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 September 30,
2009





OR





o
            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
o





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 o   No
o





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 o    Accelerated
filer o    Non-accelerated
filer o    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 o    No
x





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





2,739,496 shares of $.25 (par)
common stock were outstanding as of November 13, 2009.









UNION
NATIONAL FINANCIAL CORPORATION


FORM
10-Q


INDEX





PAGE
      NO.PART I –
      FINANCIAL
      INFORMATIONItem
      1.
                      Financial
      Statements (Unaudited)Consolidated
      Statements of Financial Condition As of September 30, 2009 and December
      31, 2008
                      1Consolidated
      Statements of Operations For the Three and Nine Months Ended September 30,
      2009 and 2008
                      2Consolidated
      Statements of Changes in Stockholders’
      EquityFor
      the Nine Months Ended September 30, 2009 and 2008
                      3Consolidated
      Statements of Cash FlowsFor
      the Nine Months Ended September 30, 2009 and 2008
                      4Notes
      to Unaudited Consolidated Financial Statements
                      5 -
      19Item
      2.
                      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                      21
      - 39Item
      3.
                      Quantitative
      and Qualitative Disclosures about Market Risk
                      39Item
      4.
                      Controls
      and Procedures
                      41Item 4T.
                      Controls
      and Procedures
                      41PART
      II –
      OTHER INFORMATIONItem
      1.
                      Legal
      Proceedings
                      41Item 1A.
                      Risk
      Factors
                      42Item
      2.
                      Unregistered
      Sales of Equity Securities and Use of Proceeds
                      43Item
      3.
                      Defaults
      upon Senior Securities
                      45Item
      4.
                      Submission
      of Matters to a Vote of Security Holders
                      45Item
      5.
                      Other
      Information
                      45Item
      6.
                      Exhibits
                      45Signatures
                      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)




September
      30,
                          
                          
                          December
      31,2009
                          
                          
                          2008AssetsCash
      and Due from Banks
                          
                          $
                          9,355
                          
                          
                          $
                          17,621Federal
      Funds Sold
                          
                          –
                          
                          
                          
                          14,150Short-Term
      Investments
                          
                          
                          16,000
                          
                          
                          –Interest-Bearing
      Demand Deposits in Other Banks
                          
                          
                          44,684
                          
                          
                          
                          66Total
      Cash and Cash Equivalents
                          
                          
                          70,039
                          
                          
                          
                          31,837Interest-Bearing
      Time Deposits in Other Banks
                          
                          
                          11,924
                          
                          
                          
                          1,775Investment
      Securities Available for Sale
                          
                          
                          46,374
                          
                          
                          
                          64,289Loans
      and Leases, Net of Unearned Income
                          
                          
                          342,506
                          
                          
                          
                          358,280Less:  Allowance
      for Credit Losses
                          
                          
                          (4,798
                          )
                          
                          
                          (4,358
                          )Net
      Loans and Leases
                          
                          
                          337,708
                          
                          
                          
                          353,922Premises
      and Equipment, Net
                          
                          
                          11,617
                          
                          
                          
                          12,088Restricted
      Investment in Bank Stocks
                          
                          
                          3,705
                          
                          
                          
                          3,703Bank-Owned
      Life Insurance
                          
                          
                          11,431
                          
                          
                          
                          11,108Other
      Assets
                          
                          
                          7,903
                          
                          
                          
                          6,387Total
      Assets
                          
                          $
                          500,701
                          
                          
                          $
                          485,109LiabilitiesDeposits:Non-Interest
      Bearing
                          
                          $
                          54,752
                          
                          
                          $
                          46,875Interest-Bearing
                          
                          
                          360,210
                          
                          
                          
                          336,702Total
      Deposits
                          
                          
                          414,962
                          
                          
                          
                          383,577Long-Term
      Debt
                          
                          
                          33,334
                          
                          
                          
                          50,334Junior
      Subordinated Debentures
                          
                          
                          17,341
                          
                          
                          
                          17,341Other
      Liabilities
                          
                          
                          3,506
                          
                          
                          
                          3,063Total
      Liabilities
                          
                          
                          469,143
                          
                          
                          
                          454,315Stockholders’
      EquityPreferred
      Stock (Series A), $1,000 liquidation valueShares
      authorized - 10,000,000; Issued – 700,000 and 0at
      September 30, 2009 and December 31, 2008,
    respectively
                          
                          
                          700
                          
                          
                          –Common
      Stock, par value $0.25 per shareShares
      authorized - 20,000,000; Issued – 3,107,513 and 3,138,265at
      September 30, 2009 and December 31, 2008, respectively;Outstanding
      - 2,739,324 and 2,720,076 at September 30, 2009and
      December 31, 2008, respectively
                          
                          
                          777
                          
                          
                          
                          785Surplus
                          
                          
                          13,912
                          
                          
                          
                          14,868Retained
      Earnings
                          
                          
                          23,379
                          
                          
                          
                          23,434Accumulated
      Other Comprehensive Income
                          
                          
                          123
                          
                          
                          
                          36Treasury
      Stock, at cost; 368,189 and 418,189 at September 30,
      2009and
      December 31, 2008, respectively
                          
                          
                          (7,333
                          )
                          
                          
                          (8,329
                          )Total
      Stockholders’ Equity
                          
                          
                          31,558
                          
                          
                          
                          30,794Total
      Liabilities and Stockholders’ Equity
                          
                          $
                          500,701
                          
                          
                          $
                          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 Sept. 30,
                    
                    
                    Nine
      Months Ended Sept. 30,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Interest
      IncomeInterest
      and Fees on Loans and Leases
                    
                    $
                    5,597
                    
                    
                    $
                    6,158
                    
                    
                    $
                    16,478
                    
                    
                    $
                    18,665Investment
      Securities:Taxable
      Interest
                    
                    
                    297
                    
                    
                    
                    823
                    
                    
                    
                    1,264
                    
                    
                    
                    2,395Tax-Exempt
      Interest
                    
                    
                    71
                    
                    
                    –
                    
                    
                    
                    160
                    
                    
                    –Dividends
                    
                    
                    9
                    
                    
                    
                    39
                    
                    
                    
                    31
                    
                    
                    
                    107Other
                    
                    
                    78
                    
                    
                    
                    17
                    
                    
                    
                    165
                    
                    
                    
                    239Total
      Interest Income
                    
                    
                    6,052
                    
                    
                    
                    7,037
                    
                    
                    
                    18,098
                    
                    
                    
                    21,406Interest
      ExpenseDeposits
                    
                    
                    2,022
                    
                    
                    
                    2,139
                    
                    
                    
                    6,540
                    
                    
                    
                    7,293Short-Term
      Borrowings
                    
                    –
                    
                    
                    
                    123
                    
                    
                    –
                    
                    
                    
                    188Long-Term
      Debt
                    
                    
                    468
                    
                    
                    
                    671
                    
                    
                    
                    1,629
                    
                    
                    
                    2,130Junior
      Subordinated Debentures
                    
                    
                    201
                    
                    
                    
                    264
                    
                    
                    
                    645
                    
                    
                    
                    830Total
      Interest Expense
                    
                    
                    2,691
                    
                    
                    
                    3,197
                    
                    
                    
                    8,814
                    
                    
                    
                    10,441Net
      Interest Income
                    
                    
                    3,361
                    
                    
                    
                    3,840
                    
                    
                    
                    9,284
                    
                    
                    
                    10,965Provision
      for Credit Losses
                    
                    
                    522
                    
                    
                    
                    47
                    
                    
                    
                    1,446
                    
                    
                    
                    326Net
      Interest Income after Provision for Credit Losses
                    
                    
                    2,839
                    
                    
                    
                    3,793
                    
                    
                    
                    7,838
                    
                    
                    
                    10,639Non-Interest
      IncomeIncome
      from Fiduciary Activities
                    
                    
                    39
                    
                    
                    
                    42
                    
                    
                    
                    132
                    
                    
                    
                    200Service
      Charges on Deposit Accounts
                    
                    
                    588
                    
                    
                    
                    504
                    
                    
                    
                    1,601
                    
                    
                    
                    1,450Other
      Service Charges, Commissions, Fees
                    
                    
                    294
                    
                    
                    
                    288
                    
                    
                    
                    858
                    
                    
                    
                    822Alternative
      Investment Sales Commissions
                    
                    
                    125
                    
                    
                    
                    231
                    
                    
                    
                    428
                    
                    
                    
                    638Mortgage
      Banking/Brokerage Activities
                    
                    
                    22
                    
                    
                    
                    31
                    
                    
                    
                    90
                    
                    
                    
                    67Earnings
      from Bank-Owned Life Insurance
                    
                    
                    108
                    
                    
                    
                    112
                    
                    
                    
                    323
                    
                    
                    
                    330Other
      Income
                    
                    
                    24
                    
                    
                    
                    22
                    
                    
                    
                    332
                    
                    
                    
                    168Net
      Gain (Loss) on Sale of Investment Securities
                    
                    
                    397
                    
                    
                    
                    (42
                    )
                    
                    
                    1,791
                    
                    
                    
                    159Less:
      Impairment Charges on Investment Securities
                    
                    
                    (170
                    )
                    
                    –
                    
                    
                    
                    (1,471
                    )
                    
                    –Net
      Investment Securities Gains (Losses)
                    
                    
                    227
                    
                    
                    
                    (42
                    )
                    
                    
                    320
                    
                    
                    
                    159Total
      Non-Interest Income
                    
                    
                    1,427
                    
                    
                    
                    1,188
                    
                    
                    
                    4,084
                    
                    
                    
                    3,834Non-Interest
      ExpenseSalaries,
      Wages, and Employee Benefits
                    
                    
                    1,680
                    
                    
                    
                    1,908
                    
                    
                    
                    5,297
                    
                    
                    
                    5,716Net
      Occupancy
                    
                    
                    414
                    
                    
                    
                    421
                    
                    
                    
                    1,313
                    
                    
                    
                    1,379Furniture
      and Equipment
                    
                    
                    227
                    
                    
                    
                    273
                    
                    
                    
                    713
                    
                    
                    
                    749Professional
      Fees and Regulatory Assessments
                    
                    
                    316
                    
                    
                    
                    117
                    
                    
                    
                    817
                    
                    
                    
                    685Data
      and ATM Processing
                    
                    
                    406
                    
                    
                    
                    423
                    
                    
                    
                    1,236
                    
                    
                    
                    1,243Pennsylvania
      Shares Tax
                    
                    
                    89
                    
                    
                    
                    53
                    
                    
                    
                    267
                    
                    
                    
                    228Advertising
      and Marketing
                    
                    
                    42
                    
                    
                    
                    179
                    
                    
                    
                    159
                    
                    
                    
                    366Supplies
      and Postage
                    
                    
                    66
                    
                    
                    
                    87
                    
                    
                    
                    214
                    
                    
                    
                    307FDIC
      Insurance
                    
                    
                    238
                    
                    
                    
                    104
                    
                    
                    
                    898
                    
                    
                    
                    291Other
      Expense
                    
                    
                    689
                    
                    
                    
                    576
                    
                    
                    
                    1,747
                    
                    
                    
                    1,793Total
      Non-Interest Expense
                    
                    
                    4,167
                    
                    
                    
                    4,141
                    
                    
                    
                    12,661
                    
                    
                    
                    12,757Income
      (Loss) Before (Benefit from) Provision for Income Taxes
                    
                    
                    99
                    
                    
                    
                    840
                    
                    
                    
                    (739
                    )
                    
                    
                    1,716(Benefit
      from) Provision for Income Taxes
                    
                    
                    (48
                    )
                    
                    
                    214
                    
                    
                    
                    (482
                    )
                    
                    
                    373Net
      Income (Loss)
                    
                    
                    147
                    
                    
                    
                    626
                    
                    
                    
                    (257
                    )
                    
                    
                    1,343Preferred
      Stock Dividends
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –Net
      Income (Loss) Available to Common Stockholders
                    
                    $
                    147
                    
                    
                    $
                    626
                    
                    
                    $
                    (257
                    )
                    
                    $
                    1,343Earnings
      (Loss) Per Common ShareBasic
                    
                    $
                    0.05
                    
                    
                    $
                    0.23
                    
                    
                    $
                    (0.09
                    )
                    
                    $
                    0.51Diluted
                    
                    
                    0.05
                    
                    
                    
                    0.23
                    
                    
                    
                    (0.09
                    )
                    
                    
                    0.51Cash
      Dividends Paid Per Common Share
                    
                    –
                    
                    
                    –
                    
                    
                    –
                    
                    
                    –




See
accompanying notes to unaudited consolidated financial
statements.


2


Union
National Financial Corporation


Consolidated
Statements of Changes in Stockholders’ Equity


(Unaudited;
Dollars in thousands, except share data)





Nine
      Months Ended September 30, 2009Shares
      of
                                    Common
                                    Stock
                                    Outstanding
                                  
                                  
                                  Preferred
                                    Stock
                                  
                                  
                                  Common
                                    Stock
                                  
                                  
                                  Surplus
                                  
                                  
                                  Retained
                                    Earnings
                                  
                                  
                                  Accumulated
                                    Other
                                    Comprehensive
                                    Income
                                  
                                  
                                  Treasury
                                    Stock
                                  
                                  
                                  TotalBalance
      at December 31, 2008
                                  
                                  2,720,076
                                  
                                  
                                  $
                                  –
                                  
                                  
                                  $
                                  785
                                  
                                  
                                  $
                                  14,868
                                  
                                  
                                  $
                                  23,434
                                  
                                  
                                  $
                                  36
                                  
                                  
                                  $
                                  (8,329
                                  )
                                  
                                  $
                                  30,794Comprehensive
      Income:Net
      Loss
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  (257
                                  )
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  (257
                                  )Net
      Change in Unrealized Gains (Losses) onAvailable-for-Sale
      Securities, Net of Tax
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  289
                                  
                                  
                                  –
                                  
                                  
                                  
                                  289Total
      Comprehensive Income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  32Issuance
      of Preferred Stock
                                  
                                  
                                  
                                  
                                  
                                  700
                                  
                                  
                                  –
                                  
                                  
                                  
                                  (30
                                  )
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  670Issuance
      of Common Stock under:
                                  
                                  
                                  
                                  
                                  –Dividend
      Reinvestment Plan
                                  
                                  19,248
                                  
                                  
                                  –
                                  
                                  
                                  
                                  4
                                  
                                  
                                  
                                  58
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  62Retirement
      of Treasury Stock (50,000 shares)
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  (12
                                  )
                                  
                                  
                                  (984
                                  )
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  996
                                  
                                  
                                  –Cumulative
      Effect of ASC Topic 320, “Investments – Debt and Equity
      Securities”    Adoption (net of $104 tax
      effect)
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  –
                                  
                                  
                                  
                                  202
                                  
                                  
                                  
                                  (202
                                  )
                                  
                                  –
                                  
                                  
                                  –Balance
      at September 30, 2009
                                  
                                  2,739,324
                                  
                                  
                                  $
                                  700
                                  
                                  
                                  $
                                  777
                                  
                                  
                                  $
                                  13,912
                                  
                                  
                                  $
                                  23,379
                                  
                                  
                                  $
                                  123
                                  
                                  
                                  $
                                  (7,333
                                  )
                                  
                                  $
                                  31,558





Nine
      Months Ended September 30, 2008Shares
      of
                                                  Common
                                                  Stock
                                                  Outstanding
                                                
                                                
                                                Preferred
      Stock
                                                
                                                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
      Income:Net
      Income
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                1,343
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                1,343Net
      Change in Unrealized Gains (Losses) on Available-for-Sale Securities, Net
      of Tax
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                (598
                                                )
                                                
                                                –
                                                
                                                
                                                
                                                (598
                                                )Total
      Comprehensive Income
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                
                                                745Issuance
      of Common Stock under:Private
      Placement Stock Offering, net of costs
                                                
                                                172,132
                                                
                                                
                                                –
                                                
                                                
                                                44
                                                
                                                
                                                
                                                1,546
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                1,590Dividend
      Reinvestment and
                                                  Stock
      Purchase Plan
                                                
                                                745
                                                
                                                
                                                –
                                                
                                                –
                                                
                                                
                                                
                                                8
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                8Employee
      Plans
                                                
                                                650
                                                
                                                
                                                –
                                                
                                                –
                                                
                                                
                                                
                                                5
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                5Implementation
      of ASC Topic 715, “Split- Dollar Life Insurance
      Arrangements”
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                (73
                                                )
                                                
                                                –
                                                
                                                
                                                –
                                                
                                                
                                                
                                                (73
                                                )Balance
      at September 30, 2008
                                                
                                                2,720,076
                                                
                                                $
                                                –
                                                
                                                $
                                                785
                                                
                                                
                                                $
                                                14,872
                                                
                                                
                                                $
                                                24,333
                                                
                                                
                                                $
                                                (586
                                                )
                                                
                                                $
                                                (8,329
                                                )
                                                
                                                $
                                                31,075





See
accompanying notes to unaudited consolidated financial
statements.


3


Union
      National Financial Corporation


Consolidated
      Statements of Cash Flows


(Unaudited;
      Dollars in thousands)





Nine
      Months Ended September 30,2009
                                          
                                          
                                          2008Cash
      Flows from Operating ActivitiesNet
      (Loss) Income
                                          
                                          $
                                          (257
                                          )
                                          
                                          $
                                          1,343Adjustments
      to Reconcile Net (Loss) Income to Net Cash Provided By Operating
      Activities:Depreciation
      and Amortization
                                          
                                          
                                          891
                                          
                                          
                                          
                                          969Provision
      for Credit Losses
                                          
                                          
                                          1,446
                                          
                                          
                                          
                                          326Net
      Amortization (Accretion) of Investment Securities Premiums
      (Discounts)
                                          
                                          
                                          414
                                          
                                          
                                          
                                          (69
                                          )Net
      Investment Securities Gains
                                          
                                          
                                          (320
                                          )
                                          
                                          
                                          (159
                                          )Earnings
      from Bank-Owned Life Insurance
                                          
                                          
                                          (323
                                          )
                                          
                                          
                                          (330
                                          )(Increase)
      Decrease in Accrued Interest Receivable
                                          
                                          
                                          (80
                                          )
                                          
                                          
                                          234Benefit
      from Deferred Income Taxes
                                          
                                          
                                          (626
                                          )
                                          
                                          
                                          (77
                                          )Increase
      in Other Assets
                                          
                                          
                                          (965
                                          )
                                          
                                          
                                          (353
                                          )Increase
      (Decrease) in Other Liabilities
                                          
                                          
                                          443
                                          
                                          
                                          
                                          (781
                                          )Cash
      Payments Related to Restructuring Charge
                                          
                                          –
                                          
                                          
                                          
                                          (214
                                          )Net
      Cash Provided By Operating Activities
                                          
                                          
                                          623
                                          
                                          
                                          
                                          889Cash
      Flows from Investing ActivitiesProceeds
      from Sales of Available-for-Sale Securities
                                          
                                          
                                          183,337
                                          
                                          
                                          
                                          35,808Proceeds
      from Maturities and Principal Repayments on Available-for-Sale
      Securities
                                          
                                          
                                          19,927
                                          
                                          
                                          
                                          35,190Purchases
      of Available-for-Sale Securities
                                          
                                          
                                          (185,007
                                          )
                                          
                                          
                                          (71,780
                                          )Net
      Purchases of Time Deposits in Other Banks
                                          
                                          
                                          (10,149
                                          )
                                          
                                          
                                          (1,874
                                          )Net
      Increase of Restricted Investments in Bank Stocks
                                          
                                          
                                          (2
                                          )
                                          
                                          
                                          (127
                                          )Net
      Decrease (Increase) in Loans and Leases
                                          
                                          
                                          4,549
                                          
                                          
                                          
                                          (6,327
                                          )Proceeds
      from Sale of Loans
                                          
                                          
                                          9,800
                                          
                                          
                                          –Purchases
      of Premises, Equipment and Software
                                          
                                          
                                          (342
                                          )
                                          
                                          
                                          (4,049
                                          )Proceeds
      from Sale of Real Estate Owned
                                          
                                          
                                          349
                                          
                                          
                                          –Net
      Cash Provided By (Used In) Investing Activities
                                          
                                          
                                          22,462
                                          
                                          
                                          
                                          (13,159
                                          )Cash
      Flows from Financing ActivitiesNet
      Increase (Decrease) in Demand Deposits and Savings
Accounts
                                          
                                          
                                          25,146
                                          
                                          
                                          
                                          (4,168
                                          )Net
      Increase (Decrease) in Time Deposits
                                          
                                          
                                          6,239
                                          
                                          
                                          
                                          (2,764
                                          )Issuance
      of Common Stock, net of costs
                                          
                                          
                                          62
                                          
                                          
                                          
                                          1,603Issuance
      of Preferred Stock, net of costs
                                          
                                          
                                          670
                                          
                                          
                                          –Payments
      on Long-Term Debt
                                          
                                          
                                          (17,000
                                          )
                                          
                                          
                                          (17,482
                                          )Net
      Increase in Short-Term Borrowings
                                          
                                          –
                                          
                                          
                                          
                                          14,800Net
      Cash Provided by (Used in) Financing Activities
                                          
                                          
                                          15,117
                                          
                                          
                                          
                                          (8,011
                                          )Net
      Increase (Decrease) in Cash and Cash Equivalents
                                          
                                          
                                          38,202
                                          
                                          
                                          
                                          (20,281
                                          )Cash
      and Cash Equivalents at Beginning of Period
                                          
                                          
                                          31,837
                                          
                                          
                                          
                                          37,882Cash
      and Cash Equivalents at End of Period
                                          
                                          $
                                          70,039
                                          
                                          
                                          $
                                          17,601Supplemental
      Disclosures of Cash Flow ActivitiesInterest
      Paid
                                          
                                          $
                                          8,893
                                          
                                          
                                          $
                                          11,277Income
      Tax Paid
                                          
                                          
                                          750
                                          
                                          
                                          –Supplemental
      Disclosures of Non-cash Flow ActivitiesTransfers
      to Other Real Estate Owned
                                          
                                          $
                                          419
                                          
                                          
                                          $
                                          –Retirement
      of Treasury Stock (50,000 shares in 2009)
                                          
                                          $
                                          996
                                          
                                          
                                          $
                                          –





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 (loss).  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
September 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 September 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 September 30, 2009, for items that should potentially be
recognized or disclosed in the consolidated financial statements. The evaluation
was conducted through November 16, 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 ─ Recent Accounting Pronouncements





Accounting Standards
Codification


In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards
CodificationTM and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of FASB Statement No. 162,” (“SFAS 168”). SFAS 168 establishes the
FASB Accounting Standards Codification TM (“Codification”) as the source of
authoritative generally accepted accounting principles (“GAAP”) for
nongovernmental entities.  The Codification does not change
GAAP.  Instead, it takes the thousands of individual pronouncements
that currently comprise GAAP and reorganizes them into approximately 90
accounting Topics, and displays all Topics using a consistent
structure.  Contents in each Topic are further organized first by
Subtopic, then Section and finally Paragraph.  The Paragraph level is
the only level that contains substantive content.  Citing particular
content in the Codification involves specifying the unique numeric path to the
content through the Topic, Subtopic, Section and Paragraph
structure.  FASB suggests that all citations begin with “FASB ASC,”
were ASC stands for Accounting Standards Codification.  Rules and
interpretive releases of the SEC under authority of federal securities laws
are also sources of authoritative GAAP for SEC registrants. The ASC supersedes
all existing non-SEC accounting and reporting standards. All other
nongrandfathered, non-SEC accounting literature not included in the ASC will
become nonauthoritative.




FASB will
no longer issue new standards in the form of Statements, FASB Staff Positions or
Emerging Issues Task Force Abstracts. Instead, changes to the ASC subsequent to
June 30, 2009 will be referred to as Accounting Standards Updates
(“ASU”).


5


In
conjunction with the issuance of SFAS 168, the FASB also issued its first
Accounting Standards Update No. 2009-1, “Topic 105 – Generally Accepted
Accounting Principles” (“ASU 2009-1”) which includes SFAS 168 in its entirety as
a transition to the ASC.  ASU 2009-1 is effective for interim and
annual periods ending after September 15, 2009 and will not have an impact on
the Corporation’s financial position or results of operations, but will change
the referencing system for accounting standards.





ASU
2009-05


In August
2009, the FASB issued ASU 2009-05, Fair Value Measurements and Disclosures
(Topic 820): Measuring Liabilities at Fair Value.  The amendments
within ASU 2009-05 clarify that in circumstances in which a quoted price in an
active market for the identical liability is not available, a reporting entity
is required to measure fair value using one or more of the following
techniques:





●
              A
      valuation technique that uses:a.  The
      quoted price of the identical liability when traded as an
      asset.
                b.  Quoted
      prices for similar liabilities or similar liabilities when traded as
      assets.




●
            Another
      valuation technique that is consistent with the principles of Topic
      820.





Two
examples would be an income approach, such as a present value technique, or a
market approach, such as a technique that is based on the amount at the
measurement date that the reporting entity would pay to transfer the identical
liability or would receive to enter into the identical liability.





When
estimating the fair value of a liability, a reporting entity is not required to
include a separate input or adjustment to other inputs relating to the existence
of a restriction that prevents the transfer of the liability.





Both a
quoted price in an active market for the identical liability at the measurement
date and the quoted price for the identical liability when traded as an asset in
an active market when no adjustments to the quoted price of the asset are
required are Level 1 fair value measurements.





This
guidance is effective for the first reporting period (including interim periods)
beginning after issuance.  The Corporation is currently reviewing the
effect this new pronouncement will have on its consolidated financial
statements.





Note
4 ─ 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 (i) preferred stock shares were converted to common stock
shares, and (ii) options to issue common stock were
exercised.  Potential common shares that may be issued related to
outstanding stock options are determined using the treasury stock
method.  For the three and nine months ended September 30, 2009 and
2008, there were no preferred stock conversions or no stock options, which would
have a dilutive effect.  Preferred stock was issued in 2009, but is
excluded from this calculation due to the preferred stock conversion price being
higher than Union National’s stock price.  All stock options
outstanding, 91,958 and 105,686 as of September 30, 2009 and 2008, respectively,
had no intrinsic value.  Accordingly, the diluted earnings per share
for each period was not affected by the impact of stock options
outstanding.





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





Three
      Months Ended Sept. 30,
                              
                              
                              Nine
      Months Ended Sept. 30,2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Net
      Income (Loss)
                              
                              $
                              147
                              
                              
                              $
                              626
                              
                              
                              $
                              (257
                              )
                              
                              $
                              1,343Weighted-average
      common shares outstanding
                              
                              
                              2,738
                              
                              
                              
                              2,717
                              
                              
                              
                              2,727
                              
                              
                              
                              2,617Basic
      earnings (loss) per share
                              
                              $
                              0.05
                              
                              
                              $
                              0.23
                              
                              
                              $
                              (0.09
                              )
                              
                              $
                              0.51Weighted-average
      common shares outstanding
                              
                              
                              2,738
                              
                              
                              
                              2,717
                              
                              
                              
                              2,727
                              
                              
                              
                              2,617Effect
      of Diluted Securities:Convertible
      Preferred Stock
                              
                              –
                              
                              
                              –
                              
                              
                              –
                              
                              
                              –Total
      weighted-average common shares and equivalents
                              
                              
                              2,738
                              
                              
                              
                              2,717
                              
                              
                              
                              2,727
                              
                              
                              
                              2,617Diluted
      earnings (loss) per share
                              
                              $
                              0.05
                              
                              
                              $
                              0.23
                              
                              
                              $
                              (0.09
                              )
                              
                              $
                              0.51


6


Note
5 – Investment Securities Available For Sale





Mortgage-backed
securities at December 31, 2008, have been reclassified to conform to the
financial statement footnote presentation at September 30, 2009.  At
September 30, 2009, mortgage-backed securities are reported in two categories
(i) U.S. Agency Mortgage-Backed Securities and (ii)  Private Issuer
Mortgage-Backed Securities, whereas, previously they were reported as one
category.  The reclassifications had no effect on our unaudited
consolidated financial statements.





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
      September 30, 2009Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    42,893
                    
                    
                    $
                    104
                    
                    
                    $
                    (139
                    )
                    
                    $
                    42,858Private
      Issuer Mortgage-Backed Securities
                    
                    
                    2,662
                    
                    
                    
                    123
                    
                    
                    –
                    
                    
                    
                    2,785Corporate
      Securities
                    
                    
                    550
                    
                    
                    
                    97
                    
                    
                    –
                    
                    
                    
                    647Equity
      Securities
                    
                    
                    83
                    
                    
                    
                    11
                    
                    
                    
                    (10
                    )
                    
                    
                    84Total
      Investment Securities
                    
                    $
                    46,188
                    
                    
                    $
                    335
                    
                    
                    $
                    (149
                    )
                    
                    $
                    46,374





At
      December 31, 2008Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    55,693
                    
                    
                    $
                    661
                    
                    
                    $
                    (104
                    )
                    
                    $
                    56,250Private
      Issuer Mortgage-Backed Securities
                    
                    
                    3,453
                    
                    
                    –
                    
                    
                    
                    (234
                    )
                    
                    
                    3,219Obligations
      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 September 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.





September
      30, 2009
                    
                    
                    December
      31, 2008Maturity
                    
                    Amortized
      Cost
                    
                    
                    Fair
      Value
                    
                    
                    Amortized
      Cost
                    
                    
                    Fair
      ValueDue
      in One Year or Less
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    1,514
                    
                    
                    $
                    1,528Due
      After One Year Through Five Years
                    
                    –
                    
                    
                    –
                    
                    
                    
                    1,865
                    
                    
                    
                    1,868Due
      After Five Years Through Ten Years
                    
                    –
                    
                    
                    –
                    
                    
                    
                    
                    
                    Due
      After Ten Years
                    
                    
                    550
                    
                    
                    
                    647
                    
                    
                    
                    1,481
                    
                    
                    
                    1,218550
                    
                    
                    
                    647
                    
                    
                    
                    4,860
                    
                    
                    
                    4,614U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    42,893
                    
                    
                    
                    42,858
                    
                    
                    
                    55,693
                    
                    
                    
                    56,250Private
      Issuer Mortgage-Backed Securities
                    
                    
                    2,662
                    
                    
                    
                    2,785
                    
                    
                    
                    3,453
                    
                    
                    
                    3,219Equity
      Securities
                    
                    
                    83
                    
                    
                    
                    84
                    
                    
                    
                    227
                    
                    
                    
                    206Total
      Investment Securities
                    
                    $
                    46,188
                    
                    
                    $
                    46,374
                    
                    
                    $
                    64,233
                    
                    
                    $
                    64,289


7


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 September 30, 2009 and December 31,
2008:





At
      September 30, 2009Less
      than 12 Months
                    
                    
                    12
      Months or More
                    
                    
                    TotalFair
                      Value
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      Value
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      Value
                    
                    
                    Unrealized
                      LossesU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    19,763
                    
                    
                    $
                    (139
                    )
                    
                    $
                    
                    
                    
                    $
                    
                    
                    
                    $
                    19,763
                    
                    
                    $
                    (139
                    )Equity
      Securities
                    
                    
                    
                    
                    
                    
                    
                    
                    17
                    
                    
                    
                    (10
                    )
                    
                    
                    17
                    
                    
                    
                    (10
                    )Total
      Temporarily Impaired Securities
                    
                    $
                    19,763
                    
                    
                    $
                    (139
                    )
                    
                    $
                    17
                    
                    
                    $
                    (10
                    )
                    
                    $
                    19,780
                    
                    
                    $
                    (149
                    )





At
      December 31, 2008Less
      than 12 Months
                
                
                12
      Months or More
                
                
                TotalFair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  Losses
                
                
                Fair
                  Value
                
                
                Unrealized
                  LossesU.S.
      Agency Mortgage-Backed Securities
                
                $
                15,954
                
                
                $
                (102
                )
                
                $
                73
                
                
                $
                (2
                )
                
                $
                16,027
                
                
                $
                (104
                )Private
      Issuer Mortgage-Backed Securities
                
                –
                
                
                –
                
                
                
                1,863
                
                
                
                (234
                )
                
                
                1,863
                
                
                
                (234
                )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 September 30, 2009 and 2008, Union National received gross
proceeds of $112,142,000 and $11,329,000, respectively, on the sale of
investment securities.  The following tables present information
related to the Corporation’s realized 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 September 30,
2009 and 2008 (in thousands):





Three
      Months Ended September 30, 2009Gross
                        Realized
                        Gains
                      
                      
                      Gross
                        Realized
                        Losses
                      
                      
                      Other-than-
                        temporary
                        Impairment
                        Losses
                      
                      
                      Net
      Gains
                        (Losses)Obligations
      of U.S. Government Agencies
                      
                      $
                      130
                      
                      
                      $
                      (25
                      )
                      
                      $
                      –
                      
                      
                      $
                      105U.S.
      Agency Mortgage-Backed Securities
                      
                      
                      170
                      
                      
                      
                      (27
                      )
                      
                      –
                      
                      
                      
                      143Private
      Issuer Mortgage-Backed Securities
                      
                      –
                      
                      
                      –
                      
                      
                      
                      (160
                      )
                      
                      
                      (160
                      )Municipal
      Securities
                      
                      
                      134
                      
                      
                      
                      (4
                      )
                      
                      –
                      
                      
                      
                      130U.S.
      Treasuries
                      
                      
                      19
                      
                      
                      –
                      
                      
                      –
                      
                      
                      
                      19Corporate
      Securities
                      
                      –
                      
                      
                      –
                      
                      
                      
                      (10
                      )
                      
                      
                      (10
                      )Total
                      
                      $
                      453
                      
                      
                      $
                      (56
                      )
                      
                      
                      (170
                      )
                      
                      $
                      227





Three
      Months Ended September 30, 2008Gross
                          Realized
                          Gains
                        
                        
                        Gross
                          Realized
                          Losses
                        
                        
                        Other-than-
                          temporary
                          Impairment
                          Losses
                        
                        Net
      LossesObligations
      of U.S. Government Agencies
                        
                        $
                        –
                        
                        
                        $
                        (14
                        )
                        $
                        –
                        
                        $
                        (14
                        )U.S.
      Agency Mortgage-Backed Securities
                        
                        
                        27
                        
                        
                        
                        (50
                        )
                        
                        –
                        
                        
                        (23
                        )Equity
      Securities
                        
                        
                        6
                        
                        
                        
                        (11
                        )
                        
                        –
                        
                        
                        (5
                        )Total
                        
                        $
                        33
                        
                        
                        $
                        (75
                        )
                        $
                        –
                        
                        $
                        (42
                        )


8


For the
nine months ended September 30, 2009 and 2008, Union National received gross
proceeds of $183,337,000 and $35,808,000, 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 nine months ended September 30, 2009 and 2008 (in
thousands):





Nine
      Months Ended September 30, 2009Gross
                      Realized
                      Gains
                    
                    
                    Gross
                      Realized
                      Losses
                    
                    
                    Other-Than-
                      Temporary
                      Impairment
                      Losses
                    
                    
                    Net
      Gains
                      (Losses)Obligations
      of U.S. Government Agencies
                    
                    $
                    140
                    
                    
                    $
                    (25
                    )
                    
                    $
                    –
                    
                    
                    $
                    115U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    1,636
                    
                    
                    
                    (70
                    )
                    
                    –
                    
                    
                    
                    1,566Private
      Issuer Mortgage-Backed Securities
                    
                    –
                    
                    
                    –
                    
                    
                    
                    (612
                    )
                    
                    
                    (612
                    )Municipal
      Securities
                    
                    
                    134
                    
                    
                    
                    (4
                    )
                    
                    –
                    
                    
                    
                    130U.S.
      Treasuries
                    
                    
                    19
                    
                    
                    –
                    
                    
                    –
                    
                    
                    
                    19Corporate
      Securities
                    
                    –
                    
                    
                    –
                    
                    
                    
                    (859
                    )
                    
                    
                    (859
                    )Equity
      Securities
                    
                    –
                    
                    
                    
                    (39
                    )
                    
                    –
                    
                    
                    
                    (39
                    )Total
                    
                    $
                    1,929
                    
                    
                    $
                    (138
                    )
                    
                    $
                    (1,471
                    )
                    
                    $
                    320





Nine
      Months Ended September 30, 2008Gross
                      Realized
                      Gains
                    
                    
                    Gross
                      Realized
                      Losses
                    
                    
                    Other-Than-
                      Temporary
                      Impairment
                      Losses
                    
                    Net
      Gains
                      (Losses)Obligations
      of U.S. Government Agencies
                    
                    $
                    108
                    
                    
                    $
                    (15
                    )
                    $
                    –
                    
                    $
                    93U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    120
                    
                    
                    
                    (50
                    )
                    
                    –
                    
                    
                    70Corporate
      Securities
                    
                    
                    9
                    
                    
                    
                    (62
                    )
                    
                    –
                    
                    
                    (53
                    )Equity
      Securities
                    
                    
                    60
                    
                    
                    
                    (11
                    )
                    
                    –
                    
                    
                    49Total
                    
                    $
                    297
                    
                    
                    $
                    (138
                    )
                    $
                    –
                    
                    $
                    159





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


In
determining fair value and assessing the potential for other-than-temporary
impairment (OTTI) of securities in the Union National investment portfolio as of
September 30, 2009, Union National management primarily considered the following
accounting principles and guidance from the Accounting Standards Codification
(“ASC”): (i) ASC Topic 320, “Investments – Debt and Equity Securities”, and (ii)
ASC Topic 820, “Fair Value Measurements and
Disclosures”.  Additionally, management considered SEC guidance
including (i) SAB Topic 5M, “Miscellaneous Accounting – Other Than Temporary
Impairment of Certain Investments in Debt and Equity Securities”, and (ii)
additional interpretive guidance SEC #2008-234, “SEC Office of the Chief
Accountant and FASB Staff Clarifications on Fair Value Accounting”.





In order
to determine whether unrealized losses in the fair value of investment
securities are other-than-temporary, management regularly reviews the entire
portfolio of investment securities for possible 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, the accounting principles and guidance referenced above requires
that the credit-related portion of OTTI on debt securities be recognized in
earnings, while the noncredit-related portion of OTTI on debt securities not
expected by management to be sold be recognized in Other Comprehensive Income
(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 noncredit-related portion was determined to be $306,000
pre-tax.  Accordingly, on April 1, 2009, a cumulative effect
adjustment was recorded in the after-tax amount of $202,000 to increase retained
earnings and decrease unrealized gains (losses) in accumulated other
comprehensive income (loss) for the noncredit-related portion of the OTTI
recorded in 2008.


9


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 September 30, 2009 (in thousands):





Cumulative Credit Losses on Impaired
      SecuritiesBalance
      at January 1, 2009
                  
                  $
                  2,090Cumulative
      effect of ASC Topic 320, “Investments – Debt and Equity Securities”
      adoption -non-credit
      portion of previous OTTI
                  
                  
                  (306
                  )Additional
      OTTI taken for credit losses
                  
                  
                  1,471Balance
      at September 30, 2009
                  
                  $
                  3,255





As of
September 30, 2009, Union National maintains five investment securities with
recorded impairments.  The fair value of the five impaired investments
was $3,432,000 as compared to an original amortized cost of
$8,950,000.  The following table provides additional information
related to these five investment securities(in
thousands):





At
      September 30, 2009Original
                                      Amortized
                                    
                                    
                                    Investment
      Rating
                                    
                                    
                                    Current
                                      Amortized
                                    
                                    
                                    Fair
                                    
                                    
                                    OTTIDescription
      of Investment Security
                                    
                                    Cost
                                    
                                    
                                    Original
                                    
                                    
                                    Current
                                    
                                    
                                    Value
                                    
                                    
                                    Value
                                    
                                    
                                    TakenPrivate
      Issuer Mortgage-Backed
    Securities:Countrywide
      Alt Ln 2005-83CB A3
                                    
                                    $
                                    3,018
                                    
                                    
                                    AAA
                                    
                                    
                                    CC
                                    
                                    
                                    $
                                    1,294
                                    
                                    
                                    $
                                    1,385
                                    
                                    
                                    $
                                    706Countrywide
      Alt Ln 2005-75CB A4
                                    
                                    
                                    2,932
                                    
                                    
                                    AAA
                                    
                                    
                                    CCC
                                    
                                    
                                    
                                    1,368
                                    
                                    
                                    
                                    1,400
                                    
                                    
                                    
                                    452Total
      Mortgage-Backed Securities
                                    
                                    $
                                    5,950
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    2,662
                                    
                                    
                                    $
                                    2,785
                                    
                                    
                                    $
                                    1,158Corporate
      Securities:InCaps
      Funding II Senior Note
                                    
                                    $
                                    1,000
                                    
                                    
                                    A-
                                    
                                    
                                    BB
                                    
                                    
                                    $
                                    285
                                    
                                    
                                    $
                                    330
                                    
                                    
                                    $
                                    631InCaps
      Funding II Junior Note
                                    
                                    
                                    1,000
                                    
                                    
                                    BBB
                                    
                                    
                                    B
                                    
                                    
                                    
                                    265
                                    
                                    
                                    
                                    317
                                    
                                    
                                    
                                    530USCap
      Funding V
                                    
                                    
                                    1,000
                                    
                                    
                                    BBB
                                    
                                    
                                    C
                                    
                                    
                                    –
                                    
                                    
                                    –
                                    
                                    
                                    
                                    936Total
      Corporate Securities
                                    
                                    $
                                    3,000
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    550
                                    
                                    
                                    $
                                    647
                                    
                                    
                                    $
                                    2,097Total
      Securities with OTTI
                                    
                                    $
                                    8,950
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    3,212
                                    
                                    
                                    $
                                    3,432
                                    
                                    
                                    $
                                    3,255





As
discussed more thoroughly in Note 12 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 ASC 820, when an active market for a security does
not exist, the use of management estimates that incorporate current market
participant expectations of future cash flows, and include appropriate risk
premiums, is acceptable.  Management’s judgment was that, as of
September 30, 2009, the facts and circumstances indicated significant
illiquidity and an inactive market for these types of investments when other
relevant observable inputs were not available; therefore, expected cash flows
were used as a reasonable basis in determining the fair value of the corporate
investment securities.  Prior to September 30, 2008, management used
other observable inputs to determine the fair value of the corporate investment
securities including broker indicated prices and quoted prices in limited
trading activity of the issuances.





During
the first nine months of 2009, four of the Bank’s five private-issuer securities
were downgraded to below investment grade. The fifth private-issuer security was
downgraded to below-investment-grade in December 2008.  Accordingly,
the Bank recorded $1,471,000 of other-than-temporary impairment charges in the
first nine months of 2009 including (i) $859,000 related to three pooled
trust-preferred debt securities supported primarily by obligations from other
banks, and (ii) $612,000 related to one private issuer 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 and credit
related, requiring the write-down and related impairment charge to
earnings.  For the securities with impairment charges recorded,
interest income payments received subsequent to impairment are fully applied to
principal further reducing the amortized cost of these
investments.


10


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





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


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


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


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





Note
6 – 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.  For the nine months ended
September 30, 2009, the Bank prepaid $17,000,000 of FHLB advances, which had a
fixed weighted average interest cost of 5.36%, incurring $536,000 of prepayment
penalties, which were included in other non-interest expense.  At
September 30, 2009, the balance of long-term debt was
$33,334,000.  For the nine months ended September 30, 2008, the Bank
prepaid $17,482,000 of FHLB advances, which had a fixed weighted average
interest cost of 4.18%, 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,
for the nine months ended September 30, 2008, and for all of 2008, the Bank
called $16,410,000 of brokered CDs with a fixed weighted average interest cost
of 4.91%.  No brokered CDs were called during the nine months ended
September 30, 2009.  However, subsequent to September 30, 2009, the
Bank repaid a $5,241,000 brokered CD with an interest cost of 3.90% that matured
on October 15, 2009.





In
addition, the Bank made cash payments of $214,000 during the nine months ended
September 30, 2008 related to accrued severance liabilities remaining from 2007
restructuring activities.  The severance liability was paid in full by
December 31, 2008.





Note
7 – Junior Subordinated Debentures





Union
National has three issuances of junior subordinated debentures outstanding as of
September 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 3.34% and 6.32% at
September 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 2.41% and 4.15% at September
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 became 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.


11





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





Preferred
Stock


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





Terms
of the Series A Preferred Stock:


Dividends
on the Series A Preferred Stock are payable quarterly in arrears if, when,
and as declared by the Corporation’s Board of Directors, at a rate of 5.00% per
year on the liquidation preference of $1,000 per share. Dividends, if declared,
will be payable quarterly on January 31, April 30, July 31, and October 31 of
each year (each a “Dividend Payment Date”).  In the case of the
dividend payable on the first Dividend Payment Date, such dividend shall be
prorated based on the number of days elapsed from the date of purchase to the
first Dividend Payment Date over a quarterly dividend period of ninety (90)
days.  Dividends on the Series A Preferred Stock are
non-cumulative. Holders of the Series A Preferred Stock may convert their
shares into common stock at any time upon approval of the Board of Governors of
the Federal Reserve System (the “Federal Reserve”), if required, at the
conversion prices listed below:





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





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





Terms
of the Series B Preferred Stock:


Dividends
on the Series B Preferred Stock are payable quarterly in arrears if, when,
and as declared by the Corporation’s Board of Directors, at a rate of 6.00% per
year on the liquidation preference of $1,000 per share. Dividends, if declared,
will be payable quarterly on January 31, April 30, July 31, and October 31 of
each year (each a “Dividend Payment Date”).  In the case of the
dividend payable on the first Dividend Payment Date, such dividend shall be
prorated based on the number of days elapsed from the date of purchase to the
first Dividend Payment Date over a quarterly dividend period of ninety (90)
days.  Dividends on the Series B Preferred Stock are
non-cumulative. Shares of the Series B Preferred Stock are not convertible or
exchangeable into shares of the Corporation’s common stock or any other security
of the Corporation.





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





Sales
of Preferred Stock:


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





Between
September 25, 2009, and September 30, 2009, Union National sold 700 shares of
its Series A Preferred Stock to ten “accredited investors” (as defined in Rule
501 of SEC Regulation D) and three non-accredited investors (all three of whom
had such knowledge and experience in financial and business matters that they
were capable of evaluating the merits and risks of the prospective investment)
for total gross proceeds of $700,000, which have been offset by issuance costs
of $30,000.





Subsequent
to September 30, 2009, Union National received an additional $450,000 (450
shares of its Series A Preferred Stock to six “accredited
investors”).


12





Common
Stock


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.





Dividend Reinvestment Plan
(“DRIP”)


Union
National maintains a 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. For the nine months ended September 30, 2009, there were no dividends paid
by the Corporation; however, eligible shareholders made voluntary cash payments
totaling $62,000, which were used to purchase 19,248 common shares.





Note 9 – Formal Written Agreement
with the Office of the Comptroller of the Currency (“OCC”)





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




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




Separate
from the Agreement, the OCC has established individual minimum capital
requirements for the Bank requiring Tier 1 Capital to Average Total Assets of at
least eight percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine
and one-half percent (9.5%), and Total Capital to Risk-Based Assets of at least
twelve percent (12%) effective beginning September 30, 2009.  These
minimum capital ratios are similar to the capital ratio targets agreed to
between the Bank and the OCC under the MOU which were Tier I Capital to Average
Total Assets of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital
to Risk-Based Assets of 12%.  At September 30, 2009, the Bank’s
measure of Tier I Capital to Average Total Assets was 8.19%, Tier I Capital to
Risk-Based Assets of 9.80% and Total Capital to Risk-Based Assets of
12.35%.  At September 30, 2009, all three ratios exceeded the
respective 8.0%, 9.5 % and 12% required ratios.   The capital ratios
reflect the infusion of $700,000 raised in the early phases of a preferred stock
private placement.  In order to maintain the Bank’s capital levels and
to continue to meet the OCC’s new minimum requirement, the Bank may have to
raise additional capital, reduce its assets or both.  If the Bank does
not continue to meet the OCC’s requirements, the OCC could subject the Bank to
such administrative actions or sanctions as the OCC considers
necessary.





Management
and the board of directors are committed to taking the necessary actions to
fully maintain the new minimum capital ratios and address the provisions of the
Agreement, and believe that the Bank has already made measurable progress in
addressing these requirements.


13


Note
10 – 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 September 30, 2009, the Bank had $112,071,000
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 $6,523,000 and $5,474,000 of standby letters
of credit outstanding as of September 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 September 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 15
months ended September 30, 2009 exceeded the actual processed expenses by
$246,000.  However, the Bank reduced the amount of this prepaid benefit by
a contingent reserve of $80,000 reflecting an actuarial estimate by the
consortium of the Bank’s unpaid claim liability as of September 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
11 – Stock-Based Compensation





In
accordance with ASC Topic 718, “Compensation – Stock Compensation”, Union
National recognizes compensation expense for share-based awards based upon an
assessment of the fair value on the grant date.  The fair value of
each option is estimated on the date of grant using the Black-Scholes
option-pricing model.  Stock compensation expense is recognized on a
straight-line basis over the vesting period of the award.  No
share-based awards were granted or vested during the three or nine months ended
September 30, 2009 and 2008; accordingly, no compensation expense was recorded
for these periods.





Union
National had two plans with stock options outstanding as of September 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 September 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.





Stock
option activity for the nine months ended September 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 September 30, 2009:


Number
      of options
                            
                            
                            91,958Weighted-average
      contractual remaining term
                            
                            4.1
      YearsWeighted-average
      exercise price
                            
                            $
                            18.82Aggregate
      intrinsic value
                            
                            $
                            –




14




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





ASC Topic
820, “Fair Value Measurements and Disclosures” defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles, and expands disclosures about fair value
measurements.  This guidance defines fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants.  A fair value measurement
assumes that 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.  ASC Topic 820 requires the use of valuation techniques that
are consistent with the market approach, the income approach and/or the cost
approach.  The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable
assets and liabilities.  The income approach uses valuation techniques
to convert future amounts such as cash flows or earnings, to a single present
amount on a discounted basis.  The cost approach is based on the
amount that currently would be required to replace the service capacity of an
asset (replacement cost).  Valuation techniques should be consistently
applied.  Inputs to valuation techniques refer to the assumptions that
market participants would use in pricing the asset or
liability.  Inputs may be observable, meaning those that reflect the
assumptions market participants would use in pricing the asset or liability
developed based on market data obtained from independent sources, or
unobservable, meaning those that reflect the reporting entity’s own assumptions
about the assumptions market participants would use in pricing the asset or
liability based upon the best information available in the
circumstances.  In that regard, ASC Topic 820 establishes a fair value
hierarchy for valuation inputs that gives the highest priority to quoted prices
in active markets for identical assets or liabilities and the lowest priority to
unobservable inputs.





The fair
value hierarchy is as follows:





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





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





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


15


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
September 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.  Prior to September 30, 2008,
management used market pricing based upon quoted prices from very limited
trading activity of the issuances.





The
following table summarizes financial assets and financial liabilities measured
at fair value on a recurring basis as of September 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:
                  
                  September
      30,
                    2009
                  
                  
                  December
      31,
                    2008Level
      1
                  
                  $
                  14
                  
                  
                  $
                  74Level
      2
                  
                  
                  42,928
                  
                  
                  
                  59,778Level
      3
                  
                  
                  3,432
                  
                  
                  
                  4,437Total
      Fair Value
                  
                  $
                  46,374
                  
                  
                  $
                  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
                  
                  
                  (555
                  )Total
      realized and unrealized gainsIncluded
      in net income (loss)
                  
                  
                  (1,471
                  )Included
      in other comprehensive income (loss)
                  
                  
                  1,021Ending
      Balance at September 30, 2009
                  
                  $
                  3,432





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 $1,143,000 and $1,499,000 at
September 30, 2009 and December 31, 2008, respectively.


16


The
balance of loans and leases that were considered to be impaired under GAAP was
$7,347,000 and $9,360,000, which consisted of ten and sixteen loan and lease
relationships to unrelated borrowers, at September 30, 2009 and December 31,
2008, respectively. At September 30, 2009, three of the relationships
represented 81% of the total impaired loans and leases of
$7,347,000.  The decrease in impaired loans and leases was the result
of loan pay-offs through the loan workout process as well as 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 $6,807,000 and
$5,058,000 of impaired loans and leases, which consisted of seven and eight loan
and lease relationships to unrelated borrowers, with a related allowance for
credit losses of $1,143,000 and $1,499,000 at September 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.





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 September 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):




September
      30, 2009Level
      1
                          Inputs
                        
                        
                        Level
      2
                          Inputs
                        
                        
                        Level
      3
                          Inputs
                        
                        
                        Total
      Fair
                          ValueAssets:Impaired
      Loans
                        
                        $
                        –
                        
                        
                        $
                        –
                        
                        
                        $
                        5,664
                        
                        
                        $
                        5,664Repossessed
      Assets
                        
                        
                        –
                        
                        
                        
                        –
                        
                        
                        
                        464
                        
                        
                        
                        464Other
      Real Estate Owned
                        
                        
                        –
                        
                        
                        
                        –
                        
                        
                        
                        70
                        
                        
                        
                        70Total
                        
                        $
                        –
                        
                        
                        $
                        –
                        
                        
                        $
                        6,198
                        
                        
                        $
                        6,198





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


17


ASC Topic
825, “Financial Instruments” requires disclosures about fair value of financial
instruments for interim reporting periods of publicly traded companies as well
as in annual financial statements. The estimated fair values of the
Corporation’s financial instruments as of September 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.





September
      30, 2009
                  
                  
                  December
      31, 2008Carrying
                    Amount
                  
                  
                  Fair
      Value
                  
                  
                  Carrying
                    Amount
                  
                  
                  Fair
      ValueAssets:Cash
      and Cash Equivalents
                  
                  $
                  70,039
                  
                  
                  $
                  70,039
                  
                  
                  $
                  31,837
                  
                  
                  $
                  31,837Interest-Bearing
      Time Deposits in Other Banks
                  
                  
                  11,924
                  
                  
                  
                  12,027
                  
                  
                  
                  1,775
                  
                  
                  
                  1,838Investment
      Securities Available for Sale
                  
                  
                  46,374
                  
                  
                  
                  46,374
                  
                  
                  
                  64,289
                  
                  
                  
                  64,289Loans
      and Leases, Net
                  
                  
                  337,708
                  
                  
                  
                  326,597
                  
                  
                  
                  353,922
                  
                  
                  
                  354,195Restricted
      Investment in Bank Stocks
                  
                  
                  3,705
                  
                  
                  
                  3,705
                  
                  
                  
                  3,703
                  
                  
                  
                  3,703Accrued
      Interest Receivable
                  
                  
                  1,704
                  
                  
                  
                  1,704
                  
                  
                  
                  1,624
                  
                  
                  
                  1,624Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                  
                  
                  55
                  
                  
                  
                  316
                  
                  
                  
                  86
                  
                  
                  
                  285Liabilities:Demand
      and Savings Deposits
                  
                  
                  214,870
                  
                  
                  
                  214,870
                  
                  
                  
                  189,724
                  
                  
                  
                  189,724Time
      Deposits
                  
                  
                  200,092
                  
                  
                  
                  202,514
                  
                  
                  
                  193,853
                  
                  
                  
                  195,611Long-term
      Debt
                  
                  
                  33,334
                  
                  
                  
                  34,646
                  
                  
                  
                  50,334
                  
                  
                  
                  52,976Junior
      Subordinated Debentures
                  
                  
                  17,341
                  
                  
                  
                  17,046
                  
                  
                  
                  17,341
                  
                  
                  
                  19,182Accrued
      Interest Payable
                  
                  
                  1,343
                  
                  
                  
                  1,343
                  
                  
                  
                  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 September 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 (U.S. Treasury Bills with a
maturity of less than 60 days) approximate their fair values.





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





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





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


18


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.


19


Note
13 – Comprehensive Income (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 income
(loss).   The components of comprehensive income (loss) and
related tax effects are as follows (in thousands):





Three
      Months Ended Sept. 30, 2009
                
                
                Nine
      Months Ended Sept. 30, 2009Before
                  Tax
                  Amount
                
                
                Tax
                  Impact
                
                
                Net-of-
                  Tax
                  Amount
                
                
                Before
                  Tax
                  Amount
                
                
                Tax
                  Impact
                
                
                Net-of-
                  Tax
                  AmountNet
      Income (Loss)
                
                $
                99
                
                
                $
                (48
                )
                
                $
                147
                
                
                $
                (739
                )
                
                $
                (482
                )
                
                $
                (257
                )Other
      Comprehensive Income:Unrealized
      Gains on Available-for-Sale Securities Arising During the
      Period
                
                
                415
                
                
                
                141
                
                
                
                274
                
                
                
                452
                
                
                
                154
                
                
                
                298Reclassification
      Adjustment for Cumulative Effect of ASC Topic 320, “Investments – Debt and
      Equity Securities”
                
                –
                
                
                –
                
                
                –
                
                
                
                306
                
                
                
                104
                
                
                
                202Reclassification
      Adjustment for Securities Gains  included in Net Income
      (Loss)
                
                
                (397
                )
                
                
                (135
                )
                
                
                (262
                )
                
                
                (1,791
                )
                
                
                (609
                )
                
                
                (1,182
                )Reclassification
      Adjustment for Impairment Charges on Investment Securities
                
                
                170
                
                
                
                58
                
                
                
                112
                
                
                
                1,471
                
                
                
                500
                
                
                
                971Other
      Comprehensive Income
                
                
                188
                
                
                
                64
                
                
                
                124
                
                
                
                438
                
                
                
                149
                
                
                
                289Total
      Comprehensive Income (Loss)
                
                $
                287
                
                
                $
                16
                
                
                $
                271
                
                
                $
                (301
                )
                
                $
                (333
                )
                
                $
                32





Three
      Months Ended Sept. 30, 2008
                  
                  
                  Nine
      Months Ended Sept. 30, 2008Before
                    Tax
                    Amount
                  
                  
                  Tax
                    Impact
                  
                  
                  Net-of-
                    Tax
                    Amount
                  
                  
                  Before
                    Tax
                    Amount
                  
                  
                  Tax
                    Impact
                  
                  
                  Net-of-
                    Tax
                    AmountNet
      Income
                  
                  $
                  840
                  
                  
                  $
                  214
                  
                  
                  $
                  626
                  
                  
                  $
                  1,716
                  
                  
                  $
                  373
                  
                  
                  $
                  1,343Other Comprehensive Income
      (Loss):Unrealized
      Gains (Losses) on Available-for-Sale Securities Arising During the
      Period
                  
                  
                  800
                  
                  
                  
                  272
                  
                  
                  
                  528
                  
                  
                  
                  (1,064
                  )
                  
                  
                  (361
                  )
                  
                  
                  (703
                  )Reclassification
      Adjustment for Securities (Losses) Gains included in Net
      Income
                  
                  
                  (42
                  )
                  
                  
                  (14
                  )
                  
                  
                  (28
                  )
                  
                  
                  159
                  
                  
                  
                  54
                  
                  
                  
                  105Other
      Comprehensive Income (Loss)
                  
                  
                  758
                  
                  
                  
                  258
                  
                  
                  
                  500
                  
                  
                  
                  (905
                  )
                  
                  
                  (307
                  )
                  
                  
                  (598
                  )Total
      Comprehensive Income
                  
                  $
                  1,598
                  
                  
                  $
                  472
                  
                  
                  $
                  1,126
                  
                  
                  $
                  811
                  
                  
                  $
                  66
                  
                  
                  $
                  745


20


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.





21


Fair
Value of Investment Securities


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





Federal
Home Loan Bank (“FHLB”) Stock Impairment Analysis


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





Financial
Condition





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





Investment
Securities


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





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


22


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





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





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





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





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





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





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





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





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





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


23





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





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





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





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





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


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


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


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





Loans
and Leases, Credit Quality and Credit Risk


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


24





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





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





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


25


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


Three
      Months Ended
                              September
      30,
                            
                            
                            Nine
      Months Ended
                              September
      30,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008Allowance
      for Credit Losses, Beginning of Period
                            
                            $
                            4,364
                            
                            
                            $
                            3,831
                            
                            
                            $
                            4,358
                            
                            
                            $
                            3,675Charge-Offs
                            
                            
                            (132
                            )
                            
                            –
                            
                            
                            
                            (1,065
                            )
                            
                            
                            (134
                            )Recoveries
                            
                            
                            44
                            
                            
                            
                            8
                            
                            
                            
                            59
                            
                            
                            
                            19Net
      (Charge-Offs) Recoveries
                            
                            
                            (88
                            )
                            
                            
                            8
                            
                            
                            
                            (1,006
                            )
                            
                            
                            (115
                            )Addition
      to Provision for Credit Losses
                            
                            
                            522
                            
                            
                            
                            47
                            
                            
                            
                            1,446
                            
                            
                            
                            326Allowance
      for Credit Losses, End of Period
                            
                            $
                            4,798
                            
                            
                            $
                            3,886
                            
                            
                            $
                            4,798
                            
                            
                            $
                            3,886Loans
      and Leases – Average
                            
                            $
                            351,446
                            
                            
                            $
                            376,415
                            
                            
                            $
                            352,401
                            
                            
                            $
                            370,380Gross
      Loans and Leases – Actual
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            342,506
                            
                            
                            $
                            370,549Ratio
      of Gross Loans and Leases Charged Off to Average Loans and Leases
      (Annualized)
                            
                            
                            0.15
                            %
                            
                            
                            0.00
                            %
                            
                            
                            0.40
                            %
                            
                            
                            0.05
                            %Ratio
      of Allowance for Credit Losses to Gross Loans and Leases
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1.40
                            %
                            
                            
                            1.05
                            %





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





The
balance of loans and leases that were considered to be impaired under GAAP was
$7,347,000 and $9,360,000, which consisted of ten and sixteen loan and lease
relationships to unrelated borrowers, at September 30, 2009 and December 31,
2008, respectively. At September 30, 2009, three of the relationships
represented 81% of the total impaired loans and leases of
$7,347,000.  The decrease in impaired loans and leases was the result
of loan pay-offs through the loan workout process as well as 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 $6,807,000 and
$5,058,000 of impaired loans and leases, which consisted of seven and eight loan
and lease relationships to unrelated borrowers, with a related allowance for
credit losses of $1,143,000 and $1,499,000 at September 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 $540,000 and $4,302,000
of impaired loans and leases, which consisted of three and eight loan
relationships to unrelated borrowers, without a related allowance for credit
losses at September 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.


26


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 $33,896,000 and $7,826,000 at September
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 29 and 32).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 1.98% of
total loans and leases at September 30, 2009, as compared to 1.38% 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.





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


September
      30,
                    2009
                  
                  
                  December
      31,
                    2008Nonaccruing
      Loans
                  
                  $
                  3,589
                  
                  
                  $
                  3,271Accruing
      Loans – 90 days or more past due
                  
                  
                  3,177
                  
                  
                  
                  1,685Total
      Nonperforming Loans and Leases
                  
                  
                  6,766
                  
                  
                  
                  4,956Repossessed
      Assets
                  
                  
                  534
                  
                  
                  
                  479Total
      Nonperforming Assets
                  
                  $
                  7,300
                  
                  
                  $
                  5,435Gross
      Loans and Leases
                  
                  $
                  342,506
                  
                  
                  $
                  358,280Allowance
      for Credit Losses
                  
                  $
                  4,798
                  
                  
                  $
                  4,358Nonperforming
      Loans and Leases as a % of Gross Loans and
      Leases
                  
                  
                  1.98
                  %
                  
                  
                  1.38
                  %Nonperforming
      Assets as a % of Total Assets
                  
                  
                  1.46
                  %
                  
                  
                  1.12
                  %Allowance
      for Credit Losses as a % of Nonperforming Loans and Leases
                  
                  
                  71
                  %
                  
                  
                  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 $534,000 and $479,000 at September 30, 2009
and December 31, 2008, respectively.  Included in repossessed assets
at September 30, 2009, was $70,000 of foreclosed real estate. Union National did
not have any foreclosed real estate at December 31, 2008.





Subsequent
Event:


Union
National had $5.6 million of loans outstanding to a non-profit music school
secured primarily by a first lien on the school’s primary facility in Lancaster,
PA.  Management believes the value of this real estate fully secures
the principal due on the loans outstanding and no specific loss reserve is
required.  Subsequent to September 30, 2009, the loans to the school
became more than 90 days delinquent, requiring the loans to be placed in
nonperforming status.  The Bank is pursuing its legal rights to full
collection of the loans and interest and fees due, which may result in
foreclosing on the facility or accepting a deed in lieu or
foreclosure.


27


Stockholders’
Equity


Stockholders’
equity increased by $764,000 to $31,558,000 at September 30, 2009 compared to
$30,794,000 at December 31, 2008.  The increase in stockholders’
equity was primarily the result of $700,000 received on the private placement
stock offering, proceeds received through the Dividend Reinvestment Plan
(“DRIP”), and other comprehensive income during the period offset by decreases
to retained earnings resulting from a year-to-date net loss.  Union
National’s common equity position at September 30, 2009 exceeds the current
regulatory required minimums as disclosed on page 36 (also, seeNote 9 – Formal Written Agreement
with the Office of the Comptroller of the Currency on page 13).





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





Overview


Union
National Financial Corporation reported net income of $147,000 or basic and
diluted earnings per share of $0.05 for the third quarter of 2009, as compared
to net income of $626,000 or basic and diluted earnings per share of $0.23 for
the same period in 2008.  Interest and fees on loans and leases for the
three months ended September 30, 2009 declined by 9% when compared to the same
period in 2008 as (i) outstanding loans decreased by $28 million (including a
$9.8 million loan sale in September 2009) from September 30, 2008 to September
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
2.89% for the third quarter 2009 as compared to 3.44% for the same period in
2008.





The net
interest margin of 2.89% for the third quarter of 2009 did increase slightly
from the net interest margin of 2.65% for the second quarter of 2009 as the
Corporation continued to take measures to reduce its cost of funds, including
prepaying $17 million of higher-cost long-term debt with the Federal Home Loan
Bank of Pittsburgh (FHLB) during the first nine months of 2009.





Net
Interest Income


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





Although
the effective interest rate impact on earning assets and funding sources can be
reasonably estimated at current interest rate levels, the options selected by
customers, and the future mix of the loan, investment and deposit products in
the Bank's portfolios, may significantly change the estimates used in the
simulation models. In addition, our net interest income may be impacted by
further interest rate actions of the Federal Reserve Bank.





Net
interest income as adjusted for tax-exempt financial instruments was $3,435,000
for the three months ended September 30, 2009, as compared to $3,899,000 for the
three months ended September 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 third quarter of 2009 versus 2008.  The taxable-equivalent net
interest margin for the third quarter of 2009 was 2.89% as compared to 3.44% for
the same period in 2008.  The yield on interest-earning assets
decreased by 112 basis points to 5.15% for the third quarter of 2009, as
compared to 6.27% for third quarter of 2008.  The interest rate paid
on average interest-bearing liabilities decreased by 57 basis points to 2.51%
for the third quarter of 2009, as compared to 3.08% for the third quarter of
2008.





Interest
and fees on loans and leases on a taxable-equivalent basis decreased by $582,000
to $5,634,000 for the three months ended September 30, 2009, as compared to
$6,216,000 for the same period in 2008.  The decrease in interest and
fees on loans and leases resulted from a decrease of $24,969,000 in the average
balance of the loan and lease portfolio as well as a decrease in the average
yield of 25 basis points due to interest rate cuts during 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
yield on loans and leases for the third quarter of 2009 was 6.36% as compared to
6.61% for the same period in 2008.


28





Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $418,000 to $405,000 for the three months ended September 30, 2009,
as compared to $823,000 for the same period in 2008.  A decrease in
the average yield of 250 basis points due to both market rate reductions and
generally lower risk investments, offset by a $4,313,000 increase 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 third quarter of 2009 was 2.13% as compared to
4.63% for the same period in 2008.





Interest
expense on deposits decreased by $117,000 to $2,022,000 for the three months
ended September 30, 2009, as compared to $2,139,000 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
$47,359,000 increase in the average balance of deposits. Union National’s
average rate on interest-bearing deposits was 2.17% for the three months ended
September 30, 2009 as compared to 2.63% for the same period in
2008.





Interest
expense on long-term debt was $468,000 for the three months ended September 30,
2009, as compared to $671,000 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 $35,482,000 of higher interest cost long-term
debt.  This resulted in a $14,141,000 decrease in the average balance
of long-term debt for the third quarter of 2009 versus the same period in
2008.  The average rate on long-term debt was 4.99% for the three
months ended September 30, 2009 as compared to 5.19% 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 $522,000 for the three months ended September
30, 2009, as compared to $47,000 for the same period in 2008.  The
increased provision for the three months ended September 30, 2009 as compared to
the same period in 2008 was the result of the increased credit risk related to
additional substandard rated credits at September 30, 2009 as compared to
December 31, 2008 (See discussion onSubstandard Loans
and Leaseson page
27).  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 Risksection of this Management Discussion
and Analysis on page 24).





Non-Interest
Income


For the
three months ended September 30, 2009, non-interest income increased by $239,000
or 20% 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
                    September
      30,Non-Interest Income
                  
                  2009
      vs. 2008Income
      from Fiduciary Activities
                  
                  $
                  (3
                  )Service
      Charges on Deposit Accounts
                  
                  
                  84Other
      Service Charges, Commissions, and Fees
                  
                  
                  6Alternative
      Investment Sales Commissions
                  
                  
                  (106
                  )Net
      Investment Securities Gains
                  
                  
                  269Mortgage
      Banking/Brokerage Activities
                  
                  
                  (9
                  )Earnings
      from Bank-Owned Life Insurance
                  
                  
                  (4
                  )Other
      Income
                  
                  
                  2Total
      Increase in Non-Interest Income
                  
                  $
                  239





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 $397,000 for the third quarter of 2009 as
compared to losses of $42,000 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
$170,000 were recognized during the third quarter of 2009, primarily related to
a private issuer mortgage-backed security that was downgraded further below
investment grade. There were no impairment charges on investment securities in
the third quarter of 2008.


29





The
increase in service charges on deposits accounts was the result of an increase
in deposits, which grew by 8% and 12% since December 31, 2008 and September 30,
2008, respectively.  The overall growth in deposits resulted in
increased fee income as well as an operational change in the posting of
transactions, which impacted net overdraft fee income for the three months ended
September 30, 2009, as compared to the same period in 2008.  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.





Non-Interest
Expense


For the
third quarter of 2009, non-interest expense increased by $26,000 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
September 30, 2009 and 2008 are as follows (in thousands):




Three
      Months Ended
                    September
      30,Non-Interest Expense
                  
                  2009
      vs. 2008Salaries,
      Wages and Employee Benefits
                  
                  $
                  (228
                  )Net
      Occupancy
                  
                  
                  (7
                  )Furniture
      and Equipment
                  
                  
                  (46
                  )Professional
      Fees and Regulatory Assessments
                  
                  
                  199Data
      and ATM Processing
                  
                  
                  (17
                  )Pennsylvania
      Shares Tax
                  
                  
                  36Advertising
      and Marketing
                  
                  
                  (137
                  )Supplies
      and Postage
                  
                  
                  (21
                  )FDIC
      Insurance
                  
                  
                  134Other
      Expense
                  
                  
                  113Total
      Increase in Non-Interest Expense
                  
                  $
                  26





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 September 30, 2009 to the same period in
2008.





Salaries,
wages and employee benefits decreased by $228,000 for the three months ended
September 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 suspension of the Corporation’s 401-K match during the second quarter
of 2009.





The
increase in professional fees and regulatory assessments was the result an
increase in audit fees.  Union National uses a third party vendor to
perform their internal audit function.  During the third quarter of
2008, Union National was in the process of switching third party vendors to a
new relationship.  As a result, professional fees and regulatory
assessments included no expense associated with internal audit services for the
three months ended September 30, 2008, whereas, the three months ended September
30, 2009, included internal audit expenses for the full three
months.





For the
three months ended September 30, 2009, the decrease in advertising and marketing
expense was part of Union National operating more efficiently in a difficult
economy.  The increase in FDIC insurance premiums is the direct result
of increased base assessment rates, as determined by the FDIC.  The
increase in other expense was the result of the three months ended September 30,
2009, including losses related to prepayment penalties on FHLB advances of
$143,000.  The Company did not prepay any FHLB advances during the
three months ended September 30, 2008, and therefore, no penalties were included
in other expense.





Income
Taxes


For the
three months ended September 30, 2009, Union National recorded an income tax
benefit of $48,000, which primarily resulted from tax-exempt earnings, as
compared to income tax expense of $214,000 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.


30


Results of Operations for
the Nine Months Ended September 30, 2009 and 2008
 
 Overview
 Union
National Financial Corporation reported a net loss for the first nine months of
2009 of ($257,000) or a ($0.09) basic and diluted loss per share, compared to
net income for the first nine months of 2008 of $1,343,000 or $0.51 basic and
diluted earnings per share.  Interest and fees on loans and leases for
the first nine months of 2009 declined by 12% when compared to the same period
in 2008 as (i) outstanding loans decreased by $28 million (including a $9.8
million loan sale in September 2009) from September 30, 2008 to September 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 2.71% for the first nine months of 2009 as
compared to 3.27% for the first nine months of 2008.  The discussion
that follows further explains the changes in the components of the operating
results when comparing the nine months ended September 30, 2009 to the same
period in 2008.
 
 Net
Interest Income
 Net
interest income as adjusted for tax-exempt financial instruments was $9,493,000
for the nine months ended September 30, 2009, as compared to $11,147,000 for the
nine months ended September 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 nine months ended September 30, 2009, was 2.71% as compared to 3.27% for the
same period in 2008.  The yield on interest-earning assets decreased
by 111 basis points to 5.22% for the nine months ended September 30, 2009, as
compared to 6.33% for the same period in 2008.  The interest rate paid
on average interest-bearing liabilities decreased by 61 basis points to 2.78%
for the nine months ended September 30, 2009, as compared to 3.39% for the same
period in 2008.
 
 Interest
and fees on loans and leases on a taxable-equivalent basis decreased by
$2,243,000 to $16,602,000 for the nine months ended September 30, 2009, as
compared to $18,845,000 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 48 basis points due to interest rate cuts during 2008, and a decrease
of $17,979,000 in the average balance of the loan and lease
portfolio.  The yield on loans and leases for the nine months ended
September 30, 2009, was 6.30% as compared to 6.78% for the same period in
2008.
 
 Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $888,000 to $1,507,000 for the nine months ended September 30,
2009, as compared to $2,395,000 for the same period in 2008.  The
decrease was primarily attributable to a decrease in the average yield of 173
basis points due to both market rate reductions and generally lower risk
investments, which resulted in less interest earned on investments in comparison
to the same period in 2008.  The yield on investment securities for
the first nine months of 2009 was 2.90% as compared to 4.63% for the same period
in 2008.
 
 Interest
expense on deposits decreased by $753,000 to $6,540,000 for the nine months
ended September 30, 2009, as compared to $7,293,000 for the same period in
2008.  A decrease in average rate of 56 basis points due to interest
rate cuts in the past year more than offset additional interest expense
generated from a $35,989,000 increase in average deposits. Union National’s
average rate on interest-bearing deposits was 2.40% for the nine months ended
September 30, 2009 as compared to 2.96% for the same period in
2008.
 
 Interest
expense on long-term debt was $1,629,000 for the nine months ended September 30,
2009, as compared to $2,130,000 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 $35,482,000 of higher interest cost long-term
debt.  This resulted in a $12,978,000 decrease in the average balance
of long-term debt for the nine months ended September 30, 2009 versus the same
period in 2008.  The average rate on long-term debt was 5.10% for the
nine months ended September 30, 2009 as compared to 5.09% for the same period in
2008.
  31
  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 $1,446,000 for the nine months ended September
30, 2009, as compared to $326,000 for the same period in 2008.  The
increased provision for the nine months ended September 30, 2009 as compared to
the same period in 2008 was the result of an increase in loans charged-off
during the first nine months in 2009 as compared to the same period in 2008, and
the increased credit risk related to additional substandard rated credits at
September 30, 2009 as compared to December 31, 2008 (See discussion
onSubstandard Loans and Leaseson page 27).  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 Risksection of thisManagement Discussion and Analysis on
page 24).
 
 Non-Interest
Income
 Non-interest
income was $4,084,000 for the nine months ended September 30, 2009, as compared
to $3,834,000 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):
 
 Nine Months Ended
                      September 30,Non-Interest Income
                    
                    2009 vs. 2008Income
      from Fiduciary Activities
                    
                    $
                    (68
                    )Service
      Charges on Deposit Accounts
                    
                    
                    151Other
      Service Charges, Commissions, and Fees
                    
                    
                    36Alternative
      Investment Sales Commissions
                    
                    
                    (210
                    )Net
      Investment Securities Gains
                    
                    
                    161Mortgage
      Banking/Brokerage Activities
                    
                    
                    23Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (7
                    )Other
      Income
                    
                    
                    164Total
      Increase in Non-Interest Income
                    
                    $
                    250
 
 A
significant portion of the increase in non-interest income was related to net
investment securities gains and other income.
 
 Union
National realized gains on the sale of investment securities of $1,791,000 for
the nine months ended September 30, 2009 as compared to $159,000 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
$1,471,000 were recognized during the nine months ended September 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 total impairment charges for the
first nine months of 2009 of $1,471,000 were more than offset by realized net
gains on the sale of investment securities of $1,791,000 for the first nine
months of 2009.
 
 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 nine months ended
September 30, 2009, does not reflect any income generated from this agreement,
whereas, the operating results for the nine months ended September 30, 2008,
reflected income for only the first quarter of 2008.
 
 The
increase in service charges on deposits accounts was the result of an increase
in deposits, which grew by 8% and 12% since December 31, 2008 and September 30,
2008, respectively.  The overall growth in deposits resulted in
increased fee income as well as an operational change in the posting of
transactions, which impacted net overdraft fee income for the three months ended
September 30, 2009, as compared to the same period in 2008.  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.
  32
 
 Non-Interest
Expense
 For the
nine months ended September 30, 2009, non-interest expense decreased by $96,000
or 1% as compared to the same period in 2008.  Increases (decreases)
in the components of non-interest expense when comparing the nine months ended
September 30, 2009 and 2008 are as follows (in thousands):
 
 Nine Months Ended
                      September 30,Non-Interest Expense
                    
                    2009 vs. 2008Salaries,
      Wages and Employee Benefits
                    
                    $
                    (419
                    )Net
      Occupancy
                    
                    
                    (66
                    )Furniture
      and Equipment
                    
                    
                    (36
                    )Professional
      Fees and Regulatory Assessments
                    
                    
                    132Data
      and ATM Processing
                    
                    
                    (7
                    )Pennsylvania
      Shares Tax
                    
                    
                    39Advertising
      and Marketing
                    
                    
                    (207
                    )Supplies
      and Postage
                    
                    
                    (93
                    )FDIC
      Insurance
                    
                    
                    607Other
      Expense
                    
                    
                    (46
                    )Total
      Decrease in Non-Interest Expense
                    
                    $
                    (96
                    )
 
 Union
National has focused on lowering core operating costs and creating efficiencies
in a difficult economy 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 nine months ended September 30, 2009 to the same period in
2008.
 
 Salaries,
wages and employee benefits decreased by $419,000 for the nine months ended
September 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.
 
 The
increase in professional fees and regulatory assessments was related to an
increase in audit fees and legal expenses.  Union National uses a
third party vendor to perform their internal audit function.  During
the third quarter of 2008, Union National was in the process of switching third
party vendors to a new relationship.  As a result, professional fees
and regulatory assessments included only six months worth of expenses associated
with internal audit services for the nine months ended September 30, 2008,
whereas, the nine months ended September 30, 2009, included internal audit
expenses for the full nine months.  Legal expenses increased primarily
due to Union National using a third party to help mitigate problem loans, which,
have become more prevalent primarily due to stressed cash flows among certain
commercial borrowers resulting from the weak economy and real estate
market.
 
 For the
nine months ended September 30, 2009, the decrease in advertising and marketing
expense was part of Union National operating more efficiently in a difficult
economy.
 
 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
nine months ended September 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 base
assessment rates and an emergency special assessment, as determined by the
FDIC.  The FDIC Board 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.  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.  On November 12, 2009,
the FDIC Board of Directors voted to require insured depository institutions to
prepay, on December 30, 2009, their estimated quarterly risk-based assessments
for the fourth quarter of 2009 and for all of 2010, 2011, and 2012, along with
their quarterly risk-based assessment for the third quarter of 2009 (see related
discussion titled Federal Deposit Insurance Corporation (“FDIC”) Activity on
page 38).  Due to recent changes and assessments by the FDIC, Union
National expects FDIC insurance assessments to be $1,136,000 for the entire year
of 2009, representing a 181% increase over the entire year of
2008.
  33
  The
decease in other expense included 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.  Additionally, 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 first nine months of 2009 and 2008,
the Bank prepaid $17,000,000 and $17,482,000 of FHLB advances,
respectively.  In conjunction with the prepayments, the Bank incurred
$536,000 and $68,000 of prepayment penalties for the nine months ended September
30, 2009 and 2008, respectively, which were included in other non-interest
expense.  The nine months ended September 30, 2008, included a loss of
$370,000 related to certain fraudulent loans made by one employee who has been
since terminated.
 
 Income
Taxes
 For the
nine months ended September 30, 2009, Union National recorded an income tax
benefit of $482,000, which primarily resulted from a pre-tax loss, as compared
to recording an income tax expense of $373,000 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 June 30, 2010, 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 CPP and did not file an
application.
 
 President
Obama also has announced his intention to create another capital program similar
to the TARP CPP exclusively for bank holding companies with consolidated assets
less than $1 billion for the purpose of enabling participants to increase
lending to small businesses. No details of this new program have been released
at this time.
  34
  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.
 
 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 remainder of 2009 and into 2010 to reflect more of the same issues as we
have experienced during the last 15 to 18 months, with the distinct possibility
of a continuing weak economy, volatility in investment markets, and unfavorable
interest income growth prospects.  Most recent indications from the
Federal Reserve are that interest rates will remain at exceptionally low levels
for an extended period.  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 nine
months of 2009.
 
 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 credit 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 maintaining 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.
  35
  As of
September 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, as part of a formal agreement with the OCC,
the OCC established individual minimum capital requirements for the Bank 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, 9.5% for Tier I Capital to Risk-Based Assets,
and 12% for Total Capital to Risk-Based Assets.  At September 30,
2009, the Bank’s measure of Tier I Capital to Average Total Assets was 8.19%,
Tier I Capital to Risk-Based Assets of 9.80% and Total Capital to Risk-Based
Assets of 12.35%.  At September 30, 2009, all three ratios exceeded
the respective 8.0%, 9.5 % and 12% individual minimum capital ratios established
by the OCC.
  Union
National and the Bank’s regulatory capital levels as of September 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(1)
                                        
                                        
                                        Amount
                                        
                                        
                                        RatioUnion National Financial
      CorporationSeptember
      30, 2009:Tier
      1 (leverage) capital
                                        
                                        $
                                        41,907
                                        
                                        
                                        
                                        8.26
                                        %
                                        
                                        $
                                        20,292
                                        
                                        
                                        
                                        4.00
                                        %
                                        
                                        
                                        N/A
                                        
                                        
                                        
                                        N/ATier
      1 risk-based capital
                                        
                                        
                                        41,907
                                        
                                        
                                        
                                        9.88
                                        
                                        
                                        
                                        16,968
                                        
                                        
                                        
                                        4.00
                                        
                                        
                                        
                                        N/A
                                        
                                        
                                        
                                        N/ATotal
      risk-based capital
                                        
                                        
                                        53,228
                                        
                                        
                                        
                                        12.55
                                        
                                        
                                        
                                        33,936
                                        
                                        
                                        
                                        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
    BankSeptember
      30, 2009:Tier
      1 (leverage) capital
                                        
                                        $
                                        41,449
                                        
                                        
                                        
                                        8.19
                                        %
                                        
                                        $
                                        20,235
                                        
                                        
                                        
                                        4.00
                                        %
                                        
                                        $
                                        25,294
                                        
                                        
                                        
                                        5.00
                                        %Tier
      1 risk-based capital
                                        
                                        
                                        41,449
                                        
                                        
                                        
                                        9.80
                                        
                                        
                                        
                                        16,925
                                        
                                        
                                        
                                        4.00
                                        
                                        
                                        
                                        25,388
                                        
                                        
                                        
                                        6.00Total
      risk-based capital
                                        
                                        
                                        52,247
                                        
                                        
                                        
                                        12.35
                                        
                                        
                                        
                                        33,851
                                        
                                        
                                        
                                        8.00
                                        
                                        
                                        
                                        42,313
                                        
                                        
                                        
                                        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
 
 (1)     Under
the Formal Agreement with the OCC, the bank has higher individual minimum
capital ratios established August 27, 2009 (see related discussion in Note 9 on
page 13).
 
 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 September 30, 2009, this
limitation amounted to approximately $5,225,000. 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 $10,478,000 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, $522,000, 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.
  36
 
 Liquidity
 
 Our
objective is to maintain adequate liquidity to meet funding needs at a
reasonable cost and to provide contingency plans to meet unanticipated funding
needs or a loss of funding sources, while minimizing interest rate
risk.  Adequate liquidity provides resources for credit needs of
borrowers, for depositor withdrawals and for funding corporate
operations.  Sources of liquidity are as follows:
 
 ·
              A
      growing core retail deposit base;
 ·
              Proceeds
      from the sale or maturity of investment
  securities;
 ·
              Payments
      received on loans and mortgage-backed securities;
  and,
 ·
              Overnight
      correspondent bank borrowings credit lines, and borrowing capacity
      available from the Federal Reserve
Bank.
 
 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 $112,071,000 at September 30, 2009 as compared to
$109,907,000 at December 31, 2008. Total standby letters of credit amounted to
$6,523,000 at September 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.  For the nine months ended September 30, 2009, there has been
no material change in contracts for services since this contract was
renegotiated.
 
 Regulatory
Matters
 
 From time
to time, various types of federal and state legislation have been proposed that
could result in additional regulation of, and restrictions on, the business of
Union National and the Bank.  As a consequence of the extensive
regulation of commercial banking activities in the United States, Union
National’s and the Bank’s business is particularly susceptible to being affected
by federal and state legislation and regulations that may increase the cost of
doing business (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.
 
 Formal Agreement with the
Comptroller of the Currency.  On August 27, 2009, Union
National Community Bank (the "Bank"), the wholly-owned banking subsidiary of
Union National, entered into a formal written agreement (the “Agreement”) with
the Comptroller of the Currency ("OCC").  Specifically, the Agreement
requires the Bank to (1) establish a compliance committee to monitor and
coordinate the Bank’s adherence to the provisions of the Agreement, (2) have the
board of directors evaluate and monitor executive management performance, (3)
update its three year strategic plan in accordance with specific guidelines set
forth in the Agreement, (4) update its three year capital program, (5) develop
and implement systems to provide for effective loan portfolio management, (6)
take action to protect criticized assets and implement a written program to
eliminate the basis of criticism of assets criticized by the OCC, (7) strengthen
the Bank’s contingency funding plan, (8) implement a written consumer compliance
program, and (9) not exceed the level of brokered deposits as of the date of the
Agreement without prior OCC approval.
  37
 
 The
Agreement supersedes the previous Memorandum of Understanding ("MOU") entered
into between the Bank and the OCC on June 20, 2007.  The Agreement
effectively extends several of the provisions under the MOU, including requiring
a three-year strategic plan and three-year capital plan, improving the Bank’s
loan portfolio management, implementing an effective risk based consumer
compliance audit program, and establishing a compliance committee.
  Separate
from the Agreement, the OCC has established individual minimum capital
requirements for the Bank requiring Tier 1 Capital to Average Total Assets of at
least eight percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine
and one-half percent (9.5%), and Total Capital to Risk-Based Assets of at least
twelve percent (12%) effective beginning September 30, 2009.  These
minimum capital ratios are similar to the capital ratio targets agreed to
between the Bank and the OCC under the MOU which were Tier I Capital to Average
Total Assets of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital
to Risk-Based Assets of 12%.  At September 30, 2009, the Bank’s
measure of Tier I Capital to Average Total Assets was 8.19%, Tier I Capital to
Risk-Based Assets of 9.80% and Total Capital to Risk-Based Assets of
12.35%.  At September 30, 2009, all three ratios exceeded the
respective 8.0%, 9.5 % and 12% required ratios.   The capital ratios
reflect the infusion of $700,000 raised in the early phases of a preferred stock
private placement.  In order to maintain the Bank’s Tier I capital
level and to continue to meet the OCC’s new minimum requirement, the Bank may
have to raise additional capital, reduce its assets or both.  If the
Bank does not continue to meet the OCC’s requirements, the OCC could subject the
Bank to such administrative actions or sanctions as the OCC considers
necessary.
 
 Management
and the board of directors are committed to taking the necessary actions to
continue to meet the new minimum capital ratios and address the provisions of
the Agreement, and believe that the Bank has already made measurable progress in
addressing these requirements.  This increased supervision by the OCC
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 September 30, 2009, we estimate the additional
FDIC premiums to be paid by the Corporation as a result of the increased
supervision to be $218,000 in 2009.  Management and the Board of
Directors are committed to addressing and resolving the issues identified in the
Formal Agreement.
 
 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.
 
 On Oct.
2, 2009, the U.S. Securities and Exchange Commission decided to extend the
deadline for small public companies (non-accelerated filers, defined generally
as companies with less than $75 million market capitalization) to file their
first auditor's report on internal controls under Sarbanes-Oxley Section
404b.  Without the extension, Union National, being a small public
company, would have been required to file our first auditor’s report on the
effectiveness of internal control over financial reporting for the fiscal year
ending December 31, 2009.  Under the extension, the new deadline for
Union National to file our first auditor's report on internal control will begin
for fiscal year ending December 31, 2010.
 
 In 2009,
we incurred $10,000 of additional external audit costs associated with complying
with the provisions of Sarbanes-Oxley prior to the extension being
granted.
 
 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 was
used by 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.
  38
  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.  On November
12, 2009, the FDIC Board of Directors voted to require insured depository
institutions to prepay, on December 30, 2009, their estimated quarterly
risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011,
and 2012, along with their quarterly risk-based assessment for the third quarter
of 2009.  The FDIC Board also voted to adopt a uniform three-basis
point increase in assessment rates effective on January 1, 2011. Each
institution would record the entire amount of its prepaid assessment as a
prepaid expense (asset) as of December 30, 2009.  As of December 31,
2009, and each quarter thereafter, each institution would record an expense
(charge to earnings) for its regular quarterly assessment for the quarter and an
offsetting credit to the prepaid assessment until the asset is exhausted. Once
the asset is exhausted, the institution would record an accrued expense payable
each quarter for the assessment payment, which would be paid in arrears to the
FDIC at the end of the following quarter. If the prepaid assessment is not
exhausted by December 30, 2014, any remaining amount would be returned to the
depository institution.
 
 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 September 30, 2009, based on the
Bank’s year-to-date net income of $87,000, the Bank would be permitted to
declare dividends in 2009 of $643,000.  Through September 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.
  39
  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 17.4% 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
7.8%.  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 for the remainder of 2009 and going
forward into 2010 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; and
 ·
              Repositioning
      of our investment security portfolio mix by purchasing lower-risk shorter
      term U.S. government agencies, and seasoned mortgage-backed securities,
      minimize significant changes in value due to declining interest rates and
      to improve the Bank’s regulatory capital ratios by reducing risk-weighted
      assets.
 
 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.
  40
  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 September 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 reasonably 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.
 
 On August
27, 2009, the Bank entered into a Formal Agreement with the OCC, as discussed
earlier in Note 9 on page 13, and also on page 37 of this
report.
  41
  Item
1A.  Risk Factors
 
 For the
nine months ended September 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.  The Bank is subject to higher individual
minimum capital requirements as explained on page 13.  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 –On August 27, 2009, Union National Community Bank (the "Bank"), the
wholly-owned banking subsidiary of Union National, entered into a formal written
agreement (the “Agreement”) with the Comptroller of the Currency
("OCC").  Specifically, the Agreement requires the Bank to (1)
establish a compliance committee to monitor and coordinate the Bank’s adherence
to the provisions of the Agreement, (2) have the board of directors evaluate and
monitor executive management performance, (3) update its three year strategic
plan in accordance with specific guidelines set forth in the Agreement, (4)
update its three year capital program, (5) develop and implement systems to
provide for effective loan portfolio management, (6) take action to protect
criticized assets and implement a written program to eliminate the basis of
criticism of assets criticized by the OCC, (7) strengthen the Bank’s contingency
funding plan, (8) implement a written consumer compliance program, and (9) not
exceed the level of brokered deposits as of the date of the Agreement without
prior OCC approval.
  The
Agreement supersedes the previous Memorandum of Understanding ("MOU") entered
into between the Bank and the OCC on June 20, 2007.  The Agreement
effectively extends several of the provisions under the MOU, including requiring
a three-year strategic plan and three-year capital plan, improving the Bank’s
loan portfolio management, implementing an effective risk based consumer
compliance audit program, and establishing a compliance committee.
  Separate
from the Agreement, the OCC has established individual minimum capital
requirements for the Bank requiring Tier 1 Capital to Average Total Assets of at
least eight percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine
and one-half percent (9.5%), and Total Capital to Risk-Based Assets of at least
twelve percent (12%) effective beginning September 30, 2009.  These
minimum capital ratios are similar to the capital ratio targets agreed to
between the Bank and the OCC under the MOU which were Tier I Capital to Average
Total Assets of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital
to Risk-Based Assets of 12%.  At September 30, 2009, the Bank’s
measure of Tier I Capital to Average Total Assets was 8.19%, Tier I Capital to
Risk-Based Assets of 9.80% and Total Capital to Risk-Based Assets of
12.35%.  At September 30, 2009, all three ratios exceeded the
respective 8.0%, 9.5 % and 12% required ratios.   The capital ratios
reflect the infusion of $700,000 raised in the early phases of a preferred stock
private placement.  In order to maintain the Bank’s capital levels and
to continue to meet the OCC’s new minimum requirement, the Bank may have to
raise additional capital, reduce its assets or both.  If the Bank does
not continue to meet the OCC’s requirements, the OCC could subject the Bank to
such administrative actions or sanctions as the OCC considers
necessary.
  42
  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.
  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
 
 As
previously disclosed on Form 8-K, filed on October 1, 2009, Union National has
sold shares of its 5% Non-Cumulative Non-Voting Convertible Perpetual Preferred
Stock, Series A (the “Series A Preferred Stock”), in transactions exempt from
registration under the Securities Act of 1933, pursuant to Section 4(2) thereof,
as follows:
 
 Between
September 25, 2009, and October 1, 2009, Union National sold 725 shares of its
Series A Preferred Stock to eleven “accredited investors” (as defined in Rule
501 of SEC Regulation D) and three non-accredited investors (all three of whom
had such knowledge and experience in financial and business matters that they
were capable of evaluating the merits and risks of the prospective investment)
for a total of $725,000.
  43
 
 The
Series A Preferred Stock was offered and sold to the Stock Investors in reliance
upon an exemption for sales of securities not involving a public offering, as
set forth in Section 4(2) of the 1933 Act and Rule 506 of SEC Regulation D
promulgated thereunder. The Company received an appropriate representation as to
the accredited investor status (as defined in Rule 501 of Regulation D) of each
Stock Investor purchasing the Series A Preferred Stock, or received the
appropriate representation that each Stock Investor who is not an accredited
investor (either alone or with his purchaser representative) has such knowledge
and experience in financial and business matters that he is capable of
evaluating the merits and risks of the prospective investment. No offers or
sales were effected through any general solicitation or general advertising
within the meaning of Rule 502(c) of Regulation D, and the Company received
appropriate representations that the shares were acquired for investment
purposes and not with a view to distribution. The shares that were sold have not
been registered under the Securities Act of 1933, as amended, and may not be
sold in the United States absent registration or an applicable exemption from
the registration requirements.
 
 This
offering is not underwritten. The Company is offering shares of the Series A
Preferred Stock solely through its directors, officers, and employees on a
“best-efforts” basis. None of these individuals will be entitled to receive any
compensation in connection with this offering, but the Company may reimburse
them for reasonable out-of-pocket expenses.
 
 Subsequent
to the Form 8-K, filed on October 1, 2009, Union National entered into a
Stock Subscription Agreement on October 8, 2009, two Stock Subscription
Agreements on November 10, 2009, one Stock Subscription Agreement on November
12, 2009, and one Stock Subscription Agreement on November 16, 2009
with five accredited investors (as defined in Rule 501 of Regulation D)
(together, the “Stock Investors”) under which the Company agreed to issue 425
shares of its 5% Non-Cumulative Non-Voting Convertible Perpetual Preferred
Stock, for an aggregate purchase price of $425,000.
 
 The sale
to the Stock Investors is being made as a private placement exempt from the
registration requirements of the Securities Act of 1933, as amended (the “1933
Act”), pursuant to an exemption under Section 4(2) thereof, and Rule 506 of SEC
Regulation D promulgated thereunder.
 
 A copy of
the form of Stock Subscription Agreement for the Series A Preferred Stock is
incorporated herein by reference as Exhibit 10.19 to this quarterly report on
Form 10-Q.
 
 Terms
of the Series A Preferred Stock
  In
connection with this private placement, the Company previously authorized the
Series A Preferred Stock. Dividends on the Series A Preferred Stock are
payable quarterly in arrears if, when, and as declared by the Company’s Board of
Directors, at a rate of 5.00% per year on the liquidation preference of $1,000
per share. Dividends on the Series A Preferred Stock are non-cumulative.
Holders of the Series A Preferred Stock may convert their shares into
common stock at any time upon approval of the Board of Governors of the Federal
Reserve System (the “Federal Reserve”), if required, at the conversion prices
listed below:
  Conversion Date:
                        
                        Conversion Price per ShareSeptember
      15, 2009 through September 14, 2010
                        
                        $
                        4.00September
      15, 2010 through September 14, 2011
                        
                        $
                        6.25September
      15, 2011 through September 14, 2012
                        
                        $
                        7.50September
      15, 2012 through September 14, 2013
                        
                        $
                        8.75On
      or After September 15, 2013
                        
                        $
                        10.00
 
 The
Series A Preferred Stock only may be redeemed by the Company, upon approval of
the Federal Reserve. If the Company redeems the Series A Preferred Stock on or
prior to September 14, 2014, the redemption price will include a premium
decreasing over time from 2.5% to .5% of the liquidation preference. The holders
of the Series A Preferred Stock do not have voting rights except as required by
Pennsylvania Business Corporation Law of 1988, as amended.
 
 The above
summary of the Series A Preferred Stock does not purport to be a complete
description of the Series A Preferred Stock and is qualified in its entirety by
reference to the Certificate of Designations incorporated herein by reference as
Exhibit 4.2 to this quarterly report on Form 10-Q.
  44
  Item
3.  Defaults Upon Senior Securities
 
 None
 
 Item
4.  Submission Of Matters To A Vote Of Security Holders
 
 None
 
 Item
5.  Other Information
 
 None
 
 Item
6.  Exhibits
 
 3.           The
following Exhibits are filed herewith, or incorporated by reference as a part of
this Report:
 
 3(i)
              Union
      National Financial Corporation’s Amended and Restated Articles of
      Incorporation. (Incorporated by reference to Exhibit 3.1 to Union National
      Financial Corporation’s current report on Form 8-K, filed with the
      Commission on May 13, 2009.)
 
 3(ii)
              Union
      National Financial Corporation’s Amended and Restated
      By-laws.   (Incorporated by reference to Exhibit 3(ii) to
      Union National Financial Corporation’s current report on Form 8-K, filed
      with the Commission on February 27,
2009.)
 
 4.1
              Rights
      Agreement, dated August 27, 2007, between Registrar and Transfer Company
      and Union National Financial Corporation.  (Incorporated by
      reference to Exhibit 4 to Union National Financial Corporation’s current
      report on Form 8-K, filed August 30,
2007.)
 
 4.2
              Certificate
      of Designations of the Series A Preferred Stock (Incorporated by reference
      to Exhibit 3.1 to the Corporation’s Current Report on Form 8-K dated
      September 15, 2009).
 
 10.1
              Union
      National Financial Corporation 1988 Stock Incentive Plan. (Incorporated by
      reference to Exhibit 4.3 to Union National Financial Corporation’s
      Registration Statement No. 333-27837 on Form S-8, filed with the
      Commission on May 27, 1997.)
 
 10.2
              Union
      National Financial Corporation 1997 Stock Incentive
      Plan.  (Incorporated by reference to Exhibit 4.5 to Union
      National Financial Corporation’s Registration Statement No. 333-27837 on
      Form S-8, filed with the Commission on May 27, 1997 and incorporated by
      reference to Amendment 1 to Union National Financial Corporation’s
      Registration Statement No. 333-107326 on Form S-8 filed with the
      commission on July 25, 2003.)
 
 10.3
              Union
      National Financial Corporation’s Employee Stock Purchase Plan
      (Incorporated by Reference to Exhibit 4.4 to Union National Financial
      Corporation’s Registration Statement No. 333-27837 on Form S-8, filed with
      the Commission on May 27, 1997).
 
 10.4
              Group
      Term Replacement Plan for Certain Officers, CEO, dated January 1, 2004
      between Mark D. Gainer and Union National Community
      Bank.  (Incorporated by reference to Exhibit 10.12 to Union
      National Financial Corporation’s Annual Report on Form 10-K, filed with
      the Commission on March 30,
2004.)
  45
 
 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.)
 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 10.17 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 10.18 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 10.19 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
      4.1 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.)
  46
 
 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.
 
 10.17
              Stock
      Bonus Plan and the 2009 Stock Purchase Plan, filed December 3, 2008, and
      incorporated by reference to Exhibit 99.1 to Union National Financial
      Corporation’s current report on Form
8-K.
 
 10.18
              Formal
      agreement with the Comptroller of the Currency (“OCC”) and Union
      National    Community Bank, filed August 31, 2009, as
      Item 8.01 to Form 8-K and incorporated by
  reference.
 
 10.19
                Form
      of stock subscription agreement for Series A Preferred Stock (Incorporated
      by reference to Exhibit 10.1 to Union National Financial Corporation’s
      current report on Form 8-K, filed with the Commission on October 1,
      2009).
 
 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.
  47
 
 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:
      November 16, 2009
                  By
                  /s/ Mark D. GainerMark D. GainerChairman, CEO and President(Principal Executive Officer)Date:
      November 16, 2009
                  By
                  /s/ Michael D. PeduzziMichael D. PeduzziExecutive Vice President and Chief Financial Officer(Principal Financial and Accounting
Officer)
  48