Exhibit 13





































































2009
      FINANCIAL STATEMENTS





TABLE OF
      CONTENTS





Consolidated
      Statements of Financial Condition
              2Consolidated
      Statements of Operations
              3Consolidated
      Statements of Changes in Stockholders’ Equity
              4Consolidated
      Statements of Cash Flows
              5Notes
      to Consolidated Financial Statements
              6 -
      47Report
      of Management’s Assessment of Internal Control over Financial
      Reporting
              48Report
      of Independent Registered Public Accounting Firm
              49Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              50
      - 85Stock
      Performance Graph
              86Selected
      Financial Data
              87Summary
      of Quarterly Financial Data
              88Stock
      and Dividend Information
              88





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





CONSOLIDATED STATEMENTS OF
      FINANCIAL CONDITION
 (Dollars
in thousands, except share data)


December 31,2009
                                  
                                  
                                  2008AssetsCash
      and Due from Banks
                                  
                                  $
                                  8,807
                                  
                                  
                                  $
                                  17,621Interest-Bearing
      Demand Deposits in Other Banks
                                  
                                  
                                  34,533
                                  
                                  
                                  
                                  66Federal
      Funds Sold
                                  
                                  
                                  –
                                  
                                  
                                  
                                  14,150Total
      Cash and Cash Equivalents
                                  
                                  
                                  43,340
                                  
                                  
                                  
                                  31,837Interest-Bearing
      Time Deposits in Other Banks
                                  
                                  
                                  9,229
                                  
                                  
                                  
                                  1,775Investment
      Securities Available for Sale
                                  
                                  
                                  60,546
                                  
                                  
                                  
                                  64,289Loans
      and Leases, Net of Unearned Income
                                  
                                  
                                  339,274
                                  
                                  
                                  
                                  358,280Less:  Allowance
      for Credit Losses
                                  
                                  
                                  (5,858
                                  )
                                  
                                  
                                  (4,358
                                  )Net
      Loans and Leases
                                  
                                  
                                  333,416
                                  
                                  
                                  
                                  353,922Premises
      and Equipment, Net
                                  
                                  
                                  11,403
                                  
                                  
                                  
                                  12,088Restricted
      Investment in Bank Stocks
                                  
                                  
                                  3,727
                                  
                                  
                                  
                                  3,703Bank-Owned
      Life Insurance
                                  
                                  
                                  11,539
                                  
                                  
                                  
                                  11,108Other
      Real Estate Owned
                                  
                                  
                                  5,383
                                  
                                  
                                  
                                  –Other
      Assets
                                  
                                  
                                  11,061
                                  
                                  
                                  
                                  6,387Total
      Assets
                                  
                                  $
                                  489,644
                                  
                                  
                                  $
                                  485,109LiabilitiesDeposits:Noninterest-Bearing
                                  
                                  $
                                  54,331
                                  
                                  
                                  $
                                  46,875Interest-Bearing
                                  
                                  
                                  350,434
                                  
                                  
                                  
                                  336,702Total
      Deposits
                                  
                                  
                                  404,765
                                  
                                  
                                  
                                  383,577Long-Term
      Debt
                                  
                                  
                                  33,334
                                  
                                  
                                  
                                  50,334Junior
      Subordinated Debentures
                                  
                                  
                                  17,341
                                  
                                  
                                  
                                  17,341Other
      Liabilities
                                  
                                  
                                  2,868
                                  
                                  
                                  
                                  3,063Total
      Liabilities
                                  
                                  
                                  458,308
                                  
                                  
                                  
                                  454,315Stockholders’
      EquityPreferred
      Stock (Series A), liquidation value $1,000 per shareShares
      authorized - 5,000; Issued – 1,275 and 0 atDecember
      31, 2009 and 2008, respectively
                                  
                                  
                                  1,275
                                  
                                  
                                  
                                  –Common
      Stock, par value $0.25 per shareShares authorized - 20,000,000;
      Issued – 3,109,105 and3,138,265
      at December 31, 2009 and 2008, respectively;Outstanding
      - 2,740,916 and 2,720,076 atDecember
      31, 2009 and 2008, respectively
                                  
                                  
                                  777
                                  
                                  
                                  
                                  785Surplus
                                  
                                  
                                  13,891
                                  
                                  
                                  
                                  14,868Retained
      Earnings
                                  
                                  
                                  22,921
                                  
                                  
                                  
                                  23,434Accumulated
      Other Comprehensive (Loss) Income
                                  
                                  
                                  (195
                                  )
                                  
                                  
                                  36Treasury
      Stock, at cost; 368,189 and 418,189 at December 31, 2009 and 2008,
      respectively
                                  
                                  
                                  (7,333
                                  )
                                  
                                  
                                  (8,329
                                  )Total
      Stockholders’ Equity
                                  
                                  
                                  31,336
                                  
                                  
                                  
                                  30,794Total
      Liabilities and Stockholders’ Equity
                                  
                                  $
                                  489,644
                                  
                                  
                                  $
                                  485,109





See
accompanying notes to consolidated financial statements.


2


CONSOLIDATED STATEMENTS OF
      OPERATIONS


(Dollars
in thousands, except share data)





Years Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007Interest
      IncomeInterest
      and Fees on Loans and Leases
                      
                      $
                      21,593
                      
                      
                      $
                      24,594
                      
                      
                      $
                      26,834Investment
      Securities:Taxable
      Interest
                      
                      
                      1,734
                      
                      
                      
                      3,209
                      
                      
                      
                      3,358Tax-Exempt
      Interest
                      
                      
                      160
                      
                      
                      
                      –
                      
                      
                      
                      403Dividends
                      
                      
                      40
                      
                      
                      
                      114
                      
                      
                      
                      290Other
                      
                      
                      231
                      
                      
                      
                      256
                      
                      
                      
                      488Total
      Interest Income
                      
                      
                      23,758
                      
                      
                      
                      28,173
                      
                      
                      
                      31,373Interest
      ExpenseDeposits
                      
                      
                      8,394
                      
                      
                      
                      9,470
                      
                      
                      
                      10,790Long-Term
      Debt
                      
                      
                      2,054
                      
                      
                      
                      2,795
                      
                      
                      
                      3,652Junior
      Subordinated Debentures
                      
                      
                      838
                      
                      
                      
                      1,104
                      
                      
                      
                      1,268Short-Term
      Borrowings
                      
                      
                      –
                      
                      
                      
                      210
                      
                      
                      
                      299Total
      Interest Expense
                      
                      
                      11,286
                      
                      
                      
                      13,579
                      
                      
                      
                      16,009Net
      Interest Income
                      
                      
                      12,472
                      
                      
                      
                      14,594
                      
                      
                      
                      15,364Provision
      for Credit Losses
                      
                      
                      2,627
                      
                      
                      
                      1,027
                      
                      
                      
                      1,237Net
      Interest Income after Provision for Credit Losses
                      
                      
                      9,845
                      
                      
                      
                      13,567
                      
                      
                      
                      14,127Non-Interest
      IncomeService
      Charges on Deposit Accounts
                      
                      
                      2,158
                      
                      
                      
                      1,950
                      
                      
                      
                      1,864Other
      Service Charges, Commissions, Fees
                      
                      
                      1,154
                      
                      
                      
                      1,091
                      
                      
                      
                      1,059Alternative
      Investment Sales Commissions
                      
                      
                      662
                      
                      
                      
                      814
                      
                      
                      
                      845Income
      from Fiduciary Activities
                      
                      
                      180
                      
                      
                      
                      309
                      
                      
                      
                      347Earnings
      from Bank-Owned Life Insurance
                      
                      
                      431
                      
                      
                      
                      439
                      
                      
                      
                      426Mortgage
      Banking/Brokerage Activities
                      
                      
                      112
                      
                      
                      
                      56
                      
                      
                      
                      2,000Title
      Insurance/Settlement Income
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      317Other
      Income
                      
                      
                      341
                      
                      
                      
                      186
                      
                      
                      
                      362Net
      Gain on Sale of Investment Securities
                      
                      
                      1,841
                      
                      
                      
                      252
                      
                      
                      
                      89Other-than-temporary
      Impairments (“OTTI”) of Securities
                      
                      
                      (1,504
                      )
                      
                      
                      (1,290
                      )
                      
                      
                      (800
                      )Portion
      of OTTI Recognized in Other Comprehensive Loss
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Net
      OTTI Losses on Securities
                      
                      
                      (1,504
                      )
                      
                      
                      (1,290
                      )
                      
                      
                      (800
                      )Total
      Non-Interest Income
                      
                      
                      5,375
                      
                      
                      
                      3,807
                      
                      
                      
                      6,509Non-Interest
      ExpenseSalaries,
      Wages, and Employee Benefits
                      
                      
                      7,033
                      
                      
                      
                      7,676
                      
                      
                      
                      9,723Net
      Occupancy
                      
                      
                      1,724
                      
                      
                      
                      1,818
                      
                      
                      
                      2,390Data
      and ATM Processing
                      
                      
                      1,681
                      
                      
                      
                      1,641
                      
                      
                      
                      1,662Professional
      Fees and Regulatory Assessments
                      
                      
                      1,160
                      
                      
                      
                      1,036
                      
                      
                      
                      1,516Furniture
      and Equipment
                      
                      
                      935
                      
                      
                      
                      1,017
                      
                      
                      
                      1,081FDIC
      Insurance
                      
                      
                      1,128
                      
                      
                      
                      404
                      
                      
                      
                      137Pennsylvania
      Shares Tax
                      
                      
                      297
                      
                      
                      
                      273
                      
                      
                      
                      243Advertising
      and Marketing
                      
                      
                      211
                      
                      
                      
                      412
                      
                      
                      
                      653Supplies
      and Postage
                      
                      
                      367
                      
                      
                      
                      401
                      
                      
                      
                      377Restructuring
      Charge
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      717Other
      Expense
                      
                      
                      2,201
                      
                      
                      
                      2,440
                      
                      
                      
                      2,246Total
      Non-Interest Expense
                      
                      
                      16,737
                      
                      
                      
                      17,118
                      
                      
                      
                      20,745(Loss)
      Income Before Benefit from Income Taxes
                      
                      
                      (1,517
                      )
                      
                      
                      256
                      
                      
                      
                      (109
                      )Benefit
      from Income Taxes
                      
                      
                      (802
                      )
                      
                      
                      (188
                      )
                      
                      
                      (421
                      )Net
      (Loss) Income
                      
                      
                      (715
                      )
                      
                      
                      444
                      
                      
                      
                      312Preferred
      Stock Dividends
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Net
      (Loss) Income Available to Common Stockholders
                      
                      $
                      (715
                      )
                      
                      $
                      444
                      
                      
                      $
                      312(Loss)
      Earnings Per Common ShareBasic
      and Diluted
                      
                      $
                      (0.26
                      )
                      
                      $
                      0.17
                      
                      
                      $
                      0.12Cash
      Dividends Paid Per Common Share
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      0.28





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
                          
                          
                          Preferred
                            Stock
                          
                          
                          Common
                            Stock
                          
                          
                          Surplus
                          
                          
                          Retained
                            Earnings
                          
                          
                          Accumulated
                            Other
                            Comprehensive
                            (Loss) Income
                          
                          
                          Treasury Stock
                          
                          
                          TotalBalance
      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 ASC Topic 715, “Split Dollar Life Insurance
    Arrangements”
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          (73
                          )
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          (73
                          )Balance
      at December 31, 2008
                          
                          
                          2,720,076
                          
                          
                          
                          –
                          
                          
                          
                          785
                          
                          
                          
                          14,868
                          
                          
                          
                          23,434
                          
                          
                          
                          36
                          
                          
                          
                          (8,329
                          )
                          
                          
                          30,794Comprehensive
      Loss:Net
      Loss
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          (715
                          )
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          (715
                          )Unrealized
      Gains on Available for Sale Securities, Net of Tax
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          193
                          
                          
                          
                          –
                          
                          
                          
                          193Reclassification
      Adjustment for Cumulative Effect of ASC Topic 320, “Investments – Debt and
      Equity Securities” (net of $104 tax effect)
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          202
                          
                          
                          
                          (202
                          )
                          
                          
                          –
                          
                          
                          
                          –Reclassification
      Adjustment for Gains Included in Net Loss, Net of Tax
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          (1,215
                          )
                          
                          
                          –
                          
                          
                          
                          (1,215
                          )Reclassification
      Adjustment for Impairment Charges on Investment Securities, Net of
      Tax
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          993
                          
                          
                          
                          –
                          
                          
                          
                          993Total
      Comprehensive Loss
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (744
                          )Issuance
      of Preferred Stock, Net of Costs
                          
                          
                          –
                          
                          
                          
                          1,275
                          
                          
                          
                          –
                          
                          
                          
                          (57
                          )
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          1,218Issuance
      of Common Stock under Dividend Reinvestment Plan
                          
                          
                          20,840
                          
                          
                          
                          –
                          
                          
                          
                          5
                          
                          
                          
                          63
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          68Retirement
      of Treasury Stock (50,000 shares)
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          (13
                          )
                          
                          
                          (983
                          )
                          
                          
                          –
                          
                          
                          
                          –
                          
                          
                          
                          996
                          
                          
                          
                          –Balance
      at December 31, 2009
                          
                          
                          2,740,916
                          
                          
                          $
                          1,275
                          
                          
                          $
                          777
                          
                          
                          $
                          13,891
                          
                          
                          $
                          22,921
                          
                          
                          $
                          (195
                          )
                          
                          $
                          (7,333
                          )
                          
                          $
                          31,336
 
 See
accompanying notes to consolidated financial statements.
  4
  CONSOLIDATED
      STATEMENTS OF CASH FLOWS
 (Dollars
in thousands, except share data)
 Years Ended December 31,2009
                    
                    
                    2008
                    
                    
                    2007Cash
      Flows from Operating ActivitiesNet
      (Loss) Income
                    
                    $
                    (715
                    )
                    
                    $
                    444
                    
                    
                    $
                    312Adjustments
      to Reconcile Net (Loss) Income to Net Cash (Used In) Provided by Operating
      Activities:Depreciation
      and Amortization
                    
                    
                    1,171
                    
                    
                    
                    1,313
                    
                    
                    
                    1,429Provision
      for Credit Losses
                    
                    
                    2,627
                    
                    
                    
                    1,027
                    
                    
                    
                    1,237Net
      Amortization (Accretion) of Investment Securities Premiums
      (Discounts)
                    
                    
                    559
                    
                    
                    
                    (51
                    )
                    
                    
                    (245
                    )Net
      Investment Securities Gains on Sales and OTTI Losses
                    
                    
                    (337
                    )
                    
                    
                    1,038
                    
                    
                    
                    711Benefit
      from Deferred Income Taxes
                    
                    
                    (609
                    )
                    
                    
                    (1,472
                    )
                    
                    
                    (8
                    )Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (431
                    )
                    
                    
                    (439
                    )
                    
                    
                    (426
                    )Decrease
      in Accrued Interest Receivable
                    
                    
                    55
                    
                    
                    
                    450
                    
                    
                    
                    485(Increase)
      Decrease in Other Assets
                    
                    
                    (4,201
                    )
                    
                    
                    131
                    
                    
                    
                    42(Decrease)
      Increase in Other Liabilities
                    
                    
                    (195
                    )
                    
                    
                    (666
                    )
                    
                    
                    212Loss
      (Gain) on Sale of Loans
                    
                    
                    –
                    
                    
                    
                    37
                    
                    
                    
                    (1,428
                    )Cash
      Payments Related to Restructuring Charge
                    
                    
                    –
                    
                    
                    
                    (223
                    )
                    
                    
                    (494
                    )Proceeds
      from Sale of Loans
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    60,586Loans
      Originated for Sale
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (57,496
                    )Restructuring
      Charge
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    717Goodwill
      Impairment
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    157Stock-Based
      Compensation Expense
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    82Decrease
      in Minority Interest in Consolidated Subsidiaries
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (75
                    )Net
      Gain on Sale of Foreclosed Real Estate
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (128
                    )Net
      Cash (Used In) Provided by Operating Activities
                    
                    
                    (2,076
                    )
                    
                    
                    1,589
                    
                    
                    
                    5,670Cash
      Flows from Investing ActivitiesProceeds
      from Sales of Available-for-Sale Securities
                    
                    
                    197,637
                    
                    
                    
                    42,463
                    
                    
                    
                    95,514Proceeds
      from Maturities and Principal Repayments on Available-for-Sale
      Securities
                    
                    
                    39,152
                    
                    
                    
                    38,254
                    
                    
                    
                    13,028Purchases
      of Available-for-Sale Securities
                    
                    
                    (233,313
                    )
                    
                    
                    (71,780
                    )
                    
                    
                    (53,074
                    )Net
      Purchases of Time Deposits in Other Banks
                    
                    
                    (7,454
                    )
                    
                    
                    (1,775
                    )
                    
                    
                    –(Purchase)
      Sale of Restricted Investments in Bank Stocks, net
                    
                    
                    (24
                    )
                    
                    
                    (51
                    )
                    
                    
                    2,342Net
      Decrease (Increase) in Loans and Leases
                    
                    
                    2,347
                    
                    
                    
                    (1,090
                    )
                    
                    
                    (23,856
                    )Proceeds
      from Sale of Loans
                    
                    
                    9,800
                    
                    
                    
                    6,766
                    
                    
                    
                    –Purchases
      of Premises, Equipment and Software
                    
                    
                    (389
                    )
                    
                    
                    (4,175
                    )
                    
                    
                    (688
                    )Proceeds
      from Sale of Other Real Estate Owned
                    
                    
                    349
                    
                    
                    
                    –
                    
                    
                    
                    314Net
      Cash Provided by Investing Activities
                    
                    
                    8,105
                    
                    
                    
                    8,612
                    
                    
                    
                    33,580Cash
      Flows from Financing ActivitiesNet
      Increase (Decrease) in Demand Deposits and Savings
Accounts
                    
                    
                    22,733
                    
                    
                    
                    (11,097
                    )
                    
                    
                    9,485Net
      (Decrease) Increase in Time Deposits
                    
                    
                    (1,545
                    )
                    
                    
                    18,363
                    
                    
                    
                    26,751Net
      Decrease in Short-Term Borrowings
                    
                    
                    –
                    
                    
                    
                    (6,629
                    )
                    
                    
                    (3,915
                    )Payments
      on Long-Term Debt
                    
                    
                    (17,000
                    )
                    
                    
                    (18,482
                    )
                    
                    
                    (53,009
                    )Issuance
      of Common Stock, Net of Costs
                    
                    
                    68
                    
                    
                    
                    1,599
                    
                    
                    
                    319Issuance
      of Preferred Stock, Net of Costs
                    
                    
                    1,218
                    
                    
                    
                    –
                    
                    
                    
                    –Cash
      Dividends Paid
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (709
                    )Proceeds
      from Issuance of Long-Term Debt
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    4,254Acquisition
      of Treasury Stock
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (6
                    )Net
      Cash Provided by (Used in) Financing Activities
                    
                    
                    5,474
                    
                    
                    
                    (16,246
                    )
                    
                    
                    (16,830
                    )Net
      Increase (Decrease) in Cash and Cash Equivalents
                    
                    
                    11,503
                    
                    
                    
                    (6,045
                    )
                    
                    
                    22,420Cash
      and Cash Equivalents at Beginning of Period
                    
                    
                    31,837
                    
                    
                    
                    37,882
                    
                    
                    
                    15,462Cash
      and Cash Equivalents at End of Period
                    
                    $
                    43,340
                    
                    
                    $
                    31,837
                    
                    
                    $
                    37,882Supplemental
      Disclosures of Cash Flow InformationInterest
      Paid
                    
                    $
                    11,771
                    
                    
                    $
                    14,247
                    
                    
                    $
                    15,893Income
      Tax Paid
                    
                    
                    750
                    
                    
                    
                    525
                    
                    
                    
                    231Supplemental
      Schedule of Noncash ActivitiesTransfers
      to Other Real Estate Owned
                    
                    $
                    5,732
                    
                    
                    $
                    –
                    
                    
                    $
                    –Retirement
      of Treasury Stock (50,000 shares in 2009)
                    
                    $
                    996
                    
                    
                    $
                    –
                    
                    
                    $
                    –
 
 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 - Junior Subordinated
Debentures).
 
 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.  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 until it ceased
operations effective October 31, 2007 (for additional information, refer to
Note 16 - Residential Mortgage
Business Venture).  Home Team had mortgage banking operations,
including mortgage brokerage as well as title insurance and settlement services
through its subsidiary, TA of Lancaster, LLC.  Union National’s 2007
operating results included the income and expenses generated by Home
Team.
 
 Basis of
Presentation.The consolidated financial statements include
the accounts of Union National, the Bank and Home Team.  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 2009.  The reclassifications had no effect
on the results of operations.
 
 Union
National has evaluated events and transactions occurring subsequent to the
balance sheet date of December 31, 2009, for items that should potentially be
recognized or disclosed in the consolidated financial statements.  The
evaluation was conducted through the date these consolidated financial
statements were issued.
 
 Use of Estimates.The process
of preparing consolidated financial statements in conformity with GAAP requires
the use of estimates and assumptions that affect the reported amounts of certain
types of assets, liabilities, revenues and expenses.  Accordingly,
actual results may differ from estimated amounts.  Material estimates
that are particularly susceptible to significant change in the near term relate
to the determination of the allowance for credit losses, the valuation of
deferred tax assets, the assessment of other-than-temporary impairment of
investment securities, and the potential impairment of restricted investment in
bank stocks.
 
 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 -
Investment Securities Available for Sale, while the types of lending
activities that are engaged in by Union National are discussed in Note 4 - Loans and
Leases.  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.
  6
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
 
 Interest-Bearing Time Deposits in
Other Banks.Interest-bearing time deposits in other banks consist of
certificates of deposit 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, 2009 and 2008, 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 undefined 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 to enhance net interest margin, changes
in maturity mix of assets and liabilities, liquidity needs, regulatory capital
considerations and other similar factors.  The securities portfolio is
evaluated regularly for possible opportunities to increase earnings through
potential sales or portfolio repositioning.  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 (loss) income, a component of
stockholders’ equity.  Gains and losses on the sale of securities are
recorded on the trade date and are determined using the specific identification
method.
 
 Other-Than-Temporary Impairment of
Investment Securities (“OTTI”) - In order to determine whether unrealized
losses in the fair value of investment securities are other-than-temporary, the
entire portfolio of investment securities is reviewed regularly for possible
impairment, analyzing factors including but not limited to the underlying
creditworthiness of the issuing organization, the length of time for which the
fair value of the investment securities has been less than cost, and independent
analysts’ opinions about circumstances that could affect the performance of the
investment securities.  In assessing potential OTTI for debt
securities, other considerations include (i) whether management intends to sell
the security, or (ii) if it is more likely than not that management will be
required to sell the security before recovery, or (iii) if management does not
expect to recover the entire amortized cost basis.  In assessing
potential OTTI for equity securities, consideration is given tomanagement’s intention and
ability to hold the securities until recovery of any unrealized
losses.
 
 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
Accounting Standards Codification (“ASC”) Topic 840.  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 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 the collectability 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
collectability 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 collectability of the total contractual principal and
interest is no longer in doubt. Nonaccrual loans and leases include impaired
loans and leases.
  7
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Allowance for Credit Losses.In accordance with GAAP, the allowance for credit losses (also referred
to as 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
principal losses.  The allowance for credit losses is established
through provisions charged against income.  The uncollectible
principal portion of impaired loans and leases is charged against the allowance
for credit losses, and subsequent principal recoveries are credited to the
allowance for credit losses.
 
 Management’s
evaluation of the adequacy of the allowance is based on Union National’s past
loan and lease loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower’s ability to repay (including
the timing of future payments), the estimated value of any underlying
collateral, composition of the loan portfolio, current economic conditions and
other relevant qualitative factors. This evaluation is inherently subjective as
it requires material estimates including the amounts and timing of future cash
flows expected to be received on impaired loans and leases that may be
susceptible to significant change.
 
 The
allowance for credit losses is evaluated based on an assessment of the losses
inherent in the loan and lease portfolio.  This assessment results in an
allowance that consists of specific, general and unallocated components. 
The specific component relates to loans and leases that are classified as
impaired.  For such loans and leases, an allowance is established when the
(i) discounted cash flows, or (ii) collateral value, or (iii) observable market
price of the impaired loan or lease is lower than the carrying value.  The
general component covers all other loans and leases, including criticized loans
that are not impaired, and is based on historical loss experience adjusted for
relevant qualitative factors.  Separate qualitative adjustments are made
for higher-risk criticized loans that are not impaired.  An
unallocated component is maintained to cover uncertainties that could affect our
estimate of probable losses.  The unallocated component of the allowance
reflects the margin of imprecision inherent in the underlying assumptions used
in the methodologies for estimating specific and general losses in the
portfolio.
 
 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.
 
 For
collateral-dependent loans and leases, information considered and supporting the
impairment amount of a loan or lease would include (i) how the fair value of
underlying collateral was determined, (ii) the use, if any, of independent
appraisals, the rationale by appraisers supporting adjustments to property
values, and the independence/quality/expertise of the appraiser, (iii)
identification and discussion of valuation assumptions, and (iv) consideration
of collateral liquidation costs.
  8
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Premises and Equipment.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. Land is carried at cost. 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 since
there is no market value available.  Restricted investments in banks
stocks consist of the common stock of the Federal Reserve Bank (“FRB”) of
Philadelphia, the Atlantic Central Bankers Bank (“ACBB”) and the Federal Home
Loan Bank (“FHLB”) of Pittsburgh.
 
 FHLB Stock Impairment Analysis- Investment in FHLB stock is required for membership in the organization
and is dependent upon the relative size of outstanding borrowings Union National
has with the FHLB.  Throughout most of 2008, Union National earned a
return or dividend on the amount invested.  In late December 2008, the
FHLB announced that it had suspended the payment of dividends and the repurchase
of excess capital stock to preserve its capital level.  That decision
was based on the FHLB’s analysis and consideration of certain negative market
trends and the impact those trends had on their financial
condition.  Based on the financial results of the FHLB for the years
ended December 31, 2009 and 2008, management believes that the suspension of
both the dividend payments and excess capital stock repurchasing by the FHLB is
temporary in nature. Management has concluded that its investment in FHLB stock
is not other-than-temporarily impaired, and will continue to monitor the
financial condition of the FHLB.
 
 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 as an asset 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.
 
 ASC Topic
715, “Compensation – Retirement Benefits” requires the recognition of a
liability related to the postretirement benefits covered by an endorsement
split-dollar life insurance arrangement.  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 ASC Topic 715.  On January 1, 2008, Union
National recorded a cumulative effect adjustment to the balance of retained
earnings of $73,000 for the liability from split-dollar life insurance
arrangements related to periods prior to 2008.  Compensation expense
related to this split-dollar life insurance was $16,000 and $12,000 for the
years ended December 31, 2009 and 2008, respectively.
 
 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 (i) the assets
have been isolated from Union National; (ii) 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, (iii) Union National does not
maintain effective control over the transferred assets through an agreement to
repurchase them before their maturity.
  9
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  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 rights is based on the present value of estimated future cash flows
for pools of mortgages sold stratified by rate and maturity date. Assumptions
that are incorporated in the valuation of servicing rights include assumptions
about prepayment speeds on mortgages and the cost to service
loans.  Servicing rights 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 mortgage
servicing rights was $34,000 and $60,000 at December 31, 2009 and 2008,
respectively.  Amortization expense is netted against loan servicing
fee income and is reflected in the Consolidated Statements of Operations in
mortgage banking/brokerage activities.  Servicing rights are evaluated
for impairment based upon estimated fair value as compared to unamortized book
value.
 
 Union
National retains the servicing rights on certain mortgage loans sold to the FHLB
in years prior to 2008 and receives a fee based upon the principal balance
outstanding.  Total loans serviced for the FHLB amounted to
$23,921,000, $28,284,000, and $32,332,000 at December 31, 2009, 2008, and 2007,
respectively, and are not reflected in the Consolidated Statements of Financial
Condition.
 
 Derivative Instruments. Union
National had no derivative instruments (“derivatives”) at December 31, 2009,
2008 and 2007.  For asset/liability management purposes, Union
National can use interest rate cap and collar agreements to hedge various
exposures or to modify interest rate characteristics of various balance sheet
accounts.  Derivatives may be used as part of the asset/liability
management process and are linked to specific assets or liabilities and have a
high correlation between the contract and the underlying item being hedged both
at inception and throughout the hedge period.
 
 Union
National records any 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.
 
 Other Real Estate Owned.Other
real estate owned (“OREO”) includes assets acquired through foreclosure, deed
in-lieu of foreclosure, and loans identified as in-substance
foreclosures.  A loan is classified as an in-substance foreclosure
when effective control of the collateral has been taken prior to completion of
formal foreclosure proceedings.  OREO is held for sale and is recorded
at fair value less estimated costs to sell.  Costs to maintain OREO
and subsequent gains and losses attributable to OREO liquidation are included in
the Consolidated Statements of Operations in other income and other expense as
realized.  No depreciation or amortization expense is
recognized.
 
 Trust Assets.The market value
of trust assets under management amounted to $30,748,000 and $83,728,000 at
December 31, 2009 and 2008 respectively.  Trust assets held in a
fiduciary capacity are not assets of Union National and are not included in the
Consolidated Statements of Financial Condition.
 
 Subsequent
to December 31, 2009, Union National has agreed to sell its trust department to
Security National Trust Company (“Security National”).  Closure,
subject to regulatory approval, is expected in the second quarter of
2010.  Under the agreement, Union National will continue to share in
the revenues generated from Security National’s management of these assets, and
will receive a share of revenues on future trust business
referrals.
  10
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Off-Balance Sheet Commitments and
Contingencies.In the ordinary course of business, Union National makes
commitments to extend credit to customers through loan commitments, lines of
credit and letters of credit.  Such financial instruments are recorded
when they are funded.
 
 The Bank
does not issue any guarantees that would require liability recognition or
disclosure, other than standby letters of credit. Standby letters of credit are
written conditional commitments issued by the Bank to guarantee the performance
of a customer to a third party.  Generally, all letters of credit,
when issued, have expiration dates within one year. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers.  The Bank generally holds collateral
and/or personal guarantees supporting these commitments (for additional
information regarding off-balance sheet commitments, refer to Note 14 – Commitments, Guarantees,
and Contingencies).
 
 Since
July 1, 2008, the Bank has participated in a health care expense management
consortium with other Pennsylvania banks. The purpose of the consortium is
to pool the risks of covered groups of employees, and to provide effective
claims-based expense management, administrative efficiencies, and use of
high-dollar claim stop loss insurance coverage, to reduce the overall health
care costs to the consortium member banks, while maintaining high quality
coverage for employees.  The Bank’s payments to the consortium to cover
estimated claims expenses, administrative expenses, and stop loss insurance
premiums through December 31, 2009 exceeded the actual processed expenses by
$312,000.  However, the Bank reduced the amount of this prepaid benefit by
a contingent reserve of $63,000 reflecting an actuarial estimate by the
consortium of the Bank’s unpaid claim liability as of December 31, 2009 to
include potential (i) unreported claims, (ii) reported but unprocessed claims,
and (iii) processed but unpaid claims, related to both medical and drug
coverage.
 
 Comprehensive Income (Loss).
GAAP requires that recognized revenue, expenses, gains, and losses be included
in net income (loss).  Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component in the equity section of the
Consolidated Statements of Financial Condition, such items, along with net
income (loss), are components of comprehensive income
(loss).   Union National reports the components of comprehensive
income (loss), net of related tax effects, in the Consolidated Statements of
Changes in Stockholders’ Equity.
 
 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.  During the year ended December 31, 2009, Union
National retired 50,000 shares of treasury stock.
 
 Stock-Based Compensation.In
accordance with ASC Topic 718, “Compensation – Stock Compensation”, Union
National recognizes compensation expense for share-based awards based upon an
assessment of the fair value on the grant date.  The fair value of
each option is estimated on the date of grant using the Black-Scholes
option-pricing model.  Stock compensation expense is recognized on a
straight-line basis over the vesting period of the award (for additional
information regarding stock-based compensation, refer to Note 2 – Stock-Based
Compensation).
 
 Advertising and Marketing Costs.Advertising and marketing costs are charged to expense as
incurred.
  11
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Income Taxes.The provision
for or benefit from 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.  The provision for or benefit from income
taxes is the tax payable or refundable for the period, plus or minus the change
in deferred tax assets and liabilities during the period.
 
 Earnings (Loss) Per Common Share.Basic earnings (loss) per common share is computed by dividing net income
(loss) available to common shareholders by the weighted-average number of common
shares outstanding during the period.  Diluted earnings (loss) per
common share reflects the potential dilution that could occur if (i) preferred
stock shares were converted to common stock shares, and (ii) options to issue
common stock were exercised.  Convertible preferred stock was issued
in 2009.  For the year ended December 31, 2009, there were no
preferred stock conversions, or stock options with an intrinsic value, which
potentially would have a dilutive effect.  Potential common shares
that may be issued related to outstanding stock options are determined using the
treasury stock method.  Stock options outstanding which had no
intrinsic value, and therefore were not included in the diluted earnings (loss)
per common share computation, were 78,674 and 93,511 and 116,468 as of December
31, 2009, 2008 and 2007, respectively.  Accordingly, the dilutive
(loss) earnings per common share for each period was not affected by the impact
of stock options outstanding.
 
 The
computation of basic and diluted (loss) earnings per common share, net (loss)
income available to common shareholders, and weighted-average number of shares
outstanding for the years ended December 31, 2009, 2008 and 2007, are presented
below (amounts, except (loss) earnings per share, in thousands):
 
 Years Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007Net
      (Loss) Income available to
      common shareholders
                      
                      $
                      (715
                      )
                      
                      $
                      444
                      
                      
                      $
                      312Weighted-average
      common shares outstanding
                      
                      
                      2,730
                      
                      
                      
                      2,643
                      
                      
                      
                      2,536Basic
      (Loss) Earnings Per Common Share
                      
                      $
                      (0.26
                      )
                      
                      $
                      0.17
                      
                      
                      $
                      0.12Weighted-average
      common shares outstanding
                      
                      
                      2,730
                      
                      
                      
                      2,643
                      
                      
                      
                      2,536Effect
      of Dilutive Securities:Convertible
      preferred stock (1)
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Stock
      options
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      8Total
      weighted-average common shares and equivalents
                      
                      
                      2,730
                      
                      
                      
                      2,643
                      
                      
                      
                      2,544Diluted
      (Loss) Earnings Per Common Share
                      
                      $
                      (0.26
                      )
                      
                      $
                      0.17
                      
                      
                      $
                      0.12
 
 (1)    Had
Union National not been in a loss position for the year-ended December 31, 2009,
the impact on diluted (loss) earnings per common share would have been an
additional 64,000 weighted-average common shares.  This would reflect
the potential dilution that could occur if preferred stock shares were converted
to common stock shares.
 
 Segment Reporting. Union
National has only one operating segment consisting primarily of its banking and
fiduciary activities, consistent with how 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.
  12
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Recent
Accounting Pronouncements
 
 Accounting
Standards Codification.In June 2009, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 168, “The FASB
Accounting Standards CodificationTM and the Hierarchy of Generally Accepted
Accounting Principles – a replacement of FASB Statement No. 162,” (“SFAS 168”).
SFAS 168 established the FASB Accounting Standards Codification TM
(“Codification”) as the source of authoritative generally accepted accounting
principles (“GAAP”) for nongovernmental entities.  The Codification
did not change GAAP.  Instead, it took the thousands of individual
pronouncements that currently comprise GAAP and reorganized them into
approximately 90 accounting Topics, and displays all Topics using a consistent
structure.  Contents in each Topic are further organized first by
Subtopic, then Section and finally Paragraph.  The Paragraph level is
the only level that contains substantive content.  Citing particular
content in the Codification involves specifying the unique numeric path to the
content through the Topic, Subtopic, Section and Paragraph
structure.  FASB suggests that all citations begin with “FASB ASC,”
where ASC stands for Accounting Standards Codification.  Rules and
interpretive releases of the SEC under authority of federal securities laws
are also sources of authoritative GAAP for SEC registrants. The ASC supersedes
all existing non-SEC accounting and reporting standards. All other
nongrandfathered, non-SEC accounting literature not included in the ASC will
become nonauthoritative.
 
 FASB will
no longer issue new standards in the form of Statements, FASB Staff Positions or
Emerging Issues Task Force Abstracts. Instead, changes to the ASC subsequent to
June 30, 2009 will be referred to as Accounting Standards Updates
(“ASU”).
 
 In
conjunction with the issuance of SFAS 168, the FASB also issued its first
Accounting Standards Update (“ASU”) No. 2009-1, “Topic 105 – Generally Accepted
Accounting Principles” (“ASU 2009-1”) which includes SFAS 168 in its entirety as
a transition to the ASC.  ASU 2009-1 was effective for interim and
annual periods ending after September 15, 2009 and did not have an impact on
Union National’s financial position or results of operations, but did change the
referencing system for accounting standards.
 
 ASU
2009-05.In
August 2009, the FASB issued ASU 2009-05, “Fair Value Measurements and
Disclosures (ASC Topic 820) - Measuring Liabilities at Fair
Value”.  The amendments within ASU 2009-05 clarify that in
circumstances in which a quoted price in an active market for the identical
liability is not available, a reporting entity is required to measure fair value
using one or more of the following techniques (i) the quoted price of the
identical liability when traded as an asset, (ii) quoted prices for similar
liabilities or similar liabilities when traded as assets, or (iii) another
valuation technique that is consistent with the principles of ASC Topic
820.
 
 Two
examples would be an income approach, such as a present value technique, or a
market approach, such as a technique that is based on the amount at the
measurement date that the reporting entity would pay to transfer the identical
liability or would receive to enter into the identical
liability.  When estimating the fair value of a liability, a reporting
entity is not required to include a separate input or adjustment to other inputs
relating to the existence of a restriction that prevents the transfer of the
liability.  Both a quoted price in an active market for the identical
liability at the measurement date and the quoted price for the identical
liability when traded as an asset in an active market when no adjustments to the
quoted price of the asset are required are Level 1 fair value
measurements.
 
 This
guidance is effective for the first reporting period (including interim periods)
beginning after issuance.  Union National’s adoption of this new
pronouncement did not have a material impact on the fair value measurements or
disclosures in the consolidated financial statements.
  13
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  ASU
2009-16. In
October 2009, the FASB issued ASU 2009-16, “Transfers and Servicing (ASC Topic
860) - Accounting for Transfers of Financial Assets”. This ASU amends the
Codification for the issuance of FASB Statement No. 166, Accounting for
Transfers of Financial Assets - an amendment of FASB Statement No.
140.
 
 The
amendments in this ASU improve financial reporting by eliminating the exceptions
for qualifying special-purpose entities from the consolidation guidance and the
exception that permitted sale accounting for certain mortgage securitizations
when a transferor has not surrendered control over the transferred financial
assets. In addition, the amendments require enhanced disclosures about the risks
that a transferor continues to be exposed to because of its continuing
involvement in transferred financial assets.  Comparability and
consistency in accounting for transferred financial assets will also be improved
through clarifications of the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting.
 
 This ASU
is effective at the start of a reporting entity’s first fiscal year beginning
after November 15, 2009.  Early application is not
permitted.  Union National is currently reviewing the effect this new
pronouncement will have on its consolidated financial statements.
 
 ASU
2009-17. In
October 2009, the FASB issued ASU 2009-17, “Consolidations (ASC Topic 810) -
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities”.  This Update amends the Codification for the
issuance of FASB Statement No. 167, “Amendments to FASB Interpretation No.
46(R)”.
 
 The
amendments in this ASU replace the quantitative-based risks and rewards
calculation for determining which reporting entity, if any, has a controlling
financial interest in a variable interest entity with an approach focused on
identifying which reporting entity has the power to direct the activities of a
variable interest entity that most significantly impact the entity’s economic
performance and (1) the obligation to absorb losses of the entity or (2) the
right to receive benefits from the entity. An approach that is expected to be
primarily qualitative will be more effective for identifying which reporting
entity has a controlling financial interest in a variable interest
entity.  The amendments in this ASU also require additional
disclosures about a reporting entity’s involvement in variable interest
entities, which will enhance the information provided to users of financial
statements.
 
 This ASU
is effective at the start of a reporting entity’s first fiscal year beginning
after November 15, 2009.  Early application is not
permitted.  Union National is currently reviewing the effect this new
pronouncement will have on its consolidated financial statements.
 
 ASU
2010-01. In
January 2010, the FASB issued ASU 2010-01, “Equity (ASC Topic 505) - Accounting
for Distributions to Shareholders with Components of Stock and
Cash”.  The amendments in this ASU clarify that the stock portion of a
distribution to shareholders that allows them to elect to receive cash or stock
with a potential limitation on the total amount of cash that all shareholders
can elect to receive in the aggregate is considered a share issuance that is
reflected in earnings per share prospectively and is not a stock
dividend.  This ASU codifies the consensus reached in EITF Issue No.
09-E, “Accounting for Stock Dividends, Including Distributions to Shareholders
with Components of Stock and Cash”.
 
 This ASU
is effective for interim and annual periods ending on or after December 15,
2009, and should be applied on a retrospective basis.  Union
National’s adoption of this new pronouncement did not have a material impact on
its consolidated financial statements.
  14
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  ASU
2010-02. In
January 2010, the FASB issued ASU 2010-02, “Consolidation (ASC Topic 810) -
Accounting and Reporting for Decreases in Ownership of a Subsidiary - A Scope
Clarification”.
 
 This ASU
clarifies that the scope of the decrease in ownership provisions of ASC Subtopic
810-10 and related guidance applies to (i) a subsidiary or group of assets that
is a business or nonprofit activity, (ii) a subsidiary that is a business or
nonprofit activity that is transferred to an equity method investee or joint
venture, and (iii) an exchange of a group of assets that constitutes a business
or nonprofit activity for a non-controlling interest in an entity (including an
equity method investee or joint venture).
 
 This ASU
also clarifies that the decrease in ownership guidance in ASC Subtopic 810-10
does not apply to (i) sales of in substance real estate; and (ii) conveyances of
oil and gas mineral rights, even if these transfers involve
businesses.
 
 The
amendments in this ASU expand the disclosure requirements about deconsolidation
of a subsidiary or derecognition of a group of assets to include:
 
 ·
              The
      valuation techniques used to measure the fair value of any retained
      investment;
 ·
              The
      nature of any continuing involvement with the subsidiary or entity
      acquiring the group of assets; and
 ·
              Whether
      the transaction that resulted in the deconsolidation or derecognition was
      with a related party or whether the former subsidiary or entity acquiring
      the assets will become a related party after the
    transaction.
 
 This ASU
is effective beginning in the period that an entity adopts FASB Statement No.
160, “Noncontrolling Interests in Consolidated Financial Statements - an
amendment of ARB 51” (now included in Subtopic 810-10).  If an entity
has previously adopted Statement 160, the amendments are effective beginning in
the first interim or annual reporting period ending on or after December 15,
2009.  These amendments should be applied retrospectively to the first
period that an entity adopts Statement 160. Union National’s adoption of this
new pronouncement did not have a material impact on its consolidated financial
statements.
 
 ASU
2010-06.The FASB
has issued ASU 2010-06, “Fair Value Measurements and Disclosures (ASC Topic 820)
- Improving Disclosures about Fair Value Measurements”. This ASU requires some
new disclosures and clarifies some existing disclosure requirements about fair
value measurement as set forth in ASC Subtopic 820-10. The FASB’s objective is
to improve these disclosures and, thus, increase the transparency in financial
reporting. Specifically, ASU 2010-06 amends ASC Subtopic 820-10 to now
require:
 
 ·
              A
      reporting entity to disclose separately the amounts of significant
      transfers in and out of Level 1 and Level 2 fair value measurements and
      describe the reasons for the transfers;
and
 ·
              In
      the reconciliation for fair value measurements using significant
      unobservable inputs, a reporting entity should present separately
      information about purchases, sales, issuances, and
      settlements.
 
 In
addition, ASU 2010-06 clarifies the requirements of the following existing
disclosures:
 
 ·
              For
      purposes of reporting fair value measurement for each class of assets and
      liabilities, a reporting entity needs to use judgment in determining the
      appropriate classes of assets and liabilities;
  and
 ·
              A
      reporting entity should provide disclosures about the valuation techniques
      and inputs used to measure fair value for both recurring and nonrecurring
      fair value measurements.
 
 ASU
2010-06 is effective for interim and annual reporting periods beginning after
December 15, 2009, except for the disclosures about purchases, sales, issuances,
and settlements in the roll forward of activity in Level 3 fair value
measurements. Those disclosures are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. Early
adoption is permitted.  Union National’s adoption of this new
pronouncement did not have a material impact on its consolidated financial
statements.
  15
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
 
 NOTE
2 – STOCK-BASED COMPENSATION
 
 In
accordance with ASC Topic 718, “Compensation – Stock Compensation”, Union
National recognizes compensation expense for share-based awards based upon an
assessment of the fair value on the grant date.  The fair value of
each option is estimated on the date of grant using the Black-Scholes
option-pricing model.  Stock compensation expense is recognized on a
straight-line basis over the vesting period of the award.
 
 Union
National had two plans with stock options outstanding as of December 31, 2009:
(i) the Employee Stock Incentive Plan (“SIP”); and, (ii) the Independent
Directors’ Stock Option Plan (“IDSOP”).  Neither of these plans had
remaining options available for grant as of December 31,
2009.  Options granted under the SIP are incentive stock options with
terms up to 10 years and option prices equal to the fair value of the shares on
the date of the grant.  SIP options vest over six months, become
exercisable nine months after the grant date, and generally lapse 90 days after
termination of employment.  Options granted under the IDSOP consist of
non-qualified stock options with terms up to 10 years.  IDSOP options
have exercise prices equal to the fair value of the shares on the date of the
grant and expire one year after departure from the Board of
Directors.  It is Union National’s policy to issue new shares upon the
exercise of stock options.
 
 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,
2009 and 2008; accordingly, no compensation expense was recorded for the years
ended December 31, 2009 and 2008.  For the year ended December 31,
2007, share-based compensation expense of $82,000 was recorded in the
Consolidated Statement of Operations in salaries, wages and employee
benefits.  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, 2009, 2008 and 2007, is
summarized below:
 
 2009
                    
                    
                    2008
                    
                    
                    2007Shares
                    
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    
                    Shares
                    
                    
                    Weighted
                      Average
                      Exercise
                      Price
                    
                    
                    Shares
                    
                    
                    Weighted
                      Average
                      Exercise
                      PriceBeginning
      of Year
                    
                    
                    93,511
                    
                    
                    $
                    18.82
                    
                    
                    
                    124,439
                    
                    
                    $
                    18.32
                    
                    
                    
                    177,330
                    
                    
                    $
                    18.14Granted
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    31,900
                    
                    
                    
                    18.50Exercised
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (650
                    )
                    
                    
                    8.70
                    
                    
                    
                    (13,296
                    )
                    
                    
                    12.91Forfeited
                    
                    
                    (2,710
                    )
                    
                    
                    19.77
                    
                    
                    
                    (20,886
                    )
                    
                    
                    18.06
                    
                    
                    
                    (68,942
                    )
                    
                    
                    18.45Expired
                    
                    
                    (12,127
                    )
                    
                    
                    18.49
                    
                    
                    
                    (9,392
                    )
                    
                    
                    14.44
                    
                    
                    
                    (2,553
                    )
                    
                    
                    20.10End
      of Year
                    
                    
                    78,674
                    
                    
                    $
                    18.83
                    
                    
                    
                    93,511
                    
                    
                    $
                    18.82
                    
                    
                    
                    124,439
                    
                    
                    $
                    18.32Weighted-average
      fair value of options granted during the year
                    
                    
                    
                    
                    
                    $
                    –
                    
                    
                    
                    
                    
                    
                    $
                    –
                    
                    
                    
                    
                    
                    
                    $
                    3.41
 
 All stock
options outstanding at December 31, 2009, had no intrinsic value (the amount by
which the market price exceeds the exercise price).  For stock options
outstanding at December 31, 2008 and 2007, the intrinsic value of stock options
outstanding was $1,000 and $26,000, respectively.
  16
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  All stock
options outstanding at December 31, 2009 were fully vested and exercisable, and
consisted of the following:
 
 Weighted-AverageRange of Exercise Prices
                    
                    Options
                      Outstanding
                    
                    
                    Exercise
                      Price
                    
                    Remaining
                      Contractual Life$11.52
      – $13.08
                    
                    
                    11,615
                    
                    
                    $
                    12.52
                    
                    1.6
      years$13.09
      – $16.10
                    
                    
                    8,066
                    
                    
                    
                    15.80
                    
                    2.5
      years$16.11
      – $18.49
                    
                    
                    2,314
                    
                    
                    
                    17.89
                    
                    3.3
      years$18.50
      – $20.81
                    
                    
                    23,325
                    
                    
                    
                    19.00
                    
                    6.0
      years$20.82
      – $22.14
                    
                    
                    33,354
                    
                    
                    
                    21.71
                    
                    4.8 yearsTotal
                    
                    
                    78,674
                    
                    
                    $
                    18.83
                    
                    4.4
years
 
 ASC Topic
718 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 Consolidated Statements of Cash Flows as a cash inflow from financing
activities.  No tax benefit was recorded for the years ended December
31, 2009, 2008 and 2007, as there were no such exercises or dispositions during
those years.
 
 NOTE
3 – INVESTMENT SECURITIES AVAILABLE FOR SALE
 
 Mortgage-backed
securities at December 31, 2008, have been reclassified to conform to the
financial statement footnote presentation at December 31, 2009.  At
December 31, 2009, mortgage-backed securities are reported in two categories,
(i) U.S. agency mortgage-backed securities and (ii) private issuer
mortgage-backed securities, whereas, previously they were reported as one
category.  The reclassifications had no effect on the consolidated
financial statements.
 
 The
amortized cost and fair value of investment securities are presented in the
table below as of December 31, 2009 (in thousands).  The unrealized
gains (losses) for these investment securities have been recorded in accumulated
other comprehensive income (loss), net of related tax (benefit)
expense.  The amortized cost of the private issuer mortgage-backed
securities and corporate securities reflect cumulative reductions for
other-than-temporary impairment charges of $1,191,000 and $2,097,000,
respectively.  During 2009, other-than-temporary impairment charges on
the private issuer mortgage-backed securities were adjusted accordingly for the
cumulative effect of ASC Topic 320, “Investments – Debt and Equity Securities”,
as discussed on page 21 under the section “Other-Than-Temporary Impairment of
Investment Securities”.
 
 At December 31, 2009Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    53,752
                    
                    
                    $
                    26
                    
                    
                    $
                    (384
                    )
                    
                    $
                    53,394Private
      Issuer Mortgage-Backed Securities
                    
                    
                    2,468
                    
                    
                    
                    170
                    
                    
                    
                    –
                    
                    
                    
                    2,638Obligations
      of State and Political Subdivisions
                    
                    
                    4,016
                    
                    
                    
                    –
                    
                    
                    
                    (201
                    )
                    
                    
                    3,815Corporate
      Securities
                    
                    
                    535
                    
                    
                    
                    96
                    
                    
                    
                    –
                    
                    
                    
                    631Equity
      Securities
                    
                    
                    71
                    
                    
                    
                    8
                    
                    
                    
                    (11
                    )
                    
                    
                    68Total
      Investment Securities
                    
                    $
                    60,842
                    
                    
                    $
                    300
                    
                    
                    $
                    (596
                    )
                    
                    $
                    60,546
  17
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  The
amortized cost and fair value of investment securities are presented in the
table below as of December 31, 2008 (in thousands).  The amortized
cost of the private issuer mortgage-backed securities and corporate securities
reflect cumulative reductions for other-than-temporary impairment charges of
$1,290,000 and $800,000, respectively.
 At December 31, 2008Gross
                    
                    
                    GrossAmortized
                    
                    
                    Unrealized
                    
                    
                    Unrealized
                    
                    
                    FairCost
                    
                    
                    Gains
                    
                    
                    Losses
                    
                    
                    ValueU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    55,693
                    
                    
                    $
                    661
                    
                    
                    $
                    (104
                    )
                    
                    $
                    56,250Private
      Issuer Mortgage-Backed Securities
                    
                    
                    3,453
                    
                    
                    
                    –
                    
                    
                    
                    (234
                    )
                    
                    
                    3,219Obligations
      of U.S. Government Agencies
                    
                    
                    3,379
                    
                    
                    
                    17
                    
                    
                    
                    –
                    
                    
                    
                    3,396Corporate
      Securities
                    
                    
                    1,481
                    
                    
                    
                    6
                    
                    
                    
                    (269
                    )
                    
                    
                    1,218Equity
      Securities
                    
                    
                    227
                    
                    
                    
                    42
                    
                    
                    
                    (63
                    )
                    
                    
                    206Total
      Investment Securities
                    
                    $
                    64,233
                    
                    
                    $
                    726
                    
                    
                    $
                    (670
                    )
                    
                    $
                    64,289
 
 Investment
securities carried at fair value of $57,209,000 and $59,646,000 at December 31,
2009 and 2008, respectively, were pledged to secure public and government entity
deposits, trust deposits, and for providing collateral for the Bank’s borrowing
availability at the Federal Reserve Bank.
 
 The
amortized cost and fair value of investment securities at December 31, 2009 and
2008, by contractual maturity, are presented below (in
thousands).  Expected maturities will differ from contractual
maturities.  Borrowers have the right to call or prepay obligations
with or without call or prepayment penalties.
 
 December 31, 2009Amortized
                      Cost
                    
                    
                    Fair ValueObligations
      of U.S. Government Agencies, Obligations of State and Political
      Subdivisions and Corporate Securities:Due
      in One Year or Less
                    
                    $
                    –
                    
                    
                    $
                    –Due
      After One Year Through Five Years
                    
                    
                    –
                    
                    
                    
                    –Due
      After Five Years Through Ten Years
                    
                    
                    –
                    
                    
                    
                    –Due
      After Ten Years
                    
                    
                    4,551
                    
                    
                    
                    4,4464,551
                    
                    
                    
                    4,446U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    53,752
                    
                    
                    
                    53,394Private
      Issuer Mortgage-Backed Securities
                    
                    
                    2,468
                    
                    
                    
                    2,638Equity
      Securities
                    
                    
                    71
                    
                    
                    
                    68Total
      Investment Securities
                    
                    $
                    60,842
                    
                    
                    $
                    60,546
 
 December 31, 2008Amortized
                      Cost
                    
                    
                    Fair ValueObligations
      of U.S. Government Agencies and Corporate Securities:Due
      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
                    
                    
                    
                    4,614U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    55,693
                    
                    
                    
                    56,250Private
      Issuer Mortgage-Backed Securities
                    
                    
                    3,453
                    
                    
                    
                    3,219Equity
      Securities
                    
                    
                    227
                    
                    
                    
                    206Total
      Investment Securities
                    
                    $
                    64,233
                    
                    
                    $
                    64,289
  18
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  The
following tables present gross unrealized losses and fair value of investment
securities that are not deemed to be other-than-temporarily impaired, aggregated
by investment category and length of time that individual securities have been
in a continuous unrealized loss position, at December 31, 2009 and 2008 (in
thousands):
 At December 31, 2009Less than 12 Months
                    
                    
                    12 Months or More
                    
                    
                    TotalFair
                      Value
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      Value
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      Value
                    
                    
                    Unrealized
                      LossesU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    41,565
                    
                    
                    $
                    (384
                    )
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    41,565
                    
                    
                    $
                    (384
                    )Obligations
      of State and Political Subdivisions
                    
                    
                    3,815
                    
                    
                    
                    (201
                    )
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    3,815
                    
                    
                    
                    (201
                    )Equity
      Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    18
                    
                    
                    
                    (11
                    )
                    
                    
                    18
                    
                    
                    
                    (11
                    )Temporarily
      Impaired Securities
                    
                    $
                    45,380
                    
                    
                    $
                    (585
                    )
                    
                    $
                    18
                    
                    
                    $
                    (11
                    )
                    
                    $
                    45,398
                    
                    
                    $
                    (596
                    )
 
 At December 31, 2008Less than 12 Months
                    
                    
                    12 Months or More
                    
                    
                    TotalFair
                      Value
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      Value
                    
                    
                    Unrealized
                      Losses
                    
                    
                    Fair
                      Value
                    
                    
                    Unrealized
                      LossesU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    15,954
                    
                    
                    $
                    (102
                    )
                    
                    $
                    73
                    
                    
                    $
                    (2
                    )
                    
                    $
                    16,027
                    
                    
                    $
                    (104
                    )Private
      Issuer Mortgage-Backed Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    1,863
                    
                    
                    
                    (234
                    )
                    
                    
                    1,863
                    
                    
                    
                    (234
                    )Corporate
      Securities
                    
                    
                    476
                    
                    
                    
                    (269
                    )
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    476
                    
                    
                    
                    (269
                    )Equity
      Securities
                    
                    
                    69
                    
                    
                    
                    (42
                    )
                    
                    
                    26
                    
                    
                    
                    (21
                    )
                    
                    
                    95
                    
                    
                    
                    (63
                    )Temporarily
      Impaired Securities
                    
                    $
                    16,499
                    
                    
                    $
                    (413
                    )
                    
                    $
                    1,962
                    
                    
                    $
                    (257
                    )
                    
                    $
                    18,461
                    
                    
                    $
                    (670
                    )
 
 Debt
securities include mortgage-backed securities, obligations of state and
political subdivisions, obligations of U.S. Government agencies and corporate
securities.  At December 31, 2009, there were twenty-seven debt
securities with unrealized losses of $585,000 that amounted to 1.3% of their
amortized cost, as compared to December 31, 2008, when there were twenty-three
debt securities with unrealized losses of $607,000 that amounted to 3.2% of
their amortized cost.  Management believes that the unrealized losses
reflect temporary declines primarily due to changes in interest rates subsequent
to the acquisition of specific securities.  These temporary declines
have been provided for in other comprehensive (loss)
income.  Subsequent to December 31, 2009, all of the obligations of
state and political subdivisions were sold, and as a result of positive market
interest movements, no losses were recognized on these securities.
 
 Equity
securities held are comprised primarily of common stock holdings in other
financial institutions.  The market values include net unrealized
losses of $11,000 at December 31, 2009.  Union National has the
ability and intent to hold these investments for a reasonable period of time
sufficient for each security to increase to Union National’s
cost.  Union National does not consider these investments to be
other-than-temporarily impaired at December 31, 2009.
  19
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  For the
years ended December 31, 2009, 2008 and 2007, Union National received gross
proceeds of $197,637,000, $42,463,000 and $95,514,000, respectively, on the sale
of investment securities.  The following tables present information
related to the realized gains and losses on the sales of investment securities,
and losses recognized on the other-than-temporary impairment of investment
securities, for the years ended December 31, 2009, 2008 and 2007 (in
thousands):
 Year Ended December 31, 2009Gross
                        Realized
                        Gains
                      
                      
                      Gross
                        Realized
                        Losses
                      
                      
                      Other-than-
                        Temporary
                        Impairment
                        Losses
                      
                      
                      Net Gains
                        (Losses)U.S.
      Agency Mortgage-Backed Securities
                      
                      $
                      1,685
                      
                      
                      $
                      (71
                      )
                      
                      $
                      –
                      
                      
                      $
                      1,614Private
      Issuer Mortgage-Backed Securities
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      (645
                      )
                      
                      
                      (645
                      )Obligations
      of U.S Government Agencies
                      
                      
                      140
                      
                      
                      
                      (24
                      )
                      
                      
                      –
                      
                      
                      
                      116Obligations
      of State and Political Subdivisions
                      
                      
                      134
                      
                      
                      
                      (4
                      )
                      
                      
                      –
                      
                      
                      
                      130U.S.
      Treasuries
                      
                      
                      19
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      19Corporate
      Securities
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      (859
                      )
                      
                      
                      (859
                      )Equity
      Securities
                      
                      
                      17
                      
                      
                      
                      (55
                      )
                      
                      
                      –
                      
                      
                      
                      (38
                      )Total
                      
                      $
                      1,995
                      
                      
                      $
                      (154
                      )
                      
                      $
                      (1,504
                      )
                      
                      $
                      337
 
 Year Ended December 31, 2008Gross
                      Realized
                      Gains
                    
                    
                    Gross
                      Realized
                      Losses
                    
                    
                    Other-than-
                      Temporary
                      Impairment
                      Losses
                    
                    
                    Net Gains
                      (Losses)Obligations
      of U.S. Government Agencies
                    
                    $
                    160
                    
                    
                    $
                    (13
                    )
                    
                    $
                    –
                    
                    
                    $
                    147U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    159
                    
                    
                    
                    (50
                    )
                    
                    
                    –
                    
                    
                    
                    109Private
      Issuer Mortgage-Backed Securities
                    
                    
                    1
                    
                    
                    
                    –
                    
                    
                    
                    (852
                    )
                    
                    
                    (851
                    )Corporate
      Securities
                    
                    
                    9
                    
                    
                    
                    (62
                    )
                    
                    
                    (438
                    )
                    
                    
                    (491
                    )Equity
      Securities
                    
                    
                    60
                    
                    
                    
                    (12
                    )
                    
                    
                    –
                    
                    
                    
                    48Total
                    
                    $
                    389
                    
                    
                    $
                    (137
                    )
                    
                    $
                    (1,290
                    )
                    
                    $
                    (1,038
                    )
 
 Year Ended December 31, 2007Gross
                      Realized
                      Gains
                    
                    
                    Gross
                      Realized
                      Losses
                    
                    
                    Other-than-
                      temporary
                      Impairment
                      Losses
                    
                    
                    Net Gains
                      (Losses)Obligations
      of U.S. Government Agencies
                    
                    $
                    9
                    
                    
                    $
                    (30
                    )
                    
                    $
                    –
                    
                    
                    $
                    (21
                    )U.S.
      Agency Mortgage-Backed Securities
                    
                    
                    108
                    
                    
                    
                    (552
                    )
                    
                    
                    –
                    
                    
                    
                    (444
                    )Private
      Issuer Mortgage-Backed Securities
                    
                    
                    –
                    
                    
                    
                    (48
                    )
                    
                    
                    –
                    
                    
                    
                    (48
                    )Obligations
      of State and Political Subdivisions
                    
                    
                    718
                    
                    
                    
                    (45
                    )
                    
                    
                    –
                    
                    
                    
                    673Corporate
      Securities
                    
                    
                    30
                    
                    
                    
                    (141
                    )
                    
                    
                    (800
                    )
                    
                    
                    (911
                    )Equity
      Securities
                    
                    
                    40
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    40Total
                    
                    $
                    905
                    
                    
                    $
                    (816
                    )
                    
                    $
                    (800
                    )
                    
                    $
                    (711
                    )
  20
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
 
 Other-Than-Temporary
Impairment of Investment Securities
 In
determining fair value and assessing the potential for OTTI of investment
securities  as of December 31, 2009, Union National management
primarily considered the following accounting principles and guidance from the
Accounting Standards Codification (“ASC”): (i) ASC Topic 320, “Investments –
Debt and Equity Securities”, and (ii) ASC Topic 820, “Fair Value Measurements
and Disclosures”.  Additionally, management considered SEC guidance
including (i) SAB Topic 5M, “Miscellaneous Accounting – Other Than Temporary
Impairment of Certain Investments in Debt and Equity Securities”, and (ii)
additional interpretive guidance SEC Press Release #2008-234, “SEC Office of the
Chief Accountant and FASB Staff Clarifications on Fair Value
Accounting”.
 
 In order
to determine whether unrealized losses in the fair value of investment
securities are other-than-temporary, management regularly reviews the entire
portfolio of investment securities for possible OTTI, analyzing factors
including but not limited to the underlying creditworthiness of the issuing
organization, the length of time for which the fair value of the investment
securities has been less than cost, and independent analysts’ opinions about
circumstances that could affect the performance of the investment
securities.  In assessing potential OTTI for debt securities, other
considerations include (i) whether management intends to sell the security, or
(ii) if it is more likely than not that management will be required to sell the
security before recovery, or (iii) if management does not expect to recover the
entire amortized cost basis.  In assessing potential OTTI for equity
securities, consideration is given tomanagement’s intention and
ability to hold the securities until recovery of any unrealized
losses.
 
 Effective
April 1, 2009, the accounting principles and guidance referenced above requires
that the credit-related portion of OTTI on debt securities be recognized in
earnings, while the noncredit-related portion of OTTI on debt securities not
expected by management to be sold be recognized in Other Comprehensive Income
(“OCI”).  Management determined that OTTI recorded in the fourth
quarter of 2008 against a private-issuer mortgage-backed security, not expected
to be sold, had both credit-related and noncredit-related portions of OTTI;
however, in 2008, the entire OTTI charge on this security was recognized in
earnings.  The noncredit-related portion was determined to be $306,000
pre-tax.  Accordingly, on April 1, 2009, a cumulative effect
adjustment was recorded in the after-tax amount of $202,000 to increase retained
earnings and decrease unrealized gains (losses) in accumulated other
comprehensive income (loss) for the noncredit-related portion of the OTTI
recorded in 2008.
 
 The
following summarizes the cumulative credit related OTTI charges recognized as
components of earnings for investment securities still held at December 31,
2009 (in thousands):
 
 Balance
      at January 1, 2009
                      
                      $
                      2,090Cumulative
      effect of ASC Topic 320, “Investments – Debt and Equity Securities”
      adoption - non-credit portion of previous OTTI (pre-tax)
                      
                      
                      (306
                      )Additional
      OTTI taken for credit losses during 2009
                      
                      
                      1,504Balance
      at December 31, 2009
                      
                      $
                      3,288
  21
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  As of
December 31, 2009, Union National maintains five investment securities with
recorded impairments.  The fair value of the five impaired investments
was $3,269,000 as compared to an original amortized cost of
$8,950,000.  The following table provides additional information
related to these five investment securities(in
thousands):
 At December 31, 2009Original
                                      Amortized
                                    
                                    
                                    Investment Rating
                                    
                                    
                                    Current
                                      Amortized
                                    
                                    
                                    Fair
                                    
                                    
                                    OTTIDescription of Investment Security
                                    
                                    Cost
                                    
                                    
                                    Original
                                    
                                    
                                    Current
                                    
                                    
                                    Cost
                                    
                                    
                                    Value
                                    
                                    
                                    TakenPrivate
      Issuer Mortgage-Backed Securities:Countrywide
      Alt Ln 2005-83CB A3
                                    
                                    $
                                    3,018
                                    
                                    
                                    AAA
                                    
                                    
                                    CC
                                    
                                    
                                    $
                                    1,214
                                    
                                    
                                    $
                                    1,333
                                    
                                    
                                    $
                                    711Countrywide
      Alt Ln 2005-75CB A4
                                    
                                    
                                    2,932
                                    
                                    
                                    AAA
                                    
                                    
                                    CCC
                                    
                                    
                                    
                                    1,254
                                    
                                    
                                    
                                    1,305
                                    
                                    
                                    
                                    480Total
      Mortgage-Backed Securities
                                    
                                    $
                                    5,950
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    2,468
                                    
                                    
                                    $
                                    2,638
                                    
                                    
                                    $
                                    1,191Corporate
      Securities:InCaps
      Funding II Senior Note
                                    
                                    $
                                    1,000
                                    
                                    
                                    A-
                                    
                                    
                                    BB
                                    
                                    
                                    $
                                    279
                                    
                                    
                                    $
                                    322
                                    
                                    
                                    $
                                    631InCaps
      Funding II Junior Note
                                    
                                    
                                    1,000
                                    
                                    
                                    BBB
                                    
                                    
                                    B
                                    
                                    
                                    
                                    256
                                    
                                    
                                    
                                    309
                                    
                                    
                                    
                                    530USCap
      Funding V
                                    
                                    
                                    1,000
                                    
                                    
                                    BBB
                                    
                                    
                                    C
                                    
                                    
                                    
                                    –
                                    
                                    
                                    
                                    –
                                    
                                    
                                    
                                    936Total
      Corporate Securities
                                    
                                    $
                                    3,000
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    535
                                    
                                    
                                    $
                                    631
                                    
                                    
                                    $
                                    2,097Total
      Securities with OTTI
                                    
                                    $
                                    8,950
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    3,003
                                    
                                    
                                    $
                                    3,269
                                    
                                    
                                    $
                                    3,288
 
 As
discussed more thoroughly in Note 20 – Fair Value of Assets and
Liabilities and Fair Value of Financial Instruments, the fair value of
these investment securities was determined by calculating the net present value
of the expected future cash flows of each security, with qualitative
risk-adjusted discounting for potential credit risks and nonperformance in the
underlying issuers, and market sector illiquidity concerns. In accordance with
ASC 820, when an active market for a security does not exist, the use of
management estimates that incorporate current market participant expectations of
future cash flows, and include appropriate risk premiums, is
acceptable.  Management’s judgment was that, as of December 31, 2009,
the facts and circumstances indicated significant illiquidity and an inactive
market for these types of investments when other relevant observable inputs were
not available; therefore, expected cash flows were used as a reasonable basis in
determining the fair value of the corporate investment
securities.  Prior to September 30, 2008, management used other
observable inputs to determine the fair value of the corporate investment
securities including broker indicated prices and quoted prices in limited
trading activity of the issuances.
 
 During
2009, four of the Bank’s five private-issuer securities were downgraded to below
investment grade (one private-issuer security was downgraded to below investment
grade in 2008).  Accordingly, the Bank recorded $1,504,000 of
other-than-temporary impairment charges in 2009 including (i) $859,000 related
to three corporate securities supported primarily by obligations from other
financial industry entities, and (ii) $645,000 related to two private issuer
mortgage-backed securities not guaranteed by the U.S.
government.  During 2008, Union National recorded $1,290,000 of
other-than-temporary investment impairment charges related to two securities,
including the private-issuer security that was downgraded to
below-investment-grade in 2008, and a corporate security.  Management
determined that, due to severe illiquidity and distress in the financial
markets, the unrealized declines in the value of these investments were
other-than-temporary and credit related, requiring the write-down and related
impairment charge to earnings.  For the securities with impairment
charges recorded, interest income payments received subsequent to impairment are
fully applied to principal further reducing the amortized cost of these
investments.
 
 Subsequent
to December 31, 2009, Union National sold one of the previously impaired
corporate securities (InCaps Funding II Senior Note) for
$277,000.   At the time of the sale, the amortized cost was
$272,000, which resulted in a $5,000 gain that was recorded on the
sale.
  22
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
4 – LOANS AND LEASES
 
 At
December 31, 2009 and 2008, loans and leases outstanding consisted of the
following (in thousands):
 
 At December 31,2009
                    
                    
                    2008Real
      Estate MortgagesFirst
      and Second Residential
                    
                    $
                    112,535
                    
                    
                    
                    33
                    %
                    
                    $
                    127,636
                    
                    
                    
                    35
                    %Commercial
      and Industrial
                    
                    
                    120,610
                    
                    
                    
                    36
                    
                    
                    
                    121,619
                    
                    
                    
                    34Construction
      and Land Development
                    
                    
                    21,970
                    
                    
                    
                    6
                    
                    
                    
                    24,757
                    
                    
                    
                    7Agricultural
                    
                    
                    28,099
                    
                    
                    
                    8
                    
                    
                    
                    27,485
                    
                    
                    
                    8Commercial
      and Industrial
                    
                    
                    37,410
                    
                    
                    
                    11
                    
                    
                    
                    35,061
                    
                    
                    
                    10Consumer,
      Net of Unearned Income
                    
                    
                    5,854
                    
                    
                    
                    2
                    
                    
                    
                    7,172
                    
                    
                    
                    2Agricultural
                    
                    
                    4,464
                    
                    
                    
                    1
                    
                    
                    
                    3,588
                    
                    
                    
                    1Political
      Subdivisions
                    
                    
                    5,764
                    
                    
                    
                    2
                    
                    
                    
                    6,553
                    
                    
                    
                    2Lease
      Financing Receivables, Net of Unearned Income
                    
                    
                    1,929
                    
                    
                    
                    1
                    
                    
                    
                    3,792
                    
                    
                    
                    1Other
                    
                    
                    639
                    
                    
                    
                    0
                    
                    
                    
                    617
                    
                    
                    
                    0Total
      Loans and Leases
                    
                    $
                    339,274
                    
                    
                    
                    100
                    %
                    
                    $
                    358,280
                    
                    
                    
                    100
                    %
 
 The Bank
grants commercial loans and leases, and residential and consumer loans to
customers primarily located in Lancaster County,
Pennsylvania.  Although the Bank has a diversified loan and lease
portfolio, its debtors’ ability to honor their contracts is influenced by the
region’s economy.  At December 31, 2009, the Bank had $72,287,000 of
loans specifically pledged to the FHLB for providing collateral on FHLB
long-term debt.
 
 Loans and
leases include the net investment in direct lease financing receivables,
determined as follows (in thousands):
 
 At December 31,2009
                      
                      
                      2008Minimum
      Lease Payments Receivable
                      
                      $
                      1,747
                      
                      
                      $
                      3,834Residual
      Values
                      
                      
                      343
                      
                      
                      
                      432Unearned
      Income
                      
                      
                      (161
                      )
                      
                      
                      (474
                      )Total
      Leases
                      
                      $
                      1,929
                      
                      
                      $
                      3,792
 
 The
allowance for uncollectible lease payments, included in the allowance for credit
losses, was $68,000 and $149,000 at December 31, 2009 and 2008,
respectively.  Net charge-offs of direct lease financing receivables
was $93,000 and $163,000 in 2009 and 2008, respectively.
 
 Minimum
future rentals on noncancelable financing leases as of December 31, 2009, are as
follows (in thousands):
 
 December 31,
                      20092010
                    
                    $
                    9962011
                    
                    
                    4852012
                    
                    
                    1892013
                    
                    
                    662014
                    
                    
                    11Thereafter
                    
                    
                    –$
                    1,747
  23
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Nonperforming
assets at December 31, 2009 and 2008 consisted of the following (in
thousands):
 
 At December 31,2009
                    
                    
                    2008Nonaccruing
      Loans and Leases
                    
                    $
                    8,034
                    
                    
                    $
                    3,271Accruing
      Loans – 90 Days or More Past Due
                    
                    
                    506
                    
                    
                    
                    1,685Total
      Nonperforming Loans and Leases
                    
                    
                    8,540
                    
                    
                    
                    4,956Other
      Real Estate Owned
                    
                    
                    5,383
                    
                    
                    
                    –Repossessed
      Assets
                    
                    
                    436
                    
                    
                    
                    479Total
      Nonperforming Assets
                    
                    $
                    14,359
                    
                    
                    $
                    5,435
 
 Following
is a summary of impaired loan and lease data at December 31, 2009, 2008 and 2007
(in thousands):
 At December 31,2009
                    
                    
                    2008
                    
                    
                    2007Impaired
      Loans and Leases with a Related
                      Allowance
      for Credit Losses
                    
                    $
                    5,916
                    
                    
                    $
                    5,058
                    
                    
                    $
                    1,814Impaired
      Loans and Leases without a Related
                      Allowance
      for Credit Losses
                    
                    
                    2,799
                    
                    
                    
                    4,302
                    
                    
                    
                    822Total
      Impaired Loans and Leases
                    
                    $
                    8,715
                    
                    
                    $
                    9,360
                    
                    
                    $
                    2,636Related
      Allowance for Credit Losses
                    
                    $
                    1,458
                    
                    
                    $
                    1,499
                    
                    
                    $
                    380Average
      Outstanding Balance for the Year
                    
                    
                    8,731
                    
                    
                    
                    6,446
                    
                    
                    
                    2,993Recognized
      Interest Income on Impaired Loans
                    
                    
                    605
                    
                    
                    
                    705
                    
                    
                    
                    21
 
 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 $3,255,000 at December  31, 2009.  Such
loans were made in the ordinary course of business at normal credit terms,
including interest rates and collateral requirements, and do not represent more
than a normal risk of collection.  Transactions on these loans for the
years ended December 31, 2009 and 2008 are as follows (in
thousands):
 
 2009
                    
                    
                    2008Balance,
      Beginning of Year
                    
                    $
                    4,386
                    
                    
                    $
                    3,499Additions
                    
                    
                    54
                    
                    
                    
                    1,467Deletions
                    
                    
                    (1,185
                    )
                    
                    
                    (580
                    )Balance,
      End of Year
                    
                    $
                    3,255
                    
                    
                    $
                    4,386
 
 NOTE
5 – ALLOWANCE FOR CREDIT LOSSES
 
 An
analysis of changes in the allowance for credit losses for the years ended
December 31, 2009, 2008 and 2007 is as follows (dollars in
thousands):
 2009
                    
                    
                    2008
                    
                    
                    2007Allowance
      for Credit Losses, Beginning of Year
                    
                    $
                    4,358
                    
                    
                    $
                    3,675
                    
                    
                    $
                    3,070Charge-Offs
                    
                    
                    (1,189
                    )
                    
                    
                    (364
                    )
                    
                    
                    (637
                    )Recoveries
                    
                    
                    62
                    
                    
                    
                    20
                    
                    
                    
                    5Net
      Charge-Offs
                    
                    
                    (1,127
                    )
                    
                    
                    (344
                    )
                    
                    
                    (632
                    )Addition
      to Provision for Credit Losses
                    
                    
                    2,627
                    
                    
                    
                    1,027
                    
                    
                    
                    1,237Allowance
      for Credit Losses, End of Year
                    
                    $
                    5,858
                    
                    
                    $
                    4,358
                    
                    
                    $
                    3,675Total
      Gross Loans and Leases at End of Year
                    
                    $
                    339,274
                    
                    
                    $
                    358,280
                    
                    
                    $
                    364,337Ratio
      of Allowance for Credit Losses to Total Loans and Leases
                    
                    
                    1.73
                    %
                    
                    
                    1.22
                    %
                    
                    
                    1.01
                    %
  24
 NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
6 – PREMISES AND EQUIPMENT
 
 Premises
and equipment consist of the following (in thousands):
 
 At December 31,2009
                    
                    
                    2008Buildings
      and Improvements
                    
                    $
                    10,814
                    
                    
                    $
                    10,603Furniture,
      Fixtures & Equipment
                    
                    
                    9,024
                    
                    
                    
                    8,852Leasehold
      Improvements
                    
                    
                    1,470
                    
                    
                    
                    1,470Land
                    
                    
                    1,168
                    
                    
                    
                    1,168Land
      Improvements
                    
                    
                    1,100
                    
                    
                    
                    1,085Construction
      and Development
                    
                    
                    –
                    
                    
                    
                    101Subtotal
                    
                    
                    23,576
                    
                    
                    
                    23,279Less:  Accumulated
      Depreciation
                    
                    
                    (12,173
                    )
                    
                    
                    (11,191
                    )Premises
      and Equipment - Net
                    
                    $
                    11,403
                    
                    
                    $
                    12,088
 
 For the
years ended December 31, 2009, 2008 and 2007, depreciation expense on premises
and equipment was $1,058,000, $1,093,000 and $1,078,000,
respectively.
 
 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 operating leases are renewable
at Union National’s 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, 2009, are as follows (in thousands):
 
 Lease
                      Obligations
                    
                    
                    Sublease
                      Income
                    
                    
                    Net Lease
                      Obligations
                    
                    
                    Obligations
                      to
                      Related
                      Party2010
                    
                    $
                    648
                    
                    
                    $
                    287
                    
                    
                    $
                    361
                    
                    
                    $
                    1972011
                    
                    
                    693
                    
                    
                    
                    299
                    
                    
                    
                    394
                    
                    
                    
                    2292012
                    
                    
                    699
                    
                    
                    
                    282
                    
                    
                    
                    417
                    
                    
                    
                    2502013
                    
                    
                    692
                    
                    
                    
                    150
                    
                    
                    
                    542
                    
                    
                    
                    3822014
                    
                    
                    591
                    
                    
                    
                    153
                    
                    
                    
                    438
                    
                    
                    
                    379Thereafter
                    
                    
                    3,532
                    
                    
                    
                    600
                    
                    
                    
                    2,932
                    
                    
                    
                    2,900$
                    6,855
                    
                    
                    $
                    1,771
                    
                    
                    $
                    5,084
                    
                    
                    $
                    4,337
 
 Net rent
expense from continuing operations consisted of the following (in
thousands):
 
 For the Year Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007Rental
      Expense
                      
                      $
                      845
                      
                      
                      $
                      755
                      
                      
                      $
                      1,184Sublease
      Rental Income
                      
                      
                      (316
                      )
                      
                      
                      (225
                      )
                      
                      
                      (28
                      )Net
      Rental Expense
                      
                      $
                      529
                      
                      
                      $
                      530
                      
                      
                      $
                      1,156
 
 Net
rental payments to a related party were $208,000, $282,000, and $473,000, for
the years ended December 31, 2009, 2008 and 2007,
respectively.
  25
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
7 – DEPOSITS
 
 Union
National’s deposits at December 31, 2009 and 2008 consisted of the following (in
thousands):
 
 December 31,2009
                      
                      
                      2008Noninterest-Bearing
      Demand
                      
                      $
                      54,331
                      
                      
                      $
                      46,875Money
      Market and NOW
                      
                      
                      134,600
                      
                      
                      
                      120,762Savings
                      
                      
                      23,526
                      
                      
                      
                      22,087Certificates
      of Deposit
                      
                      
                      192,308
                      
                      
                      
                      193,853Total
      Deposits
                      
                      $
                      404,765
                      
                      
                      $
                      383,577
 
 Scheduled
maturities of certificates of deposit (time deposits) at December 31, 2009 are
as follows (in thousands):
  December 31,20092010
                    
                    $
                    117,5432011
                    
                    
                    49,9912012
                    
                    
                    13,7442013
                    
                    
                    6,2992014
                    
                    
                    4,650Thereafter
                    
                    
                    81Total
      Certificate of Deposits
                    
                    $
                    192,308
 
 Total
certificates of deposit included $6,572,000 and $12,278,000 of brokered CDs
outstanding at December 31, 2009 and 2008, respectively.  Certificates
of deposit in denominations of $100,000 or more amounted to $63,183,000 and
$52,822,000 at December 31, 2009 and 2008, respectively.  The
maturities of certificates of deposit in denominations of $100,000 or more at
December 31, 2009, are as follows (in thousands):
  December 31,Maturity
                      
                      20093
      months or less
                      
                      $
                      12,1153 -
      6 months
                      
                      
                      10,0696 -
      12 months
                      
                      
                      10,869Over
      12 months
                      
                      
                      30,130Total
      CDs of $100,000 or more
                      
                      $
                      63,183
 
 Interest
expense on deposits was $8,394,000, $9,470,000 and $10,790,000 for the years
ended December 31, 2009, 2008 and 2007, respectively.
  26
 NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
8 – SHORT-TERM BORROWINGS
 
 There
were no short-term borrowings outstanding as of December 31, 2009 and
2008.  There were no short-term borrowings outstanding at any month
end during 2009.  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.
 
 Union
National has a line of credit with a correspondent bank amounting to $7,000,000
for overnight federal funds borrowings, none of which was outstanding at
December 31, 2009, 2008 or 2007.
 
 Union
National also has the ability to borrow overnight funds through the Federal
Reserve discount window, which amounted to $14,839,000 at December 31,
2009.  The Federal Reserve borrowing capacity is collateralized by
$15,151,000 of investment securities at December 31, 2009.  Union
National did not have the ability to borrow any overnight funds through the
Federal Reserve at December 31, 2008.
 
 At
December 31, 2008, Union National had an agreement with the FHLB, for a line of
credit available in the amount of $15,000,000, none of which was outstanding at
December 31, 2008 or 2007.  As a result of the formal agreement
entered into with the Office of the Comptroller of the Currency (“OCC”) during
2009 (for additional information, refer to Note 18 – Enforcement Actions with
Bank Regulatory Agencies), the $15,000,000 line of credit is no longer
available without Union National providing collateral to the
FHLB.  Union National did not pledge collateral to the FHLB for
short-term borrowings at December 31, 2009.
 
 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.
 
 Interest
expense on short-term borrowings was $210,000 and $299,000 for the years ended
December 31, 2008 and 2007, respectively.  For the year ended December
31, 2009, interest expense on short-term borrowings was less than
$1,000.
  27
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
9 – LONG-TERM DEBT
 
 Maturities
of long-term debt are as follows as of December 31, 2009 and 2008 (dollars in
thousands):
 
 December 31, 2009
                    
                    
                    December 31, 2008Amount
                    
                    
                    Rate
                    
                    
                    Amount
                    
                    
                    RateFHLB
      Fixed Rate Advances:2010
                    
                    $
                    2,500
                    
                    
                    
                    4.67
                    %
                    
                    $
                    9,500
                    
                    
                    
                    4.67
                    %2012
                    
                    
                    10,834
                    
                    
                    
                    4.31
                    
                    
                    
                    10,834
                    
                    
                    
                    4.31FHLB
      Convertible Fixed-Rate Advances:2010
                    
                    
                    10,000
                    
                    
                    
                    5.55
                    
                    
                    
                    20,000
                    
                    
                    
                    5.702011
                    
                    
                    10,000
                    
                    
                    
                    5.23
                    
                    
                    
                    10,000
                    
                    
                    
                    5.23Total
                    
                    $
                    33,334
                    
                    
                    
                    4.98
                    %
                    
                    $
                    50,334
                    
                    
                    
                    5.11
                    %
 
 FHLB
advances are collateralized by a security agreement covering qualifying loans
and unpledged treasury, agency and mortgage-backed securities.  At
December 31, 2009, the Bank had $72,287,000 of loans specifically pledged to the
FHLB for providing collateral on FHLB advances.  In addition, FHLB
advances are secured by FHLB stock owned by Union National with a carrying
amount of $3,298,000 at December 31, 2009 and 2008.
 
 Membership
in the FHLB provides us with additional liquidity alternatives such as short- or
long-term funding on fixed- or variable-rate terms.  However, as a
result of the formal agreement entered into in 2009 with the OCC (for additional
information, refer to Note 18
– Enforcement Actions with Bank Regulatory Agencies), (i) the Bank’s
borrowing capacity has been reduced to the current outstanding balance, (ii) the
Bank has delivered collateral to the FHLB to support the current outstanding
balance owed to the FHLB and (iii) any future advances are contingent upon
additional collateral delivery to the FHLB. As of December 31, 2009, long-term
debt outstanding was $33,334,000.  All FHLB long-term advances are
subject to prepayment penalties, which vary based upon current market interest
rates.  At December 31, 2009, $20,000,000 of the FHLB long-term debt
advances 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 .10% to .20%.  Upon the FHLB’s
conversion, the Bank has the option to repay the respective advances in full
without prepayment.
 
 At
December 31, 2008 (prior to the formal agreement with the OCC), total long-term
advances outstanding were $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 line of credit.
 
 Interest
expense on long-term debt was $2,054,000, $2,795,000 and $3,652,000 for the
years ended December 31, 2009, 2008 and 2007, respectively.
  28
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
10 – DERIVATIVE FINANCIAL INSTRUMENTS
 
 Union
National had no derivatives at December 31, 2009, 2008 and
2007.  Derivatives were used in 2007.  For asset/liability
management purposes, Union National has used interest rate cap and collar
agreements to hedge various exposures or to modify interest rate characteristics
of various balance sheet accounts.  Such derivatives used in the past
as part of the asset/liability management process were linked to specific assets
or liabilities and had high correlation between the contract and the underlying
item being hedged both at inception and throughout the hedge
period.  These transactions involved 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.
 
 Union
National records all derivatives on the balance sheet at fair value.  The
accounting for changes in the fair value of derivatives depended 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, were designated as cash flow
hedges.  For derivatives designated as cash flow hedges, the effective
portion of changes in the fair value of the derivative was 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 was recognized directly
in earnings.
 
 NOTE
11 – JUNIOR SUBORDINATED DEBENTURES
 
 Union
National had three issuances of junior subordinated debentures, totaling
$17,341,000, outstanding as of both December 31, 2009 and 2008.
 
 On July
28, 2006, the Bank issued $6,000,000 of subordinated debentures due September
15, 2021 with a five-year initial fixed rate of 7.17%, and then an annual coupon
rate, reset quarterly, based on three-month LIBOR plus 1.65%.
 
 In
December 2003, Union National Capital Trust I (“UNCT I”) issued $8,248,000 of
floating-rate debentures due January 23, 2034, of which $248,000 is related to
Union National’s capital contribution.  UNCT I provides for quarterly
distributions at a variable annual coupon rate that is reset quarterly, based on
three-month LIBOR plus 2.85%.  The coupon rate was 3.13% and 6.32% at
December 31, 2009 and 2008, respectively.
 
 In
October 2004, Union National Capital Trust II (“UNCT II”) issued $3,093,000 of
debentures due November 23, 2034, of which $93,000 is related to Union
National’s capital contribution.  UNCT II provides for quarterly
distributions at a variable annual coupon rate that is reset quarterly, based on
three-month LIBOR plus 2.00%. The coupon rate was 2.27% and 4.15% at December
31, 2009 and 2008, respectively.
 
 All of
the junior subordinated debentures are callable at Union National’s option
beginning at five years from the date of issuance.  These debentures
do not have to be called in full.  UNCT I became callable in December
2008, UNCT II became callable in October 2009, and the Bank’s junior
subordinated debenture will become callable in July 2011.  All three
issuances of junior subordinated debentures qualify as a component of risk-based
capital for regulatory purposes.  For additional information related
to Federal Reserve pre-approval requirements related to payments on UNCT I and
UNCT II, refer to Note 15 -
Regulatory Restrictions.
 
 Interest
expense on junior subordinated debentures was $838,000, $1,104,000 and
$1,268,000 for the years ended December 31, 2009, 2008 and 2007,
respectively.
  29
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  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 $48,000, $166,000, and
$187,000 for the years ended December 31, 2009, 2008 and 2007,
respectively.  During the second quarter of 2009, Union National
changed the 401(k) profit-sharing plan to suspend the employee match, which
resulted in a decrease of expense for the year ended December 31, 2009 as
compared to the years ended December 31, 2008 and 2007.
 
 Employee
Stock Purchase Plan
 In 2009,
Union National established an Employee Stock Purchase Plan
(“ESPP”).  The ESPP is a company-run program in which
participating employees can purchase shares of Union National stock at
a 15% discounted price.  Employees contribute to the plan through
payroll deductions, which accumulate until the shares are
purchased.  On a quarterly basis, the accumulated funds are used to
purchase shares of Union National stock on behalf of the participating
employees.  The difference between the market price and the purchase
price for participants (the 15% discount) is recognized as expense in the
Consolidated Statements of Operations in salaries, wages and employee
benefits.  Union National’s expense relative to its ESPP was $7,000
for the year ended December 31, 2009.  There was no expense recognized
for the years ended December 31, 2008 and 2007, as the plan was not established
until 2009.
 
 Stock
Option Plan
 Union
National has two stock option plans, one plan for its employees and one plan for
its independent directors.  These plans are discussed separately in
Note 2 – Stocked-Based
Compensation.
 
 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, 2009 and 2008, Union
National’s total accrued liability under this agreement was $403,000 and
$290,000, respectively. Total expenses related to this liability and related
insurance costs as provided for in the agreement amounted to $113,000, $59,000,
and $69,000 for the years ended December 31, 2009, 2008, and 2007,
respectively.
  30
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
13 - INCOME TAXES
 
 ASC Topic
740, “Income Taxes” 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.  ASC Topic 740 provides guidance on how to determine whether
a tax position is effectively settled for the purpose of recognizing previously
unrecognized tax benefits.  ASC Topic 740 was adopted by Union
National retroactive to January 1, 2007.  As a result of Union
National’s adoption, no significant income tax uncertainties were identified;
therefore, Union National recognized no adjustment for unrecognized income tax
benefits for the years ended December 31, 2009, 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
Operations.
 
 The net
deferred tax asset consisted of the following components as of December 31, 2009
and 2008 (in thousands):
 At December 31,2009
                    
                    
                    2008Deferred
      Tax Assets:Allowance
      for Credit Losses
                    
                    $
                    1,992
                    
                    
                    $
                    1,482Recoverable
      Alternative Minimum Taxes
                    
                    
                    804
                    
                    
                    
                    804Income
      Tax Credit Carryforward
                    
                    
                    502
                    
                    
                    
                    515Impairment
      Charges on Investment Securities
                    
                    
                    961
                    
                    
                    
                    806Unrealized
      Losses on Investment Securities Available for Sale
                    
                    
                    101
                    
                    
                    
                    –Other
                    
                    
                    270
                    
                    
                    
                    280Total
      Deferred Tax Assets
                    
                    
                    4,630
                    
                    
                    
                    3,887Deferred
      Tax Liabilities:Deferred
      Net Loan Fees
                    
                    
                    (61
                    )
                    
                    
                    (57
                    )Depreciation
                    
                    
                    (415
                    )
                    
                    
                    (452
                    )Prepaid
      Expenses
                    
                    
                    (130
                    )
                    
                    
                    (91
                    )Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                    
                    
                    (16
                    )
                    
                    
                    (29
                    )Leasing
                    
                    
                    (585
                    )
                    
                    
                    (572
                    )Unrealized
      Gains on Investment Securities Available for Sale
                    
                    
                    –
                    
                    
                    
                    (19
                    )Other
                    
                    
                    (37
                    )
                    
                    
                    (10
                    )Total
      Deferred Tax Liabilities
                    
                    
                    (1,244
                    )
                    
                    
                    (1,230
                    )Net
      Deferred Tax Asset
                    
                    $
                    3,386
                    
                    
                    $
                    2,657
 
 At
December 31, 2009, Union National had no valuation allowance established against
its deferred tax assets as management believes Union National will generate
sufficient future taxable income to fully utilize all net operating loss
carryforwards and AMT tax credits.
 
 An
analysis of income tax expense included in the Consolidated Statements of
Operations for the years ended December 31, 2009, 2008 and 2007, is as follows
(in thousands):
 
 Years Ended December 31,2009
                    
                    
                    2008
                    
                    
                    2007(Tax
      Benefits Receivable) Tax Currently Payable
                    
                    $
                    (193
                    )
                    
                    $
                    1,284
                    
                    
                    $
                    (413
                    )Deferred
      Income Tax Benefit
                    
                    
                    (609
                    )
                    
                    
                    (1,472
                    )
                    
                    
                    (8
                    )Benefit
      from Income Taxes
                    
                    $
                    (802
                    )
                    
                    $
                    (188
                    )
                    
                    $
                    (421
                    )
  31
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  The
reasons for the difference between the benefit from income taxes and the amount
computed by applying the statutory federal income tax rate to (loss) income
before income taxes for the years ended December 31, 2009, 2008 and 2007, are as
follows (dollars in thousands):
 
 Years Ended December 31,2009
                    
                    
                    2008
                    
                    
                    2007(Loss)
      Income Before Income Taxes
                    
                    $
                    (1,517
                    )
                    
                    $
                    256
                    
                    
                    $
                    (109
                    )Statutory
      Tax Rate
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %
                    
                    
                    34.0
                    %Federal
      Tax at Statutory Rate
                    
                    
                    (516
                    )
                    
                    
                    87
                    
                    
                    
                    (37
                    )Tax
      Benefits From:Tax-Exempt
      Income, Net of Disallowed Interest Expense
                    
                    
                    (146
                    )
                    
                    
                    (132
                    )
                    
                    
                    (267
                    )Earnings
      from Bank-Owned Life Insurance
                    
                    
                    (147
                    )
                    
                    
                    (149
                    )
                    
                    
                    (145
                    )Income
      Tax Credits
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    (38
                    )Other
                    
                    
                    7
                    
                    
                    
                    6
                    
                    
                    
                    66Benefit
      from Income Taxes
                    
                    $
                    (802
                    )
                    
                    $
                    (188
                    )
                    
                    $
                    (421
                    )
 
 Income
tax credit carryforwards will begin to expire in 2020 and income tax credits are
recognized as earned.  There were no income tax credits earned for the
years ended December 31, 2009 and 2008.  There was $38,000 of income
tax credits earned for the year ended December 31, 2007.
 
 Years
that remain open for potential review by the Internal Revenue Service are 2006
through 2008.
 
 NOTE
14 – COMMITMENTS, GUARANTEES AND CONTINGENCIES
 
 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 31,2009
                    
                    
                    2008Financial
      Instruments Whose Contract Amounts Represent Credit Risk:Commitments
      to Extend Credit
                    
                    $
                    1,499
                    
                    
                    $
                    800Unused
      Portion of Home Equity, Personal and Overdraft Lines
                    
                    
                    43,674
                    
                    
                    
                    43,259Other
      Unused Commitments, Principally Commercial Lines of Credit
                    
                    
                    59,419
                    
                    
                    
                    60,374Standby
      Letters of Credit
                    
                    
                    6,199
                    
                    
                    
                    5,474Total
      Commitments and Guarantees
                    
                    $
                    110,791
                    
                    
                    $
                    109,907
 
 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.
  32
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  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 $411,000 and $555,000 at December 31, 2009 and 2008,
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, 2009 and 2008, for guarantees under standby letters of credit issued is not
considered to be material.
 
 The Bank
occasionally sells residential mortgage loans to the FHLB of Pittsburgh under an
agreement that includes a maximum credit enhancement liability of
$815,000.  The Bank 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.  The Bank’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 monthly at an
annual rate of 0.10% on the outstanding loan portfolio balance.  The
Bank 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 $14,000 at December 31, 2009 and $26,000 at
December 31, 2008, are included in other assets on the Consolidated Statements
of Financial Condition and are amortized as principal is received on loans
sold.
 
 Effective
July 1, 2008, the Bank joined a health care expense management consortium with
other Pennsylvania banks.  The purpose of the consortium is to pool the
risks of covered groups of employees, and to provide effective claims-based
expense management, administrative efficiencies, and use of high-dollar claim
stop loss insurance coverage, to reduce the overall health care costs to the
consortium member banks, while maintaining high quality coverage for
employees.  Through December 31, 2009, the Bank’s payments to the
consortium to cover estimated claims expenses, administrative expenses, and stop
loss insurance premiums exceeded the actual processed expenses by
$312,000.  However, the Bank reduced the amount of this prepaid benefit by
a contingent reserve of $63,000 reflecting an actuarial estimate by the
consortium of the Bank’s unpaid claim liability as of December 31, 2009 to
include potential (i) unreported claims, (ii) reported but unprocessed claims,
and (iii) processed but unpaid claims, related to both medical and drug
coverage.
  33
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
15 - REGULATORY RESTRICTIONS
 
 The Bank
is required to maintain reserves, in the form of cash and balances with the FRB,
against its deposit liabilities.  The average amount of required
reserves was approximately $7,201,000 and $6,135,000 during 2009 and 2008,
respectively.
 
 The Bank
is also subject to certain restrictions in connection with the payment of
dividends.  National banking laws require the approval of the Office
of the Comptroller of the Currency if the total of all dividends declared by a
national bank in any calendar year exceeds the net profits of the Bank for that
year (as defined)  combined with the Bank’s retained net operating
results for the preceding two calendar years.  Under this formula, the
Bank’s retained net operating results for the preceding two calendar years was
($189,000).  In 2010, the Bank may declare dividends to the parent
company, Union National, an amount equal to the net profits of the Bank in 2010
less $189,000, up to the date of any such dividend declaration.
 
 Additionally,
on January 28, 2010, Union National entered into an informal Memorandum of
Understanding with the FRB.  The Memorandum of Understanding, which is
not a “written agreement” for purposes of Section 8 of the Federal Deposit
Insurance Act, requires, among other things, Union National to seek prior
approval by the FRB before Union National (i) declares or pays dividends to
shareholders, (ii) distributes interest, principal or other sums on UNCT I and
UNCT II junior subordinated debentures, and (iii) incurs, increases or
guarantees any additional debt.  Subsequent to December 31, 2009, the
FRB did approve the quarterly interest payments for the first quarter of 2010 on
the UNCT I and UNCT II junior subordinated debentures and the preferred stock
dividend payments.
 
 Bank
regulatory authorities in the United States issue risk-based capital
standards.  These capital standards relate a bank’s capital to the
risk profile of its assets and provide the basis by which all banks are
evaluated in terms of its capital adequacy.  Union National and the
Bank are subject to various regulatory capital requirements administered by the
federal banking agencies.  Failure to meet the minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on our consolidated financial statements.  Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, Union National and the Bank must meet specific capital guidelines that
involve quantitative measures of their assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting
practices.  The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors.
 
 Quantitative
measures established by regulation to ensure capital adequacy require Union
National and the Bank to maintain minimum amounts and ratios (set forth below)
of Tier 1 capital to average assets and of total capital (as defined in the
regulations) to risk-weighted assets.
 
 As of
December 31, 2009 and 2008, Union National and the Bank exceeded the current
regulatory requirements to be considered a quantitatively “well capitalized”
financial institution, i.e. a leverage ratio exceeding 5%, Tier 1 risk-based
capital exceeding 6%, and total risk-based capital exceeding 10%.
 
 In
addition to the above requirements, effective September 30, 2009, the OCC
established individual minimum capital requirements for the Bank (for additional
information, refer to Note 18
– Enforcement Actions with Bank Regulatory Agencies). The specific
capital requirements established for the Bank were 8% for Tier 1 Capital to
Average Total Assets, 9.5% for Tier 1 Capital to Risk-Based Assets, and 12% for
Total Capital to Risk-Based Assets.  At December 31, 2009, the Bank’s
measure of Tier 1 Capital to Average Total Assets was 8.31%, Tier 1 Capital to
Risk-Based Assets of 9.69% and Total Capital to Risk-Based Assets of
12.37%.  At December 31, 2009, all three ratios exceeded the
respective individual minimum capital requirements established by the
OCC.
  34
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
 
 Union
National and the Bank’s regulatory capital levels as of December 31, 2009 and
2008 are as follows (dollars in thousands):
 Actual
                        
                        
                        Minimum Required
                          For Capital
                          Adequacy Purposes
                        
                        
                        To Be Well-
                          Capitalized Under
                          Prompt Corrective
                          Action ProvisionsAmount
                        
                        
                        Ratio
                        
                        
                        Amount
                        
                        
                        Ratio(1)
                        
                        
                        Amount
                        
                        
                        RatioUnion National Financial
      CorporationDecember
      31, 2009:Tier
      1 (leverage) capital
                        
                        $
                        42,036
                        
                        
                        
                        8.52
                        %
                        
                        $
                        19,744
                        
                        
                        
                        4.00
                        %
                        
                        
                        N/A
                        
                        
                        
                        N/ATier
      1 risk-based capital
                        
                        
                        42,036
                        
                        
                        
                        9.93
                        
                        
                        
                        16,929
                        
                        
                        
                        4.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ATotal
      risk-based capital
                        
                        
                        53,825
                        
                        
                        
                        12.72
                        
                        
                        
                        33,858
                        
                        
                        
                        8.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ADecember
      31, 2008:Tier
      1 (leverage) capital
                        
                        $
                        40,982
                        
                        
                        
                        8.44
                        %
                        
                        $
                        19,414
                        
                        
                        
                        4.00
                        %
                        
                        
                        N/A
                        
                        
                        
                        N/ATier
      1 risk-based capital
                        
                        
                        40,982
                        
                        
                        
                        10.03
                        
                        
                        
                        16,340
                        
                        
                        
                        4.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/ATotal
      risk-based capital
                        
                        
                        52,092
                        
                        
                        
                        12.75
                        
                        
                        
                        32,680
                        
                        
                        
                        8.00
                        
                        
                        
                        N/A
                        
                        
                        
                        N/AUnion National Community
    BankDecember
      31, 2009:Tier
      1 (leverage) capital
                        
                        $
                        40,910
                        
                        
                        
                        8.31
                        %
                        
                        $
                        19,686
                        
                        
                        
                        4.00
                        %
                        
                        $
                        24,608
                        
                        
                        
                        5.00
                        %Tier
      1 risk-based capital
                        
                        
                        40,910
                        
                        
                        
                        9.69
                        
                        
                        
                        16,881
                        
                        
                        
                        4.00
                        
                        
                        
                        25,322
                        
                        
                        
                        6.00Total
      risk-based capital
                        
                        
                        52,194
                        
                        
                        
                        12.37
                        
                        
                        
                        33,762
                        
                        
                        
                        8.00
                        
                        
                        
                        42,203
                        
                        
                        
                        10.00December
      31, 2008:Tier
      1 (leverage) capital
                        
                        $
                        40,601
                        
                        
                        
                        8.41
                        %
                        
                        $
                        19,306
                        
                        
                        
                        4.00
                        %
                        
                        $
                        24,133
                        
                        
                        
                        5.00
                        %Tier
      1 risk-based capital
                        
                        
                        40,601
                        
                        
                        
                        9.97
                        
                        
                        
                        16,292
                        
                        
                        
                        4.00
                        
                        
                        
                        24,438
                        
                        
                        
                        6.00Total
      risk-based capital
                        
                        
                        50,959
                        
                        
                        
                        12.51
                        
                        
                        
                        32,584
                        
                        
                        
                        8.00
                        
                        
                        
                        40,731
                        
                        
                        
                        10.00
 
 (1)
              The
      OCC requires the Bank to meet higher individual minimum capital ratios
      effective September 30, 2009 (for additional information, refer to Note 18 – Enforcement Actions
      with Bank Regulatory
Agencies).
 
 Included
in Tier 1 regulatory capital of Union National is $10,510,000 of trust capital
securities issued through the UNCT I  and UNCT II subsidiaries of
Union National.  The balance of these trust capital securities,
$490,000, is included in Tier 2 regulatory capital of Union
National.  Additionally, included in Tier 2 regulatory capital of the
Bank and Union National is $6,000,000 of junior subordinated debentures issued
by the Bank.  These securities would become callable if the Federal
Reserve makes a determination that trust capital securities can no longer be
considered in regulatory capital.
 
 Regulatory
capital requirements may be increased in the future.  Union National
will closely monitor and evaluate its capital position as the regulatory capital
environment changes, and if regulatory capital requirements are
changed.
 
 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, 2009, this limitation
amounted to approximately $5,219,000. 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.
  35
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  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 2009 and 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.
 
 NOTE
17 - DE-LEVERAGING AND RESTRUCTURING ACTIVITIES
 
 In 2009,
the Bank continued with de-leveraging activities to reduce its cost of funds and
improve its net interest margin by using funds from low-interest earning assets
to pay down higher-interest long-term debt.  The Bank prepaid
$17,000,000 of FHLB advances, which had a fixed weighted average interest cost
of 5.36%, incurring $536,000 of debt prepayment penalties, which were included
in other non-interest expense.  At December 31, 2009, the balance of
long-term debt was $33,334,000.  During 2009, the Bank also repaid a
$5,241,000 brokered CD with an interest cost of 3.90% that matured on October
15, 2009.
 
 In 2008,
the Bank prepaid $18,482,000 of FHLB advances, which had a fixed weighted
average interest cost of 4.19%, incurring $72,000 of debt prepayment
penalties.  At December 31, 2008, the balance of total long-term debt
was $50,334,000.  During 2008, the Bank also called and prepaid
$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 2009
and 2008.  Union National made cash payments of $223,000 and $494,000
in 2008 and 2007, respectively, related to accrued severance liabilities
remaining from the 2007 restructuring activities.  The severance
liability was paid in full by December 31, 2008.
 
 NOTE 18 – ENFORCEMENT ACTIONS WITH
BANK REGULATORY AGENCIES
 
 Formal Written Agreement with the Office of the
Comptroller of the Currency
 On August
27, 2009, the Bank, the wholly-owned banking subsidiary of Union National,
entered into a formal written agreement (the “Agreement”) with the
OCC.  Specifically, the Agreement requires the Bank to (1) establish a
compliance committee to monitor and coordinate the Bank’s adherence to the
provisions of the Agreement, (2) have the Board of Directors evaluate and
monitor executive management performance, (3) update its three year strategic
plan in accordance with specific guidelines set forth in the Agreement, (4)
update its three year capital program, (5) develop and implement systems to
provide for effective loan portfolio management, (6) take action to protect
criticized assets and implement a written program to eliminate the basis of
criticism of assets criticized by the OCC, (7) strengthen the Bank’s contingency
funding plan, (8) implement a written consumer compliance program, and (9) not
exceed the level of brokered deposits as of the date of the Agreement without
prior OCC approval.
  The
Agreement supersedes the previous Memorandum of Understanding (“MOU”) entered
into between the Bank and the OCC on June 20, 2007.  The Agreement
effectively extends several of the provisions under the MOU, including requiring
a three year strategic plan and three year capital plan, improving the Bank’s
loan portfolio management, implementing an effective risk-based consumer
compliance audit program, and establishing a compliance
committee.
  36
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Separate
from the Agreement, the OCC has established individual minimum capital
requirements for the Bank requiring Tier 1 Capital to Average Total Assets of at
least eight percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine
and one-half percent (9.5%), and Total Capital to Risk-Based Assets of at least
twelve percent (12%) effective beginning September 30, 2009.  These
minimum capital ratios are similar to the capital ratio targets agreed to
between the Bank and the OCC under the MOU which were Tier I Capital to Average
Total Assets of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital
to Risk-Based Assets of 12%.  At December 31, 2009, the Bank’s measure
of Tier I Capital to Average Total Assets was 8.31%, Tier I Capital to
Risk-Based Assets of 9.69% and Total Capital to Risk-Based Assets of
12.37%.  At December 31, 2009, all three ratios exceeded the
respective OCC individual minimum capital requirements.  The Bank
capital ratios reflect the infusion to the Bank subsidiary of $700,000 of the
$1,275,000 proceeds raised in Union National’s preferred stock private
placement.
 
 In order
to maintain the Bank’s capital levels and to continue to meet the OCC’s
individual minimum capital requirement, Union National and the Bank may have to
raise additional capital, reduce its assets or both.  If the Bank does
not continue to meet the OCC’s requirements, the OCC could subject the Bank to
such administrative actions or sanctions as the OCC considers
necessary.
 
 Management
and the Board of Directors are committed to taking the necessary actions to
fully maintain the new minimum capital ratios and address the provisions of the
Agreement, and believe that the Bank has already made measurable progress in
addressing these requirements.
 
 Memorandum of Understanding
with the Federal Reserve Bank
 On
January 28, 2010, Union National entered into an informal Memorandum of
Understanding with the FRB.  Union National is the registered bank
holding company that wholly owns the Bank; however, the Bank subsidiary is
separately supervised by the Office of the Comptroller of the
Currency.  The Memorandum of Understanding, which is not a “written
agreement” for purposes of Section 8 of the Federal Deposit Insurance Act,
requires, among other things, Union National to seek prior approval by the FRB
before (i) declaring or paying dividends to stockholders, (ii) distributing
interest, principal or other sums on UNCT I and UNCT II junior subordinated
debentures, and (iii) incurring, increasing or guaranteeing any additional debt.
Subsequent to December 31, 2009, the FRB did approve the quarterly interest
payments for the first quarter of 2010 on the UNCT I and UNCT II junior
subordinated debentures and the preferred stock dividend
payments.
  37
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
19 – STOCK ISSUED UNDER PRIVATE PLACEMENT OFFERINGS AND DIVIDEND REINVESTMENT
PLAN
 
 Preferred Stock Private
Placement Offering
 On
September 15, 2009, Union National filed with the Pennsylvania Department
of State two Statements with
Respect to Shares which, effective upon filing, designated two series of
preferred stock as “5% Non-Cumulative Non-Voting Convertible Perpetual Preferred
Stock, Series A” (“Series A Preferred Stock”), and “6% Non-Cumulative Non-Voting
Non-Convertible Perpetual Preferred Stock, Series B” (“Series B Preferred
Stock”), and set forth the voting and other powers, designations, preferences
and relative, participating, optional or other rights, and the qualifications,
limitations or restrictions of the Series A Preferred Stock and Series B
Preferred Stock.
 
 Sales of Preferred
Stock:
 Union
National has sold shares of its Non-Cumulative Non-Voting Convertible Perpetual
Preferred Stock, Series A (“Series A Preferred Stock”), in transactions exempt
from registration under the Securities Act of 1933, pursuant to Section 4(2)
thereof.
 
 Between
September 25, 2009, and December 31, 2009, Union National sold 1,275 shares of
its Series A Preferred Stock for total gross proceeds of $1,275,000, which have
been offset by issuance costs of $57,000.
 As of
December 31, 2009, no Series B Preferred stock shares were sold, issued or
outstanding.
 
 The
following table summarizes the Series A Preferred Stock shares sold and the
gross proceeds received through the private placement offering as of December
31, 2009 (dollars in thousands):
 
 Period
                  
                  Shares
                  
                  
                  Gross
                    ProceedsSeptember
      25, 2009 – September 30, 2009
                  
                  
                  700
                  
                  
                  $
                  700October
      1, 2009 – December 31, 2009
                  
                  
                  575
                  
                  
                  
                  575Total
                  
                  
                  1,275
                  
                  
                  $
                  1,275
 
 As of
December 31, 2009, none of the 1,275 Series A Preferred Stock Shares issued
converted to common stock.
 
 Terms of the Series A
Preferred Stock:
 Dividends
on the Series A Preferred Stock are payable quarterly in arrears if, when,
and as declared by Union National’s Board of Directors, at a rate of 5.00% per
year on the liquidation preference of $1,000 per share. Dividends, if declared,
will be payable quarterly on January 31, April 30, July 31, and October 31 of
each year (each a “Dividend Payment Date”) with the first scheduled dividend
being January 31, 2010.  For additional information related to Federal
Reserve pre-approval requirements related to dividend payments on Preferred
Stock, refer to Note 15 -
Regulatory Restrictions.  In the case of the dividend payable
on the first Dividend Payment Date, such dividend shall be prorated based on the
number of days elapsed from the date of purchase to the first Dividend Payment
Date over a quarterly dividend period of ninety (90) days.  Dividends
on the Series A Preferred Stock are non-cumulative.
  38
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  Holders
of the Series A Preferred Stock may convert their shares into common stock
at any time upon approval of the Board of Governors of the Federal Reserve
System (the “Federal Reserve”), if required, at the conversion prices listed
below:
 
 Conversion Date:
                    
                    Conversion Price
                      per ShareSeptember
      15, 2009 through September 14, 2010
                    
                    $
                    4.00September
      15, 2010 through September 14, 2011
                    
                    $
                    6.25September
      15, 2011 through September 14, 2012
                    
                    $
                    7.50September
      15, 2012 through September 14, 2013
                    
                    $
                    8.75On
      or After September 15, 2013
                    
                    $
                    10.00
 
 The
Series A Preferred Stock only may be redeemed by Union National, upon approval
of the Federal Reserve. If Union National redeems the Series A Preferred Stock
on or prior to September 14, 2014, the redemption price will include a premium
decreasing over time from 2.5% to 0.5% of the liquidation preference. The
holders of the Series A Preferred Stock do not have voting rights except as
required by Pennsylvania Business Corporation Law of 1988, as
amended.
 
 Common Stock Private
Placement 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.  Proceeds from
the sale of the shares were immediately contributed to the general corporate
purposes of Union National including, but not limited to, continuing to meet
regulatory capital requirements and increasing the regulatory lending ability of
the Bank.  The shares were being offered pursuant to an exemption from
registration under Section 3(b) of the Securities Act of 1933 and Rule 505 of
SEC Regulation D.  The shares sold were restricted securities for
purposes of the United States securities laws and cannot be transferred except
under these laws.  The initial private placement offering was for an
initial period of six months commencing May 19, 2008.  The Board of
Directors of Union National subsequently elected to extend the offering period
for the shares until February 17, 2009, at which time the private placement
common stock offering expired.
 
 Union
National received gross proceeds of $1,635,000 on the private placement common
stock offering and issued 172,132 shares.  Issuance costs of $49,000
were offset against the gross proceeds.
 
 Dividend Reinvestment
Plan
 Union
National maintains a Dividend Reinvestment Plan (“DRIP”) for record holders of
Union National’s common stock to provide a convenient method of investing cash
dividends payable upon their common stock and to provide participants with the
opportunity to make voluntary cash payments, from a minimum of $500 to a maximum
of $50,000 per calendar quarter, to purchase additional common shares at a 10%
discount to the fair market value of the shares on the effective purchase date
as defined by the DRIP.  There were no dividends paid by Union
National in 2009; however, eligible shareholders made voluntary cash payments
totaling $68,000, which were used to purchase 20,840 common
shares.  Union National reserved 200,000 common stock shares to be
issued under the DRIP, of which, 22,992 shares have been issued as of December
31, 2009.
  39
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  NOTE
20 – FAIR VALUE MEASUREMENT OF ASSETS AND LIABILITIES / FAIR VALUE OF FINANCIAL
INSTRUMENTS
 
 ASC Topic
820, “Fair Value Measurements and Disclosures” defines fair value, establishes a
framework for measuring fair value in accordance with generally accepted
accounting principles, and expands disclosures about fair value
measurements.  This guidance defines fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. A fair value measurement assumes that a
transaction to sell an asset or transfer a liability occurs in the principal
market for the asset or liability or, in the absence of a principal market, the
most advantageous market for the asset or liability.  The price in the
principal (or most advantageous) market used to measure the fair value of the
asset or liability shall not be adjusted for transaction costs.  An
orderly transaction is not a forced transaction, but rather a 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.
 
 Market
participants are buyers and sellers in the principal market that are (i)
independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to
transact.  ASC Topic 820 requires the use of valuation techniques that
are consistent with the market approach, the income approach and/or the cost
approach.  The market approach uses prices and other relevant
information generated by market transactions involving identical or comparable
assets and liabilities.  The income approach uses valuation techniques
to convert future amounts such as cash flows or earnings, to a single present
amount on a discounted basis.  The cost approach is based on the
amount that currently would be required to replace the service capacity of an
asset (replacement cost).  Valuation techniques should be consistently
applied.  Inputs to valuation techniques refer to the assumptions that
market participants would use in pricing the asset or
liability.  Inputs may be observable, meaning those that reflect the
assumptions market participants would use in pricing the asset or liability
developed based on market data obtained from independent sources, or
unobservable, meaning those that reflect the reporting entity’s own assumptions
about the assumptions market participants would use in pricing the asset or
liability based upon the best information available in the
circumstances.  In that regard, ASC Topic 820 establishes a fair value
hierarchy for valuation inputs that gives the highest priority to quoted prices
in active markets for identical assets or liabilities and the lowest priority to
unobservable inputs.
 
 The fair
value hierarchy is as follows:
 
 Level
      1
              -
              Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or liabilities;Level
      2
              -
              Quoted
      prices in markets that are not active, or inputs that are observable
      either directly or indirectly, for substantially the full term of the
      asset or liability;Level
      3
              -
              Prices
      or valuation techniques that require inputs that are both significant to
      the fair value measurement and unobservable (i.e., supported by little or
      no market activity).
  40
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  ASC Topic
820 provides a list of factors that a reporting entity should evaluate to
determine whether there has been a significant decrease in the volume and level
of activity for the asset or liability in relation to normal market activity for
the asset or liability. When the reporting entity concludes there has been a
significant decrease in the volume and level of activity for the asset or
liability, further analysis of the information from that market is needed and
significant adjustments to the related prices may be necessary to estimate fair
value in accordance with fair value measurement and disclosure
guidance.  Further, ASC Topic 820 clarifies that when there has been a
significant decrease in the volume and level of activity for the asset or
liability, some transactions may not be orderly, and Union National must
evaluate the weight of evidence to determine whether the transactions are
orderly. It provides a list of circumstances that may indicate that a
transaction is not orderly. A transaction price that is not associated with an
orderly transaction is given little, if any, weight when estimating fair
value.
 A
description of the valuation methodologies used for instruments measured at fair
value, as well as the general classification of such instruments pursuant to the
valuation hierarchy, is set forth below.  The valuation methodologies
were applied to all of Union National’s financial assets and financial
liabilities carried at fair value, effective January 1, 2008.  In
addition, Union National adopted fair value measurement and disclosure guidance
for non-financial assets and non-financial liabilities on January 1,
2009.
 
 Securities Available for
Sale
 Equity
securities, comprised mostly of bank stocks, traded on a national securities
exchange are reported at fair value using the Level 1 valuation hierarchy
because these securities tend to trade frequently, and quoted prices are
considered active.  Other equity securities, comprised mostly of bank
stocks, traded on the OTC Bulletin Board (“OTCBB”) or privately are reported at
fair value using the Level 2 valuation hierarchy because these securities tend
to trade infrequently, and quoted prices are not considered
active.  Debt securities classified as available for sale are
generally reported at fair value utilizing Level 2 inputs.  For these
securities, Union National obtained fair value measurements from an independent
pricing service.  The fair value measurements consider observable data
that may include dealer quotes, market spreads, cash flows, the U.S. Treasury
yield curve, live trading levels, trade execution data, market consensus
prepayment speeds, credit information and the bond’s terms and conditions, among
other things.
 
 Level 3
inputs are for certain corporate investment security positions that are not
traded in active markets or are subject to transfer restrictions, and/or where
valuations are adjusted to reflect illiquidity and/or
non-transferability.  Such adjustments are generally based on
available market evidence.  In the absence of such evidence,
management’s best estimate is used.  Management’s best estimate
consists of both internal and external support on certain Level 3
investments.  Management only changes Level 3 inputs and assumptions
when corroborated by evidence such as transactions in similar instruments,
completed or pending third-party transactions in the underlying investment or
comparable entities, subsequent transactions or rounds of financing,
recapitalizations and other transactions across the capital structure, offerings
in the equity or debt markets, and changes in financial ratios or cash
flows.  As of December 31, 2009, the fair value of securities valued
using Level 3 inputs was determined by management by calculating the net present
value of the expected future cash flows of each security, with qualitative
risk-adjusted discounting for potential credit risks and nonperformance in the
underlying issuers, and market sector illiquidity concerns.
  41
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  The
following tables present available-for-sale investment securities measured at
fair value on a recurring basis as of December 31, 2009 and 2008, segregated by
the level of the valuation inputs within the hierarchy utilized to measure fair
value (in thousands):
 At December 31, 2009Level 1
                    
                    
                    Level 2
                    
                    
                    Level 3
                    
                    
                    TotalU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    –
                    
                    
                    $
                    53,394
                    
                    
                    $
                    –
                    
                    
                    $
                    53,394Private
      Issuer Mortgage-Backed Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    2,638
                    
                    
                    
                    2,638Obligations
      of State and Political Subdivisions
                    
                    
                    –
                    
                    
                    
                    3,815
                    
                    
                    
                    –
                    
                    
                    
                    3,815Corporate
      Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    631
                    
                    
                    
                    631Equity
      Securities
                    
                    
                    13
                    
                    
                    
                    55
                    
                    
                    
                    –
                    
                    
                    
                    68Total
      Investment Securities
                    
                    $
                    13
                    
                    
                    $
                    57,264
                    
                    
                    $
                    3,269
                    
                    
                    $
                    60,546
 
 At December 31, 2008Level 1
                    
                    
                    Level 2
                    
                    
                    Level 3
                    
                    
                    TotalU.S.
      Agency Mortgage-Backed Securities
                    
                    $
                    –
                    
                    
                    $
                    56,250
                    
                    
                    $
                    –
                    
                    
                    $
                    56,250Private
      Issuer Mortgage-Backed Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    3,219
                    
                    
                    
                    3,219Obligations
      of U.S. Government Agencies
                    
                    
                    –
                    
                    
                    
                    3,396
                    
                    
                    
                    –
                    
                    
                    
                    3,396Corporate
      Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    1,218
                    
                    
                    
                    1,218Equity
      Securities
                    
                    
                    74
                    
                    
                    
                    132
                    
                    
                    
                    –
                    
                    
                    
                    206Total
      Investment Securities
                    
                    $
                    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, 2009
                    
                    $
                    4,437Payments
      received (applied to principal), net of accretion
                    
                    
                    (733
                    )Total
      realized and unrealized gainsIncluded
      in net income (loss)
                    
                    
                    (1,504
                    )Included
      in other comprehensive income (loss)
                    
                    
                    1,069Ending
      Balance at December 31, 2009
                    
                    $
                    3,269
 
 Certain
financial assets and financial liabilities are measured at fair value on a
nonrecurring basis; that is, the instruments are not measured at fair value on
an ongoing basis, but are subject to fair value adjustments in certain
circumstances (for example, when there is evidence of impairment).
 
 Impaired
Loans.Certain impaired loans
are reported at the fair value of the underlying collateral if repayment is
expected solely from the collateral.  Collateral values are estimated
using Level 3 inputs based upon customized discounting criteria. The valuation
allowance (allowance for credit losses) associated with impaired loans was
$1,458,000 and $1,499,000 at December 31, 2009 and 2008,
respectively.
 
 The
balance of loans and leases that were considered to be impaired under GAAP was
$8,715,000 and $9,360,000, which consisted of ten and sixteen loan and lease
relationships to unrelated borrowers, at December 31, 2009 and 2008,
respectively. At December 31, 2009, four of the relationships represented 90% of
the total impaired loans and leases of $8,715,000.  The decrease in
impaired loans and leases during 2009 was primarily the result of loan pay-offs
through the loan workout process as well as charge-offs during the
year.  Management continues to diligently monitor and evaluate the
existing portfolio, and identify credit concerns and risks, including those
resulting from the current weak economy.The
measure of impairment is based primarily on the fair value of collateral
securing these loans, which is primarily real estate and
equipment.
  42
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
 
 Impaired Loans With a
Related Allowance.  Union National had $5,916,000 and
$5,058,000 of impaired loans and leases with a related allowance for credit
losses at December 31, 2009 and 2008, respectively.  These consisted
of five and eight loan and lease relationships to unrelated borrowers, with a
related allowance for credit losses of $1,458,000 and $1,499,000 at December 31,
2009 and 2008, respectively.  This group of impaired loans and leases
has a related allowance due to the probability of the borrower not being able to
continue to make principal and interest payments due under the contractual terms
of the loan or lease.  These loans and leases appear to have
insufficient collateral and Union National’s principal may be at risk; as a
result, a related allowance is necessary to cover future potential
losses.
 
 Repossessed
Assets.Assets included
in repossessed assets are reported at fair value on a non-recurring
basis.  Values are estimated using Level 3 inputs, based on appraisals
that consider the sales prices of similar assets.
 
 Other
Real Estate Owned.Assets included
in other real estate owned are reported at fair value on a non-recurring
basis.  Values are estimated using Level 3 inputs, based on appraisals
that consider the sales prices of properties in the proximate vicinity, and
estimated liquidation costs.
 
 The
following table summarizes financial assets and financial liabilities measured
at fair value on a nonrecurring basis as of December 31, 2009 and 2008,
segregated by the level of the valuation inputs within the fair value hierarchy
utilized to measure fair value (in thousands):
 
 December 31, 2009Assets:
                    
                    Level 1
                      Inputs
                    
                    
                    Level 2
                      Inputs
                    
                    
                    Level 3
                      Inputs
                    
                    
                    Total Fair
                      ValueImpaired
      Loans
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    4,458
                    
                    
                    $
                    4,458Repossessed
      Assets
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    436
                    
                    
                    
                    436Other
      Real Estate Owned
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    5,383
                    
                    
                    
                    5,383Total
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    10,277
                    
                    
                    $
                    10,277
 
 December 31, 2008Assets:
                    
                    Level 1
                      Inputs
                    
                    
                    Level 2
                      Inputs
                    
                    
                    Level 3
                      Inputs
                    
                    
                    Total Fair
                      ValueImpaired
      Loans
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    3,559
                    
                    
                    $
                    3,559Repossessed
      Assets
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    479
                    
                    
                    
                    479Other
      Real Estate Owned
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –Total
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    4,038
                    
                    
                    $
                    4,038
  43
  NOTES TO
      CONSOLIDATED FINANCIAL STATEMENTScontinued
  The
estimated fair values of financial instruments as of December 31, 2009 and 2008
are set forth in the table below (in thousands).  The information in
the table should not be interpreted as an estimate of the fair value of Union
National in its entirety since a fair value calculation is only provided for a
limited portion of Union National’s assets and liabilities.  Due to a
wide range of valuation techniques and the degree of subjectivity used in making
the estimates, comparisons between Union National’s disclosures and those of
other companies may not be meaningful.
 
 December 31, 2009
                    
                    
                    December 31, 2008Carrying
                      Amount
                    
                    
                    Fair
                      Value
                    
                    
                    Carrying
                      Amount
                    
                    
                    Fair
                      ValueAssets:Cash
      and Cash Equivalents
                    
                    $
                    43,340
                    
                    
                    $
                    43,340
                    
                    
                    $
                    31,837
                    
                    
                    $
                    31,837Interest-Bearing
      Time Deposits in Other Banks
                    
                    
                    9,229
                    
                    
                    
                    9,252
                    
                    
                    
                    1,775
                    
                    
                    
                    1,838Investment
      Securities Available for Sale
                    
                    
                    60,546
                    
                    
                    
                    60,546
                    
                    
                    
                    64,289
                    
                    
                    
                    64,289Loans
      and Leases, Net
                    
                    
                    333,416
                    
                    
                    
                    317,459
                    
                    
                    
                    353,922
                    
                    
                    
                    354,195Restricted
      Investment in Bank Stocks
                    
                    
                    3,727
                    
                    
                    
                    3,727
                    
                    
                    
                    3,703
                    
                    
                    
                    3,703Accrued
      Interest Receivable
                    
                    
                    1,569
                    
                    
                    
                    1,569
                    
                    
                    
                    1,624
                    
                    
                    
                    1,624Mortgage
      Servicing Assets and Credit Enhancement Fees Receivable
                    
                    
                    48
                    
                    
                    
                    267
                    
                    
                    
                    86
                    
                    
                    
                    285Liabilities:Demand
      and Savings Deposits
                    
                    
                    212,457
                    
                    
                    
                    212,457
                    
                    
                    
                    189,724
                    
                    
                    
                    189,724Time
      Deposits
                    
                    
                    192,308
                    
                    
                    
                    194,218
                    
                    
                    
                    193,853
                    
                    
                    
                    195,611Long-Term
      Debt
                    
                    
                    33,334
                    
                    
                    
                    34,798
                    
                    
                    
                    50,334
                    
                    
                    
                    52,976Junior
      Subordinated Debentures
                    
                    
                    17,341
                    
                    
                    
                    17,017
                    
                    
                    
                    17,341
                    
                    
                    
                    19,182Accrued
      Interest Payable
                    
                    
                    938
                    
                    
                    
                    938
                    
                    
                    
                    1,422
                    
                    
                    
                    1,422Off-balance-sheet
      Items:Commitments
      to Extend Credit and Standby Letters of Credit
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
 
 The
following methods and assumptions were used by Union National to estimate the
fair value of its financial instruments at December 31, 2009 and
2008:
 
 Cash and
cash equivalents:
The carrying amounts of cash and short-term investments (U.S. Treasury Bills
with a maturity of less than 60 days) approximate their fair
values.
 
 Interest-bearing
time deposits in other banks:The carrying amounts of
interest-bearing time deposits in other banks approximate their fair
values.  The Bank generally purchases amounts below the insured limit,
limiting the amount of credit risk on these time deposits.
 
 Investment
securities: The
carrying values of securities available for sale (carried at fair value) are
determined by obtaining quoted market prices on nationally recognized securities
exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical
technique used widely in the industry to value debt securities without relying
exclusively on quoted market prices for the specific securities but rather by
relying on the securities’ relationship to other benchmark quoted
prices.  For certain securities which are not traded in active markets
or are subject to transfer restrictions, valuations are adjusted to reflect
illiquidity and/or non-transferability, and such adjustments are generally based
on available market evidence (Level 3).  In the absence of such
evidence, management’s best estimate is used.  Management’s best
estimate consists of both internal and external support on certain Level 3
investments.  Internal cash flow models using a present value formula
that includes assumptions market participants would use along with indicative
exit pricing obtained from broker/dealers (where available) were used to support
fair values of certain Level 3 investments.
  44


NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued


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





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





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





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





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





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





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





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





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


45




NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued




NOTE 21 ─ UNION NATIONAL FINANCIAL
CORPORATION (PARENT COMPANY ONLY)





Condensed
Statements of Financial Condition


(in
thousands)





December 31,2009
                
                
                2008AssetsCash
      in Bank Subsidiary
                
                $
                505
                
                
                $
                50Interest-Bearing
      Deposits in Other Banks
                
                
                2
                
                
                
                3Cash
      and Cash Equivalents
                
                
                507
                
                
                
                53Investment
      in Subsidiaries
                
                
                41,063
                
                
                
                41,003Other
      Equity Investment Securities
                
                
                68
                
                
                
                206Investments
      in Limited Partnerships
                
                
                109
                
                
                
                196Other
      Assets
                
                
                1,313
                
                
                
                1,338Total
      Assets
                
                $
                43,060
                
                
                $
                42,796LiabilitiesJunior
      Subordinated Debentures
                
                $
                11,341
                
                
                $
                11,341Other
      Liabilities
                
                
                383
                
                
                
                661Stockholders’
      Equity
                
                
                31,336
                
                
                
                30,794Total
      Liabilities and Stockholders’ Equity
                
                $
                43,060
                
                
                $
                42,796





Condensed
Statements of Operations


(in
thousands)





Years Ended December 31,2009
                    
                    
                    2008
                    
                    
                    2007IncomeDividends
      from Subsidiaries
                    
                    $
                    409
                    
                    
                    $
                    537
                    
                    
                    $
                    843Dividends
      on Other Equity Investment Securities
                    
                    
                    3
                    
                    
                    
                    10
                    
                    
                    
                    16Interest
      on Deposits in Bank Subsidiary
                    
                    
                    1
                    
                    
                    
                    1
                    
                    
                    
                    1(Loss)
      Gain on Sale of Securities
                    
                    
                    (38
                    )
                    
                    
                    49
                    
                    
                    
                    40Management
      Fees from Bank Subsidiary
                    
                    
                    42
                    
                    
                    
                    42
                    
                    
                    
                    42Other
      Income – Insurance Settlement
                    
                    
                    279
                    
                    
                    ─
                    
                    
                    ─Total
      Income
                    
                    
                    696
                    
                    
                    
                    639
                    
                    
                    
                    942ExpenseInterest
      Expense on Junior Subordinated Debentures
                    
                    
                    408
                    
                    
                    
                    673
                    
                    
                    
                    843Other
      Expenses
                    
                    
                    609
                    
                    
                    
                    248
                    
                    
                    
                    269Total
      Expenses
                    
                    
                    1,017
                    
                    
                    
                    921
                    
                    
                    
                    1,112Loss
      before Income Tax Benefit and Equity inUndistributed
      (Loss) Income of Subsidiary
                    
                    
                    (321
                    )
                    
                    
                    (282
                    )
                    
                    
                    (170
                    )Benefit
      from Income Taxes
                    
                    
                    (245
                    )
                    
                    
                    (274
                    )
                    
                    
                    (377
                    )(Loss)
      Income before Equity in Undistributed
                      (Loss)
      Income of Subsidiary
                    
                    
                    (76
                    )
                    
                    
                    (8
                    )
                    
                    
                    207Equity
      in Undistributed (Loss) Income of Subsidiary
                    
                    
                    (639
                    )
                    
                    
                    452
                    
                    
                    
                    105Net
      (Loss) Income
                    
                    $
                    (715
                    )
                    
                    $
                    444
                    
                    
                    $
                    312




46


NOTES TO CONSOLIDATED
      FINANCIAL STATEMENTS   continued




Condensed
Statements of Cash Flows


(in
thousands)





Years Ended December 31,2009
                
                
                2008
                
                
                2007Cash
      Flows from Operating ActivitiesNet
      (Loss) Income
                
                $
                (715
                )
                
                $
                444
                
                
                $
                312Adjustments
      to Reconcile Net Income to Net CashUsed
      in Operating Activities:Equity
      In Undistributed Loss (Income) of Bank Subsidiary
                
                
                639
                
                
                
                (452
                )
                
                
                (105
                )Investment
      Securities Losses (Gains)
                
                
                38
                
                
                
                (49
                )
                
                
                (40
                )Deferred
      Income Taxes (Benefit)
                
                
                13
                
                
                
                (274
                )
                
                
                (8
                )Decrease
      (Increase) in Other Assets
                
                
                93
                
                
                
                138
                
                
                
                (21
                )Decrease
      in Other Liabilities
                
                
                (278
                )
                
                
                (40
                )
                
                
                (240
                )Stock-Based
      Compensation Expense
                
                ─
                
                
                ─
                
                
                
                82Net
      Cash Used in Operating Activities
                
                
                (210
                )
                
                
                (233
                )
                
                
                (20
                )Cash
      Flows from Investing ActivitiesProceeds
      from Sales of Available for Sale Securities
                
                
                120
                
                
                
                180
                
                
                
                49Investment
      in Subsidiaries
                
                
                (742
                )
                
                
                (1,585
                )
                
                ─Net
      Cash (Used in) Provided by Investing Activities
                
                
                (622
                )
                
                
                (1,405
                )
                
                
                49Cash
      Flows from Financing ActivitiesIssuance
      of Common Stock, Net of Costs
                
                
                68
                
                
                
                1,599
                
                
                
                319Issuance
      of Preferred Stock, Net of Costs
                
                
                1,218
                
                
                ─
                
                
                ─Cash
      Dividends Paid
                
                ─
                
                
                ─
                
                
                
                (709
                )Acquisition
      of Treasury Stock
                
                ─
                
                
                ─
                
                
                
                (6
                )Net
      Cash Provided by (Used in) Financing Activities
                
                
                1,286
                
                
                
                1,599
                
                
                
                (396
                )Net
      Increase (Decrease) in Cash and Cash Equivalents
                
                
                454
                
                
                
                (39
                )
                
                
                (367
                )Cash
      and Cash Equivalents at Beginning Of Period
                
                
                53
                
                
                
                92
                
                
                
                459Cash
      and Cash Equivalents at End Of Period
                
                $
                507
                
                
                $
                53
                
                
                $
                92


47




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




The
management of Union National Financial Corporation (“Union National”) 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.  Union National’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 Union National’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,
2009.  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, Union National followed the standards of the
Public Company Accounting Oversight Board (United States).





Management
has disclosed to Union National’s auditors and Union National’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 Union National’s ability to record, process, summarize and
report financial information.





Based on
its assessment, Union National’s management has concluded that, as of December
31, 2009, Union National’s internal control over financial reporting is
effective.





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





Mark
      D. Gainer
            Michael
      D. PeduzziChairman,
      Chief Executive Officer and President
            Treasurer
      and Chief Financial OfficerDate:  March
      29, 2010
            Date:
      March 29, 2010




48


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, 2009 and 2008,
and the related consolidated statements of operations, changes in stockholders’
equity, and cash flows for each of the years in the three-year period ended
December 31, 2009. 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, 2009 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, 2009 and 2008, and the results of their operations and their
cash flows for each of the years in the three-year period ended December 31,
2009 in conformity with accounting principles generally accepted in the United
States of America.




As discussed in Note 3 to the
consolidated financial statements, the Corporation changed its method of
accounting for other-than-temporary impairment in 2009.








ParenteBeard
LLC


Lancaster,
Pennsylvania


March 30,
2010


49






MANAGEMENT’S
      DISCUSSION AND ANALYSIS


OVERVIEW


Management’s
discussion and analysis represents an overview of the financial condition and
results of operations, and highlights the significant changes in the financial
condition and results of operations, as presented in the accompanying
consolidated financial statements for Union National Financial Corporation
(“Union National”), a bank holding company, and its wholly-owned subsidiary,
Union National Community Bank (the “Bank”).  Union National’s
consolidated financial condition and results of operations consist primarily of
the Bank’s financial condition and results of operations. Union National’s trust
subsidiaries, Union National Capital Trust I (“UNCT I”) and Union National
Capital Trust II (“UNCT 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 (for
additional information, refer to Note 16 ─ Residential Mortgage
Business Venture to the consolidated financial statements).





FORWARD
LOOKING STATEMENTS


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





Stockholders
should note that many factors, some of which are discussed above and elsewhere
in this Annual Report for the year ended December 31, 2009, and those discussed
in the Forms 10-Q and 8-K that were filed during 2009, and in the documents that
are incorporated by reference, could affect the future financial results of
Union National or the Bank and could cause those results to differ materially
from those expressed in the forward-looking statements contained or incorporated
by reference in this document.  Union National undertakes no
obligation to publicly revise or update these forward-looking statements to
reflect events or circumstances that arise after the date of this
report.  Readers should carefully review the risk factors described in
the Annual Report and other documents that we periodically file with the
Securities and Exchange Commission, including our Form 10-K for the year ended
December 31, 2009.


50






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





Determination
of the Allowance for Credit Losses


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





Fair
Value of Investment Securities


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


51






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


FINANCIAL
CONDITION


Total
assets increased by $4,535,000 or 1% to $489,644,000 at December 31, 2009 from
$485,109,000 at December 31, 2008. The increase was primarily the result of
strong retail deposit generation, which further strengthened Union National’s
liquidity position. The proceeds received from the deposit growth were used to
pay down high cost long-term debt and to purchase short-term
investments.  Total deposits grew by $21,188,000 or 6% to $404,765,000
at December 31, 2009 from $383,577,000 at December 31, 2008.





Investment
Securities


Investment
securities were $60,546,000 at December 31, 2009 as compared to $64,289,000 at
December 31, 2008.  All of Union National’s investment securities were
classified as available for sale at December 31, 2009 and
2008.  Investment securities classified as available for sale are
marketable equity securities, and those debt securities that we intend to hold
for an undefined period of time, but not necessarily to maturity.  In
addition to the investment portfolio generating interest income, it serves other
primary financial management functions such as an ultimate source of liquidity
and a tool to manage interest rate risk.  In order to support these
functions, the entire investment securities portfolio has been designated as
being available for sale.  Any decision to sell an available-for-sale
investment security would be based on various factors, including significant
movements in interest rates, changes in maturity mix of assets and liabilities,
liquidity needs, regulatory capital considerations, changes in the
creditworthiness of the issuing entity, changes in investment strategy and
portfolio mix, and other similar factors. Changes in unrealized gains or losses
on available-for-sale investment securities, net of taxes, are recorded as other
comprehensive (loss) income, a component of stockholders’ equity.





At
December 31, 2009, there were no significant concentrations of investments
(greater than 10% of stockholders’ equity) in any individual investment security
issue.  The investment securities portfolio included $53,394,000 or
88% of U.S. agency mortgage-backed securities at December 31, 2009.





The
following is a summary of available-for-sale investment securities recorded at
fair value as of December 31, 2009, 2008 and 2007 (in thousands):





At December 31,2009
                  
                  
                  2008
                  
                  
                  2007U.S.
      Agency Mortgage-Backed Securities
                  
                  $
                  53,394
                  
                  
                  $
                  56,250
                  
                  
                  $
                  19,572Private
      Issuer Mortgage-Backed Securities
                  
                  
                  2,638
                  
                  
                  
                  3,219
                  
                  
                  
                  6,658Obligations
      of U.S. Government Agencies
                  
                  ─
                  
                  
                  
                  3,396
                  
                  
                  
                  43,086Obligations
      of State and Political Subdivisions
                  
                  
                  3,815
                  
                  
                  ─
                  
                  
                  ─Corporate
      Debt Securities
                  
                  
                  631
                  
                  
                  
                  1,218
                  
                  
                  
                  4,413Equity
      Securities
                  
                  
                  68
                  
                  
                  
                  206
                  
                  
                  
                  447Total
                  
                  $
                  60,546
                  
                  
                  $
                  64,289
                  
                  
                  $
                  74,176


52






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


The
following table presents the stated maturities of investment securities at fair
value and the weighted-average yields as of December 31, 2009.  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
                    
                    
                    YieldU.S.
      Agency Mortgage-Backed  Securities (1)
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    53,394
                    
                    
                    $
                    –
                    
                    
                    $
                    53,394
                    
                    
                    
                    4.31
                    %Private
      Issuer Mortgage-Backed Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    2,638
                    
                    
                    
                    –
                    
                    
                    
                    2,638
                    
                    
                    
                    –Obligations
      of State and Political Subdivisions
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    3,815
                    
                    
                    
                    –
                    
                    
                    
                    3,815
                    
                    
                    
                    5.89Corporate
      Debt Securities
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    631
                    
                    
                    
                    –
                    
                    
                    
                    631
                    
                    
                    
                    –Equity
      Securities (2)
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    68
                    
                    
                    
                    68
                    
                    
                    
                    2.67Total
      Securities
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    –
                    
                    
                    $
                    60,478
                    
                    
                    $
                    68
                    
                    
                    $
                    60,546
                    
                    
                    
                    4.18
                    %Yield
                    
                    
                    –
                    %
                    
                    
                    –
                    %
                    
                    
                    –
                    %
                    
                    
                    4.18
                    %
                    
                    
                    2.67
                    %
      (2)
                    
                    
                    4.18
                    %





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





(2)  The yield on the equity securities
assumes the same dividend payout ratio as in 2009.





The
realized rate of return on average investment securities, including net
investment securities gains (losses) and OTTI charges was 3.39% and 3.12% for
the years ended December 31, 2009 and 2008, respectively.  The
following table presents the realized rate of return on average investment
securities by investment category for the years ended December 31, 2009 and 2008
(dollars in thousands).





Year Ended December 31, 2009Average
                  Balance
                
                
                Tax-Equivalent
                  Interest
                  and
                  Dividends
                
                
                Net
                  Realized
                  Gain on
                  Sale
                
                
                OTTI
                  Charge
                
                
                Total
                  Return
                
                
                YieldU.S.
      Agency and Treasury Holdings
                
                $
                58,661
                
                
                $
                1,551
                
                
                $
                1,749
                
                
                $
                –
                
                
                $
                3,300
                
                
                
                5.63
                %Private
      Issuer MBS and Corporate Securities
                
                
                3,834
                
                
                
                131
                
                
                
                –
                
                
                
                (1,504
                )
                
                
                (1,373
                )
                
                
                (35.81
                )All
      Other Securities
                
                
                5,766
                
                
                
                294
                
                
                
                92
                
                
                
                –
                
                
                
                386
                
                
                
                6.69Total
                
                $
                68,261
                
                
                $
                1,976
                
                
                $
                1,841
                
                
                $
                (1,504
                )
                
                $
                2,313
                
                
                
                3.39
                %





Year Ended December 31, 2008Average
                  Balance
                
                
                Tax-Equivalent
                  Interest
                  and
                  Dividends
                
                
                Net
                  Realized
                  Gain (Loss)
                  on Sale
                
                
                OTTI
                  Charge
                
                
                Total
                  Return
                
                
                YieldU.S.
      Agency and Treasury Holdings
                
                $
                62,675
                
                
                $
                2,904
                
                
                $
                256
                
                
                $
                –
                
                
                $
                3,160
                
                
                
                5.04
                %Private
      Issuer MBS and Corporate Securities
                
                
                6,627
                
                
                
                305
                
                
                
                (52
                )
                
                
                (1,290
                )
                
                
                (1,037
                )
                
                
                (15.65
                )All
      Other Securities
                
                
                316
                
                
                
                –
                
                
                
                48
                
                
                
                –
                
                
                
                48
                
                
                
                15.19Total
                
                $
                69,618
                
                
                $
                3,209
                
                
                $
                252
                
                
                $
                (1,290
                )
                
                $
                2,171
                
                
                
                3.12
                %




53






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


The total
expected cash flows from investment securities, including estimated prepayments
and expected call options, is $8,349,000 for 2010, which represents
approximately 14% of the investment securities portfolio as of December 31,
2009.  The estimated amount of expected cash flows from investment
securities will vary significantly with changes in market interest rates. 
For example, an increase in interest rates will decrease the level of
prepayments received on mortgage-backed securities.  The factors affecting
the investment securities portfolio are included in our net interest income
simulation model, which is discussed in the section “MARKET RISK – INTEREST RATE
RISK” on page 80.





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





Investment
security purchases and sales generally occur to manage the Bank’s liquidity
requirements, pledging requirements, interest rate risk, and to enhance net
interest margin.  The investment securities portfolio is evaluated
regularly for possible opportunities to increase earnings through potential
sales or portfolio repositioning.  In 2009, proceeds of $197,637,000
were received on sales, and $1,841,000 was recognized in net gains, while
$233,313,000 of investment securities were purchased during the
year.  Investment securities of $57,209,000 and $59,646,000 were
pledged to secure public, trust, and government deposits and for other purposes
at December 31, 2009 and 2008, respectively.





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





As of
December 31, 2009 and 2008, investment securities consisted of the following (in
thousands):





December 31,2009
                  
                  
                  2008Market
      Value of Debt Securities
                  
                  $
                  60,478
                  
                  
                  $
                  64,083Market
      Value of Equity Securities
                  
                  
                  68
                  
                  
                  
                  206Total
      Market Value of Investment Securities
                  
                  $
                  60,546
                  
                  
                  $
                  64,289





Debt
securities include mortgage-backed securities, obligations of state and
political subdivisions, obligations of U.S. Government agencies and corporate
securities.  At December 31, 2009, there were twenty-seven debt
securities with unrealized losses of $585,000 that amounted to 1.3% of their
amortized cost, as compared to December 31, 2008, when there were twenty-three
debt securities with unrealized losses of $607,000 that amounted to 3.2% of
their amortized cost.  Management believes that the unrealized losses
reflect temporary declines primarily due to changes in interest rates subsequent
to the acquisition of specific securities.  These temporary declines
have been provided for in other comprehensive (loss) income.





Equity
securities held are comprised primarily of common stock holdings in other
financial institutions.  The market values include net unrealized
losses of $11,000 at December 31, 2009, as compared to net unrealized losses of
$63,000 at December 31, 2008.  In 2009, proceeds of $119,000 were
received on equity sales, and $38,000 was recognized in net losses.





54




MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


As of
December 31, 2009, $13,000 of the fair value of the total investment securities
portfolio was measured using Level 1 inputs as defined by fair value measurement
and disclosure guidance, $57,264,000 or 95% of the fair value of total
investment securities was measured using Level 2 inputs, and $3,269,000 or 5% of
the fair value of total investment securities was measured using Level 3 inputs
(for additional information, refer to Note 20 – Fair Value Measurement of
Assets and Liabilities and Fair Value of Financial Instruments to the
consolidated financial statements).





The fair
value of Level 3 investment securities decreased to $3,269,000 at December 31,
2009, as compared to $4,437,000 at December 31, 2008. Of the decrease in value,
$1,504,000 was related to impairment charges that were included in the
Consolidated Statements of Operations and $733,000 was related to principal and
interest payments received (net of accretion) and fully applied to principal,
offset by $1,069,000 of net unrealized gains (with a corresponding after-tax
increase to stockholders’ equity of $706,000 recorded as other comprehensive
income).





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





As of
December 31, 2009, Union National maintains five investment securities with
recorded impairments.  The fair value of the five impaired investments
was $3,269,000 as of December 31, 2009, as compared to an original amortized
cost of $8,950,000. All principal and interest payments received on impaired
investment securities are fully applied to principal.





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





55






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


As
discussed in Note 20 – Fair
Value Measurement of Assets and Liabilities and Fair Value of Financial
Instruments to the consolidated financial statements, the fair value of
debt investment securities was determined by calculating the net present value
of the expected future cash flows of each security, with qualitative
risk-adjusted discounting for potential credit risks and nonperformance in the
underlying issuers, and market sector illiquidity concerns.  Under ASC
Topic 320, “Investments – Debt and Equity Securities” when an active market for
a security does not exist, the use of management estimates that incorporate
current market participant expectations of future cash flows, and include
appropriate risk premiums, is acceptable.  Management’s judgment was
that, as of December 31, 2009, the facts and circumstances indicated significant
illiquidity and an inactive market for these types of investments when other
relevant observable inputs were not available; therefore, expected cash flows
were a reasonable basis in determining the fair value of the corporate
investment securities.  Prior to September 30, 2008, management used
other observable inputs to determine the fair value of the corporate investment
securities including broker indicated prices and quoted prices in limited
trading activity of the issuances.





During
2009, four of the Bank’s five private-issuer securities were downgraded to below
investment grade. The fifth private-issuer security was downgraded to
below-investment-grade in December 2008.  Accordingly, the Bank
recorded $1,504,000 of other-than-temporary impairment charges in 2009 including
(i) $859,000 related to three pooled trust-preferred debt securities supported
primarily by obligations from other banks, and (ii) $645,000 related to a
mortgage-backed security not guaranteed by the U.S.
government.  Management determined that, due to severe illiquidity and
distress in the financial markets, the unrealized declines in the value of these
investments were other-than-temporary, requiring the write-down.  For
the securities with impairment charges recorded, interest income payments
received subsequent to impairment are fully applied to principal further
reducing the amortized cost of these investments (for additional information,
refer to Note 3 – Investment
Securities Available for Sale to the consolidated financial
statements.)





Management
determined that further impairments as of December 31, 2009 were not warranted
on these five securities based upon the following considerations:





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


·
            Four
      of the five impaired investment securities were current, as of December
      31, 2009, for scheduled investment interest payments, and principal
      repayments for the two private issuer mortgage-backed securities have
      occurred regularly since issuance.  Based upon the information
      reviewed by management in preparing the financial statements, the
      financial condition and near-term prospects of the issuers do not reflect
      any specific events which may have influenced the operations of the
      issuers, such as changes in technology or a discontinuance of a business
      segment that may have further impaired the earnings potential of the
      investments.


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


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




56






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Loans
and Leases, Credit Quality and Credit Risk


Loans
include leases that meet the criteria for direct financing
leases.  Loans and lease financing receivables may, throughout
Management’s Discussion and Analysis, together be referred to as
“loans.”  Loans and leases were $339,274,000 at December 31, 2009, as
compared to $358,280,000 at December 31, 2008.  Loans and leases
decreased by $19,006,000 from December 31, 2008 to December 31, 2009 due to (i)
reduced loan demand from creditworthy borrowers, and (ii) the impact of nearly
$10 million of loan participations sold for capital and risk management
purposes.





At
December 31, 2009, there were no loan or lease concentrations over 10% of total
gross loans and leases to any one category or borrower.  However,
loans secured by real estate constitute 83% 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.





For the
most recent five years, loans and leases were composed of the following (in
thousands):





December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Real
      Estate Mortgages:First
      and Second Residential
                
                $
                112,535
                
                
                $
                127,636
                
                
                $
                137,724
                
                
                $
                130,395
                
                
                $
                124,344Commercial
      and Industrial
                
                
                120,610
                
                
                
                121,619
                
                
                
                115,630
                
                
                
                105,158
                
                
                
                94,016Construction
      and Land Development
                
                
                21,970
                
                
                
                24,757
                
                
                
                29,427
                
                
                
                23,634
                
                
                
                10,618Agricultural
                
                
                28,099
                
                
                
                27,485
                
                
                
                24,839
                
                
                
                24,133
                
                
                
                23,488Commercial
      and Industrial
                
                
                37,410
                
                
                
                35,061
                
                
                
                28,741
                
                
                
                27,226
                
                
                
                20,291Consumer
      (Net of Unearned Income)
                
                
                5,854
                
                
                
                7,172
                
                
                
                7,832
                
                
                
                7,893
                
                
                
                8,159Agricultural
                
                
                4,464
                
                
                
                3,588
                
                
                
                4,341
                
                
                
                3,733
                
                
                
                3,300Political
      Subdivisions
                
                
                5,764
                
                
                
                6,553
                
                
                
                8,993
                
                
                
                9,803
                
                
                
                11,029Lease
      Financing Receivables (Net of Unearned Income)
                
                
                1,929
                
                
                
                3,792
                
                
                
                6,078
                
                
                
                8,339
                
                
                
                3,707Other
                
                
                639
                
                
                
                617
                
                
                
                732
                
                
                
                799
                
                
                
                1,261Total
      Loans and Leases (Net of Unearned Income)
                
                $
                339,274
                
                
                $
                358,280
                
                
                $
                364,337
                
                
                $
                341,113
                
                
                $
                300,213





Total
loans and leases with variable-rate pricing amounted to $225,434,000 at December
31, 2009, and $235,635,000 at December 31, 2008.  Loan maturities and
interest sensitivity of total loans, excluding residential real estate
mortgages, leases, and consumer loans at December 31, 2009, are as follows (in
thousands):


Years to Maturity *Within
                    1 Year
                  
                  
                  1-5
                    Years
                  
                  
                  Over 5
                    Years
                  
                  
                  TotalCommercial,
      Agricultural and Other
                  
                  $
                  33,040
                  
                  
                  $
                  42,899
                  
                  
                  $
                  121,047
                  
                  
                  $
                  196,986Construction
      and Land Development
                  
                  
                  17,704
                  
                  
                  
                  1,777
                  
                  
                  
                  2,489
                  
                  
                  
                  21,970Total
                  
                  $
                  50,744
                  
                  
                  $
                  44,676
                  
                  
                  $
                  123,536
                  
                  
                  $
                  218,956Fixed
      Rate Loans
                  
                  $
                  5,932
                  
                  
                  $
                  32,957
                  
                  
                  $
                  7,828
                  
                  
                  $
                  46,717Variable
      Rate Loans
                  
                  
                  44,812
                  
                  
                  
                  11,719
                  
                  
                  
                  115,708
                  
                  
                  
                  172,239Total
                  
                  $
                  50,744
                  
                  
                  $
                  44,676
                  
                  
                  $
                  123,536
                  
                  
                  $
                  218,956





* 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.





Management
continues to focus lending on creditworthy consumers and businesses, with
necessary consideration given to increased credit risks posed by the weak
economy and the housing market.  The economy and housing market, and
increased unemployment, has affected some of Union National’s borrowers,
resulting in an increase in nonperforming loans and credit losses.





57






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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





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





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





Union
National continues to closely monitor the loan portfolio, and the underlying
borrower financial performance and collateral values, identifying credit
concerns and risks, including those resulting from the current weak
economy.  Future adjustments may be necessary to the allowance for
credit losses, and consequently the provision for credit losses, if economic
conditions or loan credit quality differ substantially from the assumptions
management used in the evaluation of the level of the allowance as compared to
the balance of outstanding loans and leases.  The allowance for credit
losses was $5,858,000 at December 31, 2009, as compared to $4,358,000 at
December 31, 2008.  The provision for credit losses for the year ended
December 31, 2009, was significantly higher than the provision for credit losses
for the year ended December 31, 2008 (for additional information, refer to the
related discussion on “Provision for Credit Losses” on page 69) given the
increased credit risks in the loan portfolio, including those resulting from the
current weak economy and real estate markets, and due to loan charge-offs being
significantly higher for the year ended December 31, 2009, as compared to the
same period in 2008.  A provision for credit losses of $2,627,000 was
made for 2009.  With the higher provision exceeding net loan
charge-offs of $1,127,000, the allowance for credit losses increased to 1.73% of
loans at December 31, 2009 as compared to 1.22% of loans at December 31,
2008.  Management believes, based on information then currently
available, that the allowance for credit losses as of December 31, 2009 of
$5,858,000 was adequate to meet potential credit losses at that
date.





58






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


The
following table is a five year summary of the changes in the allowance for
credit losses (dollars in thousands):





2009
                      
                      
                      2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005Allowance
      for Credit Losses, Beginning of Year
                      
                      $
                      4,358
                      
                      
                      $
                      3,675
                      
                      
                      $
                      3,070
                      
                      
                      $
                      2,675
                      
                      
                      $
                      2,288Charge-Offs:Real
      Estate
                      
                      
                      (11
                      )
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      (11
                      )
                      
                      
                      (150
                      )Consumer
                      
                      
                      (152
                      )
                      
                      
                      (155
                      )
                      
                      
                      (111
                      )
                      
                      
                      (43
                      )
                      
                      
                      (77
                      )Commercial,
      Industrial and Agricultural (1)
                      
                      
                      (1,026
                      )
                      
                      
                      (209
                      )
                      
                      
                      (526
                      )
                      
                      
                      (285
                      )
                      
                      
                      (100
                      )Total
      Charge-Offs
                      
                      
                      (1,189
                      )
                      
                      
                      (364
                      )
                      
                      
                      (637
                      )
                      
                      
                      (339
                      )
                      
                      
                      (327
                      )Recoveries:Real
      Estate
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      5
                      
                      
                      
                      5Consumer
                      
                      
                      10
                      
                      
                      
                      14
                      
                      
                      
                      3
                      
                      
                      
                      14
                      
                      
                      
                      9Commercial,
      Industrial and Agricultural
                      
                      
                      52
                      
                      
                      
                      6
                      
                      
                      
                      2
                      
                      
                      
                      43
                      
                      
                      
                      19Total
      Recoveries
                      
                      
                      62
                      
                      
                      
                      20
                      
                      
                      
                      5
                      
                      
                      
                      62
                      
                      
                      
                      33Net
      Loans and Leases Charged-Off
                      
                      
                      (1,127
                      )
                      
                      
                      (344
                      )
                      
                      
                      (632
                      )
                      
                      
                      (277
                      )
                      
                      
                      (294
                      )Addition
      to Provision for Credit Losses
                      
                      
                      2,627
                      
                      
                      
                      1,027
                      
                      
                      
                      1,237
                      
                      
                      
                      672
                      
                      
                      
                      681Allowance
      for Credit Losses, End of Year
                      
                      $
                      5,858
                      
                      
                      $
                      4,358
                      
                      
                      $
                      3,675
                      
                      
                      $
                      3,070
                      
                      
                      $
                      2,675Loans
      and Leases – Average
                      
                      $
                      350,307
                      
                      
                      $
                      369,554
                      
                      
                      $
                      357,795
                      
                      
                      $
                      318,251
                      
                      
                      $
                      280,245Gross
      Loans and Leases – Actual
                      
                      $
                      339,274
                      
                      
                      $
                      358,280
                      
                      
                      $
                      364,337
                      
                      
                      $
                      341,113
                      
                      
                      $
                      300,213Ratio
      of Gross Loans and Leases Charged Off to Average Loans and
      Leases
                      
                      
                      0.34
                      %
                      
                      
                      0.10
                      %
                      
                      
                      0.18
                      %
                      
                      
                      0.11
                      %
                      
                      
                      0.12
                      %Ratio
      of Allowance for Credit Losses to Gross Loans and Leases
                      
                      
                      1.73
                      %
                      
                      
                      1.22
                      %
                      
                      
                      1.01
                      %
                      
                      
                      0.90
                      %
                      
                      
                      0.89
                      %





(1)
            Included
      in commercial loans were $93,000, $163,000 and $38,000 of charge-offs in
      direct lease financing receivables in 2009, 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.




59






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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




Allowance
                    Amount
                  
                  
                  Percentage
                    Mix of Total
                    Loans and
                    LeasesDecember
      31, 2009:Commercial,
      Industrial and Agricultural
                  
                  $
                  5,306
                  
                  
                  
                  71
                  %Lease
      Financing Receivables
                  
                  
                  91
                  
                  
                  
                  1Real
      Estate – Residential Mortgages
                  
                  
                  22
                  
                  
                  
                  5Consumer
                  
                  
                  399
                  
                  
                  
                  23Unallocated
                  
                  
                  40
                  
                  
                  
                  –Total
      Allowance for Credit Losses
                  
                  $
                  5,858
                  
                  
                  
                  100
                  %December
      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 Credit 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 Credit 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 Credit 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 Credit Losses
                  
                  $
                  2,675
                  
                  
                  
                  100
                  %





60






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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





The
balance of loans and leases that were considered to be impaired under GAAP was
$8,715,000 and $9,360,000, which consisted of ten and sixteen loan and lease
relationships to unrelated borrowers, at December 31, 2009 and 2008,
respectively.  At December 31, 2009, four of the relationships
represented 90% of the total impaired loans and leases of
$8,715,000.  The decrease in impaired loans and leases during 2009 was
primarily the result of loan pay-offs through the loan workout process as well
as charge-offs during the year.  Management continues to diligently
monitor and evaluate the existing portfolio, and identify credit concerns and
risks, including those resulting from the current weak economy and real estate
market.The
measure of impairment is based primarily on the fair value of collateral
securing these loans, which is primarily real estate and equipment.





Impaired Loans with a
Related Allowance.  Union National had $5,916,000 and
$5,058,000 of impaired loans and leases with a related allowance for credit
losses at December 31, 2009 and 2008, respectively.  These consisted
of five and eight loan and lease relationships to unrelated borrowers, with a
related allowance for credit losses of $1,458,000 and $1,499,000 at December 31,
2009 and 2008, respectively.  This group of impaired loans and leases
has a related allowance due to the probability of the borrower not being able to
continue to make principal and interest payments due under the contractual terms
of the loan or lease.  These loans and leases appear to have
insufficient collateral and Union National’s principal may be at risk; as a
result, a related allowance is necessary to cover future potential
losses.





Impaired Loans without a
Related Allowance.  Union National had $2,799,000 and
$4,302,000 of impaired loans and leases without a related allowance at December
31, 2009 and 2008, respectively.  These consisted of five and eight
loan and lease relationships to unrelated borrowers at December 31, 2009 and
2008, respectively.  This group of impaired loans and leases is
considered impaired due to the likelihood of the borrower not being able to
continue to make principal and interest payments due under the contractual terms
of the loan or lease.  Additionally, these loans and leases appear to
have sufficient collateral and Union National’s principal does not appear to be
at risk; as a result, management believes a related allowance is not
necessary.





Substandard Loans and
Leases.  Under the Bank’s current internal risk rating system,
loans and leases with a rating of “substandard” that were performing, and not
determined to be impaired amounted to $32,410,000 and $7,826,000 at December 31,
2009 and 2008, respectively.  Despite these credits not being
impaired, management believes these substandard credits reflect increased risks
to the loan portfolio, including risks resulting from the current weak economy
and real estate markets, and considered such increased risks in determining the
provision for credit losses (refer to the related discussion on “Provision for Credit
Losses”on page 69).Management continues to
closely monitor the loan portfolio, and the underlying borrower financial
performance and collateral values, identifying credit concerns and risks,
including those resulting from the current weak economy.  Management
considers both impaired and these substandard loans to be potential problem
loans, and believes that the current economic conditions may result in
additional loans being classified or nonperforming throughout 2010.





61






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Non-Performing
Assets.  Nonperforming assets consist of nonperforming loans
and leases, other real estate owned, and repossessed assets.  The
following table provides a five-year summary of nonperforming assets (dollars in
thousands):





December 31,2009
                
                
                2008
                
                
                2007
                
                
                2006
                
                
                2005Nonaccruing
      Loans
                
                $
                8,034
                
                
                $
                3,271
                
                
                $
                2,919
                
                
                $
                2,280
                
                
                $
                1,814Accruing
      Loans – 90 days or more past due
                
                
                506
                
                
                
                1,685
                
                
                
                120
                
                
                
                253
                
                
                
                298Total
      Nonperforming Loans and Leases
                
                
                8,540
                
                
                
                4,956
                
                
                
                3,039
                
                
                
                2,533
                
                
                
                2,112Other
      Real Estate Owned
                
                
                5,383
                
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                –Repossessed
      Assets
                
                
                436
                
                
                
                479
                
                
                
                156
                
                
                
                358
                
                
                
                214Total
      Nonperforming Assets
                
                $
                14,359
                
                
                $
                5,435
                
                
                $
                3,195
                
                
                $
                2,891
                
                
                $
                2,326Gross
      Loans and Leases
                
                $
                339,274
                
                
                $
                358,280
                
                
                $
                364,337
                
                
                $
                341,113
                
                
                $
                300,213Allowance
      for Credit Losses
                
                $
                5,858
                
                
                $
                4,358
                
                
                $
                3,675
                
                
                $
                3,070
                
                
                $
                2,675Nonperforming
      Loans and Leases as a % of Gross Loans and Leases
                
                
                2.5
                %
                
                
                1.4
                %
                
                
                0.8
                %
                
                
                0.7
                %
                
                
                0.7
                %Nonperforming
      Assets as a % of Total Assets
                
                
                2.9
                %
                
                
                1.1
                %
                
                
                0.6
                %
                
                
                0.6
                %
                
                
                0.5
                %Allowance
      for Credit Losses as a % of Nonperforming Loans and Leases
                
                
                69
                %
                
                
                88
                %
                
                
                121
                %
                
                
                121
                %
                
                
                127
                %





Nonperforming
loans and leases consist of loans and leases that are nonaccruing, and those
that are 90 days or more past due.  Nonaccruing loans and leases are
no longer accruing interest income because of apparent financial difficulties of
the borrower.  Interest received on nonaccruing loans and leases is
recorded as income only after the past due principal is brought current and
deemed collectible in full.  If nonaccrual loans and leases had been
current and in accordance with their original terms, gross interest income of
approximately $417,000, $151,000 and $203,000 would have been recorded on such
loans and leases for the years ended December 31, 2009, 2008 and 2007,
respectively.  There was no interest income recognized on nonaccruing
loans and leases for the years ended December 31, 2009, 2008 and 2007. Total
nonperforming loans and leases increased to $8,540,000, or 2.5%, of gross loans
and leases at December 31, 2009, as compared to $4,956,000, or 1.4% of gross
loans and leases, at December 31, 2008.  Management specifically
evaluated the loans and leases that became nonperforming in 2009, and determined
that most were well-secured by collateral, not warranting a proportional
increase to the allowance for credit losses.  Historically, the
percentage of nonperforming loans to gross loans for the five-year period ending
December 31, 2009, was an average of 1.2%.  There were no transactions
deemed to be troubled debt restructurings during 2009.





Other
real estate owned (“OREO”) includes assets acquired through foreclosure, deed
in-lieu of foreclosure, and loans identified as in-substance
foreclosures.  A loan is classified as an in-substance foreclosure,
when effective control of the collateral has been taken prior to completion of
formal foreclosure proceedings.  OREO is held for sale and is recorded
at fair value less estimated costs to sell.  Costs to maintain OREO
and subsequent gains and losses attributable to OREO liquidation are included in
the Consolidated Statements of Operations in other income and other expense as
realized.  No depreciation or amortization expense is
recognized.  At December 31, 2009, Union National had $5,383,000 of
OREO comprised primarily of a facility in Lancaster, PA housing a non-profit
music school.  At December 31, 2008, Union National had no
OREO.





Repossessed
assets consist of (i) vehicles and other equipment acquired from lessees, who
defaulted on their contractual lease obligation, and (ii) mobile homes where the
Bank does not own the real estate.  Union National had repossessed
assets of $436,000 and $479,000 at December 31, 2009 and 2008,
respectively.





62






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Stockholders’
Equity


Stockholders’
equity increased by $542,000 to $31,336,000 at December 31, 2009, as compared to
$30,794,000 at December 31, 2008.  The increase in stockholders’
equity was the result of $1,218,000 of proceeds  received (net of
costs) on a preferred stock private placement offering and $68,000 of proceeds
received through the Dividend Reinvestment Plan (“DRIP”) offset by decreases to
retained earnings resulting from a net loss for the year and a decrease in
accumulated other comprehensive income (loss) for the year.





The ratio
of average stockholders’ equity to average assets, which measures the adequacy
of capital, was 6.29% for 2009 as compared to 6.15% for 2008.  The increase
in this ratio was primarily the result of an increase in stockholders’ equity
resulting from the preferred stock private placement offering.  Union
National did not pay a dividend in 2009 and 2008.  Union National’s
Board of Directors believed it prudent for the Bank to fully maintain its
strong, well-capitalized position in these uncertain economic
times.  Therefore, the decision was made not to pay dividends to
stockholders in 2009 and 2008.





Union
National maintains a DRIP for record holders of common stock to provide a
convenient method of investing cash dividends payable upon their common stock
and to provide participants with the opportunity to make voluntary cash
payments, to purchase additional common stock shares at a 10% discount to the
fair market value of the shares on the effective purchase date as defined by the
DRIP.  In 2009, eligible shareholders made voluntary cash payments
totaling $68,000, which were used to purchase 20,840 common shares.





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





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





As of
December 31, 2009 and 2008, Union National and the Bank exceeded the current
regulatory requirements to be considered a quantitatively “well capitalized”
financial institution, i.e. a leverage ratio exceeding 5%, Tier 1 risk-based
capital exceeding 6%, and total risk-based capital exceeding 10%.





In
addition to the above requirements, effective September 30, 2009, the OCC
established individual minimum capital requirements for the Bank (for additional
information, refer to Note 18
– Enforcement Actions with Bank Regulatory Agencies). The specific
capital requirements established for the Bank were 8% for Tier 1 capital to
average total assets, 9.5% for Tier 1 capital to risk-based assets, and 12% for
total capital to risk-based assets.  At December 31, 2009, the Bank’s
measure of Tier I capital to average Total assets was 8.31%, Tier 1 capital to
risk-based assets of 9.69% and total capital to risk-based assets of
12.37%.  At December 31, 2009, all three ratios exceeded the
respective individual minimum capital requirements established by the
OCC.





63






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Included
in Tier 1 capital of Union National is $10,510,000 of trust capital securities
issued through the UNCT I and UNCT II subsidiaries of Union
National.  The balance of these trust capital securities, $490,000, is
included in Tier 2 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.





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





Restrictions.  Banking
regulations limit the amount of investments, loans, extensions of credit and
advances the Bank can make to Union National at any time to 10% of the Bank’s
total regulatory capital.  At December 31, 2009, this limitation
amounted to approximately $5,219,000. These regulations also require any such
investment, loan, extension of credit or advance to be secured by securities
having a market value in excess of the amount thereof.





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





Additionally,
on January 28, 2010, Union National entered into an informal Memorandum of
Understanding with the Federal Reserve Bank (“FRB”) of
Philadelphia.  The Memorandum of Understanding, which is not a
“written agreement” for purposes of Section 8 of the Federal Deposit Insurance
Act, requires, among other things, Union National to seek prior approval by the
FRB before Union National (i) declares or pays dividends to shareholders, (ii)
distributes interest, principal or other sums on UNCT I and UNCT II junior
subordinated debentures, and (iii) incurs, increases or guarantees any
additional debt.  Subsequent to December 31, 2009, the FRB did approve
the quarterly interest payments for the first quarter of 2010 on the UNCT I and
UNCT II junior subordinated debentures and the preferred stock dividend
payments.





64






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


RESULTS
OF OPERATIONS





Summary
of Performance - 2009 Compared to 2008





Overview


Union
National reported a net loss of ($715,000) for the year ended December 31, 2009,
as compared to net income of $444,000 for the year ended December 31,
2008.  Basic and diluted losses per share for 2009 were ($0.26), as
compared to basic and diluted earnings per common share of $0.17 for 2008. 
Operating results for 2009 were significantly reduced by (i) certain non-routine
expenses, (ii) net interest margin compression, and (iii) an increased provision
for credit losses, which are discussed in more detail below.





(i)
            Non-routine
      expenses for the year ended December 31, 2009, included $237,000 related
      to the FDIC’s special assessment on deposit-insured institutions, $536,000
      of penalties on the prepayment of FHLB debt, and $1,504,000 of OTTI
      charges primarily related to private-issuer mortgage-backed securities and
      pooled trust-preferred debt securities that were downgraded to
      below-investment-grade.  The OTTI charges were more than offset
      by $1,841,000 of net realized gains on the sale of primarily U.S.
      Government guaranteed securities that had temporarily appreciated at
      certain periods during 2009.





(ii)
            Reduced
      earning asset yields in the low interest rate environment, while borrowing
      costs remained at higher fixed rates, resulted in a lower net interest
      margin in 2009 versus 2008.  The variable rate structure of many of
      the Union National’s loans reduced overall yield due to the persistent low
      market interest rates.  As a result, interest and fees on loans
      and leases declined by 12% when comparing the year ended December 31, 2009
      to the same period in 2008.  A decrease in loans outstanding
      also contributed to the decline in interest income generated from loans
      and leases.  Outstanding loans decreased by $19 million from
      December 31, 2008 to December 31, 2009 due to (i) reduced loan demand from
      creditworthy borrowers, and (ii) the impact of nearly $10 million of loan
      participations sold for capital and risk management
      purposes.  The lack of income from impaired and non-accruing
      investments, and reduced yields on re-invested proceeds from investment
      maturities and sales, contributed to lower investment interest income in
      2009.  Union National continued to take measures to reduce its
      cost of funds, prepaying $17 million of higher-cost long-term debt with
      the Federal Home Loan Bank (“FHLB”) of Pittsburgh during 2009, as well as
      prepaying an additional $2.5 million subsequent to December 31,
      2009.  The taxable-equivalent net interest margin percentage for
      2009 was 2.73%, as compared to 3.28% for
  2008.





(iii)
            Nonperforming
      loans and leases increased to 2.52% of total loans and leases at December
      31, 2009, as compared to 1.38% at December 31, 2008.  The
      increasing trend in nonperforming loans is attributable primarily to
      stressed cash flows among certain commercial borrowers due largely to the
      weak economy and real estate market.  Union National continues
      to closely monitor the loan portfolio and the adequacy of the loan loss
      reserve by regularly evaluating borrower financial performance and
      underlying collateral values.  Accordingly, a significant
      provision for credit losses of $2,627,000 was made for the year ended
      December 31, 2009, as compared to $1,027,000 for the year ended December
      31, 2008.  With the higher provision exceeding net loan
      charge-offs of $1,127,000 for 2009, as compared to $344,000 in 2008, the
      allowance for credit losses increased to 1.73% of loans at December 31,
      2009, as compared to 1.22% of loans at December 31,
  2008.





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%.





65






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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 $12,715,000
for the year ended December 31, 2009, as compared to $14,817,000 for the year
ended December 31, 2008.  The yield on interest-earning assets
decreased by 113 basis points to 5.15% for 2009, as compared to 6.28% for
2008.  The interest rate paid on average interest-bearing liabilities
decreased by 63 basis points to 2.69% for 2009, as compared to 3.32% for
2008.  Reduced earning asset yields in the low interest rate
environment, while borrowing costs remained at higher fixed rates, resulted in a
lower net interest margin in 2009 versus 2008. The taxable-equivalent net
interest margin percentage for 2009 was 2.73%, as compared to 3.28% for
2008.





Interest
and fees on loans and leases on a taxable-equivalent basis decreased by
$3,063,000, or by 12%, to $21,754,000 for the year ended December 31, 2009, as
compared to $24,817,000 for the year ended December 31, 2008.  The
average yield decreased by 51 basis points to 6.21% for 2009, as compared to
6.72% for 2008.  The variable rate structure of many of Union
National’s loans reduced overall yield due to the persistent low market interest
rates and a decrease in loans outstanding also contributed to the decline in
interest income generated from loans and leases.  The average balance
of loans and leases decreased by $19,247,000 in 2009, as compared to 2008 due to
reduced loan demand from creditworthy borrowers, and the impact of nearly $10
million of loan participations sold for capital and risk management
purposes.





Interest
and dividends earned on investment securities on a taxable-equivalent basis
decreased by $1,233,000, or by 38%, to $1,976,000 for the year ended December
31, 2009, as compared to $3,209,000 for the year ended December 31,
2008.  The lack of income from impaired and non-accruing investments,
and reduced yields on re-invested proceeds from investment maturities and sales,
contributed to lower investment interest income in 2009.  As a result,
the average yield decreased by 172 basis points to 2.89% for 2009, as compared
to 4.61% for 2008.





Interest
expense on deposits decreased by $1,076,000, or by 11%, to $8,394,000 for the
year ended December 31, 2009, as compared to $9,470,000 for the year ended
December 31, 2008.  A decrease in average rate of 56 basis points to
2.32% for 2009, as compared to 2.88% for 2008 more than offset additional
interest expense from a $32,843,000 increase in the average balance of
deposits.





Interest
expense on long-term debt decreased by $741,000, or by 27%, to $2,054,000 for
the year ended December 31, 2009, as compared to $2,795,000 for the year ended
December 31, 2008.  During 2009, Union National continued to take
measures to reduce its cost of funds, prepaying $17,000,000 of higher-cost
long-term debt with the FHLB, which resulted in a $14,115,000 decrease in the
average balance of long-term debt for 2009, as compared to
2008.





66






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Distribution
of Assets, Liabilities and Stockholders’ Equity


The table
below provides average asset and liability balances and the corresponding
interest income and expense along with the average interest yields (assets) and
interest rates (liabilities) for the years 2009, 2008 and
2007.  Interest income and the average interest yields are presented
on a taxable-equivalent basis (dollars in thousands).


Years Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007Average
                        Balance
                      
                      
                      Interest
                      
                      
                      Yield/
                        Rate
                      
                      
                      Average
                        Balance
                      
                      
                      Interest
                      
                      
                      Yield/
                        Rate
                      
                      
                      Average
                        Balance
                      
                      
                      Interest
                      
                      
                      Yield/
                        RateAssetsInterest-Earning
      Cash in Other Banks
                      
                      $
                      27,233
                      
                      
                      $
                      70
                      
                      
                      
                      0.26
                      %
                      
                      $
                      165
                      
                      
                      $
                      6
                      
                      
                      
                      3.64
                      %
                      
                      $
                      197
                      
                      
                      $
                      10
                      
                      
                      
                      5.08
                      %Interest-Earning
      Time Deposits in Other Banks
                      
                      
                      9,622
                      
                      
                      
                      143
                      
                      
                      
                      1.49
                      
                      
                      
                      1,077
                      
                      
                      
                      36
                      
                      
                      
                      3.34
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –Federal
      Funds Sold
                      
                      
                      7,010
                      
                      
                      
                      18
                      
                      
                      
                      0.26
                      
                      
                      
                      8,503
                      
                      
                      
                      214
                      
                      
                      
                      2.52
                      
                      
                      
                      9,363
                      
                      
                      
                      459
                      
                      
                      
                      4.90Investment
      Securities: (a)Taxable
                      
                      
                      64,060
                      
                      
                      
                      1,734
                      
                      
                      
                      2.71
                      
                      
                      
                      69,618
                      
                      
                      
                      3,209
                      
                      
                      
                      4.61
                      
                      
                      
                      65,255
                      
                      
                      
                      3,358
                      
                      
                      
                      5.15Tax-Exempt
      (c)
                      
                      
                      4,201
                      
                      
                      
                      242
                      
                      
                      
                      5.76
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      8,334
                      
                      
                      
                      610
                      
                      
                      
                      7.32Loans
      and Leases (b), (c), (d)
                      
                      
                      350,307
                      
                      
                      
                      21,754
                      
                      
                      
                      6.21
                      
                      
                      
                      369,554
                      
                      
                      
                      24,817
                      
                      
                      
                      6.72
                      
                      
                      
                      357,795
                      
                      
                      
                      27,092
                      
                      
                      
                      7.57Restricted
      Investment in Bank Stocks
                      
                      
                      3,705
                      
                      
                      
                      40
                      
                      
                      
                      1.08
                      
                      
                      
                      3,365
                      
                      
                      
                      114
                      
                      
                      
                      3.39
                      
                      
                      
                      3,950
                      
                      
                      
                      290
                      
                      
                      
                      7.34Total
      Earning Assets
                      
                      
                      466,138
                      
                      
                      
                      24,001
                      
                      
                      
                      5.15
                      %
                      
                      
                      452,282
                      
                      
                      
                      28,396
                      
                      
                      
                      6.28
                      %
                      
                      
                      444,894
                      
                      
                      
                      31,819
                      
                      
                      
                      7.15
                      %Allowance
      for Credit Losses
                      
                      
                      (4,529
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (3,798
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (3,363
                      )Non
      Interest-Earning Assets
                      
                      
                      40,664
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      40,234
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      38,870Total
      Assets
                      
                      $
                      502,273
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      488,718
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      480,401Liabilities
      and Stockholders’ EquityInterest-Bearing
      Liabilities:Interest-Bearing
      Demand Deposits
                      
                      $
                      133,525
                      
                      
                      
                      1,458
                      
                      
                      
                      1.09
                      %
                      
                      $
                      127,128
                      
                      
                      
                      1,988
                      
                      
                      
                      1.56
                      %
                      
                      $
                      120,637
                      
                      
                      
                      3,174
                      
                      
                      
                      2.63
                      %Savings
      Deposits
                      
                      
                      23,607
                      
                      
                      
                      64
                      
                      
                      
                      0.27
                      
                      
                      
                      23,589
                      
                      
                      
                      66
                      
                      
                      
                      0.28
                      
                      
                      
                      25,367
                      
                      
                      
                      77
                      
                      
                      
                      0.30Brokered
      Deposits
                      
                      
                      10,845
                      
                      
                      
                      508
                      
                      
                      
                      4.68
                      
                      
                      
                      14,381
                      
                      
                      
                      828
                      
                      
                      
                      5.76
                      
                      
                      
                      25,211
                      
                      
                      
                      1,262
                      
                      
                      
                      5.01Other
      Time Deposits
                      
                      
                      193,218
                      
                      
                      
                      6,364
                      
                      
                      
                      3.29
                      
                      
                      
                      163,254
                      
                      
                      
                      6,588
                      
                      
                      
                      4.04
                      
                      
                      
                      134,142
                      
                      
                      
                      6,277
                      
                      
                      
                      4.68Total
      Deposits
                      
                      
                      361,195
                      
                      
                      
                      8,394
                      
                      
                      
                      2.32
                      
                      
                      
                      328,352
                      
                      
                      
                      9,470
                      
                      
                      
                      2.88
                      
                      
                      
                      305,357
                      
                      
                      
                      10,790
                      
                      
                      
                      3.53Short-Term
      Borrowings
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      –
                      
                      
                      
                      9,090
                      
                      
                      
                      210
                      
                      
                      
                      2.31
                      
                      
                      
                      6,025
                      
                      
                      
                      299
                      
                      
                      
                      4.96Long-Term
      Debt
                      
                      
                      40,386
                      
                      
                      
                      2,054
                      
                      
                      
                      5.09
                      
                      
                      
                      54,501
                      
                      
                      
                      2,795
                      
                      
                      
                      5.13
                      
                      
                      
                      72,586
                      
                      
                      
                      3,652
                      
                      
                      
                      5.03Junior
      Subordinated Debentures
                      
                      
                      17,341
                      
                      
                      
                      838
                      
                      
                      
                      4.83
                      
                      
                      
                      17,341
                      
                      
                      
                      1,104
                      
                      
                      
                      6.37
                      
                      
                      
                      17,341
                      
                      
                      
                      1,268
                      
                      
                      
                      7.31Total
      Interest-Bearing Liabilities
                      
                      
                      418,922
                      
                      
                      
                      11,286
                      
                      
                      
                      2.69
                      %
                      
                      
                      409,284
                      
                      
                      
                      13,579
                      
                      
                      
                      3.32
                      %
                      
                      
                      401,309
                      
                      
                      
                      16,009
                      
                      
                      
                      3.99
                      %Non-Interest
      Bearing Liabilities:Demand
      Deposits
                      
                      
                      48,310
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      46,342
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      46,393Other
      Liabilities
                      
                      
                      3,439
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3,045
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3,634Stockholders’
      Equity
                      
                      
                      31,602
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      30,047
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      29,065Total
      Stockholder’s Equity
                      
                      $
                      502,273
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      488,718
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      480,401Net
      Interest Income / Spread
                      
                      
                      
                      
                      
                      $
                      12,715
                      
                      
                      
                      2.46
                      %
                      
                      
                      
                      
                      
                      $
                      14,817
                      
                      
                      
                      2.96
                      %
                      
                      
                      
                      
                      
                      $
                      15,810
                      
                      
                      
                      3.16
                      %Net
      Interest Margin
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      2.73
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3.28
                      %
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3.55
                      %





(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 $481,000 for the year ended December 31, 2009, $798,000 for
      the year ended December 31, 2008, and $771,000 for the year ended December
      31, 2007.




67






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Rate/Volume
Analysis of Net Interest Income


The table
below shows changes attributable to the volume and rate components of net
interest income on a taxable equivalent basis (in thousands):





2009 Compared to 2008
                  
                  
                  2008 Compared to 2007Increase (Decrease) Due to
                  
                  
                  Increase (Decrease) Due toVolume(a)
                  
                  
                  Rate(a)
                  
                  
                  Total
                  
                  
                  Volume(a)
                  
                  
                  Rate(a)
                  
                  
                  TotalInterest
      Earning Assets:Interest
      Bearing Deposits in Other Banks
                  
                  $
                  984
                  
                  
                  $
                  (920
                  )
                  
                  $
                  64
                  
                  
                  $
                  (2
                  )
                  
                  $
                  (2
                  )
                  
                  $
                  (4
                  )Interest
      Bearing Time Deposits in Other Banks
                  
                  
                  286
                  
                  
                  
                  (179
                  )
                  
                  
                  107
                  
                  
                  
                  36
                  
                  
                  
                  –
                  
                  
                  
                  36Federal
      Funds Sold
                  
                  
                  (38
                  )
                  
                  
                  (158
                  )
                  
                  
                  (196
                  )
                  
                  
                  (42
                  )
                  
                  
                  (203
                  )
                  
                  
                  (245
                  )Investment
      Securities:Taxable
                  
                  
                  (256
                  )
                  
                  
                  (1,219
                  )
                  
                  
                  (1,475
                  )
                  
                  
                  226
                  
                  
                  
                  (375
                  )
                  
                  
                  (149
                  )Tax-Exempt
      (c)
                  
                  
                  –
                  
                  
                  
                  242
                  
                  
                  
                  242
                  
                  
                  
                  (610
                  )
                  
                  
                  –
                  
                  
                  
                  (610
                  )Loans
      and Leases – Net (b),
      (c)
                  
                  
                  (1,293
                  )
                  
                  
                  (1,770
                  )
                  
                  
                  (3,063
                  )
                  
                  
                  878
                  
                  
                  
                  (3,153
                  )
                  
                  
                  (2,275
                  )Restricted
      Investment in Bank Stocks
                  
                  
                  12
                  
                  
                  
                  (86
                  )
                  
                  
                  (74
                  )
                  
                  
                  (43
                  )
                  
                  
                  (133
                  )
                  
                  
                  (176
                  )Total
      Earning Assets
                  
                  
                  (305
                  )
                  
                  
                  (4,090
                  )
                  
                  
                  (4,395
                  )
                  
                  
                  443
                  
                  
                  
                  (3,866
                  )
                  
                  
                  (3,423
                  )Interest-Bearing
      Liabilities:Interest-Bearing
      Demand Deposits
                  
                  
                  100
                  
                  
                  
                  (630
                  )
                  
                  
                  (530
                  )
                  
                  
                  172
                  
                  
                  
                  (1,358
                  )
                  
                  
                  (1,186
                  )Savings
      Deposits
                  
                  
                  –
                  
                  
                  
                  (2
                  )
                  
                  
                  (2
                  )
                  
                  
                  (5
                  )
                  
                  
                  (6
                  )
                  
                  
                  (11
                  )Brokered
      Deposits
                  
                  
                  (204
                  )
                  
                  
                  (116
                  )
                  
                  
                  (320
                  )
                  
                  
                  (541
                  )
                  
                  
                  107
                  
                  
                  
                  (434
                  )Other
      Time Deposits
                  
                  
                  1,209
                  
                  
                  
                  (1,433
                  )
                  
                  
                  (224
                  )
                  
                  
                  1,375
                  
                  
                  
                  (1,064
                  )
                  
                  
                  311Total
      Deposits
                  
                  
                  1,105
                  
                  
                  
                  (2,181
                  )
                  
                  
                  (1,076
                  )
                  
                  
                  1,001
                  
                  
                  
                  (2,321
                  )
                  
                  
                  (1,320
                  )Short-Term
      Borrowings
                  
                  
                  (210
                  )
                  
                  
                  –
                  
                  
                  
                  (210
                  )
                  
                  
                  152
                  
                  
                  
                  (241
                  )
                  
                  
                  (89
                  )Long-Term
      Debt
                  
                  
                  (741
                  )
                  
                  
                  –
                  
                  
                  
                  (741
                  )
                  
                  
                  (905
                  )
                  
                  
                  48
                  
                  
                  
                  (857
                  )Junior
      Subordinated Debentures
                  
                  
                  –
                  
                  
                  
                  (266
                  )
                  
                  
                  (266
                  )
                  
                  
                  –
                  
                  
                  
                  (164
                  )
                  
                  
                  (164
                  )Total
      Interest-Bearing Liabilities
                  
                  
                  154
                  
                  
                  
                  (2,447
                  )
                  
                  
                  (2,293
                  )
                  
                  
                  248
                  
                  
                  
                  (2,678
                  )
                  
                  
                  (2,430
                  )Net
      Interest Income
                  
                  $
                  (459
                  )
                  
                  $
                  (1,643
                  )
                  
                  $
                  (2,102
                  )
                  
                  $
                  195
                  
                  
                  $
                  (1,188
                  )
                  
                  $
                  (993
                  )





(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%.




68






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Provision
for Credit Losses


The
provision for credit losses is an expense charged against net interest income to
provide for estimated losses attributable to uncollectible loans and
leases.  The provision is based on management’s analysis of the
adequacy of the allowance for credit losses.  The provision for credit
losses was $2,627,000 for the year ended December 31, 2009, as compared to
$1,027,000 for the same period in 2008.  The increased provision was
the result of increased credit risk related to additional substandard rated
credits at December 31, 2009, as compared to December 31, 2008 (refer to the
related discussion on“Substandard Loans and
Leases”on page
61) and an increase in loans charged-off during 2009 as compared to the same
period in 2008.  Management continues to closely monitor the loan
portfolio and the adequacy of the allowance for credit loss reserve considering
underlying borrower financial performance and collateral values, and increasing
credit risks.  Future adjustments may be necessary to the provision
for credit losses, and consequently the allowance for credit losses, if economic
conditions or loan credit quality differ substantially from the assumptions we
used in making our evaluation of the level of the allowance for credit losses as
compared to the balance of outstanding loans and leases(refer to the related
discussion on“Allowance for Credit
Losses”on page
58).





Non-Interest
Income


Non-interest
income increased by $1,568,000, or by 41%, to $5,375,000 for the year ended
December 31, 2009, as compared to $3,807,000 for the same period in
2008.   Increases (decreases) in the components of non-interest
income when comparing the year ended December 31, 2009 to 2008 are as follows
(in thousands):





Year Ended December 31,
                  
                  
                  IncreaseNon-Interest Income
                  
                  2009
                  
                  
                  2008
                  
                  
                  (Decrease)Service
      Charges on Deposit Accounts
                  
                  $
                  2,158
                  
                  
                  $
                  1,950
                  
                  
                  $
                  208Other
      Service Charges, Commissions, Fees
                  
                  
                  1,154
                  
                  
                  
                  1,091
                  
                  
                  
                  63Alternative
      Investment Sales Commissions
                  
                  
                  662
                  
                  
                  
                  814
                  
                  
                  
                  (152
                  )Income
      from Fiduciary Activities
                  
                  
                  180
                  
                  
                  
                  309
                  
                  
                  
                  (129
                  )Earnings
      from Bank-Owned Life Insurance
                  
                  
                  431
                  
                  
                  
                  439
                  
                  
                  
                  (8
                  )Mortgage
      Banking/Brokerage Activities
                  
                  
                  112
                  
                  
                  
                  56
                  
                  
                  
                  56Other
      Income
                  
                  
                  341
                  
                  
                  
                  186
                  
                  
                  
                  155Net
      Gain on Sale of Investment Securities
                  
                  
                  1,841
                  
                  
                  
                  252
                  
                  
                  
                  1,589Less:
      Impairment Charge on Investment Securities
                  
                  
                  (1,504
                  )
                  
                  
                  (1,290
                  )
                  
                  
                  (214
                  )Net
      Investment Securities Gains (Losses)
                  
                  
                  337
                  
                  
                  
                  (1,038
                  )
                  
                  
                  1,375Total
      Non-Interest Income
                  
                  $
                  5,375
                  
                  
                  $
                  3,807
                  
                  
                  $
                  1,568





A
significant portion of the increase in non-interest income was related to net
investment securities gains. Realized
gains on the sale of investment securities were $1,841,000 for the year ended
December 31, 2009, as compared to $252,000 for the same period in
2008.  These investment sales activities related to continued
repositioning of the investment portfolio to a lower-risk profile that more
effectively supports liquidity, capital, and interest rate risk management,
while providing realized gains to offset the impact of investment securities
impairment charges.  Other-than-temporary investment impairment
charges of $1,504,000 were recognized during the year ended December 31, 2009,
related to investment securities that were downgraded to below investment
grade.  Other-than-temporary investment impairment charges of
$1,290,000 were recognized during the year ended December 31,
2008.  The total impairment charges for the year ended December 31,
2009 of $1,504,000 were more than offset by realized net gains on the sale of
investment securities of $1,841,000.





69






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


The
increase in other income was the result of a $279,000 insurance settlement
against losses from loans which were fraudulently or otherwise improperly made
by one former employee.  The settlement provided for substantial
reimbursement of a one-time charge of $370,000 which was recorded and previously
disclosed in 2008 related to the irregular activity.  Subsequent to
December 31, 2009, Union National received an additional $7,000 as final
settlement and legal restitution from the former employee. This was offset by
$96,000 of income generated from a cash bailment agreement on a network of ATM
machines in 2008.  This agreement was terminated during the first
quarter of 2008 and previously provided transaction fee
income.  Accordingly, operating results for the year ended December
31, 2009, did not reflect any income generated from this agreement, whereas, the
operating results for the same period in 2008 reflected income for the first
quarter of 2008.





The
increase in service charges on deposit accounts was the result of an increase in
deposits, which grew by 6% since December 31, 2008.  The overall
growth in deposits resulted in increased fee income as well as an operational
change in the posting of transactions, which impacted net overdraft fee
income.  The decrease in alternative investment sales commissions was
primarily the result of a turbulent investment market and a weak economy, which
negatively impacted growth and sales opportunities.  The decrease
associated with income from fiduciary activities was primarily the result of
fewer estate fees.





Non-Interest
Expense


For the
year ended December 31, 2009, non-interest expense decreased by $381,000, or by
2%, as compared to the year ended December 31, 2008.  Increases
(decreases) in the components of non-interest expense when comparing the year
ended December 31, 2009 to 2008 are as follows (in thousands):





Year Ended December 31,
                    
                    
                    IncreaseNon-Interest Expense
                    
                    2009
                    
                    
                    2008
                    
                    
                    (Decrease)Salaries,
      Wages, and Employee Benefits
                    
                    $
                    7,033
                    
                    
                    $
                    7,676
                    
                    
                    $
                    (643
                    )Net
      Occupancy
                    
                    
                    1,724
                    
                    
                    
                    1,818
                    
                    
                    
                    (94
                    )Data
      and ATM Processing
                    
                    
                    1,681
                    
                    
                    
                    1,641
                    
                    
                    
                    40Professional
      Fees and Regulatory Assessments
                    
                    
                    1,160
                    
                    
                    
                    1,036
                    
                    
                    
                    124Furniture
      and Equipment
                    
                    
                    935
                    
                    
                    
                    1,017
                    
                    
                    
                    (82
                    )FDIC
      Insurance
                    
                    
                    1,128
                    
                    
                    
                    404
                    
                    
                    
                    724Pennsylvania
      Shares Tax
                    
                    
                    297
                    
                    
                    
                    273
                    
                    
                    
                    24Advertising
      and Marketing
                    
                    
                    211
                    
                    
                    
                    412
                    
                    
                    
                    (201
                    )Supplies
      and Postage
                    
                    
                    367
                    
                    
                    
                    401
                    
                    
                    
                    (34
                    )Other
      Expense
                    
                    
                    2,201
                    
                    
                    
                    2,440
                    
                    
                    
                    (239
                    )Total
      Non-Interest Expense
                    
                    $
                    16,737
                    
                    
                    $
                    17,118
                    
                    
                    $
                    (381
                    )





Union
National has focused on lowering core operating costs and creating efficiencies
in a difficult economy, when income growth is challenging, by exploring cost
cutting initiatives.  The discussion that follows explains the changes
in the components of non-interest expense when comparing the year ended December
31, 2009 to the same period in 2008.





Salaries,
wages and employee benefits decreased by $643,000 for the year ended December
31, 2009 as compared to the same period in 2008.  The decrease was
related to positions that were eliminated in the fourth quarter of 2008 and the
first quarter of 2009, savings in health care costs, and savings from the
elimination of the company 401-K match during the second quarter of
2009.





70






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


The
increase in professional fees and regulatory assessments was related to an
increase in audit fees and legal expenses.  Union National uses a
third party vendor to perform the internal audit function.  During
2008, Union National was in the process of switching third party vendors to a
new relationship.  As a result, professional fees and regulatory
assessments did not include a full years worth of expenses associated with
internal audit services for the year ended December 31, 2008, whereas, the year
ended December 31, 2009, included internal audit expenses for the full
year.  Legal expenses increased primarily due to a third party vendor
utilized to help mitigate problem loans, which have become more prevalent
primarily due to stressed cash flows among certain commercial borrowers
resulting from the weak economy and real estate market.





Due to
recent changes and assessments by the FDIC, FDIC insurance assessments amounted
to $1,128,000 for the entire year of 2009, representing a $724,000 or 179%
increase over the entire year of 2008.  The increase in FDIC insurance
premiums is the direct result of increased base assessment rates and an
emergency special assessment, as determined by the FDIC.  The FDIC
Board adopted an interim rule imposing an emergency special assessment on the
industry on June 30, 2009.  For Union National, the emergency special
assessment amounted to $237,000.  The interim rule would also permit
the FDIC Board to impose another similar emergency special assessment after June
30, 2009, if necessary, to maintain public confidence in federal deposit
insurance.  On November 12, 2009, the FDIC Board of Directors voted to
require insured depository institutions to prepay, on December 30, 2009, their
estimated quarterly risk-based assessments for the fourth quarter of 2009 and
for all of 2010, 2011, and 2012 (see related discussion on “Federal Deposit
Insurance Corporation Activity” on page 84).





For the
year ended December 31, 2009, the decrease in advertising and marketing expense
was part of operating more efficiently in a difficult economy.





The
decrease in other expense included a decrease in employee related expenses such
as training, travel, seminars, and staff recruitment and a decrease in the
expense paid for coffee in the Bank’s gold café
branches.  Additionally, in 2009, the Bank continued with certain
cost-reducing de-leveraging activities by using funds from low-interest earning
assets and low-interest cost short-term borrowings to pay down higher interest
cost long-term debt.  During the year ended December 31, 2009 and
2008, the Bank prepaid $17,000,000 and $18,482,000 of FHLB advances,
respectively.  In conjunction with the prepayments, the Bank incurred
$536,000 and $72,000 of prepayment penalties for the years ended December 31,
2009 and 2008, respectively, which were included in other non-interest
expense.  The year ended December 31, 2008, included a loss of
$370,000 related to certain fraudulent loans made by a former
employee.





Income
Taxes


For the
year ended December 31, 2009, an income tax benefit was recorded for $802,000,
which primarily resulted from a pre-tax loss, as compared to an income tax
benefit of $188,000 for the same period in 2008.  Generally, Union
National’s effective tax rate is below the statutory rate due to tax-exempt
earnings on loans, investments, and bank-owned life insurance, and the impact of
tax credits.  In accordance with ASC Topic 740, “Income Taxes”, no
adjustments have been recorded for unrecognized income tax benefits for the
periods ended December 31, 2009 and 2008.  The realization of deferred
tax assets is dependent on future earnings.   Management
anticipates that future earnings will be adequate to fully utilize deferred tax
assets.





71






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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 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.





72






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Provision
for Credit Losses


The
provision for credit losses is an expense charged to earnings to provide for
estimated losses attributable to uncollectible loans and leases.  The
provision is based on our analysis of the adequacy of the allowance for credit
losses.  The provision for credit losses was $1,027,000 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
credit losses, and consequently the allowance for credit losses, if economic
conditions or loan credit quality differ substantially from the assumptions we
used in making our evaluation of the level of the allowance for credit losses as
compared to the balance of outstanding loans and leases (See additional
discussion in the section “Allowance for Credit Losses” on page
58).





Non-Interest
Income


For the
year ended December 31, 2008, non-interest income decreased by $2,702,000 or 42%
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):





Year Ended December 31,
                  
                  
                  IncreaseNon-Interest Income
                  
                  2008
                  
                  
                  2007
                  
                  
                  (Decrease)Service
      Charges on Deposit Accounts
                  
                  $
                  1,950
                  
                  
                  $
                  1,864
                  
                  
                  $
                  86Other
      Service Charges, Commissions, Fees
                  
                  
                  1,091
                  
                  
                  
                  1,059
                  
                  
                  
                  32Alternative
      Investment Sales Commissions
                  
                  
                  814
                  
                  
                  
                  845
                  
                  
                  
                  (31
                  )Income
      from Fiduciary Activities
                  
                  
                  309
                  
                  
                  
                  347
                  
                  
                  
                  (38
                  )Earnings
      from Bank-Owned Life Insurance
                  
                  
                  439
                  
                  
                  
                  426
                  
                  
                  
                  13Mortgage
      Banking/Brokerage Activities
                  
                  
                  56
                  
                  
                  
                  2,000
                  
                  
                  
                  (1,944
                  )Title
      Insurance/Settlement Income
                  
                  
                  –
                  
                  
                  
                  317
                  
                  
                  
                  (317
                  )Other
      Income
                  
                  
                  186
                  
                  
                  
                  362
                  
                  
                  
                  (176
                  )Net
      Gain on Sale of Investment Securities
                  
                  
                  252
                  
                  
                  
                  89
                  
                  
                  
                  163Less:
      Impairment Charge on Investment Securities
                  
                  
                  (1,290
                  )
                  
                  
                  (800
                  )
                  
                  
                  (490
                  )Net
      Investment Securities Gains (Losses)
                  
                  
                  (1,038
                  )
                  
                  
                  (711
                  )
                  
                  
                  (327
                  )Total
      Non-Interest Income
                  
                  $
                  3,807
                  
                  
                  $
                  6,509
                  
                  
                  $
                  (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 - Residential Mortgage
Business Venture 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 3 – Investment Securities
Available For Sale to the consolidated financial
statements.





73






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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% 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):





Year Ended December 31,
                  
                  
                  IncreaseNon-Interest Expense
                  
                  2008
                  
                  
                  2007
                  
                  
                  (Decrease)Salaries,
      Wages, and Employee Benefits
                  
                  $
                  7,676
                  
                  
                  $
                  9,723
                  
                  
                  $
                  (2,047
                  )Net
      Occupancy
                  
                  
                  1,818
                  
                  
                  
                  2,390
                  
                  
                  
                  (572
                  )Data
      and ATM Processing
                  
                  
                  1,641
                  
                  
                  
                  1,662
                  
                  
                  
                  (21
                  )Professional
      Fees and Regulatory Assessments
                  
                  
                  1,036
                  
                  
                  
                  1,516
                  
                  
                  
                  (480
                  )Furniture
      and Equipment
                  
                  
                  1,017
                  
                  
                  
                  1,081
                  
                  
                  
                  (64
                  )FDIC
      Insurance
                  
                  
                  404
                  
                  
                  
                  137
                  
                  
                  
                  267Pennsylvania
      Shares Tax
                  
                  
                  273
                  
                  
                  
                  243
                  
                  
                  
                  30Advertising
      and Marketing
                  
                  
                  412
                  
                  
                  
                  653
                  
                  
                  
                  (241
                  )Supplies
      and Postage
                  
                  
                  401
                  
                  
                  
                  377
                  
                  
                  
                  24Restructuring
      Charge
                  
                  
                  –
                  
                  
                  
                  717
                  
                  
                  
                  (717
                  )Other
      Expense
                  
                  
                  2,440
                  
                  
                  
                  2,246
                  
                  
                  
                  194Total
      Non-Interest Expense
                  
                  $
                  17,118
                  
                  
                  $
                  20,745
                  
                  
                  $
                  (3,627
                  )





The
decrease in salaries, wages, and employee benefits expense reflect the savings
impact realized from the 2007 staff restructuring, as well as the staff
reductions from the closure of operations of Home Team during 2007.





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 having
additional expenses related to a nonrecurring profit improvement consulting
engagement, and consulting and legal fees associated with the 2007 restructuring
and complying with the MOU with the OCC.  Effective August 27, 2009,
the Bank entered into a formal written agreement (the “Agreement”) with the
OCC.  The Agreement supersedes the previous MOU between the Bank and
the OCC (for additional information, refer to Note 18 – Enforcement Actions with
Bank Regulatory Agenciesto the consolidated financial statements).





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 MOU.  Effective August 27, 2009, the Bank entered
into a formal written Agreement with the OCC.  The Agreement
supersedes the previous MOU between the Bank and the OCC (for additional
information, refer to Note 18
– Enforcement Actions with Bank Regulatory Agenciesto the consolidated
financial statements).





74






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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 were not any
      additional losses or the involvement of other employees.  Union
      National evaluated the impact of this incident on current internal
      controls and procedures and implemented changes necessary to strengthen
      control processes and address the issues raised by this isolated
      event.  The appropriate governmental authorities were notified
      and Union National has cooperated fully with respect to the authorities’
      investigation.  During 2009, a $279,000 insurance settlement was
      received and provided for substantial reimbursement of the one-time
      charge.  Subsequent to December 31, 2009, Union National
      received an additional $7,000 as final settlement 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 ASC
Topic 740, “Income Taxes” 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.





RECENT
ACCOUNTING PRONOUNCEMENTS


Refer to
Note 1 – Summary of
Significant Accounting Policies to the consolidated financial statements
for recently issued accounting standards.





75






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


RECENT
DEVELOPMENTS


The
global and U.S. economies experienced reduced business activity and unemployment
as a result of, among other factors, disruptions in the financial system during
the past year. Declines in the housing market during the past year, with falling
home prices and increasing foreclosures and unemployment, 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 has been significantly adversely affected
as a result.





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
had the authority to, among other things, purchase up to $700 billion of
mortgages, mortgage-backed securities and certain other financial instruments
from financial institutions for the purpose of stabilizing and providing
liquidity to the U.S. financial markets.  The EESA included a
provision for a temporary increase in FDIC insurance from $100,000 to $250,000
per depositor through December 31, 2013.





The FDIC
has also established a program under which all non-interest-bearing accounts at
FDIC insured institutions (including Union National) will be fully insured,
regardless of dollar amount, until June 30, 2010, unless an eligible institution
formally opts out of this program.  Under the terms of the program, a
10 basis point surcharge will be applied to the balances of non-interest-bearing
deposit accounts not otherwise covered by the increased deposit insurance limit
of $250,000.  The surcharge will be added to the participating bank’s
existing risk-based deposit insurance premium paid on those
deposits.  Union National has opted to participate in this program to
ensure its current and prospective deposit customers are provided the maximum
amount of insurance coverage provided by the FDIC.





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





President
Obama also has announced his intention to create another capital program similar
to the TARP CPP exclusively for bank holding companies with consolidated assets
less than $1 billion for the purpose of enabling participants to increase
lending to small businesses. No details of this new program have been released
at this time.





It is not
clear at this time what, if any, additional programs that may be initiated in
the future, will have on the financial markets and the other difficulties
described above, including the 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.





76






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


OUTLOOK
FOR 2010


The U.S.
economy appears to be in the early stages of recovery, labor market conditions
have begun to stabilize and the housing market appears to be showing signs of
recovery.  While there is still considerable uncertainty about the
outlook, the balance of evidence suggests that a recovery is gaining
momentum.  The Federal Reserve cut interest rates to near zero in
December 2008 and created a host of emergency lending facilities to fight the
worst recession in more than 70 years. Most recent indications from the Federal
Reserve are that interest rates will remain at exceptionally low levels for an
extended period.  Maintaining short-term interest rates near zero
could actually impede the recovery process in financial markets.





The
banking industry experienced significant interest rate cuts throughout 2008 and
remain at a historical low.  For Union National, reduced earning asset
yields in the low interest rate environment, while borrowing costs remained at
higher fixed rates, resulted in a lower net interest margin in 2009 versus 2008.
 The variable rate structure of many of the Bank’s loans reduced the
overall yield.  The lack of income from impaired and non-accruing
investments, and reduced yields on re-invested proceeds from investment
maturities and sales, contributed to lower investment interest income in
2009.  Union National continues to take measures to reduce its cost of
funds, prepaying $17,000,000 of higher-cost long-term debt with the Federal Home
Loan Bank (“FHLB”) of Pittsburgh during 2009, as well as prepaying an additional
$2,500,000 subsequent to December 31, 2009.  The taxable-equivalent
net interest margin percentage for 2009 was 2.73%, as compared to 3.28% for
2008.




Regardless
of some indications that the economy may be improving, for Union National, 2010
will most likely reflect more of the same issues and challenges experienced in
2009, which included unfavorable interest income growth prospects, volatility in
investment markets and a weak economy and housing market.  A weak
economy and housing market, and high unemployment both nationally and locally,
will likely create cash flow difficulties and collateral de-valuation for some
borrowers, resulting in increased nonperforming loans and possible increased
credit losses.  Management continues to closely monitor the loan
portfolio, and the underlying borrower financial performance and collateral
values.





Management
continues to take the necessary, conservative measures to ensure Union National
maintains its safe and sound position, including strengthening our liquidity and
capital positions, managing increasing risks, and operating
prudently.  We have continued to lower our core operating costs,
allowing us to be more efficient in a difficult market when income growth is
challenging, and continue to explore revenue generation, cost cutting
initiatives, and capital enhancement methods and alternatives.





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





Union
National’s Board of Directors believed it prudent for the Bank to fully maintain
its strong, well-capitalized position in these uncertain economic
times.  Therefore, the decision was made not to pay dividends to
stockholders in 2009 and 2008.  In addition, the Board of Directors
did not declare a dividend to be paid in the first quarter of
2010.





77






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


LIQUIDITY


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





·
            A
      growing core retail deposit base;


·
            Proceeds
      from the sale or maturity of investment
  securities;


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


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





Management
believes that the Bank’s core deposits are fairly stable.  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.





In 2009,
the Bank focused on growing low-cost retail deposits, while reducing high-cost
wholesale funding (i.e. FHLB advances and brokered time
deposits).  For the year, low-cost retail deposits increased by
$22,732,000, or 12%, while high-cost wholesale funding decreased by $22,717,000
or 36%.  As of December 31, 2009 and 2008, the ratio of wholesale
funding to total assets was 8% and 13%, respectively.  The decrease in
the percentage of these wholesale funding sources was attributable to the
de-leveraging which is discussed in Note 17 – De-Leveraging and
Restructuring Activities to the consolidated financial statements. 
As such, the Bank prepaid $17,000,000 of FHLB advances in
2009.  Overall, total deposits grew by $21,188,000 or 6% during
2009.





The Bank
has a line of credit with a correspondent bank amounting to $7,000,000 for
overnight federal funds borrowings, none of which was outstanding at December
31, 2009, 2008 or 2007.  The Bank also has the ability to borrow
overnight funds through the Federal Reserve discount window, which amounted to
$14,839,000 at December 31, 2009.  The Federal Reserve borrowing
capacity is collateralized by $15,151,000 of investment securities at December
31, 2009.





In 2008,
the Bank had an agreement with the FHLB, for a line of credit available in the
amount of $15,000,000.  As a result of the formal agreement entered
into with the OCC during 2009 (for additional information, refer to Note 18 – Enforcement Actions with
Bank Regulatory Agencies to the consolidated financial statements), the
$15,000,000 line of credit is no longer available without the Bank providing
collateral to the FHLB.  The Bank did not pledge collateral to the
FHLB at December 31, 2009.





In 2009,
Union National raised $1,275,000 (prior to offering costs) through a preferred
stock private placement offering.  In 2008, $1,635,000 was obtained
(prior to offering costs), through a common stock private placement
offering.  Both of these private placement stock offerings are
discussed in Note 19 – Stock
Issued Under Private Placement Offerings and Dividend Reinvestment Plan
to the consolidated financial statements.





Union
National has obtained $17,341,000 of funding in the past through the issuance of
junior subordinated debentures as described in Note 11 – Junior Subordinated
Debentures to the consolidated financial statements.





78






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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, 2009 (in
thousands):





Less Than
                      1 Year
                    
                    
                    1-3
                      Years
                    
                    
                    4-5
                      Years
                    
                    
                    Over
                      5 Years
                    
                    
                    TotalTime
      Deposits
                    
                    $
                    117,543
                    
                    
                    $
                    63,735
                    
                    
                    $
                    10,949
                    
                    
                    $
                    81
                    
                    
                    $
                    192,308Long-Term
      Debt
                    
                    
                    12,500
                    
                    
                    
                    20,834
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    33,334Junior
      Subordinated Debentures
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    –
                    
                    
                    
                    17,341
                    
                    
                    
                    17,341Operating
      Leases
                    
                    
                    361
                    
                    
                    
                    811
                    
                    
                    
                    980
                    
                    
                    
                    2,932
                    
                    
                    
                    5,084Total
                    
                    $
                    130,404
                    
                    
                    $
                    85,380
                    
                    
                    $
                    11,929
                    
                    
                    $
                    20,354
                    
                    
                    $
                    248,067





In
addition, in the normal conduct of business operations, contracts for services
are routinely entered into.  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.  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.  Payments under this
contract amounted to $1,021,000 for the year ended December 31, 2009. 
Future payments under this contract will vary based on transaction and account
volumes and may also reflect inflationary cost adjustments.





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, which are discussed in Note 14 – Commitments, Guarantees
and Contingencies to the consolidated financial
statements.





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.





79






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, 2009 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 $237,140,000 as compared to cumulative rate-sensitive
liabilities of $299,510,000 for the one-year time frame.  Our cumulative
interest-sensitivity gap for the one-year time frame is a negative 12.7% of
total assets at December 31, 2009, as compared to a negative 3.5% at December
31, 2008.  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, 2009, with investment
securities presented at fair value, is as follows (dollars in
thousands):





1-90
                  Days
                
                
                91-365
                  Days
                
                
                1-5
                  Years
                
                
                Over
                  5 Years
                
                
                TotalInterest
      Earnings Assets:Interest-Bearing
      Deposits in Other Banks
                
                $
                35,758
                
                
                $
                3,134
                
                
                $
                4,870
                
                
                $
                –
                
                
                $
                43,762Investment
      Securities Available for Sale
                
                
                1,155
                
                
                
                4,701
                
                
                
                52,453
                
                
                
                2,237
                
                
                
                60,546Loans
      and Leases
                
                
                125,540
                
                
                
                66,852
                
                
                
                109,181
                
                
                
                37,701
                
                
                
                339,274Restricted
      Investments in Bank Stocks
                
                
                –
                
                
                
                –
                
                
                
                –
                
                
                
                3,727
                
                
                
                3,727Total
      Interest Earning Assets
                
                $
                162,453
                
                
                $
                74,687
                
                
                $
                166,504
                
                
                $
                43,665
                
                
                $
                447,309Interest
      Bearing Liabilities:Demand
      and Money Market Deposits
                
                $
                134,600
                
                
                $
                –
                
                
                $
                –
                
                
                $
                –
                
                
                $
                134,600Savings
                
                
                23,327
                
                
                
                199
                
                
                
                –
                
                
                
                –
                
                
                
                23,526Time
      Deposits
                
                
                45,412
                
                
                
                72,131
                
                
                
                74,684
                
                
                
                81
                
                
                
                192,308FHLB
      Advances and Other Borrowings
                
                
                11,341
                
                
                
                12,500
                
                
                
                26,834
                
                
                
                –
                
                
                
                50,675Total
      Interest Bearing Liabilities
                
                $
                214,680
                
                
                $
                84,830
                
                
                $
                101,518
                
                
                $
                81
                
                
                $
                401,109Gap
                
                $
                (52,227
                )
                
                $
                (10,143
                )
                
                $
                64,986
                
                
                $
                43,584Cumulative
      Gap
                
                $
                (52,227
                )
                
                $
                (62,370
                )
                
                $
                2,616
                
                
                $
                46,200Cumulative
      Sensitivity Gap as a Percent of Total Assets
                
                
                (10.7
                )%
                
                
                (12.7
                )%
                
                
                0.5
                %
                
                
                9.4
                %




80






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


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.





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, 2009 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 $20,000,000 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.





81




MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued






The
Bank’s net interest income and net income sensitivity analysis indicates that as
of December 31, 2009 and 2008, a hypothetical 2% (200 basis points) decline in
prevailing market interest rates would cause our net interest income to decline
16.8% and 12.2% 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, 2009 and 2008 would cause our net interest income to increase by
3.7% and 10.2% 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.  The following
table reflects the Bank’s net interest income and net income sensitivity
analysis as of December 31, 2009 and 2008:





Percent Change in CategoriesMarket Interest
                        Rate Increase of
                        2%
                      
                      
                      Market Interest
                        Rate Decline of
                        2%Net Interest Income:
                      
                      Policy Limit = Change in Net Interest
                        Income +/- Less Than 10%Hypothetical
      Percent Decrease in Net Interest Income from the Current Rate
      Scenario:As
      of December 31, 2009
                      
                      
                      3.7
                      %
                      
                      
                      (16.8
                      )%*As
      of December 31, 2008
                      
                      
                      10.2
                      %
                      
                      
                      (12.2
                      )%*Net
      Income:Hypothetical
      Percent Decrease from Prior Year's Net Income:As
      of December 31, 2009
                      
                      
                      26
                      %
                      
                      
                      (118
                      )%*As
      of December 31, 2008
                      
                      
                      221
                      %
                      
                      
                      (265
                      )%*





*   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 beyond December 31, 2009 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 increase the 2009 net loss and could offset the entire
portion of net income in 2008.





We
managed our interest rate risk position in 2009, and expect to continue to
manage our interest rate risk position going forward into 2010, by the
following:





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


·
            De-leveraging
      with repayment of higher-cost, fixed rate Federal Loan Home Bank (“FHLB”)
      long-term debt and brokered CDs;


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


·
            Repositioning
      of our investment security portfolio mix by purchasing lower-risk shorter
      term U.S. government agencies, and seasoned mortgage-backed securities,
      minimizing significant changes in value due to declining interest rates
      and improving the Bank’s regulatory capital ratios by reducing
      risk-weighted assets.





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





82






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


REGULATORY
MATTERS


From time
to time, various types of federal and state legislation have been proposed that
could result in additional regulation of, and restrictions on, the business of
Union National and the Bank.  As a consequence of the extensive
regulation of commercial banking activities in the United States, Union
National’s and the Bank’s business is particularly susceptible to being affected
by federal and state legislation and regulations that may increase the cost of
doing business (See the related discussion of the Emergency Economic
Stabilization Act of 2008 in the preceding Recent Developments
section).  Also, Union National is susceptible to changes in tax law
that may increase the cost of doing business or impact Union National’s ability
to realize the value of deferred tax assets. Further, the business of Union
National is affected by the state of the financial services industry in
general.





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




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




Separate
from the Agreement, the OCC has established individual minimum capital
requirements for the Bank requiring Tier 1 Capital to Average Total Assets of at
least eight percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine
and one-half percent (9.5%), and Total Capital to Risk-Based Assets of at least
twelve percent (12%) effective beginning September 30, 2009.  These
minimum capital ratios are similar to the capital ratio targets agreed to
between the Bank and the OCC under the MOU which were Tier I Capital to Average
Total Assets of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital
to Risk-Based Assets of 12%.  At December 31, 2009, the Bank’s measure
of Tier I Capital to Average Total Assets was 8.31%, Tier I Capital to
Risk-Based Assets of 9.69% and Total Capital to Risk-Based Assets of
12.37%.  At December 31, 2009, all three ratios exceeded the
respective OCC individual minimum capital requirements.  The Bank
capital ratios reflect the infusion of $700,000 of the $1,275,000 proceeds
raised in Union National’s preferred stock private placement.





In order
to maintain the Bank’s capital levels and to continue to meet the OCC’s
individual minimum capital requirement, Union National and the Bank may have to
raise additional capital, reduce its assets or both.  If the Bank does
not continue to meet the OCC’s requirements, the OCC could subject the Bank to
such administrative actions or sanctions as the OCC considers
necessary.





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





83






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


This
increased supervision by the OCC has negatively impacted our operating results
by increasing our FDIC base insurance premiums.  Based upon deposit
levels and the FDIC base insurance premium assessment criteria as of December
31, 2009, the additional FDIC premiums paid by the Bank as a result of the
increased supervision was approximately $207,000 for the year ended December 31,
2009.





Memorandum of Understanding with the
Federal Reserve Bank.  On January 28, 2010, Union National
entered into an informal Memorandum of Understanding with the
FRB.  Union National is the registered bank holding company that
wholly owns the Bank; however, the Bank subsidiary is separately supervised by
the Office of the Comptroller of the Currency.  The Memorandum of
Understanding, which is not a “written agreement” for purposes of Section 8 of
the Federal Deposit Insurance Act, requires, among other things, Union National
to seek prior approval by the FRB before (i) declaring or paying dividends to
stockholders, (ii) distributing interest, principal or other sums on Union
National’s subordinated debentures or trust preferred securities, and (iii)
incurring, increasing or guaranteeing any additional debt.  Subsequent
to December 31, 2009, the FRB did approve the quarterly interest payments for
the first quarter of 2010 on the UNCT I and UNCT II junior subordinated
debentures and the preferred stock dividend payments.





The Sarbanes-Oxley
Act.  The Sarbanes-Oxley Act, enacted in July 2002, represents
a comprehensive revision of laws affecting corporate governance, accounting
obligations and corporate reporting.  Many of the provisions of this
act had already been implemented by Union National, and Union National has
complied with the provisions of Section 404 of the Sarbanes-Oxley Act as
required during 2009, including providing a report on our internal control over
financial reporting as of December 31, 2009.  To support our report on
the internal control over financial reporting, we used contracted, independent
internal audit services to identify, document and test key controls over the
financial reporting process.





On
October 2, 2009, the U.S. Securities and Exchange Commission decided to extend
the deadline for small public companies (non-accelerated filers, defined
generally as companies with less than $75 million market capitalization) to file
their first auditor’s report on internal controls under Sarbanes-Oxley Section
404b.  Without the extension, Union National, being a small public
company, would have been required to file our first auditor’s report on the
effectiveness of internal control over financial reporting for the fiscal year
ending December 31, 2009.  Under the extension, the new deadline for
Union National to file our first auditor’s report on internal control will begin
for fiscal year ending December 31, 2010.





In 2009,
$10,000 of external audit costs were incurred prior to the extension being
granted, associated with complying with the provisions of
Sarbanes-Oxley.  Additional costs associated with this requirement are
expected to be $25,000 pre-tax for the year ended December 31,
2010.





Federal Deposit Insurance Corporation
Activity.  The Federal Deposit Insurance Reform Act of 2005
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, which
$150,000 and $78,000 of this credit was used in 2007and 2008,
respectively.





On
February 27, 2009, The Board of Directors of the FDIC voted to amend the
restoration plan for the Deposit Insurance Fund (“DIF”). The FDIC Board also
took action to ensure the continued strength of the insurance fund by imposing a
special assessment on insured institutions of 20 basis points, implementing
changes to the risk-based assessment system, and setting rates beginning the
second quarter of 2009.   Under the restoration plan approved in
October 2008, the FDIC Board set a rate schedule to raise the DIF reserve ratio
to 1.15 percent within five years. The February 27, 2009 restoration plan
amendment action extends the restoration plan horizon to seven years in
recognition of the current significant strains on banks and the financial system
and the likelihood of a severe recession.  The amended restoration
plan was accompanied by a final rule that sets assessment rates and makes
adjustments that improve how the assessment system differentiates for
risk.





84






MANAGEMENT’S
      DISCUSSION AND ANALYSIS  continued


Currently,
most banks are in the best risk category and pay anywhere from 12 cents per $100
of deposits to 14 cents per $100 for insurance. Under the final rule, banks in
this category will pay initial base rates ranging from 12 cents per $100 to 16
cents per $100 on an annual basis, beginning on April 1,
2009.  Changes to the assessment system include higher rates for
institutions that rely significantly on secured liabilities, which may increase
the FDIC’s loss in the event of failure without providing additional assessment
revenue. Under the final rule, assessments will be higher for institutions that
rely significantly on brokered deposits but, for well-managed and
well-capitalized institutions, only when accompanied by rapid asset growth.
Brokered deposits combined with rapid asset growth have played a role in a
number of costly failures, including recent failures. The final rule also would
provide incentives in the form of a reduction in assessment rates for
institutions to hold long-term unsecured debt and, for smaller institutions,
high levels of Tier 1 capital.





The FDIC
Board adopted an interim rule imposing an emergency special assessment on the
industry on June 30, 2009. The new FDIC emergency premium, to be collected from
all federally-insured institutions, will be 5 cents for every $100 of the Bank’s
assets minus its Tier 1, or regulatory capital, as of June 30,
2009.  The FDIC’s previous planned fee was 20 cents per $100 of the
Bank’s insured deposits.  For Union National, based upon the Bank’s
assets and Tier 1 capital position at June 30, 2009, the additional amount of
FDIC insurance expense related to this special assessment, was
$237,000.  The interim rule would also permit the FDIC Board to impose
a similar emergency special assessment after June 30, 2009, if necessary to
maintain public confidence in federal deposit insurance.  On November
12, 2009, the FDIC Board of Directors voted to require insured depository
institutions to prepay, on December 30, 2009, their estimated quarterly
risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011,
and 2012.  The FDIC Board also voted to adopt a uniform three basis
point increase in assessment rates effective on January 1, 2011.  As a
result, the Bank prepaid $3,400,000 and recorded the entire amount of its
assessment as a prepaid expense (asset) as of December 30, 2009.  As
of December 31, 2009, and each quarter thereafter, the Bank will record an
expense (charge to earnings) for its regular quarterly assessment and an
offsetting credit to the prepaid assessment until the asset is exhausted. Once
the asset is exhausted, the Bank will record an accrued expense payable each
quarter for the assessment payment, which would be paid in arrears to the FDIC
at the end of the following quarter. If the prepaid assessment is not exhausted
by December 31, 2014, any remaining amount would be returned to the
Bank.





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





Pennsylvania Business Corporation
Law.  Union National is subject to restrictions on the payment
of dividends to its stockholders pursuant to the Pennsylvania Business
Corporation Law of 1988, as amended (the “BCL”).  The BCL operates
generally to preclude dividend payments if the effect thereof would render us
insolvent.  Payment of dividends is contingent upon the 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 which requires the approval of the Office of the Comptroller
of the Currency if the total of all dividends declared by a national bank in any
calendar year exceeds the net profits of the Bank for that year (as defined)
combined with the Bank’s retained net operating results for the preceding two
calendar years.  Under this formula, the Bank’s retained net operating
results for the preceding two calendar years was ($189,000).  In 2010,
the Bank may declare dividends to the parent company, Union National, an amount
equal to the net profits of the Bank in 2010 less $189,000, up to the date of
any such dividend declaration.





85






STOCK
      PERFORMANCE GRAPH


The
following graph shows the yearly percentage change in Union National’s
cumulative total stockholder return on its common stock from December 31,
2004 to December 31, 2009 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 Corporation, First Chester County
Corporation, VIST Financial Corp., Franklin Financial Services Corporation, ENB
Financial Corp., Orrstown Financial Services, Inc., DNB Financial Corporation,
Juniata Valley Financial Corp., Mid Penn Bancorp, Inc., Codorus Valley Bancorp,
Inc., and Tower Bancorp, Inc.





Union
National Financial Corporation











Period EndingIndex
                
                12/31/04
                
                
                12/31/05
                
                
                12/31/06
                
                
                12/31/07
                
                
                12/31/08
                
                
                12/31/09Union
      National Financial Corporation
                
                
                100.00
                
                
                
                86.14
                
                
                
                73.22
                
                
                
                45.63
                
                
                
                20.00
                
                
                
                12.50NASDAQ
      Composite
                
                
                100.00
                
                
                
                101.37
                
                
                
                111.03
                
                
                
                121.92
                
                
                
                72.49
                
                
                
                104.31Mid-Atlantic
      Custom Peer Group(1)
                
                
                100.00
                
                
                
                100.01
                
                
                
                102.06
                
                
                
                95.05
                
                
                
                75.16
                
                
                
                70.20Custom
      Peer Group(2)
                
                
                100.00
                
                
                
                93.17
                
                
                
                98.02
                
                
                
                89.16
                
                
                
                67.28
                
                
                
                65.13





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





(2)
            Custom
      Peer Group index consists of ACNB Corporation, First Chester County
      Corporation, VIST Financial Corp.,


Franklin
Financial Services Corporation, ENB Financial Corp., Orrstown Financial
Services, Inc.,


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


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




86




SELECTED
      FINANCIAL DATA
  (In
thousands, except per share data)


Years Ended December 31,2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005Statement
      of Financial ConditionLoans
      and Leases
                  
                  $
                  339,274
                  
                  
                  $
                  358,280
                  
                  
                  $
                  364,337
                  
                  
                  $
                  341,113
                  
                  
                  $
                  300,213Investment
      Securities
                  
                  
                  60,546
                  
                  
                  
                  64,289
                  
                  
                  
                  74,176
                  
                  
                  
                  129,810
                  
                  
                  
                  119,702Total
      Earning Assets
                  
                  
                  447,309
                  
                  
                  
                  442,263
                  
                  
                  
                  463,347
                  
                  
                  
                  478,912
                  
                  
                  
                  427,982Total
      Assets
                  
                  
                  489,644
                  
                  
                  
                  485,109
                  
                  
                  
                  501,776
                  
                  
                  
                  517,597
                  
                  
                  
                  462,178Deposits
                  
                  
                  404,765
                  
                  
                  
                  383,577
                  
                  
                  
                  376,311
                  
                  
                  
                  340,075
                  
                  
                  
                  296,610Short-Term
      Borrowings
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  6,629
                  
                  
                  
                  10,544
                  
                  
                  
                  18,305Long-Term
      Debt
                  
                  
                  33,334
                  
                  
                  
                  50,334
                  
                  
                  
                  68,816
                  
                  
                  
                  117,571
                  
                  
                  
                  105,815Junior
      Subordinated Debentures
                  
                  
                  17,341
                  
                  
                  
                  17,341
                  
                  
                  
                  17,341
                  
                  
                  
                  17,341
                  
                  
                  
                  11,341Stockholders’
      Equity
                  
                  
                  31,336
                  
                  
                  
                  30,794
                  
                  
                  
                  28,800
                  
                  
                  
                  28,548
                  
                  
                  
                  27,225Statement
      of OperationsInterest
      Income
                  
                  $
                  23,758
                  
                  
                  $
                  28,173
                  
                  
                  $
                  31,373
                  
                  
                  $
                  30,290
                  
                  
                  $
                  23,978Interest
      Expense
                  
                  
                  11,286
                  
                  
                  
                  13,579
                  
                  
                  
                  16,009
                  
                  
                  
                  15,626
                  
                  
                  
                  9,662Net
      Interest Income
                  
                  
                  12,472
                  
                  
                  
                  14,594
                  
                  
                  
                  15,364
                  
                  
                  
                  14,664
                  
                  
                  
                  14,316Provision
      for Credit Losses
                  
                  
                  2,627
                  
                  
                  
                  1,027
                  
                  
                  
                  1,237
                  
                  
                  
                  672
                  
                  
                  
                  681Net
      Interest Income after Provisionfor
      Credit Losses
                  
                  
                  9,845
                  
                  
                  
                  13,567
                  
                  
                  
                  14,127
                  
                  
                  
                  13,992
                  
                  
                  
                  13,635Non-Interest
      Income
                  
                  
                  5,375
                  
                  
                  
                  3,807
                  
                  
                  
                  6,509
                  
                  
                  
                  8,262
                  
                  
                  
                  6,011Non-Interest
      Expense
                  
                  
                  16,737
                  
                  
                  
                  17,118
                  
                  
                  
                  20,745
                  
                  
                  
                  19,711
                  
                  
                  
                  15,627(Loss)
      Income before Income Taxes (Benefit)
                  
                  
                  (1,517
                  )
                  
                  
                  256
                  
                  
                  
                  (109
                  )
                  
                  
                  2,543
                  
                  
                  
                  4,019(Benefit
      from) Provision for Income Taxes
                  
                  
                  (802
                  )
                  
                  
                  (188
                  )
                  
                  
                  (421
                  )
                  
                  
                  99
                  
                  
                  
                  666Net
      (Loss) Income
                  
                  $
                  (715
                  )
                  
                  $
                  444
                  
                  
                  $
                  312
                  
                  
                  $
                  2,444
                  
                  
                  $
                  3,353Share
      InformationAverage
      Shares Outstanding – Diluted
                  
                  
                  2,730
                  
                  
                  
                  2,643
                  
                  
                  
                  2,544
                  
                  
                  
                  2,537
                  
                  
                  
                  2,556(Loss)
      Earnings Per Common Share – Diluted
                  
                  $
                  (0.26
                  )
                  
                  $
                  0.17
                  
                  
                  $
                  0.12
                  
                  
                  $
                  0.96
                  
                  
                  $
                  1.31Cash
      Dividends Per Common Share
                  
                  $
                  –
                  
                  
                  $
                  –
                  
                  
                  $
                  0.280
                  
                  
                  $
                  0.620
                  
                  
                  $
                  0.625Average
      Balance SheetLoans
      and Leases
                  
                  $
                  350,307
                  
                  
                  $
                  369,554
                  
                  
                  $
                  357,795
                  
                  
                  $
                  318,251
                  
                  
                  $
                  280,245Investment
      Securities
                  
                  
                  68,261
                  
                  
                  
                  69,618
                  
                  
                  
                  73,589
                  
                  
                  
                  129,413
                  
                  
                  
                  110,440Other
      Earning Assets
                  
                  
                  47,570
                  
                  
                  
                  13,110
                  
                  
                  
                  13,510
                  
                  
                  
                  6,482
                  
                  
                  
                  5,982Total
      Assets
                  
                  
                  502,273
                  
                  
                  
                  488,718
                  
                  
                  
                  480,401
                  
                  
                  
                  489,884
                  
                  
                  
                  425,611Deposits
                  
                  
                  361,195
                  
                  
                  
                  374,694
                  
                  
                  
                  351,750
                  
                  
                  
                  316,402
                  
                  
                  
                  282,934Short-Term
      Borrowings
                  
                  
                  –
                  
                  
                  
                  9,090
                  
                  
                  
                  6,025
                  
                  
                  
                  9,790
                  
                  
                  
                  7,584Long-Term
      Debt
                  
                  
                  40,386
                  
                  
                  
                  54,501
                  
                  
                  
                  72,586
                  
                  
                  
                  119,326
                  
                  
                  
                  94,474Junior
      Subordinated Debentures
                  
                  
                  17,341
                  
                  
                  
                  17,341
                  
                  
                  
                  17,341
                  
                  
                  
                  13,922
                  
                  
                  
                  11,341Stockholders’
      Equity
                  
                  
                  31,602
                  
                  
                  
                  30,047
                  
                  
                  
                  29,065
                  
                  
                  
                  27,754
                  
                  
                  
                  26,621Financial
      RatiosReturn
      on Average Assets
                  
                  
                  (0.14
                  )%
                  
                  
                  0.09
                  %
                  
                  
                  0.06
                  %
                  
                  
                  0.50
                  %
                  
                  
                  0.79
                  %Return
      on Average Stockholders’ Equity
                  
                  
                  (2.26
                  )%
                  
                  
                  1.48
                  %
                  
                  
                  1.07
                  %
                  
                  
                  8.81
                  %
                  
                  
                  12.59
                  %Return
      on Average Realized Stockholders’ Equity (1)
                  
                  
                  (2.27
                  )%
                  
                  
                  1.44
                  %
                  
                  
                  1.08
                  %
                  
                  
                  8.55
                  %
                  
                  
                  12.64
                  %Dividend
      Payout Ratio
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  227.24
                  %
                  
                  
                  63.83
                  %
                  
                  
                  47.00
                  %Average
      Stockholders’ Equity to Average Assets
                  
                  
                  6.29
                  %
                  
                  
                  6.15
                  %
                  
                  
                  6.05
                  %
                  
                  
                  5.67
                  %
                  
                  
                  6.25
                  %





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





87






SUMMARY
      OF QUARTERLY FINANCIAL DATA
  (In
thousands, except per share data)
  The
unaudited quarterly results of operations for the years ended December 31, 2009
and 2008 are as follows:


2009
                                
                                
                                20081st
                                  Qtr
                                
                                
                                2nd
                                  Qtr
                                
                                
                                3rd
                                  Qtr
                                
                                
                                4th
                                  Qtr
                                
                                
                                1st
                                  Qtr
                                
                                
                                2nd
                                  Qtr
                                
                                
                                3rd
                                  Qtr
                                
                                
                                4th
                                  QtrInterest
      Income
                                
                                $
                                6,049
                                
                                
                                $
                                5,997
                                
                                
                                $
                                6,052
                                
                                
                                $
                                5,660
                                
                                
                                $
                                7,337
                                
                                
                                $
                                7,032
                                
                                
                                $
                                7,037
                                
                                
                                $
                                6,767Interest
      Expense
                                
                                
                                3,178
                                
                                
                                
                                2,945
                                
                                
                                
                                2,691
                                
                                
                                
                                2,472
                                
                                
                                
                                3,903
                                
                                
                                
                                3,341
                                
                                
                                
                                3,197
                                
                                
                                
                                3,138Net
      Interest Income
                                
                                
                                2,871
                                
                                
                                
                                3,052
                                
                                
                                
                                3,361
                                
                                
                                
                                3,188
                                
                                
                                
                                3,434
                                
                                
                                
                                3,691
                                
                                
                                
                                3,840
                                
                                
                                
                                3,629Provision
      for Credit Losses
                                
                                
                                313
                                
                                
                                
                                611
                                
                                
                                
                                522
                                
                                
                                
                                1,181
                                
                                
                                
                                140
                                
                                
                                
                                139
                                
                                
                                
                                47
                                
                                
                                
                                701Net
      Interest Income after Provision for Credit Losses
                                
                                
                                2,558
                                
                                
                                
                                2,441
                                
                                
                                
                                2,839
                                
                                
                                
                                2,007
                                
                                
                                
                                3,294
                                
                                
                                
                                3,552
                                
                                
                                
                                3,793
                                
                                
                                
                                2,928Non-Interest
      Income (excluding securities activities)
                                
                                
                                1,047
                                
                                
                                
                                1,517
                                
                                
                                
                                1,200
                                
                                
                                
                                1,274
                                
                                
                                
                                1,221
                                
                                
                                
                                1,224
                                
                                
                                
                                1,230
                                
                                
                                
                                1,170Net
      Investment Securities Gains (Losses)
                                
                                
                                (428
                                )
                                
                                
                                521
                                
                                
                                
                                227
                                
                                
                                
                                17
                                
                                
                                
                                191
                                
                                
                                
                                10
                                
                                
                                
                                (42
                                )
                                
                                
                                (1,197
                                )Non-Interest
      Expense
                                
                                
                                4,014
                                
                                
                                
                                4,480
                                
                                
                                
                                4,167
                                
                                
                                
                                4,076
                                
                                
                                
                                4,186
                                
                                
                                
                                4,430
                                
                                
                                
                                4,141
                                
                                
                                
                                4,361(Loss)
      Income before Income Taxes (Benefit)
                                
                                
                                (837
                                )
                                
                                
                                (1
                                )
                                
                                
                                99
                                
                                
                                
                                (778
                                )
                                
                                
                                520
                                
                                
                                
                                356
                                
                                
                                
                                840
                                
                                
                                
                                (1,460
                                )(Benefit
      from) Provision for Income Taxes
                                
                                
                                (328
                                )
                                
                                
                                (106
                                )
                                
                                
                                (48
                                )
                                
                                
                                (320
                                )
                                
                                
                                107
                                
                                
                                
                                52
                                
                                
                                
                                214
                                
                                
                                
                                (561
                                )Net
      (Loss) Income
                                
                                $
                                (509
                                )
                                
                                $
                                105
                                
                                
                                $
                                147
                                
                                
                                $
                                (458
                                )
                                
                                $
                                413
                                
                                
                                $
                                304
                                
                                
                                $
                                626
                                
                                
                                $
                                (899
                                )(Loss)
      Earnings Per Common Share:Basic
                                
                                $
                                (0.19
                                )
                                
                                $
                                0.04
                                
                                
                                $
                                0.05
                                
                                
                                $
                                (0.16
                                )
                                
                                $
                                0.16
                                
                                
                                $
                                0.12
                                
                                
                                $
                                0.23
                                
                                
                                $
                                (0.33
                                )Diluted
                                
                                
                                (0.19
                                )
                                
                                
                                0.04
                                
                                
                                
                                0.05
                                
                                
                                
                                (0.16
                                )
                                
                                
                                0.16
                                
                                
                                
                                0.12
                                
                                
                                
                                0.23
                                
                                
                                
                                (0.33
                                )





Note:  Due
to rounding, 2008 quarterly (loss) earnings per share do not add up to 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 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.





2009
                  
                  
                  2008First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    Quarter
                  
                  
                  First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    QuarterHigh
                  
                  $
                  5.00
                  
                  
                  $
                  5.00
                  
                  
                  $
                  6.10
                  
                  
                  $
                  4.25
                  
                  
                  $
                  11.50
                  
                  
                  $
                  10.20
                  
                  
                  $
                  9.15
                  
                  
                  $
                  8.50Low
                  
                  
                  3.51
                  
                  
                  
                  3.50
                  
                  
                  
                  3.20
                  
                  
                  
                  2.82
                  
                  
                  
                  9.40
                  
                  
                  
                  9.05
                  
                  
                  
                  5.26
                  
                  
                  
                  4.76Dividends
      Paid
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –
                  
                  
                  
                  –





Union
National had approximately 1,445 stockholders (including stockholders of record
and individual participants in security position listings) at December 31, 2009,
and approximately 1,351 stockholders at December 31, 2008.





88