fair
values.  The Bank generally purchases amounts below the insured limit,
limiting the amount of credit risk on these time deposits.





Investment
securities: The
carrying values of securities available for sale (carried at fair value) are
determined by obtaining quoted market prices on nationally recognized securities
exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical
technique used widely in the industry to value debt securities without relying
exclusively on quoted market prices for the specific securities but rather by
relying on the securities’ relationship to other benchmark quoted prices. 
For certain securities which are not traded in active markets or are subject to
transfer restrictions, valuations are adjusted to reflect illiquidity and/or
non-transferability, and such adjustments are generally based on available
market evidence (Level 3).  In the absence of such evidence, management’s
best estimate is used.  Management’s best estimate consists of both
internal and external support on certain Level 3 investments.  Internal
cash flow models using a present value formula that includes assumptions market
participants would use along with indicative exit pricing obtained from
broker/dealers (where available) were used to support fair values of certain
Level 3 investments.


23


Loans and
leases: For variable-rate loans that reprice frequently and which entail
no significant changes in credit risk, carrying value approximates fair
value.  The fair value of other loans and leases are estimated by
calculating the present value of future cash flows, discounted at the interest
rates currently being offered for loans with similar terms to borrowers with
similar credit quality.





Restricted
investment in bank stocks: The carrying amounts
reported in the consolidated statements of financial condition for restricted
investment in bank stocks approximate their fair values.





Accrued
interest receivable: The carrying amount of
accrued interest receivable approximates its fair value.





Mortgage
servicing assets and credit enhancement fees receivable: The fair value of servicing
assets and credit enhancement fees receivable is based on the present value of
estimated future cash flows on pools of mortgages stratified by rate and
maturity date.





Deposit
liabilities: The
fair values of deposits with no stated maturities, such as demand deposits,
savings accounts, NOW and money market deposits, equal their carrying amounts,
which represent the amount payable on demand.  Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on certificates to a
schedule of aggregated expected monthly maturities on time
deposits.





Long-term
debt: The fair
values of long-term debt are estimated using discounted cash flow analyses,
based on Union National's incremental borrowing rates for similar types of
borrowing arrangements.





Junior
subordinated debentures: For floating-rate
debentures, fair value is based on the difference between current interest rates
for similar types of borrowing arrangements and the current coupon rate. 
For debentures that are at a fixed rate for a period of time, the fair value is
determined using discounted cash flow analyses, based on current interest rates
for similar types of borrowing arrangements.





Accrued
interest payable:
The carrying amount of accrued interest payable approximates its fair
value.





Off-balance-sheet
instruments:
Union National's off-balance-sheet instruments consist of commitments to extend
credit, and financial and performance standby letters of credit.  The
estimated fair value is based on fees currently charged to enter into similar
agreements, taking into account the remaining term of the agreements and the
present creditworthiness of the counterparties.  For fixed-rate loan
commitments, fair value also considers the difference between current levels of
interest rates and the committed rates.


24


Note
13 — Comprehensive Loss





U.S.
generally accepted accounting principles require that recognized revenue,
expenses, gains, and losses be included in net income (loss). Although certain
changes in assets and liabilities, such as unrealized gains and losses on
available-for-sale securities, are reported as a separate component of the
equity section of the consolidated statements of financial condition, such
items, along with net income (loss), are components of comprehensive loss. 
 The components of comprehensive loss and related tax effects are as
follows (in thousands):





Three Months Ended June 30, 2010
                  
                  
                  Six Months Ended June 30, 2010Before
                    Tax
                    Amount
                  
                  
                  Tax
                    Impact
                  
                  
                  Net-of-
                    Tax
                    Amount
                  
                  
                  Before
                    Tax
                    Amount
                  
                  
                  Tax
                    Impact
                  
                  
                  Net-of-
                    Tax
                    AmountNet
      Loss
                  
                  $
                  (1,614
                  )
                  
                  $
                  (610
                  )
                  
                  $
                  (1,004
                  )
                  
                  $
                  (1,693
                  )
                  
                  $
                  (692
                  )
                  
                  $
                  (1,001
                  )Other
      Comprehensive (Loss) Income:Unrealized
      Losses on Available-for-Sale Securities Arising During the
      Period
                  
                  
                  (1,553
                  )
                  
                  
                  (528
                  )
                  
                  
                  (1,025
                  )
                  
                  
                  (868
                  )
                  
                  
                  (295
                  )
                  
                  
                  (573
                  )Reclassification
      Adjustment for Securities Gains included in Net Loss
                  
                  
                  (289
                  )
                  
                  
                  (98
                  )
                  
                  
                  (191
                  )
                  
                  
                  (366
                  )
                  
                  
                  (124
                  )
                  
                  
                  (242
                  )Reclassification
      Adjustment for Impairment Charges on Investment Securities
                  
                  
                  1,560
                  
                  
                  
                  530
                  
                  
                  
                  1,030
                  
                  
                  
                  1,560
                  
                  
                  
                  530
                  
                  
                  
                  1,030Other
      Comprehensive (Loss) Income
                  
                  
                  (282
                  )
                  
                  
                  (96
                  )
                  
                  
                  (186
                  )
                  
                  
                  326
                  
                  
                  
                  111
                  
                  
                  
                  215Total
      Comprehensive Loss
                  
                  $
                  (1,896
                  )
                  
                  $
                  (706
                  )
                  
                  $
                  (1,190
                  )
                  
                  $
                  (1,367
                  )
                  
                  $
                  (581
                  )
                  
                  $
                  (786
                  )





Three Months Ended June 30, 2009
                  
                  
                  Six Months Ended June 30, 2009Before
                    Tax
                    Amount
                  
                  
                  Tax
                    Impact
                  
                  
                  Net-of-
                    Tax
                    Amount
                  
                  
                  Before
                    Tax
                    Amount
                  
                  
                  Tax
                    Impact
                  
                  
                  Net-of-
                    Tax
                    AmountNet
      Income (Loss)
                  
                  $
                  (1
                  )
                  
                  $
                  (106
                  )
                  
                  $
                  105
                  
                  
                  $
                  (838
                  )
                  
                  $
                  (434
                  )
                  
                  $
                  (404
                  )Other
      Comprehensive (Loss) Income:Unrealized
      (Losses) Gains on Available-for-Sale Securities Arising During the
      Period
                  
                  
                  (198
                  )
                  
                  
                  (67
                  )
                  
                  
                  (131
                  )
                  
                  
                  342
                  
                  
                  
                  116
                  
                  
                  
                  226Reclassification
      Adjustment for Securities Gains included in Net Income
    (Loss)
                  
                  
                  (983
                  )
                  
                  
                  (334
                  )
                  
                  
                  (649
                  )
                  
                  
                  (1,394
                  )
                  
                  
                  (474
                  )
                  
                  
                  (920
                  )Reclassification
      Adjustment for Impairment Charges on Investment Securities
                  
                  
                  462
                  
                  
                  
                  157
                  
                  
                  
                  305
                  
                  
                  
                  1,301
                  
                  
                  
                  442
                  
                  
                  
                  859Other
      Comprehensive (Loss) Income
                  
                  
                  (719
                  )
                  
                  
                  (244
                  )
                  
                  
                  (475
                  )
                  
                  
                  249
                  
                  
                  
                  84
                  
                  
                  
                  165Total
      Comprehensive Loss
                  
                  $
                  (720
                  )
                  
                  $
                  (350
                  )
                  
                  $
                  (370
                  )
                  
                  $
                  (589
                  )
                  
                  $
                  (350
                  )
                  
                  $
                  (239
                  )


25


Note
14 — Proposed Merger Agreement





On April
19, 2010, Union National, the parent company of Union National Community Bank
(“UNCB”), entered into an Agreement and Plan of Merger (the “Merger Agreement”)
as amended and restated as of May 20, 2010, with Donegal Financial Services
Corporation (“DFSC”), the parent company of Province Bank FSB (“Province”), and
certain affiliated entities of DFSC, pursuant to which Union National will merge
with and into DFSC.  DFSC is wholly owned by Donegal Mutual Insurance
Company (“DMIC”) and Donegal Group Inc. (“DGI”).





As part
of the transaction, UNCB will merge with and into Province (the “Bank
Merger”).  The merged bank will operate as a federally-chartered savings
association under a new bank name to be mutually determined by UNCB and Province
and will continue to operate the UNCB offices.





Under the
terms of the Merger Agreement, each share of Union National common stock (OTC
Bulletin Board: “UNNF.OB”), other than shares held by DMIC and any dissenting
shares, will convert into the right to receive $5.05 in cash and 0.2134 of a
share of DGI Class A common stock (NASDAQ Global Select: “DGICA”).





Following
the consummation of the transactions, the executive officers of the merged
entities will include: Donald H. Nikolaus, currently the President of DFSC and
the Chairman of Province, will continue as President of DFSC and Chairman of the
merged bank; Mark D. Gainer, currently Chairman, President and Chief Executive
Officer of Union National and UNCB, will become a Senior Vice President of DFSC
and President and Chief Executive Officer of the merged bank; Gregory J. Diehl,
currently President of Province, will become Executive Vice President and Chief
Operating Officer of the merged bank; and Michael D. Peduzzi, Treasurer and
Chief Financial Officer of Union National and Executive Vice President and Chief
Financial Officer of UNCB, will become a Vice President of DFSC and Executive
Vice President and Chief Financial Officer of the merged bank.  The
Directors of DFSC immediately after the merger will be the Directors of DFSC
immediately prior to the merger plus Mark D. Gainer and two other current
members of Union National’s Board of Directors.  In addition, the Directors
of the merged bank immediately after the Bank Merger will consist of six current
Directors of Province and five current Directors of UNCB.





The
transaction is subject to customary closing conditions, including the receipt of
regulatory approvals and approval of the merger by the holders of at least 80%
of the outstanding common shares of Union National.  If the merger is not
consummated under certain circumstances, Union National has agreed to pay DFSC a
termination fee of $800,000.  Currently, the merger is expected to be
completed in the fourth quarter of 2010.





The
foregoing summary of the Merger Agreement is not complete and is qualified in
its entirety by reference to the complete text of the definitive agreement,
which was filed as Exhibit 2.1 to Form 8-K that was filed by Union National on
April 23, 2010.





On July
27, 2010, Union National announced that it will convene a Special Meeting of
Shareholders on September 16, 2010 to vote on its proposed merger with DFSC, an
affiliate of Donegal Group Inc.  The holders of outstanding shares of
common stock of record as of the close of business on July 29, 2010 are entitled
to vote at the Special Meeting of Shareholders.  Proxy solicitation
materials, including a proxy statement/prospectus, for the Special Meeting of
Shareholders were mailed on or about August 5, 2010.





Through
June 30, 2010, Union National has incurred merger and acquisition related
expenses of $436,000, which include primarily legal and investment banking costs
associated with the proposed merger.


26


ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





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





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





Readers
should carefully review the risk factors described in the Annual Report and
other documents that we periodically file with the Securities and Exchange
Commission, including our Form 10-K for the year ended December 31, 2009, Union
National’s Forms 8-K, and other reports, that were filed during 2010 with the
SEC.


27


Critical Accounting
Policies.Union National’s consolidated financial statements are prepared based
upon the application of U.S. generally accepted accounting principles
(“GAAP”).   The reporting of our financial condition and results of
operations is impacted by the application of accounting policies by management,
some of which are particularly sensitive and require significant judgments,
estimates and assumptions to be made in matters that are inherently
uncertain.  These accounting policies, along with the disclosures presented
in other financial statement notes and in this financial review, provide
information on how significant assets and liabilities are valued in the
financial statements and how those values are determined.  Management views
critical accounting policies to be those which are highly dependent on
subjective or complex judgments, estimates and assumptions, and where changes in
those estimates and assumptions could have a significant impact on the
consolidated financial statements.  Management currently views the
determination of the allowance for credit losses, the fair value of investment
securities and the fair value of other real estate owned to be critical
accounting policies.





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





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





Fair Value of Other Real
Estate Owned.    Other Real Estate Owned (“OREO”) includes
property acquired through foreclosure, deed in-lieu of foreclosure, and an
in-substance foreclosure.  OREO is held for sale. The carrying value of the
property is recorded at the fair value of the property as determined based upon
an independent appraisal, less estimated costs to sell at the time of
acquisition.  Any excess of the loan balance over the carrying value of the
property at the time of transfer from loans to OREO is charged to the allowance
for credit losses.  Subsequent to the transfer to OREO, if the sales price
of the property less actual costs to sell is less than the carrying value of the
property, the deficiency is charged against income as a loss on sale. Due to
changing market conditions, there are inherent uncertainties upon liquidation
with respect to determining the fair value of OREO.  Therefore, the amount
ultimately realized upon liquidation may differ from the carrying value
reflected in the accompanying consolidated financial
statements.


28


FINANCIAL
CONDITION


Total
assets increased by $12,236,000 or 2% to $501,880,000 at June 30, 2010 from
$489,644,000 at December 31, 2009.  The increase was primarily the result
of strong retail deposit generation, which further strengthened Union National’s
liquidity position.  Total deposits grew by $8,920,000 or 2% to
$413,685,000 at June 30, 2010 from $404,765,000 at December 31,
2009.





Investment Securities.Investment securities were $54,765,000 at June 30, 2010, as compared to
$60,546,000 at December 31, 2009.  All of Union National’s investment
securities were classified as available for sale at June 30, 2010 and December
31, 2009.  Investment securities classified as available for sale are
marketable equity securities, and those debt securities that we intend to hold
for an undefined period of time, but not necessarily to maturity.  In
addition to the investment portfolio generating interest income, it serves other
primary financial management functions such as a reliable source of liquidity
and a tool to manage interest rate risk.  In order to support these
functions, the entire investment securities portfolio has been designated as
being available for sale.  Any decision to sell an available-for-sale
investment security would be based on various factors, including significant
movements in interest rates, changes in maturity mix of assets and liabilities,
liquidity needs, regulatory capital considerations, reasonable gain realization,
changes in the creditworthiness of the issuing entity, changes in investment
strategy and portfolio mix, and other similar factors. Changes in unrealized
gains or losses on available-for-sale investment securities, net of taxes, are
recorded as other comprehensive income (loss), a component of stockholders’
equity.





Certain
types of mortgage-backed and asset-backed securities are purchased to better
position the investment securities portfolio for a subsequent increase or
decrease in interest rates, as aligned with our interest rate risk
position.  These investment securities may be purchased at premiums or
discounts, with short, mid, or long-term average expected lives or
maturities.  Overall yields on these investment securities will increase or
decrease based on changes in prepayment speeds and subsequent cash flow
reinvestments.





Investment
security purchases and sales generally occur to manage the Bank’s liquidity
requirements, pledging requirements, interest rate risk, and to enhance net
interest margin and capital management.  The investment securities
portfolio is evaluated regularly for possible opportunities to increase earnings
through potential sales or portfolio repositioning.  In the first six
months of 2010, proceeds of $61,398,000 were received on sales, and $366,000 was
recognized in net gains, while $61,538,000 of investment securities was
purchased.





Investment
securities of $47,034,000 and $57,209,000 were pledged to secure public, trust,
and government deposits and for other purposes at June 30, 2010 and December 31,
2009, respectively.





In
addition to the credit risk present in the loan portfolio, we also have credit
risk associated with our investment security holdings.  Based on recent
national economic trends and other factors, the private issuer mortgage-backed
securities and corporate debt securities credit ratings as published by national
statistical rating organizations are being monitored closely.





Investment
securities consisted of the following at June 30, 2010 and December 31, 2009,
(in thousands):





June 30,
                    2010
                  
                  
                  December 31,
                    2009Market
      Value of Debt Securities
                  
                  $
                  54,700
                  
                  
                  $
                  60,478Market
      Value of Equity Securities
                  
                  
                  65
                  
                  
                  
                  68Total
      Market Value of Investment Securities
                  
                  $
                  54,765
                  
                  
                  $
                  60,546


29


Debt
securities include mortgage-backed securities, obligations of state and
political subdivisions, obligations of U.S. government agencies, structured
notes and corporate securities.  At June 30, 2010, there were fourteen debt
securities with unrealized losses of $203,000 that amounted to 1.4% of their
amortized cost, as compared to December 31, 2009, when there were twenty-seven
debt securities with unrealized losses of $585,000 that amounted to 1.3% of
their amortized cost.  Management believes that the unrealized losses
reflect temporary declines primarily due to changes in interest rates subsequent
to the acquisition of specific securities.  These temporary declines have
been provided for in other comprehensive income (loss).





Equity
securities held are comprised primarily of common stock holdings in other
financial institutions.  There were nine and ten equity securities with
unrealized losses of $13,000 and $11,000 at June 30, 2010 and December 31, 2009,
respectively.  Union National has the ability and intent to hold these
investments for a reasonable period of time sufficient for the fair value of
each equity security to increase to Union National’s cost.  Management does
not consider the equity securities to be other-than-temporarily impaired at June
30, 2010.





As of
June 30, 2010, (i) $10,000 of the fair value of the total investment securities
portfolio was measured using Level 1 inputs as defined by fair value measurement
and disclosure guidance, (ii) $53,920,000 or 98.5% of the fair value of total
investment securities was measured using Level 2 inputs, and (iii) $835,000 or
1.5% of the fair value of total investment securities was measured using Level 3
inputs (for additional information, refer to Note 12 – Fair Value Measurement of
Assets and Liabilities and Fair Value of Financial Instruments to the
consolidated financial statements).





The fair
value of Level 3 investment securities decreased to $835,000 at June 30, 2010,
as compared to $3,269,000 at December 31, 2009. Of the decrease in value,
$1,560,000 was related to additional other-than-temporary impairment of
investment securities, $336,000 was related to principal and interest payments
received and fully applied to principal, $277,000 was related to net proceeds
received on the sale of an impaired investment security, and $266,000 was
related to net unrealized losses (with a corresponding after-tax impact to
stockholders’ equity of $176,000 recorded as other comprehensive
loss).





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





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


30


During
the second quarter of 2010, the three remaining impaired securities experienced
further downgrades and/or a reduction in cash flows.  As a result,
management made the determination to sell the securities, and valued the
securities based upon current distressed market trading values.





As
discussed more thoroughly in Note 12 — Fair Value Measurement of
Assets and Liabilities and Fair Value of Financial Instruments, the fair
value of these investment securities for quarters ended prior to June 30, 2010,
was determined by calculating the net present value of the expected future cash
flows of each security, with qualitative risk-adjusted discounting for potential
credit risks and nonperformance in the underlying issuers, and market sector
illiquidity concerns. In accordance with ASC Topic 820, when an active market
for a security does not exist, the use of management estimates that incorporate
current market participant expectations of future cash flows, and include
appropriate risk premiums, is acceptable.  For quarters ended prior to June
30, 2010, management’s judgment was that the facts and circumstances indicated
significant illiquidity and an inactive market for these types of investments
when other relevant observable inputs were not available; therefore, expected
cash flows were used as a reasonable basis in determining the fair value of the
corporate investment securities.





During
2009, four of the Bank’s private issuer securities were downgraded to below
investment grade (another private issuer mortgage-backed security was downgraded
to below investment grade in 2008).  Accordingly, the Bank recorded
$1,504,000 of other-than-temporary impairment charges for the year ended
December 31, 2009 including (i) $859,000 related to three corporate securities
supported primarily by obligations from other financial industry entities, and
(ii) $645,000 related to two private issuer mortgage-backed securities not
guaranteed by the U.S. government ($462,000 of the $1,504,000
other-than-temporary impairment charges for the year ended December 31, 2009,
were recorded in the second quarter of 2009).  Management determined that,
due to severe illiquidity and distress in the financial markets, the unrealized
declines in the value of these investments were other-than-temporary and credit
related, requiring the write-down and related impairment charge to
earnings.  For the securities with impairment charges recorded, interest
income payments received subsequent to impairment are fully applied to principal
further reducing the amortized cost of these investments.





During
2009, one of the previously impaired corporate securities (USCap Funding V) was
fully impaired, completely written-off and declared as a worthless asset for tax
purposes. This impaired corporate security had a cumulative credit related OTTI
of $936,000 at December 31, 2009. At December 31, 2009, the Bank had four
impaired securities remaining.





During
the first quarter of 2010, one of the impaired corporate securities (InCaps
Funding II Senior Note) held at December 31, 2009, was sold for $277,000. 
At the time of the sale, the security had $631,000 of previously recorded
impairments, and an adjusted amortized cost of $272,000, which resulted in a
$5,000 gain recorded on the sale.





During
the second quarter of 2010, the three remaining impaired securities experienced
further downgrades and/or a reduction in cash flows.  As a result,
management made the determination to sell the securities, and valued the
securities based upon current distressed market trading values.  The Bank
recorded $1,560,000 of other-than-temporary impairment charges for the six
months ended June 30, 2010, including (i) $1,451,000 related to the two private
issuer mortgage-backed securities not guaranteed by the U.S. government, and
(ii) $109,000 related to one corporate security supported primarily by
obligations from other financial industry entities.


31


Subsequent
to June 30, 2010, the last corporate security (InCaps Funding II Junior Note)
was sold for $129,000. Additionally, one of the private issuer mortgage-backed
securities (Countrywide Alt Ln 2005-75CB A4) was sold.  The sales proceeds
plus estimated principal and interest proceeds yet to be received on the private
issuer mortgage-backed security, approximate $471,000, which was the recorded
impaired value at June 30, 2010. At the time of the sales, the impaired
securities had $639,000 and $1,092,000, respectively, of previously recorded
impairments.





As of
June 30, 2010, Union National’s recorded investment balances include three
securities with previously recorded impairments, two of which were subsequently
sold.  The fair value of the three impaired investments was $835,000 at
June 30, 2010, as compared to an original amortized cost of $6,950,000. All
principal and interest payments received on impaired investment securities are
fully applied to principal.





As of
June 30, 2010, management determined that further impairments were not warranted
on the three remaining impaired investment securities as two securities were
sold subsequent to June 30, 2010, and because the value for the third security
was written-down to distressed trading levels.





Loans and Leases, Credit Quality and
Credit Risk. Loans and leases at June 30, 2010 were $332,735,000 as
compared to $339,274,000 at December 31, 2009.  Outstanding loans decreased
by $6,539,000 from December 31, 2009 to June 30, 2010, primarily due to reduced
loan demand from creditworthy borrowers and the impact of certain loans at
December 31, 2009, that subsequently involved collateral foreclosure and were
classified as other real estate owned (“OREO”) at June 30, 2010, in the
Consolidated Statements of Financial Condition (for additional information,
refer to the discussion on “Non-Performing Assets” on page 35).  Union
National continues to focus lending on creditworthy consumers and businesses,
with necessary consideration given to increased credit risks posed by the weak
economy and the housing market.  The economy and housing market, and
increased unemployment, could affect some of Union National’s borrowers, and may
result in increased nonperforming loans and credit losses.





At June
30, 2010, the Bank had $70,746,000 of loans specifically pledged to the FHLB for
providing collateral on FHLB long-term debt, as compared to $72,287,000 of
pledged loans at December 31, 2009.





Allowance for Credit Losses.In accordance with GAAP, the allowance for credit losses is maintained at
a level believed by management to be adequate to absorb estimated probable loan
and lease principal losses.  The allowance for credit losses is established
through provisions charged against net interest income.  The uncollectible
principal portion of impaired loans and leases is charged against the allowance
for credit losses, and subsequent principal recoveries are credited to the
allowance for credit losses.





Management’s
evaluation of the adequacy of the allowance is based on the Bank’s past loan and
lease loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower’s ability to repay (including the timing
of future payments), the estimated value of any underlying collateral,
composition of the loan portfolio, current economic conditions and other
relevant qualitative factors. This evaluation is inherently subjective as it
requires material estimates including the amounts and timing of future cash
flows expected to be received on impaired loans and leases that may be
susceptible to significant change.


32


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





Union
National continues to closely monitor the loan portfolio, and the underlying
borrower financial performance and collateral values, identifying credit
concerns and risks, including those resulting from the uncertain and weakened
economy.  Future adjustments may be necessary to the allowance for credit
losses, and consequently the provision for credit losses, if economic conditions
or loan credit quality differ substantially from the assumptions management used
in the evaluation of the level of the allowance as compared to the balance of
outstanding loans and leases.





The
allowance for credit losses was $5,989,000 at June 30, 2010, as compared to
$5,858,000 at December 31, 2009.  A provision for credit losses of
$1,124,000 was made for the six months ended June 30, 2010, as compared to
$924,000 for the same period in 2009.  The provision for credit losses for
the six months ended June 30, 2010, as compared to the same period in 2009,
increased by 22% (for additional information, refer to the related discussion on
“Provision for Credit Losses” on pages 40 and 44) given the higher charge-offs
for the first six months of 2010, and the higher credit risks in the loan
portfolio, including those resulting from the current weak economy and real
estate market.  With the higher provision exceeding net loan charge-offs by
$131,000 as well as the decrease to the loan and lease portfolio, the allowance
for credit losses increased to 1.80% of loans at June 30, 2010 as compared to
1.73% of loans at December 31, 2009.  Management believes, based on
information then currently available, that the allowance for credit losses as of
June 30, 2010, was adequate to meet probable credit losses at that
date.





The
following table summarizes the changes in the allowance for credit losses for
the three and six months ended June 30, 2010 and 2009 (dollars in
thousands):





Three Months Ended
                          June 30,
                        
                        
                        Six Months Ended
                          June 30,2010
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2009Allowance
      for Credit Losses, Beginning of Period
                        
                        $
                        5,995
                        
                        
                        $
                        4,319
                        
                        
                        $
                        5,858
                        
                        
                        $
                        4,358Charge-Offs
                        
                        
                        (635
                        )
                        
                        
                        (570
                        )
                        
                        
                        (995
                        )
                        
                        
                        (933
                        )Recoveries
                        
                        
                        1
                        
                        
                        
                        4
                        
                        
                        
                        2
                        
                        
                        
                        15Net
      Charge-Offs
                        
                        
                        (634
                        )
                        
                        
                        (566
                        )
                        
                        
                        (993
                        )
                        
                        
                        (918
                        )Addition
      to Provision for Credit Losses
                        
                        
                        628
                        
                        
                        
                        611
                        
                        
                        
                        1,124
                        
                        
                        
                        924Allowance
      for Credit Losses, End of Period
                        
                        $
                        5,989
                        
                        
                        $
                        4,364
                        
                        
                        $
                        5,989
                        
                        
                        $
                        4,364Loans
      and Leases – Average
                        
                        $
                        333,206
                        
                        
                        $
                        349,697
                        
                        
                        $
                        335,759
                        
                        
                        $
                        352,893Gross
      Loans and Leases – Actual
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        332,735
                        
                        
                        $
                        349,958Ratio
      of Gross Loans and Leases Charged Off to Average Loans and Leases
      (Annualized)
                        
                        
                        0.76
                        %
                        
                        
                        0.65
                        %
                        
                        
                        0.59
                        %
                        
                        
                        0.53
                        %Ratio
      of The Allowance for Credit Losses to Gross Loans and
    Leases
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        1.80
                        %
                        
                        
                        1.25
                        %


33


Impaired Loans. Other
than as described herein, management does not believe there are any significant
trends, events or uncertainties that are reasonably expected to have a material
impact on our loan and lease portfolio to affect future results of operations,
liquidity or capital resources.  However, based on known information,
management believes that the effects of current and past economic conditions and
other unfavorable business conditions may impact certain borrowers’ abilities to
comply with their repayment terms and therefore may have an adverse effect on
future results of operations, liquidity, or capital resources.  Management
continues to closely monitor economic and business conditions and the impact on
borrowers’ financial strength.  For certain loans and leases, management
has determined that it is probable that all principal and interest payments due
according to the contractual terms of the loan agreements will not be collected.
These loans are considered to be impaired as defined by GAAP.





The
balance of loans and leases that were considered to be impaired under GAAP was
$4,976,000 and $8,715,000, which consisted of seven and ten separate loan and
lease relationships to unrelated borrowers, at June 30, 2010 and December 31,
2009, respectively.  At June 30, 2010, three of the relationships
represented 88% of the total impaired loans and leases of $4,976,000.  The
decrease in impaired loans from December 31, 2009 to June 30, 2010, primarily
resulted from several loans, with a related allowance, that were foreclosed on
and transferred into other real estate owned during 2010 (for additional
information, refer to the discussion on “Non-Performing Assets” on page 35).
Management continues to diligently monitor and evaluate the impaired loan
portfolio, and identify new credit concerns and collectability risks, including
those resulting from the current uncertain and weakened economy.The
measure of impairment is based primarily on the fair value of collateral
securing these loans, which is primarily real estate and equipment.





Impaired Loans With a
Related Allowance.  Union National had $4,581,000 and $5,916,000 of
impaired loans and leases with a related allowance for credit losses at June 30,
2010 and December 31, 2009, respectively. These consisted of five loan and lease
relationships to unrelated borrowers, with a related allowance for credit losses
of $860,000 and $1,458,000 at June 30, 2010 and December 31, 2009,
respectively.  The decrease in impaired loans with a related allowance from
December 31, 2009 to June 30, 2010, primarily resulted from several loans that
were either charged-off or foreclosed on and transferred into other real estate
owned during 2010. This group of impaired loans and leases has a related
allowance due to the probability that the borrower is not able to continue to
make principal and interest payments due under the contractual terms of the loan
or lease.  These loans and leases appear to have insufficient collateral
and Union National’s principal may be at risk; as a result, a related allowance
is necessary to cover future potential principal losses.





Impaired Loans without a
Related Allowance.  Union National had $395,000 and $2,799,000 of
impaired loans and leases without a related allowance at June 30 2010 and
December 31, 2009, respectively.  These consisted of two and five separate
loan and lease relationships at June 30, 2010 and December 31, 2009,
respectively.  The decrease in impaired loans without a related allowance
from December 31, 2009 to June 30, 2010, was related to one relationship for
which management established a related allowance during 2010, which resulted
from continuing stress with certain commercial real estate property
values.  This group of impaired loans and leases is considered impaired due
to the likelihood of the borrower not being able to continue to make principal
and interest payments due under the contractual terms of the loan or
lease.  However, these loans and leases appear to have sufficient
collateral and Union National’s principal does not appear to be at risk of
probable principal losses; as a result, management believes a related allowance
is not necessary.


34


Substandard Loans and
Leases.  Under the Bank’s current internal risk rating system, loans
and leases with a rating of “substandard” that were performing, and not
determined to be impaired, amounted to $32,647,000 and $32,410,000 at June 30,
2010 and December 31, 2009, respectively.  Despite these credits not being
impaired, management believes these substandard credits reflect increased risks
to the loan portfolio, including risks resulting from the current weak economy
and real estate markets.  Management considered such increased risks in
determining the provision for credit losses (refer to the related discussion on
“Provision for Credit
Losses”on pages 40 and 44).Management continues to
closely monitor the loan portfolio, and the underlying borrower financial
performance and collateral values, identifying credit concerns and risks,
including those resulting from the current weak economy.  Management
considers both impaired and these substandard loans to be potential problem
loans, and believes that the current persisting and weakened economic conditions
may result in additional loans being classified or nonperforming in future
periods.





Non-Performing
Assets.  Nonperforming assets consist of nonperforming loans and
leases, other real estate owned (“OREO”), and repossessed assets.  The
following table provides a summary of nonperforming assets at June 30, 2010 and
December 31, 2009 (dollars in thousands):





June 30,
                            2010
                          
                          
                          December31,
                            2009Nonaccruing
      Loans
                          
                          $
                          5,157
                          
                          
                          $
                          8,034Accruing
      Loans – 90 days or more past due
                          
                          
                          341
                          
                          
                          
                          506Total
      Nonperforming Loans and Leases
                          
                          
                          5,498
                          
                          
                          
                          8,540Other
      Real Estate Owned
                          
                          
                          8,694
                          
                          
                          
                          5,383Repossessed
      Assets
                          
                          
                          167
                          
                          
                          
                          436Total
      Nonperforming Assets
                          
                          $
                          14,359
                          
                          
                          $
                          14,359Gross
      Loans and Leases
                          
                          $
                          332,735
                          
                          
                          $
                          339,274Allowance
      for Credit Losses
                          
                          $
                          5,989
                          
                          
                          $
                          5,858Nonperforming
      Loans and Leases as a % of Gross Loans and Leases
                          
                          
                          1.7
                          %
                          
                          
                          2.5
                          %Nonperforming
      Assets as a % of Total Assets
                          
                          
                          2.9
                          %
                          
                          
                          2.9
                          %Allowance
      for Credit Losses as a % of Nonperforming Loans and Leases
                          
                          
                          109
                          %
                          
                          
                          69
                          %





Nonperforming
loans and leases consist of loans and leases that are nonaccruing, and those
that are 90 days or more past due. Nonaccruing loans and leases are no longer
accruing interest income because of apparent financial difficulties of the
borrower.  Interest received on nonaccruing loans and leases is recorded as
income only after the past due principal is brought current and deemed
collectible in full. Total nonperforming loans and leases decreased to
$5,498,000, or 1.7%, of gross loans and leases at June 30, 2010, as compared to
$8,540,000, or 2.5% of gross loans and leases, at December 31, 2009.  The
decrease in nonperforming loans and leases primarily resulted from certain loans
being foreclosed on in 2010 and are reported as OREO in the Consolidated
Statements of Financial Condition at June 30, 2010.  The percentage of
nonperforming loans to gross loans for the five year-end periods ended December
31, 2009, was an average of 1.2%.


35


OREO
includes assets acquired through foreclosure, deed in-lieu of foreclosure, and
loans identified as in-substance foreclosures.  A loan is classified as an
in-substance foreclosure when effective control of the collateral has been taken
prior to completion of formal foreclosure proceedings.  OREO is held for
sale and is recorded at fair value less estimated costs to sell.  Costs to
maintain OREO and subsequent gains and losses attributable to OREO liquidation
are included in the Consolidated Statements of Operations in other income and
other expense as realized.  No depreciation or amortization expense is
recognized. OREO was $8,694,000 and $5,383,000 at June 30, 2010 and December 31,
2009, respectively.  The increase was primarily the result of Union
National foreclosing on two commercial mortgages in 2010. At June 30, 2010,
$7,375,000, or 85% of the total OREO balance, consisted of two large commercial
properties in Lancaster, PA.  The remaining $1,319,000, or 15% of the total
OREO balance, was comprised of five smaller commercial and residential
properties.





Repossessed
assets consist of (i) vehicles and other equipment acquired from lessees, who
defaulted on their contractual lease obligation, and (ii) mobile homes where the
Bank does not own the underlying real estate.  Repossessed assets were
$167,000 and $436,000 at June 30, 2010 and December 31, 2009,
respectively.  The decrease resulted primarily from sales of repossessed
assets, as well as the write-down of certain repossessed leased assets to fair
market value, with such write-downs amounting to $144,000.





Stockholders’ Equity.Stockholders’ equity decreased by $815,000 to $30,521,000 at June 30,
2010, as compared to $31,336,000 at December 31, 2009.  The decrease in
stockholders’ equity was primarily the result of decreases to retained earnings
resulting from the year-to-date net loss and dividends paid to preferred
stockholders, offset by other comprehensive income during the period and
proceeds received through the Dividend Reinvestment Plan (“DRIP”).





Regulatory
Capital.Bank
regulatory authorities in the United States issue risk-based capital
standards.  These capital standards relate a bank’s capital to the risk
profile of its assets and provide the basis by which all banks are evaluated in
terms of its capital adequacy.  Union National and the Bank are subject to
various regulatory capital requirements administered by the federal banking
agencies.  Failure to meet the minimum capital requirements can initiate
certain mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on our consolidated
financial statements.  Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, Union National and the Bank must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices.  The capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require Union
National and the Bank to maintain minimum amounts and ratios of Tier 1 capital
to average assets and of total capital (as defined in the regulations) to
risk-weighted assets.





As of
June 30, 2010 and December 31, 2009, Union National and the Bank exceeded the
current regulatory requirements to be considered a quantitatively “well
capitalized” financial institution, i.e. a leverage ratio exceeding 5%, Tier 1
risk-based capital exceeding 6%, and total risk-based capital exceeding
10%.





In
addition to the above regulatory capital standards, effective September 30,
2009, the OCC established individual minimum capital requirements for the Bank
(for additional information, refer to Note 9 — Enforcement Actions with
Bank Regulatory Agenciesto the consolidated financial statements). The
specific capital requirements established for the Bank were 8% for Tier 1
capital to average total assets, 9.5% for Tier 1 capital to risk-based assets,
and 12% for total capital to risk-based assets.  At June 30, 2010, the
Bank’s measure of Tier I capital to average Total assets was 8.09%, Tier 1
capital to risk-based assets of 10.17% and total capital to risk-based assets of
12.94%. At June 30, 2010, all three ratios exceeded the respective individual
minimum capital requirements established by the OCC.


36


Union
National and the Bank’s regulatory capital levels as of June 30, 2010 and
December 31, 2009, are as follows (dollars in thousands):


Actual
                        
                        
                        Minimum Required
                          For Capital
                          Adequacy Purposes
                        
                        
                        To Be Well-
                          Capitalized Under
                          Prompt Corrective
                          Action ProvisionsAmount
                        
                        
                        Ratio
                        
                        
                        Amount
                        
                        
                        Ratio (1)
                        
                        
                        Amount
                        
                        
                        RatioUnion National Financial
      CorporationJune
      30, 2010:Tier
      1 (leverage) capital
                        
                        $
                        40,663
                        
                        
                        
                        8.18
                        %
                        
                        $
                        19,894
                        
                        
                        
                        4.00
                        %
                        
                        
                        N/A
                        
                        
                        
                        N/ATier
      1 risk-based capital
                        
                        
                        40,663
                        
                        
                        
                        10.28
                        
                        
                        
                        15,827
                        
                        
                        
                        4.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ATotal
      risk-based capital
                        
                        
                        52,457
                        
                        
                        
                        13.26
                        
                        
                        
                        31,654
                        
                        
                        
                        8.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ADecember
      31, 2009:Tier
      1 (leverage) capital
                        
                        $
                        42,036
                        
                        
                        
                        8.52
                        %
                        
                        $
                        19,744
                        
                        
                        
                        4.00
                        %
                        
                        
                        N/A
                        
                        
                        
                        N/ATier
      1 risk-based capital
                        
                        
                        42,036
                        
                        
                        
                        9.93
                        
                        
                        
                        16,929
                        
                        
                        
                        4.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ATotal
      risk-based capital
                        
                        
                        53,825
                        
                        
                        
                        12.72
                        
                        
                        
                        33,858
                        
                        
                        
                        8.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/AUnion National Community
    BankJune
      30, 2010:Tier
      1 (leverage) capital
                        
                        $
                        40,103
                        
                        
                        
                        8.09
                        %
                        
                        $
                        19,831
                        
                        
                        
                        4.00
                        %
                        
                        $
                        24,789
                        
                        
                        
                        5.00
                        %Tier
      1 risk-based capital
                        
                        
                        40,103
                        
                        
                        
                        10.17
                        
                        
                        
                        15,777
                        
                        
                        
                        4.00
                        
                        
                        
                        23,666
                        
                        
                        
                        6.00Total
      risk-based capital
                        
                        
                        51,048
                        
                        
                        
                        12.94
                        
                        
                        
                        31,554
                        
                        
                        
                        8.00
                        
                        
                        
                        39,443
                        
                        
                        
                        10.00December
      31, 2009:Tier
      1 (leverage) capital
                        
                        $
                        40,910
                        
                        
                        
                        8.31
                        %
                        
                        $
                        19,686
                        
                        
                        
                        4.00
                        %
                        
                        $
                        24,608
                        
                        
                        
                        5.00
                        %Tier
      1 risk-based capital
                        
                        
                        40,910
                        
                        
                        
                        9.69
                        
                        
                        
                        16,881
                        
                        
                        
                        4.00
                        
                        
                        
                        25,322
                        
                        
                        
                        6.00Total
      risk-based capital
                        
                        
                        52,194
                        
                        
                        
                        12.37
                        
                        
                        
                        33,762
                        
                        
                        
                        8.00
                        
                        
                        
                        42,203
                        
                        
                        
                        10.00





(1)
            The
      OCC requires the Bank to meet higher individual minimum capital ratios
      effective September 30, 2009 (for additional information, refer to Note 9 — Enforcement Actions
      with Bank Regulatory
Agencies).





Included
in Tier 1 regulatory capital of Union National is $10,167,000 of trust capital
securities issued through the UNCT I  and UNCT II subsidiaries of Union
National.  The balance of these trust capital securities, $833,000, is
included in Tier 2 regulatory capital of Union National.  Additionally,
included in Tier 2 regulatory capital of the Bank and Union National is
$6,000,000 of junior subordinated debentures issued by the Bank.  These
securities would become callable if the Federal Reserve makes a determination
that trust capital securities can no longer be considered in regulatory
capital.





Regulatory
capital requirements may be increased in the future.  Union National will
closely monitor and evaluate its capital position as the regulatory capital
environment changes, and if regulatory capital requirements are
changed.





Restrictions. Banking
regulations limit the amount of investments, loans, extensions of credit and
advances the Bank can make to Union National at any time to 10% of the Bank’s
total regulatory capital.  At June 30, 2010, this limitation amounted to
approximately $5,105,000. These regulations also require any such investment,
loan, extension of credit or advance to be secured by securities having a market
value in excess of the amount thereof.


37


The Bank
is subject to certain restrictions in connection with the payment of
dividends.  National banking laws require the approval of the Office of the
Comptroller of the Currency if the total of all dividends declared by a national
bank in any calendar year exceeds the net profits of the Bank for that year (as
defined)  combined with the Bank’s retained net operating results for the
preceding two calendar years.  Under this formula, the Bank’s retained net
operating results for the preceding two calendar years was ($189,000).  As
a result, in 2010, the Bank may declare dividends to the parent company, Union
National, in an amount equal to the net profits of the Bank in 2010 less
$189,000, up to the date of any such dividend declaration.   The Bank
had a net loss of $808,000 for the six months ended June 30, 2010, restricting
the Bank from declaring or making any dividend payment to Union National at June
30, 2010.





On
January 28, 2010, Union National entered into an informal Memorandum of
Understanding with the Federal Reserve Bank (“FRB”) of Philadelphia.  The
Memorandum of Understanding, which is not a “written agreement” for purposes of
Section 8 of the Federal Deposit Insurance Act, requires, among other things,
Union National to seek prior approval by the FRB before Union National (i)
declares or pays dividends to shareholders, (ii) distributes interest, principal
or other sums on UNCT I and UNCT II junior subordinated debentures, and (iii)
incurs, increases or guarantees any additional debt.





The FRB
approved Union National’s request to pay preferred stock dividends and
distributions on its two issuances of trust-preferred securities for the first
and second quarters of 2010.  Union National made a similar request for the
third quarter of 2010, but the FRB denied the request.  Accordingly, Union
National has acted to suspend the preferred stock dividend and to defer
distributions on its trust-preferred securities indefinitely. 
Distributions on one class of trust preferred securities, issued by UNCT I, were
next scheduled for July 23, 2010 and distributions on the other class, issued by
UNCT II, were next scheduled for August 23, 2010.  Dividend payments on the
preferred stock were next scheduled for July 31, 2010.  Union National’s
preferred stock is non-cumulative so the suspension of dividends will not result
in any accrued dividend liability.  The deferral of distributions on the
trust-preferred securities will continue to accrue as interest expense payable
by Union National.  Union National is prohibited from declaring or paying
any dividends on its common stock or preferred stock while distributions on the
trust-preferred securities are in arrears.


38


RESULTS
OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2010 AND 2009





Overview. Union National
reported a net loss available to common stockholders of ($1,021,000) for the
second quarter of 2010, as compared to net income available to common
stockholders of $105,000 for the same period in 2009.  Basic and diluted
losses per common share were ($0.37) for the second quarter of 2010, as compared
to basic and diluted earnings per common share of $0.04 for the same period in
2009.





The
operating results for the second quarter of 2010 included $1,560,000 in
other-than-temporary investment impairment charges, as compared to $462,000 for
the same period in 2009.  The impairment charges for both periods are
reflective of investment rating downgrades and/or a reduction in cash flows on
private-issuer mortgage-backed securities and corporate securities, and reflect
management’s intention to now sell these impaired securities.  The second
quarter operating results also reflect merger and acquisition related expenses
of $436,000 (for additional information, refer to Note 14 — Proposed Merger
Agreement to the unaudited consolidated financial
statements).





The
discussion that follows further explains the changes in the components of the
operating results when comparing the three months ended June 30, 2010 to the
same period in 2009.





Net Interest Income.Net
interest income, our primary source of revenue, is the amount by which interest
income on loans and investments exceeds interest incurred on deposits and
borrowings.  The amount of net interest income is affected by changes in
interest rates and by changes in the volume and mix of interest-sensitive assets
and liabilities.  Net interest income and corresponding yields are
presented in the discussion and analysis below on a taxable-equivalent
basis.  Income from tax-exempt assets, primarily loans to or securities
issued by state and local governments, is adjusted by an amount equivalent to
the federal income taxes which would have been paid if the income received on
these assets was taxable at the statutory rate of 34%.





Although
the effective interest rate impact on earning assets and funding sources can be
reasonably estimated at current interest rate levels, the options selected by
customers, and the future mix of the loan, investment and deposit products in
the Bank’s portfolios, may significantly change the estimates used in the
simulation models. In addition, our net interest income may be impacted by
further interest rate actions of the Federal Reserve Bank and movements in the
London Interbank Offered Rate (“LIBOR”) upon which certain variable rate loans
and debentures are priced.





Net
interest income as adjusted for tax-exempt financial instruments was $3,453,000
for the three months ended June 30, 2010, as compared to $3,128,000 for the same
period in 2009.  The decrease in the interest rate paid on average
interest-bearing liabilities more than offset the decrease in the yield on
interest-earning assets, which resulted in a higher net interest margin for
three months ended June 30, 2010, as compared to the same period in 2009. 
The taxable-equivalent net interest margin percentage for the first quarter of
2010 was 3.06%, as compared to 2.65% for the same period in 2009.  The
interest rate paid on average interest-bearing liabilities decreased by 68 basis
points to 2.08% for the three months ended June 30, 2010, as compared to 2.76%
for the same period in 2009.  The yield on interest-earning assets
decreased by 24 basis points to 4.91% for the three months ended June 30, 2010,
as compared to 5.15% for the same period in 2009.





Interest
and fees on loans and leases, on a taxable-equivalent basis, decreased by
$499,000, or 9%, to $5,039,000 for the three months ended June 30, 2010, as
compared to $5,538,000 for the same period in 2009. The decrease in interest and
fees on loans and leases primarily resulted from the decrease in loans
outstanding.  The average balance of loans and leases decreased by
$16,491,000 for the three months ended June 30, 2010, as compared to the same
period in 2009, due to reduced loan demand from creditworthy borrowers, the
impact of nearly $10 million of loan participations sold for capital and risk
management purposes in the third quarter of 2009, and the impact of
approximately $8.7 million of loans that were foreclosed on and transferred to
OREO since June 30, 2009.  The average yield decreased by 28 basis points
to 6.07% for the three months ended June 30, 2010, as compared to 6.35% for the
same period in 2009. The variable rate structure of many of Union National’s
loans reduced the overall yield due to the persistent low market interest
rates.


39


Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $55,000, or 12%, to $418,000 for the three months ended June 30,
2010, as compared to $473,000 for the same period in 2009.  The decrease in
interest and dividends earned on investment securities primarily resulted from a
decrease in the average balance of investment securities, which decreased by
$4,468,000 for the three months ended June 30, 2010, as compared to the same
period in 2009.  A lack of income from impaired and non-accruing
investments, and reduced yields on re-invested proceeds from investment
maturities and sales, also contributed to lower investment interest income for
the second quarter of 2010.  As a result, the average yield decreased by 15
basis points to 2.76% for the three months ended June 30, 2010, as compared to
2.91% for the same period in 2009.





Interest
expense on deposits decreased by $722,000, or 33%, to $1,494,000 for the three
months ended June 30, 2010, as compared to $2,216,000 for the same period in
2009.  The decrease in interest expense on deposits was primarily driven by
a decrease of 70 basis points in the average rate paid on deposits.  The
average rate paid on deposits was 1.70% for the second quarter of 2010, as
compared to 2.40% for the same period in 2009.





Interest
expense on long-term debt decreased by $125,000, or 24%, to $391,000 for the
three months ended June 30, 2010, as compared to $516,000 for the same period in
2009.  Union National continued to take measures to reduce its cost of
borrowings, prepaying $2,500,000 and $17,000,000 of higher-cost long-term debt
in the first quarter of 2010 and for the full year of 2009, respectively, which
contributed to a $9,995,000 decrease in the average balance of long-term debt
for the second quarter of 2010, as compared to the same period in
2009.





Subsequent
to June 30, 2010, Union National prepaid an additional $10,000,000 of
higher-cost long-term debt, incurring $136,000 of related prepayment penalties,
charged to non-interest expense in July 2010.





Provision for Credit
Losses.  The provision for credit losses is an expense charged
against net interest income to provide for estimated losses attributable to
uncollectible loans and leases.  The provision is based on management’s
analysis of the adequacy of the allowance for credit losses.  The provision
for credit losses was $628,000 for the three months ended June 30, 2010, as
compared to $611,000 for the same period in 2009.  The increased provision
was the result of higher charge-offs and continued higher credit risk related to
the loan portfolio  at June 30, 2010, as compared to June 30, 2009 (refer
to the related discussions on the “Allowance for Credit Losses” on page 32 and
“Substandard Loans and Leases” on page 35).  Management continues to
closely monitor the loan portfolio and the adequacy of the allowance for credit
loss reserve considering underlying borrower financial performance and
collateral values, and increasing credit risks.  Future adjustments may be
necessary to the provision for credit losses, and consequently the allowance for
credit losses, if economic conditions or loan credit quality differ
substantially from the assumptions we used in making our evaluation of the level
of the allowance for credit losses as compared to the balance of outstanding
loans and leases.


40


Non-Interest Income. 
Non-interest income decreased by $2,143,000, or 105%, to $(105,000) for the
three months ended June 30, 2010, as compared to $2,038,000 for the same period
in 2009, which was primarily the result of an increase in other-than-temporary
investment impairment charges and a decrease in net gains realized on investment
security sales. Increases (decreases) in the components of non-interest income
when comparing the three months ended June 30, 2010 to the same period in 2009,
are as follows (in thousands):





Three Months Ended June 30,
                
                
                IncreaseNon-Interest Income
                
                2010
                
                
                2009
                
                
                (Decrease)Service
      Charges on Deposit Accounts
                
                $
                498
                
                
                $
                540
                
                
                $
                (42
                )Other
      Service Charges, Commissions, Fees
                
                
                316
                
                
                
                297
                
                
                
                19Alternative
      Investment Sales Commissions
                
                
                167
                
                
                
                193
                
                
                
                (26
                )Income
      from Fiduciary Activities
                
                
                41
                
                
                
                47
                
                
                
                (6
                )Earnings
      from Bank-Owned Life Insurance
                
                
                102
                
                
                
                107
                
                
                
                (5
                )Other
      Income
                
                
                42
                
                
                
                333
                
                
                
                (291
                )Net
      Gain on Sale of Investment Securities
                
                
                289
                
                
                
                983
                
                
                
                (694
                )Other-than-temporary
      Impairments (“OTTI”) of Securities
                
                
                (1,560
                )
                
                
                (462
                )
                
                
                (1,098
                )Portion
      of OTTI Recognized in Other Comprehensive Income
                
                
                —
                
                
                
                —
                
                
                
                —Net
      OTTI Losses on Securities
                
                
                (1,560
                )
                
                
                (462
                )
                
                
                (1,098
                )Total
      Non-Interest Income
                
                $
                (105
                )
                
                $
                2,038
                
                
                $
                (2,143
                )





The
operating results for the second quarter of 2010 included $1,560,000 in
other-than-temporary investment impairment charges, as compared to $462,000 for
the same period in 2009.  The impairment charges for both periods are
reflective of investment rating downgrades on two private-issuer mortgage-backed
securities and one corporate security, and management’s intention to now sell
such securities, resulting in values being reduced to distressed market trading
levels.  The operating results for the second quarter of 2010 included
$289,000 in net gains on the sale of investment securities, as compared to
$983,000 for the same period in 2009.





Other
income decreased by $291,000 for the three months ended June 30, 2010, as
compared to the same period in 2009, which was primarily the result of the
impact of other income recorded during the second quarter 2009 from an insurance
payment to Union National in recovery of a 2008 fraud loss.





Non-Interest Expense. 
Non-interest expense was $4,284,000 for the three months ended June 30, 2010, as
compared to $4,480,000 for the same period in 2009.  Increases (decreases)
in the components of non-interest expense when comparing the three months ended
June 30, 2010, to the same period in 2009, are as follows (in
thousands):


Three Months Ended June 30,
                  
                  
                  IncreaseNon-Interest Expense
                  
                  2010
                  
                  
                  2009
                  
                  
                  (Decrease)Salaries,
      Wages, and Employee Benefits
                  
                  $
                  1,663
                  
                  
                  $
                  1,671
                  
                  
                  $
                  (8
                  )Net
      Occupancy
                  
                  
                  442
                  
                  
                  
                  421
                  
                  
                  
                  21Data
      and ATM Processing
                  
                  
                  461
                  
                  
                  
                  426
                  
                  
                  
                  35Professional
      Fees and Regulatory Assessments
                  
                  
                  206
                  
                  
                  
                  244
                  
                  
                  
                  (38
                  )Furniture
      and Equipment
                  
                  
                  220
                  
                  
                  
                  240
                  
                  
                  
                  (20
                  )FDIC
      Insurance
                  
                  
                  239
                  
                  
                  
                  540
                  
                  
                  
                  (301
                  )Pennsylvania
      Shares Tax
                  
                  
                  96
                  
                  
                  
                  89
                  
                  
                  
                  7Advertising
      and Marketing
                  
                  
                  52
                  
                  
                  
                  50
                  
                  
                  
                  2Supplies
      and Postage
                  
                  
                  59
                  
                  
                  
                  74
                  
                  
                  
                  (15
                  )Merger
      and Acquisition Expenses
                  
                  
                  436
                  
                  
                  
                  —
                  
                  
                  
                  436Other
      Expense
                  
                  
                  410
                  
                  
                  
                  725
                  
                  
                  
                  (315
                  )Total
      Non-Interest Expense
                  
                  $
                  4,284
                  
                  
                  $
                  4,480
                  
                  
                  $
                  (196
                  )


41


The
discussion that follows explains the significant changes in the components of
non-interest expense when comparing the three months ended June 30, 2010 to the
same period in 2009.





The
second quarter operating results reflect merger and acquisition related expenses
of $436,000.  These expenses are comprised of primarily merger-related
legal and investment banking fees. As previously disclosed, Union National
entered into the Merger Agreement on April 19, 2010, as amended and restated as
of May 20, 2010 with DFSC pursuant to which Union National will merge with and
into DFSC. If the transaction is approved by the regulators and shareholders,
and meets all closing conditions, Union National Community Bank also will merge
with and into Province. A Special Meeting of Shareholders will be held on
September 16, 2010 to vote on the proposed merger with DFSC. The holders of
outstanding shares of common stock of record as of the close of business on July
29, 2010 are entitled to vote at the Special Meeting of
Shareholders.





Operating
results also reflect lower Federal Deposit Insurance Corporation (“FDIC”)
insurance assessments when comparing the three months ended June 30, 2010, to
the same period in 2009.  The second quarter of 2009 FDIC insurance
reflects the impact of $237,000 related to the FDIC special assessment on
deposit-insured institutions.





The
decrease in other expense was primarily the result of $393,000 of FHLB debt
prepayment penalties incurred during the three months ended June 30, 2009. 
The Bank did not prepay any FHLB advances in the second quarter of 2010, and
therefore, did not incur any prepayment penalties for the three months ended
June 30, 2010.  The decline in debt prepayment penalties was slightly
offset by expenses related to OREO and repossessed assets, which were higher for
the three months ended June 30, 2010, as compared to the same period in
2009.





Income Taxes.An income
tax benefit of $610,000 and $106,000 was recorded for the three months ended
June 30, 2010 and 2009, respectively.  For the three months ended June 30,
2010, the income tax benefit resulted from a pre-tax loss as well as from the
benefits of tax-exempt income. For the three months ended June 30, 2009, the
income tax benefit resulted primarily from the benefits of tax-exempt
income.  Generally, Union National’s effective tax rate is below the
statutory rate due to tax-exempt earnings on loans, investments, and bank-owned
life insurance, and the impact of tax credits.


42


RESULTS
OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009





Overview. Union National
reported a net loss available to common stockholders of ($1,036,000) or basic
and diluted losses per common share of ($0.38) for the six months ended June 30,
2010, as compared to a net loss available to common stockholders of ($404,000)
or basic and diluted losses per common share of ($0.15) for the same period in
2009.





The
discussion that follows further explains the changes in the components of the
operating results when comparing the six months ended June 30, 2010 to the same
period in 2009.





Net Interest
Income.  Net interest
income as adjusted for tax-exempt financial instruments was $6,749,000 for the
six months ended June 30, 2010, as compared to $6,053,000 for the same period in
2009.  The decrease in the interest rate paid on average interest-bearing
liabilities more than offset the decrease in the yield on interest-earning
assets, which resulted in a higher net interest margin for the first six months
of 2010, as compared to the same period in 2009.  The taxable-equivalent
net interest margin percentage for the first six months of 2010 was 3.01%, as
compared to 2.61% for the same period in 2009.  The interest rate paid on
average interest-bearing liabilities decreased by 73 basis points to 2.18% for
the first six months of 2010, as compared to 2.91% for the same period in
2009.  The yield on interest-earning assets decreased by 31 basis points to
4.95% for the first six months of 2010, as compared to 5.26% for the same period
in 2009.





Interest
and fees on loans and leases, on a taxable-equivalent basis, decreased by
$878,000, or 8%, to $10,087,000 for the six months ended June 30, 2010, as
compared to $10,965,000 for the same period in 2009.  The average yield
decreased by 21 basis points to 6.06% for the first six months of 2010, as
compared to 6.27% for the same period in 2009.  The variable rate structure
of many of Union National’s loans reduced the overall yield due to the
persistent low market interest rates.  The average balance of loans and
leases decreased by $17,134,000 for the first six months of 2010, as compared to
the same period in 2009 due to reduced loan demand from creditworthy borrowers,
the impact of nearly $10 million of loan participations sold for capital and
risk management purposes in the third quarter of 2009, and the impact of
approximately $8.7 million of loans that were foreclosed on and transferred to
OREO since June 30, 2009.  The decrease in interest and fees on loans and
leases primarily resulted from the decrease in loans outstanding.





Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $245,000, or 22%, to $856,000 for the six months ended June 30,
2010, as compared to $1,101,000 for the same period in 2009.  The decrease
in interest and dividends earned on investment securities primarily resulted
from a decrease in the average balance of investment securities, which decreased
by $7,532,000 for the first six months of 2010, as compared to the same period
in 2009.  A lack of income from impaired and non-accruing investments, and
reduced yields on re-invested proceeds from investment maturities and sales,
also contributed to lower investment interest income for the six months ended
June 30, 2010.  As a result, the average yield decreased by 42 basis points
to 2.93% for the first six months of 2010, as compared to 3.35% for the same
period in 2009.





Interest
expense on deposits decreased by $1,343,000, or 30%, to $3,175,000 for the six
months ended June 30, 2010, as compared to $4,518,000 for the same period in
2009.  The decrease in interest expense on deposits was primarily driven by
a decrease of 72 basis points in average rate paid on deposits.  The
average rate paid on deposits was 1.81% for the first six months of 2010, as
compared to 2.53% for the same period in 2009.





Interest
expense on long-term debt decreased by $377,000, or 32%, to $784,000 for the six
months ended June 30, 2010, as compared to $1,161,000 for the same period in
2009.  Union National continued to take measures to reduce its cost of
borrowings, prepaying $2,500,000 and $17,000,000 of higher-cost long-term debt
in the first quarter of 2010 and for the full year of 2009, respectively, which
contributed to a $14,431,000 decrease in the average balance of long-term debt
for the first six months of 2010, as compared to the same period in
2009.


43


Subsequent
to June 30, 2010, Union National prepaid an additional $10,000,000 of
higher-cost long-term debt, incurring $136,000 of related prepayment penalties,
charged to non-interest expense in July 2010.





Provision for Credit
Losses.  The provision for credit losses was $1,124,000 for the six
months ended June 30, 2010, as compared to $924,000 for the same period in
2009.  The increased provision was the result of higher charge-offs and
continued higher credit risk related to the loan portfolio  at June 30,
2010, as compared to June 30, 2009 (refer to the related discussions on the
“Allowance for Credit Losses” on page 32 and “Substandard Loans and Leases” on
page 35).  Management continues to closely monitor the loan portfolio and
the adequacy of the allowance for credit loss reserve considering underlying
borrower financial performance and collateral values, and increasing credit
risks.  Future adjustments may be necessary to the provision for credit
losses, and consequently the allowance for credit losses, if economic conditions
or loan credit quality differ substantially from the assumptions we used in
making our evaluation of the level of the allowance for credit losses as
compared to the balance of outstanding loans and leases.





Non-Interest Income. 
Non-interest income decreased by $1,582,000, or 60%, to $1,075,000 for the six
months ended June 30, 2010, as compared to $2,657,000 for the same period in
2009, which was primarily the result of a decrease in net gains on the sale of
investment securities and an increase in other-than-temporary investment
impairment charges. Increases (decreases) in the components of non-interest
income when comparing the six months ended June 30, 2010 to the same period in
2009, are as follows (in thousands):





Six Months Ended June 30,
                
                
                IncreaseNon-Interest Income
                
                2010
                
                
                2009
                
                
                (Decrease)Service
      Charges on Deposit Accounts
                
                $
                956
                
                
                $
                1,013
                
                
                $
                (57
                )Other
      Service Charges, Commissions, Fees
                
                
                604
                
                
                
                564
                
                
                
                40Alternative
      Investment Sales Commissions
                
                
                334
                
                
                
                303
                
                
                
                31Income
      from Fiduciary Activities
                
                
                88
                
                
                
                93
                
                
                
                (5
                )Earnings
      from Bank-Owned Life Insurance
                
                
                204
                
                
                
                215
                
                
                
                (11
                )Other
      Income
                
                
                83
                
                
                
                376
                
                
                
                (293
                )Net
      Gain on Sale of Investment Securities
                
                
                366
                
                
                
                1,394
                
                
                
                (1,028
                )Other-than-temporary
      Impairments (“OTTI”) of Securities
                
                
                (1,560
                )
                
                
                (1,301
                )
                
                
                (259
                )Portion
      of OTTI Recognized in Other Comprehensive Income
                
                
                —
                
                
                
                —
                
                
                
                —Net
      OTTI Losses on Securities
                
                
                (1,560
                )
                
                
                (1,301
                )
                
                
                (259
                )Total
      Non-Interest Income
                
                $
                1,075
                
                
                $
                2,657
                
                
                $
                (1,582
                )





The
operating results for the six months ended June 30, 2010 included $366,000 in
net gains on the sale of investment securities, as compared to $1,394,000 for
the same period in 2009.  The operating results for the six months ended
June 30, 2010, included $1,560,000 in other-than-temporary investment impairment
charges, as compared to $1,301,000 for the same period in 2009.  The
impairment charges for both periods are reflective of investment rating
downgrades on two private-issuer mortgage-backed securities and one corporate
security, and management’s intention to now sell such securities, resulting in
values being reduced to distressed market trading levels.





Other
income decreased by $293,000 for the six months ended June 30, 2010, as compared
to the same period in 2009, which was primarily the result of the impact of
other income recorded during the second quarter 2009 from an insurance payment
to Union National in recovery of a 2008 fraud loss.


44


Non-Interest Expense. 
Non-interest expense was $8,306,000 for the six months ended June 30, 2010, as
compared to $8,494,000 for the same period in 2009.  Increases (decreases)
in the components of non-interest expense when comparing the six months ended
June 30, 2010, to the same period in 2009, are as follows (in
thousands):





Six Months Ended June 30,
                  
                  
                  IncreaseNon-Interest Expense
                  
                  2010
                  
                  
                  2009
                  
                  
                  (Decrease)Salaries,
      Wages, and Employee Benefits
                  
                  $
                  3,461
                  
                  
                  $
                  3,617
                  
                  
                  $
                  (156
                  )Net
      Occupancy
                  
                  
                  904
                  
                  
                  
                  899
                  
                  
                  
                  5Data
      and ATM Processing
                  
                  
                  867
                  
                  
                  
                  830
                  
                  
                  
                  37Professional
      Fees and Regulatory Assessments
                  
                  
                  412
                  
                  
                  
                  501
                  
                  
                  
                  (89
                  )Furniture
      and Equipment
                  
                  
                  438
                  
                  
                  
                  486
                  
                  
                  
                  (48
                  )FDIC
      Insurance
                  
                  
                  467
                  
                  
                  
                  660
                  
                  
                  
                  (193
                  )Pennsylvania
      Shares Tax
                  
                  
                  191
                  
                  
                  
                  178
                  
                  
                  
                  13Advertising
      and Marketing
                  
                  
                  90
                  
                  
                  
                  117
                  
                  
                  
                  (27
                  )Supplies
      and Postage
                  
                  
                  119
                  
                  
                  
                  148
                  
                  
                  
                  (29
                  )Merger
      and Acquisition Expenses
                  
                  
                  436
                  
                  
                  
                  —
                  
                  
                  
                  436Other
      Expense
                  
                  
                  921
                  
                  
                  
                  1,058
                  
                  
                  
                  (137
                  )Total
      Non-Interest Expense
                  
                  $
                  8,306
                  
                  
                  $
                  8,494
                  
                  
                  $
                  (188
                  )





The
discussion that follows explains the significant changes in the components of
non-interest expense when comparing the six months ended June 30, 2010 to the
same period in 2009.





Salaries,
wages and employee benefits decreased by $156,000 for the six months ended June
30, 2010, as compared to the same period in 2009.  The decrease was related
to positions that were eliminated in the first quarter of 2009 and savings from
the suspension of the company 401-K match which began during the second quarter
of 2009 and remained suspended through June 30, 2010.  As a result,
salaries, wages and employee benefits for the first six months of 2010 did not
include any expense associated with the eliminated positions or the 401-K match,
whereas, the same period in 2009 included several months worth of these
expenses.





The
second quarter operating results reflect merger and acquisition related expenses
of $436,000.  These expenses are comprised of primarily merger-related
legal and investment banking fees. As previously disclosed, Union National
entered into the Merger Agreement on April 19, 2010, as amended and restated as
of May 20, 2010 with DFSC pursuant to which Union National will merge with and
into DFSC. If the transaction is approved by the regulators and shareholders,
and meets all closing conditions, Union National Community Bank also will merge
with and into Province. A Special Meeting of Shareholders will be held on
September 16, 2010 to vote on the proposed merger with DFSC. The holders of
outstanding shares of common stock of record as of the close of business on July
29, 2010 are entitled to vote at the Special Meeting of
Shareholders.


45


As noted
in the table below (in thousands), operating results also reflect higher Federal
Deposit Insurance Corporation (“FDIC”) base insurance assessments when comparing
the six months ended June 30, 2010, to the same period in 2009.  FDIC base
insurance assessments amounted to $467,000 for the six months ended June 30,
2010, representing a $44,000 or 10% increase over the same period in 2009. 
The increase in FDIC base insurance assessments was the direct result of
increased base assessment rates, as determined by the FDIC. 
 Additionally, the six months ended June 30, 2009, included $237,000
related to the Federal Deposit Insurance Corporation (“FDIC”) special assessment
on deposit-insured institutions.





Six Months Ended June 30,
                  
                  
                  IncreaseFDIC Insurance Expense
                  
                  2010
                  
                  
                  2009
                  
                  
                  (Decrease)Base
      Insurance Assessments
                  
                  $
                  467
                  
                  
                  $
                  423
                  
                  
                  $
                  44Special
      Insurance Assessments
                  
                  
                  —
                  
                  
                  
                  237
                  
                  
                  
                  (237
                  )Total
      FDIC Insurance Expense
                  
                  $
                  467
                  
                  
                  $
                  660
                  
                  
                  $
                  (193
                  )





The
decrease in other expense was primarily the result of $96,000 of FHLB debt
prepayment penalties incurred during the six months ended June 30, 2010, as
compared to $393,000 for the same period in 2009.  The decrease in other
expense resulting from the decline in debt prepayment penalties was offset by
expenses related to OREO and repossessed assets, which were $209,000 for the six
months ended June 30, 2010, as compared to $57,000 for the same period in
2009.





Income Taxes.An income
tax benefit of $692,000 and $434,000 was recorded for the six months ended June
30, 2010 and 2009, respectively.  For both of these periods, the benefit
resulted from a pre-tax loss as well as the benefits of tax-exempt income. 
Generally, Union National’s effective tax rate is below the statutory rate due
to tax-exempt earnings on loans, investments, and bank-owned life insurance, and
the impact of tax credits.  The realization of deferred tax assets is
dependent upon future earnings.   Management anticipates that future
earnings will be adequate to fully utilize deferred tax assets.





LIQUIDITY


Our
objective is to maintain adequate liquidity to meet funding needs at a
reasonable cost and to provide contingency plans to meet unanticipated funding
needs or a loss of funding sources, while minimizing interest rate risk. 
Adequate liquidity provides resources for credit needs of borrowers, for
depositor withdrawals and for funding corporate operations.  Sources of
liquidity are as follows:





·
            A
      growing core retail deposit base;


·
            Proceeds
      from the sale or maturity of investment
  securities;


·
            Payments
      received on loans and mortgage-backed securities;
  and,


·
            Overnight
      correspondent bank borrowings credit lines, and borrowing capacity
      available from the Federal Reserve
Bank.





Management
believes that the Bank’s core deposits remain fairly stable.  Liquidity and
funds management is governed by policies and measured on a daily basis, with
supplementary weekly and monthly analyses.  These measurements indicate
that liquidity generally remains stable and exceeds our minimum defined levels
of adequacy. Other than the trends of continued competitive pressures and
volatile interest rates, there are no known demands, commitments, events or
uncertainties that will result in, or that are reasonably likely to result in,
liquidity increasing or decreasing in any material way.


46


OFF-BALANCE
SHEET COMMITMENTS


In the
normal course of business, we are party to financial instruments with
off-balance sheet risk to meet the financing needs of our customers.  These
financial instruments include commitments to extend credit and standby letters
of credit.  Total commitments to extend credit amounted to $110,316,000 at
June 30, 2010 as compared to $110,791,000 at December 31, 2009.  Total
standby letters of credit amounted to $5,925,000 at June 30, 2010 as compared to
$6,199,000 at December 31, 2009.





In
addition, in the normal course of business operations, we routinely enter into
contracts for services. These contracts may require payment for services to be
provided in the future and may also contain penalty clauses for the early
termination of the contracts. In January 2007, the contract with our core data
processor was renegotiated, resulting in a new maturity date of November
2013.  Any early termination will require the payment of a substantial
penalty.  For the three months ended June 30, 2010, there has been no
material change in contracts for services since this contract was
renegotiated.





REGULATORY
MATTERS


From time
to time, various types of federal and state legislation have been proposed that
could result in additional regulation of, and restrictions on, the business of
Union National and the Bank.  As a consequence of the extensive regulation
of commercial banking activities in the United States, Union National’s and the
Bank’s business is particularly susceptible to being affected by federal and
state legislation and regulations that may increase the cost of doing
business.  Also, Union National is susceptible to changes in tax law that
may increase the cost of doing business or impact Union National’s ability to
realize the value of deferred tax assets. Further, the business of Union
National is affected by the state of the financial services industry in
general.  Please refer to Note 9 — Enforcement Actions with
Bank Regulatory Agencies to the consolidated financial statements for a
discussion on specific regulatory matters impacting Union National.





ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Not
required for smaller reporting companies.





ITEM
4.  CONTROLS AND PROCEDURES





Evaluation of Disclosure Controls and
Procedures.  Union National maintains controls and procedures
designed to ensure that information required to be disclosed in the reports that
Union National files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported within the time periods specified
in the rules and forms of the Securities and Exchange Commission. Based upon
their evaluation of those controls and procedures as of June 30, 2010, Union
National’s Chief Executive Officer and Chief Financial Officer concluded that
the disclosure controls and procedures were adequate.





Changes in Internal
Controls.  There were no changes during the quarter ended June 30,
2010 in our internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, these
controls.


47


PART II - OTHER
INFORMATION





ITEM
1.  LEGAL PROCEEDINGS





Union
National entered into an Agreement and Plan of Merger (the “Merger Agreement”)
on April 19, 2010, with Donegal Financial Services Corporation (“DFSC”), the
parent company of Province Bank FSB (“Province”), and certain affiliated
entities of DFSC, pursuant to which Union National will merge with and into
DFSC. DFSC is wholly owned by Donegal Mutual Insurance Company and Donegal Group
Inc.





On June
16, 2010, Union National, DFSC and Donegal Mutual Insurance Company, became
aware of the filing of a complaint on June 14, 2010 in the Court of Common Pleas
of Lancaster County, Pennsylvania against Union National, each of the Directors
of Union National, DFSC and certain affiliated entities of DFSC (collectively,
the "Donegal Parties"). The complaint purports to be a class action filed on
behalf of the holders of Union National common stock arising from certain
alleged actions by Union National and its Board of Directors in connection with
the previously announced proposed merger of Union National with and into DFSC.
Union National and the Donegal Parties believe the factual allegations in the
complaint are without merit and intend to defend vigorously against the
allegations in the complaint.





Other
than above, management is not aware of any other litigation affecting Union
National.





ITEM
1A.  RISK FACTORS





Recently
enacted regulatory reform may have a material impact on our
operations.




On July 21, 2010, the President signed
into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the
“Dodd-Frank Act”). The Dodd-Frank Act restructures the regulation of depository
institutions.  The Dodd-Frank Act contains various provisions designed to
enhance the regulation of depository institutions and prevent the recurrence of
a financial crisis such as occurred in 2008-2009.  Also included is the
creation of a new federal agency to administer and enforce consumer and fair
lending laws, a function that is now performed by the depository institution
regulators. The federal preemption of state laws currently accorded federally
chartered depository institutions will be reduced as well.  The full impact
of the Dodd-Frank Act on our business and operations will not be known for years
until regulations implementing the statute are written and adopted.  The
Dodd-Frank Act may have a material impact on our operations, particularly
through increased compliance costs resulting from possible future consumer and
fair lending regulations.




In addition to the other information
set forth in this report, you should carefully consider the factors discussed in
Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year
ended December 31, 2009, which could materially affect our business, financial
condition or future results. The risks described in our Annual Report on Form
10-K are not the only risks that we face. Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may
materially adversely affect our business, financial condition and/or operating
results.





ITEM
2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





None





ITEM
3.  DEFAULTS UPON SENIOR SECURITIES





None





ITEM
4.  (REMOVED AND RESERVED)





ITEM
5.  OTHER INFORMATION





None


48


ITEM
6.  EXHIBITS





3. 
The following Exhibits are filed herewith, or incorporated by reference as a
part of this Report:





3(i)
                  
                  
                  
                  Union
      National Financial Corporation’s Amended and Restated Articles of
      Incorporation. (Incorporated by reference to Exhibit 3.1 to Union National
      Financial Corporation’s current report on Form 8-K, filed with the
      Commission on May 13, 2009.)3(ii)
                  
                  
                  
                  Union
      National Financial Corporation’s Amended and Restated By-laws. 
       (Incorporated by reference to Exhibit 3(ii) to Union National
      Financial Corporation’s current report on Form 8-K, filed with the
      Commission on February 27, 2009.)4.1
                  
                  
                  
                  Rights
      Agreement, dated August 27, 2007, between Registrar and Transfer Company
      and Union National Financial Corporation.  (Incorporated by reference
      to Exhibit 4 to Union National Financial Corporation’s current report on
      Form 8-K, filed August 30, 2007.)4.2
                  
                  
                  
                  Certificate
      of Designations of the Series A Preferred Stock (Incorporated by reference
      to Exhibit 3.1 to Union National’s Current Report on Form 8-K dated
      September 15, 2009).10.1
                  
                  **
                  
                  Union
      National Financial Corporation 1988 Stock Incentive Plan. (Incorporated by
      reference to Exhibit 4.3 to Union National Financial Corporation’s
      Registration Statement No. 333-27837 on Form S-8, filed with the
      Commission on May 27, 1997.)10.2
                  
                  **
                  
                  Union
      National Financial Corporation 1997 Stock Incentive Plan. 
      (Incorporated by reference to Exhibit 4.5 to Union National Financial
      Corporation’s Registration Statement No. 333-27837 on Form S-8, filed with
      the Commission on May 27, 1997 and incorporated by reference to Amendment
      1 to Union National Financial Corporation’s Registration Statement No.
      333-107326 on Form S-8 filed with the commission on July 25,
      2003.)10.3
                  
                  **
                  
                  Union
      National Financial Corporation’s Employee Stock Purchase Plan
      (Incorporated by Reference to Exhibit 4.4 to Union National Financial
      Corporation’s Registration Statement No. 333-27837 on Form S-8, filed with
      the Commission on May 27, 1997).10.4
                  
                  *
                  
                  Group
      Term Replacement Plan for Certain Officers, CEO, dated January 1, 2004
      between Mark D. Gainer and Union National Community Bank. 
      (Incorporated by reference to Exhibit 10.12 to Union National Financial
      Corporation’s Annual Report on Form 10-K, filed with the Commission on
      March 30, 2004.)10.5
                  
                  **
                  
                  Union
      National Financial Corporation, 1999 Independent Directors Stock Option
      Plan.  (Incorporated by Reference to Exhibit 4.3 to Union National
      Financial Corporation’s Registration Statement No. 333-80739 on Form S-8,
      filed with the Commission on June 15, 1999.)10.6
                  
                  
                  
                  Office
      Lease between Lausch Lane Associates LP as Landlord and Union 
      National Community Bank as Tenant for 570 Lausch Lane, Lancaster,  PA
      17601. (Incorporated by reference to Exhibit 99.1 to Union National
      Financial Corporation’s Current Report of Form 8-K, filed with the
      Commission on May 17,
2005.)


49





10.7
                    
                    *
                    
                    Amended
      and Restated Employment Agreement and Amended and Restated Executive
      Salary Continuation Agreement dated as of December 29, 2006, with Mark D.
      Gainer, Chairman, President and Chief Executive Officer. 
      (Incorporated by reference to Exhibit 10.15 to Union National Financial
      Corporation’s 2006 Annual Report on Form 10-K, filed with the Commission
      on March 28, 2007.)10.8
                    
                    
                    
                    Amended
      and Restated Declaration of Trust of Union National Capital Trust II,
      dated as of October 14, 2004, among Union National Financial Corporation,
      as sponsor, the Delaware and institutional trustee named therein, and the
      administrators named therein.  (Incorporated by reference to Exhibit
      10.17 to Union National Financial Corporation’s 2006 Annual Report on Form
      10-K, filed with the Commission on March 28, 2007.)10.9
                    
                    
                    
                    Indenture,
      dated as of October 14, 2004, between Union National Financial
      Corporation, as issuer, and the trustee named therein, relating to the
      Junior Subordinated Debt Securities due 2034.  (Incorporated by
      reference to Exhibit 10.18 to Union National Financial Corporation’s 2006
      Annual Report on Form 10-K, filed with the Commission on March 28,
      2007.)10.10
                    
                    
                    
                    Guarantee
      Agreement, dated as of October 14, 2004, between Union National Financial
      Corporation and the guarantee trustee named therein.  (Incorporated
      by reference to Exhibit 10.19 to Union National Financial Corporation’s
      2006 Annual Report on Form 10-K, filed with the Commission on March 28,
      2007.)10.11
                    
                    
                    
                    Indenture,
      dated as of July 27, 2006, between Union National Community Bank, as
      issuer, and the trustee named therein, relating to the Junior Subordinated
      Debt Securities due 2036.  (Incorporated by reference to Exhibit 4.1
      to Union National Financial Corporation’s quarterly  report on
      Form 10-Q, filed with the Commission on August 14,
  2006.)10.12
                    
                    *
                    
                    Employment
      Agreement, dated March 8, 2007 (with an expiration date of March 7, 2010),
      between Stephen D. Staman, Executive Vice President and Chief Revenue
      Officer and Union National Financial Corporation and its subsidiary, Union
      National Community Bank.  (Incorporated by reference to Exhibit 10.16
      to Union National Financial Corporation’s 2007 Annual Report on Form 10-K,
      filed with the Commission on April 1, 2008.)10.13
                    
                    *
                    
                    Change
      of Control Agreement, dated September 4, 2007, between Michael D. Peduzzi,
      Executive Vice President, Chief Financial Officer and Union National
      Financial Corporation and its subsidiary, Union National Community
      Bank.  (Incorporated by reference to Exhibit 99.1 to Union National
      Financial Corporation’s current report on Form 8-K, filed with the
      Commission on September 6, 2007.)10.14
                    
                    *
                    
                    Change
      of Control Agreement among Union National Financial Corporation, Union
      National Community Bank and each of the following officers: Michael L.
      Maurer and Bradley A. Willow, filed August 13, 2008, as Item 10.18 to
      Form 10-Q for the fiscal quarter ended June 30, 2008
      (No. 0-19214) and incorporated herein by
reference.10.15
                    
                    *
                    
                    Change
      of Control Agreement among Union National Financial Corporation, Union
      National Community Bank and each of the following officers: R. Michael
      Mohn, Steve D. Garber and Kevin Hersh, filed August 13, 2008, as
      Item 10.19 to Form 10-Q for the fiscal quarter ended June 30,
      2008 (No. 0-19214) and incorporated herein by
    reference.


50





10.16
                      
                      ***
                      
                      Stock
      Bonus Plan and the 2009 Stock Purchase Plan, filed December 3, 2008, and
      incorporated by reference to Exhibit 99.1 to Union National Financial
      Corporation’s current report on Form 8-K.10.17
                      
                      
                      
                      Formal
      agreement with the Comptroller of the Currency (“OCC”) and Union National
      Community Bank, filed August 31, 2009, as Item 8.01 to Form 8-K and
      incorporated by reference.10.18
                      
                      
                      
                      Form
      of stock subscription agreement for Series A Preferred Stock (Incorporated
      by reference to Exhibit 10.1 to Union National Financial Corporation’s
      current report on Form 8-K, filed with the Commission on October 1,
      2009).10.19
                      
                      
                      
                      On
      April 19, 2010, Union National Financial Corporation, the parent company
      of Union National Community Bank (“UNCB”), entered into an Agreement and
      Plan of Merger (the “Merger Agreement”) with Donegal Financial Services
      Corporation (“DFSC”), the parent company of Province Bank FSB
      (“Province”), and certain affiliated entities of DFSC, pursuant to which
      Union National will merge with and into DFSC.  DFSC is wholly owned
      by Donegal Mutual Insurance Company (“DMIC”) and Donegal Group Inc.
      (“DGI”) (Incorporated by reference to Exhibit 2.1 to Union National
      Financial Corporation’s current report on Form 8-K, filed with the
      Commission on April 23, 2010).10.20
                      
                      
                      
                      Amendment
      to the Merger Agreement and Plan of Merger by and among Donegal
      Acquisition Inc., Donegal Financial Services Corporation, Donegal Mutual
      Insurance Company, Donegal Group Inc. and Union National Financial
      Corporation dated as of May 20, 2010 (Incorporated by reference to Exhibit
      2.1 to Union National Financial Corporation’s current report on Form 8-K,
      filed with the Commission on May 21, 2010).14
                      
                      
                      
                      Union
      National Financial Corporation Directors and Senior Management Code of
      Ethics. (Incorporated by reference to Exhibit 14 to Union National
      Financial Corporation’s 2009 Annual Report on Form 10-K, filed with the
      Commission on March 31, 2010.)31.1
                      
                      
                      
                      Certification
      of Principal Executive Officer Pursuant to Exchange Act Rules
      13a-14(a)/15d-14(a) as added by Section 302 of the Sarbanes-Oxley Act of
      2002, filed herewith.31.2
                      
                      
                      
                      Certification
      of Principal Financial Officer Pursuant to Exchange Act Rules
      13a-14(a)/15d-14(a) as added by Section 302 of the Sarbanes-Oxley Act of
      2002, filed herewith.32
                      
                      
                      
                      Certification
      of Principal Executive Officer and Principal Financial Officer Pursuant to
      U.S.C. Section 1350 as added by Section 906 of the Sarbanes-Oxley Act of
      2002, filed
herewith.





*
            Management
      contract or compensatory plan
arrangement.




**
            Stockholder
      approved compensatory plan pursuant to which the Registrant’s Common Stock
      may be issued to employees of the
Corporation.




***
            Non-stockholder
      approved compensatory plan pursuant to which the Registrant's Common Stock
      may be issued to employees of the
Corporation.


51





SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





Union
      National Financial Corporation(Registrant)Date:
      August 13, 2010
              By
              /s/ Mark D. GainerMark
      D. Gainer
                Chairman,
      CEO and President
                (Principal
      Executive Officer)Date:
      August 13, 2010
              By
              /s/ Michael D. PeduzziMichael
      D. Peduzzi
                Executive
      Vice President and Chief Financial Officer
                (Principal
      Financial Officer)


52