EXHIBIT
13
 
 Excerpts
From Union National Financial Corporation’s Annual Report to Shareholders for
the year ended December 31, 2008.



























































v




TABLE
      OF CONTENTS





Consolidated
      Statements of Financial Condition
                2Consolidated
      Statements of Income
                3Consolidated
      Statements of Changes in Stockholders’ Equity
                4Consolidated
      Statements of Cash Flows
                5Notes
      to Consolidated Financial Statements
                6 -
      35Report
      of Management’s Assessment of Internal Control over Financial
      Reporting
                36Report
      of Independent Registered Public Accounting Firm
                37Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                38
      - 63Stock
      Performance Graph
                64Selected
      Financial Data
                65Summary
      of Quarterly Financial Data
                66Stock
      and Dividend Information
                66





CORPORATE
      INTRODUCTION





Union
National Financial Corporation, headquartered in Lancaster, Pennsylvania, is the
holding company of Union National Community Bank. Union National Community Bank
provides a full range of financial services for both retail and business
customers, and offers insurance, retirement plan services and wealth management
services through Union National Advisors. Union National Community Bank has ten
full-service offices in Lancaster County, Pennsylvania including Centerville,
Columbia, East Lampeter, Elizabethtown, Ephrata, Hempfield, Manheim, Manheim
Township, Maytown and Mount Joy.  The deposits of Union National
Community Bank are insured by the Federal Deposit Insurance Corporation (FDIC)
to the maximum extent provided by law.





CORPORATE
      OFFICERS





Mark
      D. Gainer, Chairman, CEO and President
            Michael
      D. Peduzzi, Treasurer and CFOJames
      R. Godfrey, Vice Chairman
            Darwin
      A. Nissley, SecretaryStephen
      D. Staman, Vice President





FORWARD-LOOKING
      INFORMATION





This
annual report may contain 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
factors.  Such factors include the possibility that anticipated cost
savings may not be realized, estimated synergies may not occur, increased demand
or prices for the company's financial services and products may not occur,
changing economic and competitive conditions, technological developments and
other risks and uncertainties.  Such risks, uncertainties and other
factors that could cause actual results and experience to differ from those
projected include, but are not limited to, the following: ineffectiveness of the
company’s business strategy due to changes in current or future market
conditions; the effects of competition, and of changes in laws and regulations
on competition, including industry consolidation and development of competing
financial products and services; interest rate movements; difficulties in
integrating distinct business operations, including information technology
difficulties; disruption from the transaction making it more difficult to
maintain relationships with customers and employees, and challenges in
establishing and maintaining operations in new markets; volatilities in the
securities markets; and deteriorating economic conditions.  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.








CONSOLIDATED
      STATEMENTS OF FINANCIAL CONDITION


(Dollars-in-thousands;
except share data)





December
      31,2008
                                  
                                  
                                  2007ASSETSCash
      and Due from Banks
                                  
                                  $
                                  17,621
                                  
                                  
                                  $
                                  16,700Federal
      Funds Sold
                                  
                                  
                                  14,150
                                  
                                  
                                  
                                  20,955Interest-Bearing
      Demand Deposits in Other Banks
                                  
                                  
                                  66
                                  
                                  
                                  
                                  227Total
      Cash and Cash Equivalents
                                  
                                  
                                  31,837
                                  
                                  
                                  
                                  37,882Interest-Bearing
      Time Deposits in Other Banks
                                  
                                  
                                  1,775
                                  
                                  
                                  –Investment
      Securities Available for Sale
                                  
                                  
                                  64,289
                                  
                                  
                                  
                                  74,176Loans
      and Leases, Net of Unearned Income
                                  
                                  
                                  358,280
                                  
                                  
                                  
                                  364,337Less:  Allowance
      for Loan and Lease Losses
                                  
                                  
                                  (4,358
                                  )
                                  
                                  
                                  (3,675
                                  )Net
      Loans and Leases
                                  
                                  
                                  353,922
                                  
                                  
                                  
                                  360,662Premises
      and Equipment, Net
                                  
                                  
                                  12,088
                                  
                                  
                                  
                                  9,038Restricted
      Investment in Bank Stocks
                                  
                                  
                                  3,703
                                  
                                  
                                  
                                  3,652Bank-Owned
      Life Insurance
                                  
                                  
                                  11,108
                                  
                                  
                                  
                                  10,669Other
      Assets
                                  
                                  
                                  6,387
                                  
                                  
                                  
                                  5,697TOTAL
      ASSETS
                                  
                                  $
                                  485,109
                                  
                                  
                                  $
                                  501,776LIABILITIESDeposits:Noninterest-Bearing
                                  
                                  $
                                  46,875
                                  
                                  
                                  $
                                  46,624Interest-Bearing
                                  
                                  
                                  336,702
                                  
                                  
                                  
                                  329,687Total
      Deposits
                                  
                                  
                                  383,577
                                  
                                  
                                  
                                  376,311Short-Term
      Borrowings
                                  
                                  
                                  
                                  
                                  
                                  6,629Long-Term
      Debt
                                  
                                  
                                  50,334
                                  
                                  
                                  
                                  68,816Junior
      Subordinated Debentures
                                  
                                  
                                  17,341
                                  
                                  
                                  
                                  17,341Other
      Liabilities
                                  
                                  
                                  3,063
                                  
                                  
                                  
                                  3,879TOTAL
      LIABILITIES
                                  
                                  
                                  454,315
                                  
                                  
                                  
                                  472,976STOCKHOLDERS'
      EQUITYCommon
      Stock, par value $0.25 per shareShares
      authorized - 20,000,000; Issued – 3,138,265 and 2,964,738 at December 31,
      2008 and 2007, respectively; Outstanding - 2,720,076 and 2,546,549 at
      December 31, 2008 and 2007, respectively
                                  
                                  
                                  785
                                  
                                  
                                  
                                  741Surplus
                                  
                                  
                                  14,868
                                  
                                  
                                  
                                  13,313Retained
      Earnings
                                  
                                  
                                  23,434
                                  
                                  
                                  
                                  23,063Accumulated
      Other Comprehensive Income
                                  
                                  
                                  36
                                  
                                  
                                  
                                  12Treasury
      Stock - 418,189 shares, at cost
                                  
                                  
                                  (8,329
                                  )
                                  
                                  
                                  (8,329
                                  )TOTAL
      STOCKHOLDERS' EQUITY
                                  
                                  
                                  30,794
                                  
                                  
                                  
                                  28,800TOTAL
      LIABILITIES and STOCKHOLDERS' EQUITY
                                  
                                  $
                                  485,109
                                  
                                  
                                  $
                                  501,776





See
accompanying notes to consolidated financial statements.


2





CONSOLIDATED
      STATEMENTS OF INCOME


(Dollars-in-thousands;
except per share data)





Years Ended December 31,2008
                
                
                2007
                
                
                2006INTEREST
      INCOMEInterest
      and Fees on Loans and Leases
                
                $
                24,594
                
                
                $
                26,834
                
                
                $
                23,613Investment
      Securities:Taxable
      Interest
                
                
                3,209
                
                
                
                3,358
                
                
                
                4,875Tax-Exempt
      Interest
                
                –
                
                
                
                403
                
                
                
                1,365Dividends
                
                
                114
                
                
                
                290
                
                
                
                402Other
                
                
                256
                
                
                
                488
                
                
                
                35Total
      Interest Income
                
                
                28,173
                
                
                
                31,373
                
                
                
                30,290INTEREST
      EXPENSEDeposits
                
                
                9,470
                
                
                
                10,790
                
                
                
                8,392Short-Term
      Borrowings
                
                
                210
                
                
                
                299
                
                
                
                489Long-Term
      Debt
                
                
                2,795
                
                
                
                3,652
                
                
                
                5,729Junior
      Subordinated Debentures
                
                
                1,104
                
                
                
                1,268
                
                
                
                1,016Total
      Interest Expense
                
                
                13,579
                
                
                
                16,009
                
                
                
                15,626Net
      Interest Income
                
                
                14,594
                
                
                
                15,364
                
                
                
                14,664PROVISION
      for LOAN and LEASE LOSSES
                
                
                1,027
                
                
                
                1,237
                
                
                
                672NET
      INTEREST INCOME after PROVISION for LOAN and LEASE LOSSES
                
                
                13,567
                
                
                
                14,127
                
                
                
                13,992NON-INTEREST
      INCOMEIncome
      from Fiduciary Activities
                
                
                309
                
                
                
                347
                
                
                
                274Service
      Charges on Deposit Accounts
                
                
                1,950
                
                
                
                1,864
                
                
                
                1,671Other
      Service Charges, Commissions, Fees
                
                
                1,091
                
                
                
                1,059
                
                
                
                954Alternative
      Investment Sales Commissions
                
                
                814
                
                
                
                845
                
                
                
                673Impairment
      Charge on Investment Securities
                
                
                (1,290
                )
                
                
                (800
                )
                
                –Net
      Investment Securities Gains
                
                
                252
                
                
                
                89
                
                
                
                209Mortgage
      Banking/Brokerage Activities
                
                
                56
                
                
                
                2,000
                
                
                
                3,129Title
      Insurance/Settlement Income
                
                –
                
                
                
                317
                
                
                
                585Earnings
      from Bank-Owned Life Insurance
                
                
                439
                
                
                
                426
                
                
                
                383Other
      Income
                
                
                186
                
                
                
                362
                
                
                
                384Total
      Non-Interest Income
                
                
                3,807
                
                
                
                6,509
                
                
                
                8,262NON-INTEREST
      EXPENSESalaries,
      Wages, and Employee Benefits
                
                
                7,676
                
                
                
                9,723
                
                
                
                10,426Net
      Occupancy
                
                
                1,818
                
                
                
                2,390
                
                
                
                1,693Furniture
      and Equipment
                
                
                1,017
                
                
                
                1,081
                
                
                
                886Professional
      Fees and Regulatory Assessments
                
                
                1,036
                
                
                
                1,516
                
                
                
                928Data
      and ATM Processing
                
                
                1,641
                
                
                
                1,662
                
                
                
                1,555Pennsylvania
      Shares Tax
                
                
                273
                
                
                
                243
                
                
                
                216Advertising
      and Marketing
                
                
                412
                
                
                
                653
                
                
                
                1,308Supplies
      and Postage
                
                
                401
                
                
                
                377
                
                
                
                460FDIC
      Insurance
                
                
                404
                
                
                
                137
                
                
                
                38Minority
      Interests in (Earnings) Losses of Subsidiaries
                
                –
                
                
                
                (41
                )
                
                
                130Restructuring
      Charge
                
                –
                
                
                
                717
                
                
                –Other
      Expense
                
                
                2,440
                
                
                
                2,287
                
                
                
                2,071Total
      Non-Interest Expense
                
                
                17,118
                
                
                
                20,745
                
                
                
                19,711Income
      (Loss) Before Provision for (Benefit from) Income Taxes
                
                
                256
                
                
                
                (109
                )
                
                
                2,543PROVISION
      for (BENEFIT from) INCOME TAXES
                
                
                (188
                )
                
                
                (421
                )
                
                
                99NET
      INCOME
                
                $
                444
                
                
                $
                312
                
                
                $
                2,444EARNINGS
      PER SHAREBasic
                
                $
                0.17
                
                
                $
                0.12
                
                
                $
                0.97Diluted
                
                
                0.17
                
                
                
                0.12
                
                
                
                0.96Cash Dividends
      Paid Per Share
                
                –
                
                
                
                0.28
                
                
                
                0.62





See
accompanying notes to consolidated financial statements.


3





CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY


(Dollars-in-thousands;
except share data)





Shares of
                              Common
                              Stock
                              Outstanding
                            
                            
                            Common
                              Stock
                            
                            
                            Surplus
                            
                            
                            Retained
                              Earnings
                            
                            
                            Accumulated
                              Other
                              Comprehensive
                              Income (Loss)
                            
                            
                            Treasury
                              Stock
                            
                            
                            TotalBalance
      at December 31, 2005
                            
                            
                            2,510,682
                            
                            
                            $
                            734
                            
                            
                            $
                            12,855
                            
                            
                            $
                            22,576
                            
                            
                            $
                            (447
                            )
                            
                            $
                            (8,493
                            )
                            
                            $
                            27,225Comprehensive
      Income:Net
      Income
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            2,444
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            2,444Unrealized
      Gains on Available for Sale Securities, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            370
                            
                            
                            –
                            
                            
                            
                            370Reclassification
      Adjustment for Gains Included in Net Income, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (139
                            )
                            
                            –
                            
                            
                            
                            (139
                            )Unrealized
      Losses on Cash Flow Hedges, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (26
                            )
                            
                            –
                            
                            
                            
                            (26
                            )Total
      Comprehensive Income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            2,649Acquisition
      of Treasury Stock
                            
                            
                            (8,709
                            )
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (168
                            )
                            
                            
                            (168
                            )Issuance
      of Common Stock under:Dividend
      Reinvestment and Stock Purchase Plans
                            
                            
                            18,404
                            
                            
                            
                            4
                            
                            
                            
                            349
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            353Employee
      Plans
                            
                            
                            3,606
                            
                            
                            
                            1
                            
                            
                            
                            48
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            49Retirement
      of Treasury Stock (17,000 shares)
                            
                            –
                            
                            
                            
                            (4
                            )
                            
                            
                            (334
                            )
                            
                            –
                            
                            
                            –
                            
                            
                            
                            338
                            
                            
                            –Cash
      Dividends Paid
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (1,560
                            )
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (1,560
                            )Balance
      at December 31, 2006
                            
                            
                            2,523,983
                            
                            
                            
                            735
                            
                            
                            
                            12,918
                            
                            
                            
                            23,460
                            
                            
                            
                            (242
                            )
                            
                            
                            (8,323
                            )
                            
                            
                            28,548Comprehensive
      Income:Net
      Income
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            312
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            312Unrealized
      Losses on Available for Sale Securities, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (272
                            )
                            
                            –
                            
                            
                            
                            (272
                            )Reclassification
      Adjustment for Gains Included in Net Income, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (58
                            )
                            
                            –
                            
                            
                            
                            (58
                            )Reclassification
      Adjustment for Impairment Charges on Investment Securities, Net of
      Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            528
                            
                            
                            –
                            
                            
                            
                            528Unrealized
      Gains on Cash Flow Hedges, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            56
                            
                            
                            –
                            
                            
                            
                            56Total
      Comprehensive Income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            566Acquisition
      of Treasury Stock
                            
                            
                            (364
                            )
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (6
                            )
                            
                            
                            (6
                            )Issuance
      of Common Stock under:Dividend
      Reinvestment and Stock Purchase Plans
                            
                            
                            9,634
                            
                            
                            
                            3
                            
                            
                            
                            145
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            148Employee
      Plans
                            
                            
                            13,296
                            
                            
                            
                            3
                            
                            
                            
                            168
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            171Share-Based
      Compensation Expense
                            
                            –
                            
                            
                            –
                            
                            
                            
                            82
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            82Cash
      Dividends Paid
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (709
                            )
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (709
                            )Balance
      at December 31, 2007
                            
                            
                            2,546,549
                            
                            
                            
                            741
                            
                            
                            
                            13,313
                            
                            
                            
                            23,063
                            
                            
                            
                            12
                            
                            
                            
                            (8,329
                            )
                            
                            
                            28,800Comprehensive
      Income:Net
      Income
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            444
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            444Unrealized
      Losses on Available for Sale Securities, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (661
                            )
                            
                            –
                            
                            
                            
                            (661
                            )Reclassification
      Adjustment for Gains Included in Net Income, Net of Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (166
                            )
                            
                            –
                            
                            
                            
                            (166
                            )Reclassification
      Adjustment for Impairment Charges on Investment Securities, Net of
      Tax
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            851
                            
                            
                            –
                            
                            
                            
                            851Total
      Comprehensive Income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            468Issuance
      of Common Stock under:Private
      Placement Stock Offering, Net of Costs
                            
                            
                            172,132
                            
                            
                            
                            44
                            
                            
                            
                            1,542
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            1,586Dividend
      Reinvestment and Stock Purchase Plans
                            
                            
                            745
                            
                            
                            –
                            
                            
                            
                            8
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            8Employee
      Plans
                            
                            
                            650
                            
                            
                            –
                            
                            
                            
                            5
                            
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            5Implementation
      of EITF 06-4
                            
                            –
                            
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (73
                            )
                            
                            –
                            
                            
                            –
                            
                            
                            
                            (73
                            )Balance
      at December 31, 2008
                            
                            
                            2,720,076
                            
                            
                            $
                            785
                            
                            
                            $
                            14,868
                            
                            
                            $
                            23,434
                            
                            
                            $
                            36
                            
                            
                            $
                            (8,329
                            )
                            
                            $
                            30,794





See
accompanying notes to consolidated financial statements.


4





CONSOLIDATED
      STATEMENTS OF CASH FLOWS


(Dollars-in-thousands;
except share data)





Year
      Ended December 31,2008
                                      
                                      
                                      2007
                                      
                                      
                                      2006CASH
      FLOWS from OPERATING ACTIVITIESNet
      Income
                                      
                                      $
                                      444
                                      
                                      
                                      $
                                      312
                                      
                                      
                                      $
                                      2,444Adjustments
      to Reconcile Net Income to Net Cash Provided by Operating
      Activities:Depreciation
      and Amortization
                                      
                                      
                                      1,313
                                      
                                      
                                      
                                      1,429
                                      
                                      
                                      
                                      1,104Provision
      for Loan and Lease Losses
                                      
                                      
                                      1,027
                                      
                                      
                                      
                                      1,237
                                      
                                      
                                      
                                      672Cash
      Payments Related to Restructuring Charge
                                      
                                      
                                      (223
                                      )
                                      
                                      
                                      (494
                                      )
                                      
                                      –Impairment
      Charge on Investment Securities
                                      
                                      
                                      1,290
                                      
                                      
                                      
                                      800
                                      
                                      
                                      –Net
      (Accretion) Amortization of Investment Securities (Discounts)
      Premiums
                                      
                                      
                                      (51
                                      )
                                      
                                      
                                      (245
                                      )
                                      
                                      
                                      429Net
      Investment Securities Gains
                                      
                                      
                                      (252
                                      )
                                      
                                      
                                      (89
                                      )
                                      
                                      
                                      (209
                                      )Benefit
      From Deferred Income Taxes
                                      
                                      
                                      (1,472
                                      )
                                      
                                      
                                      (8
                                      )
                                      
                                      
                                      (344
                                      )Earnings
      from Bank-Owned Life Insurance
                                      
                                      
                                      (439
                                      )
                                      
                                      
                                      (426
                                      )
                                      
                                      
                                      (383
                                      )Loss
      (Gain) on Sale of Loans
                                      
                                      
                                      37
                                      
                                      
                                      
                                      (1,428
                                      )
                                      
                                      
                                      (2,149
                                      )Decrease
      (Increase) in Accrued Interest Receivable
                                      
                                      
                                      450
                                      
                                      
                                      
                                      485
                                      
                                      
                                      
                                      (371
                                      )(Increase)
      Decrease in Other Assets
                                      
                                      
                                      131
                                      
                                      
                                      
                                      42
                                      
                                      
                                      
                                      (661
                                      )(Decrease)
      Increase in Other Liabilities
                                      
                                      
                                      (666
                                      )
                                      
                                      
                                      212
                                      
                                      
                                      
                                      630Proceeds
      from Sale of Loans
                                      
                                      –
                                      
                                      
                                      
                                      60,586
                                      
                                      
                                      
                                      80,315Loans
      Originated for Sale
                                      
                                      –
                                      
                                      
                                      
                                      (57,496
                                      )
                                      
                                      
                                      (77,681
                                      )Restructuring
      Charge
                                      
                                      –
                                      
                                      
                                      
                                      717
                                      
                                      
                                      –Goodwill
      Impairment
                                      
                                      –
                                      
                                      
                                      
                                      157
                                      
                                      
                                      –Stock-Based
      Compensation Expense
                                      
                                      –
                                      
                                      
                                      
                                      82
                                      
                                      
                                      –(Decrease)
      Increase in Minority Interest in Consolidated Subsidiaries
                                      
                                      –
                                      
                                      
                                      
                                      (75
                                      )
                                      
                                      
                                      10Net
      Gain on Sale of Foreclosed Real Estate
                                      
                                      –
                                      
                                      
                                      
                                      (128
                                      )
                                      
                                      –Net
      Cash Provided by Operating Activities
                                      
                                      
                                      1,589
                                      
                                      
                                      
                                      5,670
                                      
                                      
                                      
                                      3,806CASH
      FLOWS from INVESTING ACTIVITIESProceeds
      from Sales of Available for Sale Securities
                                      
                                      
                                      42,463
                                      
                                      
                                      
                                      95,514
                                      
                                      
                                      
                                      19,549Proceeds
      from Maturities and Principal Repayments on Available for Sale
      Securities
                                      
                                      
                                      38,254
                                      
                                      
                                      
                                      13,028
                                      
                                      
                                      
                                      17,491Purchases
      of Available for Sale Securities
                                      
                                      
                                      (71,780
                                      )
                                      
                                      
                                      (53,074
                                      )
                                      
                                      
                                      (47,015
                                      )Net
      Purchases of Time Deposits in Other Banks
                                      
                                      
                                      (1,775
                                      )
                                      
                                      –
                                      
                                      
                                      –(Purchase)
      Sale of Restricted Investments in Bank Stocks, net
                                      
                                      
                                      (51
                                      )
                                      
                                      
                                      2,342
                                      
                                      
                                      
                                      (258
                                      )Net
      Loans and Leases Made to Customers
                                      
                                      
                                      (1,090
                                      )
                                      
                                      
                                      (23,856
                                      )
                                      
                                      
                                      (41,177
                                      )Proceeds
      from Sale of Loans
                                      
                                      
                                      6,766
                                      
                                      
                                      –
                                      
                                      
                                      –Purchases
      of Premises, Equipment and Software
                                      
                                      
                                      (4,175
                                      )
                                      
                                      
                                      (688
                                      )
                                      
                                      
                                      (3,569
                                      )Proceeds
      from Sale of Foreclosed Real Estate
                                      
                                      –
                                      
                                      
                                      
                                      314
                                      
                                      
                                      –Net
      Cash Provided by (Used In) Investing Activities
                                      
                                      
                                      8,612
                                      
                                      
                                      
                                      33,580
                                      
                                      
                                      
                                      (54,979
                                      )CASH
      FLOWS from FINANCING ACTIVITIESNet
      (Decrease) Increase in Demand Deposits and Savings
Accounts
                                      
                                      
                                      (11,097
                                      )
                                      
                                      
                                      9,485
                                      
                                      
                                      
                                      10,856Net
      Increase in Time Deposits
                                      
                                      
                                      18,363
                                      
                                      
                                      
                                      26,751
                                      
                                      
                                      
                                      32,609Net
      Decrease in Short-Term Borrowings
                                      
                                      
                                      (6,629
                                      )
                                      
                                      
                                      (3,915
                                      )
                                      
                                      
                                      (7,761
                                      )Payments
      on Long-Term Debt
                                      
                                      
                                      (18,482
                                      )
                                      
                                      
                                      (53,009
                                      )
                                      
                                      
                                      (32,730
                                      )Issuance
      of Common Stock
                                      
                                      
                                      1,599
                                      
                                      
                                      
                                      319
                                      
                                      
                                      
                                      402Cash
      Dividends Paid
                                      
                                      –
                                      
                                      
                                      
                                      (709
                                      )
                                      
                                      
                                      (1,560
                                      )Proceeds
      from Issuance of Long-Term Debt
                                      
                                      –
                                      
                                      
                                      
                                      4,254
                                      
                                      
                                      
                                      44,486Proceeds
      from Issuance of Junior Subordinated Debentures
                                      
                                      –
                                      
                                      
                                      –
                                      
                                      
                                      
                                      6,000Acquisition
      of Treasury Stock
                                      
                                      –
                                      
                                      
                                      
                                      (6
                                      )
                                      
                                      
                                      (168
                                      )Net
      Cash (Used in) Provided by Financing Activities
                                      
                                      
                                      (16,246
                                      )
                                      
                                      
                                      (16,830
                                      )
                                      
                                      
                                      52,134Net
      (Decrease) Increase in Cash and Cash Equivalents
                                      
                                      
                                      (6,045
                                      )
                                      
                                      
                                      22,420
                                      
                                      
                                      
                                      961CASH
      and CASH EQUIVALENTS - Beginning of Period
                                      
                                      
                                      37,882
                                      
                                      
                                      
                                      15,462
                                      
                                      
                                      
                                      14,501CASH
      and CASH EQUIVALENTS - End of Period
                                      
                                      $
                                      31,837
                                      
                                      
                                      $
                                      37,882
                                      
                                      
                                      $
                                      15,462Supplemental
      Disclosures of Cash Flow InformationInterest
      Paid
                                      
                                      $
                                      14,247
                                      
                                      
                                      $
                                      15,893
                                      
                                      
                                      $
                                      15,011Income
      Tax Paid
                                      
                                      
                                      525
                                      
                                      
                                      
                                      231
                                      
                                      
                                      
                                      800Supplemental
      Schedule of Noncash ActivitiesRetirement of Treasury Stock (17,000 shares in
      2006)
                                      
                                      $
                                      –
                                      
                                      
                                      $
                                      –
                                      
                                      
                                      $
                                      338





See
accompanying notes to consolidated financial statements.


5





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS





NOTE
1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





The
accounting and reporting policies of Union National Financial Corporation
(“Union National”) and its subsidiary, Union National Community Bank (the
“Bank”), are in conformance with accounting principles generally accepted in the
United States of America (“GAAP”) and prevailing practices within the banking
industry.  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 (for
additional information, refer to Note 11).





The Bank
is a full-service commercial bank which operates ten retail office locations in
Lancaster County, Pennsylvania, providing a wide range of services to
individuals and businesses.  The Bank accepts time, demand and savings
deposits and offers secured and unsecured commercial, real estate and consumer
loans, and leases.  The Bank also offers investment, custodial, estate
planning and trust services.  The Bank is subject to government
regulation and undergoes periodic examinations by its federal regulator, the
Office of the Comptroller of the Currency.





Home Team
Financial, LLC, (“Home Team”) was a subsidiary of the Bank and began operations
in July 2005, had mortgage banking operations, offered mortgage brokerage
services, and offered title insurance and settlement services through its
subsidiary, TA of Lancaster, LLC.  The Bank’s ownership interest in
Home Team was 98%.  Home Team ceased operations effective October 31,
2007 (for additional information, refer to Note 16).





Basis
of Presentation


The
consolidated financial statements include the accounts of Union National, the
Bank, Home Team, and its subsidiary, TA of Lancaster, LLC.  All
material intercompany accounts and transactions have been
eliminated.  Union National’s two trust subsidiaries are not
consolidated.  Certain amounts previously reported have been
reclassified to conform to the financial statement presentation for
2008.  The reclassifications had no effect on net income.





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 loan and lease losses, the valuation of deferred tax assets, the assessment
of other-than-temporary impairment of investment securities, and the potential
impairment of restricted stock.





Significant
Group Concentrations of Credit Risk


Most of
Union National’s activities are with customers primarily located in Lancaster
County, PA.  The types of securities in which Union National invests
are discussed in Note 3, while the types of lending activities that are engaged
in by Union National are discussed in Note 4.  Union National does not
have any significant concentrations of risk in any one industry or
customer.  A large portion of the loan portfolio consists of
commercial and agricultural loans, primarily secured by real
estate.





Cash
and Cash Equivalents


For
purposes of reporting the consolidated statement of cash flows, cash and cash
equivalents include cash on hand, amounts due from banks, interest-bearing
demand deposits with banks, and federal funds sold.  Generally,
federal funds sold are for one-day periods.





Interest-Bearing
Time Deposits in Other Banks


Interest
bearing time deposits in other banks consist of certificate of deposits in other
banks with maturities less than two years, and are carried at cost.





Investment
Securities


Investment
securities include both debt securities and equity securities.  As of
December 31, 2008 and 2007, all of Union National’s investment securities are
classified as available for sale.  Securities classified as available
for sale are marketable equity securities and those debt securities that Union
National intends to hold for an indefinite period of time, but not necessarily
to maturity.  Any decision to sell a security would be based on
various factors, including significant movements in interest rates, changes in
maturity mix of Union National's assets and liabilities, liquidity needs,
regulatory capital considerations and other similar
factors.  Available for sale securities are carried at fair value with
premiums and discounts amortized or accreted
to interest income using the interest method.  Changes in unrealized
gains or losses on available for sale securities, net of taxes, are recorded in
accumulated other comprehensive income (loss), a component of stockholders'
equity.


6





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





When a
determination is made that a decline in fair value below the cost of a
marketable equity or debt security is other than temporary, the cost basis of
the individual security is written down to the fair value and the impact is
reflected in earnings as a realized loss.  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, independent analysts’ opinions
about circumstances that could affect the performance of the investment
securities, and management’s intention and ability to hold the investment
securities to the earlier of recovery of losses or maturity.





Loans
and Leases


Loans
that management has the intent and ability to hold are generally stated at their
outstanding unpaid principal balances adjusted for charge-offs, plus any
unamortized premiums on purchased loans, net of any deferred fees or costs on
originated loans.  Interest income is accrued on the unpaid principal
balance.  Loan origination fees, net of certain direct origination
costs, are deferred and recognized as an adjustment to interest income generally
over the contractual life of the related loans.





Loans
include leases that meet the criteria for direct financing leases under
Statement of Financial Accounting Standards (“SFAS”) No. 13.  Such
leases are recorded as assets at the total minimum lease payments and residual
value to be received, less unearned interest income.  Unearned
interest income and initial direct costs are amortized to interest income over
the lease term using the interest method.





Nonaccrual Loans and Leases -
Generally, a loan or lease (including an impaired loan or lease as discussed
below under “Allowance for Loan and Lease Losses”) is classified as nonaccrual
and the accrual of interest on such loan or lease is discontinued when the
contractual payment of principal or interest has become 90 days past due or
management has serious doubts about further collectibility of principal or
interest.  A loan or lease 90 days or more past due may remain on
accrual status if it is in the process of collection and is either guaranteed or
well-secured.  When a loan or lease is placed on nonaccrual status,
uncollected interest previously credited to interest income that is deemed
uncollectible, is reversed.  Interest received on nonaccrual loans and
leases is either applied against principal or reported as interest income,
according to management's judgment as to the collectibility of
principal.  Generally, loans and leases are restored to accrual status
when both principal and interest are brought current, the loan or lease has
performed in accordance with the contractual terms for a reasonable period of
time, and the ultimate collectibility of the total contractual principal and
interest is no longer in doubt.





Allowance
for Loan and Lease Losses


The
allowance for loan and lease losses is established through provisions for losses
charged against income.  Loans and leases, including impaired loans
and leases, deemed to be uncollectible are charged against the allowance for
loan and lease losses, and subsequent recoveries, if any, are credited to the
allowance.





The
allowance for loan and lease losses is maintained at a level believed by
management to be adequate to absorb estimated probable loan and lease
losses.  Management's periodic evaluation of the adequacy of the
allowance is based on Union National's past 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), estimated value of
any underlying collateral, composition of the portfolio, current economic
conditions and other relevant factors.  This evaluation is inherently
subjective as it requires material estimates including the amounts and timing of
future cash flows expected to be received on impaired loans and leases that may
be susceptible to significant change.





The
allowance 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
fair value) of the impaired loan or lease is lower than the carrying value of
that loan or lease.  The general component covers non-classified loans
and leases and is based on historical loss experience adjusted for qualitative
factors.  An unallocated component is maintained to cover
uncertainties that could affect management’s 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.


7





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





Impaired Loans and Leases -
Union National considers a loan or lease to be impaired when, based upon current
information and events, it is probable that all interest and principal payments
due according to the contractual terms of the loan or lease agreement will not
be collected.  An insignificant delay or shortfall in the amounts of
payments would not cause a loan or lease  to be considered
impaired.  Management determines the significance of payment delays
and shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan or lease and the borrower, including the
length and reasons for the delay, the borrower’s prior payment record, and the
amount of the shortfall in relation to the principal and interest
owed.  Larger groups of small-balance loans, such as residential
mortgages and consumer installment loans, are collectively evaluated for
impairment.  Accordingly, Union National does not separately identify
individual consumer and residential loans for impairment disclosures unless such
loans are the subject of a restructuring agreement.  Union National
measures impairment of commercial loans and leases on a loan-by-loan basis based
upon the present value of expected future cash flows discounted at the loan or
lease’s effective interest rate, or the fair value of the collateral for certain
collateral-dependent loans.





Premises
and Equipment


Land is
carried at cost.  Premises and equipment are stated at cost less
accumulated depreciation, which is computed over the assets' estimated useful
lives on both the accelerated and the straight-line
methods.  Leasehold improvements are stated at cost less accumulated
amortization, which is computed over the term of the lease, including renewal
options, if reasonably assured, on the straight-line method.  Gains
and losses on premises and equipment are recognized upon disposal of the
asset.  Charges for maintenance and repairs are charged to expense as
incurred.





Restricted
Investment in Bank Stocks


Restricted
investment in bank stocks, which represents required investments in the common
stock of correspondent banks is carried at cost and as of December 31, 2008 and
2007, consists of the common stock of the Federal Home Loan Bank of Pittsburgh
(“FHLB”), the Federal Reserve Bank of Philadelphia (“FRB”) and the Atlantic
Central Bankers Bank (“ACBB”).  In December 2008, the FHLB notified
member banks that it was suspending dividend payments and the repurchase of
capital stock.





Management
evaluates the restricted stock for impairment in accordance with Statement of
Position (“SOP”) 01-6, “Accounting by Certain Entities (Including Entities With
Trade Receivables) That Lend to or Finance the Activities of
Others.”  Management’s determination of whether these investments are
impaired is based on their assessment of the ultimate recoverability of their
cost rather than by recognizing temporary declines in value.  The
determination of whether a decline affects the ultimate recoverability of their
cost is influenced by criteria such as (1) the significance of the decline in
net assets of the FHLB as compared to the capital stock amount for the FHLB and
the length of time this situation has persisted, (2) commitments by the FHLB to
make payments required by law or regulation and the level of such payments in
relation to the operating performance of the FHLB, and (3) the impact of
legislative and regulatory changes on institutions and, accordingly, on the
customer base of the FHLB.





Management
believes no impairment charge is necessary related to the restricted investment
in bank stocks as of December 31, 2008.





Bank-Owned
Life Insurance


Union
National invests in bank-owned life insurance (“BOLI”) as a source of funding
for employee benefit expenses.  BOLI involves the purchase of life
insurance by the Bank on a chosen group of employees.  The Bank is the
owner and is a joint or sole beneficiary of the policies.  This life
insurance investment is carried at the cash surrender value of the underlying
policies.   Income from the increase in cash surrender value of
the policies is reflected in non-interest income.





Effective
January 1, 2008, Union National adopted the provisions of Emerging Issues Task
Force (“EITF”) Issue No. 06-4, “Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance
Arrangements” (“EITF 06-4”).  EITF 06-4 requires the recognition of a
liability related to the postretirement benefits covered by an endorsement
split-dollar life insurance arrangement, and the liability for the future death
benefit should be recognized by following the guidance in SFAS No. 106 or
Accounting Principles Board Opinion No. 12, as appropriate.  Union
National has certain split-dollar life insurance arrangements as part of Union
National’s bank-owned life insurance program, and recognized its liability and
related compensation expense in accordance with SFAS No. 106.  In
adopting EITF 06-4, Union National recorded a cumulative effect adjustment to
the balance of retained earnings of $73,000 on January 1, 2008.


8





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





Transfers
of Financial Assets


Transfers
of financial assets are accounted for as sales when control over the assets is
deemed to be surrendered, specifically when (1) the assets have been isolated
from Union National; (2) the transferee obtains the right (free of conditions
that constrain it from taking advantage of that right) to pledge or exchange the
transferred assets; and (3) Union National does not maintain effective control
over the transferred assets through an agreement to repurchase them before their
maturity.





Mortgage
Servicing Rights


Mortgage
servicing rights are recognized as assets upon the sale of a mortgage
loan.  A portion of the cost of the loan is allocated to the servicing
right based upon relative fair value.  The fair value of servicing
assets is based on the present value of estimated future cash flows for pools of
mortgages stratified by rate and maturity date. Assumptions that are
incorporated in the valuation of servicing assets include assumptions about
prepayment speeds on mortgages and the cost to service
loans.  Servicing assets are reported in other assets and are
amortized over the estimated period of future servicing income to be received on
the underlying mortgage loans.  The carrying amount of Union
National’s mortgage servicing assets was $60,000 and $104,000 at December 31,
2008 and 2007, respectively.  Amortization expense is netted against
loan servicing fee income and is reflected in the consolidated statements of
income in mortgage banking/brokerage activities.  Servicing assets are
evaluated for impairment based upon estimated fair value as compared to
unamortized book value.





Union
National retains the servicing on the loans sold to the FHLB and receives a fee
based upon the principal balance outstanding.  Total loans serviced
for others amounted to $28,284,000, $32,332,000, and $35,225,000 at December 31,
2008, 2007, and 2006, respectively, and are not reflected in the consolidated
statements of financial condition.





Derivative
Instruments


For
asset/liability management purposes, Union National occasionally uses interest
rate cap and collar agreements to hedge various exposures or to modify interest
rate characteristics of various balance sheet accounts.  Such
derivatives are used as part of the asset/liability management process and are
linked to specific assets or liabilities and have high correlation between the
contract and the underlying item being hedged both at inception and throughout
the hedge period.





In
accordance with SFAS No. 133, as amended, Union National records all derivatives
on the balance sheet at fair value.  The accounting for changes in the fair
value of derivatives depends on the intended use of the derivative and the
resulting designation.  Derivatives used to hedge Union National’s
exposure to variability in expected future cash flows, or other types of
forecasted transactions, are designated as cash flow hedges.




For
derivatives designated as cash flow hedges, the effective portion of changes in
the fair value of the derivative is initially reported in other comprehensive
income (loss) and subsequently reclassified to earnings when the underlying
hedged transaction affects earnings.  The ineffective portion of
changes in the fair value of the derivative is recognized directly in earnings.
Union National assesses the effectiveness of each hedging relationship by using
the hypothetical derivative method.  This method compares the actual
hedge with a hypothetically perfect hedge, where the cumulative change in fair
value of the actual hedge will be compared to the cumulative change in fair
value of a hypothetically perfect hedge with critical terms that exactly match
the critical terms of the hedged transactions.





Cash
flows resulting from the derivative financial instruments that are accounted for
as hedges of assets and liabilities are classified in the cash flow statement in
the same category as the cash flows of the underlying hedged items.





As of
December 31, 2008 and 2007, Union National had no derivatives.





Foreclosed
Real Estate


Foreclosed
real estate includes assets acquired through foreclosure and loans identified as
in-substance foreclosures.  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, included in other expenses. Union National
had no foreclosed real estate at December 31, 2008 and 2007.


9





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





Trust
Assets


Assets
held in a fiduciary capacity are not assets of Union National and are not
included in the consolidated financial statements. The market value of trust
assets under management amounted to $83,728,000 and $115,079,000 at December 31,
2008 and 2007, respectively.





Off-Balance
Sheet Commitments


In the
ordinary course of business, Union National has entered into commitments to
extend credit, including commitments under commercial lines of credit,
commercial lines of credit, and standby letters of credit.  Such
financial instruments are recorded when they are funded.





Comprehensive
Income


Union
National reports comprehensive income and the components of other comprehensive
income in the Consolidated Statements of Changes in Stockholders’
Equity.  Union National’s comprehensive income consists of net income,
unrealized gains and losses on available for sale investment securities, and
changes in the fair value of cash flow hedges arising during the
period.  The components of accumulated other comprehensive income are
as follows (in thousands):





December
      31,2008
                    
                    
                    2007Unrealized
      Holding Gains on Investment Securities Available for Sale, Net of Tax
      Expense of $20 and $6,  respectively
                    
                    $
                    36
                    
                    
                    $
                    12Accumulated
      Other Comprehensive Income
                    
                    $
                    36
                    
                    
                    $
                    12





Treasury
Stock


The
acquisition of treasury stock is recorded under the cost method.  The
subsequent disposition or sale of the treasury stock is recorded using the
average cost method.





Stock-Based
Compensation


On
January 1, 2006, Union National adopted Statement of Financial Accounting
Standards No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which requires
recognition of compensation expense for future share-based awards based upon an
assessment of the grant date fair value.  Stock compensation expense
for share-based awards is recognized on a straight-line basis over the vesting
period of the award.  See additional information regarding stock-based
compensation in Note 2.





Advertising
and Marketing Costs


Advertising
costs are charged to expense as incurred.





Income
Taxes


The
provision for income taxes is based upon the results of operations, adjusted
principally for tax-exempt income.  Accounting for income taxes is
under the liability method, whereby a deferred tax asset or liability is
recorded based upon the difference between the tax basis of assets and
liabilities and their carrying amounts for financial reporting
purposes.  The deferred tax assets and liabilities are adjusted for
the impact of tax-rate changes.  Valuation allowances are established
when necessary to reduce deferred tax assets to the amount expected to be
realized in the future.  Provision or benefit is the tax payable or
refundable for the period, plus or minus the change in deferred tax assets and
liabilities during the period.





Earnings
Per Share


Basic
earnings per share is computed by dividing net income by the weighted-average
number of common shares outstanding during the period.  Diluted
earnings per share reflects the potential dilution that could occur if options
to issue common stock were exercised.  Potential common shares that
may be issued relate solely to outstanding stock options and are determined
using the treasury stock method.


10





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





The
computation of basic and diluted earnings per share, net income, and
weighted-average number of shares outstanding for the years ended December 31,
2008, 2007 and 2006, are presented below (amounts, except earnings per share, in
thousands):





Years
      Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Net
      Income
                  
                  $
                  444
                  
                  
                  $
                  312
                  
                  
                  $
                  2,444Weighted-average
      number of common shares outstanding
                  
                  
                  2,643
                  
                  
                  
                  2,536
                  
                  
                  
                  2,518Earnings
      Per Share – Basic
                  
                  $
                  0.17
                  
                  
                  $
                  0.12
                  
                  
                  $
                  0.97Weighted-average
      number of common shares outstanding
                  
                  
                  2,643
                  
                  
                  
                  2,536
                  
                  
                  
                  2,518Common
      stock equivalents due to effect of stock options
                  
                  –
                  
                  
                  
                  8
                  
                  
                  
                  19Total
      weighted-average common shares and equivalents
                  
                  
                  2,643
                  
                  
                  
                  2,544
                  
                  
                  
                  2,537Earnings
      Per Share – Diluted
                  
                  $
                  0.17
                  
                  
                  $
                  0.12
                  
                  
                  $
                  0.96





Stock
options outstanding which had no intrinsic value, and therefore, would not be
included in a diluted earnings per share computation, were 93,511, 116,468 and
88,532 as of December 31, 2008, 2007 and 2006, respectively.





Segment
Reporting


Union
National has only one operating segment consisting primarily of its banking and
fiduciary activities, consistent with the way management monitors financial
results.  Management does not separately allocate expenses between the
commercial, retail and trust operations of the Bank.  As such,
discrete information is not available and segment reporting would not be
meaningful.





Recent
Accounting Pronouncements


In June
2007, the Emerging Issues Task Force (EITF) reached a consensus on Issue
No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based
Payment Awards” (“EITF 06-11”). EITF 06-11 states that an entity should
recognize a realized tax benefit associated with dividends on nonvested equity
shares, nonvested equity share units and outstanding equity share options
charged to retained earnings as an increase in additional paid in
capital. The amount recognized in additional paid in capital should be
included in the pool of excess tax benefits available to absorb potential future
tax deficiencies on share-based payment awards. EITF 06-11 should be
applied prospectively to income tax benefits of dividends on equity-classified
share-based payment awards that are declared in fiscal years beginning after
December 15, 2007.  The adoption of EITF 06-11 did not have a
significant impact on Union National’s consolidated financial
statements.





On
January 1, 2008, Union National adopted SFAS No. 157, “Fair Value Measurements.”
SFAS No. 157 defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles, and expands disclosures about
fair value measurements (See Note 20 - Fair Value Measurements and Fair
Value of Financial Instruments).





On
January 1, 2008, Union National adopted the provisions of the Emerging Issues
Task Force (“EITF”) Issue No. 06-4, “Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance
Arrangements” (“EITF 06-4”).  EITF 06-4 requires the recognition of a
liability related to the postretirement benefits covered by an endorsement
split-dollar life insurance arrangement.  Union National has
split-dollar life insurance arrangements and has recorded the impact of adopting
the standard on the Consolidated Statements of Financial Condition, the
Consolidated Statements of Income, and Changes in Stockholder’s
Equity.





On
January 1, 2008, Union National adopted the provisions of SFAS No. 159, “The
Fair Value Option for Financial Assets and Financial Liabilities-Including an
amendment of FASB Statement No. 115” (“SFAS 159”).  SFAS 159 expands
the use of fair value accounting but does not affect existing standards which
require assets and liabilities to be carried at fair value. Under SFAS 159,
Union National may elect to use fair value to measure accounts and loans
receivable, available for sale and held to maturity securities, accounts
payable, guarantees, issued debt and other eligible financial
instruments.  (See Note 20 - Fair Value Measurements and Fair
Value of Financial Instruments).  Adoption of SFAS 159 did not
have a significant impact on Union National’s consolidated financial
statements.


11





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





The SEC
has issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded
at Fair Value Through Earnings” (“SAB 109”), which expresses the views of the
staff regarding written loan commitments that are accounted for at fair value
through earnings under generally accepted accounting principles. To make the
staff's views consistent with current authoritative accounting guidance, the SAB
revises and rescinds portions of SAB No. 105, “Application of Accounting
Principles to Loan Commitments.”  Specifically, the SAB revises the
SEC staff's views on incorporating expected net future cash flows related to
loan servicing activities in the fair value measurement of a written loan
commitment. The SAB retains the staff's views on incorporating expected net
future cash flows related to internally-developed intangible assets in the fair
value measurement of a written loan commitment. The staff expects registrants to
apply the views in Question 1 of SAB 109 on a prospective basis to derivative
loan commitments issued or modified in fiscal quarters beginning after December
15, 2007.  Adoption and consideration of SAB 109 did not have a
significant impact on Union National’s consolidated financial
statements.





The SEC
has issued Staff Accounting Bulletin No. 110 (“SAB 110”), which amends and
replaces Question 6 of Section D.2 of Topic 14, “Share-Based Payment,” of the
Staff Accounting Bulletin series. Question 6 of Section D.2 of Topic 14
expresses the views of the staff regarding the use of the “simplified” method in
developing an estimate of expected term of “plain vanilla” share options and
allows usage of the “simplified” method for share option grants prior to
December 31, 2007. SAB 110 allows public companies which do not have
historically sufficient experience to provide a reasonable estimate to continue
use of the “simplified” method for estimating the expected term of “plain
vanilla” share option grants after December 31, 2007.  Adoption
and consideration of SAB 110 did not have a significant impact on Union
National’s consolidated financial statements.





In
September 2008, the FASB issued FASB Staff Position (“FSP”) 133-1 and FASB
Interpretation (“FIN”) 45-4, “Disclosures about Credit Derivatives and Certain
Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No.
45; and Clarification of the Effective Date of FASB Statement No. 161” (“FSP
133-1” and “FIN 45-4”).  FSP 133-1 and FIN 45-4 amends and enhances
disclosure requirements for sellers of credit derivatives and financial
guarantees.  It also clarifies that the disclosure requirements of
SFAS No. 161 are effective for quarterly periods beginning after November 15,
2008, and fiscal years that include those periods.  FSP 133-1 and FIN
45-4 is effective for reporting periods (annual or interim) ending after
November 15, 2008.  The implementation of this standard will not have
a material impact on our consolidated financial position and results of
operations.





In
October 2008, the FASB issued FSP SFAS No. 157-3, “Determining the
Fair Value of a Financial Asset When The Market for That Asset Is Not
Active”  (“FSP 157-3”), to clarify the application of the
provisions of SFAS 157 in an inactive market and how an entity would
determine fair value in an inactive market.  FSP 157-3 is
effective immediately.  The application of the provisions of
FSP 157-3 did not materially affect our consolidated financial statements
for the period ended December 31, 2008.





In
December 2007, the FASB issued SFAS No. 141 (R), “Business Combinations” (“SFAS
141(R)”).  SFAS 141(R) establishes principles and requirements for how
the acquirer of a business recognizes and measures in its financial statements
the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree. SFAS 141(R) also provides guidance for
recognizing and measuring the goodwill acquired in the business combination and
determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. The guidance will become effective as of the beginning of a
corporation’s fiscal year beginning after December 15, 2008.  SFAS
141(R) will impact Union National’s accounting for business combinations
beginning January 1, 2009.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS
160”).  SFAS 160 establishes accounting and reporting standards for
the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. The guidance will become effective as of the beginning of a
corporation’s fiscal year beginning after December 15,
2008.  Management does not believe that SFAS 160 will have a material
impact on Union National’s consolidated financial statements in future
periods.





In
February 2008, the FASB issued FSP FAS 140-3, “Accounting for Transfers of
Financial Assets and Repurchase Financing Transactions.” This FSP addresses the
issue of whether or not these transactions should be viewed as two separate
transactions or as one "linked" transaction. The FSP includes a “rebuttable
presumption” that presumes linkage of the two transactions unless the
presumption can be overcome by meeting certain criteria. The FSP will be
effective for fiscal years beginning after November 15, 2008 and will apply only
to original transfers made after that date; early adoption will not be allowed.
Management is currently evaluating the potential impact the new pronouncement
will have on its consolidated financial statements.




12





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





In March
2008, the FASB issued Statement No. 161, “Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No. 133”
(“Statement 161”).  Statement 161 requires entities that utilize
derivative instruments to provide qualitative disclosures about their objectives
and strategies for using such instruments, as well as any details of
credit-risk-related contingent features contained within
derivatives.  Statement 161 also requires entities to disclose
additional information about the amounts and location of derivatives located
within the financial statements, how the provisions of SFAS 133 have been
applied, and the impact that hedges have on an entity’s financial position,
financial performance, and cash flows.  Statement 161 is effective for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged.  Management is currently evaluating the
potential impact the new pronouncement will have on its consolidated financial
statements.





In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets.” This FSP amends the factors that should
be considered in developing renewal or extension assumptions used to determine
the useful life of a recognized intangible asset under FASB Statement
No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). The intent of
this FSP is to improve the consistency between the useful life of a recognized
intangible asset under SFAS 142 and the period of expected cash flows used
to measure the fair value of the asset under SFAS 141(R), and other
GAAP.  This FSP is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. Early adoption is prohibited.  Management is
currently evaluating the potential impact the new pronouncement will have on its
consolidated financial statements.





In May
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles.”  This Statement identifies the sources of
accounting principles and the framework for selecting the principles used in the
preparation of financial statements.  This Statement is effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity
with Generally Accepted Accounting Principles.”  Management is
currently evaluating the potential impact the new pronouncement will have on its
consolidated financial statements.





In May
2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments
That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”
which clarifies the accounting for convertible debt instruments that may be
settled in cash (including partial cash settlement) upon
conversion.  The FSP requires issuers to account separately for the
liability and equity components of certain convertible debt instruments in a
manner that reflects the issuer's nonconvertible debt borrowing rate when
interest cost is recognized.  The FSP requires bifurcation of a
component of the debt, classification of that component in equity and the
accretion of the resulting discount on the debt to be recognized as part of
interest expense.  The FSP requires retrospective application to the
terms of instruments as they existed for all periods presented.  The
FSP is effective for fiscal years beginning after December 15, 2008, and interim
periods within those years.  Management is currently evaluating the
potential impact the new pronouncement will have on its consolidated financial
statements.





In June
2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted
in Share-Based Payment Transactions Are Participating
Securities.”  This FSP clarifies that all outstanding unvested
share-based payment awards that contain rights to nonforfeitable dividends
participate in undistributed earnings with common shareholders. Awards of this
nature are considered participating securities and the two-class method of
computing basic and diluted earnings per share must be applied.  This
FSP is effective for fiscal years beginning after December 15,
2008.  Management is currently evaluating the potential impact the new
pronouncement will have on its consolidated financial statements.





In June
2008, the FASB ratified EITF Issue No. 07-5, “Determining Whether an Instrument
(or an Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF
07-5”).  EITF 07-5 provides that an entity should use a two step
approach to evaluate whether an equity-linked financial instrument (or embedded
feature) is indexed to its own stock, including evaluating the instrument’s
contingent exercise and settlement provisions.  It also clarifies the
impact of foreign currency denominated strike prices and market-based employee
stock option valuation instruments on the evaluation.  EITF 07-5 is
effective for fiscal years beginning after December 15,
2008.  Management is currently evaluating the potential impact the new
pronouncement will have on its consolidated financial
statements.


13





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





In
September 2008, the FASB ratified EITF Issue No. 08-5, “Issuer’s Accounting for
Liabilities Measured at Fair Value With a Third-Party Credit Enhancement” (“EITF
08-5”).  EITF 08-5 provides guidance for measuring liabilities issued
with an attached third-party credit enhancement (such as a
guarantee).  It clarifies that the issuer of a liability with a
third-party credit enhancement should not include the effect of the credit
enhancement in the fair value measurement of the liability.  EITF 08-5
is effective for the first reporting period beginning after December 15,
2008.  Adoption and consideration of EITF 08-5 did not have a
significant impact on Union National’s consolidated financial position and
results of operations.





In
December 2008, the FASB issued FAS 140-4 and FIN 46(R)-8, “Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interests in
Variable Interest Entities” (“FSP 140-4” and “FIN 46(R)-8”). FSP 140-4 and FIN
46(R)-8 amends FASB SFAS 140 “Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities”, to require public entities
to provide additional disclosures about transfers of financial assets. It also
amends FIN 46(R), “Consolidation of Variable Interest Entities”, to require
public enterprises, including sponsors that have a variable interest in a
variable interest entity, to provide additional disclosures about their
involvement with variable interest entities. Additionally, this FSP requires
certain disclosures to be provided by a public enterprise that is (a) a sponsor
of a qualifying Special Purpose Entity (“SPE”) that holds a variable interest in
the qualifying SPE but was not the transferor of financial assets to the
qualifying SPE and (b) a servicer of a qualifying SPE that holds a significant
variable interest in the qualifying SPE but was not the transferor of financial
assets to the qualifying SPE. The disclosures required by FSP SFAS 140-4 and FIN
46(R)-8 are intended to provide greater transparency to financial statement
users about a transferor’s continuing involvement with transferred financial
assets and an enterprise’s involvement with variable interest entities and
qualifying SPEs. FSP 140-4 and FIN 46(R) are effective for reporting periods
(annual or interim) ending after December 15, 2008.  Adoption and
consideration of FSP 140-4 and FIN46(R)-8 did not have a significant impact on
Union National’s consolidated financial statements.





In
January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment
Guidance of EITF Issue No. 99-20” (“FSP EITF 99-20-1”). FSP EITF 99-20-1 amends
the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest Income
and Impairment on Purchased Beneficial Interests and Beneficial Interests That
Continue to Be Held by a Transferor in Securitized Financial Assets”, to achieve
more consistent determination of whether an other-than-temporary impairment has
occurred. FSP EITF 99-20-1 also retains and emphasizes the objective of an
other-than-temporary impairment assessment and the related disclosure
requirements in SFAS No. 115, “Accounting for Certain Investments in Debt and
Equity Securities”, and other related guidance. FSP EITF 99-20-1 is effective
for interim and annual reporting periods ending after December 15, 2008, and
shall be applied prospectively. Retrospective application to a prior interim or
annual reporting period is not permitted. Adoption and consideration of FSP EITF
99-20-1 did not have a significant impact on Union National’s consolidated
financial statements.





In
November 2008, the SEC released a proposed roadmap regarding the potential use
by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards (“IFRS”). IFRS is a comprehensive
series of accounting standards published by the International Accounting
Standards Board (“IASB”). Under the proposed roadmap, Union National may be
required to prepare financial statements in accordance with IFRS as early as
2014. The SEC will make a determination in 2011 regarding the mandatory adoption
of IFRS.  Management is currently assessing the impact that this
potential change would have on its consolidated financial statements, and it
will continue to monitor the development of the potential implementation of
IFRS.





In
December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about
Postretirement Benefit Plan Assets”.  This FSP amends SFAS 132(R),
“Employers’ Disclosures about Pensions and Other Postretirement Benefits”, to
provide guidance on an employer’s disclosures about plan assets of a defined
benefit pension or other postretirement plan.  The disclosures about
plan assets required by this FSP shall be provided for fiscal years ending after
December 15, 2009.  Management is currently reviewing the effect this
new pronouncement will have on its consolidated financial
statements.





In
November 2008, the FASB ratified EITF Issue No. 08-6, “Equity Method
Investment Accounting Considerations” (“EITF 08-6”).  EITF 08-6
clarifies the accounting for certain transactions and impairment considerations
involving equity method investments. EITF 08-6 is effective for fiscal
years beginning after December 15, 2008, with early adoption prohibited.
Management is currently reviewing the effect this new pronouncement will have on
its consolidated financial statements.


14





NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued





NOTE
2 - STOCK-BASED COMPENSATION





In
accordance with Statement of Financial Accounting Standards No. 123(R),
“Share-Based Payment” (“SFAS No. 123(R)”), Union National recognizes
compensation expense for future share-based awards based upon an assessment of
the fair value on the grant date.  The fair value of each option is
estimated on the date of grant using the Black-Scholes option-pricing
model.  Stock compensation expense is recognized on a straight-line
basis over the vesting period of the award.





Union
National had two stock option plans outstanding as of December 31, 2008: (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 December 31, 2008.





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.  The IDSOP consists of non-qualified stock options with
terms up to 10 years.  These 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.





Prior to
March 1, 2008, Union National had an Employee Stock Purchase Plan (“ESPP”);
options granted under the ESPP had a five-year term and could be exercised at
85% of the fair market value of the stock on the date of exercise.





No
share-based awards were granted or vested during the years ended December 31,
2008 and 2006; accordingly, no compensation expense was recorded in 2008 and
2006.  For the year ended December 31, 2007, Union National recorded
$82,000 of share-based compensation expense which is included in Salaries, Wages
and Employee Benefits expense in the 2007 consolidated statement of
income.  This represents all of the share-based compensation expense
associated with the 2007 stock option grants. The per-share weighted-average
fair value of the 31,900 stock options granted during 2007 (7,200 of which were
forfeited during 2007 due to employee terminations) was $3.41 computed using the
following assumptions:





Expected Dividend
      Yield:
                    
                    
                    3.45
                    %
                    
                    Expected
      Life (Years):
                    
                    
                    8.0Risk-Free
      Interest Rate:
                    
                    
                    5.02
                    %
                    
                    Expected
      Volatility:
                    
                    
                    17.11
                    %





Stock
option activity for the years ended December 31, 2008, 2007 and 2006, is
summarized below:





2008
                            
                            
                            2007
                            
                            
                            2006Stock Options Outstanding
                            
                            Shares
                            
                            
                            Weighted-
                              Average
                              Exercise
                              Price
                            
                            
                            Shares
                            
                            
                            Weighted-
                              Average
                              Exercise
                              Price
                            
                            
                            Shares
                            
                            
                            Weighted-
                              Average
                              Exercise
                              PriceBeginning
      of Year
                            
                            
                            124,439
                            
                            
                            $
                            18.32
                            
                            
                            
                            177,330
                            
                            
                            $
                            18.14
                            
                            
                            
                            202,999
                            
                            
                            $
                            18.22Granted
                            
                            –
                            
                            
                            –
                            
                            
                            
                            31,900
                            
                            
                            
                            18.50
                            
                            
                            –
                            
                            
                            –Exercised
                            
                            
                            (650
                            )
                            
                            
                            8.70
                            
                            
                            
                            (13,296
                            )
                            
                            
                            12.91
                            
                            
                            
                            (3,606
                            )
                            
                            
                            13.67Forfeited
                            
                            
                            (20,886
                            )
                            
                            
                            18.06
                            
                            
                            
                            (68,942
                            )
                            
                            
                            18.45
                            
                            
                            
                            (11,647
                            )
                            
                            
                            19.90Expired
                            
                            
                            (9,392
                            )
                            
                            
                            14.44
                            
                            
                            
                            (2,553
                            )
                            
                            
                            20.10
                            
                            
                            
                            (10,416
                            )
                            
                            
                            16.78End
      of Year
                            
                            
                            93,511
                            
                            
                            $
                            18.82
                            
                            
                            
                            124,439
                            
                            
                            $
                            18.32
                            
                            
                            
                            177,330
                            
                            
                            $
                            18.14Weighted-average
      fair value of options granted during the year
                            
                            $
                            –
                            
                            
                            
                            
                            
                            
                            $
                            3.41
                            
                            
                            
                            
                            
                            
                            $
                            –Intrinsic
      value of options exercised during the year
                            
                            $
                            1,000
                            
                            
                            
                            
                            
                            
                            $
                            26,000
                            
                            
                            
                            
                            
                            
                            $
                            20,000





All
options outstanding at December 31, 2008 were fully vested and exercisable, but
had no intrinsic value (the difference between the market price and the exercise
price).


15


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





Options
outstanding and exercisable at December 31, 2008, consisted of the
following:





Weighted-AverageRange of Exercise Prices
                  
                  Options
                    Outstanding
                  
                  
                  Exercise
                    Price
                  
                  Remaining
                    Contractual Life$11.52
       $13.08
                  
                  
                  11,668
                  
                  
                  $
                  12.52
                  
                  2.6
      years$13.09
       $16.10
                  
                  
                  8,066
                  
                  
                  
                  15.80
                  
                  3.5
      years$16.11
       $18.49
                  
                  
                  14,442
                  
                  
                  
                  18.40
                  
                  1.5
      years$18.50
       $20.81
                  
                  
                  24,825
                  
                  
                  
                  18.98
                  
                  7.1
      years$20.82
       $22.14
                  
                  
                  34,510
                  
                  
                  
                  21.71
                  
                  5.8 yearsTotal
                  
                  
                  93,511
                  
                  
                  $
                  18.82
                  
                  4.9
years





SFAS No.
123(R) also requires that the tax benefit from the exercise of non-qualified
stock options and disqualifying dispositions of incentive stock options and
shares purchased under the Employee Stock Purchase Plan (“ESPP”) in excess of
the tax benefit from the compensation expense recorded for those options be
included in the cash flow statement as a cash inflow from financing
activities.  No tax benefit was recorded during the years ended
December 31, 2008, 2007 and 2006 as there were no such exercises or dispositions
during those years.





NOTE
3 - INVESTMENT SECURITIES AVAILABLE FOR SALE





The
amortized cost and fair value of investment securities are as follows (in
thousands):





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





At December 31, 2007Gross
                      
                      
                      GrossAmortized
                      
                      
                      Unrealized
                      
                      
                      Unrealized
                      
                      
                      FairCost
                      
                      
                      Gains
                      
                      
                      Losses
                      
                      
                      ValueMortgage-Backed
      Securities
                      
                      $
                      26,329
                      
                      
                      $
                      109
                      
                      
                      $
                      (208
                      )
                      
                      $
                      26,230Obligations
      of U.S. Government Agencies
                      
                      
                      43,031
                      
                      
                      
                      59
                      
                      
                      
                      (4
                      )
                      
                      
                      43,086Corporate
      Securities
                      
                      
                      4,439
                      
                      
                      
                      26
                      
                      
                      
                      (52
                      )
                      
                      
                      4,413Equity
      Securities
                      
                      
                      359
                      
                      
                      
                      108
                      
                      
                      
                      (20
                      )
                      
                      
                      447Total
      Investment Securities
                      
                      $
                      74,158
                      
                      
                      $
                      302
                      
                      
                      $
                      (284
                      )
                      
                      $
                      74,176





The
following table shows gross unrealized losses and fair value, aggregated by
investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2008 (in
thousands):





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




16


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





The
following table shows gross unrealized losses and fair value, aggregated by
investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2007 (in
thousands):




Less than 12 Months
                                                      
                                                      12 Months or More
                                                      
                                                      TotalFair
                                                        Value
                                                      
                                                      Unrealized
                                                        Losses
                                                      
                                                      Fair
                                                        Value
                                                      
                                                      Unrealized
                                                        Losses
                                                      
                                                      Fair
                                                        Value
                                                      
                                                      Unrealized
                                                        LossesMortgage-Backed
      Securities
                                                      $    9,961
                                                      
                                                      $     (118
                                                      )
                                                      $      8,462
                                                      
                                                      $       (90
                                                      )
                                                      $  18,423
                                                      
                                                      $     (208
                                                      )Obligations
      of U.S. Government Agencies
                                                      12,031
                                                      
                                                      (4
                                                      )
                                                      
                                                      
                                                      
                                                      
                                                      12,031
                                                      
                                                      (4
                                                      )Corporate
      Securities
                                                      
                                                      
                                                      
                                                      
                                                      1,226
                                                      
                                                      (52
                                                      )
                                                      1,226
                                                      
                                                      (52
                                                      )Equity
      Securities
                                                      90
                                                      
                                                      (16
                                                      )
                                                      14
                                                      
                                                      (4
                                                      )
                                                      104
                                                      
                                                      (20
                                                      )Total
      Temporarily Impaired Securities
                                                      $  22,082
                                                      
                                                      $     (138
                                                      )
                                                      $     9,702
                                                      
                                                      $     (146
                                                      )
                                                      $  31,784
                                                      
                                                      $     (284
                                                      )





At
December 31, 2008, there were a total of 23 debt securities with unrealized
losses of $607,000 that amounted to 3.2% of their amortized
cost.  These unrealized losses are considered to be temporary
impairments.  Decline in the value of these debt securities is only
due to interest rate fluctuations, rather than erosion of quality.  As
a result, the payment of contractual cash flows, including principal repayments,
is not at risk.  As management has the intent and ability to hold
these investments until market recovery or maturity, none of these debt
securities are deemed to be other than temporarily impaired.





In order
to determine whether unrealized losses in the market 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 market value had been less than
cost, independent analysts’ opinions about circumstances that could affect the
performance of the investment, and management’s intention and ability to hold
the securities to the earlier of the recovery of losses or
maturity.





During
2008, Union National recorded $1,290,000 of other-than-temporary investment
impairment charges related to two securities, including a non-agency
mortgage-backed security that was downgraded to below-investment-grade during
December 2008, and a pooled trust preferred debt security supported primarily by
obligations from other banks.  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 in value.  During 2007, Union National recorded
$800,000 of other-than-temporary investment impairment charges related to our
portfolio of pooled trust preferred debt securities.





For the
impaired securities, scheduled income payments received after the time of
impairment are fully applied to principal further reducing the carrying value of
these investments.





Investment
securities carried at $59,646,000 at December 31, 2008, and $60,784,000 at
December 31, 2007 were pledged to secure public, trust, and government deposits
and for other purposes.  In addition, investment securities carried at
$8,530,000  at December 31, 2007 were pledged for repurchase
agreements.  There were no investment securities pledged for
repurchase agreements at December 31, 2008.





The
amortized cost and fair value of debt securities at December 31, 2008 and 2007,
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.





December 31, 2008Maturity
                  
                  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
                  
                  
                  1,481
                  
                  
                  
                  1,2184,860
                  
                  
                  
                  4,614Mortgage-Backed
      Securities
                  
                  
                  59,146
                  
                  
                  
                  59,469Equity
      Securities
                  
                  
                  227
                  
                  
                  
                  206Total
      Investment Securities
                  
                  $
                  64,233
                  
                  
                  $
                  64,289




17


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





December 31, 2007Maturity
                  
                  Amortized Cost
                  
                  
                  Fair ValueDue
      in One Year or Less
                  
                  $
                  29,999
                  
                  
                  $
                  30,029Due
      After One Year Through Five Years
                  
                  
                  15,316
                  
                  
                  
                  15,298Due
      After Five Years Through Ten Years
                  
                  
                  
                  
                  Due
      After Ten Years
                  
                  
                  2,155
                  
                  
                  
                  2,17247,470
                  
                  
                  
                  47,499Mortgage-Backed
      Securities
                  
                  
                  26,329
                  
                  
                  
                  26,230Equity
      Securities
                  
                  
                  359
                  
                  
                  
                  447Total
      Investment Securities
                  
                  $
                  74,158
                  
                  
                  $
                  74,176





The
following information is related to the sales of available for sale securities
(in thousands):





Year Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006Gross
      Proceeds Received from Sales of Securities
                        
                        $
                        42,463
                        
                        
                        $
                        95,514
                        
                        
                        $
                        19,549Securities
      Available for Sale:Gross
      Realized Gains
                        
                        $
                        389
                        
                        
                        $
                        905
                        
                        
                        $
                        273Gross
      Realized Losses
                        
                        
                        (137
                        )
                        
                        
                        (816
                        )
                        
                        
                        (64
                        )Net
      Realized Gains
                        
                        $
                        252
                        
                        
                        $
                        89
                        
                        
                        $
                        209





NOTE
4 - LOANS AND LEASES





Loans and
leases outstanding at the end of each year consisted of the following (in
thousands):





December 31,2008
                    
                    
                    2007Real
      Estate MortgagesFirst
      and Second Residential
                    
                    $
                    127,636
                    
                    
                    $
                    137,724Commercial
      and Industrial
                    
                    
                    121,619
                    
                    
                    
                    115,630Construction
      and Land Development
                    
                    
                    24,757
                    
                    
                    
                    29,427Agricultural
                    
                    
                    27,485
                    
                    
                    
                    24,839Commercial
      and Industrial
                    
                    
                    35,061
                    
                    
                    
                    28,741Consumer,
      Net of Unearned Income
                    
                    
                    7,172
                    
                    
                    
                    7,832Agricultural
                    
                    
                    3,588
                    
                    
                    
                    4,341Political
      Subdivisions
                    
                    
                    6,553
                    
                    
                    
                    8,993Lease
      Financing Receivables, Net of Unearned Income
                    
                    
                    3,792
                    
                    
                    
                    6,078Other
                    
                    
                    617
                    
                    
                    
                    732Total
      Loans and Leases
                    
                    $
                    358,280
                    
                    
                    $
                    364,337





Union
National grants commercial loans and leases, and residential and consumer loans
to customers primarily located in Lancaster County,
Pennsylvania.  Although Union National has a diversified loan and
lease portfolio, its debtors’ ability to honor their contracts is influenced by
the region's economy.





Loans and
leases include the net investment in direct lease financing receivables,
determined as follows (in thousands):





December 31,2008
                  
                  
                  2007Minimum
      Lease Payments Receivable
                  
                  $
                  3,834
                  
                  
                  $
                  6,592Residual
      Values
                  
                  
                  432
                  
                  
                  
                  450Unearned
      Income
                  
                  
                  (474
                  )
                  
                  
                  (964
                  )Total
      Leases
                  
                  $
                  3,792
                  
                  
                  $
                  6,078




18


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





The
allowance for uncollectible lease payments, included in the allowance for loan
and lease losses, was $149,000 and $152,000 at December 31, 2008 and 2007,
respectively.





Minimum
future rentals on noncancelable financing leases as of December 31, 2008 are as
follows (in thousands):





December 31,
                    20082009
                  
                  $
                  1,6222010
                  
                  
                  1,1542011
                  
                  
                  6622012
                  
                  
                  2602013
                  
                  
                  84Thereafter
                  
                  
                  52$
                  3,834





Union
National’s nonperforming assets at December 31, 2008 and 2007 consisted of the
following (in thousands):





December 31,2008
                    
                    
                    2007Nonaccruing
      Loans and Leases
                    
                    $
                    3,271
                    
                    
                    $
                    2,919Accruing
      Loans – 90 Days or More Past Due
                    
                    
                    1,685
                    
                    
                    
                    120Total
      Nonperforming Loans and Leases
                    
                    
                    4,956
                    
                    
                    
                    3,039Repossessed
      Assets
                    
                    
                    479
                    
                    
                    
                    156Total
      Nonperforming Assets
                    
                    $
                    5,435
                    
                    
                    $
                    3,195





Following
is a summary of impaired loan and lease data as of the date of each balance
sheet presented (in thousands):





December 31,2008
                  
                  
                  2007
                  
                  
                  2006Impaired
      Loans and Leases with a Related Allowance for Loan and Lease
      Losses
                  
                  $
                  5,058
                  
                  
                  $
                  1,814
                  
                  
                  $
                  1,798Impaired
      Loans and Leases without a Related Allowance for Loan and Lease
      Losses
                  
                  
                  4,302
                  
                  
                  
                  822
                  
                  
                  
                  4,786Total
      Outstanding Balance at Year End
                  
                  $
                  9,360
                  
                  
                  $
                  2,636
                  
                  
                  $
                  6,584Related
      Allowance for Loan and Lease Losses
                  
                  $
                  1,499
                  
                  
                  $
                  380
                  
                  
                  $
                  146Average
      Outstanding Balance for the Year
                  
                  
                  6,446
                  
                  
                  
                  2,993
                  
                  
                  
                  4,645Recognized
      Interest Income
                  
                  
                  705
                  
                  
                  
                  21
                  
                  
                  
                  239





Loans to
certain directors and principal officers of Union National, including their
immediate families and companies in which they are principal owners (more than
10%), amounted to $4,386,000 at December 31, 2008.  Such loans were
made in the ordinary course of business at Union National's normal credit terms,
including interest rates and security, and do not represent more than a normal
risk of collection.  Transactions on these loans for the years ended
December 31, 2008 and 2007, are as follows (in thousands):


For the Year Ended December 31,2008
                    
                    
                    2007Balance,
      Beginning of Year
                    
                    $
                    3,499
                    
                    
                    $
                    5,708Additions
                    
                    
                    1,467
                    
                    
                    
                    1,578Deletions
                    
                    
                    (580
                    )
                    
                    
                    (3,787
                    )Balance,
      End of Year
                    
                    $
                    4,386
                    
                    
                    $
                    3,499


19


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





NOTE
5 - ALLOWANCE FOR LOAN AND LEASE LOSSES





An
analysis of changes in the allowance for loan and lease losses for the years
ended December 31 is as follows (dollars in thousands):





2008
                    
                    
                    2007
                    
                    
                    2006Allowance
      for Loan and Lease Losses, Beginning of Year
                    
                    $
                    3,675
                    
                    
                    $
                    3,070
                    
                    
                    $
                    2,675Charge-Offs
                    
                    
                    (364
                    )
                    
                    
                    (637
                    )
                    
                    
                    (339
                    )Recoveries
                    
                    
                    20
                    
                    
                    
                    5
                    
                    
                    
                    62Net
      Charge-Offs
                    
                    
                    (344
                    )
                    
                    
                    (632
                    )
                    
                    
                    (277
                    )Addition
      to Provision for Loan and Lease Losses
                    
                    
                    1,027
                    
                    
                    
                    1,237
                    
                    
                    
                    672Allowance
      for Loan and Lease Losses, End of Year
                    
                    $
                    4,358
                    
                    
                    $
                    3,675
                    
                    
                    $
                    3,070




NOTE
6 - PREMISES AND EQUIPMENT





Premises
and equipment consist of the following (in thousands):





December 31,2008
                      
                      
                      2007Construction
      & Development
                      
                      $
                      101
                      
                      
                      $
                      19Land
                      
                      
                      1,168
                      
                      
                      
                      644Land
      Improvements
                      
                      
                      1,085
                      
                      
                      
                      1,055Furniture,
      Fixtures & Equipment
                      
                      
                      8,852
                      
                      
                      
                      8,715Buildings
      and Improvements
                      
                      
                      10,603
                      
                      
                      
                      7,506Leasehold
      Improvements
                      
                      
                      1,470
                      
                      
                      
                      1,217Subtotal
                      
                      
                      23,279
                      
                      
                      
                      19,156Less:  Accumulated
      Depreciation
                      
                      
                      (11,191
                      )
                      
                      
                      (10,118
                      )Premises
      and Equipment - Net
                      
                      $
                      12,088
                      
                      
                      $
                      9,038





During
2008, the increase in land and buildings was due to the purchase of the Bank’s
Centerville branch location.  The cost of this location, which was
previously leased, was $3,650,000 for the land and the building.





Depreciation
expense on premises and equipment was $1,093,000 in 2008, $1,078,000 in 2007 and
$879,000 in 2006.





Union
National has entered into a number of arrangements that are classified as
operating leases.  The operating leases are for several branch and
office locations.  The majority of the branch and office leases are
renewable at our option.  Future minimum rental and sublease payments
under terms of noncancelable operating lease and sublease agreements, including
certain amounts which are payable to a related party, as of December 31, 2008
are as follows (in thousands):





Lease
                    Obligations
                  
                  
                  Sublease
                    Income
                  
                  
                  Net Lease
                    Obligations
                  
                  
                  Obligations to
                    Related Party2009
                  
                  $
                  649
                  
                  
                  $
                  275
                  
                  
                  $
                  374
                  
                  
                  $
                  2082010
                  
                  
                  648
                  
                  
                  
                  287
                  
                  
                  
                  361
                  
                  
                  
                  1972011
                  
                  
                  693
                  
                  
                  
                  299
                  
                  
                  
                  394
                  
                  
                  
                  2292012
                  
                  
                  699
                  
                  
                  
                  282
                  
                  
                  
                  417
                  
                  
                  
                  2502013
                  
                  
                  692
                  
                  
                  
                  150
                  
                  
                  
                  542
                  
                  
                  
                  382Thereafter
                  
                  
                  4,123
                  
                  
                  
                  753
                  
                  
                  
                  3,370
                  
                  
                  
                  3,280$
                  7,504
                  
                  
                  $
                  2,046
                  
                  
                  $
                  5,458
                  
                  
                  $
                  4,546




20


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





Net rent
expense from continuing operations consisted of the following (in
thousands):





For the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Rental
      Expense
                  
                  $
                  755
                  
                  
                  $
                  1,184
                  
                  
                  $
                  663Sublease
      Rental Income
                  
                  
                  (225
                  )
                  
                  
                  (28
                  )
                  
                  
                  (12
                  )Net
      Rental Expense
                  
                  $
                  530
                  
                  
                  $
                  1,156
                  
                  
                  $
                  651





Rental
payments paid to a related party were $282,000, $473,000, and $412,000, for the
years ended 2008, 2007 and 2006, respectively.





NOTE
7 - DEPOSITS





Union
National’s deposits at December 31, 2008 and 2007 consist of the following (in
thousands):





December 31,2008
                        
                        
                        2007Non-Interest-Bearing
      Demand
                        
                        $
                        46,875
                        
                        
                        $
                        46,624NOW
      and Money Market
                        
                        
                        120,762
                        
                        
                        
                        131,293Savings
                        
                        
                        22,087
                        
                        
                        
                        22,904Certificates
      of Deposits
                        
                        
                        193,853
                        
                        
                        
                        175,490$
                        383,577
                        
                        
                        $
                        376,311





Scheduled
maturities of certificates of deposit (time deposits) at December 31, 2008 are
as follows (in thousands):





December 31,20082009
                    
                    $
                    115,9652010
                    
                    
                    47,2462011
                    
                    
                    17,9682012
                    
                    
                    7,5802013
                    
                    
                    5,003Thereafter
                    
                    
                    91$
                    193,853





Total
certificates of deposit included $12,278,000 and $23,785,000 of brokered CDs
outstanding at December 31, 2008 and 2007, respectively.  Retail
certificates of deposit in denominations of $100,000 or more amounted to
$52,822,000 and $50,902,000 at December 31, 2008 and 2007,
respectively.  The maturities of certificates of deposit in
denominations of $100,000 or more at December 31, 2008, are as follows (in
thousands):





December 31,Maturity
                  
                  20083
      months or less
                  
                  $
                  11,9253 -
      6 months
                  
                  
                  8,6596 -
      12 months
                  
                  
                  6,747Over
      12 months
                  
                  
                  25,491$
                  52,822


21


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





NOTE
8 - SHORT-TERM BORROWINGS





There
were no short-term borrowings outstanding as of December 31,
2008.  Short-term borrowings and weighted-average interest rates at
December 31, 2007 are as follows (dollars in thousands):





2007
                  
                  
                  2006Amount
                  
                  
                  Rate
                  
                  
                  Amount
                  
                  
                  RateTreasury
      Tax and Loan Notes
                  
                  $
                  42
                  
                  
                  
                  4.87
                  %
                  
                  $
                  900
                  
                  
                  
                  5.00
                  %Federal
      Funds Purchased
                  
                  
                  
                  
                  
                  
                  
                  
                  6,550
                  
                  
                  
                  5.25Securities
      Sold Under Repurchase Agreements
                  
                  
                  6,587
                  
                  
                  
                  4.13
                  
                  
                  
                  3,094
                  
                  
                  
                  4.79FHLB
      Short-Term Advances
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  Total
                  
                  $
                  6,629
                  
                  
                  
                  4.13
                  %
                  
                  $
                  10,544
                  
                  
                  
                  5.09
                  %





For 2008,
short-term borrowings had an average outstanding balance of $9,090,000 with a
weighted-average interest rate of 2.31%.  The highest balance
outstanding at a month-end was $23,478,000.  For 2007, short-term
borrowings had an average outstanding balance of $6,025,000 with a
weighted-average interest rate of 4.96%.  The highest balance
outstanding at a month-end was $8,223,000.





Under an
agreement with the Federal Home Loan Bank of Pittsburgh (“FHLB”), Union National
has a line of credit available in the amount of $15,000,000, none of which was
outstanding at December 31, 2008 or 2007.





All FHLB
advances are collateralized by a security agreement covering qualifying loans
and unpledged treasury, agency and mortgage-backed securities.  In
addition, all FHLB advances are secured by the FHLB capital stock owned by Union
National with a carrying amount of $3,298,000 at December 31, 2008, and
$3,292,000 at December 31, 2007.  In addition to the FHLB line of
credit, Union National has combined lines of credit with correspondent banks
amounting to $12,000,000 for overnight federal funds borrowings, none of which
were outstanding at December 31, 2008 or 2007.





In 2007,
Union National offered a secured short-term investment program for certain
corporate customers consisting of overnight repurchase agreements that were
secured by designated investment securities of the Bank.  This program
was discontinued in 2008.




NOTE
9 - LONG-TERM DEBT





A summary
of the maturities of long-term debt as of December 31 is as follows (dollars in
thousands):





2008
                    
                    
                    2007Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    RateFHLB
      Fixed Rate Advances:2008
                    
                    $
                    
                    
                    
                    
                    %
                    
                    $
                    1,550
                    
                    
                    
                    3.36
                    %2009
                    
                    
                    
                    
                    
                    
                    
                    
                    6,707
                    
                    
                    
                    3.782010
                    
                    
                    9,500
                    
                    
                    
                    4.67
                    
                    
                    
                    9,500
                    
                    
                    
                    4.672011
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2012
                    
                    
                    10,834
                    
                    
                    
                    4.31
                    
                    
                    
                    13,054
                    
                    
                    
                    4.252013
                    
                    
                    
                    
                    
                    
                    
                    
                    1,000
                    
                    
                    
                    4.39FHLB
      Floating-Rate Advances:2009
                    
                    
                    
                    
                    
                    
                    
                    
                    2,131
                    
                    
                    
                    4.772010
                    
                    
                    
                    
                    
                    
                    
                    
                    2,000
                    
                    
                    
                    4.772011
                    
                    
                    
                    
                    
                    
                    
                    
                    2,874
                    
                    
                    
                    4.77FHLB
      Convertible Fixed-Rate Advances:2010
                    
                    
                    20,000
                    
                    
                    
                    5.70
                    
                    
                    
                    20,000
                    
                    
                    
                    5.702011
                    
                    
                    10,000
                    
                    
                    
                    5.23
                    
                    
                    
                    10,000
                    
                    
                    
                    5.23Total
                    
                    $
                    50,334
                    
                    
                    
                    5.11
                    %
                    
                    $
                    68,816
                    
                    
                    
                    4.86
                    %




22


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





FHLB
advances are collateralized by a security agreement and FHLB capital stock as
described in Note 8.  As of December 31, 2008, Union National had a
maximum borrowing capacity of $101,087,000 from the FHLB, of which $50,753,000
was available.  All FHLB long-term borrowings are subject to
prepayment penalties which vary based upon current market interest
rates.  The FHLB's convertible fixed-rate advances allow the FHLB the
periodic option to convert to an adjustable-rate advance at the three-month
London Interbank Offered Rate (“LIBOR”) plus .08% to .20%.  The FHLB
currently has the option to convert all $30,000,000 of the outstanding
convertible advances on a quarterly basis. Upon the FHLB's conversion, the Bank
has the option to repay the respective advances in full without prepayment
penalties.





NOTE
10 - DERIVATIVE FINANCIAL INSTRUMENTS





Interest
Rate Derivatives


Union
National occasionally has derivative financial instruments in the form of an
interest rate collar agreement and an interest rate cap agreement which derive
their value from underlying interest rates, both of which have been designated
as cash flow hedges.  These transactions involve both credit and
market risk.  The notional amounts are amounts on which calculations,
payments, and the value of the derivative are based.  Notional amounts
do not represent direct credit exposures.  Direct credit exposure is
limited to the net difference between the calculated amounts to be received and
paid, if any.  Such difference, which represents the fair value of the
derivative instruments, is reflected on Union National’s balance sheet as
derivative assets and derivative liabilities, with changes in such fair values
reflected in accumulated other comprehensive income (loss).  Union
National’s objective in using derivatives is to add stability to its net
interest income by managing its exposure to interest rate movements or other
identified risks.





Union
National is exposed to credit-related losses, in the event of nonperformance by
the counterparties to these agreements.  Union National controls the
credit risk of its financial contracts through credit approvals, limits, and
monitoring procedures, and does not expect any counterparties to fail their
obligations.  Union National deals only with primary
dealers.





At
December 31, 2008 and 2007, Union National had no interest rate derivative
agreements.





NOTE
11 - JUNIOR SUBORDINATED DEBENTURES





Union
National has three issuances of junior subordinated debentures outstanding as of
December 31, 2008 and 2007.





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 6.32% and 7.83% at
December 31, 2008 and 2007, 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 4.15% and 5.28% at December
31, 2008 and 2007, respectively.





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


23


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





NOTE
12 - EMPLOYEE BENEFITS





401(k)
Profit-Sharing Plan


Union
National has a 401(k) profit-sharing plan that covers substantially all
full-time employees.  This plan allows employees to contribute a
portion of their salaries and wages to the plan.  The Bank may elect
to make discretionary contributions to the plan. The plan provides for the Bank
to match a portion of employee-elected salary deferrals, subject to certain
percentage maximums of their salaries and wages.  Union National’s
expense relative to its profit-sharing plan amounted to $166,000, $187,000 and
$329,000 for the years ended December 31, 2008, 2007 and 2006,
respectively.





Salary
Continuation Plan


Union
National has a salary continuation agreement with its
Chairman/CEO/President.  This is an unfunded plan that provides for
target retirement benefits beginning at age 62.  The agreement also
provides for benefits in the event of the disability or death of the
participant, the termination of employment of the participant, or a change in
control of Union National.  At December 31, 2008 and 2007, Union
National’s total accrued liability under this agreement was $290,000 and
$231,000, respectively. Total expenses related to this liability and related
insurance costs as provided for in the agreement amounted to $59,000, $69,000,
and $62,000 for the years ended December 31, 2008, 2007, and 2006,
respectively.





Stock
Option Plan


Union
National has two stock option plans, one plan for its employees and one plan for
its directors.  These plans are discussed separately in Note
2.





NOTE
13 - INCOME TAXES





Effective
January 1, 2007, Union National adopted the provisions of FASB Interpretation
No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109” (“FIN 48”), which requires that companies recognize
in their financial statements the impact of a tax position, if that position is
more likely than not of being sustained on audit, based on the technical merits
of the position.  In May 2007, the FASB issued FASB Staff Position
(“FSP”) FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48” (“FSP
FIN 48-1”).  FSP FIN 48-1 provides guidance on how to determine
whether a tax position is effectively settled for the purpose of recognizing
previously unrecognized tax benefits.  FSP FIN 48-1 was adopted by
Union National retroactive to January 1, 2007. As a result of Union National’s
adoption of FIN 48 and FSP FIN 48-1, no significant income tax uncertainties
were identified; therefore, Union National recognized no adjustment for
unrecognized income tax benefits for the years ended December 31, 2008 and
2007.  Union National’s policy is to recognize interest and penalties
on unrecognized tax benefits in income tax expense in the Consolidated
Statements of Income.





The net
deferred tax asset consisted of the following components as of December 31, 2008
and 2007 (in thousands):





At December 31,2008
                  
                  
                  2007Deferred
      Tax Assets:Allowance
      for Loan and Lease Losses
                  
                  $
                  1,482
                  
                  
                  $
                  1,142Recoverable
      Alternative Minimum Taxes
                  
                  
                  804
                  
                  
                  
                  732Income
      Tax Credit Carryforward
                  
                  
                  515
                  
                  
                  
                  443Impairment
      Charges on Investment Securities
                  
                  
                  806
                  
                  
                  
                  272Other
                  
                  
                  280
                  
                  
                  
                  132Total
      Deferred Tax
      Assets
                  
                  
                  3,887
                  
                  
                  
                  2,721Deferred
      Tax Liabilities:Deferred
      Net Loan Fees
                  
                  
                  (57
                  )
                  
                  
                  (47
                  )Depreciation
                  
                  
                  (452
                  )
                  
                  
                  (416
                  )Prepaid
      Expenses
                  
                  
                  (91
                  )
                  
                  
                  (130
                  )Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                  
                  
                  (29
                  )
                  
                  
                  (51
                  )Leasing
                  
                  
                  (572
                  )
                  
                  
                  (762
                  )Unrealized
      Gains on Investment Securities Available for Sale
                  
                  
                  (19
                  )
                  
                  
                  (6
                  )Other
                  
                  
                  (10
                  )
                  
                  
                  (111
                  )Total
      Deferred Tax Liabilities
                  
                  
                  (1,230
                  )
                  
                  
                  (1,523
                  )Net
      Deferred Tax Asset
                  
                  $
                  2,657
                  
                  
                  $
                  1,198


24


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued




At
December 31, 2008, Union National had no valuation allowance established against
its deferred tax assets as we believe the Corporation will generate sufficient
future taxable income to fully utilize all net operating loss carryforwards and
AMT tax credits.





An
analysis of the income tax expense included in the consolidated statements of
income for the years ended December 31, 2008, 2007 and 2006 is as follows (in
thousands):





Years Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Taxes
      Currently Payable (Benefits Receivable)
                    
                    $
                    739
                    
                    
                    $
                    (413
                    )
                    
                    $
                    443Deferred
      Income Tax Benefit
                    
                    
                    (927
                    )
                    
                    
                    (8
                    )
                    
                    
                    (344
                    )(Benefit
      from) Provision for Income Taxes
                    
                    $
                    (188
                    )
                    
                    $
                    (421
                    )
                    
                    $
                    99





The
reasons for the difference between Union National's provision for income taxes
and the amount computed by applying the statutory federal income tax rate to
income before income taxes for the years ended December 31, 2008, 2007 and 2006
are as follows (in thousands):





Years Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Income
      (Loss) Before Income Taxes
                    
                    $
                    256
                    
                    
                    $
                    (109
                    )
                    
                    $
                    2,543Statutory
      Tax Rate
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %Federal
      Tax at Statutory Rate
                    
                    
                    87
                    
                    
                    
                    (37
                    )
                    
                    
                    865Tax
      Benefits From:Tax-Exempt
      Income, Net of Disallowed Interest Expense
                    
                    
                    (132
                    )
                    
                    
                    (267
                    )
                    
                    
                    (583
                    )Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (149
                    )
                    
                    
                    (145
                    )
                    
                    
                    (130
                    )Income
      Tax Credits
                    
                    
                    
                    
                    
                    (38
                    )
                    
                    
                    (72
                    )Other
                    
                    
                    6
                    
                    
                    
                    66
                    
                    
                    
                    19(Benefit
      from) Provision for Income Taxes
                    
                    $
                    (188
                    )
                    
                    $
                    (421
                    )
                    
                    $
                    99





Income
tax credit carryforwards will begin to expire in 2020 and income tax credits are
recognized as earned.  Income tax credits earned were $38,000 and
$72,000 in 2007 and 2006, respectively.  There were no income tax
credits earned in 2008.





Years
that remain open for potential review by the Internal Revenue Service are 2005
through 2007.





NOTE
14 - COMMITMENTS AND GUARANTEES





The Bank
is a party to financial instruments with off-balance sheet risk, in the normal
course of business, to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit and standby letters of credit.  These instruments involve, to
varying degrees, elements of credit risk and interest rate risk in excess of the
amount recognized in the consolidated statements of financial
condition.  The contract amounts of these instruments reflect the
exposure to credit loss in the event of nonperformance (in
thousands).





At December 31,2008
                  
                  
                  2007Financial
      Instruments Whose Contract Amounts Represent Credit Risk:Commitments
      to Extend Credit
                  
                  $
                  800
                  
                  
                  $
                  5,762Unused
      Portion of Home Equity, Personal and Overdraft Lines
                  
                  
                  43,259
                  
                  
                  
                  48,715Other
      Unused Commitments, Principally Commercial Lines of Credit
                  
                  
                  60,374
                  
                  
                  
                  57,026Standby
      Letters of Credit
                  
                  
                  5,474
                  
                  
                  
                  6,239Total
      Commitments and Guarantees
                  
                  $
                  109,907
                  
                  
                  $
                  117,742





Commitments
to extend credit are agreements to lend to customers as long as there is no
violation of any condition established in the contracts.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Certain commitments may expire without
being drawn upon and, therefore, future cash may not be required.  The
Bank evaluates each customer's creditworthiness on a case-by-case
basis.  The Bank generally requires collateral or other security to
support financial instruments with credit risk.  Collateral held
varies but may include residential or commercial real estate, equipment,
inventory, and accounts receivable.


25


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





Standby
letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party.  These letters of
credit are issued primarily to support public and private borrowing arrangements
and have terms of less than two years.  The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan advances to customers.  The contract amounts of letter of credit
instruments reflect the exposure to credit loss in the event of
nonperformance.  The Bank requires collateral supporting these letters
of credit as deemed necessary.  Based on the creditworthiness of the
borrowers, Union National had unsecured letters of credit outstanding that
totaled $555,000 and $547,000 at December 31, 2008 and 2007,
respectively.  Management believes that the proceeds obtained through
a liquidation of collateral on secured letters of credit would be sufficient to
cover the maximum potential amount of future payments required under the
corresponding guarantees.  The amount of the liability as of December
31, 2008 and 2007, for guarantees under standby letters of credit issued is not
considered to be material.





Union
National occasionally sells residential mortgage loans to the FHLB of Pittsburgh
under an agreement that includes a maximum credit enhancement liability of
$815,000.  Union National may be required to pay the FHLB if realized
losses on  any of the sold mortgages exceed the amount held in a
spread account at the FHLB funded annually at 0.04% of the outstanding balance
of loans sold.  Union National’s historical losses on residential
mortgages have been lower than the amount being funded to the spread
account.  As such, Union National does not anticipate recognizing any
losses and accordingly, has not recorded a liability for the credit
enhancement.  As compensation for the credit enhancement, the FHLB is
paying Union National 0.10% of the outstanding loan balance in the portfolio on
a monthly basis.  Union National records credit enhancement fees
receivable based upon the present value of estimated future cash flows as loans
are sold.  The credit enhancement fees receivable, which amounted to
$26,000 at December 31, 2008 and $45,000 at December 31, 2007, are included in
other assets on the Consolidated Statements of Financial Condition and are
amortized as principal is received on loans sold.





NOTE
15 - REGULATORY RESTRICTIONS





The Bank
is required to maintain reserves, in the form of cash and balances with the
Federal Reserve Bank, against its deposit liabilities.  The average
amount of required reserves was approximately $6,135,000 and $5,521,000 during
2008 and 2007, respectively.





The Bank
is also subject to certain restrictions in connection with the payment of
dividends.  National banking laws require the approval of the
Comptroller of the Currency if the total of all dividends declared by a national
bank in any calendar year exceeds the net profits of the Bank (as defined) for
that year combined with the Bank’s retained net profits for the preceding two
calendar years.  Under this formula, in 2009, the Bank may declare
dividends to the parent company, Union National, 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.





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
material adverse effect on Union National’s financial
statements.  Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, Union National and the Bank must meet
specific capital guidelines that involve quantitative measures of their assets,
liabilities and certain off-balance sheet items as calculated under regulatory
accounting practices.  The capital amounts and classification are also
subject to qualitative judgments by the regulators about components, risk
weightings and other factors.





Quantitative
measures established by regulation to ensure capital adequacy require Union
National and the Bank to maintain minimum amounts and ratios of (i) Tier I
capital to average assets, and of (ii) Tier I and total capital (as defined in
the regulations) to risk-weighted assets.  As of December 31,
2008 and 2007, Union National and the Bank met all capital adequacy requirements
to which they are subject. As of December 31, 2008, the most recent
notification from the regulators categorized the Bank as “well-capitalized”
under the regulatory framework for prompt corrective action.  There
are no conditions or events since that notification that management believes
have changed the Bank’s category.


26


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





Union
National and the Bank maintained the following regulatory capital levels and
leverage and risk-based capital ratios (in thousands):




Actual
                        
                        
                        Minimum Required
                          For Capital Adequacy
                          Purposes
                        
                        
                        To Be Well-Capitalized
                          Under Prompt Corrective
                          Action ProvisionsAmount
                        
                        
                        Ratio
                        
                        
                        Amount
                        
                        
                        Ratio
                        
                        
                        Amount
                        
                        
                        RatioUnion National Financial
      CorporationDecember
      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/ADecember
      31, 2007:Tier 1 (leverage)
      capital
                        
                        $
                        38,370
                        
                        
                        
                        7.79
                        %
                        
                        $
                        19,705
                        
                        
                        
                        4.00
                        %
                        
                        
                        N/A
                        
                        
                        
                        N/ATier 1 risk-based
      capital
                        
                        
                        38,370
                        
                        
                        
                        9.08
                        
                        
                        
                        16,905
                        
                        
                        
                        4.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ATotal risk-based
      capital
                        
                        
                        49,487
                        
                        
                        
                        11.71
                        
                        
                        
                        33,810
                        
                        
                        
                        8.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/AUnion National Community
    BankDecember
      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
                        
                        
                        
                        10.00December
      31, 2007:Tier 1 (leverage)
      capital
                        
                        $
                        38,633
                        
                        
                        
                        7.84
                        %
                        
                        $
                        19,705
                        
                        
                        
                        4.00
                        %
                        
                        $
                        24,631
                        
                        
                        
                        5.00
                        %Tier 1 risk-based
      capital
                        
                        
                        38,633
                        
                        
                        
                        9.17
                        
                        
                        
                        16,845
                        
                        
                        
                        4.00
                        
                        
                        
                        25,268
                        
                        
                        
                        6.00Total risk-based
      capital
                        
                        
                        48,308
                        
                        
                        
                        11.47
                        
                        
                        
                        33,691
                        
                        
                        
                        8.00
                        
                        
                        
                        42,114
                        
                        
                        
                        10.00





In
response to the Memorandum of Understanding with the Office of the Comptroller
of the Currency (OCC) as discussed in Note 18, Union National Community Bank has
established target capital rates of 8% for Tier I Capital to Average Total
Assets, 9% for Tier I Capital to Risk-Based Assets, and 12% for Total Capital to
Risk-Based Assets.  Beginning June 30, 2008 through December 31, 2008,
Union National met these target capital rates by reducing borrowings, generating
capital from net earnings, and by raising additional capital through a private
placement stock offering (see related discussion in Note 22 to the consolidated
financial statements).





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 December 31, 2008, this
limitation amounted to approximately $5,096,000.  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.





NOTE
16 - RESIDENTIAL MORTGAGE BUSINESS VENTURE





Effective
October 31, 2007, Union National management decided to cease operations of Home
Team due to the weakening housing market and the related reduction in brokered
residential mortgage loan volume.  Accordingly, consolidated operating
results for 2008 reflected no mortgage brokerage and title insurance income, and
no operating expenses, related to Home Team.  Consolidated operating
results for 2007 included $1,932,000 of mortgage brokerage income, $317,000 of
title insurance/settlement income, and $2,572,000 of non-interest expenses,
related to Home Team.


27


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





NOTE
17 - DE-LEVERAGING AND RESTRUCTURING ACTIVITIES





During
2007, Union National began to de-leverage its balance sheet and reposition its
investment portfolio in order to strengthen the Bank’s capital position, enhance
its income tax effectiveness, facilitate its future core banking growth
strategies for loans and deposits, and improve its interest rate
profile.  In conjunction with the de-leveraging activities, Union
National sold $64,345,000 of available for sale securities, and liquidated
$2,039,000 of restricted FHLB stock, using the majority of the proceeds to pay
down $48,755,000 of FHLB debt and $6,550,000 of other short-term borrowings, and
incurring pre-tax debt prepayment penalties of $31,000 (included in Other
Non-Interest Expense).  Union National realized pre-tax losses of
$519,000 on the sale of the securities (Union National sold other securities
during 2007 at a net gain $608,000).





In 2008,
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 higher interest cost long-term borrowings.  The
Bank prepaid a total of $18,482,000 of FHLB long-term advances, reducing total
FHLB long-term borrowings outstanding to $50,334,000.  The FHLB
long-term debt that was prepaid had a weighted average interest cost of
4.19%.  In conjunction with the prepayments, the Bank incurred $72,000
of prepayment penalties, which were included in Other Non-Interest
Expense.  Additionally in 2008, the Bank called $16,410,000 of
brokered CDs which had a fixed weighted average interest cost of
4.91%.





Union
National incurred restructuring charges, consisting of severance and related
costs, totaling $717,000 in 2007. There were no restructuring charges in
2008.  Union National made cash payments related to the 2007 severance
liability of $223,000 and $494,000 in 2008 and 2007, respectively.





NOTE
18 - MEMORANDUM OF UNDERSTANDING





On June
20, 2007, the Bank entered into a Memorandum of Understanding (“MOU”) with the
Comptroller of the Currency (“OCC”).  Specifically, the MOU requires
the Bank to (1) implement a three-year strategic plan in accordance with
specific guidelines set forth in the MOU, (2) develop and implement a three-year
capital plan, in accordance with specific guidelines set forth in the MOU,
including a dividend policy for the payment of dividends provided the Bank is in
compliance with the capital plan, and applicable laws and regulations, (3)
review and revise a written program to improve the Bank’s loan portfolio
management, (4) review and revise the Bank’s funds management reports to ensure
that they reflect current and projected funding needs, (5) develop and implement
a risk based audit program to determine weaknesses or deficiencies in the Bank’s
consumer compliance program, (6) ensure the Bank’s interest rate risk (“IRR”)
measurement tool or model conforms to OCC guidelines and, if necessary, develop
an action plan to address the need for a more acceptable IRR measurement model,
and (7) furnish written quarterly progress reports to the OCC detailing the form
and manner of actions taken to comply with the MOU.  Each provision of
the MOU is subject to OCC approval, non-objection and/or
review.  Included in the response to the MOU, Union National
established target capital rates for the Bank of 8% for Tier I Capital to
Average Total Assets, 9% for Tier I Capital to Risk-Based Assets, and 12% for
Total Capital to Risk-Based Assets. (see related discussion in Note 15 to the
consolidated financial statements).





As of
December 31, 2008, management believes that the Bank has made substantial
progress in addressing the terms of the MOU and has sent to the OCC the
documentation and progress reports as required under the MOU.





NOTE
19 - DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN





Union
National maintains a Dividend Reinvestment and Stock Purchase
Plan.  Stockholders may participate in the plan, which provides that
additional shares of common stock may be purchased with reinvested dividends and
optional cash payments within specified limits at prevailing market
prices.  Union National has reserved 200,000 shares of its common
stock to be issued under the plan and 2,152 shares have been issued under the
plan as of December 31, 2008.


28


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





NOTE
20 - FAIR VALUE MEASUREMENTS AND FAIR VALUE OF FINANCIAL
INSTRUMENTS





Effective
January 1, 2008, Union National adopted SFAS No. 157, “Fair Value Measurements”,
for financial assets and financial liabilities.  In accordance with
Financial Accounting Standards Board Staff Position (FSP) No. 157-2, “Effective
Date of FASB Statement No. 157,” Union National will delay application of SFAS
No. 157 for non-financial assets and non-financial liabilities, until January 1,
2009.  SFAS 157 defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting
principles, and expands disclosures about fair value measurements.





SFAS 157
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market
participants.  A fair value measurement assumes that the transaction
to sell the asset or transfer the liability occurs in the principal market for
the asset or liability or, in the absence of a principal market, the most
advantageous market for the asset or liability.  The price in the
principal (or most advantageous) market used to measure the fair value of the
asset or liability shall not be adjusted for transaction costs.  An
orderly transaction is a transaction that assumes exposure to the market for a
period prior to the measurement date to allow for marketing activities that are
usual and customary for transactions involving such assets and liabilities; it
is not a forced transaction.  Market participants are buyers and
sellers in the principal market that are (i) independent, (ii) knowledgeable,
(iii) able to transact, and (iv) willing to transact.





SFAS 157
requires the use of valuation techniques that are consistent with the market
approach, the income approach and/or the cost approach.  The market
approach uses prices and other relevant information generated by market
transactions involving identical or comparable assets and
liabilities.  The income approach uses valuation techniques to convert
future amounts such as cash flows or earnings, to a single present amount on a
discounted basis.  The cost approach is based on the amount that
currently would be required to replace the service capacity of an asset
(replacement cost).  Valuation techniques should be consistently
applied.  Inputs to valuation techniques refer to the assumptions that
market participants would use in pricing the asset or
liability.  Inputs may be observable, meaning those that reflect the
assumptions market participants would use in pricing the asset or liability
developed based on market data obtained from independent sources, or
unobservable, meaning those that reflect the reporting entity’s own assumptions
about the assumptions market participants would use in pricing the asset or
liability based upon the best information available in the
circumstances.  In that regard, SFAS 157 establishes a fair value
hierarchy for valuation inputs that gives the highest priority to quoted prices
in active markets for identical assets or liabilities and the lowest priority to
unobservable inputs.  The fair value hierarchy is as
follows:





Level 1 Inputs - Unadjusted
quoted prices in active markets that are accessible at the measurement date for identical,
unrestricted assets or liabilities;





Level 2 Inputs - 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 Inputs - 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).





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.  These valuation
methodologies were applied to all of Union National’s financial assets and
financial liabilities carried at fair value effective January 1,
2008.





Securities
Available for Sale


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.


29


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





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
December 31, 2008, the fair value of securities valued using Level 3 inputs was
determined by management by calculating the net present value of the expected
future cash flows of each security, with qualitative risk-adjusted discounting
for potential credit risks and nonperformance in the underlying issuers, and
market sector illiquidity concerns (in accordance with FSP
SFAS No. 157-3, “Determining the Fair Value of a Financial Asset When
The Market for That Asset Is Not Active”).  Prior to September 30,
2008, management used market pricing based upon quoted prices from very limited
trading activity of the issuances.





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




Level 1
                    Inputs
                  
                  
                  Level 2
                    Inputs
                  
                  
                  Level 3
                    Inputs
                  
                  
                  Total Fair
                    ValueInvestment
      Securities Available For Sale
                  
                  $
                  74
                  
                  
                  $
                  59,778
                  
                  
                  $
                  4,437
                  
                  
                  $
                  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, 2008
                  
                  $
                  2,172Addition:
      Private mortgage-backed securities (previously Level 2)
                  
                  
                  4,305Payments
      received and applied to principal
                  
                  
                  (236
                  )Total
      realized and unrealized gains (losses)Included
      in net income
                  
                  
                  (1,290
                  )Included
      in other comprehensive income (loss)
                  
                  
                  (514
                  )Ending
      Balance at December 31, 2008
                  
                  $
                  4,437





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 $1,499,000 and $380,000 at
December 31, 2008 and 2007, respectively.





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





Level 1
                          Inputs
                        
                        Level 2
                          Inputs
                        
                        Level 3
                          Inputs
                        
                        
                        Total Fair
                          ValueImpaired
      Loans
                        
                        
                        
                        
                        $
                        5,058
                        
                        
                        $
                        5,058





Effective
January 1, 2008, Union National adopted the provisions of SFAS No. 159, "The
Fair Value Option for Financial Assets and Financial Liabilities-Including an
Amendment of FASB Statement No. 115”, (“SFAS 159”).  SFAS 159 expands
the use of fair value accounting but does not affect existing standards which
require assets and liabilities to be carried at fair value. Under SFAS 159, a
company may elect to use fair value to measure accounts and loans receivable,
available for sale and held to maturity securities, accounts payable,
guarantees, issued debt and other eligible financial
instruments.  SFAS 159 permits Union National to measure eligible
items at fair value at specified election dates.  Unrealized gains and
losses on items for which the fair value measurement option has been elected are
reported in earnings at each subsequent reporting date.  The fair
value option (i) may be applied instrument by instrument, with certain
exceptions, thus Union National may record identical assets and liabilities at
fair value or by another measurement basis permitted under generally accepted
accounting principles, (ii) is irrevocable (unless a new election date occurs)
and (iii) is applied only to entire instruments and not to portions of
instruments.  Adoption of SFAS 159 on January 1, 2008, did not have a
significant impact on Union National’s consolidated financial
statements.


30


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





The
following information 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.  The following methods and
assumptions were used by Union National to estimate the fair value of its
financial instruments at December 31, 2008 and 2007:





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





Interest-bearing
time deposits in other banks:The carrying amounts
reported in the consolidated statements of financial condition for
Interest-Bearing Time Deposits in Other Banks approximate their fair
values.  The Bank generally purchases amounts below the insured limit,
limiting the amount of credit risk on these time deposits.





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





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





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





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





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





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





Short-term
borrowings: The
carrying amounts of federal funds purchased, advances from the Federal Home Loan
Bank and other short-term borrowings approximate their fair values.





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.


31


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





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.





The
estimated fair values of financial instruments were as follows as of December
31, 2008 and 2007 (in thousands):





December 31, 2008
                
                
                December 31, 2007Carrying
                  Amount
                
                
                Fair Value
                
                
                Carrying
                  Amount
                
                
                Fair ValueAssets:Cash
      and Cash Equivalents
                
                $
                31,837
                
                
                $
                31,837
                
                
                $
                37,882
                
                
                $
                37,882Interest-Bearing
      Time Deposits in Other Banks
                
                
                1,775
                
                
                
                1,775
                
                
                –
                
                
                –Investment
      Securities Available for Sale
                
                
                64,289
                
                
                
                64,289
                
                
                
                74,176
                
                
                
                74,176Loans
      (excluding Leases), Net
                
                
                350,130
                
                
                
                350,288
                
                
                
                354,584
                
                
                
                351,400Restricted
      Investment in Bank Stocks
                
                
                3,703
                
                
                
                3,703
                
                
                
                3,652
                
                
                
                3,652Accrued
      Interest Receivable
                
                
                1,624
                
                
                
                1,624
                
                
                
                2,074
                
                
                
                2,074Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                
                
                86
                
                
                
                285
                
                
                
                149
                
                
                
                331Liabilities:Demand
      and Savings Deposits
                
                
                189,724
                
                
                
                189,724
                
                
                
                200,821
                
                
                
                200,821Time
      Deposits
                
                
                193,853
                
                
                
                195,611
                
                
                
                175,490
                
                
                
                177,894Short-term
      Borrowings
                
                –
                
                
                –
                
                
                
                6,629
                
                
                
                6,629Long-term
      Debt
                
                
                50,334
                
                
                
                52,976
                
                
                
                68,816
                
                
                
                70,054Junior
      Subordinated Debentures
                
                
                17,341
                
                
                
                19,182
                
                
                
                17,341
                
                
                
                17,607Accrued
      Interest Payable
                
                
                1,422
                
                
                
                1,422
                
                
                
                2,090
                
                
                
                2,090Off-balance-sheet
      Items:Commitments
      to Extend Credit and Standby Letters of Credit
                
                –
                
                
                –
                
                
                –
                
                
                –





NOTE
21 - OTHER-THAN-TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES





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, independent analysts’ opinions about
circumstances that could affect the performance of the investment securities,
and management’s intention and ability to hold the investment securities to the
earlier of recovery of losses or maturity.  As discussed inNote 3to the consolidated
financial statements during 2008 and 2007, respectively, the Bank recorded
$1,290,000 and $800,000 of other-than-temporary investment impairment
charges.





As of
December 31, 2008, Union National maintains four investment securities with
previously recorded impairments.  The fair value of the four impaired
investments is $2,574,000 as compared to an original amortized cost of
$5,986,000 as of December 31, 2008.  All payments received on impaired
investment securities are fully applied to principal.  As discussed
more thoroughly in Note 20 to the consolidated financial statements, the fair
value of these investment securities was determined by calculating the net
present value of the expected future cash flows of each security, with
qualitative risk-adjusted discounting for potential credit risks and
nonperformance in the underlying issuers, and market sector illiquidity concerns
(in accordance with FSP SFASNo.157-3,
“Determining the Fair Value of a Financial Asset When The Market for That Asset
Is Not Active”(“FSP 157-3”)).  Under FSP 157-3, when an active market
for a security does not exist, the use of management estimates that incorporate
current market participant expectations of future cash flows, and include
appropriate risk premiums, is acceptable.  Management’s judgment was
that, as of December 31, 2008, 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.


32


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





As of
December 31, 2008, one of the impaired investment securities was a
private-issuer mortgage backed security that was downgraded to
below-investment-grade during December.  The other three impaired
investment securities are pooled trust preferred debt securities which remain
rated as investment grade as of December 31, 2008, as they have been since the
time of purchase.





Management
determined that further impairments as of December 31, 2008 were not warranted
based upon the following considerations:





·
            The
      financial condition and near-term prospects of the issuers do not reflect
      any defaults or other specific events which may have influenced the
      operations of the issuers, such as changes in technology that may have
      impaired the earnings potential of the investments, or the discontinuance
      of a segment of the business that may affect the future earnings
      potential.  The four investment securities were current, as of
      December 31, 2008, for scheduled investment interest payments since
      issuance.


·
            The
      securities experienced very limited trading activity in 2008 as the
      securities are in a market sector with a high degree of illiquidity and
      dislocation; therefore the determined fair value based upon discounted
      cash flows is reasonable.


·
            Management
      has both the ability and intention to hold the securities until a
      reasonable recovery towards the carrying
value.





NOTE
22 - PRIVATE PLACEMENT STOCK OFFERING





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





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





Although
Union National could withdraw or terminate the offering of the shares at any
time, its intentions were to offer the shares for a period of six months
commencing May 19, 2008.  The offering period could be extended at the
discretion of Union National to a date not exceeding 90 days from the end of the
six month period.  The Board of Directors of Union National elected on
October 23, 2008, to extend the offering period for the shares until February
17, 2009.  Subsequently, the Board of Directors elected to let the
current private placement expire on its own terms on February 17,
2009.





The
following table summarizes the shares sold and the gross proceeds received
through the private placement stock offering as of December 31, 2008 (dollars in
thousands):





Period
                
                Shares
                  Sold
                
                
                Gross
                  ProceedsMay
      19, 2008 – June 30, 2008
                
                
                163,690
                
                
                $
                1,555July
      1, 2008 – September 30, 2008
                
                
                8,442
                
                
                
                80October
      1, 2008 – December 31, 2008
                
                
                
                
                Total
                
                
                172,132
                
                
                $
                1,635





Issuance
costs of $49,000 were offset against the gross proceeds.  No
additional shares were sold under the private placement stock offering
subsequent to December 31, 2008 through the offering expiration on February 17,
2009.


33


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued





NOTE 23 - UNION NATIONAL FINANCIAL
CORPORATION (PARENT COMPANY ONLY)





Condensed
Statements of Financial Condition


(in
thousands)





December 31,2008
                  
                  
                  2007ASSETSCash
      in Bank Subsidiary
                  
                  $
                  50
                  
                  
                  $
                  44Interest-Bearing
      Deposits in Other Banks
                  
                  
                  3
                  
                  
                  
                  48Cash
      and Cash Equivalents
                  
                  
                  53
                  
                  
                  
                  92Investment
      in Subsidiaries
                  
                  
                  41,003
                  
                  
                  
                  38,941Other
      Equity Investment Securities
                  
                  
                  206
                  
                  
                  
                  447Investments
      in Limited Partnerships
                  
                  
                  196
                  
                  
                  
                  269Recoverable
      Federal Income Taxes
                  
                  
                  
                  
                  
                  480Other
      Assets
                  
                  
                  797
                  
                  
                  
                  76Total
      Assets
                  
                  $
                  42,255
                  
                  
                  $
                  40,305LIABILITIESJunior
      Subordinated Debentures
                  
                  $
                  11,341
                  
                  
                  $
                  11,341Other
      Liabilities
                  
                  
                  120
                  
                  
                  
                  164STOCKHOLDERS'
      EQUITY
                  
                  
                  30,794
                  
                  
                  
                  28,800Total
      Liabilities and Stockholders' Equity
                  
                  $
                  42,255
                  
                  
                  $
                  40,305





Condensed
Statements of Income


(in
thousands)





Years Ended December 31,2008
                      
                      
                      2007
                      
                      
                      2006INCOMEDividends
      from Subsidiaries
                      
                      $
                      537
                      
                      
                      $
                      843
                      
                      
                      $
                      1,895Dividends
      on Other Equity Investment Securities
                      
                      
                      10
                      
                      
                      
                      16
                      
                      
                      
                      13Interest
      on Deposits in Bank Subsidiary
                      
                      
                      1
                      
                      
                      
                      1
                      
                      
                      
                      3Gain
      on Sale of Securities
                      
                      
                      49
                      
                      
                      
                      40
                      
                      
                      
                      47Management
      Fees from Bank
      Subsidiary
                      
                      
                      42
                      
                      
                      
                      42
                      
                      
                      
                      42Total
      Income
                      
                      
                      639
                      
                      
                      
                      942
                      
                      
                      
                      2,000EXPENSESInterest
      Expense on Junior Subordinated Debentures
                      
                      
                      673
                      
                      
                      
                      843
                      
                      
                      
                      828Other
      Expenses
                      
                      
                      248
                      
                      
                      
                      269
                      
                      
                      
                      207Total
      Expenses
                      
                      
                      921
                      
                      
                      
                      1,112
                      
                      
                      
                      1,035Income
      (Loss) before Income Tax (Benefit) and Equity inUndistributed
      Income of Subsidiary
                      
                      
                      (282
                      )
                      
                      
                      (170
                      )
                      
                      
                      965Provision
      for Income Taxes
      (Benefit)
                      
                      
                      (274
                      )
                      
                      
                      (377
                      )
                      
                      
                      (383
                      )Income
      (Loss) before Equity in Undistributed Income of Subsidiary
                      
                      
                      (8
                      )
                      
                      
                      207
                      
                      
                      
                      1,348EQUITY
      in UNDISTRIBUTED INCOME of SUBSIDIARY
                      
                      
                      452
                      
                      
                      
                      105
                      
                      
                      
                      1,096NET
      INCOME
                      
                      $
                      444
                      
                      
                      $
                      312
                      
                      
                      $
                      2,444




34


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS   continued




Condensed
Statements of Cash Flows


(in
thousands)





Years Ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006CASH
      FLOWS from OPERATING ACTIVITIESNet
      Income
                    
                    $
                    444
                    
                    
                    $
                    312
                    
                    
                    $
                    2,444Adjustments
      to Reconcile Net Income to Net CashProvided
      by (Used in) Operating Activities:Equity
      In Undistributed Income of Bank Subsidiary
                    
                    
                    (452
                    )
                    
                    
                    (105
                    )
                    
                    
                    (1,096
                    )Investment
      Securities Gains
                    
                    
                    (49
                    )
                    
                    
                    (40
                    )
                    
                    
                    (47
                    )Provision
      for Deferred Income Taxes
                    
                    
                    (274
                    )
                    
                    
                    (8
                    )
                    
                    
                    26Decrease
      (Increase) in Other Assets
                    
                    
                    138
                    
                    
                    
                    (21
                    )
                    
                    
                    481Increase
      (Decrease) in Other Liabilities
                    
                    
                    (40
                    )
                    
                    
                    (240
                    )
                    
                    
                    236Stock-Based
      Compensation Expense
                    
                    
                    
                    
                    
                    82
                    
                    
                    Net
      Cash Provided by (Used in) Operating Activities
                    
                    
                    (233
                    )
                    
                    
                    (20
                    )
                    
                    
                    2,044CASH
      FLOWS from INVESTING ACTIVITIESProceeds
      from Sales of Available for Sale Securities
                    
                    
                    180
                    
                    
                    
                    49
                    
                    
                    
                    100Purchases
      of Available for Sale Securities
                    
                    
                    
                    
                    
                    
                    
                    
                    (73
                    )Investment
      in Subsidiaries
                    
                    
                    (1,585
                    )
                    
                    
                    
                    
                    
                    (900
                    )Net
      Cash Provided by (Used in) Investing Activities
                    
                    
                    (1,405
                    )
                    
                    
                    49
                    
                    
                    
                    (873
                    )CASH
      FLOWS from FINANCING ACTIVITIESIssuance
      of Common Stock
                    
                    
                    1,599
                    
                    
                    
                    319
                    
                    
                    
                    402Cash
      Dividends Paid
                    
                    
                    
                    
                    
                    (709
                    )
                    
                    
                    (1,560
                    )Acquisition
      of Treasury Stock
                    
                    
                    
                    
                    
                    (6
                    )
                    
                    
                    (168
                    )Net
      Cash Provided by (Used in) Financing Activities
                    
                    
                    1,599
                    
                    
                    
                    (396
                    )
                    
                    
                    (1,326
                    )NET
      DECREASE in CASH AND CASH EQUIVALENTS
                    
                    
                    (39
                    )
                    
                    
                    (367
                    )
                    
                    
                    (155
                    )CASH
      AND CASH EQUIVALENTS - Beginning of Period
                    
                    
                    92
                    
                    
                    
                    459
                    
                    
                    
                    614CASH
      AND CASH EQUIVALENTS - End of Period
                    
                    $
                    53
                    
                    
                    $
                    92
                    
                    
                    $
                    459


35




REPORT OF MANAGEMENT’S ASSESSMENT OF INTERNAL
CONTROL OVER FINANCIAL REPORTING





The
management of Union National Financial Corporation (Corporation) is responsible
for establishing and maintaining adequate internal control over financial
reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities and
Exchange Act of 1934.  The Corporation’s internal control system is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation and fair presentation of published financial
statements in accordance with U.S. generally accepted accounting
principles.





Because
of inherent limitations, all internal control systems over financial reporting,
no matter how well designed, may not prevent or detect all potential
misstatements. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.  Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





In order
to ensure that the Corporation’s internal control over financial reporting is
effective, management regularly assesses such controls and did so most recently
for its audited financial statements prepared as of December 31,
2008.  This assessment was based on criteria for effective internal
control over financial reporting described in Internal Control – Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission (“COSO”).  Management retained the assistance of
an outside provider of internal auditing services in its documentation, testing
and evaluation of internal control over financial reporting.   In
assessing its internal controls, the Corporation followed the standards of the
Public Company Accounting Oversight Board (United States).





Management
has disclosed to the Corporation’s auditors and the Corporation’s Audit
Committee the results of its internal control assessment and potential
deficiencies in the design or operation of the internal control over financial
reporting which could adversely affect the Corporation’s ability to record,
process, summarize and report financial information.





Based on
its assessment, the Corporation’s management has concluded that, as of December
31, 2008, the Corporation’s internal control over financial reporting is
effective.





This
annual report does not include an attestation report of the Corporation’s
independent registered public accounting firm regarding internal control over
financial reporting.  The Corporation’s internal control over
financial reporting was not subject to attestation by the Corporation’s
independent registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Corporation to provide only
management’s report in this annual report.





Mark
      D. Gainer
                
                Michael
      D. PeduzziChairman,
      Chief Executive Officer and President
                
                Executive
      Vice President, Chief Financial OfficerDate:  March
      26, 2009
                
                Date:
      March 26, 2009


36







REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM





To the
Board of Directors and Stockholders


Union
National Financial Corporation




We have audited the accompanying
consolidated statements of financial condition of Union National Financial
Corporation and subsidiary (the “Corporation”) as of December 31, 2008 and 2007,
and the related consolidated statements of income, changes in stockholders’
equity, and cash flows for each of the years in the three-year period ended
December 31, 2008. Union National Financial Corporation’s management is
responsible for these consolidated financial statements. Our responsibility is
to express an opinion on these consolidated financial statements based on our
audits.




We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. The Corporation is not required to have, nor were
we engaged to perform, an audit of their December 31, 2008 internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Corporation’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.




In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects,
the financial position of Union National Financial Corporation and subsidiary as
of December 31, 2008 and 2007, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
2008 in conformity with accounting principles generally accepted in the United
States of America.







Beard
Miller Company LLP


Lancaster,
Pennsylvania


March 27,
2009


37







































































38




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. Home Team Financial, LLC (“Home Team”), a
subsidiary of the Bank, and its subsidiary, TA of Lancaster, LLC (together,
“Home Team”) began operations in July 2005, but ceased operations in October
2007. Home Team operated a mortgage banking and brokerage business and also
offered title insurance and settlement services.





FORWARD
LOOKING STATEMENTS





This
annual report may contain 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
factors.  Such factors include the possibility that anticipated cost
savings may not be realized, estimated synergies may not occur, increased demand
or prices for the Corporation's financial services and products may not occur,
changing economic and competitive conditions, technological developments and
other risks and uncertainties.  Such risks, uncertainties and other
factors that could cause actual results and experience to differ from those
projected include, but are not limited to, the following: ineffectiveness of the
Corporation’s business strategy due to changes in current or future market
conditions; the effects of competition, and of changes in laws and regulations
on competition, including industry consolidation and development of competing
financial products and services; interest rate movements; inability to achieve
merger-related synergies; difficulties in integrating distinct business
operations, including information technology difficulties; disruption from the
transaction making it more difficult to maintain relationships with customers
and employees, and challenges in establishing and maintaining operations in new
markets; volatilities in the securities markets; and deteriorating economic
conditions.  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.





Stockholders
should note that many factors, some of which are discussed elsewhere in this
Annual Report for the year ending December 31, 2008, and the Forms 10-Q and 8-K
that were filed during 2008, and in the documents that are incorporated by
reference, could affect the future financial results of Union National, the Bank
or the combined corporation and could cause those results to differ materially
from those expressed in the forward-looking statements contained or incorporated
by reference in this document. These factors include but are not limited to the
following:





•      Operating,
legal and regulatory risks;


•      Economic,
political and competitive forces;


•      Rapidly
changing technology; and


•
            Our
      analyses of these risks and forces could be incorrect and/or that the
      strategies developed to


address
      them could be unsuccessful.





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.


39







MANAGEMENT’S DISCUSSION AND
ANALYSIS    continued





CRITICAL
ACCOUNTING POLICIES





Union
National’s consolidated financial statements are prepared based upon the
application of U.S. generally accepted accounting principles, the most
significant of which are described in our consolidated financial statements,
Note 1 - Summary of Significant Accounting Policies.  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 loan and lease losses and the fair value of investment securities
to be critical accounting policies.





Determination
of the Allowance for Loan and Lease Losses


The
provision for loan and lease losses and the level of the allowance for loan and
lease losses involve significant estimates by management.  In
evaluating the adequacy of the allowance for loan and lease 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 loan losses and the
provision for loan losses may be necessary if economic conditions or loan credit
quality differ substantially from the factors and assumptions used in making the
evaluation.





Fair
Value of Investment Securities


All
investments are carried at fair value with any unrealized gains and losses,
considered to be temporary, reported net of tax as an adjustment to
stockholders’ equity. If management determines that a decline in the value of an
investment security is an other-than-temporary impairment, the related loss is
recorded in the consolidated income statement. In order to determine whether
declines are other than temporary, management regularly reviews 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 market value has been less than cost, independent analysts’
opinions about circumstances that could affect the performance of the
investment, and management’s intention and ability to hold the securities to
either of a reasonable recovery toward carrying value, or
maturity.  After considering such factors, it is a matter of judgment
on the part of management to make the determination of whether or not the
decline in market value is other-than-temporary.





FINANCIAL
CONDITION





As of
December 31, 2008, total assets decreased 3.3% to $485,109,000 as compared to
$501,776,000 at December 31, 2007.  The decrease resulted primarily
from Union National selling some of its investment portfolio and using excess
liquid funds to prepay $18,482,000 of borrowings from the Federal Home Loan Bank
of Pittsburgh, continuing with Union National’s strategy to de-leverage its
balance sheet by reducing higher-cost borrowings.





Investment
Securities





All of
Union National’s investment securities were classified as available for sale at
December 31, 2008 and 2007.  Securities classified as available for
sale are marketable equity securities and those debt securities that we intend
to hold for an indefinite period of time, but not necessarily to
maturity.    We possess the ability and intent to hold
securities with temporary impairment to maturity or recovery; however, we
recognize that the investment portfolio serves other primary financial
management functions including an ultimate source of liquidity and a tool to
manage interest rate risk.  In order to support these functions, we
have designated our entire portfolio of investment securities as being available
for sale.  Any decision to sell a security classified as available for
sale would be based on various factors, including significant movements in
interest rates, changes in maturity mix of our assets and liabilities, liquidity
needs, regulatory capital considerations, changes in the creditworthiness of the
issuing entity, changes in investment strategy and portfolio mix, and other
similar factors. Changes in unrealized gains or losses on available for sale
securities, net of taxes, are recorded as other comprehensive income (loss), a
component of stockholders’ equity.


40




MANAGEMENT’S DISCUSSION AND
ANALYSIS    continued





Total
expected cash flows from investment securities, including estimated prepayments
and expected call options, is $14,027,000 for 2009, which represents
approximately 22% of our investment securities as of December 31, 2008. 
 The estimated amount of expected cash flows from other investment
securities will vary significantly with changes in assumed interest rates. 
For example, an increase in interest rates will decrease the level of
prepayments received on mortgage-backed securities.  These factors
affecting our investment securities are included in our net interest income
simulation model.  We purchase 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 sections on Liquidity and Market Risk - Interest Rate Risk
for further discussion.





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.





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.  At December 31, 2008, there were a
total of 23 debt securities with unrealized losses of $607,000 that amounted to
3.20% of their amortized cost, as compared to December 31, 2007, when there were
a total of 34 debt securities with unrealized losses of $264,000 that amounted
to 0.83% 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).





During
2008, the Bank recorded $1,290,000 of other-than-temporary investment impairment
charges related to two securities, including a non-agency mortgage-backed
security that was downgraded to below-investment-grade during December 2008, and
a pooled trust preferred debt security supported primarily by obligations from
other banks.  During 2007, the Bank recorded $800,000 of
other-than-temporary investment impairment charges related to three pooled trust
preferred debt securities.  We 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 in value.





For the
securities with impairment charges recorded, scheduled income payments received
subsequent to impairment were fully applied to principal further reducing the
book value of these investments.





As of
December 31, 2008, there are no significant concentrations of investments
(greater than 10% of stockholders’ equity) in any individual security
issue.  Of the $64,289,000 of investment securities portfolio at
December 31, 2008, $59,646,000 or 93% were obligations issued by U.S. Agencies,
including discount notes and shorter-term obligations, mortgage-backed
securities, and collateralized mortgage obligations.





The
following is a summary of our available for sale investment securities (in
thousands):





Carrying Value at December 31,2008
                  
                  
                  2007
                  
                  
                  2006Mortgage-Backed
      Securities
                  
                  $
                  59,469
                  
                  
                  $
                  26,230
                  
                  
                  $
                  85,646Obligations
      of U.S. Government Agencies
                  
                  
                  3,396
                  
                  
                  
                  43,086
                  
                  
                  
                  4,151Corporate
      Debt Securities
                  
                  
                  1,218
                  
                  
                  
                  4,413
                  
                  
                  
                  12,527Obligations
      of State and Political Subdivisions
                  
                  –
                  
                  
                  –
                  
                  
                  
                  26,939Equity
      Securities
                  
                  
                  206
                  
                  
                  
                  447
                  
                  
                  
                  547Total
                  
                  $
                  64,289
                  
                  
                  $
                  74,176
                  
                  
                  $
                  129,810


41




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





The
following table illustrates the stated maturities of investment securities and
the weighted-average yields based upon carrying value as of December 31,
2008.  Yields are shown on a taxable-equivalent basis, assuming a 34%
federal income tax rate (dollars in thousands).




Within
                                1
      Year
                              
                              
                              1-5
                                Years
                              
                              
                              5-10
                                Years
                              
                              
                              After
                                10
      Years
                              
                              
                              No
                                Stated
                                Maturity
                              
                              
                              Total
                              
                              
                              YieldMortgage-Backed
      Securities *
                              
                              $
                              –
                              
                              
                              $
                              –
                              
                              
                              $
                              2,824
                              
                              
                              $
                              56,645
                              
                              
                              $
                              –
                              
                              
                              $
                              59,469
                              
                              
                              
                              4.75
                              %Obligations
      of U.S. Government Agencies *
                              
                              
                              1,528
                              
                              
                              
                              1,868
                              
                              
                              –
                              
                              
                              –
                              
                              
                              –
                              
                              
                              
                              3,396
                              
                              
                              
                              3.08Corporate
      Debt Securities
                              
                              –
                              
                              
                              –
                              
                              
                              –
                              
                              
                              
                              1,218
                              
                              
                              –
                              
                              
                              
                              1,218
                              
                              
                              –Equity
      Securities
                              
                              –
                              
                              
                              –
                              
                              
                              –
                              
                              
                              –
                              
                              
                              
                              206
                              
                              
                              
                              206
                              
                              
                              
                              3.07Total
      Securities
                              
                              $
                              1,528
                              
                              
                              $
                              1,868
                              
                              
                              $
                              2,824
                              
                              
                              $
                              57,863
                              
                              
                              $
                              206
                              
                              
                              $
                              64,289
                              
                              
                              
                              4.57
                              %Yield
                              
                              
                              2.81
                              %
                              
                              
                              3.30
                              %
                              
                              
                              4.24
                              %
                              
                              
                              4.67
                              %
                              
                              
                              3.07
                              %
                              
                              
                              4.57
                              %





* It is
anticipated that these mortgage-backed securities and structured agency
securities will be repaid prior to their contractual maturity
dates.  The yield for these securities is impacted for normal
amortization and estimated prepayments based on current market interest
rates.





Loans
and Leases





Total
gross loans and leases were $358,280,000 at December 31, 2008, representing a
1.7% decrease over total gross loans and leases of $364,337,000 at December 31,
2007.  The decrease in loans was primarily due to the sale of a
$6,803,000 pool of longer-term residential mortgages in December
2008.  The Bank continues to focus its lending efforts on creditworthy
consumers and businesses, with necessary consideration to increased credit risks
posed by the poor economy and the decline in the housing market.





At
December 31, 2008, there were no loan or lease concentrations over 10% of loans
and leases to any one category or borrower.  However, loans secured by
real estate constitute 84% of the Bank's loan and lease portfolio; consequently,
the quality of these loans is affected by the region's economy and real estate
market.





Loans and
leases are composed of the following (in thousands):


December
      31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Real
      Estate Mortgages:First
      and Second Residential
                    
                    $
                    127,636
                    
                    
                    $
                    137,724
                    
                    
                    $
                    130,363
                    
                    
                    $
                    124,259
                    
                    
                    $
                    121,799Commercial
      and Industrial
                    
                    
                    121,619
                    
                    
                    
                    115,630
                    
                    
                    
                    105,158
                    
                    
                    
                    94,016
                    
                    
                    
                    79,711Construction
      and Land Development
                    
                    
                    24,757
                    
                    
                    
                    29,427
                    
                    
                    
                    23,634
                    
                    
                    
                    10,618
                    
                    
                    
                    9,396Agricultural
                    
                    
                    27,485
                    
                    
                    
                    24,839
                    
                    
                    
                    24,133
                    
                    
                    
                    23,488
                    
                    
                    
                    17,423Commercial
      and Industrial
                    
                    
                    35,061
                    
                    
                    
                    28,741
                    
                    
                    
                    27,226
                    
                    
                    
                    20,291
                    
                    
                    
                    12,674Consumer
      (Net of Unearned Income)
                    
                    
                    7,172
                    
                    
                    
                    7,832
                    
                    
                    
                    7,893
                    
                    
                    
                    8,159
                    
                    
                    
                    9,678Agricultural
                    
                    
                    3,588
                    
                    
                    
                    4,341
                    
                    
                    
                    3,733
                    
                    
                    
                    3,300
                    
                    
                    
                    4,614Political
      Subdivisions
                    
                    
                    6,553
                    
                    
                    
                    8,993
                    
                    
                    
                    9,803
                    
                    
                    
                    11,029
                    
                    
                    
                    6,166Lease
      Financing Receivables
                    
                    
                    3,792
                    
                    
                    
                    6,078
                    
                    
                    
                    8,339
                    
                    
                    
                    3,707
                    
                    
                    –Other
                    
                    
                    617
                    
                    
                    
                    732
                    
                    
                    
                    799
                    
                    
                    
                    1,261
                    
                    
                    
                    1,349Total
      Loans
                    
                    
                    358,280
                    
                    
                    
                    364,337
                    
                    
                    
                    341,081
                    
                    
                    
                    300,128
                    
                    
                    
                    262,810Add:
      Unamortized Premium on Purchased Loans
                    
                    –
                    
                    
                    –
                    
                    
                    
                    32
                    
                    
                    
                    85
                    
                    
                    
                    191Loans
      (Net of Unearned Income)
                    
                    $
                    358,280
                    
                    
                    $
                    364,337
                    
                    
                    $
                    341,113
                    
                    
                    $
                    300,213
                    
                    
                    $
                    263,001


42




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Total
loans and leases with variable-rate pricing amounted to $235,635,000 at December
31, 2008, and $232,547,000 at December 31, 2007.  Loan maturities and
interest sensitivity of total loans, excluding residential real estate
mortgages, leases, and consumer loans at December 31, 2008, are as follows (in
thousands):





Years to Maturity *Within
                      1 Year
                    
                    
                    1-5
                      Years
                    
                    
                    Over 5
                      Years
                    
                    
                    TotalCommercial, Agricultural
      and Other
                    
                    $
                    34,485
                    
                    
                    $
                    37,055
                    
                    
                    $
                    123,383
                    
                    
                    $
                    194,923Construction
      and Land
    Development
                    
                    
                    19,815
                    
                    
                    
                    4,825
                    
                    
                    
                    117
                    
                    
                    
                    24,757Total
                    
                    $
                    54,300
                    
                    
                    $
                    41,880
                    
                    
                    $
                    123,500
                    
                    
                    $
                    219,680Fixed
      Rate Loans
                    
                    $
                    5,398
                    
                    
                    $
                    34,153
                    
                    
                    $
                    5,714
                    
                    
                    $
                    45,265Variable
      Rate Loans
                    
                    
                    48,902
                    
                    
                    
                    7,727
                    
                    
                    
                    117,786
                    
                    
                    
                    174,415Total
                    
                    $
                    54,300
                    
                    
                    $
                    41,880
                    
                    
                    $
                    123,500
                    
                    
                    $
                    219,680





*
            Due
      to interest rate levels, economic conditions and other relevant factors,
      it is anticipated that there will be loans repaid prior to their
      contractual maturity dates.





Nonperforming
Assets





Nonperforming
loans and leases consist of loans and leases that are non-accruing, 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.  If nonaccrual loans and leases had been
current and in accordance with their original terms, gross interest income of
approximately $151,000, $203,000 and $201,000 would have been recorded on such
loans and leases for the years ended December 31, 2008, 2007 and 2006,
respectively. Interest income of $0, $0 and $4,000 was recognized on nonaccruing
loans and leases for the years ended December 31, 2008, 2007, and 2006,
respectively.  At December 31, 2008, total nonperforming loans and
leases amounted to $4,956,000, or 1.4%, of gross loans and leases, as compared
to $3,039,000, or 0.8% of gross loans and leases, at December 31,
2007.    Historically, the percent of nonperforming loans
and leases to gross loans and leases as of December 31, for the previous
five-year period, was an average of 0.9%.  There were no transactions
deemed to be troubled debt restructurings during 2008.





The
following is a summary of our nonperforming loans (dollars in
thousands):


December
      31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004Nonaccruing
      Loans
                    
                    $
                    3,271
                    
                    
                    $
                    2,919
                    
                    
                    $
                    2,280
                    
                    
                    $
                    1,814
                    
                    
                    $
                    1,192Accruing
      Loans – 90 days or more past due
                    
                    
                    1,685
                    
                    
                    
                    120
                    
                    
                    
                    253
                    
                    
                    
                    298
                    
                    
                    
                    761Total
      Nonperforming Loans and Leases
                    
                    
                    4,956
                    
                    
                    
                    3,039
                    
                    
                    
                    2,533
                    
                    
                    
                    2,112
                    
                    
                    
                    1,953Repossessed
      Assets
                    
                    
                    479
                    
                    
                    
                    156
                    
                    
                    
                    358
                    
                    
                    
                    214
                    
                    
                    –Total
      Nonperforming Assets
                    
                    $
                    5,435
                    
                    
                    $
                    3,195
                    
                    
                    $
                    2,891
                    
                    
                    $
                    2,326
                    
                    
                    $
                    1,953Gross
      Loans and Leases
                    
                    $
                    358,280
                    
                    
                    $
                    364,337
                    
                    
                    $
                    341,113
                    
                    
                    $
                    300,213
                    
                    
                    $
                    263,001Allowance
      for Loan and Lease Losses
                    
                    $
                    4,358
                    
                    
                    $
                    3,675
                    
                    
                    $
                    3,070
                    
                    
                    $
                    2,675
                    
                    
                    $
                    2,288Nonperforming
      Loans and Leases as a % of Gross Loans and
      Leases
                    
                    
                    1.4
                    %
                    
                    
                    0.8
                    %
                    
                    
                    0.7
                    %
                    
                    
                    0.7
                    %
                    
                    
                    0.7
                    %Nonperforming
      Assets as a % of Total Assets
                    
                    
                    1.1
                    %
                    
                    
                    0.6
                    %
                    
                    
                    0.6
                    %
                    
                    
                    0.5
                    %
                    
                    
                    0.5
                    %Allowance
      for Loan and Lease Losses as a % of Nonperforming Loans and
      Leases
                    
                    
                    88
                    %
                    
                    
                    121
                    %
                    
                    
                    121
                    %
                    
                    
                    127
                    %
                    
                    
                    117
                    %





Nonperforming
loans and leases were 1.38% and 0.83% of total loans and leases as of December
31, 2008 and 2007, respectively.  Included in nonperforming loans and
leases at December 31, 2008, was $857,000 which was related to one loan that was
fully repaid in January 2009.  Nonperforming loans and leases,
excluding this one repaid loan, would have been 1.14% of total loans and leases
as of December 31, 2008.  The allowance for loan and lease losses,
excluding this one repaid loan, would have been 106% of nonperforming loans and
leases as of December 31, 2008.





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.


43




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





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,
included in other expenses.





Union
National had repossessed assets of $479,000, $156,000, $358,000 and $214,000 at
December 31, 2008, 2007, 2006 and 2005, respectively.  Union National
did not have any repossessed assets at December 31, 2004.Union National had
foreclosed real estate of $186,000 at December 31, 2006. Union National did not
have any foreclosed real estate in any of the other years presented in the table
above.





Loan
Quality / Allowance for Loan and Lease Losses





The
allowance for loan and lease 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 loan and losses,
which is formally reviewed by management on a quarterly basis. The allowance is
increased by provisions charged to operating expense and reduced by net
charge-offs.  Our evaluation of the adequacy of the allowance is based on
our past loan 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 loan and lease
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 loan and lease losses was necessary as a result of the Office of the
Comptroller of the Currency’s (“OCC’s”) most recent
examination.


The Bank
uses the services of a recognized, regional independent contractor which
periodically, throughout the year, evaluates credit
risk.  Additionally, internally, we review and evaluate higher
risk rated commercial exposures on a quarterly basis and review or
assign a risk rating at the time of an approval.





The Bank
maintains a relationship with third party vendors who underwrite and process
residential first mortgage loan applications
originated principally through our retail offices.  The
Bank’s current practice is not to fund or purchase residential first
mortgage loans, although it may choose to do so at a later date.  The
Bank offers home equity term and revolving loans for retention in its portfolio
based on the applicant’s creditworthiness using the criteria of credit score,
loan to collateral value ratio, and debt to income ratio.  The pricing
of home equity loans is based upon these criteria, which are universally applied
and periodically reviewed.





The
allowance for loan and lease 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 and is
based on historical loss experience adjusted for qualitative factors.  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.





The
allowance for loan and lease losses at December 31, 2008 increased by $683,000
or 18.6% over the prior year.  The increased allowance for loan and lease
losses reflects Union National’s continued emphasis on diligently monitoring and
evaluating its existing portfolio, and identifying credit concerns and risks,
including those resulting from the current weak economy.   Future
adjustments may be necessary to the allowance for loan and lease losses, and
consequently the provision for loan and lease losses, if economic conditions or
loan credit quality differ substantially from the assumptions we used in making
our evaluation of the level of the allowance as compared to the balance of
outstanding loans and leases. The ratio of the allowance for loan and leases
losses to gross loans and leases was 1.22% at December 31, 2008, as compared to
1.01% at December 31, 2007.  We believe, based on information currently
available, that the allowance as of December 31, 2008 of $4,358,000 is adequate
to meet potential losses.


44




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Analysis
of Allowance for Loan and Lease Losses


(Dollars
in thousands)


December
      31,2008
                    
                    
                    2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004 (1)Allowance
      for Loan and Lease Losses, Beginning of Year
                    
                    $
                    3,675
                    
                    
                    $
                    3,070
                    
                    
                    $
                    2,675
                    
                    
                    $
                    2,288
                    
                    
                    $
                    1,985Charge-Offs:Real
      Estate
                    
                    –
                    
                    
                    –
                    
                    
                    
                    (11
                    )
                    
                    
                    (150
                    )
                    
                    
                    (112
                    )Consumer
                    
                    
                    (155
                    )
                    
                    
                    (111
                    )
                    
                    
                    (43
                    )
                    
                    
                    (77
                    )
                    
                    
                    (25
                    )Commercial, Industrial and Agricultural (2)
                    
                    
                    (209
                    )
                    
                    
                    (526
                    )
                    
                    
                    (285
                    )
                    
                    
                    (100
                    )
                    
                    
                    (24
                    )Total
      Charge-Offs
                    
                    
                    (364
                    )
                    
                    
                    (637
                    )
                    
                    
                    (339
                    )
                    
                    
                    (327
                    )
                    
                    
                    (161
                    )Recoveries:Real
      Estate
                    
                    –
                    
                    
                    –
                    
                    
                    
                    5
                    
                    
                    
                    5
                    
                    
                    
                    24Consumer
                    
                    
                    14
                    
                    
                    
                    3
                    
                    
                    
                    14
                    
                    
                    
                    9
                    
                    
                    
                    35Commercial,
      Industrial and Agricultural
                    
                    
                    6
                    
                    
                    
                    2
                    
                    
                    
                    43
                    
                    
                    
                    19
                    
                    
                    
                    1Total
      Recoveries
                    
                    
                    20
                    
                    
                    
                    5
                    
                    
                    
                    62
                    
                    
                    
                    33
                    
                    
                    
                    60Net
      Loans and Leases Charged-Off
                    
                    
                    (344
                    )
                    
                    
                    (632
                    )
                    
                    
                    (277
                    )
                    
                    
                    (294
                    )
                    
                    
                    (101
                    )Addition
      to Provision for Loan and Lease Losses
                    
                    
                    1,027
                    
                    
                    
                    1,237
                    
                    
                    
                    672
                    
                    
                    
                    681
                    
                    
                    
                    404Allowance
      for Loan and Lease Losses, End of Year
                    
                    $
                    4,358
                    
                    
                    $
                    3,675
                    
                    
                    $
                    3,070
                    
                    
                    $
                    2,675
                    
                    
                    $
                    2,288Loans
      and Leases – Average
                    
                    $
                    369,554
                    
                    
                    $
                    357,795
                    
                    
                    $
                    318,251
                    
                    
                    $
                    280,245
                    
                    
                    $
                    244,752Gross
      Loans and Leases – Actual
                    
                    $
                    358,280
                    
                    
                    $
                    364,337
                    
                    
                    $
                    341,113
                    
                    
                    $
                    300,213
                    
                    
                    $
                    263,001Ratio
      of Gross Loans and Leases Charged Off to Average Loans and
      Leases
                    
                    
                    0.10
                    %
                    
                    
                    0.18
                    %
                    
                    
                    0.11
                    %
                    
                    
                    0.12
                    %
                    
                    
                    0.07
                    %Ratio
      of Allowance for Loan and Lease Losses to Gross Loans and
      Leases
                    
                    
                    1.22
                    %
                    
                    
                    1.01
                    %
                    
                    
                    0.90
                    %
                    
                    
                    0.89
                    %
                    
                    
                    0.87
                    %





(1)
            There
      were no financing leases in 2004.


(2)
            Included
      in commercial loans were $163,000 and $38,000 of charge-offs in financing
      leases in 2008 and 2007, respectively.  There were no financing
      lease charge-offs in 2006 and 2005.  There were no recoveries of
      financing leases in any of the periods
  presented.


45






MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





The
specific allocation in any particular category may be reallocated in the future
to reflect current conditions.  Accordingly, we consider the entire
allowance to be available to absorb losses in any category.  The
following table sets forth an allocation of the allowance for loan and lease
losses by loan category (dollars in thousands):


Allowance
                  Amount
                
                
                Percentage Mix
                  of Total Loans
                  and LeasesDecember 31,
      2008:Commercial,
      Industrial and Agricultural
                
                $
                3,066
                
                
                
                71
                %Lease
      Financing Receivables
                
                
                155
                
                
                
                1Real
      Estate – Residential Mortgages
                
                
                102
                
                
                
                5Consumer
                
                
                991
                
                
                
                23Unallocated
                
                
                44
                
                
                –Total
      Allowance for Loan and Lease Losses
                
                $
                4,358
                
                
                
                100
                %December
      31, 2007:Commercial,
      Industrial and Agricultural
                
                $
                2,776
                
                
                
                58
                %Lease
      Financing Receivables
                
                
                152
                
                
                
                2Real
      Estate – Residential Mortgages
                
                
                375
                
                
                
                38Consumer
                
                
                243
                
                
                
                2Unallocated
                
                
                129
                
                
                –Total
      Allowance for Loan and Lease Losses
                
                $
                3,675
                
                
                
                100
                %December
      31, 2006:Commercial,
      Industrial and Agricultural
                
                $
                2,228
                
                
                
                58
                %Lease
      Financing Receivables
                
                
                63
                
                
                
                2Real
      Estate – Residential Mortgages
                
                
                469
                
                
                
                38Consumer
                
                
                92
                
                
                
                2Unallocated
                
                
                218
                
                
                –Total
      Allowance for Loan and Lease Losses
                
                $
                3,070
                
                
                
                100
                %December
      31, 2005:Commercial,
      Industrial and Agricultural
                
                $
                1,778
                
                
                
                55
                %Lease
      Financing Receivables
                
                
                25
                
                
                
                1Real
      Estate – Residential Mortgages
                
                
                379
                
                
                
                41Consumer
                
                
                135
                
                
                
                3Unallocated
                
                
                358
                
                
                –Total
      Allowance for Loan and Lease Losses
                
                $
                2,675
                
                
                
                100
                %December
      31, 2004:Commercial,
      Industrial and Agricultural
                
                $
                1,293
                
                
                
                50
                %Real
      Estate – Residential Mortgages
                
                
                514
                
                
                
                46Consumer
                
                
                147
                
                
                
                4Unallocated
                
                
                334
                
                
                –Total
      Allowance for Loan and Lease Losses
                
                $
                2,288
                
                
                
                100
                %





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.  Further, 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. 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
$9,360,000 and $2,636,000, which consisted of sixteen and thirteen loan
relationships, at December 31, 2008 and 2007, respectively.  At
December 31, 2008, three of the impaired loans represented 62% of the total
impaired loans and leases of $9,360,000.  The increase in impaired
loans and leases in 2008 reflected management’s continued emphasis on diligently
monitoring and evaluating the existing portfolio, and identifying 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.


46




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Union
National had $5,058,000 and $1,814,000 of impaired loans and leases with a
related allowance for loan and lease losses of $1,499,000 and $380,000, which
consisted of eight and nine loan relationships, at December 31, 2008 and 2007,
respectively.  The increase in the related allowance for loan and
lease losses is reflective of the increase in impaired loans.  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.





Union
National had $4,302,000 and $822,000 of impaired loans and leases without a
related allowance for loan and lease losses, which consisted of eight and four
loan relationships, at December 31, 2008 and 2007, 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 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.





In
addition, under our current internal risk rating system, loans with a rating of
“substandard” that were performing and not impaired amounted to $7,826,000 at
December 31, 2008, and $10,786,000 at December 31, 2007. We consider both
impaired and substandard loans to be potential problem loans, and believe that
the current economic conditions may result in additional loans being classified
or nonperforming during 2009.





Stockholders’
Equity





Stockholders’
equity increased to $30,794,000 at December 31, 2008 as compared to $28,800,000
at December 31, 2007.  The increase in stockholders’ equity was
primarily a result of net cash proceeds received from a private placement stock
offering in the amount of $1,586,000 (see related discussion in Note 22 to the
consolidated financial statements) and increases to retained earnings from 2008
net income.  Union National's common equity and regulatory capital
position at December 31, 2008 exceeds the regulatory required minimums as
disclosed in Note 15.





As more
fully described in Notes 11 and 15 to the Consolidated Financial Statements,
included in Tier 1 regulatory capital of Union National is $10,248,000 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, $752,000, is
included in Tier II regulatory capital of Union
National.  Additionally, included in Tier II regulatory capital of the
Bank and Union National is $6,000,000 of junior subordinated debentures issued
by the Bank.  These securities would become callable if the Federal
Reserve makes a determination that trust capital securities can no longer be
considered in regulatory capital.





The ratio
of average stockholders’ equity to average assets, which measures the adequacy
of capital, was 6.15% for 2008 as compared to 6.05% for 2007.  The increase
in this ratio is primarily a result of the increase in stockholders’ equity from
the private placement stock offering and the reduction in average assets due to
the 2008 de-leveraging activities.  The dividend payout ratio, which
represents the percentage of earnings returned to the stockholders in the form
of cash dividends, was 227.24% for 2007.  The 2007 dividend payout
ratio exceeded 100% due to the lower net income for the year, primarily
resulting from certain nonrecurring costs, as discussed in the “Results of
Operations” section.  Union National did not pay a dividend in
2008.  We believed it prudent for Union National to fully maintain its
strong, well-capitalized position in these uncertain economic times, so
management and the Board of Directors made the decision to not pay dividends to
stockholders in 2008.





In
response to the Memorandum of Understanding with the Office of the Comptroller
of the Currency (“OCC”) as discussed in Note 18, Union National Community Bank
has established target capital rates of 8% for Tier I Capital to Average Total
Assets, 9% for Tier I Capital to Risk-Based Assets, and 12% for Total Capital to
Risk-Based Assets effective June 30, 2008.  Union National met these
capital targets as of June 30, 2008 and through December 31, 2008 by reducing
borrowings, generating capital from net earnings, and by raising additional
capital through the private placement stock offering discussed in Note 22 to the
consolidated financial statements.


47




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





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 December 31, 2008, this
limitation amounted to approximately $5,096,000.  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.  The Bank fully complied with these
requirements.





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. 
Generally, 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.





Union
National maintains a Dividend Reinvestment and Stock Purchase
Plan.  Holders of common stock may participate in the plan, which
provides that additional shares of common stock may be purchased with reinvested
dividends and optional cash payments within specified limits at prevailing
market prices.





Except as
discussed in the investments and allowance for loan and lease losses sections
previously, there are no other known trends or uncertainties, including
regulatory matters, that are expected to have a material adverse impact on the
capital resources of Union National for 2009.


48




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





RESULTS
OF OPERATIONS





Summary
of Performance - 2008 Compared to 2007





Overview





Union
National reported net income of $444,000 for the year ended December 31, 2008,
as compared to net income of $312,000 for the year ended December 31, 2007. Basic and
diluted earnings per share for 2008 were $0.17, as compared to basic and diluted
earnings per share of $0.12 for 2007. The
discussion that follows further explains the changes in the components of net
income when comparing the year ended December 31, 2008 to the year ended
December 31, 2007.





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 $14,817,000
for the year ended December 31, 2008, as compared to $15,810,000 for the year
ended December 31, 2007.  The yield on interest-earning assets
decreased by 87 basis points to 6.28% for 2008, as compared to 7.15% for
2007.  The interest rate paid on average interest-bearing liabilities
decreased by 67 basis points to 3.32% for 2008, as compared to 3.99% for
2007.  With the decline in interest rates, including the market prime
rate decreasing 4% through 2008, Union National’s interest rates on
interest-earning assets re-priced lower and more quickly than interest-bearing
liabilities, resulting in a lower net interest margin in 2008 versus
2007.  The taxable-equivalent net interest margin for 2008 was 3.28%,
as compared to 3.55% for 2007.





Interest
and fees on loans and leases decreased by $2,275,000 to $24,817,000 for the year
ended December 31, 2008, as compared to $27,092,000 for the year ended December
31, 2007.  A decrease in average yield of 85 basis points due to
interest rate cuts during the year more than offset additional earnings from a
$11,759,000 increase in the average balance of loans and leases from 2007 to
2008.





Interest
and dividends earned on investment securities decreased by $759,000 to
$3,209,000 for the year ended December 31, 2008, as compared to $3,968,000 for
the year ended December 31, 2007.  A decrease in the average yield of
78 basis points due to both market rate reductions and generally lower risk,
investments, coupled with a $3,971,000 decrease in the average balance of
investment securities, resulted in less interest earned on investment securities
in comparison to 2007.





Interest
expense on deposits decreased by $1,320,000 to $9,470,000 for the year ended
December 31, 2008, as compared to $10,790,000 for the year ended December 31,
2007.  A decrease in average rate of 65 basis points due to interest
rate cuts in the past year more than offset additional interest expense from a
$22,995,000 increase in the average balance of deposits. Union National’s
average rate on interest bearing deposits was 2.88% for 2008 as compared to
3.53% for 2007.





Interest
expense on long-term debt was $2,795,000 for the year ended December 31, 2008,
as compared to $3,652,000 for the year ended December 31, 2007.  The
$857,000 decrease was primarily the result of an $18,085,000 decrease in the
average balance of long-term debt.  In 2008, 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 higher interest cost long-term debt.  As a result, the Bank
prepaid a total of $18,482,000 of FHLB long-term advances, reducing total FHLB
long-term borrowings outstanding to $50,334,000 at December 31, 2008 as compared
to $68,816,000 at December 31, 2007.


49




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued






Distribution
of Assets, Liabilities and Stockholders' Equity


(Dollars
in thousands)


Years Ended December
      31,2008
                  
                  
                  2007
                  
                  
                  2006Average
                    Balance
                  
                  
                  Interest
                  
                  
                  Yield/
                    Rate
                  
                  
                  Average
                    Balance
                  
                  
                  Interest
                  
                  
                  Yield/
                    Rate
                  
                  
                  Average
                    Balance
                  
                  
                  Interest
                  
                  
                  Yield/
                    RateASSETSInterest-Earning
      Cash in Other Banks
                  
                  $
                  165
                  
                  
                  $
                  6
                  
                  
                  
                  3.64
                  %
                  
                  $
                  197
                  
                  
                  $
                  10
                  
                  
                  
                  5.08
                  %
                  
                  $
                  196
                  
                  
                  $
                  16
                  
                  
                  
                  8.16
                  %Interest-Earning
      Time Deposits in Other Banks
                  
                  
                  1,077
                  
                  
                  
                  36
                  
                  
                  
                  3.34
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  –Federal
      Funds Sold
                  
                  
                  8,503
                  
                  
                  
                  214
                  
                  
                  
                  2.52
                  
                  
                  
                  9,363
                  
                  
                  
                  459
                  
                  
                  
                  4.90
                  
                  
                  
                  358
                  
                  
                  
                  19
                  
                  
                  
                  5.31Investment Securities: (a)Taxable
                  
                  
                  69,618
                  
                  
                  
                  3,209
                  
                  
                  
                  4.61
                  
                  
                  
                  65,255
                  
                  
                  
                  3,358
                  
                  
                  
                  5.15
                  
                  
                  
                  98,956
                  
                  
                  
                  4,913
                  
                  
                  
                  4.96Tax-Exempt (c)
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  
                  8,334
                  
                  
                  
                  610
                  
                  
                  
                  7.32
                  
                  
                  
                  30,457
                  
                  
                  
                  2,068
                  
                  
                  
                  6.79Loans and Leases (b), (c),
      (d)
                  
                  
                  369,554
                  
                  
                  
                  24,817
                  
                  
                  
                  6.72
                  
                  
                  
                  357,795
                  
                  
                  
                  27,092
                  
                  
                  
                  7.57
                  
                  
                  
                  318,251
                  
                  
                  
                  23,933
                  
                  
                  
                  7.52Restricted
      Investment in Bank Stocks
                  
                  
                  3,365
                  
                  
                  
                  114
                  
                  
                  
                  3.39
                  
                  
                  
                  3,950
                  
                  
                  
                  290
                  
                  
                  
                  7.34
                  
                  
                  
                  5,928
                  
                  
                  
                  364
                  
                  
                  
                  6.14Total
      Earning Assets
                  
                  
                  452,282
                  
                  
                  
                  28,396
                  
                  
                  
                  6.28
                  %
                  
                  
                  444,894
                  
                  
                  
                  31,819
                  
                  
                  
                  7.15
                  %
                  
                  
                  454,146
                  
                  
                  
                  31,313
                  
                  
                  
                  6.89
                  %Allowance
      for Loan and Lease Losses
                  
                  
                  (3,798
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (3,363
                  )
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (2,818
                  )Other
      Non Interest-Earning Assets
                  
                  
                  40,234
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  38,870
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  38,556TOTAL
      ASSETS
                  
                  $
                  488,718
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  480,401
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  489,884LIABILITIES AND
      STOCKHOLDERS’ EQUITYInterest-Bearing
      Liabilities:Interest-Bearing
      Demand Deposits
                  
                  $
                  127,128
                  
                  
                  
                  1,988
                  
                  
                  
                  1.56
                  %
                  
                  $
                  120,637
                  
                  
                  
                  3,174
                  
                  
                  
                  2.63
                  %
                  
                  $
                  114,938
                  
                  
                  
                  2,881
                  
                  
                  
                  2.51
                  %Savings
      Deposits
                  
                  
                  23,589
                  
                  
                  
                  66
                  
                  
                  
                  0.28
                  
                  
                  
                  25,367
                  
                  
                  
                  77
                  
                  
                  
                  0.30
                  
                  
                  
                  28,771
                  
                  
                  
                  77
                  
                  
                  
                  0.27Brokered
      Deposits
                  
                  
                  14,381
                  
                  
                  
                  828
                  
                  
                  
                  5.76
                  
                  
                  
                  25,211
                  
                  
                  
                  1,262
                  
                  
                  
                  5.01
                  
                  
                  
                  27,701
                  
                  
                  
                  1,311
                  
                  
                  
                  4.73Other
      Time Deposits
                  
                  
                  163,254
                  
                  
                  
                  6,588
                  
                  
                  
                  4.04
                  
                  
                  
                  134,142
                  
                  
                  
                  6,277
                  
                  
                  
                  4.68
                  
                  
                  
                  102,412
                  
                  
                  
                  4,123
                  
                  
                  
                  4.03Total
      Deposits
                  
                  
                  328,352
                  
                  
                  
                  9,470
                  
                  
                  
                  2.88
                  
                  
                  
                  305,357
                  
                  
                  
                  10,790
                  
                  
                  
                  3.53
                  
                  
                  
                  273,822
                  
                  
                  
                  8,392
                  
                  
                  
                  3.06Short-Term
      Borrowings
                  
                  
                  9,090
                  
                  
                  
                  210
                  
                  
                  
                  2.31
                  
                  
                  
                  6,025
                  
                  
                  
                  299
                  
                  
                  
                  4.96
                  
                  
                  
                  9,790
                  
                  
                  
                  489
                  
                  
                  
                  4.99Long-Term
      Debt
                  
                  
                  54,501
                  
                  
                  
                  2,795
                  
                  
                  
                  5.13
                  
                  
                  
                  72,586
                  
                  
                  
                  3,652
                  
                  
                  
                  5.03
                  
                  
                  
                  119,326
                  
                  
                  
                  5,729
                  
                  
                  
                  4.80Junior
      Subordinated Debentures
                  
                  
                  17,341
                  
                  
                  
                  1,104
                  
                  
                  
                  6.37
                  
                  
                  
                  17,341
                  
                  
                  
                  1,268
                  
                  
                  
                  7.31
                  
                  
                  
                  13,922
                  
                  
                  
                  1,016
                  
                  
                  
                  7.30Total Interest-Bearing Liabilities
                  
                  
                  409,284
                  
                  
                  
                  13,579
                  
                  
                  
                  3.32
                  %
                  
                  
                  401,309
                  
                  
                  
                  16,009
                  
                  
                  
                  3.99
                  %
                  
                  
                  416,860
                  
                  
                  
                  15,626
                  
                  
                  
                  3.75
                  %Non-Interest
      Bearing Liabilities:Demand Deposits
                  
                  
                  46,342
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  46,393
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  42,580Other Liabilities
                  
                  
                  3,045
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,634
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,690Stockholders'
      Equity
                  
                  
                  30,047
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  29,065
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  27,754TOTAL
      LIABILITIES and STOCKHOLDERS' EQUITY
                  
                  $
                  488,718
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  480,401
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  489,884Net
      Interest Spread
                  
                  
                  
                  
                  
                  $
                  14,817
                  
                  
                  
                  2.96
                  %
                  
                  
                  
                  
                  
                  $
                  15,810
                  
                  
                  
                  3.16
                  %
                  
                  
                  
                  
                  
                  $
                  15,687
                  
                  
                  
                  3.14
                  %Net
      Interest Margin
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.28
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.55
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.45
                  %





(a)
              Balances
      reflect amortized historical cost for available for sale securities. The
      related average unrealized holding gain or loss on securities is included
      in other non interest-earning
assets.


(b)
            Balances
      of nonaccrual loans and related income recognized have been included for
      computational purposes.


(c)
            Tax-exempt
      income included in loans and securities has been adjusted to a
      taxable-equivalent basis using an incremental rate of
  34%.


(d)
              Includes
      loan fees of $798,000 for the year ended December 31, 2008, $771,000 for
      the year ended December 31, 2007 and $813,000 for the year ended December
      31, 2006.


50




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





The
Rate/Volume Analysis of Net Interest Income table below further shows changes
attributable to the volume and rate components of net interest income on a
taxable equivalent basis.





Rate/Volume
Analysis of Net Interest Income


(in
thousands)


2008 Compared to 2007
                        
                        
                        2007 Compared to 2006Increase (Decrease) Due to
                        
                        
                        Increase (Decrease) Due toVolume (a)
                        
                        
                        Rate (a)
                        
                        
                        Total
                        
                        
                        Volume (a)
                        
                        
                        Rate (a)
                        
                        
                        TotalInterest
      Earning Assets:Interest
      Bearing Deposits in Other Banks
                        
                        $
                        (2
                        )
                        
                        $
                        (2
                        )
                        
                        $
                        (4
                        )
                        
                        $
                        –
                        
                        
                        $
                        (6
                        )
                        
                        $
                        (6
                        )Interest
      Bearing Time Deposits in Other Banks
                        
                        
                        36
                        
                        
                        –
                        
                        
                        
                        36
                        
                        
                        –
                        
                        
                        –
                        
                        
                        –Federal
      Funds Sold
                        
                        
                        (42
                        )
                        
                        
                        (203
                        )
                        
                        
                        (245
                        )
                        
                        
                        478
                        
                        
                        
                        (38
                        )
                        
                        
                        440Investment
      Securities:Taxable
                        
                        
                        226
                        
                        
                        
                        (375
                        )
                        
                        
                        (149
                        )
                        
                        
                        (1,676
                        )
                        
                        
                        121
                        
                        
                        
                        (1,555
                        )Tax-Exempt (c)
                        
                        
                        (610
                        )
                        
                        –
                        
                        
                        
                        (610
                        )
                        
                        
                        (1,502
                        )
                        
                        
                        44
                        
                        
                        
                        (1,458
                        )Loans and Leases – Net (b),
      (c)
                        
                        
                        878
                        
                        
                        
                        (3,153
                        )
                        
                        
                        (2,275
                        )
                        
                        
                        2,977
                        
                        
                        
                        182
                        
                        
                        
                        3,159Restricted
      Investment in Bank Stocks
                        
                        
                        (43
                        )
                        
                        
                        (133
                        )
                        
                        
                        (176
                        )
                        
                        
                        (123
                        )
                        
                        
                        49
                        
                        
                        
                        (74
                        )Total
      Earning Assets
                        
                        
                        443
                        
                        
                        
                        (3,866
                        )
                        
                        
                        (3,423
                        )
                        
                        
                        154
                        
                        
                        
                        352
                        
                        
                        
                        506Interest
      Bearing Liabilities:Interest-Bearing
      Demand Deposits
                        
                        
                        172
                        
                        
                        
                        (1,358
                        )
                        
                        
                        (1,186
                        )
                        
                        
                        146
                        
                        
                        
                        147
                        
                        
                        
                        293Savings
      Deposits
                        
                        
                        (5
                        )
                        
                        
                        (6
                        )
                        
                        
                        (11
                        )
                        
                        
                        (9
                        )
                        
                        
                        9
                        
                        
                        –Brokered
      Deposits
                        
                        
                        (541
                        )
                        
                        
                        107
                        
                        
                        
                        (434
                        )
                        
                        
                        (119
                        )
                        
                        
                        70
                        
                        
                        
                        (49
                        )Other
      Time Deposits
                        
                        
                        1,375
                        
                        
                        
                        (1,064
                        )
                        
                        
                        311
                        
                        
                        
                        1,281
                        
                        
                        
                        873
                        
                        
                        
                        2,154Total
      Deposits
                        
                        
                        1,001
                        
                        
                        
                        (2,321
                        )
                        
                        
                        (1,320
                        )
                        
                        
                        1,299
                        
                        
                        
                        1,099
                        
                        
                        
                        2,398Short-Term
      Borrowings
                        
                        
                        152
                        
                        
                        
                        (241
                        )
                        
                        
                        (89
                        )
                        
                        
                        (188
                        )
                        
                        
                        (2
                        )
                        
                        
                        (190
                        )Long-Term
      Debt
                        
                        
                        (905
                        )
                        
                        
                        48
                        
                        
                        
                        (857
                        )
                        
                        
                        (2,244
                        )
                        
                        
                        167
                        
                        
                        
                        (2,077
                        )Junior
      Subordinated Debentures
                        
                        –
                        
                        
                        
                        (164
                        )
                        
                        
                        (164
                        )
                        
                        
                        250
                        
                        
                        
                        2
                        
                        
                        
                        252Total
      Interest-Bearing Liabilities
                        
                        
                        248
                        
                        
                        
                        (2,678
                        )
                        
                        
                        (2,430
                        )
                        
                        
                        (883
                        )
                        
                        
                        1,266
                        
                        
                        
                        383Net
      Interest Income
                        
                        $
                        195
                        
                        
                        $
                        (1,188
                        )
                        
                        $
                        (993
                        )
                        
                        $
                        1,037
                        
                        
                        $
                        (914
                        )
                        
                        $
                        123





(a)
            The
      change in interest due to both volume and rate has been allocated
      individually to the change in volume and rate on a proportional
      basis.


(b)
            The
      balance of nonaccrual loans and related income recognized have been
      included for computational
purposes.


(c)
            Tax-exempt
      income included in loans and securities has been adjusted to a taxable
      equivalent basis using an incremental rate of
  34%.





Provision
for Loan and Lease Losses





The loan
and lease loss provision 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 loan and
lease losses.  The provision for loan and lease losses was $1,027,000
for the year ended December 31, 2008, as compared to $1,237,000 for the year
ended December 31, 2007.  Future adjustments may be necessary to the
provision for loan and lease losses, and consequently the allowance for loan and
lease 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 loan and lease losses as compared to the balance of outstanding
loans and leases (See additional discussion in the Allowance for Loan and Lease
Losses section).


51




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Non-Interest
Income





For the
year ended December 31, 2008, non-interest income decreased by $2,702,000 or
41.5% as compared to the year ended December 31, 2007.  Increases
(decreases) in the components of non-interest income when comparing the year
ended December 31, 2008 to 2007 are as follows (in thousands):





Non-Interest Income
                      
                      2008 vs. 2007Income
      from Fiduciary Activities
                      
                      $
                      (38
                      )Service
      Charges on Deposit Accounts
                      
                      
                      86Other
      Service Charges, Commissions, and Fees
                      
                      
                      32Alternative
      Investment Sales Commissions
                      
                      
                      (31
                      )Impairment
      Charge on Investment Security
                      
                      
                      (490
                      )Net
      Investment Securities Gains
                      
                      
                      163Mortgage
      Banking/Brokerage Activities
                      
                      
                      (1,944
                      )Title
      Insurance/Settlement Income
                      
                      
                      (317
                      )Earnings
      from Bank-Owned Life Insurance
                      
                      
                      13Other
      Income
                      
                      
                      (176
                      )Total
      Decrease in Non-Interest Income
                      
                      $
                      (2,702
                      )





Much of
the decrease in non-interest income was primarily due to reductions in mortgage
banking income related to the closure in 2007 of Union National’s mortgage
brokerage subsidiary, Home Team (see related discussion in Note 16 to the
consolidated financial statements).  Accordingly, consolidated
operating results for the year ended December 31, 2008, reflected no mortgage
brokerage and title insurance income related to Home
Team.  Consolidated operating results for the year ended December 31,
2007, included $1,932,000 of mortgage brokerage income and $317,000 of title
insurance/settlement income related to Home Team.





In
December 2008, we recorded $1,290,000 of impairment charges resulting from fair
value reductions in two of our investment securities which are not guaranteed by
agencies of the U.S. government.  We 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 in value.  The results for the year ended December 31, 2007
included $800,000 of other-than-temporary investment impairment charges related
to certain corporate debt securities.   The impairment charges
incurred in 2008 and 2007 are described in more detail in Note 21 to the
consolidated financial statements.





For the
year ended December 31, 2008, Union National realized gains on sales of
investment securities of $252,000 as compared to $89,000 for the year ended
December 31, 2007. The 2008 investment sales activity related to continued
repositioning of our investment portfolio to a lower-risk profile that more
effectively supports liquidity and capital management. The 2007 investment sales
activity related to securities sold as part of 2007 de-leveraging
activities.





Non-Interest
Expense





For the
year ended December 31, 2008, non-interest expense decreased by $3,627,000 or
17.5% as compared to the year ended December 31, 2007.  Increases
(decreases) in the components of non-interest expense when comparing the year
ended December 31, 2008 to 2007 are as follows (in thousands):





Non-Interest Expense
                      
                      2008 vs. 2007Salaries, Wages
      and Employee Benefits
                      
                      $
                      (2,047
                      )Net
      Occupancy
                      
                      
                      (572
                      )Furniture
      and Equipment
                      
                      
                      (64
                      )Professional
      Fees and Regulatory Assessments
                      
                      
                      (480
                      )Data
      and ATM Processing
                      
                      
                      (21
                      )Pennsylvania
      Shares Tax
                      
                      
                      30Advertising
      and Marketing
                      
                      
                      (241
                      )Supplies
      and Postage
                      
                      
                      24FDIC
      Insurance
                      
                      
                      267Minority
      Interest in Earnings (Losses) of Subsidiaries
                      
                      
                      41Restructuring
      Charge
                      
                      
                      (717
                      )Other
      Expense
                      
                      
                      153Total
      Decrease in Non-Interest Expense
                      
                      $
                      (3,627
                      )


The
decrease in Salaries, Wages, and Employee Benefits expense reflect the positive
impact realized from the 2007 staff restructuring, as well as the staff
reductions from the closure of operations of Home Team during
2007.


52




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Net
Occupancy expense decreased due to 2007 including a charge of $259,000 for a
commitment on a parcel of real estate which was to be used for a future retail
branch site.  Additionally, Union National reduced its net occupancy
expense in 2008 by $197,000 from subleasing two-thirds of its corporate office
facility.





Professional
Fees and Regulatory Assessments decreased primarily due to 2007 expenses related
to a nonrecurring profit improvement consulting engagement, and consulting and
legal fees associated with the 2007 restructuring and complying with the
Memorandum of Understanding with the OCC.





Advertising
and Marketing expenses were higher in 2007 due to marketing expenses related to
the now closed Home Team subsidiary.





FDIC
insurance premiums increased as the result of a one-time assessment credit which
reduced the 2007 expense, and additional premium assessments due to the Bank’s
status under the Memorandum of Understanding.





The
Restructuring Charge, as previously described in Note 17 to the consolidated
financial statements, consisted of staff reorganization severance and related
costs incurred in 2007.





Other
Expense variances include the following:





§
            2008
      included a one-time charge of $370,000 that related to certain fraudulent
      loans made by one employee who has since been terminated.  Based
      upon Union National’s investigation of the matter, there does not appear
      to be any additional losses or the involvement of other
      employees.  Union National has evaluated the impact of this
      incident on its current internal controls and procedures and has
      implemented changes necessary to strengthen control processes and address
      the issues raised by this isolated event.  The appropriate
      governmental authorities have been notified and Union National is
      cooperating fully with respect to the authorities’
      investigation.  Union National is pursuing available avenues for
      collection of the loss including insurance recovery and legal restitution
      from the former employee.





§
            Union
      National prepaid $18,482,000 of FHLB advances during 2008, which resulted
      in $72,000 of prepayment penalties which were recorded in other
      non-interest expense.





§
            Other
      Expense for 2007 included $157,000 related to the impairment of previously
      recorded goodwill and minority interest assets associated with Union
      National’s ownership of Home Team.





Income
Taxes





Union
National realized a net benefit for income taxes of $188,000 for 2008, as
compared to $421,000 for 2007.  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.  As a result of Union National’s adoption of FIN 48
and FIN 48-1 effective January 1, 2007, no significant income tax uncertainties
were identified, therefore, Union National recognized no adjustment for
unrecognized income tax benefits for the periods ended December 31, 2008 and
2007.  We currently anticipate that future earnings will be adequate
to fully utilize deferred tax assets.


53




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Summary
of Performance - 2007 Compared to 2006





Overview





Union
National reported net income of $312,000 for the year ended December 31, 2007, a
decrease of 87% from net income of $2,444,000 for the year ended December 31,
2006.  Basic and diluted earnings per share for 2007 were $0.12, as
compared to basic earnings per share of $0.97 and diluted earnings per share of
$0.96 for 2006.  An increase of $3,221,000 from 2006 to 2007 in
top-line revenue, interest and fee income on loans, contributed to an increase
of $700,000 in net interest income.  The increase in net interest
income and certain other operating revenues were more than offset by significant
pre-tax costs incurred during 2007 including:





§
            Realized
      net losses of $519,000 on the sale of available for sale securities, and
      $31,000 in debt prepayment penalties, associated with de-leveraging
      activities that occurred during the first quarter of
  2007;





§
            Restructuring
      charges of $717,000 consisting of severance and related benefits resulting
      from staff reductions that were completed during March and April of
      2007;





§
            Other-than-temporary
      impairment charges of $800,000 recognized during 2007 related to
      significant reductions in the market value of three available for sale
      corporate debt securities;





§
            Operating
      losses of $384,000, goodwill impairment of $157,000, and severance and
      related costs of $111,000 related to Union National’s Home Team Financial,
      LLC subsidiary, which ceased operations effective October 31,
      2007;





§
            An
      increase in professional fees expense of $549,000 for 2007, as compared to
      $102,000 for 2006, incurred in connection with several areas including the
      implementation of Sarbanes Oxley requirements, regulatory matters
      including those related to the Memorandum of Understanding, legal services
      regarding employee severance, and a profit enhancement consulting project;
      and





§
            A
      net occupancy expense charge of $259,000 for a commitment on a parcel of
      real estate to be used for potential bank use or sublease as a future
      retail branch site.





The
combined 2007 after-tax impact of the above nonrecurring costs totaled
$2,328,000 or $0.92 per diluted share, as compared to the $2,132,000 or $0.85
per diluted share decrease in net income from 2006 to 2007.





Net
income as a percent of total average assets, also known as return on average
assets (ROA), was 0.06% for 2007 as compared to 0.50% for 2006.  Net
income as a percent of average stockholders' equity, also known as return on
average equity (ROE), was 1.07% for 2007 as compared to 8.81% for
2006.  Net income as a percent of average realized stockholders’
equity, which excludes the impact of accumulated other comprehensive income
(loss), was 1.08% for 2007 as compared to 8.55% for 2006.





Net
Interest Income





Net
interest income was $15,810,000 for the year ended December 31, 2007, as
compared to $15,687,000 for the year ended December 31, 2006.  The
yield on interest-earning assets increased by 26 basis points to 7.15% for 2007,
as compared to 6.89% for 2006.  The rate on interest-bearing
liabilities increased by 24 basis points to 3.99% for 2007, as compared to 3.75%
for 2006.  The taxable-equivalent net interest margin for 2007 was
3.55%, as compared to 3.45% for 2006.





Interest
and fees on loans and leases increased by $3,159,000 to $27,092,000 for the year
ended December 31, 2007, as compared to $23,933,000 for the year ended December
31, 2006.  This increase was primarily the result of a $39,544,000
increase in the average balance of the loan and lease portfolio coupled with a
slight increase in average yield of 5 basis points.





Interest
and dividends earned on investment securities decreased by $3,013,000 to
$3,968,000 for the year ended December 31, 2007, as compared to $6,981,000 for
the year ended December 31, 2006.  A $55,824,000 decrease in the
average balance of the investment securities portfolio resulted in less interest
earned on investment securities in comparison to 2006.During 2007, Union
National began to de-leverage its balance sheet and reposition its investment
portfolio in order to strengthen the Bank’s capital position, enhance its income
tax effectiveness, facilitate its future core banking growth strategies for
loans and deposits, and improve its interest rate profile.  In
conjunction with the de-leveraging activities, Union National sold $64,345,000
of available for sale securities, and liquidated $2,039,000 of restricted FHLB
stock, using the majority of the proceeds to pay down $48,755,000 of FHLB debt
and $6,550,000 of other short-term borrowings.


54




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Interest
expense on deposits increased by $2,398,000 to $10,790,000 for the year ended
December 31, 2007, as compared to $8,392,000 for the year ended December 31,
2006.  An increase in average rate of 47 basis points, in addition to,
a $31,535,000 increase in the average balance of deposits resulted in an
increase of interest expense on deposits. Union National’s average rate on
interest bearing deposits was 3.53% for 2007 as compared to 3.06% for
2006.





Interest
expense on long-term debt was $3,652,000 for the year ended December 31, 2007,
as compared to $5,729,000 for the year ended December 31, 2006.  The
$2,077,000 decrease was primarily the result of a $46,740,000 decrease in the
average balance of long-term debt offset by a 23 basis point increase in the
average rate.  The decrease in average balance was a result of Union
National using proceeds from the de-leveraging activities discussed above to pay
down $48,755,000 of FHLB long- term debt.





Non-Interest
Income





Non-Interest
Income for 2007 was $6,509,000, a decrease of $1,753,000 or 21.2% as compared to
Non-Interest Income of $8,262,000 for 2006.  The decrease was a result
of net increases (decreases) in the following elements of non-interest
income  (in thousands):


Non-Interest Income
                    
                    2007 vs. 2006Income
      from Fiduciary Activities
                    
                    $
                    73Service
      Charges on Deposit Accounts
                    
                    
                    193Other
      Service Charges, Commissions, and Fees
                    
                    
                    105Alternative
      Investment Sales Commissions
                    
                    
                    172Impairment
      Charge on Investment Security
                    
                    
                    (800
                    )Net
      Investment Securities Gains
                    
                    
                    (120
                    )Mortgage
      Banking/Brokerage Activities
                    
                    
                    (1,129
                    )Title
      Insurance/Settlement Income
                    
                    
                    (268
                    )Earnings
      from Bank-Owned Life Insurance
                    
                    
                    43Other
      Income
                    
                    
                    (22
                    )Total
      Decrease in Non-Interest Income
                    
                    $
                    (1,753
                    )





The
decreases in Mortgage Banking/Brokerage Activities and Title
Insurance/Settlement Income related to the substantial decline in business
activity and revenue in the residential mortgage brokerage business of Union
National’s subsidiary, Home Team Financial, LLC.  The weakening
housing market experienced beginning in mid-2007, and the related reduction in
brokered residential mortgage loan volume, contributed to significant mortgage
brokerage revenue reductions and operating losses at Home Team Financial,
LLC.  As a result, Union National’s management decided to cease
operations at Home Team Financial, LLC effective October 31, 2007.





The
$800,000 of Impairment Charges on Investments resulted from management’s
determination that three corporate debt securities held as available for sale
with a combined amortized cost (book value) of $3,000,000 had a combined market
value of $2,200,000, with the $800,000 decline in value being other than
temporary.In order
to determine whether unrealized losses in the market value of investment
securities were 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 market value has been less than
cost, independent analysts’ opinions about circumstances that could affect the
performance of the investment, and management’s intention and ability to hold
the securities to the earlier of the recovery of losses or
maturity.  For the year ended December 31, 2006, there were no
impairment charges on investment securities recorded.





Increases
in Service Charges on Deposit Accounts and Other Fees result from over 10%
growth in our retail deposits and continued development of fee-based services
for commercial customers.  Alternative Investment Sales Commissions
and Income from Fiduciary Activities reflects continued growth of Union
National’s wealth management services.


55




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Non-Interest
Expense





Non-Interest
Expense for 2007 increased to $20,745,000 as compared to $19,711,000 for 2006,
an increase of $1,034,000 or 5.2%.  The increase was primarily a
result of increases (decreases) in the following items (in
thousands):





Non-Interest Expense
                  
                  2007 vs. 2006Salaries, Wages
      and Employee Benefits
                  
                  $
                  (703
                  )Net
      Occupancy
                  
                  
                  697Furniture
      and Equipment
                  
                  
                  195Professional
      Fees and Regulatory Assessments
                  
                  
                  588Data
      and ATM Processing
                  
                  
                  107Pennsylvania
      Shares Tax
                  
                  
                  27Advertising
      and Marketing
                  
                  
                  (655
                  )Supplies
      and Postage
                  
                  
                  (83
                  )FDIC
      Insurance
                  
                  
                  99Minority
      Interest in Earnings of Subsidiaries
                  
                  
                  (171
                  )Restructuring
      Charge
                  
                  
                  717Other
      Expense
                  
                  
                  216Total
      Decrease in Non-Interest Expense
                  
                  $
                  1,034





The
reductions in Salaries, Wages and Employee Benefits and Advertising and
Marketing relate to both savings from the closure of the Home Team Financial,
LLC subsidiary, and savings related to both the first quarter 2007 restructuring
initiative (discussed below).  With the decision by Union National
management to close the Home Team Financial, LLC subsidiary effective October
31, 2007, we recorded in Other Expenses a $157,000 impairment of previously
recorded goodwill associated with the Bank’s ownership of Home Team Financial,
LLC.  With Home Team Financial, LLC being profitable in 2006 but
incurring operating losses in 2007, Union National’s minority interest in
subsidiaries changed by $171,000 from a $130,000 expense for 2006 to a $41,000
benefit in 2007.





The
increase in Net Occupancy and Furniture and Equipment expenses reflect that in
2007, we recorded a full year’s lease cost of our Lausch Lane Corporate Offices
and Gold Café Offices.  These leases were initiated during 2006 and
were not in place for the entire 2006 year.  Also, we initiated a new
lease in 2007 for our Ephrata location.  Additionally, the increase
includes a charge of $259,000 for a commitment on a parcel of real estate to be
used for potential bank use or sublease as a future retail branch
site.  The increase also reflects increased depreciation expense
related to technology assets, leasehold improvements, and furniture and fixtures
related to recent years’ capital expenditures.





The
restructuring charges of $717,000 consist of severance and related costs
incurred during the first and second quarters of 2007 as management performed a
restructuring evaluation of the Bank’s operations, reducing certain management
and staffing positions in order to establish more appropriate and efficient
staffing levels.





The
increase in Professional Fees and Regulatory expense of $588,000 for 2007, as
compared to 2006, reflects professional costs incurred in connection with
several areas including the implementation of Sarbanes Oxley requirements,
regulatory matters including those related to the Memorandum of Understanding,
legal services regarding employee severance, and a profit enhancement consulting
project.





The
decrease in Data and ATM Processing expenses reflect nominal data processing
contract increases being more than offset by a substantial savings in ATM
processing costs related to management’s negotiation of a more favorable ATM
processing service agreement.


56




MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued





Income
Taxes





Union
National realized a net benefit for income taxes of $421,000 for 2007, and a
provision (expense) for income taxes of $99,000 for 2006.  The net tax
benefit in 2007 relates to both the pre-tax operating loss for the year combined
with preferential tax benefits related primarily to income on tax-exempt
securities and loans.  Because of the expected lower income results
for 2007, management sold its remaining tax-exempt available for sale securities
during June 2007 to avoid incurrence of undesirable alternative minimum tax
implications.  The realization of net deferred tax assets, which
amounted to $1,198,000 and $1,321,000 at December 31, 2007 and 2006,
respectively, is dependent on our future earnings.  We currently
anticipate that future earnings will be adequate to utilize these deferred tax
assets.  The decrease in deferred tax assets resulted primarily from
an increase in the allowance for loan and lease losses, offset by timing
differences related to our portfolio of financing leases.





Recent
Accounting Pronouncements





Refer to
Note 1 of the financial statements for recently issued accounting standards.





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, 2009.





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


57







MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







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.  Under the CPP, qualifying financial
institutions may apply to the Treasury for capital funding, in the form of
senior preferred stock issued to the Treasury, with a value equal to not less
that 1% of risk-weighted assets and not more than the lesser of $25 billion or
3% of risk-weighted assets.  The senior preferred stock will pay
dividends at the rate of 5% per annum until the fifth anniversary of the
investment and thereafter at the rate of 9% per annum.  The senior
preferred stock may not be redeemed for three years except with the proceeds
from an offering of common stock or preferred stock qualifying as Tier 1 capital
in an amount equal to not less than 25% of the amount of the senior
preferred.  After three years, the senior preferred may be redeemed at
any time in whole or in part by the financial institution.  No
dividends may be paid on common stock unless dividends have been paid on the
senior preferred stock.  Until the third anniversary of the issuance
of the senior preferred, the consent of the U.S. Treasury will be required for
any increase in the dividends on the common stock or for any stock repurchases
unless the senior preferred has been redeemed in its entirety or the Treasury
has transferred the senior preferred to third parties.  The senior
preferred will not have voting rights other than the right to vote as a class on
the issuance of any preferred stock ranking senior, any change in its terms or
any merger, exchange or similar transaction that would adversely affect its
rights.  The senior preferred will also have the right to elect two
directors if dividends have not been paid for six periods.  The senior
preferred will be freely transferable and participating institutions will be
required to file a shelf registration statement covering the senior
preferred.  The issuing institution must grant the Treasury piggyback
registration rights.  Prior to issuance, the financial institution and
its senior executive officers must modify or terminate all benefit plans and
arrangements to comply with EESA.  Senior executives must also waive
any claims against the Department of Treasury.  In connection with the
issuance of the senior preferred, participating institutions must issue to the
Secretary immediately exercisable 10-year warrants to purchase common stock with
an aggregate market price equal to 15% of the amount of senior preferred. The
exercise price of the warrants will equal the market price of the common stock
on the date of the investment.  The Secretary may only exercise or
transfer one-half of the warrants prior to the earlier of December 31, 2009 or
the date the issuing financial institution has received proceeds
equal  to the senior preferred investment from one or more offerings
of common or preferred stock qualifying as Tier 1 capital.  The
Secretary will not exercise voting rights with respect to any shares of common
stock acquired through exercise of the warrants.  The financial
institution must file a shelf registration statement covering the warrants and
underlying common stock as soon as practicable after issuance and grant
piggyback registration rights.  The number of warrants will be reduced
by one-half if the financial institution raises capital equal to the amount of
the senior preferred through one or more offerings of common stock or preferred
stock qualifying as Tier 1 capital.  If the financial institution does
not have sufficient authorized shares of common stock available to satisfy the
warrants or their issuance otherwise requires shareholder approval, the
financial institution must call a meeting of shareholders for that purpose as
soon as practicable after the date of investment.  The exercise price
of the warrants will be reduced by 15% for each six months that lapse before
shareholder approval subject to a maximum deduction of 45%.





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.





Union
National’s management and Board of Directors evaluated the considerations
regarding participation in the CPP and  opted not to apply for CPP
funding.





It is not
clear at this time what impact the EESA, TARP Capital Purchase Program, the
Temporary Liquidity Guarantee Program, other liquidity and funding initiatives
of the Federal Reserve and other agencies that have been previously announced,
and 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
2009 to reflect the same issues as in 2008, with the distinct possibility of an
increasingly weak economy, and further turbulence in financial
markets.  Accordingly, we have taken necessary, conservative measures
to ensure Union National maintains its safe and sound position.  We
substantially lowered our operating costs, allowing us to be more efficient in a
difficult market when income growth is challenging.  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 quarter
of 2009.





58





MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







These
important and prudent actions did not allow us to avoid the impact of what we
could not control, specifically, the severe deterioration in the economy and
financial markets throughout 2008.  In December, we incurred
significant impairment charges resulting from fair value reductions in two of
our investment securities which are not guaranteed by agencies of the U.S.
government.  We 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 in
value.  The weak economy and volatile financial markets increase the
possibility for defaults by underlying issuers and creditors of our
private-issuer debt securities, making them susceptible to further
other-than-temporary impairments.





With the
decline in interest rates, including the market prime rate decreasing 4% through
2008, Union National’s interest rates on loans re-priced lower and more quickly
than retail interest-bearing deposits and wholesale funding sources, resulting
in a lower net interest margin in 2008 versus 2007.  The
taxable-equivalent net interest margin percentage for 2008 was 3.28%, as
compared to 3.55% for 2007.  The current low interest rate
environment, which shows no indication of changing into 2009, may result in
further net interest margin compression.  The weak economy and housing
market, and increased unemployment both nationally and locally, will likely
create cash flow difficulties and collateral de-valuation for some of Union
National’s borrowers, resulting in increased nonperforming loans and possible
increased loan and lease losses.  We continue to closely monitor our
portfolio, and the underlying borrower financial performance and collateral
values.  We have appropriately increased the allowance for loan and
lease losses in anticipation of potentially increased losses in the continuing
weak economy.





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





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 deposit base;


·
            Proceeds
      from the sale or maturity of investment
  securities;


·
            Overnight
      correspondent bank borrowings on various credit lines and borrowing
      capacity available from the FHLB;


·
            Acquisition
      of CDs and brokered CDs through the CDARS program as discussed below;
      and


·
            Payments
      on loans and mortgage-backed
securities.





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.





As of
December 31, 2008 and 2007, the ratio of aggregated FHLB advances and brokered
CDs to total assets was 13% and 20%, respectively.  The decrease in
the percentage of these wholesale funding sources is attributable to the
de-leveraging which began in 2007 and is discussed in Note 17 to the
consolidated financial statements.  In 2008, we focused our funding growth
efforts on retail deposit sources.  We favorably grew lower-costing
retail deposits by $18,773,000, or 5.3%, while we reduced higher-cost wholesale
brokered deposits by $11,507,000 or 48.4%, for the year.  Overall,
total deposits grew 1.9% during 2008. We also
prepaid $18,482,000 of borrowings from the Federal Home Loan Bank of Pittsburgh,
continuing our strategy to de-leverage our balance sheet by reducing high-cost
funding sources.





59





MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







Membership
in the FHLB provides us with additional liquidity alternatives such as short- or
long-term funding on fixed- or variable-rate terms.  As of December
31, 2008, we had outstanding total long-term advances of $50,334,000 from our
available maximum borrowing capacity with the FHLB of $101,087,000, with
$50,753,000 of borrowing capacity available including a $15,000,000 open line of
credit.  As of December 31, 2007, we had outstanding total long-term
advances of $68,816,000 from our available maximum borrowing capacity with the
FHLB at that time of $88,719,000, with $19,903,000 of borrowing capacity
available.  All FHLB long-term borrowings are subject to prepayment
penalties which vary based upon current market interest rates.  Of the
FHLB long-term debt outstanding at December 31, 2008, $30,000,000 are
convertible fixed-rate advances which allow the FHLB the periodic option to
convert to an adjustable-rate advance at the three-month London Interbank
Offered Rate (“LIBOR”) plus .08% to .20%. Upon the FHLB's conversion, the Bank
has the option to repay the respective advances in full without prepayment
penalties.  See section on Market Risk - Interest Rate Risk for further
discussion and analysis of these advances.





Union
National offers deposit customers FDIC insurance coverage beyond $250,000
through a unique program called the Certificate of Deposit Account Registry
Service (“CDARS”).  Through this program, customers may be able to deposit
up to $50 million with us and maintain full FDIC insurance coverage.  We
are also able to bid for and obtain additional brokered CDs through this program
as an additional source of liquidity.  As of December 31, 2008 and 2007, we
had $32,514,000 and $14,150,000, respectively, in CDs acquired through the CDARS
program.





We have
obtained funding in the past through the issuance of junior subordinated
debentures as described in Note 11 to the consolidated financial
statements.





During
2008, we obtained an additional $1,635,000, prior to offering costs, of funding
through a private placement stock offering which is discussed in Note 22 to the
consolidated financial statements.





Off-Balance
Sheet Arrangements and Aggregate Contractual Obligations





The
following table represents Union National’s on- and off-balance sheet aggregate
contractual obligations to make future payments as of December 31, 2008 (in
thousands):





Less Than
                    1 Year
                  
                  
                  1-3
                    Years
                  
                  
                  4-5
                    Years
                  
                  
                  Over
                    5 Years
                  
                  
                  TotalTime
      Deposits
                  
                  $
                  115,965
                  
                  
                  $
                  65,214
                  
                  
                  $
                  12,583
                  
                  
                  $
                  91
                  
                  
                  $
                  193,853Long-Term
      Debt
                  
                  –
                  
                  
                  
                  39,500
                  
                  
                  
                  10,834
                  
                  
                  –
                  
                  
                  
                  50,334Junior
      Subordinated Debentures
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  
                  17,341
                  
                  
                  
                  17,341Operating
      Leases
                  
                  
                  374
                  
                  
                  
                  755
                  
                  
                  
                  959
                  
                  
                  
                  3,370
                  
                  
                  
                  5,458Total
                  
                  $
                  116,339
                  
                  
                  $
                  105,469
                  
                  
                  $
                  24,376
                  
                  
                  $
                  20,802
                  
                  
                  $
                  266,986





In
addition, in the conduct 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.  We have contracted with our core data
processor for certain services including transaction processing, branch
automation and communication services, trust processing, ATM processing and
various other services.  Payments under this contract amounted to $900,000
for the year ended December 31, 2008.  Future payments under this contract
will vary based on transaction and account volumes and may also reflect
inflationary cost adjustments.  The current contract was renegotiated in
January 2007 with a maturity date of November 2013.  Any early termination
would require the payment of a substantial penalty.





We are
not aware of any other commitments or contingent liabilities which may have a
material adverse impact on our liquidity or capital
resources.





We are
also party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of our customers.  These
financial instruments include commitments to extend credit and standby letters
of credit (See Note 14 to the consolidated financial statements for additional
details).





Inflation





Inflation
has some impact on our operating costs, but unlike many other corporations,
substantially all of our assets and liabilities are monetary in nature.  As
a result, changes in interest rates have a more significant impact on our
performance than the general level of inflation.  Interest rates do not
necessarily move in the same direction or in the same magnitude as prices of
goods and services.  The effects of changes in interest rates are discussed
in the following section on Market Risk – Interest Rate Risk.





60





MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







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
objective of interest rate risk management is 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, and by the pricing,
structure, and promotion of our 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
addition, we utilize an interest rate-sensitivity report called a "Gap" report,
which illustrates the time intervals of cash flows or the next repricing date of
interest-earning assets and interest-bearing liabilities.  Our Gap report
at December 31, 2008 reflects a negative rate-sensitivity position throughout
the first year, meaning that our rate-sensitive liabilities exceed our
rate-sensitive assets.  The following analysis reflects cumulative
rate-sensitive assets of $253,403,000 as compared to cumulative rate-sensitive
liabilities of $270,155,000 for the one-year time frame.  Our cumulative
interest-sensitivity gap for the one-year time frame is a negative 3.5% of total
assets at December 31, 2008, as compared to a negative 10.4% at December 31,
2007.  We manage the interest-sensitivity gap for the one-year time frame
with a guideline of plus-or-minus 15% of total assets.





The
interest rate sensitivity analysis at December 31, 2008, with investment
securities presented at amortized cost, is as follows (dollars in
thousands):





Interest
Rate Sensitivity




1-90
                          Days
                        
                        
                        91-365
                          Days
                        
                        
                        1-5
                          Years
                        
                        
                        Over
                          5 Years
                        
                        
                        TotalInterest
      Earnings Assets:Interest-Bearing
      Deposits in Other Banks
                        
                        $
                        457
                        
                        
                        $
                        988
                        
                        
                        $
                        396
                        
                        
                        $ –
                        
                        
                        $
                        1,841Federal
      Funds Sold
                        
                        
                        14,150
                        
                        
                        –
                        
                        
                        –
                        
                        
                        –
                        
                        
                        
                        14,150Investment
      Securities Available for Sale
                        
                        
                        9,182
                        
                        
                        
                        21,724
                        
                        
                        
                        28,186
                        
                        
                        
                        5,197
                        
                        
                        
                        64,289Loans
      and Leases
                        
                        
                        128,309
                        
                        
                        
                        78,593
                        
                        
                        
                        128,928
                        
                        
                        
                        22,450
                        
                        
                        
                        358,280Total
      Interest Earning Assets
                        
                        $
                        152,098
                        
                        
                        $
                        101,305
                        
                        
                        $
                        157,510
                        
                        
                        $
                        27,647
                        
                        
                        $
                        438,560Interest
      Bearing Liabilities:Demand
      and Money Market Deposits
                        
                        $
                        120,762
                        
                        
                        $
                        –
                        
                        
                        $
                        –
                        
                        
                        $
                        –
                        
                        
                        $
                        120,762Savings
                        
                        
                        21,880
                        
                        
                        
                        207
                        
                        
                        –
                        
                        
                        –
                        
                        
                        
                        22,087Time
      Deposits
                        
                        
                        44,886
                        
                        
                        
                        71,079
                        
                        
                        
                        70,478
                        
                        
                        
                        7,410
                        
                        
                        
                        193,853FHLB
      Advances and Other Borrowings
                        
                        
                        11,341
                        
                        
                        –
                        
                        
                        
                        56,334
                        
                        
                        –
                        
                        
                        
                        67,675Total
      Interest Bearing Liabilities
                        
                        $
                        198,869
                        
                        
                        $
                        71,286
                        
                        
                        $
                        126,812
                        
                        
                        $
                        7,410
                        
                        
                        $
                        404,377Gap
                        
                        $
                        (46,771
                        )
                        
                        $
                        30,019
                        
                        
                        $
                        30,698
                        
                        
                        $
                        20,237Cumulative
      Gap
                        
                        $
                        (46,771
                        )
                        
                        $
                        (16,752
                        )
                        
                        $
                        13,946
                        
                        
                        $
                        34,183Cumulative
      Sensitivity Gap as a Percent of Total Assets
                        
                        
                        (9.6
                        )%
                        
                        
                        (3.5
                        )%
                        
                        
                        2.9
                        %
                        
                        
                        7.1
                        %





The
amount of assets and liabilities shown, which reprice or mature during a
particular period, were determined based on the earlier of when each asset or
liability reprices or when it is to be repaid.  Callable investment
securities are reflected based on the security's anticipated call date where the
call on the security is likely when compared to the current interest rate yield
curve. Also, loans and mortgage-backed securities are reflected based on
contractual amortization or contractual interest rate adjustments and on
estimates for prepayments and refinancings based on current market interest
rates.  Interest-bearing demand and savings deposits have always been
considered a stable source of funds, and although the rates are subject to
change, rates on these accounts historically have not changed as quickly or as
often as other loan and deposit rates.  Based on an historical analysis,
during periods of rising interest rates, a portion of these deposits will invest
in higher yielding instruments.  This portion is deemed to be sensitive to
interest rate fluctuations in the earliest periods.  We believe that the
remaining balances of these deposits are not repriceable based on current
industry experience.  We currently do not expect to adjust the interest
rates on these deposit balances in any significant amount that would materially
affect our Gap or income simulation models.





61





MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







Certain
shortcomings are inherent in the method of analysis presented in the foregoing
schedule.  For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates.  Interest rates on certain types of
assets and liabilities may fluctuate in advance of, or lag behind, changes in
market interest rates.  Additionally, certain repriceable assets, such as
adjustable-rate securities or loans, have features like annual and lifetime rate
caps or floors that restrict changes in interest rates both on a short-term
basis and over the life of the asset.  Further, a change in market interest
rates from the interest rate scenarios that existed on December 31, 2008 may
cause assumptions, such as estimated prepayment speeds, refinancings, embedded
options, early withdrawals, and FHLB advance conversion clauses to significantly
change from those reflected in the Gap report above.  Based on the low
current market interest rates, the $30,000,000 in FHLB convertible advances that
are currently convertible on a quarterly basis are presented in the Gap report
above at their original scheduled maturity dates.  These may convert with a
substantial increase in market interest rates and are reflected accordingly in
the Bank’s simulation model.





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 of changes in 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 accuracy and
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 simulation model presents the hypothetical effects to our net
interest income and net income from various rate change scenarios.
 Projections for loan and deposit growth are not factored into the main
analysis presented by 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 percentage declines in the
table below are measured as percentage changes from the values of simulated net
interest income in the current rate scenario and the impact of those changes on
the prior year’s net income.





The
Sensitivity Analysis schedule indicates that as of December 31, 2008 and 2007, a
hypothetical 2% (200 basis points) decline in prevailing market interest rates
would cause our net interest income to decline 12.2% and 8.1% as compared to the
current rate scenario at the respective year ends.  A hypothetical 2% (200
basis points) increase in interest rates as of December 31, 2008 and 2007 would
cause our net interest income to increase by 10.2% and 4.3% as compared to the
current rate scenario at the respective year ends.  These computations do
not contemplate any actions management or the Asset and Liability Management
Committee could undertake in response to other changes in market conditions or
market interest rates.





We
managed our interest rate risk position in 2008 by performing the
following:





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


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





62





MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







·
            managing
      and expanding the Bank's core retail deposit base including deposits
      obtained in our commercial cash management programs, premium money market
      accounts, and retail time deposits, and attempting to extend the duration
      of lower cost time deposits; and


·
            de-leveraging
      by repayment of higher cost FHLB advances and brokered
  CDs.




The above
strategies and actions impact interest rate risk and are addressed in our
quarterly simulation model results in order to determine future asset and
liability management strategies.





Based
upon the simulation model, the following reflects our net interest income and
net income sensitivity analysis as of December 31, 2008 and 2007:





Sensitivity Analysis
                      
                      Percent Change in CategoriesMarket Interest Rate
                        Increase of 2%
                      
                      
                      Market Interest Rate
                        Decline of 2%Net
      Interest Income:
                      
                      Policy
      Limit = Change in Net InterestIncome +/- Less Than 10%Hypothetical
      Percent Decrease in Net Interest Income from Current Rate
      Scenario:As
      of December 31, 2008
                      
                      
                      10.2
                      %
                      
                      
                      (12.2
                      )%*As
      of December 31, 2007
                      
                      
                      4.3
                      %
                      
                      
                      (8.1
                      )%Net
      Income:Hypothetical
      Percent Decrease from Prior Year's Net Income:As
      of December 31, 2008
                      
                      
                      221
                      %
                      
                      
                      (265
                      )%*As
      of December 31, 2007
                      
                      
                      140
                      %
                      
                      
                      (263
                      )%*





*      During
2008, the Federal Funds and Prime rates decreased by 4% to record lows of 0.25%
and 3.25%, respectively.  Given the record low interest rate
environment, a 2% market interest rate decline is deemed by management to be
unlikely.  In the unlikely event that interest rates would decline by
2%, the decrease in net interest income from a 2% market decline would more than
offset the entire portion of net income in 2008 and 2007.





REGULATORY
ACTIVITY





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 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.





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





Management
believes we have made substantial progress in addressing the terms of the MOU
and has sent to the OCC the documentation and progress reports as required under
the MOU to be submitted through the end of 2008.  We believe that the
MOU will have no material impact on our operating results or financial
condition, except for related increases to our FDIC insurance premiums,
currently estimated to be $231,000 in 2009, and that the MOU will not constrain
our businesses.  We are committed to addressing and resolving the
issues identified in the MOU.





63





MANAGEMENT’S
DISCUSSION AND ANALYSIS    continued







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





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





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





The FDIC
Board also adopted an interim rule imposing a 20 basis point emergency special
assessment on the industry on June 30, 2009. The assessment is to be collected
on September 30, 2009. For Union National, based upon our deposit levels at
December 31, 2008, the additional amount of 2009 FDIC insurance expense related
to this special assessment, if imposed, would be approximately
$769,000.  The interim rule would also permit the FDIC Board to impose
an emergency special assessment after June 30, 2009, of up to 10 basis points if
necessary to maintain public confidence in federal deposit
insurance.  If this emergency special assessment is imposed, it would
add an additional $385,000 to Union National’s 2009 FDIC insurance expense
(based upon deposit levels as of December 31, 2008).





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.





64


65
   STOCK
PERFORMANCE GRAPH







The
following graph shows the yearly percentage change in Union National’s
cumulative total shareholder return on its common stock from December 31,
2003 to December 31, 2008 compared with the NASDAQ Composite Index, a
Mid-Atlantic Custom Peer Group index and a Custom Peer Group
index.   The Mid-Atlantic Custom Peer Group consists of
Mid-Atlantic commercial banks with assets less than $1 billion.  The
Custom Peer Group consists of consists of ACNB, First Chester County
Corporation, VIST Financial Corp., Franklin Financial Services Corporation,
Ephrata National Bank, Orrstown Financial Services, Inc., DNB Financial
Corporation, Juniata Valley Financial Corporation, Mid Penn Bancorp, Inc.,
Codorus Valley Bancorp, Inc., and Tower Bancorp Incorporated.





Union
National Financial Corporation








Period
      EndingIndex
                        
                        12/31/03
                        
                        
                        12/31/04
                        
                        
                        12/31/05
                        
                        
                        12/31/06
                        
                        
                        12/31/07
                        
                        
                        12/31/08Union
      National Financial Corporation
                        
                        
                        100.00
                        
                        
                        
                        127.35
                        
                        
                        
                        109.70
                        
                        
                        
                        93.25
                        
                        
                        
                        58.11
                        
                        
                        
                        25.47NASDAQ
      Composite
                        
                        
                        100.00
                        
                        
                        
                        108.59
                        
                        
                        
                        110.08
                        
                        
                        
                        120.56
                        
                        
                        
                        132.39
                        
                        
                        
                        78.72Mid-Atlantic
      Custom Peer Group*
                        
                        
                        100.00
                        
                        
                        
                        113.29
                        
                        
                        
                        113.25
                        
                        
                        
                        115.44
                        
                        
                        
                        107.89
                        
                        
                        
                        83.30Custom
      Peer Group**
                        
                        
                        100.00
                        
                        
                        
                        114.48
                        
                        
                        
                        106.66
                        
                        
                        
                        112.22
                        
                        
                        
                        102.07
                        
                        
                        
                        77.02





*Mid-Atlantic
Custom Peer Group consists of Mid-Atlantic commercial banks with assets less
than $1B.





**Custom Peer Group index consists
of ACNB, First Chester County Corporation, VIST Financial Corp.,


Franklin Financial Services
Corporation, Ephrata National Bank, Orrstown Financial Services,
Inc.,


DNB Financial Corporation,
Juniata Valley Financial Corporation, Mid Penn Bancorp,
Inc.,


Codorus Valley Bancorp, Inc., and Tower Bancorp Incorporated.





Source
      : SNL Financial LC, Charlottesville, VA
                    (434)
      977-1600© 2008
                    www.snl.com





66


SELECTED
FINANCIAL DATA





(In
thousands, except per share data)





Years Ended December 31,2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004BALANCE
      SHEETLoans
      and Leases
                        
                        $
                        358,280
                        
                        
                        $
                        364,337
                        
                        
                        $
                        341,113
                        
                        
                        $
                        300,213
                        
                        
                        $
                        263,001Investment
      Securities
                        
                        
                        64,289
                        
                        
                        
                        74,176
                        
                        
                        
                        129,810
                        
                        
                        
                        119,702
                        
                        
                        
                        103,490Total
      Earning Assets
                        
                        
                        442,263
                        
                        
                        
                        463,347
                        
                        
                        
                        478,912
                        
                        
                        
                        427,982
                        
                        
                        
                        371,724Total
      Assets
                        
                        
                        485,109
                        
                        
                        
                        501,776
                        
                        
                        
                        517,597
                        
                        
                        
                        462,178
                        
                        
                        
                        399,290Deposits
                        
                        
                        383,577
                        
                        
                        
                        376,311
                        
                        
                        
                        340,075
                        
                        
                        
                        296,610
                        
                        
                        
                        265,970Short-Term
      Borrowings
                        
                        
                        
                        
                        
                        6,629
                        
                        
                        
                        10,544
                        
                        
                        
                        18,305
                        
                        
                        
                        4,524Long-Term
      Debt
                        
                        
                        50,334
                        
                        
                        
                        68,816
                        
                        
                        
                        117,571
                        
                        
                        
                        105,815
                        
                        
                        
                        88,630Junior
      Subordinated Debentures
                        
                        
                        17,341
                        
                        
                        
                        17,341
                        
                        
                        
                        17,341
                        
                        
                        
                        11,341
                        
                        
                        
                        11,341Stockholders'
      Equity
                        
                        
                        30,794
                        
                        
                        
                        28,800
                        
                        
                        
                        28,548
                        
                        
                        
                        27,225
                        
                        
                        
                        26,853INCOME
      STATEMENTInterest
      Income
                        
                        $
                        28,173
                        
                        
                        $
                        31,373
                        
                        
                        $
                        30,290
                        
                        
                        $
                        23,978
                        
                        
                        $
                        19,638Interest
      Expense
                        
                        
                        13,579
                        
                        
                        
                        16,009
                        
                        
                        
                        15,626
                        
                        
                        
                        9,662
                        
                        
                        
                        6,621Net
      Interest Income
                        
                        
                        14,594
                        
                        
                        
                        15,364
                        
                        
                        
                        14,664
                        
                        
                        
                        14,316
                        
                        
                        
                        13,017Provision
      for Loan and Lease Losses
                        
                        
                        1,027
                        
                        
                        
                        1,237
                        
                        
                        
                        672
                        
                        
                        
                        681
                        
                        
                        
                        404Net
      Interest Income after Provision for Loan and Lease Losses
                        
                        
                        13,567
                        
                        
                        
                        14,127
                        
                        
                        
                        13,992
                        
                        
                        
                        13,635
                        
                        
                        
                        12,613Non-Interest
      Income
                        
                        
                        3,807
                        
                        
                        
                        6,509
                        
                        
                        
                        8,262
                        
                        
                        
                        6,011
                        
                        
                        
                        4,095Non-Interest
      Expense
                        
                        
                        17,118
                        
                        
                        
                        20,745
                        
                        
                        
                        19,711
                        
                        
                        
                        15,627
                        
                        
                        
                        12,809Income
      (Loss) before Income Taxes (Benefit)
                        
                        
                        256
                        
                        
                        
                        (109
                        )
                        
                        
                        2,543
                        
                        
                        
                        4,019
                        
                        
                        
                        3,899Provision
      for (Benefit of ) Income Taxes
                        
                        
                        (188
                        )
                        
                        
                        (421
                        )
                        
                        
                        99
                        
                        
                        
                        666
                        
                        
                        
                        676Net
      Income
                        
                        $
                        444
                        
                        
                        $
                        312
                        
                        
                        $
                        2,444
                        
                        
                        $
                        3,353
                        
                        
                        $
                        3,223SHARE
      INFORMATIONAverage
      Shares Outstanding - Diluted
                        
                        
                        2,643
                        
                        
                        
                        2,544
                        
                        
                        
                        2,537
                        
                        
                        
                        2,556
                        
                        
                        
                        2,580Earnings
      Per Share – Diluted
                        
                        $
                        0.17
                        
                        
                        $
                        0.12
                        
                        
                        $
                        0.96
                        
                        
                        $
                        1.31
                        
                        
                        $
                        1.25Cash
      Dividends Per Share
                        
                        $
                        –
                        
                        
                        $
                        0.280
                        
                        
                        $
                        0.620
                        
                        
                        $
                        0.625
                        
                        
                        $
                        0.610AVERAGE
      BALANCE SHEETLoans
      and Leases
                        
                        $
                        369,554
                        
                        
                        $
                        357,795
                        
                        
                        $
                        318,251
                        
                        
                        $
                        280,245
                        
                        
                        $
                        244,752Investment
      Securities
                        
                        
                        69,618
                        
                        
                        
                        73,589
                        
                        
                        
                        129,413
                        
                        
                        
                        110,440
                        
                        
                        
                        95,033Other
      Earning Assets
                        
                        
                        13,110
                        
                        
                        
                        13,510
                        
                        
                        
                        6,482
                        
                        
                        
                        5,982
                        
                        
                        
                        5,201Total
      Assets
                        
                        
                        488,718
                        
                        
                        
                        480,401
                        
                        
                        
                        489,884
                        
                        
                        
                        425,611
                        
                        
                        
                        372,207Deposits
                        
                        
                        328,352
                        
                        
                        
                        351,750
                        
                        
                        
                        316,402
                        
                        
                        
                        282,934
                        
                        
                        
                        246,445Short-Term
      Borrowings
                        
                        
                        9,090
                        
                        
                        
                        6,025
                        
                        
                        
                        9,790
                        
                        
                        
                        7,584
                        
                        
                        
                        7,602Long-Term
      Debt
                        
                        
                        54,501
                        
                        
                        
                        72,586
                        
                        
                        
                        119,326
                        
                        
                        
                        94,474
                        
                        
                        
                        81,442Junior
      Subordinated Debentures
                        
                        
                        17,341
                        
                        
                        
                        17,341
                        
                        
                        
                        13,922
                        
                        
                        
                        11,341
                        
                        
                        
                        8,916Stockholders'
      Equity
                        
                        
                        30,047
                        
                        
                        
                        29,065
                        
                        
                        
                        27,754
                        
                        
                        
                        26,621
                        
                        
                        
                        26,250FINANCIAL
      RATIOSReturn
      on Average Assets
                        
                        
                        0.09
                        %
                        
                        
                        0.06
                        %
                        
                        
                        0.50
                        %
                        
                        
                        0.79
                        %
                        
                        
                        0.87
                        %Return
      on Average Stockholders' Equity
                        
                        
                        1.48
                        %
                        
                        
                        1.07
                        %
                        
                        
                        8.81
                        %
                        
                        
                        12.59
                        %
                        
                        
                        12.28
                        %Return on Average Realized Stockholders' Equity (1)
                        
                        
                        1.44
                        %
                        
                        
                        1.08
                        %
                        
                        
                        8.55
                        %
                        
                        
                        12.64
                        %
                        
                        
                        12.62
                        %Dividend
      Payout Ratio
                        
                        –
                        
                        
                        
                        227.24
                        %
                        
                        
                        63.83
                        %
                        
                        
                        47.00
                        %
                        
                        
                        47.84
                        %Average
      Stockholders' Equity to Average Assets
                        
                        
                        6.15
                        %
                        
                        
                        6.05
                        %
                        
                        
                        5.67
                        %
                        
                        
                        6.25
                        %
                        
                        
                        7.05
                        %





(1)  Excludes
the impact of accumulated other comprehensive income (loss) on total
stockholders' equity.





67




SUMMARY
OF QUARTERLY FINANCIAL DATA





(In
thousands, except per share data)





The
unaudited quarterly results of operations for the years ended December 31, 2008
and 2007 are as follows:





2008
                  
                  
                  2007First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    Quarter
                  
                  
                  First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    QuarterInterest
      Income
                  
                  $
                  7,337
                  
                  
                  $
                  7,032
                  
                  
                  $
                  7,037
                  
                  
                  $
                  6,767
                  
                  
                  $
                  7,690
                  
                  
                  $
                  7,814
                  
                  
                  $
                  8,036
                  
                  
                  $
                  7,833Interest
      Expense
                  
                  
                  3,903
                  
                  
                  
                  3,341
                  
                  
                  
                  3,197
                  
                  
                  
                  3,138
                  
                  
                  
                  3,916
                  
                  
                  
                  3,778
                  
                  
                  
                  4,149
                  
                  
                  
                  4,166Net
      Interest Income
                  
                  
                  3,434
                  
                  
                  
                  3,691
                  
                  
                  
                  3,840
                  
                  
                  
                  3,629
                  
                  
                  
                  3,774
                  
                  
                  
                  4,036
                  
                  
                  
                  3,887
                  
                  
                  
                  3,667Provision
      for Loan and Lease Losses
                  
                  
                  140
                  
                  
                  
                  139
                  
                  
                  
                  47
                  
                  
                  
                  701
                  
                  
                  
                  207
                  
                  
                  
                  270
                  
                  
                  
                  230
                  
                  
                  
                  530Net
      Interest Income after Provision for Loan and Lease Losses
                  
                  
                  3,294
                  
                  
                  
                  3,552
                  
                  
                  
                  3,793
                  
                  
                  
                  2,928
                  
                  
                  
                  3,567
                  
                  
                  
                  3,766
                  
                  
                  
                  3,657
                  
                  
                  
                  3,137Non-Interest
      Income (excluding securities activities)
                  
                  
                  1,221
                  
                  
                  
                  1,224
                  
                  
                  
                  1,230
                  
                  
                  
                  1,170
                  
                  
                  
                  2,113
                  
                  
                  
                  2,037
                  
                  
                  
                  1,748
                  
                  
                  
                  1,322Impairment
      Charge on Investment Securities
                  
                  –
                  
                  
                  –
                  
                  
                  –
                  
                  
                  
                  (1,290
                  )
                  
                  –
                  
                  
                  
                  (450
                  )
                  
                  –
                  
                  
                  
                  (350
                  )Investment
      Securities Gains (Losses)
                  
                  
                  191
                  
                  
                  
                  10
                  
                  
                  
                  (42
                  )
                  
                  
                  93
                  
                  
                  
                  (519
                  )
                  
                  
                  597
                  
                  
                  –
                  
                  
                  
                  11Non-Interest
      Expense
                  
                  
                  4,186
                  
                  
                  
                  4,430
                  
                  
                  
                  4,141
                  
                  
                  
                  4,361
                  
                  
                  
                  5,857
                  
                  
                  
                  5,657
                  
                  
                  
                  4,895
                  
                  
                  
                  4,336Income
      (Loss) before Income Taxes (Benefit)
                  
                  
                  520
                  
                  
                  
                  356
                  
                  
                  
                  840
                  
                  
                  
                  (1,460
                  )
                  
                  
                  (696
                  )
                  
                  
                  293
                  
                  
                  
                  510
                  
                  
                  
                  (216
                  )Provision
      for Income Taxes (Benefit)
                  
                  
                  107
                  
                  
                  
                  52
                  
                  
                  
                  214
                  
                  
                  
                  (561
                  )
                  
                  
                  (340
                  )
                  
                  
                  (44
                  )
                  
                  
                  117
                  
                  
                  
                  (154
                  )Net
      Income (Loss)
                  
                  $
                  413
                  
                  
                  $
                  304
                  
                  
                  $
                  626
                  
                  
                  $
                  (899
                  )
                  
                  $
                  (356
                  )
                  
                  $
                  337
                  
                  
                  $
                  393
                  
                  
                  $
                  (62
                  )Earnings
      (Loss) Per Share:Basic
                  
                  $
                  0.16
                  
                  
                  $
                  0.12
                  
                  
                  $
                  0.23
                  
                  
                  $
                  (0.33
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  0.13
                  
                  
                  $
                  0.15
                  
                  
                  $
                  (0.02
                  )Diluted
                  
                  
                  0.16
                  
                  
                  
                  0.12
                  
                  
                  
                  0.23
                  
                  
                  
                  (0.33
                  )
                  
                  
                  (0.14
                  )
                  
                  
                  0.13
                  
                  
                  
                  0.15
                  
                  
                  
                  (0.02
                  )





Note:  Due
to rounding, quarterly earnings (loss) per share may not add up to reported
annual earnings per share.





STOCK AND
DIVIDEND INFORMATION







Union
National Financial Corporation has only one class of common stock authorized,
issued, and outstanding.  The outstanding common stock is traded on
the OTC Bulletin Board (OTCBB), primarily in Lancaster County, Pennsylvania,
under the symbol UNNF.  Prices presented in the table below reflect
actual transactions known to management.  Prices and dividends per
share presented below are adjusted for stock dividends.  Cash
dividends, when declared by the Board of Directors, are payable on or about the
20th day of February, May, August, and November.  Stockholders of
record may elect to have cash dividends deposited directly to their checking or
savings accounts.  Union National offers its stockholders a Dividend
Reinvestment and Stock Purchase Plan, whereby holders of stock may have their
quarterly cash dividends automatically invested in additional shares of common
stock of the corporation and may purchase additional shares within specified
limits.





2008
                
                
                2007First
                  Quarter
                
                
                Second
                  Quarter
                
                
                Third
                  Quarter
                
                
                Fourth
                  Quarter
                
                
                First
                  Quarter
                
                
                Second
                  Quarter
                
                
                Third
                  Quarter
                
                
                Fourth
                  QuarterHigh
                
                $
                11.50
                
                
                $
                10.20
                
                
                $
                9.15
                
                
                $
                8.50
                
                
                $
                19.00
                
                
                $
                17.35
                
                
                $
                14.95
                
                
                $
                14.65Low
                
                
                9.40
                
                
                
                9.05
                
                
                
                5.26
                
                
                
                4.76
                
                
                
                16.00
                
                
                
                14.25
                
                
                
                12.20
                
                
                
                10.15Dividends
      Paid
                
                –
                
                
                –
                
                
                –
                
                
                –
                
                
                
                0.10
                
                
                
                0.06
                
                
                
                0.06
                
                
                
                0.06





Union
National had approximately 1,351 stockholders (including stockholders of record
and individual participants in security position listings) at December 31, 2008,
and approximately 1,363 stockholders at December 31, 2007.





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