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,
2009





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.





2,738,390 shares of $.25 (par) common
stock were outstanding as of August 13, 2009.









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, 2009 and December 31, 2008
                                            
                                            1Consolidated
      Statements of OperationsFor
      the Three and Six Months Ended June 30, 2009 and 2008
                                            
                                            2Consolidated
      Statements of Changes in Stockholders’ EquityFor
      the Six Months Ended June 30, 2009 and 2008
                                            
                                            3Consolidated
      Statements of Cash FlowsFor
      the Six Months Ended June 30, 2009 and 2008
                                            
                                            4Notes
      to Unaudited Consolidated Financial Statements
                                            
                                            5 -
      18Item
      2.
                                            Management’s
      Discussion and Analysis ofFinancial
      Condition and Results of Operations
                                            
                                            19
      - 37Item
      3.
                                            Quantitative
      and Qualitative Disclosures about Market Risk
                                            
                                            38Item
      4.
                                            Controls
      and Procedures
                                            
                                            39Item
      4T.
                                            Controls
      and Procedures
                                            
                                            39PART
      II – OTHER
      INFORMATIONItem
      1.
                                            Legal
      Proceedings
                                            
                                            39Item
      1A.
                                            Risk
      Factors
                                            
                                            40Item
      2.
                                            Unregistered
      Sales of Equity Securities and Use of Proceeds
                                            
                                            41Item
      3.
                                            Defaults
      upon Senior Securities
                                            
                                            41Item
      4.
                                            Submission
      of Matters to a Vote of Security Holders
                                            
                                            42Item
      5.
                                            Other
      Information
                                            
                                            42Item
      6.
                                            Exhibits
                                            
                                            43Signatures
                                            
                                            46





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 data)




June
      30,
                      
                      
                      December
      31,2009
                      
                      
                      2008AssetsCash
      and Due from Banks
                      
                      $
                      11,508
                      
                      
                      $
                      17,621Federal
      Funds Sold
                      
                      
                      3,000
                      
                      
                      
                      14,150Interest-Bearing
      Demand Deposits in Other Banks
                      
                      
                      28,562
                      
                      
                      
                      66Total
      Cash and Cash Equivalents
                      
                      
                      43,070
                      
                      
                      
                      31,837Interest-Bearing
      Time Deposits in Other Banks
                      
                      
                      12,448
                      
                      
                      
                      1,775Investment
      Securities Available for Sale
                      
                      
                      79,171
                      
                      
                      
                      64,289Loans
      and Leases, Net of Unearned Income
                      
                      
                      349,958
                      
                      
                      
                      358,280Less:  Allowance
      for Credit Losses
                      
                      
                      (4,364
                      )
                      
                      
                      (4,358
                      )Net
      Loans and Leases
                      
                      
                      345,594
                      
                      
                      
                      353,922Premises
      and Equipment, Net
                      
                      
                      11,876
                      
                      
                      
                      12,088Restricted
      Investment in Bank Stocks
                      
                      
                      3,705
                      
                      
                      
                      3,703Bank-Owned
      Life Insurance
                      
                      
                      11,323
                      
                      
                      
                      11,108Other
      Assets
                      
                      
                      8,550
                      
                      
                      
                      6,387Total
      Assets
                      
                      $
                      515,737
                      
                      
                      $
                      485,109LiabilitiesDeposits:Non-Interest
      Bearing
                      
                      $
                      48,671
                      
                      
                      $
                      46,875Interest-Bearing
                      
                      
                      376,997
                      
                      
                      
                      336,702Total
      Deposits
                      
                      
                      425,668
                      
                      
                      
                      383,577Long-Term
      Debt
                      
                      
                      38,334
                      
                      
                      
                      50,334Junior
      Subordinated Debentures
                      
                      
                      17,341
                      
                      
                      
                      17,341Other
      Liabilities
                      
                      
                      3,792
                      
                      
                      
                      3,063Total
      Liabilities
                      
                      
                      485,135
                      
                      
                      
                      454,315Stockholders’
      EquityPreferred
      Stock, par value $0.25 per shareShares authorized - 10,000,000;
      Issued – 0 at June 30, 2009 and December 31, 2008
                      
                      
                      ─
                      
                      
                      
                      ─Common
      Stock, par value $0.25 per shareShares authorized - 20,000,000;
      Issued – 3,152,845 and 3,138,265 at June 30, 2009 and December 31, 2008,
      respectively; Outstanding - 2,734,656 and 2,720,076 at June 30, 2009 and
      December 31, 2008, respectively
                      
                      
                      788
                      
                      
                      
                      785Surplus
                      
                      
                      14,912
                      
                      
                      
                      14,868Retained
      Earnings
                      
                      
                      23,232
                      
                      
                      
                      23,434Accumulated
      Other Comprehensive (Loss) Income
                      
                      
                      (1
                      )
                      
                      
                      36Treasury
      Stock - 418,189 shares, at cost
                      
                      
                      (8,329
                      )
                      
                      
                      (8,329
                      )Total
      Stockholders’ Equity
                      
                      
                      30,602
                      
                      
                      
                      30,794Total
      Liabilities and Stockholders’ Equity
                      
                      $
                      515,737
                      
                      
                      $
                      485,109





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 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Interest
      IncomeInterest
      and Fees on Loans and Leases
                
                $
                5,496
                
                
                $
                6,146
                
                
                $
                10,881
                
                
                $
                12,507Investment
      Securities:Taxable
      Interest
                
                
                372
                
                
                
                784
                
                
                
                967
                
                
                
                1,572Tax-Exempt
      Interest
                
                
                67
                
                
                ─
                
                
                
                89
                
                
                ─Dividends
                
                
                9
                
                
                
                25
                
                
                
                22
                
                
                
                68Other
                
                
                53
                
                
                
                77
                
                
                
                87
                
                
                
                222Total
      Interest Income
                
                
                5,997
                
                
                
                7,032
                
                
                
                12,046
                
                
                
                14,369Interest
      ExpenseDeposits
                
                
                2,216
                
                
                
                2,358
                
                
                
                4,518
                
                
                
                5,154Short-Term
      Borrowings
                
                ─
                
                
                
                4
                
                
                ─
                
                
                
                65Long-Term
      Debt
                
                
                516
                
                
                
                713
                
                
                
                1,161
                
                
                
                1,459Junior
      Subordinated Debentures
                
                
                213
                
                
                
                266
                
                
                
                444
                
                
                
                566Total
      Interest Expense
                
                
                2,945
                
                
                
                3,341
                
                
                
                6,123
                
                
                
                7,244Net
      Interest Income
                
                
                3,052
                
                
                
                3,691
                
                
                
                5,923
                
                
                
                7,125Provision
      for Credit Losses
                
                
                611
                
                
                
                139
                
                
                
                924
                
                
                
                279Net
      Interest Income after Provision for Credit Losses
                
                
                2,441
                
                
                
                3,552
                
                
                
                4,999
                
                
                
                6,846Non-Interest
      IncomeIncome
      from Fiduciary Activities
                
                
                47
                
                
                
                78
                
                
                
                93
                
                
                
                158Service
      Charges on Deposit Accounts
                
                
                540
                
                
                
                493
                
                
                
                1,013
                
                
                
                946Other
      Service Charges, Commissions, Fees
                
                
                297
                
                
                
                275
                
                
                
                564
                
                
                
                534Alternative
      Investment Sales Commissions
                
                
                193
                
                
                
                209
                
                
                
                303
                
                
                
                407Mortgage
      Banking/Brokerage Activities
                
                
                40
                
                
                
                22
                
                
                
                68
                
                
                
                36Earnings
      from Bank-Owned Life Insurance
                
                
                107
                
                
                
                111
                
                
                
                215
                
                
                
                218Other
      Income
                
                
                293
                
                
                
                36
                
                
                
                308
                
                
                
                146Net
      Gain on Sale of Investment Securities
                
                
                983
                
                
                
                10
                
                
                
                1,394
                
                
                
                201Less:
      Impairment Charges on Investment Securities
                
                
                (462
                )
                
                ─
                
                
                
                (1,301
                )
                
                ─Net
      Investment Securities Gains
                
                
                521
                
                
                
                10
                
                
                
                93
                
                
                
                201Total
      Non-Interest Income
                
                
                2,038
                
                
                
                1,234
                
                
                
                2,657
                
                
                
                2,646Non-Interest
      ExpenseSalaries,
      Wages, and Employee Benefits
                
                
                1,671
                
                
                
                1,889
                
                
                
                3,617
                
                
                
                3,808Net
      Occupancy
                
                
                421
                
                
                
                406
                
                
                
                899
                
                
                
                958Furniture
      and Equipment
                
                
                240
                
                
                
                229
                
                
                
                486
                
                
                
                476Professional
      Fees and Regulatory Assessments
                
                
                244
                
                
                
                260
                
                
                
                501
                
                
                
                568Data
      and ATM Processing
                
                
                426
                
                
                
                385
                
                
                
                830
                
                
                
                820Pennsylvania
      Shares Tax
                
                
                89
                
                
                
                75
                
                
                
                178
                
                
                
                175Advertising
      and Marketing
                
                
                50
                
                
                
                140
                
                
                
                117
                
                
                
                187Supplies
      and Postage
                
                
                74
                
                
                
                83
                
                
                
                148
                
                
                
                220FDIC
      Insurance
                
                
                540
                
                
                
                111
                
                
                
                660
                
                
                
                186Other
      Expense
                
                
                725
                
                
                
                852
                
                
                
                1,058
                
                
                
                1,218Total
      Non-Interest Expense
                
                
                4,480
                
                
                
                4,430
                
                
                
                8,494
                
                
                
                8,616(Loss)
      Income Before (Benefit from) Provision for Income Taxes
                
                
                (1
                )
                
                
                356
                
                
                
                (838
                )
                
                
                876(Benefit
      from) Provision for Income Taxes
                
                
                (106
                )
                
                
                52
                
                
                
                (434
                )
                
                
                159Net
      Income (Loss)
                
                $
                105
                
                
                $
                304
                
                
                $
                (404
                )
                
                $
                717Earnings
      (Loss) Per ShareBasic
                
                $
                0.04
                
                
                $
                0.12
                
                
                $
                (0.15
                )
                
                $
                0.28Diluted
                
                
                0.04
                
                
                
                0.12
                
                
                
                (0.15
                )
                
                
                0.28Cash
      Dividends Paid Per 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, 2009Shares of
                                                            Common
                                                            Stock
                                                            Outstanding
                                                          
                                                          
                                                          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
                                                          )Net
      Change in Unrealized Gains (Losses) on Available-for-Sale Securities, Net
      of Tax
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          165
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          165Total
      Comprehensive Loss
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          (239
                                                          )Issuance
      of Common Stock under:Dividend
      Reinvestment and Stock Purchase Plan
                                                          
                                                          
                                                          14,580
                                                          
                                                          
                                                          
                                                          3
                                                          
                                                          
                                                          
                                                          44
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          47Cumulative
      Effect of FSP FAS 115-2 and FAS 124-2 adoption (net of $104 tax
      effect)
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          202
                                                          
                                                          
                                                          
                                                          (202
                                                          )
                                                          
                                                          
                                                          ─
                                                          
                                                          
                                                          
                                                          ─Balance
      at June 30, 2009
                                                          
                                                          
                                                          2,734,656
                                                          
                                                          
                                                          $
                                                          788
                                                          
                                                          
                                                          $
                                                          14,912
                                                          
                                                          
                                                          $
                                                          23,232
                                                          
                                                          
                                                          $
                                                          (1
                                                          )
                                                          
                                                          $
                                                          (8,329
                                                          )
                                                          
                                                          $
                                                          30,602





Six Months Ended June 30, 2008Shares of
                  Common
                  Stock
                  Outstanding
                
                
                Common
                  Stock
                
                
                Surplus
                
                
                Retained
                  Earnings
                
                
                Accumulated
                  Other
                  Comprehensive
                  Income (Loss)
                
                
                Treasury
                  Stock
                
                
                TotalBalance
      at December 31, 2007
                
                
                2,546,549
                
                
                $
                741
                
                
                $
                13,313
                
                
                $
                23,063
                
                
                $
                12
                
                
                $
                (8,329
                )
                
                $
                28,800Comprehensive
      Loss:Net
      Income
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                717
                
                
                
                ─
                
                
                
                ─
                
                
                
                717Net
      Change in Unrealized Gains (Losses) on Available-for-Sale Securities, Net
      of Tax
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                (1,094
                )
                
                
                ─
                
                
                
                (1,094
                )Total
      Comprehensive Loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (377
                )Issuance
      of Common Stock under:Private
      Placement Stock Offering, net of costs
                
                
                163,690
                
                
                
                41
                
                
                
                1,469
                
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                1,510Dividend
      Reinvestment and Stock Purchase Plan
                
                
                745
                
                
                
                ─
                
                
                
                8
                
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                8Employee
      Plans
                
                
                693
                
                
                
                ─
                
                
                
                5
                
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                5Implementation
      of EITF 06-04
                
                
                ─
                
                
                
                ─
                
                
                
                ─
                
                
                
                (73
                )
                
                
                ─
                
                
                
                ─
                
                
                
                (73
                )Balance
      at June 30, 2008
                
                
                2,711,677
                
                
                $
                782
                
                
                $
                14,795
                
                
                $
                23,707
                
                
                $
                (1,082
                )
                
                $
                (8,329
                )
                
                $
                29,873





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 30,2009
                
                
                2008Cash
      Flows from Operating ActivitiesNet
      (Loss) Income
                
                $
                (404
                )
                
                $
                717Adjustments
      to Reconcile Net (Loss) Income to Net Cash Used In Operating
      Activities:Depreciation
      and Amortization
                
                
                608
                
                
                
                635Provision
      for Credit Losses
                
                
                924
                
                
                
                279Net
      Amortization (Accretion) of Investment Securities Premiums
      (Discounts)
                
                
                181
                
                
                
                (89
                )Net
      Investment Securities Gains
                
                
                (93
                )
                
                
                (201
                )Earnings
      from Bank-Owned Life Insurance
                
                
                (215
                )
                
                
                (218
                )(Increase)
      Decrease in Accrued Interest Receivable
                
                
                (211
                )
                
                
                417Increase
      in Other Assets
                
                
                (1,751
                )
                
                
                (1,833
                )Increase
      (Decrease) in Other Liabilities
                
                
                729
                
                
                
                (652
                )Cash
      Payments Related to Restructuring Charge
                
                
                ─
                
                
                
                (149
                )Net
      Cash Used In Operating Activities
                
                
                (232
                )
                
                
                (1,094
                )Cash
      Flows from Investing ActivitiesProceeds
      from Sales of Available-for-Sale Securities
                
                
                71,195
                
                
                
                24,479Proceeds
      from Maturities and Principal Repayments on Available-for-Sale
      Securities
                
                
                14,664
                
                
                
                29,772Purchases
      of Available-for-Sale Securities
                
                
                (100,581
                )
                
                
                (51,528
                )Net
      Purchases of Time Deposits in Other Banks
                
                
                (10,673
                )
                
                
                (1,874
                )Net
      (Increase) Decrease of Restricted Investments in Bank
    Stocks
                
                
                (2
                )
                
                
                131Net
      Decrease (Increase) in Loans and Leases
                
                
                7,055
                
                
                
                (11,060
                )Purchases
      of Premises, Equipment and Software
                
                
                (331
                )
                
                
                (3,952
                )Net
      Cash Used In Investing Activities
                
                
                (18,673
                )
                
                
                (14,032
                )Cash
      Flows from Financing ActivitiesNet
      Increase (Decrease) in Demand Deposits and Savings
Accounts
                
                
                28,310
                
                
                
                (614
                )Net
      Increase (Decrease) in Time Deposits
                
                
                13,781
                
                
                
                (3,192
                )Issuance
      of Common Stock
                
                
                47
                
                
                
                1,523Payments
      on Long-Term Debt
                
                
                (12,000
                )
                
                
                (17,482
                )Net
      Increase in Short-Term Borrowings
                
                
                ─
                
                
                
                12,454Net
      Cash Provided by (Used in) Financing Activities
                
                
                30,138
                
                
                
                (7,311
                )Net
      Increase (Decrease) in Cash and Cash Equivalents
                
                
                11,233
                
                
                
                (22,437
                )Cash
      and Cash Equivalents at Beginning of Period
                
                
                31,837
                
                
                
                37,882Cash
      and Cash Equivalents at End of Period
                
                $
                43,070
                
                
                $
                15,445Supplemental
      Disclosures of Cash Flow ActivitiesInterest
      Paid
                
                $
                6,281
                
                
                $
                7,953Income
      Tax Paid
                
                
                750
                
                
                
                ─Supplemental
      Disclosures of Non-cash Flow ActivitiesTransfers
      to Other Real Estate Owned
                
                $
                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
consolidated financial statements for 2009 and 2008 include the accounts of
Union National Financial Corporation (“Union National”), its subsidiary Union
National Community Bank (the “Bank”), and Bank subsidiary Union National
Insurance Agency.   All material intercompany accounts and
transactions have been eliminated in consolidation.  Certain amounts
previously reported have been reclassified to conform to the financial statement
presentation for 2009.  The reclassifications had no effect on net
income.  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”).  We believe the information presented is not misleading and
the disclosures are adequate. In our opinion, 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, 2009 and December 31, 2008, and the related consolidated statements of
operations, changes in stockholders’ equity and cash flows for each of the
periods ended June 30, 2009 and 2008.  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, 2008, and with Union National’s Forms 10-Q and 8-K, that were filed
during 2009 with the SEC.





The
Corporation has evaluated events and transactions occurring subsequent to the
balance sheet date of June 30, 2009, for items that should potentially be
recognized or disclosed in the consolidated financial statements. The evaluation
was conducted through August 14, 2009, 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, and the potential
impairment of restricted stock.





Note
3 ─ Earnings Per Share





Basic
earnings per share is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding during the
period.  Diluted earnings per share reflects the potential dilution
that could occur if options to issue common stock were
exercised.  Potential common shares that may be issued relate solely
to outstanding stock options and are determined using the treasury stock
method.  For the three and six months ended June 30, 2009 and 2008,
there were no outstanding stock options which, if exercised, would have a
dilutive effect.  All stock options outstanding, 91,958 and 108,679 as
of June 30, 2009 and 2008, respectively, had no intrinsic
value.  Accordingly, the diluted earnings per share for each period
was the same as the basic earnings per share.





The
computation of basic and diluted earnings (loss) per share for the three and six
months ended June 30, 2009 and 2008, are presented below (amounts, except
earnings per share, in thousands):




Three Months Ended June 30,
                  
                  
                  Six Months Ended June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Net
      Income (Loss)
                  
                  $
                  105
                  
                  
                  $
                  304
                  
                  
                  $
                  (404
                  )
                  
                  $
                  717Weighted-average
      number of common shares outstanding
                  
                  
                  2,721
                  
                  
                  
                  2,585
                  
                  
                  
                  2,721
                  
                  
                  
                  2,566Basic
      and diluted earnings (loss) per share
                  
                  $
                  0.04
                  
                  
                  $
                  0.12
                  
                  
                  $
                  (0.15
                  )
                  
                  $
                  0.28


5


Note
4 ─ Investment Securities Available For Sale





The
amortized cost and fair value of investment securities are presented in the
table below (in thousands).  The unrealized gains (losses) for these
investment securities have been recorded in accumulated other comprehensive
income (loss), net of the related tax expense (benefit).




At
      June 30, 2009Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueObligations
      of U.S. Government Agencies
                    
                    $
                    44,623
                    
                    
                    $
                    46
                    
                    
                    $
                    (18
                    )
                    
                    $
                    44,651Mortgage-Backed
      Securities
                    
                    
                    21,880
                    
                    
                    
                    74
                    
                    
                    
                    (52
                    )
                    
                    
                    21,902Municipal
      Securities
                    
                    
                    7,022
                    
                    
                    
                    22
                    
                    
                    
                    (98
                    )
                    
                    
                    6,946U.S.
      Treasury Securities
                    
                    
                    4,986
                    
                    
                    
                    ─
                    
                    
                    
                    (4
                    )
                    
                    
                    4,982Corporate
      Securities
                    
                    
                    579
                    
                    
                    
                    26
                    
                    
                    
                    ─
                    
                    
                    
                    605Equity
      Securities
                    
                    
                    83
                    
                    
                    
                    12
                    
                    
                    
                    (10
                    )
                    
                    
                    85Total
      Investment Securities
                    
                    $
                    79,173
                    
                    
                    $
                    180
                    
                    
                    $
                    (182
                    )
                    
                    $
                    79,171





At
      December 31, 2008Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueMortgage-Backed
      Securities
                    
                    $
                    59,146
                    
                    
                    $
                    661
                    
                    
                    $
                    (338
                    )
                    
                    $
                    59,469Obligations
      of U.S. Government Agencies
                    
                    
                    3,379
                    
                    
                    
                    17
                    
                    
                    
                    ─
                    
                    
                    
                    3,396Corporate
      Securities
                    
                    
                    1,481
                    
                    
                    
                    6
                    
                    
                    
                    (269
                    )
                    
                    
                    1,218Equity
      Securities
                    
                    
                    227
                    
                    
                    
                    42
                    
                    
                    
                    (63
                    )
                    
                    
                    206Total
      Investment Securities
                    
                    $
                    64,233
                    
                    
                    $
                    726
                    
                    
                    $
                    (670
                    )
                    
                    $
                    64,289





The
amortized cost and fair value of investment securities at June 30, 2009 and
December 31, 2008, by contractual maturity, are shown below (in
thousands).  Expected maturities will differ from contractual
maturities because borrowers may have the right to call or prepay obligations
with or without call or prepayment penalties.





June 30, 2009
                  
                  
                  December 31, 2008Maturity
                  
                  Amortized Cost
                  
                  
                  Fair Value
                  
                  
                  Amortized Cost
                  
                  
                  Fair ValueDue
      in One Year or Less
                  
                  $
                  9,079
                  
                  
                  $
                  9,087
                  
                  
                  $
                  1,514
                  
                  
                  $
                  1,528Due
      After One Year Through Five Years
                  
                  
                  37,438
                  
                  
                  
                  37,454
                  
                  
                  
                  1,865
                  
                  
                  
                  1,868Due
      After Five Years Through Ten Years
                  
                  
                  563
                  
                  
                  
                  556
                  
                  
                  
                  
                  
                  Due
      After Ten Years
                  
                  
                  10,130
                  
                  
                  
                  10,087
                  
                  
                  
                  1,481
                  
                  
                  
                  1,21857,210
                  
                  
                  
                  57,184
                  
                  
                  
                  4,860
                  
                  
                  
                  4,614Mortgage-Backed
      Securities
                  
                  
                  21,880
                  
                  
                  
                  21,902
                  
                  
                  
                  59,146
                  
                  
                  
                  59,469Equity
      Securities
                  
                  
                  83
                  
                  
                  
                  85
                  
                  
                  
                  227
                  
                  
                  
                  206Total
      Investment Securities
                  
                  $
                  79,173
                  
                  
                  $
                  79,171
                  
                  
                  $
                  64,233
                  
                  
                  $
                  64,289


6


The
following tables show gross unrealized losses and fair value of the
Corporation’s investment securities that are not deemed to be
other-than-temporarily impaired, aggregated by investment category and length of
time that individual securities have been in a continuous unrealized loss
position (in thousands) at June 30, 2009 and December 31, 2008:





At June 30, 2009Less than 12 Months
                
                
                12 Months or More
                
                
                TotalFair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  LossesObligations
      of U.S. Government Agencies
                
                $
                14,100
                
                
                $
                (18
                )
                
                $ 
                
                
                $ 
                
                
                $
                14,100
                
                
                $
                (18
                )Mortgage-Backed
      Securities
                
                
                11,686
                
                
                
                (52
                )
                
                
                
                
                
                
                
                
                11,686
                
                
                
                (52
                )Municipal
      Securities
                
                
                4,997
                
                
                
                (98
                )
                
                
                
                
                
                
                
                
                4,997
                
                
                
                (98
                )U.S.
      Treasury Securities
                
                
                4,982
                
                
                
                (4
                )
                
                
                
                
                
                
                
                
                4,982
                
                
                
                (4
                )Equity
      Securities
                
                
                2
                
                
                
                
                
                
                17
                
                
                
                (10
                )
                
                
                19
                
                
                
                (10
                )Total
      Temporarily Impaired Securities
                
                $
                35,767
                
                
                $
                (172
                )
                
                $
                17
                
                
                $
                (10
                )
                
                $
                35,784
                
                
                $
                (182
                )





At December 31, 2008Less than 12 Months
                
                
                12 Months or More
                
                
                TotalFair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  LossesMortgage-Backed
      Securities
                
                $
                15,954
                
                
                $
                (102
                )
                
                $
                1,936
                
                
                $
                (236
                )
                
                $
                17,890
                
                
                $
                (338
                )Corporate
      Securities
                
                
                476
                
                
                
                (269
                )
                
                
                ─
                
                
                
                ─
                
                
                
                476
                
                
                
                (269
                )Equity
      Securities
                
                
                69
                
                
                
                (42
                )
                
                
                26
                
                
                
                (21
                )
                
                
                95
                
                
                
                (63
                )Total
      Temporarily Impaired Securities
                
                $
                16,499
                
                
                $
                (413
                )
                
                $
                1,962
                
                
                $
                (257
                )
                
                $
                18,461
                
                
                $
                (670
                )





For the
three months ended June 30, 2009 and 2008, Union National received gross
proceeds of $48,043,000 and $6,504,000, respectively, on the sale of investment
securities.  The following tables present information related to the
Corporation’s gains and losses on the sales of investment securities, and losses
recognized for the other-than-temporary impairment of investment securities for
the three months ended June 30, 2009 and 2008:




Three Months Ended June 30, 2009Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)Obligations
      of U.S. Government Agencies
                
                $
                10
                
                
                $
                ─
                
                
                $
                ─
                
                
                $
                10Mortgage-Backed
      Securities
                
                
                1,023
                
                
                
                (11
                )
                
                
                (462
                )
                
                
                550Equity
      Securities
                
                
                ─
                
                
                
                (39
                )
                
                
                ─
                
                
                
                (39
                )Total
                
                $
                1,033
                
                
                $
                (50
                )
                
                $
                (462
                )
                
                $
                521





Three Months Ended June 30, 2008Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)Obligations
      of U.S. Government Agencies
                
                $
                9
                
                
                $
                ─
                
                
                $
                ─
                
                
                $
                9Mortgage-Backed
      Securities
                
                
                9
                
                
                
                ─
                
                
                
                ─
                
                
                
                9Corporate
      Securities
                
                
                ─
                
                
                
                (62
                )
                
                
                ─
                
                
                
                (62
                )Equity
      Securities
                
                
                54
                
                
                
                ─
                
                
                
                ─
                
                
                
                54Total
                
                $
                72
                
                
                $
                (62
                )
                
                $
                ─
                
                
                $
                10


7


For the
six months ended June 30, 2009 and 2008, Union National received gross proceeds
of $71,195,000 and $24,479,000, respectively, on the sale of investment
securities.  The following tables present information related to the
Corporation’s gains and losses on the sales of investment securities, and losses
recognized for the other-than-temporary impairment of investment securities for
the six months ended June 30, 2009 and 2008:




Six Months Ended June 30, 2009Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)Obligations
      of U.S. Government Agencies
                
                $
                10
                
                
                $
                ─
                
                
                $
                ─
                
                
                $
                10Mortgage-Backed
      Securities
                
                
                1,466
                
                
                
                (43
                )
                
                
                (452
                )
                
                
                971Corporate
      Securities
                
                
                ─
                
                
                
                ─
                
                
                
                (849
                )
                
                
                (849
                )Equity
      Securities
                
                
                ─
                
                
                
                (39
                )
                
                
                ─
                
                
                
                (39
                )Total
                
                $
                1,476
                
                
                $
                (82
                )
                
                $
                (1,301
                )
                
                $
                93





Six Months Ended June 30, 2008Gross
                  Realized
                  Gains
                
                
                Gross
                  Realized
                  Losses
                
                
                Other-than-
                  temporary
                  Impairment
                  Losses
                
                
                Net Gains
                  (Losses)Obligations
      of U.S. Government Agencies
                
                $
                108
                
                
                $
                ─
                
                
                $
                ─
                
                
                $
                108Mortgage-Backed
      Securities
                
                
                92
                
                
                
                ─
                
                
                
                ─
                
                
                
                92Corporate
      Securities
                
                
                9
                
                
                
                (62
                )
                
                
                ─
                
                
                
                (53
                )Equity
      Securities
                
                
                54
                
                
                
                ─
                
                
                
                ─
                
                
                
                54Total
                
                $
                263
                
                
                $
                (62
                )
                
                $
                ─
                
                
                $
                201





Other-Than-Temporary
Impairment (OTTI) of Investment Securities


In order
to determine whether unrealized losses in the fair value of investment
securities are other-than-temporary (OTTI), management regularly reviews the
entire portfolio of investment securities for possible impairment, analyzing
factors including but not limited to the underlying creditworthiness of the
issuing organization, the length of time for which the fair value of the
investment securities has been less than cost, and independent analysts’
opinions about circumstances that could affect the performance of the investment
securities.  In assessing potential OTTI for debt securities, other
considerations include (1) whether management intends to sell the security, or
(2) if it is more likely than not that management will be required to sell the
security before recovery, or (3) if management does not expect to recover the
entire amortized cost basis.  In assessing potential OTTI for equity
securities, consideration is given tomanagement’s
intention and ability to hold the securities until recovery of unrealized
losses.





Effective
April 1, 2009, Union National adopted FSP FAS 115-2 and FAS 124-2, “Recognition
and Presentation of Other-Than-Temporary Impairments” which 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
(OCI).  Management determined that OTTI recorded in the fourth quarter
of 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 security was recognized in
earnings.





The
following table presents a summary of the cumulative credit related OTTI charges
recognized as components of earnings for securities still held by the
Corporation at June 30, 2009 (in thousands):





Cumulative Credit Losses on Impaired
      SecuritiesBalance
      at January 1, 2009
                    
                    $
                    2,090Cumulative
      effect of FSP FAS 115-2 and FAS 124-2 adoption - non-credit portion of
      previous OTTI
                    
                    
                    (306
                    )Additional
      OTTI taken for credit losses
                    
                    
                    1,301Balance
      at June 30, 2009
                    
                    $
                    3,085


8





Upon
adoption, a cumulative effect adjustment was recorded in the amount of $202,000
to increase retained earnings with an increase to unrealized gains (losses) in
accumulated other comprehensive income (loss). This amount represented the
after-tax impact of the $306,000 non-credit related impairment charge related to
a non-agency mortgage-backed security.





As of
June 30, 2009, Union National maintains five investment securities with recorded
impairments.  The fair value of the five impaired investments was
$3,639,000 as compared to an original amortized cost of
$8,950,000.  The following table provides additional information
related to these five investment securities.




At June 30, 2009Original
      Book
                          
                          
                          Investment Rating
                          
                          
                          Current Book
                          
                          
                          Fair
                          
                          
                          OTTIDescription of Investment
      Security
                          
                          Value
                          
                          
                          Original
                          
                          
                          Current
                          
                          
                          Value
                          
                          
                          Value
                          
                          
                          TakenMortgage-Backed Securities:Countrywide
      Alt Ln 2005-83CB A3
                          
                          $
                          3,018
                          
                          
                          AAA
                          
                          
                          BB
                          
                          
                          $
                          1,457
                          
                          
                          $
                          1,576
                          
                          
                          $
                          546Countrywide
      Alt Ln 2005-75CB A4
                          
                          
                          2,932
                          
                          
                          AAA
                          
                          
                          CCC
                          
                          
                          
                          1,540
                          
                          
                          
                          1,458
                          
                          
                          
                          452Total
      Mortgage-Backed Securities
                          
                          $
                          5,950
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          2,997
                          
                          
                          $
                          3,034
                          
                          
                          $
                          998Corporate Securities:InCaps
      Funding II Senior Note
                          
                          $
                          1,000
                          
                          
                          A-
                          
                          
                          BB
                          
                          
                          $
                          293
                          
                          
                          $
                          304
                          
                          
                          $
                          631InCaps
      Funding II Junior Note
                          
                          
                          1,000
                          
                          
                          BBB
                          
                          
                          B
                          
                          
                          
                          276
                          
                          
                          
                          291
                          
                          
                          
                          530USCap
      Funding V
                          
                          
                          1,000
                          
                          
                          BBB
                          
                          
                          C
                          
                          
                          
                          10
                          
                          
                          
                          10
                          
                          
                          
                          926Total
      Corporate Securities
                          
                          $
                          3,000
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          579
                          
                          
                          $
                          605
                          
                          
                          $
                          2,087Total
      Securities with OTTI
                          
                          $
                          8,950
                          
                          
                          
                          
                          
                          
                          
                          
                          $
                          3,576
                          
                          
                          $
                          3,639
                          
                          
                          $
                          3,085





As
discussed more thoroughly in Note 10  to the unaudited consolidated
financial statements, the fair value of these investment securities was
determined by calculating the net present value of the expected future cash
flows of each security, with qualitative risk-adjusted discounting for potential
credit risks and nonperformance in the underlying issuers, and market sector
illiquidity concerns (in accordance with FSP SFAS No. 157-3,
“Determining the Fair Value of a Financial Asset When The Market for That Asset
Is Not Active”(“FSP 157-3”)).  Under FSP 157-3, when an active market
for a security does not exist, the use of management estimates that incorporate
current market participant expectations of future cash flows, and include
appropriate risk premiums, is acceptable.  Management’s judgment was
that, as of June 30, 2009, the facts and circumstances indicated significant
illiquidity and an inactive market for these types of investments when other
relevant observable inputs were not available; therefore, expected cash flows
were a reasonable basis in determining the fair value of the corporate
investment securities.  Prior to September 30, 2008, management used
other observable inputs to determine the fair value of the corporate investment
securities including broker indicated prices and quoted prices in limited
trading activity of the issuances.





During
the first six months of 2009, four of the Bank’s five private-issuer securities
were downgraded to below investment grade.  The fifth private-issuer
security was downgraded to below-investment-grade in December
2008.  Accordingly, the Bank recorded $1,301,000 of
other-than-temporary impairment charges in the first six months of 2009
including (i) $849,000 related to three pooled trust-preferred debt securities
supported primarily by obligations from other banks, and (ii) $452,000 related
to a mortgage-backed security not guaranteed by the U.S.
government.  Management determined that, due to severe illiquidity and
distress in the financial markets, the unrealized declines in the value of these
investments were other-than-temporary, requiring the write-down.  For
the securities with impairment charges recorded, interest income payments
received subsequent to impairment are fully applied to principal further
reducing the book value of these investments.


9


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





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


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


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


·
            Management
      does not intend to sell the securities, and (2) it is not likely that
      management will be required to sell the securities before recovery, and
      (3) though management does not expect to recover the amortized cost of the
      securities, management expects to hold the securities until a reasonable
      recovery towards the current carrying
value.





Note
5 ─ Stock-Based Compensation





In
accordance with Statement of Financial Accounting Standards No. 123(R),
“Share-Based Payment” (“SFAS No. 123(R)”), Union National recognizes
compensation expense for future 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, 2009: (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, 2009.  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 upon the exercise of stock
options.





No
share-based awards were granted or vested during the three or six months ended
June 30, 2009 and 2008; accordingly, no compensation expense was recorded for
these periods.  Stock option activity for the six months ended June
30, 2009, is summarized below:




Shares
                  
                  
                  Weighted-
                    Average
                    Exercise
                    PriceBeginning
      of Period (Prices range from $11.52 to $22.14)
                  
                  
                  93,511
                  
                  
                  $
                  18.82Granted
                  
                  
                  ─
                  
                  
                  
                  ─Exercised
                  
                  
                  ─
                  
                  
                  
                  ─Forfeited
                  
                  
                  (1,553
                  )
                  
                  
                  18.26Expired
                  
                  
                  ─
                  
                  
                  
                  ─End
      of Period (Prices range from $11.52 to $22.14)
                  
                  
                  91,958
                  
                  
                  $
                  18.82





The
following table presents information regarding options outstanding (all fully
vested and exercisable) at June 30, 2009:





Number
      of options
                  
                  
                  91,958Weighted-average
      contractual remaining term
                  
                  4.3
      YearsWeighted-average
      exercise price
                  
                  $
                  18.82Aggregate
      intrinsic value
                  
                  $
                  ─


10


Note
6 ─ Commitments, Guarantees and Contingencies





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, 2009, the Bank had $110,735,000 outstanding in
loan commitments and other unused lines of credit extended to its customers, as
compared to $109,907,000 at December 31, 2008.





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 $5,064,000 and $5,474,000 of standby letters
of credit outstanding as of June 30, 2009 and December 31, 2008,
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, 2009 and December 31, 2008, for Bank guarantees under
standby letters of credit issued is not considered to be material.





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.  The Bank’s payments to the consortium to cover estimated claims
expenses, administrative expenses, and stop loss insurance premiums for the 12
months ended June 30, 2009 exceeded the actual processed expenses by
$163,000.  However, the Bank reduced the amount of this prepaid benefit by
a contingent reserve of $44,000 reflecting an actuarial estimate by the
consortium of the Bank’s unpaid claim liability as of June 30, 2009 to include
potential (i) unreported claims, (ii) reported but unprocessed claims, and (iii)
processed but unpaid claims, related to both medical and drug
coverage.





Note
7 ─ De-Leveraging and Restructuring Activities





In 2009,
the Bank continued with de-leveraging activities to reduce its cost of funds and
improve its net interest margin by using funds from low-interest earning assets
to pay down higher-interest long-term debt.  During the second quarter
of 2009, the Bank prepaid $12,000,000 of FHLB advances, which had a fixed
weighted average interest cost 5.67%, incurring $393,000 of prepayment
penalties, which were included in other non-interest expense.  At June
30, 2009, the balance of long-term debt was $38,334,000.  For the six
months ended June 30, 2008, the Bank prepaid $17,482,000 of FHLB advances,
incurring $68,000 of FHLB debt prepayment penalties.  For all of 2008,
the Bank prepaid $18,482,000 of FHLB advances with a weighted average interest
cost of 4.19%, reducing total long-term debt to $50,334,000 at December 31,
2008.





Additionally,
during the first six months of 2008, the Bank called $9,809,000 of brokered CDs
with a fixed weighted average interest cost of 4.66%.  For all of
2008, the Bank called $16,410,000 of brokered CDs which had a fixed weighted
average interest cost of 4.91%.  No brokered CDs were called in the
first six months of 2009.





In
addition to the de-leveraging activities, the Bank made cash payments of
$149,000 during the six months ended June 30, 2008 related to accrued severance
liabilities remaining from 2007 restructuring activities.  There were
no restructuring expenses in 2008 or 2009, and the severance liability was paid
in full by December 31, 2008.





Note
8 ─ Common Stock Issued Under Private Placement Offering and Dividend
Reinvestment Plan





On May
19, 2008, Union National commenced a private placement stock offering for the
sale of up to 526,315 unregistered shares of Union National’s common stock, par
value $0.25 per share, at $9.50 per share for a maximum aggregate offering price
of $4,999,993. There was no minimum offering amount.  Proceeds from
the sale of the shares were immediately contributed to the general corporate
purposes of Union National including, but not limited to, continuing to meet
regulatory capital requirements and increasing the regulatory lending ability of
the Bank.  The shares were being offered pursuant to an exemption from
registration under Section 3(b) of the Securities Act of 1933 and Rule 505 of
SEC Regulation D.  The shares sold were restricted securities for
purposes of the United States securities laws and cannot be transferred except
under these laws.  The initial private placement offering was for an
initial period of six months commencing May 19, 2008.  The Board of
Directors of Union National subsequently elected to extend the offering period
for the shares until February 17, 2009, at which time the private placement
offering expired.  Union National received gross proceeds of
$1,635,000 on the private placement stock offering and issued 172,132
shares.  Issuance costs of $49,000 were offset against the gross
proceeds.


11


Union
National maintains a Dividend Reinvestment Plan (DRIP) for record holders of the
Corporation’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.  During the first six months of 2009, there
were no dividends paid by the Corporation; however, eligible shareholders made
voluntary cash payments totaling $47,000, which were used to issue 14,580 common
shares.





Note
9 ─ Memorandum of Understanding





In 2007,
the Bank entered into a Memorandum of Understanding (“MOU”) with the Office of
the Comptroller of the Currency (“OCC”).  Specifically, the MOU
requires the Bank to (1) implement a three-year strategic plan in accordance
with specific guidelines set forth in the MOU, (2) develop and implement a
three-year capital plan, in accordance with specific guidelines set forth in the
MOU, including a dividend policy for the payment of dividends provided the Bank
is in compliance with the capital plan, and applicable laws and regulations, (3)
review and revise a written program to improve the Bank’s loan portfolio
management, (4) review and revise the Bank’s funds management reports to ensure
that they reflect current and projected funding needs, (5) develop and implement
a risk based audit program to determine weaknesses or deficiencies in the Bank’s
consumer compliance program, (6) ensure the Bank’s interest rate risk (“IRR”)
measurement tool or model conforms to OCC guidelines and, if necessary, develop
an action plan to address the need for a more acceptable IRR measurement model,
and (7) furnish written quarterly progress reports to the OCC detailing the form
and manner of actions taken to comply with the MOU.  Each provision of
the MOU is subject to OCC approval, non-objection and/or
review.  Included in the response to the MOU, Union National
established target capital rates for the Bank of 8% for Tier I Capital to
Average Total Assets, 9% for Tier I Capital to Risk-Based Assets, and 12% for
Total Capital to Risk-Based Assets.  Through June 30, 2009, management
has sent to the OCC the documentation and progress reports as required under the
MOU,and managementbelieves that the Bank
has made measurable progress in addressing the issues identified in the
MOU.  However, as of June 30, 2009, the Bank’s measure of Tier I
Capital to Average Total Assets was 7.96%, slightly below the 8% target rate
established in response to the MOU.  The Bank’s measures of Tier I
Capital to Risk-Based Assets of 9.82% and Total Capital to Risk-Based Assets of
12.34% both exceeded the respective 9% and 12% target rates established by the
Corporation in response to the MOU.





Note
10 ─ Fair Value Measurement of Assets and Liabilities and Fair Value of
Financial Instruments





Effective
January 1, 2008, Union National adopted SFAS No. 157, “Fair Value Measurements”,
for financial assets and financial liabilities, and on January 1, 2009, adopted
the provision for non-financial assets and non-financial
liabilities.  SFAS 157 defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting
principles, and expands disclosures about fair value
measurements.  SFAS 157 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 the transaction to sell the asset or transfer the 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 a transaction 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; it is not a forced
transaction.





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.  SFAS 157 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, SFAS 157 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.


12


The fair
value hierarchy is as follows:





Level
      1
              -
              Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date foridentical,
      unrestricted assets or liabilities;Level
      2
              -
              Quoted
      prices in markets that are not active, or inputs that are observable
      either directly orindirectly,
      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 valuemeasurement
      and unobservable (i.e., supported by little or no market
      activity).





In April
2009, the Financial Accounting Standards Board (FASB) issued FASB Staff
Position (FSP) No. FAS 157-4, “Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions That Are Not Orderly” (“FSP FAS
157-4”).  FSP FAS 157-4 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 FASB
Statement 157.  Further, FSP FAS 157-4 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 FSP 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.
The Corporation has adopted the requirements of FSP No. 157-4 for the quarter
ended June 30, 2009 and it did not have a material impact on the Corporation’s
consolidated financial statements.





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.





Securities
Available for Sale


Equity
securities, comprised mostly of bank stocks, 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 bank
stocks, traded on the OTC Bulletin Board (“OTCBB”) 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, we obtain 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 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.  As of June
30, 2009, the fair value of securities valued using Level 3 inputs was
determined by management 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 FSP
SFAS No. 157-3, “Determining the Fair Value of a Financial Asset When
The Market for That Asset Is Not Active”).  Prior to September 30,
2008, management used market pricing based upon quoted prices from very limited
trading activity of the issuances.


13


The following table summarizes
financial assets and financial liabilities measured at fair value on a recurring
basis as of June 30, 2009 and December 31, 2008, segregated by the level of the
valuation inputs within the fair value hierarchy utilized to measure fair value
(in thousands):





Available-For-Sale SecuritiesInputs:
                  
                  June 30,
                    2009
                  
                  
                  December 31,
                    2008Level
      1
                  
                  $
                  7
                  
                  
                  $
                  74Level
      2
                  
                  
                  75,525
                  
                  
                  
                  59,778Level
      3
                  
                  
                  3,639
                  
                  
                  
                  4,437Total
      Fair Value
                  
                  $
                  79,171
                  
                  
                  $
                  64,289





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, 2009
                  
                  $
                  4,437Payments
      received (applied to principal), net of accretion
                  
                  
                  (363
                  )Total
      realized and unrealized gainsIncluded
      in net income (loss)
                  
                  
                  (1,301
                  )Included
      in other comprehensive income (loss)
                  
                  
                  866Ending
      Balance at June 30, 2009
                  
                  $
                  3,639





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.
The valuation allowance on impaired loans was $1,139,000 and $1,499,000 at June
30, 2009 and December 31, 2008, respectively.





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.





The
following table summarizes financial assets and financial liabilities measured
at fair value on a nonrecurring basis as of June 30, 2009 and December 31, 2008,
segregated by the level of the valuation inputs within the fair value hierarchy
utilized to measure fair value (in thousands):


June 30, 2009Assets:
                  
                  Level 1
                    Inputs
                  
                  
                  Level 2
                    Inputs
                  
                  
                  Level 3
                    Inputs
                  
                  
                  Total Fair
                    ValueImpaired
      Loans
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  $
                  6,341
                  
                  
                  $
                  6,341Repossessed
      Assets
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  
                  571
                  
                  
                  
                  571Other
      Real Estate Owned
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  
                  349
                  
                  
                  
                  349Total
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  $
                  7,261
                  
                  
                  $
                  7,261





December 31, 2008Assets:
                  
                  Level 1
                    Inputs
                  
                  
                  Level 2
                    Inputs
                  
                  
                  Level 3
                    Inputs
                  
                  
                  Total Fair
                    ValueImpaired
      Loans
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  $
                  3,559
                  
                  
                  $
                  3,559Repossessed
      Assets
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  
                  479
                  
                  
                  
                  479Other
      Real Estate Owned
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  
                  ─Total
                  
                  
                  ─
                  
                  
                  
                  ─
                  
                  
                  $
                  4,038
                  
                  
                  $
                  4,038


14





In April
2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures
about Fair Value of Financial Instruments” (“FSP FAS 107-1 and APB
28-1”).  FSP FAS 107-1 and APB 28-1 amends FASB Statement
No. 107, “Disclosures about Fair Value of Financial Instruments,” to
require disclosures about fair value of financial instruments for interim
reporting periods of publicly traded companies as well as in annual financial
statements. This FSP also amends APB Opinion No. 28, “Interim Financial
Reporting”, to require those disclosures in summarized financial information at
interim reporting periods.  This FSP is effective for interim and
annual reporting periods ending June 30, 2009, and after.





The
estimated fair values of the Corporation’s financial instruments as of June 30,
2009 and December 31, 2008 (in thousands) are set forth in the table
below.  The information in the table should not be interpreted as an
estimate of the fair value of the entire Corporation since a fair value
calculation is only provided for a limited portion of the Corporation’s assets
and liabilities.  Due to a wide range of valuation techniques and the
degree of subjectivity used in making the estimates, comparisons between the
Corporation’s disclosures and those of other companies may not be
meaningful.





June 30, 2009
                  
                  
                  December 31, 2008Carrying
                    Amount
                  
                  
                  Fair Value
                  
                  
                  Carrying
                    Amount
                  
                  
                  Fair ValueAssets:Cash
      and Cash Equivalents
                  
                  $
                  43,070
                  
                  
                  $
                  43,070
                  
                  
                  $
                  31,837
                  
                  
                  $
                  31,837Interest-Bearing
      Time Deposits in Other Banks
                  
                  
                  12,448
                  
                  
                  
                  12,448
                  
                  
                  
                  1,775
                  
                  
                  
                  1,775Investment
      Securities Available for Sale
                  
                  
                  79,171
                  
                  
                  
                  79,171
                  
                  
                  
                  64,289
                  
                  
                  
                  64,289Loans
      (excluding Leases), Net
                  
                  
                  342,758
                  
                  
                  
                  343,191
                  
                  
                  
                  350,130
                  
                  
                  
                  350,288Restricted
      Investment in Bank Stocks
                  
                  
                  3,705
                  
                  
                  
                  3,705
                  
                  
                  
                  3,703
                  
                  
                  
                  3,703Accrued
      Interest Receivable
                  
                  
                  1,835
                  
                  
                  
                  1,835
                  
                  
                  
                  1,624
                  
                  
                  
                  1,624Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                  
                  
                  65
                  
                  
                  
                  259
                  
                  
                  
                  86
                  
                  
                  
                  285Liabilities:Demand
      and Savings Deposits
                  
                  
                  218,033
                  
                  
                  
                  218,033
                  
                  
                  
                  189,724
                  
                  
                  
                  189,724Time
      Deposits
                  
                  
                  207,635
                  
                  
                  
                  211,586
                  
                  
                  
                  193,853
                  
                  
                  
                  195,611Long-term
      Debt
                  
                  
                  38,334
                  
                  
                  
                  40,329
                  
                  
                  
                  50,334
                  
                  
                  
                  52,976Junior
      Subordinated Debentures
                  
                  
                  17,341
                  
                  
                  
                  19,165
                  
                  
                  
                  17,341
                  
                  
                  
                  19,182Accrued
      Interest Payable
                  
                  
                  1,264
                  
                  
                  
                  1,264
                  
                  
                  
                  1,422
                  
                  
                  
                  1,422Off-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, 2009 and December 31,
2008:





Cash and
cash equivalents:
The carrying amounts reported in the consolidated statements of financial
condition for cash and short-term investments approximate their fair
values.





Interest-bearing
time deposits in other banks:The carrying amounts
reported in the consolidated statements of financial condition for
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 fair value 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.





Loans: For variable-rate loans that
reprice frequently and which entail no significant changes in credit risk,
carrying values approximate fair value.  The fair value of other loans
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.


15


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 Union National's 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 junior subordinated 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.





Note
11 ─ Junior Subordinated Debentures





Union
National has three issuances of junior subordinated debentures outstanding as of
June 30, 2009 and December 31, 2008.





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 LIBOR (“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 3.89% and 6.32% at
June 30, 2009 and December 31, 2008, 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 2.66% and 4.15% at June 30,
2009 and December 31, 2008, 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 will become callable in October 2009, and the Bank’s subordinated
debenture will become callable in July 2011.  These issuances of
junior subordinated debentures qualify as a component of risk-based capital for
regulatory purposes.


16


Note
12 ─ 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, 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
      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
                      )





Three Months Ended June 30, 2008
                    
                    
                    Six Months Ended June 30, 2008Before
                      Tax
                      Amount
                    
                    
                    Tax
                      Impact
                    
                    
                    Net-of-
                      Tax
                      Amount
                    
                    
                    Before
                      Tax
                      Amount
                    
                    
                    Tax
                      Impact
                    
                    
                    Net-of-
                      Tax
                      AmountNet
      Income
                    
                    $
                    356
                    
                    
                    $
                    52
                    
                    
                    $
                    304
                    
                    
                    $
                    876
                    
                    
                    $
                    159
                    
                    
                    $
                    717Other Comprehensive
      Loss:Unrealized
      Losses on Available-for-Sale Securities Arising During the
      Period
                    
                    
                    (729
                    )
                    
                    
                    (252
                    )
                    
                    
                    (477
                    )
                    
                    
                    (1,462
                    )
                    
                    
                    (501
                    )
                    
                    
                    (961
                    )Reclassification
      Adjustment for Securities Gains  included in Net
      Income
                    
                    
                    (10
                    )
                    
                    
                    (3
                    )
                    
                    
                    (7
                    )
                    
                    
                    (201
                    )
                    
                    
                    (68
                    )
                    
                    
                    (133
                    )Other
      Comprehensive Loss
                    
                    
                    (739
                    )
                    
                    
                    (255
                    )
                    
                    
                    (484
                    )
                    
                    
                    (1,663
                    )
                    
                    
                    (569
                    )
                    
                    
                    (1,094
                    )Total
      Comprehensive Loss
                    
                    $
                    (383
                    )
                    
                    $
                    (203
                    )
                    
                    $
                    (180
                    )
                    
                    $
                    (787
                    )
                    
                    $
                    (410
                    )
                    
                    $
                    (377
                    )


17


Note
13 ─ Recent Accounting Pronouncements





FASB
Statement No. 165


In June
2009, the FASB issued SFAS No. 165, “Subsequent Events”.  This
statement introduces the concept of financial statements being available to be
issued.  It requires the disclosure of the date through which
an entity has evaluated subsequent events and the basis for that date, that is,
whether that date represents the date the financial statements were issued or
available to be issued.  This disclosure should alert all users of
financial statements that an entity has not evaluated subsequent events after
that date in the set of financial statements being presented.  This
Statement is effective for the Corporation for interim and annual reporting
periods ending June 30, 2009 and after.





FASB
Statement No. 166


In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets, an amendment of FASB Statement No. 140”.  This statement
prescribes the information that a reporting entity must provide in its financial
reports about a transfer of financial assets; the effects of a transfer on its
financial position, financial performance and cash flows; and a transferor’s
continuing involvement in transferred financial assets.  Specifically,
among other aspects, SFAS 166 amends Statement of Financial Standard
No. 140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities”, or SFAS 140, by removing the concept of a
qualifying special-purpose entity from SFAS 140 and removes the exception
from applying FIN 46(R) to variable interest entities that are qualifying
special-purpose entities.  It also modifies the financial-components
approach used in SFAS 140. SFAS 166 is effective for fiscal years
beginning after November 15, 2009.  The Corporation is currently
reviewing the effect this new pronouncement will have on its consolidated
financial statements.





FASB
Statement No. 167


In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation
No. 46(R)”.  This statement amends FASB Interpretation
No. 46, “Consolidation of Variable Interest Entities (revised December
2003) — an interpretation of ARB No. 51”, or FIN 46(R), to
require an enterprise to determine whether it’s variable interest or interests
give it a controlling financial interest in a variable interest
entity.  The primary beneficiary of a variable interest entity is the
enterprise that has both (1) the power to direct the activities of a
variable interest entity that most significantly impact the entity’s economic
performance and (2) the obligation to absorb losses of the entity that
could potentially be significant to the variable interest entity or the right to
receive benefits from the entity that could potentially be significant to the
variable interest entity.  SFAS 167 also amends FIN 46(R) to
require ongoing reassessments of whether an enterprise is the primary
beneficiary of a variable interest entity.  SFAS 167 is effective
for fiscal years beginning after November 15, 2009.  The Corporation
is currently reviewing the effect this new pronouncement will have on its
consolidated financial statements.





FASB
Statement No. 168


In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles, a replacement of
FASB Statement No. 162”.   SFAS 168 replaces
SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
Principles”, to establish the FASB Accounting Standards Codification as the
source of authoritative accounting principles recognized by the FASB to be
applied by nongovernmental entities in preparation of financial statements in
conformity with generally accepted accounting principles in the United
States.  SFAS 168 is effective for interim and annual periods
ending after September 15, 2009. The Corporation does not expect the
adoption of this standard to have an impact on our financial position or results
of operations.


18


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





Forward Looking
Statements





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





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





Critical Accounting
Policies





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





Determination
of the Allowance for Credit Losses


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


19


Fair
Value of Investment Securities


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





Financial
Condition





Total
assets increased by $30,628,000 or 6% to $515,737,000 at June 30, 2009 from
$485,109,000 at December 31, 2008.  The increase was primarily the
result of strong retail deposit generation, which further strengthened Union
National’s liquidity position. The proceeds received from the deposit growth
were used to purchase short-term investments.  Total deposits grew by
$42,091,000 or 11% to $425,668,000 at June 30, 2009 from $383,577,000 at
December 31, 2008.





Investment
Securities


Investment
securities were $79,171,000 at June 30, 2009 as compared to $64,289,000 at
December 31, 2008.  All of Union National’s investment securities were
classified as available for sale at June 30, 2009 and December 31,
2008.  Securities classified as available for sale are marketable
equity securities, and those debt securities that we intend to hold for an
indefinite period of time, but not necessarily to maturity.  We
possess the ability and intent to hold securities with temporary impairment to
maturity or recovery; however, we recognize that the investment portfolio serves
other primary financial management functions including an ultimate source of
liquidity and a tool to manage interest rate risk.  In order to
support these functions, we have designated our entire portfolio of investment
securities as being available for sale.  Any decision to sell a
security classified as available for sale would be based on various factors,
including significant movements in interest rates, changes in maturity mix of
our assets and liabilities, liquidity needs, regulatory capital considerations,
changes in the creditworthiness of the issuing entity, changes in investment
strategy and portfolio mix, and other similar factors. Changes in unrealized
gains or losses on available-for-sale securities, net of taxes, are recorded as
other comprehensive income (loss), a component of stockholders’
equity.





Union
National purchases certain types of mortgage-backed and asset-backed securities
to better position our investment portfolio for a subsequent increase or
decrease in interest rates, as aligned with our interest rate risk
position.  These securities may be purchased at premiums or discounts,
with short-, mid-, or long-term average expected lives or
maturities.  Overall yields on these securities will increase or
decrease based on changes in prepayment speeds and subsequent cash flow
reinvestments.  Cash flows from these securities and changes in market
interest rates are considered in our net interest income simulation model (see
related discussion titled Market Risk - Interest Rate
Risk on page 38).





Union
National sold $71,195,000 of investment securities and recognized $1,394,000 in
net gains, and purchased $100,581,000 of investment securities in
2009.  We periodically assess the strategy of selling mortgage-backed
securities and other available for sale securities.  Investment
security purchases and sales generally occur to manage the Bank’s liquidity
requirements, pledging requirements, interest rate risk, and to enhance our net
interest margin.  We regularly evaluate our available for sale
portfolio for possible opportunities to increase earnings through potential
investment security sales or portfolio repositioning. Investment securities
carried at $60,578,000 at June 30, 2009, and $59,646,000 at December 31, 2008
were pledged to secure public, trust, and government deposits and for other
purposes.





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


20


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





June 30,
                      2009
                    
                    
                    December 31,
                      2008Market
      Value of Debt Securities
                    
                    $
                    79,086
                    
                    
                    $
                    64,083Market
      Value of Equity Securities
                    
                    
                    85
                    
                    
                    
                    206Total
      Market Value of Investment Securities
                    
                    $
                    79,171
                    
                    
                    $
                    64,289





Debt
securities include government agencies, mortgage-backed securities,
collateralized mortgage obligations and corporate securities.  At June
30, 2009, there were a total of 22 debt securities with unrealized losses of
$172,000 that amounted to 0.5% of their amortized cost, as compared to December
31, 2008, when there were a total of 23 debt securities with unrealized losses
of $607,000 that amounted to 3.2% of their amortized cost.  We believe
that the unrealized losses reflect temporary declines primarily due to changes
in interest rates subsequent to the acquisition of specific
securities.  These temporary declines in investment securities’ fair
value below amortized cost have been provided for in other comprehensive income
(loss).





Equity
securities held are comprised primarily of common stock holdings in other
financial institutions.  The market values include net unrealized
gains of $2,000 as of June 30, 2009 as compared to net unrealized losses of
$21,000 as of December 31, 2008.  Union National sold $105,000 of
these equity securities in 2009 and recognized losses of $39,000.





As of
June 30, 2009, $7,000 of the fair value of total investment securities were
measured using Level 1 inputs as defined by SFAS 157, $75,525,000 or 95.4% of
the fair value were measured using Level 2 inputs, and $3,639,000 or 4.6% were
measured using Level 3 inputs (see definitions and related discussion in Note 10
to the consolidated financial statements).





The fair
value of Level 3 investment securities decreased to $3,639,000 at June 30, 2009
from $4,437,000 at December 31, 2008. Of the decrease in value, $1,301,000 was
related to impairment charges that were included in net income and $363,000 was
related to principal and interest payments received (net of accretion), which
were fully applied to principal, offset by $866,000 of unrealized gains
(with a corresponding after-tax increase to stockholders’ equity of $572,000
recorded as other comprehensive income (loss)).





In order
to determine whether unrealized losses in the fair value of investment
securities are other-than-temporary, management regularly reviews the entire
portfolio of investment securities for possible impairment, analyzing factors
including but not limited to the underlying creditworthiness of the issuing
organization, the length of time for which the fair value of the investment
securities has been less than cost, and independent analysts’ opinions about
circumstances that could affect the performance of the investment
securities.  In assessing potential OTTI for debt securities, other
considerations include (1) whether management intends to sell the security, or
(2) if it is more likely than not that management will be required to sell the
security before recovery, or (3) if management does not expect to recover the
entire amortized cost basis.  In assessing potential OTTI for equity
securities, consideration is given tomanagement’s
intention and ability to hold the securities until recovery of unrealized
losses.





As of
June 30, 2009, Union National maintains five investment securities with recorded
impairments.  The fair value of the five impaired investments is
$3,639,000 at of June 30, 2009, as compared to an original amortized cost of
$8,950,000.  All payments received on impaired investment
securities are fully applied to principal.





In April
2009, the Financial Accounting Standards Board (FASB) issued FASB Staff
Position (FSP) No. FAS 157-4, “Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions That Are Not Orderly” (“FSP FAS
157-4”).  FSP FAS 157-4 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 FASB
Statement 157.  Further, FSP FAS 157-4 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 FSP 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.


21


As
discussed in Note 10 to the consolidated financial statements,
the fair value of these investment securities was determined by calculating the
net present value of the expected future cash flows of each security, with
qualitative risk-adjusted discounting for potential credit risks and
nonperformance in the underlying issuers, and market sector illiquidity concerns
(in accordance with FSP SFAS No. 157-3, “Determining the Fair Value of
a Financial Asset When The Market for That Asset Is Not Active” (“FSP
157-3”)).  Under FSP 157-3, when an active market for a security does
not exist, the use of management estimates that incorporate current market
participant expectations of future cash flows, and include appropriate risk
premiums, is acceptable.  Management’s judgment was that, as of June
30, 2009, the facts and circumstances indicated significant illiquidity and an
inactive market for these types of investments when other relevant observable
inputs were not available; therefore, expected cash flows were a reasonable
basis in determining the fair value of the corporate investment
securities.  Prior to September 30, 2008, management used other
observable inputs to determine the fair value of the corporate investment
securities including broker indicated prices and quoted prices in limited
trading activity of the issuances.





During
the first six months of 2009, four of the Bank’s five private-issuer securities
were downgraded to below investment grade.  The fifth private-issuer
security was downgraded to below-investment-grade in December
2008.  Accordingly, the Bank recorded $1,301,000 of
other-than-temporary impairment charges in the first six months of 2009
including (i) $849,000 related to three pooled trust-preferred debt securities
supported primarily by obligations from other banks, and (ii) $452,000 related
to a mortgage-backed security not guaranteed by the U.S.
government.  Management determined that, due to severe illiquidity and
distress in the financial markets, the unrealized declines in the value of these
investments were other-than-temporary, requiring the write-down.  For
the securities with impairment charges recorded, interest income payments
received subsequent to impairment are fully applied to principal further
reducing the book value of these investments.  (See Note 4to the unaudited
consolidated financial statements.)





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





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


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


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


·
            Management
      does not intend to sell the securities, and (2) it is not likely that
      management will be required to sell the securities before recovery, and
      (3) though management does not expect to recover the amortized cost of the
      securities, management expects to hold the securities until a reasonable
      recovery towards the current carrying
value.





Loans
and Leases, Credit Quality and Credit Risk


Loans and
leases at June 30, 2009 were $349,958,000 as compared to $358,280,000 at
December 31, 2008.  Union National continues to focus lending on
creditworthy consumers and businesses, with necessary consideration given to
increased credit risks posed by the weak economy and the housing
market.  The economy and housing market, and increased unemployment,
has affected some of Union National’s borrowers, resulting in increased
nonperforming loans and credit losses.





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


22


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





Union
National continues to closely monitor the loan portfolio, and the underlying
borrower financial performance and collateral values, identifying credit
concerns and risks, including those resulting from the current weak
economy.  Future adjustments may be necessary to the allowance for
credit losses, and consequently the provision for credit losses, if economic
conditions or loan credit quality differ substantially from the assumptions we
used in making our evaluation of the level of the allowance as compared to the
balance of outstanding loans and leases.  The ratio of the allowance
for credit losses to gross loans and leases was 1.25% at June 30, 2009, as
compared to 1.22% at December 31, 2008.  At June 30, 2009, the allowance
for credit losses did not change substantially from December 31,
2008.  The provision for credit losses for the three and six months
ended June 30, 2009, was significantly higher than the provision for credit
losses for the same periods in 2008(see related discussion on
Provision for Credit Losseson pages 27 and 29) given the increased credit
risks in the loan portfolio, including those resulting from the current weak
economy and real estate markets, and due to loan charge-offs being significantly
higher for the three and six months ended June 30, 2009, as compared to the same
periods in 2008.  Management believes, based on information currently
available, that the allowance for credit losses as of June 30, 2009
of $4,364,000 is adequate to meet potential credit losses.





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





Three Months Ended
                    June 30,
                  
                  
                  Six Months Ended
                    June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Allowance
      for Credit Losses, Beginning of Period
                  
                  $
                  4,319
                  
                  
                  $
                  3,742
                  
                  
                  $
                  4,358
                  
                  
                  $
                  3,675Charge-Offs
                  
                  
                  (570
                  )
                  
                  
                  (53
                  )
                  
                  
                  (933
                  )
                  
                  
                  (134
                  )Recoveries
                  
                  
                  4
                  
                  
                  
                  3
                  
                  
                  
                  15
                  
                  
                  
                  11Net
      Charge-Offs
                  
                  
                  (566
                  )
                  
                  
                  (50
                  )
                  
                  
                  (918
                  )
                  
                  
                  (123
                  )Addition
      to Provision for Credit Losses
                  
                  
                  611
                  
                  
                  
                  139
                  
                  
                  
                  924
                  
                  
                  
                  279Allowance
      for Credit Losses, End of Period
                  
                  $
                  4,364
                  
                  
                  $
                  3,831
                  
                  
                  $
                  4,364
                  
                  
                  $
                  3,831Loans
      and Leases – Average
                  
                  $
                  349,697
                  
                  
                  $
                  369,026
                  
                  
                  $
                  352,893
                  
                  
                  $
                  367,331Gross
      Loans and Leases – Actual
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  349,958
                  
                  
                  $
                  375,275Ratio
      of Gross Loans and Leases Charged Off to Average Loans and Leases
      (Annualized)
                  
                  
                  0.65
                  %
                  
                  
                  0.06
                  %
                  
                  
                  0.53
                  %
                  
                  
                  0.07
                  %Ratio
      of Allowance for Credit Losses to Gross Loans and Leases
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  1.25
                  %
                  
                  
                  1.02
                  %





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


23


The
balance of loans and leases that were considered to be impaired under GAAP was
$8,355,000 and $9,360,000, which consisted of fourteen and sixteen loan and
lease relationships to unrelated borrowers, at June 30, 2009 and December 31,
2008, respectively.  At June 30, 2009, three of the impaired loans
represented 74% of the total impaired loans and leases of
$8,355,000.  The decrease in impaired loans and leases was the result
of loan charge-offs during the year.  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 $7,480,000 and
$5,058,000 of impaired loans and leases, which consisted of eight loan
relationships to unrelated borrowers, with a related allowance for credit losses
of $1,139,000 and $1,499,000 at June 30, 2009 and December 31, 2008,
respectively.  This group of impaired loans and leases has a related
allowance due to the probability of the borrower not being 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 losses.





Impaired Loans Without a
Related Allowance.  Union National had $875,000 and $4,302,000
of impaired loans and leases, which consisted of six and eight loan
relationships to unrelated borrowers, without a related allowance for credit
losses at June 30, 2009 and December 31, 2008, respectively.  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.  Additionally, these loans and leases appear to have sufficient
collateral and Union National’s principal does not appear to be at risk; as a
result, management believes a related allowance is not necessary.





Substandard Loans and
Leases.  Under our current internal risk rating system, loans
and leases with a rating of “substandard” that were performing, and not
determined to be impaired amounted to $24,786,000 and $7,826,000 at June
30, 2009 and December 31, 2008, respectively.  Despite these credits
not being impaired, Union National believes these substandard credits reflect
increased risks to the loan portfolio, including risks resulting from the
current weak economy and real estate markets, and considered such increased
risks in determining the provision for credit losses (see related discussion on Provision
for Credit Losseson pages 27 and 29).Union National continues
to closely monitor the loan portfolio, and the underlying borrower financial
performance and collateral values, identifying credit concerns and risks,
including those resulting from the current weak economy.  We consider
both impaired and these substandard loans to be potential problem loans, and
believe that the current economic conditions may result in additional loans
being classified or nonperforming throughout 2009.





Non-Performing
Assets.  Nonperforming loans and leases increased to 1.9% of
total loans and leases at June 30, 2009, as compared to 1.4% at December 31,
2008.  Historically, the percentage of nonperforming loans to net
loans for the five-year period ending December 31, 2008, was an average of
0.9%.  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.


24


The
following table is a summary of our nonperforming assets as of June 30, 2009 and
December 31, 2008 (dollars in thousands):





June 30,
                        2009
                      
                      
                      December 31,
                        2008Nonaccruing
      Loans
                      
                      $
                      5,858
                      
                      
                      $
                      3,271Accruing
      Loans – 90 days or more past due
                      
                      
                      899
                      
                      
                      
                      1,685Total
      Nonperforming Loans and Leases
                      
                      
                      6,757
                      
                      
                      
                      4,956Repossessed
      Assets
                      
                      
                      920
                      
                      
                      
                      479Total
      Nonperforming Assets
                      
                      $
                      7,677
                      
                      
                      $
                      5,435Gross
      Loans and Leases
                      
                      $
                      349,958
                      
                      
                      $
                      358,280Allowance
      for Credit Losses
                      
                      $
                      4,364
                      
                      
                      $
                      4,358Nonperforming
      Loans and Leases as a % of Gross Loans and
      Leases
                      
                      
                      1.9
                      %
                      
                      
                      1.4
                      %Nonperforming
      Assets as a % of Total Assets
                      
                      
                      1.5
                      %
                      
                      
                      1.1
                      %Allowance
      for Credit Losses as a % of Nonperforming Loans and Leases
                      
                      
                      65
                      %
                      
                      
                      88
                      %





Repossessed
assets consist of (a) foreclosed real estate which includes collateral assets
acquired through foreclosure and loans identified as in-substance foreclosures,
(b) vehicles and other equipment acquired from lessees who defaulted on their
contractual lease obligation, and (c) mobile homes where the Bank does not own
the real estate.





A loan is
classified as an in-substance foreclosure when Union National has taken
possession of the collateral regardless of whether formal foreclosure
proceedings have taken place.  Foreclosed real estate is held for sale
and is initially recorded at fair value less cost to sell at the date of
foreclosure, establishing a new cost basis.  Subsequent to
foreclosure, valuations are periodically performed by management and the assets
are carried at the lower of carrying amount or fair value less cost to
sell.  Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed assets as part
of other expenses.





Union
National had repossessed assets of $920,000 and $479,000 at June 30, 2009 and
December 31, 2008, respectively.  Included in repossessed assets at
June 30, 2009, was $349,000 of foreclosed real estate. Union National did not
have any foreclosed real estate at December 31, 2008.





Stockholders’
Equity


Stockholders’
equity decreased by $192,000 to $30,602,000 at June 30, 2009 compared to
$30,794,000 at December 31, 2008.  The decrease  in
stockholders’ equity was primarily the result of decreases to retained earnings
resulting from a year-to-date net loss offset by other comprehensive income
during the period.  Union National’s common equity position at June
30, 2009 exceeds the current regulatory required minimums as disclosed on page
35 (also, seeNote 9 – Memorandum of
Understandingon page 12).





Results of Operations for
the Three Months Ended June 30, 2009 and 2008





Overview


Union
National Financial Corporation reported net income of $105,000 or basic and
diluted earnings per share of $0.04 for the second quarter of 2009, as compared
to net income of $304,000 or basic and diluted earnings per share of $0.12 for
the same period in 2008.  Interest and fees on loans and leases for the
three months ended June 30, 2009 declined by 11% when compared to the same
period in 2008 as (i) outstanding loans decreased by $25 million from June 30,
2008 to June 30, 2009 due to weaker loan demand from creditworthy borrowers, and
(ii) many of the Corporation’s outstanding loans have variable rate structures
resulting in a reduced loan yield from the low market interest rates that have
persisted throughout 2009.  Additionally, fixed-income investment
yields on re-invested proceeds from investment maturities, prepayments, and
sales have significantly decreased in the current low interest rate
environment.  With the combination of reduced interest income on loans
and investments, while much of the Corporation’s borrowing costs were at fixed
interest rates, the Corporation’s net interest margin percentage declined to
2.65% for the second quarter 2009 as compared to 3.31% for the same period in
2008.


25


The net
interest margin of 2.65% for the second quarter of 2009 did increase slightly
from the net interest margin of 2.58% for the first quarter of 2009 as the
Corporation continued to take measures to reduce its cost of funds, including
prepaying $12 million of higher-cost long-term debt with the Federal Home Loan
Bank of Pittsburgh (FHLB).





Second
quarter 2009 operating results also reflected the impact of several non-routine
transactions, including $278,000 of other income from an insurance payment to
the Corporation in recovery of a fraud loss in 2008, $237,000 of non-interest
expense related to the FDIC’s special assessment on deposit-insured
institutions, $393,000 of non-interest expense related to FHLB debt prepayment
penalties, and $462,000 of other-than-temporary impairment (OTTI) charges
related to certain private-issuer investment securities.  The OTTI
charges in the second quarter of 2009 primarily related to a private-issuer
mortgage-backed security which was recently downgraded to below-investment-grade
status.





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.





Net
interest income as adjusted for tax-exempt financial instruments was $3,128,000
for the three months ended June 30, 2009, as compared to $3,341,000 for the
three months ended June 30, 2008.  The reduction in net interest
income was the result of net interest margin compression from significant
interest rate reductions in 2008 as well as a decrease in the loan and lease
portfolio.  Union National’s interest rates on loans re-priced lower
and more quickly than retail interest-bearing deposits, while the Corporation’s
debt was at a fixed rate of interest, resulting in a lower net interest margin
for the second quarter of 2009 versus 2008.  The taxable-equivalent
net interest margin for the second quarter of 2009 was 2.65% as compared to
3.31% for the same period in 2008.  The yield on interest-earning
assets decreased by 110 basis points to 5.15% for the second quarter of 2009, as
compared to 6.25% for second quarter of 2008.  The interest rate paid
on average interest-bearing liabilities decreased by 55 basis points to 2.76%
for the second quarter of 2009, as compared to 3.31% for the second quarter of
2008.





Interest
and fees on loans and leases on a taxable-equivalent basis decreased by $669,000
to $5,538,000 for the three months ended June 30, 2009, as compared to
$6,207,000 for the same period in 2008.  The decrease in interest and
fees on loans and leases resulted from a decrease in the average yield of 38
basis points due to interest rate cuts during 2008, and a decrease of
$19,329,000 in the average balance of the loan and lease
portfolio.  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
yield on loans and leases for the second quarter of 2009 was 6.35% as compared
to 6.73% for the same period in 2008.





Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $311,000 to $473,000 for the three months ended June 30, 2009, as
compared to $784,000 for the same period in 2008.  A decrease in the
average yield of 174 basis points due to both market rate reductions and
generally lower risk investments, coupled with a $2,438,000 decrease in the
average balance of investment securities, resulted in less interest earned on
investment securities in comparison to the same period in 2008.  The
yield on investment securities for the second quarter of 2009 was 2.91% as
compared to 4.65% for the same period in 2008.





Interest
expense on deposits decreased by $142,000 to $2,216,000 for the three months
ended June 30, 2009, as compared to $2,358,000 for the same period in
2008.  A decrease in average rate of 46 basis points due to interest
rate cuts in the past year more than offset additional interest expense from a
$38,866,000 increase in the average balance of deposits. Union National’s
average rate on interest-bearing deposits was 2.40% for the three months ended
June 30, 2009 as compared to 2.86% for the same period in 2008.


26


Interest
expense on long-term debt was $516,000 for the three months ended June 30, 2009,
as compared to $713,000 for the same period in 2008.  In 2008 and
2009, Union National continued with certain cost-reducing de-leveraging
activities by using funds from low-interest earning assets and low-interest cost
short-term borrowings to pay down $30,482,000 of higher interest cost long-term
debt.  This resulted in a $15,207,000 decrease in the average balance
of long-term debt for the second quarter of 2009 versus the same period in
2008.  The average rate on long-term debt was 5.06% for the three
months ended June 30, 2009 as compared to 5.10% for the same period in
2008.





Provision
for Credit Losses


The provision for credit losses is an
estimated expense charged to earnings to provide for losses attributable to
uncollectible loans and leases.  The provision is based on our
analysis of the adequacy of the allowance for credit losses.  The
provision for credit losses was $611,000 for the three months ended June 30,
2009, as compared to $139,000 for the same period in 2008.  The
increased provision for the three months ended June 30, 2009 as compared to the
same period in 2008 was the result of loans charged-off during the second
quarter of 2009 andthe
increased credit risk related to additional substandard rated credits at June
30, 2009 as compared to
December 31, 2008 (See discussion onSubstandard Loans
and Leaseson page
24).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(See additional discussion
onLoans and Leases, Credit Quality and Credit Riskin theFinancial
Conditionsection of this
Management Discussion and Analysis).





Non-Interest
Income


For the
three months ended June 30, 2009, non-interest income increased by $804,000 or
65% as compared to the same period in 2008.  The increase was a result
of net increases (decreases) in the following components of non-interest income
(in thousands):





Three Months Ended
                      June 30,Non-Interest Income
                    
                    2009
      vs. 2008Income
      from Fiduciary Activities
                    
                    $
                    (31
                    )Service
      Charges on Deposit Accounts
                    
                    
                    47Other
      Service Charges, Commissions, and Fees
                    
                    
                    22Alternative
      Investment Sales Commissions
                    
                    
                    (16
                    )Net
      Investment Securities Gains
                    
                    
                    511Mortgage
      Banking/Brokerage Activities
                    
                    
                    18Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (4
                    )Other
      Income
                    
                    
                    257Total
      Increase in Non-Interest Income
                    
                    $
                    804





A
significant portion of the increase in non-interest income was related to net
investment securities gains.  Union National realized gains on the
sale of investment securities of $983,000 for the second quarter of 2009 as
compared to $10,000 for the same period in 2008.  These investment
sales activities related to continued repositioning of the investment portfolio
to a lower-risk profile that more effectively supports liquidity, capital, and
interest rate risk management, while providing realized gains to offset the
impact of investment impairment charges.  Other-than-temporary
investment impairment charges of $462,000 were recognized during the second
quarter of 2009, primarily related to a non-agency MBS investment security that
were downgraded to below investment grade. There were no impairment charges on
investment securities in the second quarter of 2008.





The
increase in other income was the result of a $278,000 insurance settlement
against losses from loans which were fraudulently or otherwise improperly made
by one former employee.  The settlement provided for substantial
reimbursement of a one-time charge of $370,000 which was recorded and previously
disclosed in 2008 related to the irregular
activity.


27


Non-Interest
Expense


For the
second quarter of 2009, non-interest expense increased by $50,000 or 1% as
compared to the same period in 2008.  Increases (decreases) in the
components of non-interest expense when comparing the three month periods ended
June 30, 2009 and 2008 are as follows (in thousands):





Three Months Ended
                      June 30,Non-Interest Expense
                    
                    2009
      vs. 2008Salaries,
      Wages and Employee Benefits
                    
                    $
                    (218
                    )Net
      Occupancy
                    
                    
                    15Furniture
      and Equipment
                    
                    
                    11Professional
      Fees and Regulatory Assessments
                    
                    
                    (16
                    )Data
      and ATM Processing
                    
                    
                    41Pennsylvania
      Shares Tax
                    
                    
                    14Advertising
      and Marketing
                    
                    
                    (90
                    )Supplies
      and Postage
                    
                    
                    (9
                    )FDIC
      Insurance
                    
                    
                    429Other
      Expense
                    
                    
                    (127
                    )Total
      Increase in Non-Interest Expense
                    
                    $
                    50





Union
National has focused on lowering core operating costs and creating efficiencies
in a difficult market when income growth is challenging.  We continue
to explore cost cutting initiatives.  The discussion that follows
explains the changes in the components of non-interest expense when comparing
the three months ended June 30, 2009 to the same period in 2008.





Salaries,
wages and employee benefits decreased by $218,000 for the three months ended
June 30, 2009 as compared to the same period in 2008.  The decrease
was related to positions that were eliminated in the fourth quarter of 2008 and
the first quarter of 2009, savings in health care costs, and savings from the
elimination of the Corporation’s 401-K match during the second quarter of
2009.





The
increase in FDIC insurance premiums is the direct result of increased assessment
rates, as determined by the FDIC.  The FDIC Board also adopted an
interim rule imposing an emergency special assessment on the industry on June
30, 2009.  For Union National, the emergency special assessment
amounted to $237,000 and is to be collected on September 30,
2009.  The interim rule would also permit the FDIC Board to impose a
similar emergency special assessment after June 30, 2009, if necessary, to
maintain public confidence in federal deposit insurance (see related discussion
titled Federal Deposit Insurance Corporation (“FDIC”) Activity on page
37).  Due to recent changes and assessments by the FDIC, Union
National expects FDIC insurance assessments to be $1,386,000 for the entire
year, representing a 243% increase over the entire year of 2008.





Other
expenses for the three months ended June 30, 2009 included losses related to
prepayment penalties on FHLB advances of $393,000.  For the three
months ended June 30, 2008, other expense included (i) a loss of $370,000
related to certain fraudulent loans made by one employee who has been since
terminated, (ii) $68,000 incurred for FHLB debt prepayment penalties, and (iii)
$33,000 of other expenses paid for coffee in the Bank’s gold café
branches.





Income
Taxes


For the
three months ended June 30, 2009, Union National recorded an income tax benefit
of $106,000, which primarily resulted from tax-exempt earnings, as compared to
income tax expense of $52,000 for the same period in 2008, which, also resulted
from primarily tax-exempt earnings.  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 on
future earnings.   We currently anticipate that future earnings
will be adequate to fully utilize deferred tax assets.





Results of Operations for
the Six Months Ended June 30, 2009 and 2008





Overview


Union
National Financial Corporation reported a net loss for the first six months of
2009 of ($404,000) or a ($0.15) basic and diluted loss per share, compared to
net income for the first six months of 2008 of $717,000 or $0.28 basic and
diluted earnings per share.  Interest and fees on loans and leases for
the first six months of 2009 declined by 13% when compared to the same period in
2008 as (i) outstanding loans decreased by $25 million from June 30, 2008 to
June 30, 2009 due to weaker loan demand from creditworthy borrowers, and (ii)
many of the Corporation’s outstanding loans have variable rate structures
resulting in a reduced loan yield from the low market interest rates that have
persisted throughout 2009.


28


Additionally,
fixed-income investment yields on re-invested proceeds from investment
maturities, prepayments, and sales have significantly decreased in the current
low interest rate environment.  With the combination of reduced
interest income on loans and investments, while much of the Corporation’s
borrowing costs were at fixed interest rates, the Corporation’s net interest
margin percentage declined to 2.61% for the first six months of 2009 as compared
to 3.18% for the first six months of 2008.  The discussion that
follows further explains the changes in the components of the operating results
when comparing the six months ended June 30, 2009 to the same period in
2008.





Net
Interest Income


Net
interest income as adjusted for tax-exempt financial instruments was $6,053,000
for the six months ended June 30, 2009, as compared to $7,247,000 for the six
months ended June 30, 2008.  The reduction in net interest income was
the result of net interest margin compression from significant interest rate
reductions in 2008.  Union National’s interest rates on loans
re-priced lower and more quickly than retail interest-bearing deposits, while
the Corporation’s debt was at a fixed rate of interest, resulting in a lower net
interest margin in 2009 versus 2008 as well as a decrease in the loan and lease
portfolio.  The taxable-equivalent net interest margin for the six
months ended June 30, 2009, was 2.61% as compared to 3.18% for the same period
in 2008.  The yield on interest-earning assets decreased by 111 basis
points to 5.26% for the six months ended June 30, 2009, as compared to 6.37% for
the same period in 2008.  The interest rate paid on average
interest-bearing liabilities decreased by 64 basis points to 2.91% for the six
months ended June 30, 2009, as compared to 3.55% for the same period in
2008.





Interest
and fees on loans and leases on a taxable-equivalent basis decreased by
$1,663,000 to $10,965,000 for the six months ended June 30, 2009, as compared to
$12,628,000 for the same period in 2008.  The decrease in interest and
fees on loans and leases resulted from a decrease in the average yield of 61
basis points due to interest rate cuts during 2008, and a decrease of
$14,438,000 in the average balance of the loan and lease
portfolio.  The yield on loans and leases for the six months ended
June 30, 2009, was 6.27% as compared to 6.88% for the same period in
2008.





Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $471,000 to $1,101,000 for the six months ended June 30, 2009, as
compared to $1,572,000 for the same period in 2008.  A decrease in the
average yield of 128 basis points due to both market rate reductions and
generally lower risk investments, coupled with a $1,524,000 decrease in the
average balance of investment securities, resulted in less interest earned on
investments in comparison to the same period in 2008.  The yield on
investment securities for the first six months of 2009 was 3.35% as compared to
4.63% for the same period in 2008.





Interest
expense on deposits decreased by $636,000 to $4,518,000 for the six months ended
June 30, 2009, as compared to $5,154,000 for the same period in
2008.  A decrease in average rate of 60 basis points due to interest
rate cuts in the past year more than offset additional interest expense from a
$30,198,000 increase in average deposit balances. Union National’s average rate
on interest-bearing deposits was 2.53% for the six months ended June 30, 2009 as
compared to 3.13% for the same period in 2008.





Interest
expense on long-term debt was $1,161,000 for the six months ended June 30, 2009,
as compared to $1,459,000 for the same period in 2008.  In 2008 and
2009, Union National continued with certain cost-reducing de-leveraging
activities by using funds from low-interest earning assets and low-interest cost
short-term borrowings to pay down $30,482,000 of higher interest cost long-term
debt.  This resulted in a $12,374,000 decrease in the average balance
of long-term debt for the six months ended June 30, 2009 versus the same period
in 2008.  The average rate on long-term debt was 5.14% for the six
months ended June 30, 2009 as compared to 5.05% for the same period in
2008.





Provision
for Credit Losses


The provision for credit losses is an
estimated expense charged to earnings to provide for losses attributable to
uncollectible loans and leases.  The provision is based on our
analysis of the adequacy of the allowance for credit losses.  The
provision for credit losses was $924,000 for the six months ended June 30, 2009,
as compared to $279,000 for the same period in 2008.  The increased
provision for the six months ended June 30, 2009 as compared to the same period
in 2008 was the result of loans charged-off during the second quarter of 2009
andthe increased credit
risk related to additional substandard rated credits at June 30,2009 as compared to December 31, 2008
(See discussion onSubstandard Loans
and Leaseson page
24).Union National 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(See additional discussion
onLoans and Leases, Credit Quality and Credit Riskin theFinancial
Conditionsection of
thisManagement Discussion and
Analysis).


29


Non-Interest
Income


Non-interest
income was $2,657,000 for the six months ended June 30, 2009, as compared to
$2,646,000 for the same period in 2008.  The increase was a
result of net increases (decreases) in the following components of non-interest
income (in thousands):





Six Months Ended
                      June 30,Non-Interest Income
                    
                    2009 vs. 2008Income from Fiduciary Activities
                    
                    $
                    (65
                    )Service
      Charges on Deposit Accounts
                    
                    
                    67Other
      Service Charges, Commissions, and Fees
                    
                    
                    30Alternative
      Investment Sales Commissions
                    
                    
                    (104
                    )Net
      Investment Securities Gains
                    
                    
                    1,193Impairment
      Charge on Investment Securities
                    
                    
                    (1,301
                    )Mortgage
      Banking/Brokerage Activities
                    
                    
                    32Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (3
                    )Other
      Income
                    
                    
                    162Total
      Increase in Non-Interest Income
                    
                    $
                    11





The
decrease in alternative investment sales commissions was primarily the result of
a turbulent investment market and a weak economy, which has impacted growth and
sales opportunities for Union National.





Union
National realized gains on the sale of investment securities of $1,394,000 for
the six months ended June 30, 2009 as compared to $201,000 for the same period
in 2008.  These investment sales activities related to continued
repositioning of the investment portfolio to a lower-risk profile that more
effectively supports liquidity, capital, and interest rate risk management,
while providing realized gains to offset the impact of investment impairment
charges.  Other-than-temporary investment impairment charges of
$1,301,000 were recognized during the six months ended June 30, 2009, related to
investment securities that were downgraded to below investment
grade.  There were no impairment charges on investment securities
during the same period in 2008.





The OTTI
charges in the second quarter of 2009 primarily related to a private-issuer
mortgage-backed security which was recently downgraded to below-investment-grade
status.  The $839,000 of OTTI charges in the first quarter of 2009
related to three pooled trust-preferred debt securities that were downgraded to
below-investment-grade in 2009.  The total impairment charges for the
first six months of 2009 of $1,301,000 were more than offset by realized net
gains on the sale of investment securities of $1,394,000 for the first six
months of 2009, with $983,000 of investment gains being realized in the second
quarter primarily from sales of fully guaranteed U.S. Government mortgage-backed
securities.





The
increase in other income was the result of a $278,000 insurance settlement
against losses from loans which were fraudulently or otherwise improperly made
by one former employee.  The settlement provided for substantial
reimbursement of a one-time charge of $370,000 which was recorded and previously
disclosed in 2008 related to the irregular activity.  This was offset
by $96,000 of income generated from a cash bailment agreement on a network of
ATM machines in 2008.  This agreement was terminated during the first
quarter of 2008 and previously provided transaction fee
income.  Accordingly, operating results for the six months ended June
30, 2009, does not reflect any income generated from this agreement, whereas,
the operating results for the six months ended June 30, 2008, reflected income
for only the first quarter of 2008.


30


Non-Interest
Expense


For the
six months ended June 30, 2009, non-interest expense decreased by $122,000 or 1%
as compared to the same period in 2008.  Increases (decreases) in the
components of non-interest expense when comparing the six months ended June 30,
2009 and 2008 are as follows (in thousands):





Six Months Ended
                      June 30,Non-Interest Expense
                    
                    2009 vs. 2008Salaries, Wages and Employee Benefits
                    
                    $
                    (191
                    )Net
      Occupancy
                    
                    
                    (59
                    )Furniture
      and Equipment
                    
                    
                    10Professional
      Fees and Regulatory Assessments
                    
                    
                    (67
                    )Data
      and ATM Processing
                    
                    
                    10Pennsylvania
      Shares Tax
                    
                    
                    3Advertising
      and Marketing
                    
                    
                    (70
                    )Supplies
      and Postage
                    
                    
                    (72
                    )FDIC
      Insurance
                    
                    
                    474Other
      Expense
                    
                    
                    (160
                    )Total
      Decrease in Non-Interest Expense
                    
                    $
                    (122
                    )





Union
National has focused on lowering core operating costs and creating efficiencies
in a difficult market when income growth is challenging.  We continue
to explore cost cutting initiatives.  The discussion that follows
explains the changes in the components of non-interest expense when comparing
the six months ended June 30, 2009 to the same period in 2008.





Salaries,
wages and employee benefits decreased by $191,000 for the six months ended June
30, 2009 as compared to the same period in 2008.  The decrease was
related to positions that were eliminated in the fourth quarter of 2008, savings
in health care costs, and savings from the elimination of the Corporation’s
401-K match during the second quarter of 2009.





Most of
the decrease in professional fees and regulatory assessments was primarily
related to the operating results for 2008 including consulting fees paid to a
third party.  Subsequent to the first quarter of 2008, the third party
was hired by Union National. The corresponding expense was included in salaries,
wages and employee benefits for the full six months of 2009, however, the
expense was charged to professional fees and regulatory assessments for part of
2008.





Most of
the decrease in supplies and postage expense was primarily due to a physical
inventory adjustment made in 2008.  The expense was recognized for the
six months ended June 30, 2008, however, there were no significant adjustments
made to inventory for the same period in 2009.





The
increase in FDIC insurance premiums is the direct result of increased assessment
rates, as determined by the FDIC.  The FDIC Board also adopted an
interim rule imposing an emergency special assessment on the industry on June
30, 2009.  For Union National, the emergency special assessment
amounted to $237,000 and is to be collected on September 30,
2009.  The interim rule would also permit the FDIC Board to impose
another similar emergency special assessment after June 30, 2009, if necessary
to maintain public confidence in federal deposit insurance (see related
discussion titled Federal Deposit Insurance Corporation (“FDIC”) Activity on
page 37).  Due to recent changes and assessments by the FDIC, Union
National expects FDIC insurance assessments to be $1,386,000 for the entire
year, representing a 243% increase over the entire year of 2008.





Other
expense decreased by $160,000 for the six months ended June 30, 2009, as
compared to the same period in 2008.  The decease was mostly related
to a decrease in employee related expenses such as training, travel, seminars,
and staff recruitment and a decrease in the expense paid for coffee in the
Bank’s gold café branches.  Other expense for the six months ended
June 30, 2009 and 2008, included losses related to prepayment penalties on FHLB
advances of $393,000 and $68,000, respectively.  Additionally, the six
months ended June 30, 2008, included a loss of $370,000 related to certain
fraudulent loans made by one employee who has been since
terminated.





In 2009,
the Bank continued with certain cost-reducing de-leveraging activities by using
funds from low-interest earning assets and low-interest cost short-term
borrowings to pay down higher interest cost long-term debt.  During
the second quarter of 2009, the Bank prepaid $12,000,000 of FHLB advances which
had a fixed weighted average interest cost 5.67%.  In conjunction with
the prepayments, the Bank incurred $393,000 of prepayment
penalties.


31


For the
six months ended June 30, 2008, Union National prepaid $17,482,000 of FHLB
advances, reducing total long-term debt to $51,334,000.  In
conjunction with the prepayments, the Bank incurred $68,000 of prepayment
penalties, which were included in other non-interest
expense.  Additionally, the Bank terminated and repaid its remaining
short-term borrowing agreements without penalty and called $9,809,000 of
brokered CD’s.  The Bank had the option to call an additional
$6,602,000 of brokered CD’s in July 2008 (and subsequently exercised the option
and called the CD’s in July 2008).  The $9,808,000 of brokered CD’s
called through June 30, 2008 had a fixed weighted average interest cost of
4.66%, and the $6,602,000 of brokered CD’s subsequently called in July 2008 had
a fixed weighted average interest cost of 5.27%.





Income
Taxes


For the
six months ended June 30, 2009, Union National recorded an income tax benefit of
$434,000, which primarily resulted from a pre-tax loss, as compared to recording
an income tax expense of $159,000 for the same period in
2008.  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 on future earnings.   We
currently anticipate that future earnings will be adequate to fully utilize
deferred tax assets.





Recent
Developments





The
global and U.S. economies are experiencing significantly reduced business
activity as a result of, among other factors, disruptions in the financial
system during the past year. Dramatic declines in the housing market during the
past year, with falling home prices and increasing foreclosures and
unemployment, have resulted in significant write-downs of asset values by
financial institutions, including government-sponsored entities and major
commercial and investment banks. These write-downs have caused many financial
institutions to seek additional capital or to merge with larger or stronger
institutions.





Reflecting
concern about the volatility in the financial markets generally and concerns
about counterparties, many lenders and institutional investors have reduced, and
in some cases, ceased to provide funding to borrowers, including other financial
institutions. The availability of credit, confidence in the financial sector,
and stability in the financial markets have been significantly adversely
affected as a result. In recent months, volatility and disruption in the capital
and credit markets has reached unprecedented levels. In some cases, the markets
have produced downward pressure on stock prices and credit capacity for certain
issuers without regard to those issuers’ underlying financial
strength.





In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, on October 3, 2008, the Emergency Economic Stabilization Act of
2008 (the “EESA”) was signed into law. Pursuant to the EESA, the U.S. Treasury
will have the authority to, among other things, purchase up to $700 billion of
mortgages, mortgage-backed securities and certain other financial instruments
from financial institutions for the purpose of stabilizing and providing
liquidity to the U.S. financial markets.  The EESA included a
provision for a temporary increase in FDIC insurance from $100,000 to $250,000
per depositor through December 31, 2013.





The FDIC
has also established a program under which all non-interest-bearing accounts at
FDIC insured institutions (including Union National) will be fully insured,
regardless of dollar amount, until December 31, 2009, unless an eligible
institution formally opts out of this program.  Under the terms of the
program, a 10 basis point surcharge will be applied to the balances of
non-interest-bearing deposit accounts not otherwise covered by the increased
deposit insurance limit of $250,000.  The surcharge will be added to
the participating bank’s existing risk-based deposit insurance premium paid on
those deposits.  Union National has opted to participate in this
program to ensure its current and prospective deposit customers are provided the
maximum amount of insurance coverage provided by the FDIC.





Pursuant
to his authority under EESA, the Secretary of the Treasury has created the TARP
Capital Purchase Plan (“CPP”) under which the Treasury Department may invest up
to $250 billion in senior preferred stock of U.S. banks and savings associations
or their holding companies.  In connection with the program, Union
National chose not to participate in the TARP CCP and did not file an
application.





Also on
October 14, 2008, after receiving a recommendation from the boards of the FDIC
and the Federal Reserve, and consulting with the President, Secretary Paulson
signed the systemic risk exception to the FDIC Act, enabling the FDIC to
temporarily provide a 100% guarantee of the senior debt of all FDIC-insured
institutions and their holding companies, as well as deposits in non-interest
bearing transaction deposit accounts under a Temporary Liquidity Guarantee
Program. Coverage under the Temporary Liquidity Guarantee Program was available
until November 12, 2008 without charge and thereafter at a cost of 75 basis
points per annum for senior unsecured debt and 10 basis points per annum for
non-interest bearing transaction deposits.




32


It is not
clear at this time what if any additional programs that may be initiated in the
future, will have on the financial markets and the other difficulties described
above, including the extreme levels of volatility and limited credit
availability in the U.S. banking and financial industries and the broader U.S.
and global economies. Further adverse effects could have an increasingly
negative impact on Union National and its business.





Outlook for
2009





We expect
the second half of 2009 to reflect more of the same issues as we experienced
through 2008 and the first half of 2009, with the distinct possibility of a
continuing weak economy, volatility in investment markets, and unfavorable
interest income growth prospects.  We continue to take the necessary,
conservative measures to ensure Union National maintains its safe and sound
position, including strengthening our liquidity and capital positions, managing
increasing risks, and operating prudently.  We have continued to lower
our core operating costs, allowing us to be more efficient in a difficult market
when income growth is challenging, and continue to explore revenue generation,
cost cutting initiatives, and capital enhancement methods and
alternatives.





Though
the significant interest rate cuts through 2008 lowered our interest income and
yields on loans, we generated savings in our funding costs by growing our
lower-cost retail deposit base and paying down higher-cost
borrowings.  We believed it prudent for Union National to fully
maintain its strong, well-capitalized position in these uncertain economic
times, so we made the difficult decision to not pay dividends to shareholders
throughout 2008, and did not declare a dividend to be paid in the first and
second quarters of 2009.


33


The weak
economy and housing market, and increased unemployment both nationally and
locally, will likely create cash flow difficulties and collateral de-valuation
for some of Union National’s borrowers, resulting in increased nonperforming
loans and possible increased loan and lease losses.  We continue to
closely monitor our portfolio, and the underlying borrower financial performance
and collateral values.





As we
continue in this difficult economy when growth is challenging and must be
managed conservatively, Union National remains committed to maintaining the
safety, soundness, and strength of our institution for our customers, while
improving earnings and enhancing our Corporation’s value for our
stockholders.





Capital
Adequacy





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 (set forth below)
of Tier 1 capital to average assets and of total capital (as defined in the
regulations) to risk-weighted assets.




As of
June 30, 2009 and December 31, 2008, Union National and the Bank exceeded the
current regulatory requirements to be considered a “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 requirements, Union National established target capital
ratios in response to the MOU as discussed in Note 9 to the unaudited
consolidated financial statements.  The targets established for the
Bank were 8% for Tier I Capital to Average Total Assets, 9% for Tier I Capital
to Risk-Based Assets, and 12% for Total Capital to Risk-Based
Assets.  As of June 30, 2009, the Bank’s measure of Tier I Capital to
Average Total Assets was 7.96% and slightly below the 8% target rate established
in response to the MOU.  The Bank’s measures of Tier I Capital to
Risk-Based Assets of 9.82% and Total Capital to Risk-Based Assets of 12.34% both
exceeded the respective 9% and 12% target rates established by the Corporation
in response to the MOU.


34


Union
National and the Bank’s regulatory capital levels as of June 30, 2009, and
December 31, 2008 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
                    
                    
                    Amount
                    
                    
                    RatioUnion National Financial
      CorporationJune
      30, 2009:Tier 1 (leverage)
      capital
                    
                    $
                    40,800
                    
                    
                    
                    8.09
                    %
                    
                    $
                    20,167
                    
                    
                    
                    4.00
                    %
                    
                    
                    N/A
                    
                    
                    
                    N/ATier 1 risk-based
      capital
                    
                    
                    40,800
                    
                    
                    
                    9.89
                    
                    
                    
                    16,510
                    
                    
                    
                    4.00
                    
                    
                    
                    N/A
                    
                    
                    
                    N/ATotal risk-based
      capital
                    
                    
                    51,965
                    
                    
                    
                    12.59
                    
                    
                    
                    33,020
                    
                    
                    
                    8.00
                    
                    
                    
                    N/A
                    
                    
                    
                    N/ADecember
      31, 2008:Tier 1 (leverage)
      capital
                    
                    $
                    40,982
                    
                    
                    
                    8.44
                    %
                    
                    $
                    19,414
                    
                    
                    
                    4.00
                    %
                    
                    
                    N/A
                    
                    
                    
                    N/ATier 1 risk-based
      capital
                    
                    
                    40,982
                    
                    
                    
                    10.03
                    
                    
                    
                    16,340
                    
                    
                    
                    4.00
                    
                    
                    
                    N/A
                    
                    
                    
                    N/ATotal risk-based
      capital
                    
                    
                    52,092
                    
                    
                    
                    12.75
                    
                    
                    
                    32,680
                    
                    
                    
                    8.00
                    
                    
                    
                    N/A
                    
                    
                    
                    N/AUnion National Community
    BankJune
      30, 2009:Tier 1 (leverage)
      capital
                    
                    $
                    40,426
                    
                    
                    
                    7.96
                    %
                    
                    $
                    20,325
                    
                    
                    
                    4.00
                    %
                    
                    $
                    25,406
                    
                    
                    
                    5.00
                    %Tier 1 risk-based
      capital
                    
                    
                    40,426
                    
                    
                    
                    9.82
                    
                    
                    
                    16,470
                    
                    
                    
                    4.00
                    
                    
                    
                    24,705
                    
                    
                    
                    6.00Total risk-based
      capital
                    
                    
                    50,790
                    
                    
                    
                    12.34
                    
                    
                    
                    32,940
                    
                    
                    
                    8.00
                    
                    
                    
                    41,175
                    
                    
                    
                    10.00December
      31, 2008:Tier 1 (leverage)
      capital
                    
                    $
                    40,601
                    
                    
                    
                    8.41
                    %
                    
                    $
                    19,306
                    
                    
                    
                    4.00
                    %
                    
                    $
                    24,133
                    
                    
                    
                    5.00
                    %Tier 1 risk-based
      capital
                    
                    
                    40,601
                    
                    
                    
                    9.97
                    
                    
                    
                    16,292
                    
                    
                    
                    4.00
                    
                    
                    
                    24,438
                    
                    
                    
                    6.00Total risk-based
      capital
                    
                    
                    50,959
                    
                    
                    
                    12.51
                    
                    
                    
                    32,584
                    
                    
                    
                    8.00
                    
                    
                    
                    40,731
                    
                    
                    
                    10.00





Additionally,
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, 2009, this limitation
amounted to approximately $5,079,000. These regulations also require that any
such investment, loan, extension of credit or advance be  secured by
securities having a market value in excess of the amount thereof.





Included
in Tier 1 regulatory capital of Union National is $10,201,000 of trust
capital securities issued through Union National Capital Trust I and Union
National Capital Trust II, wholly-owned subsidiaries of Union
National.  The balance of the trust capital securities, $799,000, is
included in Tier II regulatory capital of Union National Financial Corporation
above.  Additionally, included in Tier II regulatory capital of the
Bank and Union National Financial Corporation 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 alternatives as the regulatory
capital environment changes, and if regulatory capital requirements are
changed.





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 on various credit lines, and borrowing
      capacity available from the FHLB and the Federal Reserve
    Bank.


35


We
believe that our core deposits are fairly stable even in periods of changing
interest rates like we are currently experiencing.  Liquidity and
funds management is governed by policies and measured on a monthly
basis.  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.





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 $110,735,000 at June 30, 2009 as compared to
$109,907,000 at December 31, 2008. Total standby letters of credit amounted to
$5,064,000 at June 30, 2009 as compared to $5,474,000 at December 31,
2008.





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.  There has been no material change in contracts for services
since this contract was renegotiated in January 2007 through June 30,
2009.





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 (See the related discussion of the Emergency Economic
Stabilization Act of 2008 in the preceding Recent Developments
section).  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.





Memorandum of Understanding
(“MOU”).  On June 20, 2007, the Bank entered into an MOU with
the OCC.  Specifically, the MOU requires the Bank to (1) implement a
three-year strategic plan in accordance with specific guidelines set forth in
the MOU, (2) develop and implement a three-year capital plan, in accordance with
specific guidelines set forth in the MOU, including a dividend policy for the
payment of dividends provided the Bank is in compliance with the capital plan,
and applicable laws and regulations, (3) review and revise a written program to
improve the Bank’s loan portfolio management, (4) review and revise the Bank’s
funds management reports to ensure that they reflect current and projected
funding needs, (5) develop and implement a risk-based audit program to determine
weaknesses or deficiencies in the Bank’s consumer compliance program, (6) ensure
the Bank’s interest rate risk ("IRR") measurement tool or model conforms to OCC
guidelines and, if necessary, develop an action plan to address the need for a
more acceptable IRR measurement model, and (7) furnish written quarterly
progress reports to the OCC detailing the form and manner of actions taken to
comply with the MOU.  Each provision of the MOU is subject to OCC
approval, non-objection and/or review.





Through
June 30, 2009, management has sent to the OCC the documentation and progress
reports as required under the MOU,and managementbelieves that the Bank
has made measurable progress in addressing the issues identified in the
MOU.  However, as of June 30, 2009, the Bank’s measure of Tier I
Capital to Average Total Assets was 7.96% and slightly below the 8% target rate
established in response to the MOU.  The Bank’s measures of Tier I
Capital to Risk-Based Assets of 9.82% and Total Capital to Risk-Based Assets of
12.34% both exceeded the respective 9% and 12% target rates established by the
Corporation in response to the MOU.  We believe that the MOU will not
constrain our current business model except to the extent that complying with
capital targets may require additional capital infusions or limit the growth of
total assets until capital levels increase accordingly.  The MOU has
impacted our operating results by increasing our FDIC base insurance
premiums.  Based upon deposit levels and the FDIC base insurance
premium assessment criteria as of June 30, 2009, we estimate the additional FDIC
premiums to be paid by the Corporation as a result of the MOU to be $231,000 in
2009.  Management and the Board of Directors are committed to
addressing and resolving the issues identified in the MOU.


36


The Sarbanes-Oxley
Act.  The Sarbanes-Oxley Act, enacted in July 2002, represents
a comprehensive revision of laws affecting corporate governance, accounting
obligations and corporate reporting.  Many of the provisions of this
act had already been implemented by Union National, and Union National has
complied with the provisions of Section 404 of the Sarbanes-Oxley Act as
required during 2008, including providing a report on our internal control over
financial reporting as of December 31, 2008.  To support our report on
the internal control over financial reporting, we used contracted, independent
internal audit services to identify, document and test key controls over the
financial reporting process.  In 2009, we expect to incur additional
external audit costs associated with complying with the provisions of
Sarbanes-Oxley requiring a report by the independent external auditors on the
effectiveness of internal control over financial reporting.  We expect
the additional costs associated with this requirement to be $30,000 pretax for
the year-ended December 31, 2009.





Federal Deposit Insurance
Corporation (“FDIC”) Activity.  The Federal Deposit Insurance
Reform Act of 2005 (“the Act”) amended regulations to create a new risk
differentiation system, to establish a new base assessment rate schedule, and to
set assessment rates effective January 1, 2007.  Also, eligible
insured depository institutions shared in a one-time assessment credit, which
was approximately $228,000 for the Bank.  The Bank used $150,000 of
this credit for the year ended December 31, 2007, and the remaining $78,000 for
the six months ended June 30, 2008.





On
February 27, 2009, The Board of Directors of the FDIC voted to amend the
restoration plan for the Deposit Insurance Fund (“DIF”). The FDIC Board also
took action to ensure the continued strength of the insurance fund by imposing a
special assessment on insured institutions of 20 basis points, implementing
changes to the risk-based assessment system, and setting rates beginning the
second quarter of 2009.   Under the restoration plan approved in
October 2008, the FDIC Board set a rate schedule to raise the DIF reserve ratio
to 1.15 percent within five years. The February 27, 2009 restoration plan
amendment action extends the restoration plan horizon to seven years in
recognition of the current significant strains on banks and the financial system
and the likelihood of a severe recession.  The amended restoration
plan was accompanied by a final rule that sets assessment rates and makes
adjustments that improve how the assessment system differentiates for risk.
Currently, most banks are in the best risk category and pay anywhere from 12
cents per $100 of deposits to 14 cents per $100 for insurance. Under the final
rule, banks in this category will pay initial base rates ranging from 12 cents
per $100 to 16 cents per $100 on an annual basis, beginning on April 1,
2009.  Changes to the assessment system include higher rates for
institutions that rely significantly on secured liabilities, which may increase
the FDIC’s loss in the event of failure without providing additional assessment
revenue. Under the final rule, assessments will be higher for institutions that
rely significantly on brokered deposits but, for well-managed and
well-capitalized institutions, only when accompanied by rapid asset growth.
Brokered deposits combined with rapid asset growth have played a role in a
number of costly failures, including recent failures. The final rule also would
provide incentives in the form of a reduction in assessment rates for
institutions to hold long-term unsecured debt and, for smaller institutions,
high levels of Tier 1 capital.





The FDIC
Board adopted an interim rule imposing an emergency special assessment on the
industry on June 30, 2009. The new FDIC emergency premium, to be collected from
all federally-insured institutions, will be 5 cents for every $100 of the Bank’s
assets minus its Tier 1, or regulatory capital, as of June 30,
2009.  The FDIC’s previous planned fee was 20 cents per $100 of the
Bank’s insured deposits.  For Union National, based upon the Bank’s
assets and Tier 1 capital position at June 30, 2009, the additional amount of
FDIC insurance expense related to this special assessment, was
$237,000.  The interim rule would also permit the FDIC Board to impose
a similar emergency special assessment after June 30, 2009, if necessary to
maintain public confidence in federal deposit insurance.





Community Reinvestment
Act.  The last Community Reinvestment Act performance
evaluation by the OCC resulted in a “satisfactory” rating of the Bank’s record
of meeting the credit needs of its entire community.





Pennsylvania Business
Corporation Law.  Union National is subject to restrictions on
the payment of dividends to its stockholders pursuant to the Pennsylvania
Business Corporation Law of 1988, as amended (the “BCL”).  The BCL operates
generally to preclude dividend payments if the effect thereof would render us
insolvent.  Our payment of dividends is contingent upon our ability to
obtain funding in the form of dividends from the Bank.  Payment of
dividends to Union National by the Bank is subject to the restrictions set forth
in the National Bank Act.  At December 31, 2008, the National Bank Act
would permit the Bank to declare dividends in 2009 of approximately $556,000,
plus an amount equal to the net profits of the Bank in 2009, up to the date of
any such dividend declaration.  At June 30, 2009, based on the Bank’s
year-to-date net loss, the Bank would be permitted to declare dividends in 2009
of $320,000.  Through June 30, 2009, the Bank paid $188,000 of
dividends to Union National in compliance with the regulatory restrictions,
which was used to pay holding company interest expense and operational
costs.


37


Item
3.  Quantitative and Qualitative Disclosures about Market
Risk





Market Risk - Interest Rate
Risk





As a
financial institution, our primary component of market risk is interest rate
volatility.  Fluctuations in interest rates will ultimately impact the
level of income and expense recorded on a large portion of our assets and
liabilities.  The nature of our current operations is such that we are
not subject to foreign currency exchange or commodity price risk.  We
do not own any trading assets.




The
objectives of interest rate risk management are to maintain or increase net
interest income over a broad range of market interest rate
movements.  The Asset and Liability Management Committee is
responsible for managing interest rate risk using policies approved by Union
National’s Board of Directors.  We manage interest rate risk by
changing the mix or repricing characteristics of our investment securities
portfolio and borrowings from the FHLB and by the promotion or development of
specific loan and deposit products.  We retain an outside consulting
group to assist in monitoring our interest rate risk using a net interest income
simulation model on a quarterly basis.  The simulation model measures
the sensitivity of future net interest income to hypothetical changes in market
interest rates.





In an
effort to assess market risk, we utilize a simulation model to determine the
effect of gradual increases or decreases in market interest rates on net
interest income and net income.  The aforementioned assumptions are
revised based on defined scenarios of assumed speed and direction changes of
market interest rates.  These assumptions are inherently uncertain due
to the timing, magnitude and frequency of rate changes and changes in market
conditions, as well as management strategies, among other factors. Because it is
difficult to accurately quantify into assumptions the reaction of depositors and
borrowers to market interest rate changes, the actual net interest income and
net income results may differ from simulated results.  While
assumptions are developed based upon current economic and local market
conditions, management cannot make any assurances as to the predictive nature of
these assumptions.





The
simulation model assumes a hypothetical gradual shift in market interest rates
over a twelve-month period.  This is based on a review of historical
changes in market interest rates and the level and curve of current interest
rates.  The simulated results represent the hypothetical effects to
our net interest income and net income.  Projections for loan and
deposit growth were ignored in the simulation model.  The simulation
model includes all of our earning assets and interest-bearing liabilities and
assumes a parallel and prorated shift in interest rates over a twelve-month
period.  The results of the simulation model could change
significantly if there was not a parallel shift in interest rates, therefore
causing a change in the assumed shape of the interest rate yield
curve.





The
simulation model currently indicates that a hypothetical two-percent general
decline in prevailing market interest rates over a one-year period would cause
the Bank's net interest income over the next twelve months to decrease
approximately 6.5% as compared to the constant rate scenario.  In
addition, a hypothetical two-percent general rise in rates would cause the
Bank's net interest income over the next twelve months to increase approximately
8.9%.  These computations do not contemplate any actions management or
the Asset Liability Management Committee could undertake in response to changes
in market conditions or market interest rates.





We are
managing our interest rate risk position in 2009 by the following:





·
            Managing
      and reducing the interest cost of the Bank’s core retail deposit base
      including deposits obtained in our commercial cash management programs,
      premium money market accounts, and retail time
  deposits;


·
            De-leveraging
      with repayment of higher-cost, fixed rate FHLB long-term debt and brokered
      CDs;


·
            Managing
      the use of adjustable- and floating-rate loans, and hybrid loans with
      initial fixed-rates  converting to variable-rates, in comparison
      to totally fixed-rate loans for new or refinanced commercial and
      agricultural loans;


·
            Repositioning
      of our investment security portfolio mix by purchasing lower-risk shorter
      term U.S. government agencies, and seasoned, shorter duration
      mortgage-back securities, to maintain liquidity and minimize significant
      changes in value due to declining interest rates;
  and





The above
strategies and actions impact interest rate risk and are all included in our
quarterly simulation models in order to determine future asset and liability
management strategies.


38


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, 2009, 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 since December 31, 2008 in our internal controls over financial
reporting that have materially affected, or are reasonable likely to materially
affect, these controls.





Item
4T.  Controls and Procedures





The
information set forth in Item 4 is incorporated herein by
reference.





PART II - OTHER
INFORMATION





Item
1.  Legal Proceedings





Management
is not aware of any litigation that would have a material adverse effect on the
consolidated financial position of Union National.  There are no
proceedings pending other than the ordinary routine litigation incident to the
business of Union National and its subsidiary, Union National Community
Bank.  The Bank has been under a Memorandum of Understanding with the
OCC since June 20, 2007, as discussed earlier in Note 9 to the financial
statements and on page 36 of this report.  Through June 30, 2009,
management has sent to the OCC the documentation and progress reports as
required under the MOU,and managementbelieves that the Bank
has made measurable progress in addressing the issues identified in the
MOU.  However, the Bank does not expect relief from stricter
regulatory supervision at this time.


39


Item
1A.  Risk Factors





For the
six months ended June 30, 2009, and through the date of this report, other than
those noted below, there have been no known material changes to the risk factors
described in our Annual Report on Form 10-K for the year ended December 31,
2008.





Possible
changes to capital requirements and potential difficulties raising
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.  Regulatory capital requirements may be
increased in the future.  Union National will closely monitor and
evaluate its capital alternatives as the regulatory capital environment changes,
and if regulatory capital requirements are changed.  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.  In
addition, if the Corporation decides to raise additional equity capital,
stockholders’ interests could be diluted.





Possible
changes to regulatory supervisory activities and actions.





As
disclosed inNote 9 ─
Memorandum of Understandingon page 12, the Bank entered into a
Memorandum of Understanding (“MOU”) with the Office of the Comptroller of the
Currency (“OCC”) in 2007.  Specifically, the MOU requires the Bank to
(1) implement a three-year strategic plan in accordance with specific guidelines
set forth in the MOU, (2) develop and implement a three-year capital plan, in
accordance with specific guidelines set forth in the MOU, including a dividend
policy for the payment of dividends provided the Bank is in compliance with the
capital plan, and applicable laws and regulations, (3) review and revise a
written program to improve the Bank’s loan portfolio management, (4) review and
revise the Bank’s funds management reports to ensure that they reflect current
and projected funding needs, (5) develop and implement a risk based audit
program to determine weaknesses or deficiencies in the Bank’s consumer
compliance program, (6) ensure the Bank’s interest rate risk (“IRR”) measurement
tool or model conforms to OCC guidelines and, if necessary, develop an action
plan to address the need for a more acceptable IRR measurement model, and (7)
furnish written quarterly progress reports to the OCC detailing the form and
manner of actions taken to comply with the MOU.  Each provision of the
MOU is subject to OCC approval, non-objection and/or
review.  Management has sent to the OCC the documentation and progress
reports as required under the MOU,and although managementbelieves that the Bank
has made measurable progress in addressing the issues identified in the MOU, the
OCC has the authority to extend or terminate the MOU, or to issue additional
higher-level supervisory enforcement actions, which could have an impact on our
business strategies and operations including, but not limited to, revising our
minimum regulatory capital requirements, or limiting  asset growth and
our use of wholesale funding sources.





Economic
conditions and declines in housing prices and real estate values




The
United States, including Union National’s primary banking market, has
experienced weakening economic conditions and declines in housing prices and
real estate values in general.  Union National’s loan portfolio contains
significant amounts of loans secured by residential and commercial real
estate.  Union National has experienced increases in non-performing assets,
net charge-offs and provisions for credit losses as a result of continuing
deterioration of the housing markets, increasing financial stress on consumers
and weakening economic conditions.  Union National expects continued
economic weakness for most of 2009.  This environment could lead to
increased levels of non-performing assets, net charge-offs and provision for
credit losses compared to previous periods, which would have a negative impact
to Union National’s operating results.





We
may be required to pay significantly higher Federal Deposit Insurance
Corporation (FDIC) premiums in the future.




Recent
insured institution failures, as well as deterioration in banking and economic
conditions, have significantly increased FDIC loss provisions, resulting in a
decline in the designated reserve ratio to historical lows. The FDIC expects a
higher rate of insured institution failures in the next few years compared to
recent years; thus, the reserve ratio may continue to decline. In addition,
the EESA temporarily increased the limit on FDIC coverage to $250,000 through
December 31, 2013. These developments will cause the premiums assessed to
us by the FDIC to increase.   Potentially higher FDIC assessment
rates and special assessments could have an adverse impact on our results of
operations.


40


A
prolonged economic downturn, especially one affecting the Corporation’s
geographic market areas, could reduce the Corporation’s customer base level of
deposits and demand for financial products, such as loans.





The
Corporation’s success depends significantly upon the growth in population,
income levels, deposits and housing starts in its geographic markets. Unlike
many larger institutions, the Corporation is not able to spread the risks of
unfavorable local economic conditions across a large number of diversified
economies and geographic locations. If the communities in which the Corporation
operates do not grow, or if prevailing economic conditions locally or nationally
are unfavorable, its business could be adversely affected.





There
can be no assurance that actions of the U.S. government, Federal Reserve and
other governmental and regulatory bodies for the purpose of stabilizing the
financial markets will achieve the intended effect.





In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, on October 3, 2008, President Bush signed the EESA into law.
Pursuant to the EESA, the Treasury has the authority to utilize up to $700
billion to purchase distressed assets from financial institutions or infuse
capital into financial institutions for the purpose of stabilizing the financial
markets. The Treasury announced the CPP under the EESA pursuant to which it has
purchased and will continue to purchase senior preferred stock in participating
financial institutions.  There can be no assurance, however, as to the
actual impact that the EESA, including the CPP and the Treasury’s Troubled Asset
Repurchase Program, will have on the financial markets or on us. The failure of
these programs to help stabilize the financial markets and a continuation or
worsening of current financial market conditions could materially and adversely
affect our business, financial condition, results of operations, access to
credit or the trading price of our common stock.





The
federal government, Federal Reserve and other governmental and regulatory bodies
have taken or are considering taking other actions to address the financial
crisis. There can be no assurance as to what impact such actions will have on
the financial markets, including the extreme levels of volatility currently
being experienced. Such continued volatility could materially and adversely
affect our business, financial condition and results of operations, or the
trading price of our common stock.





Item
2.  Unregistered Sales Of Equity Securities And Use Of
Proceeds





On May
19, 2008, Union National commenced a private placement stock offering for the
sale of up to 526,315 unregistered shares of Union National’s common stock, par
value $0.25 per share, at $9.50 per share for a maximum aggregate offering price
of $4,999,993. There was no minimum offering amount. Upon receipt of proceeds
from the sale of the shares, Union National immediately contributed such amounts
to the general corporate purposes of Union National including, but not limited
to, continuing to meet regulatory capital requirements and increasing the
regulatory lending ability of the Bank.





The
shares were being offered pursuant to an exemption from registration under
Section 3(b) of the Securities Act of 1933 and Rule 505 of SEC Regulation
D.  The shares sold were restricted securities for purposes of the
United States securities laws and cannot be transferred except under these
laws.





Although
Union National could withdraw or terminate the offering of the shares at any
time, its intentions were to offer the shares for an initial period of six
months commencing May 19, 2008.  The Board of Directors of Union
National subsequently elected to extend the offering period for the shares until
February 17, 2009.  The Board of Directors further elected to let the
private placement expire on February 17, 2009.





Union
National received gross proceeds of $1,635,000 on the private placement stock
offering representing 172,132 shares.  Issuance costs of $49,000 were
offset against the gross proceeds.





Item
3.  Defaults Upon Senior Securities





None


41


Item
4.  Submission Of Matters To A Vote Of Security Holders





(a)
            The
      Annual Meeting of Stockholders was held at 10:00 a.m. on May 6, 2009,
      at The Eden Resort Inn, 222 Eden Road, Lancaster, Pennsylvania
      17601-4216.





(b)
            –   (c)
      The following matters were voted
upon:





1.      Three
Class A Directors were re-elected as follows:




Term Expires
            
            Votes
      Cast
              “For”
            
            
            Votes
      to “Withhold
              Authority”Mark
      D. Gainer
            
            2012
            
            
            1,997,799
            
            
            
            241,819Darwin
      A. Nissley
            
            2012
            
            
            1,999,161
            
            
            
            240,457James
      R. Godfrey
            
            2012
            
            
            1,957,130
            
            
            
            282,488




Directors
whose term continued after the meeting:




Class
      B Directors
                
                
                
                Class
      C DirectorsDonald
      Cargas, Jr.
                
                2010
                
                Kevin
      D. Dolan
                
                2011Barry
      C. Huber
                
                2010
                
                Thomas
      J. McGrath
                
                2011Lloyd
      C. Pickell
                
                2010
                
                William
      M. Nies
                
                2011





2.
            To
      approve and adopt the amendment to the Corporation’s Articles of
      Incorporation to authorize 10,000,000 shares of preferred stock, par value
      $0.25 per share:




Votes
      Cast For:
              
              
              1,016,189Votes
      Cast Against:
              
              
              849,748Votes
      Abstained:
              
              
              27,549





Item
5.  Other Information





None


42


Item
6.  Exhibits





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





3(i)
            Union
      National Community 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
            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.)





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.)





10.7
              Employment agreement
      between Michael A. Frey, Executive Vice President
      and Chief Operating 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
      of Form 8-K, filed with the Commission on June 23,
      2005.)




43


10.8
            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.)





10.9
            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 10.15 to Union National Financial Corporation’s 2006 Annual Report
      on Form 10-K, filed with the Commission on March 28,
  2007.)





10.10
            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 10.15 to Union National Financial Corporation’s 2006
      Annual Report on Form 10-K, filed with the Commission on March 28,
      2007.)





10.11
            Guarantee
      Agreement, dated as of October 14, 2004, between Union National Financial
      Corporation and the guarantee trustee named
      therein.  (Incorporated by reference to Exhibit 10.15 to Union
      National Financial Corporation’s 2006 Annual Report on Form 10-K, filed
      with the Commission on March 28,
2007.)





10.12
            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 to Union National Financial Corporation’s quarterly  report on
      Form 10-Q, filed with the Commission on August 14,
  2006.)





10.13
            Employment
      Agreement, dated March 8, 2007, 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.)





10.14
              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.)





10.15
            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.





10.16
            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.




44


10.17
            Stock
      Bonus Plan and the 2009 Stock Purchase Plan, dated November 26, 2008 and
      incorporated by reference to Exhibit 99.1 to Union National Financial
      Corporation’s current report on Form 8-K, filed with the Commission on
      December 3, 2008.





14
            Union
      National Financial Corporation Directors and Senior Management Code of
      Ethics. (Incorporated by reference to Exhibit 14 to Union National
      Financial Corporation’s 2008 Annual Report on Form 10-K, filed with the
      Commission on March 30, 2009.)





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.


45





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 14, 2009
                            By
                            /s/
      Mark D. GainerMark
      D. Gainer
                              Chairman,
      CEO and President
                              (Principal
      Executive Officer)Date:
      August 14, 2009
                            By
                            /s/
      Michael D. PeduzziMichael
      D. Peduzzi
                              Executive
      Vice President and Chief Financial Officer
                              (Principal
      Financial and Accounting
Officer)




46