Management’s
Discussion and Analysis of Financial Condition and Results of Operations
analyzes the major elements of our consolidated balance sheets and statements of
income. This section should be read in conjunction with our consolidated
financial statements and accompanying notes.
  Executive
Summary
  2008 was
the most profitable year in the history of Pennsylvania Commerce Bancorp (the
Company) and its wholly owned subsidiary Commerce Bank/Harrisburg (Commerce
Bank).  Our focus on community banking produced an 84% increase in net
income, driven by a 16% increase in core commercial and consumer deposits and a
24% increase in net loans as we continued to support the credit needs of our
communities.  We were able to achieve this record profitability while
at the same time increasing our allowance for loan losses by $6.0 million, or
56%, in 2008. We did not participate in sub prime lending and our overall asset
quality remained sound despite the distressed economic conditions.
   On
November 10, 2008, we announced that we entered into a plan of merger, to
acquire Republic First Bancorp, Inc. (“Republic First”) headquartered in
Philadelphia, PA.  Republic First, with total assets of approximately
$952.0 million as of December 31, 2008, will be merged with and into
Pennsylvania Commerce and the combined company will be renamed Metro Bancorp,
Inc.  This transaction is expected to close in the second quarter
2009, subject to regulatory and shareholder approval for both
companies.
  2008 was
also our last year under the Commerce Bank network as we embark on an exciting
new plan to expand into the metro Philadelphia market. In 2009 Commerce Bank
will become Metro Bank as we acquire Republic First and
rebrand.  The new company will have $3.1 billion in assets and 45
offices in Pennsylvania and New Jersey.  Also, in 2009, we will begin
an exciting new expansion of stores, based on our successful service and
convenience model as we create:  “America’s Next Great Bank”, with
unlimited potential.
  On
December 30, 2008, we entered into a Transition Agreement with TD Bank, N.A. and
Commerce Bancorp, LLC (formerly Commerce Bancorp, Inc.) which terminates the
Network Agreement and Master Services Agreement between the Company and TD Bank
for data processing, item processing, branding and other ancillary
services.  If all services are transitioned away from TD Bank by July
15, 2009, Commerce Bank will receive a fee of $6 million from TD Bank which will
substantially defray the costs of our first year obligation of approximately
$6.3 million to transition to the new service provider, Fiserv Solutions,
Inc.  See Note 19 in the Notes to the Consolidated Financial
Statementsfor the year ended December 31, 2008 for additional discussion
regarding the Transition Agreement.
  Additional
2008 highlights are summarized below.
   ● For the
fifth straight year, Commerce Bank was voted Best Bank by the Harrisburg
Magazine Simply the Best Readers’ Poll.
  ● Total
revenues increased 27% over the previous year to a total of $104.1
million.
  ● Net
income totaled $12.9 million, up $5.9 million, or 84%, over 2007.
  ● Diluted
net income per share for 2008 was $1.97, up $0.90, or 84%, over the prior
year.
  ● Our net
interest margin for the year 2008 improved 79 basis points from 3.30% to
4.09%.
  ● Total
assets reached $2.14 billion.
  ● In this
extremely difficult credit environment, our net loans grew $276 million, or
24%.
  ● Core
deposits, excluding government deposits, increased 16% in 2008.
  ● Total
deposits now exceed $1.6 billion.
  ● Both
the Company and its subsidiary bank continue to be “well-capitalized”
institutions under various regulatory capital guidelines as required by federal
banking agencies.
   During
2008, our total assets grew by $161.5 million from $1.98 billion at December 31,
2007 to $2.14 billion as of December 31, 2008. During this same time period,
interest earning assets (primarily loans and investments) increased by $180
million from $1.84 billion to $2.02 billion.
  During
2008, our total net loans (including loans held for sale) increased 26% in going
from $1.16 billion at December 31, 2007 to $1.46 billion at December 31,
2008. This growth was primarily in commercial real estate, tax exempt and
consumer loans as well as commercial lines of credit. Commerce Bank continues to
be the premier provider of business and personal loans throughout our footprint.
Our experienced calling officers and lending management team have continued to
take advantage of the bank mergers and poor financial performance of many of our
competitors by gathering both customers and skilled employees from those
affected institutions.  At the same time, Commerce Bank has avoided
the pitfalls of poor performance caused by sub-prime lending, out-of market
lending and indirect lending.  At Commerce Bank, we focus on
face-to-face relationship lending with creditworthy individuals
  1
  and
businesses within our market footprint, thereby preserving shareholder return
with strong asset quality.
  Total
deposits increased from $1.56 billion at December 31, 2007 to $1.63 billion at
December 31, 2008. In 2008, we again made a strategic decision not to match the
unusually “high rate” deposit pricing on deposits offered by most other banks in
our footprint. As a result, our deposit growth was somewhat below our historical
norm. Our pricing discipline served to stabilize and lower our overall cost of
funds. In turn, this provided us with increased net interest income and an
improved net interest margin throughout 2008.
  Net
income totaled $12.9 million for 2008, reflecting significant improvement over
the $7.0 million recorded in 2007 and diluted net income per share was $1.97 vs.
$1.07 for the prior year. The increase was primarily due to the significant
reduction in funding costs and steady improvement in noninterest income offset
by an increased provision for loan losses and a higher level of noninterest
expenses.  The increased levels of expenses were primarily due to the
following: a full year worth of expenses associated with the three new stores we
opened during the second half of 2007; costs associated with planning and
training for the conversion of a multitude of services from TD Bank to our new
provider; and costs associated with consummating the acquisition of Republic
First.
  Key
financial highlights for 2008 compared to 2007 are summarized in the following
table.
  December
      31,
                                            
                                            
                                            %2008
                                            
                                            
                                            2007
                                            
                                            
                                            ChangeTotal
      Assets
                                            
                                            $
                                            2,140.5
                                            
                                            
                                            $
                                            1,979.0
                                            
                                            
                                            
                                            8
                                            %Total
      Loans (Net)
                                            
                                            
                                            1,423.1
                                            
                                            
                                            
                                            1,146.6
                                            
                                            
                                            
                                            24Total
      Deposits
                                            
                                            
                                            1,634.0
                                            
                                            
                                            
                                            1,560.9
                                            
                                            
                                            
                                            5
 December
      31,
                                                              
                                                              
                                                              %2008
                                                              
                                                              
                                                              2007
                                                              
                                                              
                                                              Change(dollars in millions, except
      per share data)Total
      Revenues
                                                              
                                                              $
                                                              104.1
                                                              
                                                              
                                                              $
                                                              82.3
                                                              
                                                              
                                                              
                                                              27
                                                              %Net
      Income
                                                              
                                                              
                                                              12.9
                                                              
                                                              
                                                              
                                                              7.0
                                                              
                                                              
                                                              
                                                              84Diluted
      Net Income

                                                                per
      Share
                                                              
                                                              
                                                              1.97
                                                              
                                                              
                                                              
                                                              1.07
                                                              
                                                              
                                                              
                                                              84
  In the
future we expect that we will continue our pattern of expanding our footprint
not only with the aforementioned acquisition of Republic First but also by
branching into contiguous areas of our new and existing markets, and by filling
gaps between existing store locations. Accordingly, we anticipate notable
balance sheet and revenue growth as a result of the expansion. Additionally, we
expect to incur direct acquisition expenses as we consummate the merger with
Republic First including expenses to combine the operations of the two
companies. We also anticipate that the upcoming core system conversion and
re-branding initiative will result in significant increased levels of expense.
We anticipate that these initiatives will primarily be funded through cash
generated from operations, our existing funding sources and the $6 million fee
to be received from TD Bank if all services are transitioned away by July 15,
2009. Operating results for 2009 and the years that follow could also be heavily
impacted by the overall state of the local and global economy.  The Bank,
like all financial institutions whose deposits areguaranteed
by the Federal Deposit Insurance Corporation, (“FDIC”),pays a
quarterly premium to the FDIC for such deposit insurancecoverage.
The premium rates paid by the Bank were the same for both2008 and
2007.  For 2009, the FDIC has increased these ratessignificantly
over the prior years.  The new rates, as currently ineffect,
are projected to increase the Bank's expense for suchcoverage
by $1.3 million over the level incurred in 2008.  The FDIChas
further announced its intention to assess a one-time emergencydeposit
premium fee on all covered institutions during the thirdquarter
of 2009 to bolster the level of Deposit Insurance Fundsavailable
to cover possible future bank failures.  The proposal toassess
such a fee is currently open for public comment as of the dateof this
document.Continued poor economic conditions could lead to
deterioration in the credit quality of our loan portfolio, declines in
investment values, and lower loan demand.
  Application
of Critical Accounting Policies
  Our
accounting policies are fundamental to understanding Management’s Discussion and
Analysis of Financial Condition and Results of Operations. Our accounting
policies are more fully described in Note 1 of the Notes to Consolidated Financial
Statements for December 31, 2008 included herein. Our consolidated
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. These principles require our
management to make estimates and assumptions about future events that affect the
amounts reported in our consolidated financial statements and accompanying
notes. Since future events and their effects cannot be determined with absolute
certainty, actual results may differ from those estimates. Management makes
adjustments to its assumptions and estimates when facts and circumstances
dictate. We evaluate our estimates and assumptions on an ongoing basis and
predicate those estimates and assumptions on historical experience and on
various other factors that are believed to be reasonable under the
circumstances. Management believes the following critical accounting policies
encompass the more significant assumptions and estimates used in preparation of
our consolidated financial statements.
  Allowance for Loan Losses.
The allowance for loan losses represents the amount available for estimated
probable losses existing in our loan portfolio. While the allowance for loan
losses is maintained at a level believed to be adequate by management for
estimated losses in the loan portfolio, the determination of the allowance is
inherently subjective, as it involves significant estimates by management, all
of which may be susceptible to significant change.
  While
management uses available information to make such evaluations, future
adjustments to the allowance and the provision for loan losses may be necessary
if economic conditions or loan credit quality differ from the estimates and
assumptions used in making the evaluations. The use of different assumptions
could materially impact the level of the allowance for loan losses and,
therefore, the
  2
  provision
for loan losses to be charged against earnings. Such changes could impact future
results.
  Monthly,
systematic reviews of our loan portfolio are performed to identify inherent
losses and assess the overall probability of collection. These reviews include
an analysis of historical default and loss experience, which results in the
identification and quantification of loss factors. These loss factors are used
in determining the appropriate level of allowance to cover the estimated
probable losses existing in specific loan types. Management judgment involving
the estimates of loss factors can be impacted by many variables, such as the
number of years of actual default and loss history included in the evaluation
and the volatility of forecasted net credit losses.
  The
methodology used to determine the appropriate level of the allowance for loan
losses and related provisions differs for commercial and consumer loans, and
involves other evaluations. In addition, significant estimates are made in the
determination of the appropriate level of allowance related to impaired loans.
The portion of the allowance related to impaired loans is based on discounted
cash flows using the loan’s effective interest rate, or the fair value of the
collateral for collateral-dependent loans, or the observable market price of the
impaired loan. Each of these variables involves judgment and the use of
estimates.
  In
addition to calculating and testing of loss factors, we periodically evaluate
changes in levels and trends of charge-offs, delinquencies and nonaccrual loans,
trends in the volume and the term of loans, changes in underwriting standards
and practices, tenure of the loan officers and management, changes in credit
concentrations, and national and local economic trends and conditions, among
other things. Management judgment is involved at many levels of these
evaluations.
  An
integral aspect of our risk management process is allocating the allowance for
loan losses to various components of the loan portfolio based upon an analysis
of risk characteristics, demonstrated losses, industry and other segmentations,
and other more judgmental factors, including historical or forecasted net credit
losses.
   Other than Temporary Impairment of
Investment Securities. We perform periodic reviews of the fair value of
the securities in the Company’s investment portfolio and evaluate individual
securities for declines in fair value that may be other than temporary. If
declines are deemed other than temporary, an impairment loss is recognized
against earnings and the security is written down to its current fair
value.
   In
estimating other-than-temporary impairment losses, management considers (1)
adverse changes in the general market condition of the industry in which the
investment is related, (2) the financial condition and near-term prospects of
the issuer, (3) the seniority of the tranche owned by the Bank in relation to
the entire bond issue, (4) current prepayment behavior, (5) current credit
agency ratings, (6) the credit support available in the bond structure to absorb
losses, and (7) each of the following with respect to the underlying collateral:
(a) delinquency percentages and trends, (b) weighted average loan-to-value
ratios, (c) weighted average FICO scores, and (d) the level of foreclosure and
OREO activity. Also considered is the intent and ability of the Company to
retain its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value.
   Stock-Based Compensation.
Effective January 1, 2006, the Company adopted Financial Accounting Standards
Board (FASB) Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) using
the modified prospective method. FAS 123(R) requires compensation costs related
to share-based payment transactions to be recognized in the income statement
(with limited exceptions) based on the grant-date fair value of the stock-based
compensation issued. Compensation costs are recognized over the period that an
employee provides service in exchange for the award.   The
grant-date fair value and ultimately the amount of compensation expense
recognized is dependent upon certain assumptions we make such as the expected
term the options will remain outstanding, the volatility and dividend yield of
our company stock and risk free interest rate.
   Adoption of SFAS No.
157.  Beginning in 2008, the Company is required to disclose
the fair value of financial assets and liabilities that are measured at fair
value within the fair value hierarchy prescribed by SFAS No. 157.
The  fair value hierarchy prioritizes the inputs to valuation
techniques used to measure fair value, giving the highest priority to unadjusted
quoted prices in active markets for identical assets or liabilities (level 1
measurement) and the lowest priority to unobservable inputs (level 3
measurements). These disclosures appear in Note 20 of the Notes to Consolidated Financial
Statements for the year ended December 31, 2008. Judgment is involved not
only with deriving the estimated fair values but also with classifying the
particular assets recorded at fair value in the fair value
hierarchy.  Estimating the fair value of impaired loans or the value
of collateral securing foreclosed assets requires the use of significant
unobservable inputs (level 3 measurements). At December 31, 2008, the fair value
of assets based on level 3 measurements constituted 3% of the total assets
measured at fair value. The fair value of collateral securing impaired loans or
constituting foreclosed assets is generally determined based upon independent
third party appraisals of the properties, recent offers, or prices on comparable
properties in the proximate vicinity.  Such estimates can differ
significantly from the amounts the Company would ultimately realize from the
loan or disposition of underlying collateral.
   The
Company’s available for sale investment security portfolio constitutes 97% of
the total assets measured at fair value and is primarily classified as a level 2
fair value measurement (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). Management utilizes third party service
providers to aid in the determination of the fair value of the portfolio. If
quoted market prices are not available, fair values are generally based on
quoted market prices of comparable instruments. Securities that are debenture
bonds and pass through mortgage backed investments that are not quoted on an
exchange, but are traded in active markets, were obtained from matrix pricing on
similar securities.
  3
  Results
of Operations
  Average
Balances and Average Interest Rates
  Table 1
on the following page sets forth balance sheet items on a daily average basis
for the years ended December 31, 2008, 2007 and 2006 and presents the daily
average interest rates earned on assets and the daily average interest rates
paid on liabilities for such periods. During 2008, average interest-earning
assets were $1.90 billion, an increase of $121.2 million, or 7%, over 2007. This
was the result of an increase in the average balance of loans receivable
(including loans held for sale) of $240.3 million, offset by a decrease in the
average balance of investment securities of $119.2 million. The growth in the
average balance of interest earning assets was funded primarily by an increase
in the average balance of noninterest bearing funds (net) of $34.2 million, an
increase in the average level of short-term borrowings of $57.4 million and an
increase in the average level of long-term borrowings of $30.9
million.
  The
tax-equivalent yield on total interest-earning assets decreased by 64 basis
points, from 6.53% in 2007 to 5.89% in 2008.  This decrease resulted
from lower yields on our securities and loan portfolios during 2008.
Approximately 20% of our investment securities have a floating interest rate and
provide a yield that consists of a fixed spread tied to the one month LIBOR
interest rate. During 2008, the average one-month LIBOR decreased approximately
258 bps from 5.25% during 2007 to 2.67% for 2008.  Likewise, yields
received on any new investment securities purchased in 2008 were lower than
yields received on the existing portfolio due to the overall lower level of
market interest rates in 2008 vs. prior years. Floating rate loans represent
approximately 38% of our total loans receivable portfolio. The interest rates
charged on the majority of these loans are tied to the New York prime lending
rate which decreased 100 bps during the second half of 2007 and subsequently
decreased another 400 bps during 2008, following similar decreases in the
overnight federal funds rate by the Federal Open Market Committee
(“FOMC”).
   As a
result of the extremely low level of current general market interest rates,
including the one-month LIBOR and the New York prime lending rate, we expect the
yields we receive on our interest-earning assets will be lower in 2009 than in
2008.
   The
aggregate cost of interest-bearing liabilities decreased 168 basis points from
3.66% in 2007 to 1.98% in 2008.  Our deposit cost of funds decreased
from 2.37% in 2007 to 1.17% for 2008. The dramatic decreases are primarily
related to the lower level of general market interest rates present during 2008
compared to in 2007. At December 31, 2008, approximately 36% of our total
deposits were those of local municipalities, school districts, not-for-profit
organizations or corporate cash management customers, indexed to either the
91-day Treasury bill, the overnight federal funds rate, or the one-month LIBOR.
The average interest rate of the 91-day Treasury bill decreased from 4.31% for
2007 to 1.35% in 2008 thereby significantly reducing the average interest rate
paid on these deposits. Also, the overnight federal funds rate decreased by 400
basis points in 2008 from 4.25% to 0.25%. The average rate paid on savings
deposits decreased by 131 basis points from 2.41% in 2007 to 1.10% in 2008. The
average rate paid on interest checking and money market accounts decreased by
194 basis points from 3.47% to 1.53%. For time deposits, the average rate paid
in 2008 was 3.52%, down 68 basis points from 4.20% in 2007 and the rate on
public fund time deposits decreased by 119 basis points in 2008 from 4.91% to
3.72%.
  Our
aggregate cost of nondeposit funding sources decreased 261 basis points in 2008
to 2.96% from 5.57% in 2007.  The decrease is primarily related to a
314 basis point decline in the average cost of short-term borrowings, another
result of the steep decline of general market interest rates in 2008. While the
average rate paid on long-term debt decreased slightly, the average outstanding
balance increased in 2008 to include the full impact of Federal Home Loan Bank
convertible select borrowings taken out in 2007. See the Long-Term Debt section
later in this Management’s Discussion and Analysis of Financial Condition and
Results of Operations for further discussion regarding the convertible select
borrowings.
  In Table
1, nonaccrual loans have been included in the average loan balances. Securities
include securities available for sale and securities held to maturity.
Securities available for sale are carried at amortized cost for purposes ofcalculating the average
rate received on taxable securities. Yields on tax-exempt securities and loans
are computed on a tax-equivalent basis, assuming a 35% tax rate for the years
ending 2008 and 2006 and assuming a 34% tax rate for the year ending
2007.
   4
 TABLE 1
 Years
      Ended December 31,(dollars
      in thousands)
                                                        
                                                        2008
                                                        
                                                        
                                                        2007
                                                        
                                                        
                                                        2006Earning
      Assets
                                                        
                                                        Average
      Balance
                                                        
                                                        
                                                        Interest
                                                        
                                                        
                                                        Average
                                                          Rate
                                                        
                                                        
                                                        Average
      Balance
                                                        
                                                        
                                                        Interest
                                                        
                                                        
                                                        Average
                                                          Rate
                                                        
                                                        
                                                        Average
                                                          Balance
                                                        
                                                        
                                                        Interest
                                                        
                                                        
                                                        Average
                                                          RateSecurities:Taxable
                                                        
                                                        $
                                                        575,402
                                                        
                                                        
                                                        $
                                                        28,401
                                                        
                                                        
                                                        
                                                        4.94
                                                        %
                                                        
                                                        $
                                                        694,575
                                                        
                                                        
                                                        $
                                                        37,060
                                                        
                                                        
                                                        
                                                        5.34
                                                        %
                                                        
                                                        $
                                                        733,990
                                                        
                                                        
                                                        $
                                                        38,845
                                                        
                                                        
                                                        
                                                        5.29
                                                        %Tax-exempt
                                                        
                                                        
                                                        1,622
                                                        
                                                        
                                                        
                                                        101
                                                        
                                                        
                                                        
                                                        6.23
                                                        
                                                        
                                                        
                                                        1,620
                                                        
                                                        
                                                        
                                                        99
                                                        
                                                        
                                                        
                                                        6.11
                                                        
                                                        
                                                        
                                                        1,985
                                                        
                                                        
                                                        
                                                        130
                                                        
                                                        
                                                        
                                                        6.55Total
      securities
                                                        
                                                        
                                                        577,024
                                                        
                                                        
                                                        
                                                        28,502
                                                        
                                                        
                                                        
                                                        4.94
                                                        
                                                        
                                                        
                                                        696,195
                                                        
                                                        
                                                        
                                                        37,159
                                                        
                                                        
                                                        
                                                        5.34
                                                        
                                                        
                                                        
                                                        735,975
                                                        
                                                        
                                                        
                                                        38,975
                                                        
                                                        
                                                        
                                                        5.30Loans
      receivable:Mortgage
      and construction
                                                        
                                                        
                                                        652,907
                                                        
                                                        
                                                        
                                                        42,457
                                                        
                                                        
                                                        
                                                        6.41
                                                        
                                                        
                                                        
                                                        525,063
                                                        
                                                        
                                                        
                                                        38,288
                                                        
                                                        
                                                        
                                                        7.21
                                                        
                                                        
                                                        
                                                        452,781
                                                        
                                                        
                                                        
                                                        32,267
                                                        
                                                        
                                                        
                                                        7.05Commercial
      loans and lines of credit
                                                        
                                                        
                                                        349,590
                                                        
                                                        
                                                        
                                                        21,814
                                                        
                                                        
                                                        
                                                        6.14
                                                        
                                                        
                                                        
                                                        307,540
                                                        
                                                        
                                                        
                                                        24,425
                                                        
                                                        
                                                        
                                                        7.83
                                                        
                                                        
                                                        
                                                        259,280
                                                        
                                                        
                                                        
                                                        20,914
                                                        
                                                        
                                                        
                                                        7.96Consumer
                                                        
                                                        
                                                        244,625
                                                        
                                                        
                                                        
                                                        14,976
                                                        
                                                        
                                                        
                                                        6.12
                                                        
                                                        
                                                        
                                                        206,459
                                                        
                                                        
                                                        
                                                        14,040
                                                        
                                                        
                                                        
                                                        6.80
                                                        
                                                        
                                                        
                                                        170,535
                                                        
                                                        
                                                        
                                                        11,412
                                                        
                                                        
                                                        
                                                        6.69Tax-exempt
                                                        
                                                        
                                                        79,124
                                                        
                                                        
                                                        
                                                        5,272
                                                        
                                                        
                                                        
                                                        6.66
                                                        
                                                        
                                                        
                                                        46,840
                                                        
                                                        
                                                        
                                                        3,195
                                                        
                                                        
                                                        
                                                        6.82
                                                        
                                                        
                                                        
                                                        23,788
                                                        
                                                        
                                                        
                                                        1,582
                                                        
                                                        
                                                        
                                                        6.65Total
      loans receivable
                                                        
                                                        
                                                        1,326,246
                                                        
                                                        
                                                        
                                                        84,519
                                                        
                                                        
                                                        
                                                        6.30
                                                        
                                                        
                                                        
                                                        1,085,902
                                                        
                                                        
                                                        
                                                        79,948
                                                        
                                                        
                                                        
                                                        7.29
                                                        
                                                        
                                                        
                                                        906,384
                                                        
                                                        
                                                        
                                                        66,175
                                                        
                                                        
                                                        
                                                        7.23Total
      earning assets
                                                        
                                                        $
                                                        1,903,270
                                                        
                                                        
                                                        $
                                                        113,021
                                                        
                                                        
                                                        
                                                        5.89
                                                        %
                                                        
                                                        $
                                                        1,782,097
                                                        
                                                        
                                                        $
                                                        117,107
                                                        
                                                        
                                                        
                                                        6.53
                                                        %
                                                        
                                                        $
                                                        1,642,359
                                                        
                                                        
                                                        $
                                                        105,150
                                                        
                                                        
                                                        
                                                        6.36
                                                        %Sources
      of FundsInterest-bearing
      deposits:Regular
      savings
                                                        
                                                        $
                                                        351,291
                                                        
                                                        
                                                        $
                                                        3,849
                                                        
                                                        
                                                        
                                                        1.10
                                                        %
                                                        
                                                        $
                                                        373,209
                                                        
                                                        
                                                        $
                                                        8,997
                                                        
                                                        
                                                        
                                                        2.41
                                                        %
                                                        
                                                        $
                                                        363,515
                                                        
                                                        
                                                        $
                                                        8,533
                                                        
                                                        
                                                        
                                                        2.35
                                                        %Interest
      checking and
                                                          money
      market
                                                        
                                                        
                                                        727,783
                                                        
                                                        
                                                        
                                                        11,160
                                                        
                                                        
                                                        
                                                        1.53
                                                        
                                                        
                                                        
                                                        712,418
                                                        
                                                        
                                                        
                                                        24,738
                                                        
                                                        
                                                        
                                                        3.47
                                                        
                                                        
                                                        
                                                        605,043
                                                        
                                                        
                                                        
                                                        22,282
                                                        
                                                        
                                                        
                                                        3.68Time
      deposits
                                                        
                                                        
                                                        187,467
                                                        
                                                        
                                                        
                                                        6,595
                                                        
                                                        
                                                        
                                                        3.52
                                                        
                                                        
                                                        
                                                        181,080
                                                        
                                                        
                                                        
                                                        7,604
                                                        
                                                        
                                                        
                                                        4.20
                                                        
                                                        
                                                        
                                                        194,611
                                                        
                                                        
                                                        
                                                        7,541
                                                        
                                                        
                                                        
                                                        3.87Public
      funds time
                                                        
                                                        
                                                        16,338
                                                        
                                                        
                                                        
                                                        607
                                                        
                                                        
                                                        
                                                        3.72
                                                        
                                                        
                                                        
                                                        17,464
                                                        
                                                        
                                                        
                                                        858
                                                        
                                                        
                                                        
                                                        4.91
                                                        
                                                        
                                                        
                                                        32,873
                                                        
                                                        
                                                        
                                                        1,406
                                                        
                                                        
                                                        
                                                        4.28Total
      interest-bearing
                                                          deposits
                                                        
                                                        
                                                        1,282,879
                                                        
                                                        
                                                        
                                                        22,211
                                                        
                                                        
                                                        
                                                        1.73
                                                        
                                                        
                                                        
                                                        1,284,171
                                                        
                                                        
                                                        
                                                        42,197
                                                        
                                                        
                                                        
                                                        3.29
                                                        
                                                        
                                                        
                                                        1,196,042
                                                        
                                                        
                                                        
                                                        39,762
                                                        
                                                        
                                                        
                                                        3.32Short-term
      borrowings
                                                        
                                                        
                                                        265,518
                                                        
                                                        
                                                        
                                                        5,349
                                                        
                                                        
                                                        
                                                        1.98
                                                        
                                                        
                                                        
                                                        208,112
                                                        
                                                        
                                                        
                                                        10,804
                                                        
                                                        
                                                        
                                                        5.12
                                                        
                                                        
                                                        
                                                        199,742
                                                        
                                                        
                                                        
                                                        10,267
                                                        
                                                        
                                                        
                                                        5.07Long-term
      debt
                                                        
                                                        
                                                        79,400
                                                        
                                                        
                                                        
                                                        4,875
                                                        
                                                        
                                                        
                                                        6.14
                                                        
                                                        
                                                        
                                                        48,510
                                                        
                                                        
                                                        
                                                        3,494
                                                        
                                                        
                                                        
                                                        7.18
                                                        
                                                        
                                                        
                                                        17,669
                                                        
                                                        
                                                        
                                                        1,731
                                                        
                                                        
                                                        
                                                        9.80Total
      interest-bearing
                                                          liabilities
                                                        
                                                        
                                                        1,627,797
                                                        
                                                        
                                                        
                                                        32,435
                                                        
                                                        
                                                        
                                                        1.98
                                                        
                                                        
                                                        
                                                        1,540,793
                                                        
                                                        
                                                        
                                                        56,495
                                                        
                                                        
                                                        
                                                        3.66
                                                        
                                                        
                                                        
                                                        1,413,453
                                                        
                                                        
                                                        
                                                        51,760
                                                        
                                                        
                                                        
                                                        3.65Noninterest-bearing
      funds
                                                          (net)
                                                        
                                                        
                                                        275,473
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        241,304
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        228,906Total
      sources to fund
                                                          assets
                                                        
                                                        $
                                                        1,903,270
                                                        
                                                        
                                                        $
                                                        32,435
                                                        
                                                        
                                                        
                                                        1.70
                                                        %
                                                        
                                                        $
                                                        1,782,097
                                                        
                                                        
                                                        $
                                                        56,495
                                                        
                                                        
                                                        
                                                        3.16
                                                        %
                                                        
                                                        $
                                                        1,642,359
                                                        
                                                        
                                                        $
                                                        51,760
                                                        
                                                        
                                                        
                                                        3.14
                                                        %Net
      interest income and
                                                          margin
      on a tax-
                                                          equivalent
      basis
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        80,586
                                                        
                                                        
                                                        
                                                        4.19
                                                        %
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        60,612
                                                        
                                                        
                                                        
                                                        3.37
                                                        %
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        53,390
                                                        
                                                        
                                                        
                                                        3.22
                                                        %Tax-exempt
      adjustment
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        1,881
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        1,120
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        599Net
      interest income and
                                                          margin
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        78,705
                                                        
                                                        
                                                        
                                                        4.09
                                                        %
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        59,492
                                                        
                                                        
                                                        
                                                        3.30
                                                        %
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        52,791
                                                        
                                                        
                                                        
                                                        3.18
                                                        %Other
      Balances:Cash
      & due from banks
                                                        
                                                        $
                                                        44,699
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        51,874
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        $
                                                        49,210Other
      assets
                                                        
                                                        
                                                        80,605
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        90,437
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        79,815Total
      assets
                                                        
                                                        
                                                        2,028,574
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        1,924,408
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        1,771,384Noninterest-bearing
                                                          demand
      deposits
                                                        
                                                        
                                                        276,120
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        269,353
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        253,671Other
      liabilities
                                                        
                                                        
                                                        11,687
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        8,035
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        8,558Stockholders’
      equity
                                                        
                                                        
                                                        112,970
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        106,227
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        95,702
   5
  Net
Interest Income and Net Interest Margin
  Net
interest income is the difference between interest income on loans, investment
securities, and other interest-earning assets and the interest expense paid on
deposits and borrowed funds. Changes in net interest income and net interest
margin result from the interaction between the volume and composition of earning
assets, related yields and associated funding costs. Net interest income is our
primary source of earnings. There are several factors that affect net interest
income, including:
  ·
              the
      volume, pricing mix and maturity of earning assets and interest-bearing
      liabilities;
 ·
              market
      interest rate fluctuations; and
 ·
              asset
      quality.
  Net
interest income on a tax-equivalent basis (which adjusts for the tax-exempt
status of income earned on certain loans and investment securities in order to
show such income as if it were taxable) for 2008 increased $20.0 million, or
33%, over 2007 to $80.6 million. Interest income on a tax-equivalent basis
totaled $113.0 million, a decrease of $4.1 million, or 3%, from 2007. The
majority of this decrease was related to the lower interest rate environment
throughout 2008, partially offset by a volume increase in the level of interest
earning assets. Volume increases in the loans receivable portfolio more than
offset volume decreases in the investment securities portfolio. Interest expense
for 2008 decreased $24.1 million, or 43%, from $56.5 million in 2007 to $32.4
million in 2008. This decrease was related to the lower interest rate
environment as a slight volume increase in the level of interest bearing
liabilities was more than offset by significant decreases in the average rates
paid on interest-bearing deposits and short-term borrowings.
   During
the second half of 2007, the United States Treasury yield curve began to move
from flat (and sometimes inverted) to a more traditional slope with short-term
rates lower than long-term rates. As a result, the Company began to experience a
lower cost of deposits and lower cost of borrowings, thereby improving our net
interest margin. During the last four months of 2007 the FRB decreased the
overnight federal funds rate by 100 basis points from 5.25% to 4.25%. The FRB
continued its accommodative stance to interest rates throughout 2008 by lowering
the overnight federal funds rate several times throughout the year by a total of
400 basis points from 4.25% to 0.25% The decreases in the federal funds rate
have led to a lower level of interest rates associated with our overnight
short-term borrowings as well as lower yields on the 91-day Treasury bill and
one-month LIBOR. Approximately 36% of our deposits are tied to either the
federal funds rate, the 91-day Treasury bill or the one-month LIBOR. The overall
lower level of general market interest rates also allowed us to significantly
reduce the rates we paid on our interest-bearing deposits in an effort to
offset corresponding decreases on the yields we received on our interest
earning assets.
  Changes
in net interest income are frequently measured by two statistics: net interest
rate spread and net interest margin. Net interest rate spread is the difference
between the average rate earned on earning assets and the average rate incurred
on interest-bearing liabilities. Net interest margin represents the difference
between interest income, including net loan fees earned, and interest expense,
reflected as a percentage of average earning assets. Our net interest rate
spread increased to 3.91% in 2008 from 2.87% in 2007 on a fully tax-equivalent
basis. The net interest margin (non-tax-equivalent) increased 79 basis
points from 3.30% in 2007 to 4.09% in 2008.
  6
   Table 2
demonstrates the relative impact on net interest income of changes in the volume
of earning assets and interest-bearing liabilities and changes in rates earned
and paid by us on such assets and liabilities. For purposes of this table,
nonaccrual loans have been included in the average loan balances and tax-exempt
loans and securities are reported on a fully taxable-equivalent
basis.
  TABLE 2
 2008
      v. 2007
                                            
                                            
                                            2007
      v. 2006Increase
      (Decrease)
                                            
                                            
                                            Increase
      (Decrease)Due
      to Changes in (1) (2)
                                            
                                            
                                            Due
      to Changes in (1)(in
      thousands)
                                            
                                            Volume
                                            
                                            
                                            Rate
                                            
                                            
                                            Total
                                            
                                            
                                            Volume
                                            
                                            
                                            Rate
                                            
                                            
                                            TotalInterest
      on securities:Taxable
                                            
                                            $
                                            (6,377
                                            )
                                            
                                            $
                                            (2,282
                                            )
                                            
                                            $
                                            (8,659
                                            )
                                            
                                            $
                                            (2,059
                                            )
                                            
                                            $
                                            274
                                            
                                            
                                            $
                                            (1,785
                                            )Tax-exempt
                                            
                                            
                                            1
                                            
                                            
                                            
                                            1
                                            
                                            
                                            
                                            2
                                            
                                            
                                            
                                            (23
                                            )
                                            
                                            
                                            (8
                                            )
                                            
                                            
                                            (31
                                            )Interest
      on loans receivable:Mortgage
      and construction
                                            
                                            
                                            8,200
                                            
                                            
                                            
                                            (4,031
                                            )
                                            
                                            
                                            4,169
                                            
                                            
                                            
                                            5,390
                                            
                                            
                                            
                                            631
                                            
                                            
                                            
                                            6,021Commercial
                                            
                                            
                                            2,321
                                            
                                            
                                            
                                            (4,932
                                            )
                                            
                                            
                                            (2,611
                                            )
                                            
                                            
                                            3,255
                                            
                                            
                                            
                                            256
                                            
                                            
                                            
                                            3,511Consumer
                                            
                                            
                                            2,035
                                            
                                            
                                            
                                            (1,099
                                            )
                                            
                                            
                                            936
                                            
                                            
                                            
                                            2,199
                                            
                                            
                                            
                                            429
                                            
                                            
                                            
                                            2,628Tax-exempt
                                            
                                            
                                            2,165
                                            
                                            
                                            
                                            (88
                                            )
                                            
                                            
                                            2,077
                                            
                                            
                                            
                                            1,570
                                            
                                            
                                            
                                            43
                                            
                                            
                                            
                                            1,613Total
      interest income
                                            
                                            
                                            8,345
                                            
                                            
                                            
                                            (12,431
                                            )
                                            
                                            
                                            (4,086
                                            )
                                            
                                            
                                            10,332
                                            
                                            
                                            
                                            1,625
                                            
                                            
                                            
                                            11,957Interest
      on deposits:Regular
      savings
                                            
                                            
                                            (540
                                            )
                                            
                                            
                                            (4,608
                                            )
                                            
                                            
                                            (5,148
                                            )
                                            
                                            
                                            848
                                            
                                            
                                            
                                            (384
                                            )
                                            
                                            
                                            464Interest
      checking and money market
                                            
                                            
                                            314
                                            
                                            
                                            
                                            (13,892
                                            )
                                            
                                            
                                            (13,578
                                            )
                                            
                                            
                                            4,269
                                            
                                            
                                            
                                            (1,813
                                            )
                                            
                                            
                                            2,456Time
      deposits
                                            
                                            
                                            (59
                                            )
                                            
                                            
                                            (950
                                            )
                                            
                                            
                                            (1,009
                                            )
                                            
                                            
                                            (277
                                            )
                                            
                                            
                                            340
                                            
                                            
                                            
                                            63Public
      funds
                                            
                                            
                                            (44
                                            )
                                            
                                            
                                            (207
                                            )
                                            
                                            
                                            (251
                                            )
                                            
                                            
                                            (659
                                            )
                                            
                                            
                                            111
                                            
                                            
                                            
                                            (548
                                            )Short-term
      borrowings
                                            
                                            
                                            1,155
                                            
                                            
                                            
                                            (6,610
                                            )
                                            
                                            
                                            (5,455
                                            )
                                            
                                            
                                            434
                                            
                                            
                                            
                                            103
                                            
                                            
                                            
                                            537Long-term
      debt
                                            
                                            
                                            1,380
                                            
                                            
                                            
                                            1
                                            
                                            
                                            
                                            1,381
                                            
                                            
                                            
                                            1,905
                                            
                                            
                                            
                                            (142
                                            )
                                            
                                            
                                            1,763Total
      interest expense
                                            
                                            
                                            2,206
                                            
                                            
                                            
                                            (26,266
                                            )
                                            
                                            
                                            (24,060
                                            )
                                            
                                            
                                            6,520
                                            
                                            
                                            
                                            (1,785
                                            )
                                            
                                            
                                            4,735Net
      increase (decrease)
                                            
                                            $
                                            6,139
                                            
                                            
                                            $
                                            13,835
                                            
                                            
                                            $
                                            19,974
                                            
                                            
                                            $
                                            3,812
                                            
                                            
                                            $
                                            3,410
                                            
                                            
                                            $
                                            7,222
  (1)
              Changes
      due to both volume and rate have been allocated on a pro rata basis to
      either rate or volume.
  (2)
              Changes
      due to the difference in days (during leap years) are divided between Rate
      & Volume columns based on each categories percent of the total
      difference.
  Provision
for Loan Losses
  Management
undertakes a rigorous and consistently applied process in order to evaluate the
allowance for loan losses and to determine the level of provision for loan
losses. We recorded $7.5 million as a provision for loan losses in
2008 compared to $1.8 million in 2007. The increase in the provision for loan
losses in 2008 is a direct result of the Company’s strong loan growth over the
past twelve months, an increase in the level of nonperforming loans, the
increased level of net charge-offs as well as other qualitative factors which
management considers relevant in assessing the level of risk associated with the
loan portfolio.The
level of nonperforming loans increased from $2.9 million, or 0.25% of total
loans outstanding at December 31, 2007 to $27.1 million, or 1.88% of total loans
outstanding at December 31, 2008. See the Nonperforming Loans and Assets section
later in this Management’s Discussion and Analysis of Financial Condition and
Results of Operations for further discussion regarding the increase in
nonperforming loans.Net charge-offs during
2008 were $1.5 million, or 0.11%, of average loans outstanding as compared to
$705,000, or 0.07%, of average loans outstanding in 2007. Four loans totaling
$1.2 million made up the largest loan charge-offs for 2008. All other loans
charged-off in 2008 were under $100,000 each. One loan totaling $165,000 made up
the largest single loan charge-off for 2007. All other loans charged-off in 2007
were under $100,000 each. See the Application of Critical Accounting Policies
section in this Management’s Discussion and Analysis regarding the allowance for
loan losses as well as Note 1 in the Notes to Consolidated Financial
Statements for the year ended December 31, 2008 included herein for
further discussion regarding our methodology for determining the provision for
loan losses.
   Noninterest
Income
  Noninterest
income for 2008 increased by $2.6 million, or 11%, over 2007 to $25.4 million.
Service charges and fees increased $3.2 million, or 16%. The increase in this
line item as well as in other operating income was attributable to servicing a
higher volume of deposit and loan accounts. Conversely, gains on sales of loans
were $738,000 for 2008 as compared to $1.26 million in 2007, with the decrease
attributable to three factors. First, the slowing economy during the second half
of 2008 resulted in a lower level of residential mortgage loans originated,
which the Bank typically sells to investors in the secondary market. The
second factor was that we did not sell our student loan portfolio in the
secondary market in 2008 as we typically have over the past several years.
Lastly, we sold a lower volume of Small Business Administration loans in
the secondary market in 2008 as compared to 2007. Netted against noninterest
income for 2008 was a $157,000 pretax loss on sale of a corporate debt htm
security which experienced deterioration in the creditworthiness of the
underlying issuer. Conversely, noninterest income for 2007 included $171,000 of
pretax gains on the call of
  7
  two
securities prior to their stated final maturity.
   Noninterest
Expenses
  Noninterest
expenses totaled $77.9 million for 2008, an increase of $7.1 million, or 10%,
over 2007. Several expense line items were impacted by our continued growth
including the full year’s impact of opening three new full-service stores in the
second half of 2007. Additionally, costs associated with the pending acquisition
of Republic First, the pending core system conversion and transition of services
from TD Bank to a new service provider as well as our rebranding initiatives all
served to increase our expense levels in 2008.  A comparison of
noninterest expenses for certain categories for 2008 and 2007 is discussed
below.
   Salary
expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $3.6 million, or 10%, in 2008 over 2007. The
increased level of these expenses includes the impact of salary and benefit
costs associated with the additional staff hired to operate the new stores
opened in the third quarter of 2007 along with general merit increases for all
eligible employees. The increase was also partially a result of higher overall
benefit plan costs as well as additional expense related to the issuance of
stock options to employees.
  Occupancy
expenses totaled $8.1 million in 2008, an increase of 7%, over 2007 while
furniture and equipment expenses increased by 6%. The full-year impact of the
three stores opened in 2007 contributed primarily to these
increases.
  Advertising
and marketing expenses decreased $587,000, or 18%, in 2008 as the 2007 total
included grand opening expenses associated with the three new
stores.
  Data
processing expenses increased by $733,000, or 11%, in 2008 over 2007 due to
costs associated with processing additional transactions as a result of growth
in the number of accounts serviced, the costs associated with operating
additional stores, adding additional electronic products and services for
customer use and enhancements and upgrades to existing systems.
  Regulatory
expenses of $2.8 million in 2008 reflected a 7% decrease from
2007.  Included in total regulatory expenses for 2007 were costs
incurred to address the matters identified by the Office of the Comptroller of
the Currency (“OCC”) in the formal written agreement which the Bank entered into
with the OCC on January 29, 2007, as well as costs incurred during the fourth
quarter of 2007 with respect to the Consent Order entered into with the OCC on
February 5, 2008.  Offsetting this decrease in regulatory compliance
costs in 2008 was an increase in the level of FDIC premiums paid by the Bank for
deposit insurance in 2008, from $1.5 million in 2007 to $1.7 million in
2008.  The Bank,
like all financial institutions whose deposits are guaranteed by the Federal
Deposit Insurance Corporation, (“FDIC”), pays a quarterly premium to the FDIC
for such deposit insurance coverage. The premium rates paid by the Bank were the
same for both 2008 and 2007.  For 2009, the FDIC has increased these
rates significantly over the prior years.  The new rates, as currently
in effect, are projected to increase the Bank's expense for such coverage by
$1.3 million over the level incurred in 2008.  The FDIC has further
announced its intention to assess a one-time emergency deposit premium fee on
all covered institutions during the third quarter of 2009 to bolster the level
of Deposit Insurance Funds available to cover possible future bank
failures.
  Included
in noninterest expenses for the fourth quarter of 2008 was $935,000 related to
negotiating, planning and training for the conversion of core processing, item
processing and network infrastructure services from our current service
provider, TD Bank, to our new service provider, Fiserv Solutions,
Inc.  This conversion is planned for mid-2009.  Also
included in noninterest expenses for 2008 was $491,000 associated with the
Company’s pending acquisition of Republic First which is expected to close in
the second quarter of 2009. In 2009, we expect our level of expenses associated
with the transition of services from TD Bank to Fiserv Solutions to increase
dramatically over the level experienced in 2008. We also expect significant
costs in 2009 associated with our acquisition of Republic First. These higher
expense levels may constrain our ability to increase net income in 2009 over the
level achieved in 2008.
  Other
noninterest expenses totaled $9.1 million for 2008, compared to $7.4 million for
2007, an increase of $1.7 million or 22%.  Components of the increase
included costs related to lending expenses, legal expenses, bank shares tax,
expenses relating to a potential future branch site we discontinued exploring
and expenses relating to foreclosed real estate properties.
  One key
measure used to monitor progress in controlling overhead expenses is the ratio
of net noninterest expenses to average assets. For purposes of this calculation,
net noninterest expenses equal noninterest expenses less noninterest income
(exclusive of gains or losses on sales/calls of investment securities). This
ratio equaled 2.59% for 2008, compared to 2.49% for 2007. Another productivity
measure is the operating efficiency ratio. This ratio expresses the relationship
of noninterest expenses to net interest income plus noninterest income
(excluding gains or losses on sales of investment securities). For 2008, the
operating efficiency ratio was 74.7% compared to 86.0% for 2007. The improvement
was a result of positive operating leverage in 2008 as the growth in total
revenues far exceeded the growth in noninterest expenses. Our operating
efficiency ratio remains above our peer group primarily due to our aggressive
growth expansion activities.
   Provision
for Federal Income Taxes
  The
provision for federal income taxes was $5.9 million for 2008, compared to $2.7
million for 2007. The effective tax rate, which is the ratio of income tax
expense to income before taxes, was 31.2% in 2008 compared to 28.2% in 2007 due
to a 35% statutory income tax rate for 2008 vs. a 34% statutory rate in 2007, a
higher level ratio of taxable income to tax-exempt income in 2008 as compared to
2007 and partially due to non-deductible merger expenses incurred in 2008. See
Note 11 of the Notes to
Consolidated Financial Statementsfor the year ended December 31, 2008,
included herein, for an additional analysis of the provision for income taxes
for 2008 and 2007.
  In
accordance with Statement of Financial Accounting Standard No. 109 (SFAS No.
109), “Accounting for Income Taxes”, income taxes are accounted for under the
liability method. Under the liability method, deferred tax assets and
liabilities are recognized for future tax consequences attributable to temporary
differences between the financial state­ment and tax bases of existing
assets and liabilities.
  8
   At
December 31, 2008, deferred tax assets amounted to $15.7 million and deferred
tax liabilities amounted to $4.1 million. Deferred tax assets are realizable
primarily through carryback of existing deductible temporary differences to
recover taxes paid in prior years, and through future reversal of existing
taxable temporary differences. Management currently anticipates future earnings
will be adequate to utilize the net deferred tax assets.
  Net
Income and Net Income per Share
  Net
income for 2008 was $12.9 million, an increase of $5.9 million, or 84%, from the
$7.0 million recorded in 2007. This increase was due to an increase in net
interest income of $19.2 million and an increase in noninterest income of $2.6
million offset by an increase in the provision for loan losses of $5.7 million,
an increase in noninterest expenses of $7.1 million and an increase in the
provision for federal income taxes of $3.1 million.
  Basic
earnings per common share were $2.02 in 2008 compared to $1.11 in 2007. Diluted
earnings per common share were $1.97 for 2008 and $1.07 for 2007. See Note 13 in
the Notes to Consolidated
Financial Statementsfor the year ended December 31, 2008, included
herein, for an analysis of earnings per share.
  Return
on Average Assets and Average Equity
  Return on
average assets, referred to as “ROA,” measures our net income in relation to our
total average assets. Our ROA was 0.64% for 2008 compared to 0.36% for 2007.
Return on average equity, referred to as “ROE,” indicates how effectively we can
generate net income on the capital invested by our shareholders. ROE is
calculated by dividing net income by average stockholders’ equity. ROE for 2008
improved to 11.42%, compared to 6.59% for 2007.
  Both ROA
and ROE in 2008 were benefited by the substantial improvement in our net
income.
  Results
of Operations
  2007
versus 2006
  Net
income for 2007 was $7.0 million, a decrease of $253,000, or 3%, from the $7.3
million recorded in 2006.
  Diluted
earnings per common share decreased to $1.07 for 2007 from $1.12 in
2006.
  Net
interest income on a tax-equivalent basis for 2007 increased $7.2 million, or
14%, over 2006 to $60.6 million. Interest income on a tax-equivalent basis on
earning assets totaled $117.1 million, an increase of $12.0 million, or 11%,
over 2006. Interest expense for 2007 increased by $4.7 million, or 9%, from
$51.8 million to $56.5 million.
  Our net
interest rate spread increased to 2.87% in 2007 from 2.71% in 2006 and the net
interest margin increased 12 basis points from 3.18% in 2006 to 3.30% in 2007 on
a fully tax-equivalent basis.
  The
provision for loan losses totaled $1.8 million in 2007 compared to $1.6 million
in 2006. Net charge-offs in 2007 totaled $705,000, or 0.07%, of average loans
outstanding as compared to $1.2 million, or 0.13%, of average loans outstanding
in 2006.
  Noninterest
income for 2007 increased by $4.1 million, or 22%, over 2006 to $22.8 million.
The increase was primarily due to increases in other operating income
attributable to service charges and fees associated with servicing a higher
volume of deposit and loan accounts. Included in total noninterest income in
2007 were gains of $1.3 million on the sale of residential loans, student loans
and small business administration loans as well as a gain on the call of
securities of $171,000. Included in total noninterest income in 2006 were gains
of $1.1 million on the sale of residential loans, student loans and small
business administration loans as well as gains on the sale and call of
securities of $160,000.
  Noninterest
expenses totaled $70.8 million for 2007, an increase of $11.5 million, or 19%,
over 2006. Staffing levels, occupancy, furniture and equipment, and related
expenses increased as a result of opening three full-service stores in 2007 as
well as the opening of two full-services stores in the fourth quarter of
2006.
  Salary
expenses and employee benefits increased by $3.6 million, or 12%, in 2007 over
2006 primarily to staff the new stores mentioned above.  Benefit costs
for 2007 included an increase of approximately $750,000 for employee medical and
prescription plan costs over the level incurred in 2006.
  Occupancy
expenses totaled $7.6 million in 2007, an increase of $1.0 million, or 15%, over
2006 while furniture and equipment expenses increased by $488,000, or 14%, to
$4.1 million.  Again, the increase was related to the new stores as
well as expenses related to the opening of our new Headquarters, Operations and
Training Center in late March 2006.
  Advertising
and marketing expenses were $3.3 million for 2007, an increase of $363,000, or
12%, over 2006. Data processing expenses increased by $1.1 million, or 20%, in
2007 over 2006. Postage and supplies expenses of $2.0 million were $342,000, or
21%, higher than the prior year.
  Regulatory
expenses of $3.1 million in 2007 were $2.6 million higher than 2006 due to
expenses incurred for regulatory compliance matters as well as the reinstatement
of deposit insurance premiums by the FDIC during the first quarter of 2007.
Telephone expenses of $2.4 million were $1.2 million higher for 2007 compared to
2006 due to our outsourcing of our call center services to a third party in
October 2006.
  9
  Other
noninterest expenses totaled $7.4 million for 2007, compared to $6.6 million for
2006.
   Financial
Condition
  Securities
  Securities
are purchased and sold as part of our overall asset and liability management
function. The classification of all securities is determined at the time of
purchase. Securities expected to be held for an indefinite period of time are
classified as securities available for sale and are carried at fair value.
Decisions by management to purchase or sell these securities are based on an
assessment of financial and economic conditions, including changes in prepayment
risks and interest rates, liquidity needs, capital adequacy, collateral
requirements for pledging, alternative asset and liability management
strategies, tax considerations, and regulatory requirements.
  Securities
are classified as held to maturity if, at the time of purchase, management has
both the intent and ability to hold the securities until maturity. Securities
held to maturity are carried at amortized cost. Sales of securities in this
portfolio should only occur in unusual and rare situations where significant
unforeseeable changes in circumstances may cause a change in intent. Examples of
such instances would include deterioration in the issuer’s creditworthiness that
is evidently supportable and significant or a change in tax law that eliminates
or reduces the tax-exempt status of interest (but not the revision of marginal
tax rates applicable to interest income). Held to maturity securities cannot be
sold based upon any of the decisions used to sell securities available for sale
as listed above. See Note 3 in the Notes to Consolidated Financial
Statements for the year ended December 31, 2008, included herein, for
further analysis of our securities portfolio.
  Approximately
80% of our investment securities carry fixed rate coupons that do not change
over the life of the securities. Since most securities are purchased at premiums
or discounts, their yield and average life will change depending on any change
in the estimated rate of prepayments. We amortize premiums and accrete discounts
over the estimated average life of the securities. Changes in the estimated
average life of the securities portfolio will lengthen or shorten the period in
which the premium or discount must be amortized or accreted, thus affecting our
securities yields. For the year ended December 31, 2008, the yield on our
securities portfolio was 4.94%, down 40 basis points from 5.34% in 2007. This
decrease was due to: significantly lower yields earned on the 20% of our
investment securities portfolio which have floating interest rates due to the
overall lower level of general market interest rates; prepayments, calls and
maturities of securities with higher interest rates, and purchases of securities
in 2008 at lower yields than those purchased n previous years, again due to the
level of market interest rates.
  At
December 31, 2008, the weighted average life and duration of our securities
portfolio was approximately 4.7 and 3.8 years, respectively, as compared to 5.0
years and 4.0 years, respectively, at December 31, 2007. The weighted average
life of the portfolio is calculated by estimating the average rate of repayment
of the underlying collateral of each security. Mortgage-backed obligations
historically experience repayment rates in excess of the scheduled repayments,
causing a shorter weighted average life of the security. Our securities
portfolio contained no “high-risk” securities or derivatives as of December 31,
2008 or 2007.
  Securities
available for sale decreased by $24.8 million in 2008 (excluding the effect of
changes in unrealized gains or losses) primarily as a result in purchases of
$23.2 million, offset by principal repayments and maturities of $47.6 million.
The securities available for sale portfolio is comprised of U.S. Government
Agency securities, mortgage-backed securities, and Whole Loan CMO securities. At
December 31, 2008, the unrealized loss on securities available for sale included
in stockholders’ equity totaled $17.3 million, net of tax, compared to the $3.9
million, net of tax, unrealized loss on securities available for sale included
in stockholders’ equity at December 31, 2007.  The market for certain
securities held in the Company’s available for sale portfolio was extremely
volatile during 2008 due to extraordinary economic and market dislocations. As a
result of this volatility, the market prices for many types of securities at the
end of 2008 were much lower than at December 31, 2007 due to the distressed
market conditions. Management believes that the unrealized losses on these
securities are primarily the result of changes in the liquidity levels in the
market in addition to changes in general market interest rates and not material
changes in the credit characteristics of the investment
  10
  securities
portfolio.
  During
2008, securities held to maturity decreased by $104.9 million primarily as a
result of purchases of $10.6 million offset by principal repayments and
maturities of $31.3 million and the call of nine bonds totaling $82.0 million. A
$157,000 loss on the sale of one security with a principal balance of $2 million
was realized in 2008 due to significant deterioration in the credit worthiness
of the issuer. The securities held in this portfolio include U.S. Government
Agency securities, mortgage-backed securities, tax-exempt municipal bonds, Whole
Loan CMO securities, and corporate debt securities.
  The
amortized cost of available for sale and held to maturity securities are
summarized in Table 3 as of December 31, for each of the years 2006 through
2008.
  
 TABLE 3
 December
      31,(in
      thousands)
                          
                          2008
                          
                          
                          2007
                          
                          
                          2006Available
      for Sale:U.S.
      Government Agency securities
                          
                          $
                          5,000
                          
                          
                          $
                          5,000
                          
                          
                          $
                          5,000Mortgage-backed
      securities
                          
                          
                          363,241
                          
                          
                          
                          388,000
                          
                          
                          
                          393,909Total
      available for sale
                          
                          $
                          368,241
                          
                          
                          $
                          393,000
                          
                          
                          $
                          398,909Held
      to Maturity:U.S.
      Government Agency securities
                          
                          $
                          36,500
                          
                          
                          $
                          133,303
                          
                          
                          $
                          175,043Municipal
      securities
                          
                          
                          1,623
                          
                          
                          
                          1,621
                          
                          
                          
                          1,619Mortgage-backed
      securities
                          
                          
                          112,472
                          
                          
                          
                          116,058
                          
                          
                          
                          131,979Corporate
      debt securities
                          
                          
                          1,992
                          
                          
                          
                          6,485
                          
                          
                          
                          10,987Total
      held to maturity
                          
                          $
                          152,587
                          
                          
                          $
                          257,467
                          
                          
                          $
                          319,628
 
  The
contractual maturity distribution and weighted average yield of our available
for sale and held to maturity portfolios at December 31, 2008 are summarized in
Table 4. For mortgage-backed obligations, the contractual maturities may be
significantly different than actual maturities. Changes in payment patterns and
prepayments may occur depending on the market conditions and economic variables.
Weighted average yield is calculated by dividing income within each maturity
range by the outstanding amount of the related investment and has been tax
effected, assuming a tax rate of 35%, on tax-exempt obligations.
  
 TABLE 4
 December
      31, 2008
                            
                            Due
      Under 1 Year
                            
                            
                            Due
      1-5 Years
                            
                            
                            Due
      5-10 Years
                            
                            
                            Due
      Over 10 Years
                            
                            
                            Total(dollars
      in thousands)
                            
                            Amount/Yield
                            
                            
                            Amount/Yield
                            
                            
                            Amount/Yield
                            
                            
                            Amount/Yield
                            
                            
                            Amount/YieldAvailable
      for Sale:U.S.
      Government Agency
                              obligations
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            5,000
                            
                            
                            
                            5.00
                            %
                            
                            
                            
                            
                            
                            
                            
                            $
                            5,000
                            
                            
                            
                            5.00
                            %Mortgage-backed
                              obligations
                            
                            
                            
                            
                            
                            
                            
                            $
                            35
                            
                            
                            
                            6.18
                            %
                            
                            
                            16,252
                            
                            
                            
                            4.74
                            
                            
                            $
                            346,954
                            
                            
                            
                            4.19
                            %
                            
                            
                            363,241
                            
                            
                            
                            4.21Total
      available for sale
                            
                            $
                            0
                            
                            
                            
                            0
                            %
                            
                            $
                            35
                            
                            
                            
                            6.18
                            %
                            
                            $
                            21,252
                            
                            
                            
                            4.80
                            %
                            
                            $
                            346,954
                            
                            
                            
                            4.19
                            %
                            
                            $
                            368,241
                            
                            
                            
                            4.22
                            %Held
      to Maturity:U.S.
      Government Agency
                              obligations
                            
                            $
                            1,500
                            
                            
                            
                            3.50
                            %
                            
                            $
                            5,000
                            
                            
                            
                            4.75
                            %
                            
                            $
                            15,000
                            
                            
                            
                            5.34
                            %
                            
                            $
                            15,000
                            
                            
                            
                            6.15
                            %
                            
                            $
                            36,500
                            
                            
                            
                            5.52
                            %Municipal
      obligations
                            
                            
                            0
                            
                            
                            
                            0
                            
                            
                            
                            654
                            
                            
                            
                            5.53
                            
                            
                            
                            0
                            
                            
                            
                            0
                            
                            
                            
                            969
                            
                            
                            
                            6.65
                            
                            
                            
                            1,623
                            
                            
                            
                            6.20Mortgage-backed
                              obligations
                            
                            
                            22
                            
                            
                            
                            5.51
                            
                            
                            
                            43
                            
                            
                            
                            6.67
                            
                            
                            
                            6,599
                            
                            
                            
                            4.26
                            
                            
                            
                            105,808
                            
                            
                            
                            4.85
                            
                            
                            
                            112,472
                            
                            
                            
                            4.81Corporate
      debt securities
                            
                            
                            0
                            
                            
                            
                            0
                            
                            
                            
                            1,992
                            
                            
                            
                            6.62
                            
                            
                            
                            0
                            
                            
                            
                            0
                            
                            
                            
                            0
                            
                            
                            
                            0
                            
                            
                            
                            1,992
                            
                            
                            
                            6.62Total
      held to maturity
                            
                            $
                            1,522
                            
                            
                            
                            3.53
                            %
                            
                            $
                            7,689
                            
                            
                            
                            5.31
                            %
                            
                            $
                            21,599
                            
                            
                            
                            5.01
                            %
                            
                            $
                            121,777
                            
                            
                            
                            5.02
                            %
                            
                            $
                            152,587
                            
                            
                            
                            5.02
                            %
  Note:
Securities available for sale are carried at amortized cost in the table above
for purposes of calculating the weighted average yield received on such
securities.
  
  11
 
  Loan
portfolio
  The
following table summarizes the composition of our loan portfolio by type as of
December 31, for each of the years 2004 through 2008.
 
 TABLE 5
 December
      31,(in
      thousands)
                        
                        2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004Commercial
      mortgage
                        
                        $
                        599,321
                        
                        
                        $
                        430,778
                        
                        
                        $
                        365,259
                        
                        
                        $
                        299,219
                        
                        
                        $
                        239,576Construction
      and land development
                        
                        
                        54,075
                        
                        
                        
                        54,475
                        
                        
                        
                        61,365
                        
                        
                        
                        47,334
                        
                        
                        
                        39,467Residential
      real estate mortgage loans
                        
                        
                        86,490
                        
                        
                        
                        80,575
                        
                        
                        
                        83,690
                        
                        
                        
                        83,213
                        
                        
                        
                        79,672Tax-exempt
      loans
                        
                        
                        96,506
                        
                        
                        
                        53,690
                        
                        
                        
                        31,446
                        
                        
                        
                        17,055
                        
                        
                        
                        6,303Commercial,
      industrial and other business loans
                        
                        
                        195,258
                        
                        
                        
                        192,390
                        
                        
                        
                        163,708
                        
                        
                        
                        138,174
                        
                        
                        
                        97,198Consumer
      loans
                        
                        
                        237,628
                        
                        
                        
                        211,536
                        
                        
                        
                        182,058
                        
                        
                        
                        148,906
                        
                        
                        
                        109,568Commercial
      lines of credit
                        
                        
                        170,505
                        
                        
                        
                        133,927
                        
                        
                        
                        95,192
                        
                        
                        
                        90,769
                        
                        
                        
                        74,559Total
      loans
                        
                        $
                        1,439,783
                        
                        
                        $
                        1,157,371
                        
                        
                        $
                        982,718
                        
                        
                        $
                        824,670
                        
                        
                        $
                        646,343
  We manage
risk associated with our loan portfolio in part through diversification, with
what we believe are sound policies and underwriting procedures that are
reviewed, updated and approved at least annually, as well as through our ongoing
loan monitoring efforts. Additionally, we monitor concentrations of loans or
loan relationships by purpose, collateral or industry using a red/yellow/green
measurement for acceptable levels of exposure. At December 31, 2008, we do not
have a concentration to any one industry or borrower.
  Our
commercial mortgage and our construction and land development loans are
typically made to small and medium-sized investors, builders and developers and
are secured by mortgages on real property located principally in South Central
Pennsylvania (principally office buildings, multifamily residential, land
development and other commercial properties). The average loan size originated
in 2008 in this category was approximately $810,000. Our underwriting policy has
established maximum terms for commercial mortgage and construction loans
depending on the type of loan within the commercial real estate category. A
five-year call option is standard on commercial mortgages. Our underwriting
policy generally requires a loan-to-value ratio of no more than 80% on loans in
this category and typically requires owner guarantees and other collateral
depending on our total risk assessment of the transaction.
  Our
commercial, industrial and other business loans and lines of credit are
typically made to small and medium-sized businesses. The average loan size
originated in 2008 in this category was approximately $620,000. Based on our
underwriting standards, loans may be secured in whole or in part by collateral
such as liquid assets, accounts receivable, equipment, inventory and real
property. Additionally, our underwriting policy has established maximum terms
for these loans depending on the loan type within the commercial, industrial and
other business loans category. The value of the collateral in this category may
vary depending on market conditions. The Bank maintains advance rates for
particular collateral categories to mitigate the risk that the borrower defaults
and the value of the collateral is not sufficient to cover the outstanding loan
balance. We also actively manage the unused portion of commercial lines of
credit and would freeze a commitment if a borrower were in default. As of
December 31, 2008, outstanding balances under commercial lines of credit were
$170.5 million and unused commitments were $215.5 million.
  Residential
real estate mortgage loans represented approximately 6% of our total loans at
December 31, 2008. Loans in this category are collateralized by first mortgages
on residential properties located in South Central Pennsylvania. Our
underwriting policy provides that all residential loans are to be written based
upon standards used by the secondary market.
  Consumer
loans and consumer lines of credit represented approximately 16% of our total
loans at December 31, 2008. These loans and lines are secured by first and
second mortgages, personal assets of the borrower, or may be unsecured. As of
December 31, 2008, 33% of consumer loans and consumer lines of credit were
secured by second liens. When originating consumer loans, our underwriting
policy sets limitations on the term of the loan, defines allowable collateral
and the valuation of the collateral, outlines acceptable debt to income ratios
as well as acceptable credit sources to identify those loan applicants with a
proven record of credit management. We actively manage the unused portion of our
consumer lines of credit and would freeze a commitment if a borrower becomes
delinquent. As of December 31, 2008, unused commitments under consumer lines of
credit were $63.8 million.
  During
2008, total gross loans increased by $309.4 million from $1.2 billion at
December 31, 2007, to $1.5 billion at December 31, 2008, which included $41.1
million of loans held for sale on December 31, 2008 and $14.1 million of loans
held for sale on December 31, 2007. The loans held for sale represent student
loans and certain residential and small business administration loans our
management intends to sell and reinvest in higher yielding loans and securities.
Also included in gross loans are deposit accounts that are reclassified as loans
as a result of overdrawn deposit account balances. The total of overdrawn
deposit accounts reclassified as loans aggregated $3.7 million at December 31,
2008 and $740,000 at December 31, 2007. The increase in loans receivable in 2008
was represented across all loan categories except for construction and land
development loans which remained flat from 2007 to 2008 at $54
million.
  During
2008, commercial mortgage loans increased by $168.5 million, or 39%, tax-exempt
loans increased by $42.8 million or 80% and commercial lines of credit increased
by $36.6 million, or 27%. The addition to our staff of experienced lenders with
long-term ties to the business communities in our markets has enhanced our
lending portfolio and, as a result, our access to commercial lending
  12
  opportunities.
Consumer loans increased $26.1 million or 12%. Residential real estate mortgage
loans and commercial, industrial and business loans increased $5.9 million and
$2.9 million, respectively.
  Total
loans outstanding represented 88% of total deposits and 67% of total assets at
December 31, 2008, excluding the loans held for sale, compared to 74% and 58%,
respectively, at December 31, 2007.
  The
maturity ranges of the loan portfolio and the amounts of loans with
predetermined interest rates and floating interest rates in each maturity range,
as of December 31, 2008, are presented in the following table.
  TABLE6
 December
      31, 2008(in
      thousands)
                              
                              Due
      Within
                                One
      Year
                              
                              
                              Due
      1-5
                                Years
                              
                              
                              Due
      Over
                                Five
      Years
                              
                              
                              TotalReal
      estate:Commercial
      mortgage
                              
                              $
                              94,445
                              
                              
                              $
                              45,298
                              
                              
                              $
                              459,578
                              
                              
                              $
                              599,321Construction
      and land development
                              
                              
                              26,262
                              
                              
                              
                              14,218
                              
                              
                              
                              13,595
                              
                              
                              
                              54,075Residential
      mortgage
                              
                              
                              2,341
                              
                              
                              
                              14,216
                              
                              
                              
                              69,933
                              
                              
                              
                              86,490Tax-exempt
                              
                              
                              148
                              
                              
                              
                              22,908
                              
                              
                              
                              73,450
                              
                              
                              
                              96,506123,196
                              
                              
                              
                              96,640
                              
                              
                              
                              616,556
                              
                              
                              
                              836,392Commercial
                              
                              
                              18,514
                              
                              
                              
                              70,605
                              
                              
                              
                              106,139
                              
                              
                              
                              195,258Consumer
                              
                              
                              33,871
                              
                              
                              
                              23,823
                              
                              
                              
                              179,934
                              
                              
                              
                              237,628Commercial
      lines of credit
                              
                              
                              125,126
                              
                              
                              
                              45,360
                              
                              
                              
                              19
                              
                              
                              
                              170,505Total
      loans
                              
                              $
                              300,707
                              
                              
                              $
                              236,428
                              
                              
                              $
                              902,648
                              
                              
                              $
                              1,439,783Interest
      rates:Predetermined
                              
                              $
                              39,125
                              
                              
                              $
                              121,546
                              
                              
                              $
                              732,046
                              
                              
                              $
                              892,717Floating
                              
                              
                              261,582
                              
                              
                              
                              114,882
                              
                              
                              
                              170,602
                              
                              
                              
                              547,066Total
      loans
                              
                              $
                              300,707
                              
                              
                              $
                              236,428
                              
                              
                              $
                              902,648
                              
                              
                              $
                              1,439,783
  Concentrations
of Credit Risk
  The
largest portion of loans, 42%, on our balance sheet is for commercial mortgage
related loans. Our commercial real estate loan portfolio is principally to
borrowers throughout Cumberland, Dauphin, Lancaster, Lebanon, York and Berks
counties of Pennsylvania where we have full-service store locations. Commercial
real estate, construction, and land development loans aggregated $653.4 million
at December 31, 2008, compared to $485.3 million at December 31, 2007.
Commercial real estate loans are collateralized by the related project
(principally office building, multi-family residential, land development and
other properties) and we generally require loan-to-value ratios of no greater
than 80%. Collateral requirements on such loans are determined on a case-by-case
basis based on managements’ credit evaluations of the respective
borrowers.
  Commercial
loans represented 14% of total loans at December 31, 2008. Collateral for these
types of loans varies depending upon managements’ credit evaluations of the
respective borrowers and generally includes the following: business assets,
personal guarantees and/or personal assets of the borrower.
  Consumer
loans comprised 17%, or $237.6 million, of total loans at December 31, 2008.
Approximately $225.4 million of consumer loans are secured by real estate, $3.0
million are loans collateralized by personal assets of the borrower, and $9.2
million are unsecured.
  On a
monthly basis, the Bank’s credit services personnel prepare two different loan
concentration reports: one using standardized North American Industry
Classification codes and the second report by loan product type. Management
reviews and uses these concentration reports to monitor risks. Quarterly, a Risk
Management Booklet is prepared and reviewed by both management and our Board of
Directors, which identifies areas of risk and quantifies if any exceptions were
made to policies and procedures in the lending area during the preceding
quarter. Management and the board utilize the Risk Management Booklet as a tool
to identify and limit procedure and policy exceptions and to reduce any
unnecessary risk in the lending function.
  Nonperforming
Loans and Assets
  Total
nonperforming assets (nonperforming loans, foreclosed real estate and loans past
due 90 days or more and still accruing interest) at December 31, 2008, were
$27.9 million, or 1.30%, of total assets as compared to $3.4 million, or 0.17%,
of total assets at December 31, 2007. Total nonperforming loans (nonaccrual
loans, 90 days or more past due loans and restructured loans) at December 31,
2008 were $27.1 million compared to $2.9 million a year ago. Much like most of
the industry, we experienced significant increases in non-performing loans
during 2008 as overall economic conditions in our market area and most of the
United States deteriorated. The increase in nonperforming loans experienced by
the bank during 2008, primarily resulted from the addition of five commercial
relationships totaling $18.8 million at December 31, 2008.  These five
loans had an aggregate specific allocation of $2.6 million at year end
2008.  Total nonperforming commercial loans at December 31, 2008
totaled $23.7 million and consisted of 24 relationships including those
mentioned above.  At December 31, 2007, total nonperforming commercial
loans totaled $710,000 and consisted of 23 relationships.
  13
  Additionally, total
delinquent loans (those loans 30 days or more delinquent) as a percentage of
total loans were 2.20% at December 31, 2008, compared to 0.46% at December 31,
2007. We generally place a loan on nonaccrual status and cease accruing interest
when loan payment performance is deemed unsatisfactory and the loan is past due
90 days or more, unless the loan is both well-secured and in the process of
collection. At December 31, 2008 and 2007, there were no loans past due 90 days
and still accruing interest. Additional loans considered by our internal loan
review department as potential problem loans of $22.5 million at December 31,
2008, compared to $17.2 million at December 31, 2007, have been evaluated as to
risk exposure in determining the adequacy of the allowance for loan
losses.
  Foreclosed
real estate totaled $743,000 as of December 31, 2008 as compared to $489,000 as
of December 31, 2007. These properties have been written down fair value less
disposition costs. We obtain updated appraisals on nonperforming loans secured
by real estate. In those instances where appraisals reflect reduced collateral
values, an evaluation of the borrower’s overall financial condition is made to
determine the need for possible write-downs or appropriate additions to the
allowance for loan losses.  It is likely that increased levels of
nonperforming assets and probable losses will continue in the foreseeable future
due to the economic downturn, including record unemployment, lackluster consumer
spending, stagnant home sales and declining collateral values.
  The
following table summarizes information regarding nonperforming loans and
nonperforming assets as of December 31, 2004 through 2008.
 
 TABLE7
 December
      31,(dollars
      in thousands)
                              
                              2008
                              
                              
                              2007
                              
                              
                              2006
                              
                              
                              2005
                              
                              
                              2004Nonaccrual
      loans:Commercial
                              
                              $
                              6,863
                              
                              
                              $
                              534
                              
                              
                              $
                              984
                              
                              
                              $
                              684
                              
                              
                              $
                              308Consumer
                              
                              
                              492
                              
                              
                              
                              57
                              
                              
                              
                              19
                              
                              
                              
                              296
                              
                              
                              
                              11Real
      estate:   Construction
                              
                              
                              7,646
                              
                              
                              
                              385
                              
                              
                              
                              247
                              
                              
                              
                              0
                              
                              
                              
                              0Mortgage
                              
                              
                              12,121
                              
                              
                              
                              1,959
                              
                              
                              
                              2,129
                              
                              
                              
                              1,322
                              
                              
                              
                              267Total
      nonaccrual loans
                              
                              
                              27,122
                              
                              
                              
                              2,935
                              
                              
                              
                              3,379
                              
                              
                              
                              2,302
                              
                              
                              
                              586Loans
      past due 90 days or more and still accruing
                              
                              
                              0
                              
                              
                              
                              0
                              
                              
                              
                              2
                              
                              
                              
                              233
                              
                              
                              
                              0Restructured
      loans
                              
                              
                              0
                              
                              
                              
                              0
                              
                              
                              
                              0
                              
                              
                              
                              0
                              
                              
                              
                              271Total
      nonperforming loans
                              
                              
                              27,122
                              
                              
                              
                              2,935
                              
                              
                              
                              3,381
                              
                              
                              
                              2,535
                              
                              
                              
                              857Foreclosed
      real estate
                              
                              
                              743
                              
                              
                              
                              489
                              
                              
                              
                              159
                              
                              
                              
                              159
                              
                              
                              
                              507Total
      nonperforming assets
                              
                              $
                              27,865
                              
                              
                              $
                              3,424
                              
                              
                              $
                              3,540
                              
                              
                              $
                              2,694
                              
                              
                              $
                              1,364Nonperforming
      loans to total loans
                              
                              
                              1.88
                              %
                              
                              
                              0.25
                              %
                              
                              
                              0.34
                              %
                              
                              
                              0.31
                              %
                              
                              
                              0.13
                              %Nonperforming
      assets to total assets
                              
                              
                              1.30
                              %
                              
                              
                              0.17
                              %
                              
                              
                              0.19
                              %
                              
                              
                              0.16
                              %
                              
                              
                              0.11
                              %Interest
      income received on nonaccrual loans
                              
                              $
                              1,268
                              
                              
                              $
                              157
                              
                              
                              $
                              133
                              
                              
                              $
                              106
                              
                              
                              $
                              30Interest
      income that would have been recorded under the
                                original
      terms of the loans
                              
                              $
                              1,776
                              
                              
                              $
                              280
                              
                              
                              $
                              329
                              
                              
                              $
                              220
                              
                              
                              $
                              40
  Allowance
for Loan Losses
  The
allowance for loan losses (ALLL) is a reserve established in the form of a
provision expense for loan losses and is reduced by loan charge-offs net of
recoveries. When loans are deemed to be uncollectible, they are charged off.
Management has established a reserve that it believes is adequate for estimated
losses in the loan portfolio. In conjunction with an internal loan review
function that operates independently of the lending function, management
monitors the loan portfolio to identify risks on a timely basis so that an
appropriate allowance is maintained. Based on an evaluation of the loan
portfolio, management presents a quarterly review of the allowance for loan
losses to the Board of Directors, indicating any changes in the allowance since
the last review. In making the evaluation, management considers the results of
recent regulatory examinations, which typically include a review of the
allowance for loan losses as an integral part of the examination
process.
  In
establishing the allowance, management evaluates on a quantitative basis
individual classified loans and nonaccrual loans, and determines an aggregate
reserve for those loans based on that review. In addition, an allowance for the
remainder of the loan portfolio is determined based on historical loss
experience within certain components of the portfolio. These allocations may be
modified if current conditions indicate that loan losses may differ from
historical experience.
  In
addition, a portion of the allowance is established for losses inherent in the
loan portfolio, which have not been identified by the quantitative processes
described above. This determination inherently involves a higher degree of
subjectivity, and considers risk factors that may not have yet manifested
themselves in historical loss experience. These factors include:
  ·
              Changes
      in lending policies and procedures, including changes in underwriting
      standards and collection, charge-off and recovery practices. Changes in
      the volume and severity of past due loans, the volume of nonaccrual loans,
      and the volume and severity of adversely classified or graded
      loans.
  ·
              Changes
      in the nature and volume of the portfolio and the terms of
      loans.
  ·
              Changes
      in the value of underlying collateral for collateral-dependent
      loans.
  14
  ·
              Changes
      in the quality of the institution’s loan review
  system.
  ·
              Changes
      in the experience, ability, and depth of lending management and other
      relevant staff.
  ·
              The
      existence and effect of any concentrations of credit, and changes in the
      level of such concentrations.
  ·
              Changes
      in international, national, regional and local economic and business
      conditions and developments that affect the collectibility of the
      portfolio, including the condition of various market segments and the
      effect of other external factors such as competition and legal and
      regulatory requirements on the level of estimated credit losses in the
      institution’s existing portfolio.
  ·
              The
      factor used in the allowance calculation with the most significant
      increase from 2007 to 2008, was that of the economic
      conditions.
  More
specifically, the methodology utilized to assess the adequacy of the allowance
includes:
  ·
              Identifying
      loans for individual review under Statement of Financial Accounting
      Standards No. 114, “Accounting by Creditors for Impairment of a Loan”
      (Statement 114). In general, the loans identified for individual review
      under Statement 114 consist of larger balance commercial loans and
      commercial mortgages.
  ·
              Assessing
      whether the loans identified for review under Statement 114 are “impaired”
      based on the probability that all amounts due under the loan will not be
      collected according to the contractual terms of the loan
      agreement.
  ·
              For
      loans identified as impaired, calculating the estimated fair value of the
      loan, using one of the following methods, a) observable market price, b)
      discounted cash flow or c) the value of the underlying
      collateral.
  ·
              Segmenting
      classified, but non-impaired loans based on credit risk ratings and
      allocating an allowance for loan losses based on appropriate factors,
      including recent loss history for similar
loans.
  ·
              Identifying
      other loans for evaluation collectively under the provisions of Statement
      of Financial Accounting Standards No. 5 “Accounting for Contingencies”
      (Statement 5). In general, these other loans include residential mortgages
      and consumer loans.
  ·
              Segmenting
      Statement “defined” term loans into groups with similar characteristics
      and allocating an allowance for loan losses to each segment based on
      recent loss history and other relevant
  information.
  ·
              Reviewing
      the results to determine the appropriate amount of the allowance for loan
      losses.
  While the
allowance for loan losses is maintained at a level believed to be adequate by
management for covering estimated losses in the loan portfolio, determination of
the allowance is inherently subjective, as it requires estimates, all of which
may be susceptible to significant change. Changes in these estimates may impact
the provisions charged to expense in future periods.
  The Bank
recorded provisions of $7.5 million to the allowance for loan losses in 2008,
compared to $1.8 million for 2007. During 2008, net charge-offs amounted to $1.5
million, or 0.11%, of average loans outstanding for the year, compared to
$705,000, or 0.07%, of average loans outstanding for 2007. The majority of the
total net charge-off figure for 2008 was related to two loans for approximately
$960,000. One loan totaling $165,000 made up the largest single loan charge-off
for 2007. All other loans charged-off in 2007 were under $100,000 each. The
allowance for loan losses increased as a percentage of loans receivable from
0.93% of total loans outstanding at December 31, 2007, to 1.16% of total loans
outstanding at December 31, 2008 due in part to increased levels of delinquent,
nonperforming and impaired.  The allowance at December 31, 2008
provided coverage of 62% of nonperforming loans compared with 366% at December
31, 2007.
  15
  Table 8
presents, for the years 2004 through 2008, information regarding our provision
and allowance for loan losses.
  
 TABLE8
 Years
      Ended December 31,(dollars
      in thousands)
                                      
                                      2008
                                      
                                      
                                      2007
                                      
                                      
                                      2006
                                      
                                      
                                      2005
                                      
                                      
                                      2004Balance
      at beginning of year
                                      
                                      $
                                      10,742
                                      
                                      
                                      $
                                      9,685
                                      
                                      
                                      $
                                      9,231
                                      
                                      
                                      $
                                      7,847
                                      
                                      
                                      $
                                      6,007Provisions
      charged to operating expenses
                                      
                                      
                                      7,475
                                      
                                      
                                      
                                      1,762
                                      
                                      
                                      
                                      1,634
                                      
                                      
                                      
                                      1,560
                                      
                                      
                                      
                                      2,64618,217
                                      
                                      
                                      
                                      11,447
                                      
                                      
                                      
                                      10,865
                                      
                                      
                                      
                                      9,407
                                      
                                      
                                      
                                      8,653Recoveries
      of loans previously charged-off:Commercial
                                      
                                      
                                      145
                                      
                                      
                                      
                                      11
                                      
                                      
                                      
                                      34
                                      
                                      
                                      
                                      546
                                      
                                      
                                      
                                      110Consumer
                                      
                                      
                                      25
                                      
                                      
                                      
                                      53
                                      
                                      
                                      
                                      71
                                      
                                      
                                      
                                      50
                                      
                                      
                                      
                                      113Real
      estate
                                      
                                      
                                      0
                                      
                                      
                                      
                                      8
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      8Total
      recoveries
                                      
                                      
                                      170
                                      
                                      
                                      
                                      72
                                      
                                      
                                      
                                      105
                                      
                                      
                                      
                                      596
                                      
                                      
                                      
                                      231Loans
      charged-off:Commercial
                                      
                                      
                                      (1,426
                                      )
                                      
                                      
                                      (634
                                      )
                                      
                                      
                                      (895
                                      )
                                      
                                      
                                      (627
                                      )
                                      
                                      
                                      (528
                                      )Consumer
                                      
                                      
                                      (173
                                      )
                                      
                                      
                                      (69
                                      )
                                      
                                      
                                      (390
                                      )
                                      
                                      
                                      (135
                                      )
                                      
                                      
                                      (350
                                      )Real
      estate
                                      
                                      
                                      (69
                                      )
                                      
                                      
                                      (74
                                      )
                                      
                                      
                                      0
                                      
                                      
                                      
                                      (10
                                      )
                                      
                                      
                                      (159
                                      )Total
      charged-off
                                      
                                      
                                      (1,668
                                      )
                                      
                                      
                                      (777
                                      )
                                      
                                      
                                      (1,285
                                      )
                                      
                                      
                                      (772
                                      )
                                      
                                      
                                      (1,037
                                      )Net
      charge-offs
                                      
                                      
                                      (1,498
                                      )
                                      
                                      
                                      (705
                                      )
                                      
                                      
                                      (1,180
                                      )
                                      
                                      
                                      (176
                                      )
                                      
                                      
                                      (806
                                      )Balance
      at end of year
                                      
                                      $
                                      16,719
                                      
                                      
                                      $
                                      10,742
                                      
                                      
                                      $
                                      9,685
                                      
                                      
                                      $
                                      9,231
                                      
                                      
                                      $
                                      7,847Net
      charge-offs to average loans outstanding
                                      
                                      
                                      0.11
                                      %
                                      
                                      
                                      0.07
                                      %
                                      
                                      
                                      0.13
                                      %
                                      
                                      
                                      0.02
                                      %
                                      
                                      
                                      0.14
                                      %Allowance
      for loan losses to year-end loans
                                      
                                      
                                      1.16
                                      %
                                      
                                      
                                      0.93
                                      %
                                      
                                      
                                      0.99
                                      %
                                      
                                      
                                      1.12
                                      %
                                      
                                      
                                      1.21
                                      %
  Allocation
of the Allowance for Loan Losses
  The
following table details the allocation of the allowance for loan losses to the
various categories. The allocation is made for analytical purposes and it is not
necessarily indicative of the categories in which future credit losses may
occur. The total allowance is available to absorb losses from any segment of
loans. The allocations in the table below were determined by a combination of
the following factors: specific allocations made on loans considered impaired as
determined by management and the loan review committee, a general allocation on
certain other impaired loans, and historical losses in each loan type category
combined with a weighting of the current loan composition.
  
 TABLE9
 Allowance
      for Loan Losses at December 31,2008
                          
                          
                          2007
                          
                          
                          2006
                          
                          
                          2005
                          
                          
                          2004(dollars
      in thousands)
                          
                          Amount
                          
                          
                          %
      Gross Loans
                          
                          
                          Amount
                          
                          
                          %
      Gross Loans
                          
                          
                          Amount
                          
                          
                          %
      Gross Loans
                          
                          
                          Amount
                          
                          
                          %
      Gross Loans
                          
                          
                          Amount
                          
                          
                          %
      Gross LoansCommercial
      loans
                            and
      lines of
                            credit
                          
                          $
                          6,772
                          
                          
                          
                          32
                          %
                          
                          $
                          4,253
                          
                          
                          
                          31
                          %
                          
                          $
                          4,417
                          
                          
                          
                          28
                          %
                          
                          $
                          3,675
                          
                          
                          
                          28
                          %
                          
                          $
                          3,063
                          
                          
                          
                          27
                          %Consumer
                          
                          
                          1,899
                          
                          
                          
                          17
                          
                          
                          
                          1,800
                          
                          
                          
                          18
                          
                          
                          
                          1,868
                          
                          
                          
                          19
                          
                          
                          
                          1,785
                          
                          
                          
                          18
                          
                          
                          
                          1,657
                          
                          
                          
                          17Real
      estate,
                            construction
      and
                            land
      development:Commercial
                          
                          
                          7,046
                          
                          
                          
                          45
                          
                          
                          
                          3,796
                          
                          
                          
                          43
                          
                          
                          
                          2,695
                          
                          
                          
                          43
                          
                          
                          
                          3,058
                          
                          
                          
                          42
                          
                          
                          
                          2,540
                          
                          
                          
                          43Residential
                          
                          
                          1,002
                          
                          
                          
                          6
                          
                          
                          
                          893
                          
                          
                          
                          8
                          
                          
                          
                          705
                          
                          
                          
                          10
                          
                          
                          
                          713
                          
                          
                          
                          12
                          
                          
                          
                          587
                          
                          
                          
                          13Total
                          
                          $
                          16,719
                          
                          
                          
                          100
                          %
                          
                          $
                          10,742
                          
                          
                          
                          100
                          %
                          
                          $
                          9,685
                          
                          
                          
                          100
                          %
                          
                          $
                          9,231
                          
                          
                          
                          100
                          %
                          
                          $
                          7,847
                          
                          
                          
                          100
                          %
  Deposits
  Total
deposits at December 31, 2008, were $1.63 billion, an increase of $73.1 million,
or 5%, from total deposits of $1.56 billion at December 31, 2007. We made a
strategic decision not to match the unusually “high rate” deposit pricing on
deposits offered by most other banks in our footprint. As a result, our deposit
growth was below our historical norm. This pricing discipline served to
stabilize and eventually began to lower our overall cost of funds. In turn, this
provided us with increased net interest income and an improved net interest
margin throughout 2008.
  We remain
a deposit-driven financial institution with emphasis on core deposit
accumulation and retention as a basis for sound growth and profitability. We
regard core deposits as all deposits other than public certificates of deposits.
Deposits in the various core categories increased slightly to $1.63 billion at
December 31, 2008. Similarly, total deposits averaged $1.56 billion for 2008, a
slight increase over the 2007 average of $1.55 billion. As noted in Table 10
below, declines in savings balances were more than offset by
  16
  growth in
demand deposits and time deposits.
  We
believe that our record of sustaining core deposit growth is reflective of our
retail approach to banking which emphasizes a combination of free checking
accounts, convenient store locations, extended hours of operation, unparalleled
quality customer service and active marketing.
  The
average balances and weighted average rates paid on deposits for 2008, 2007 and
2006 are presented below.
  
 TABLE10
 Years
      Ended December 31,2008
      Average
                        
                        
                        2007
      Average
                        
                        
                        2006
      Average(dollars
      in thousands)
                        
                        Balance/Rate
                        
                        
                        Balance/Rate
                        
                        
                        Balance/RateDemand
      deposits:Noninterest-bearing
                        
                        $
                        276,120
                        
                        
                        
                        
                        
                        $
                        269,353
                        
                        
                        
                        
                        
                        $
                        253,671Interest-bearing
      (money market and checking)
                        
                        
                        727,783
                        
                        
                        
                        1.53
                        %
                        
                        
                        712,418
                        
                        
                        
                        3.47
                        %
                        
                        
                        605,043
                        
                        
                        
                        3.68
                        %Savings
                        
                        
                        351,291
                        
                        
                        
                        1.10
                        
                        
                        
                        373,209
                        
                        
                        
                        2.41
                        
                        
                        
                        363,515
                        
                        
                        
                        2.35Time
                        
                        
                        203,805
                        
                        
                        
                        3.53
                        
                        
                        
                        198,544
                        
                        
                        
                        4.26
                        
                        
                        
                        227,484
                        
                        
                        
                        3.93Total
      deposits
                        
                        $
                        1,558,999
                        
                        
                        
                        
                        
                        
                        $
                        1,553,524
                        
                        
                        
                        
                        
                        
                        $
                        1,449,713
  The
remaining maturity for certificates of deposit of $100,000 or more as of
December 31, 2008, 2007 and 2006 is presented in Table 11.
  
 TABLE11
 At
      December 31,(in
      thousands)
                        
                        2008
                        
                        
                        2007
                        
                        
                        20063
      months or less
                        
                        $
                        29,294
                        
                        
                        $
                        22,844
                        
                        
                        $
                        25,6963
      to 6 months
                        
                        
                        13,603
                        
                        
                        
                        19,452
                        
                        
                        
                        22,7596
      to 12 months
                        
                        
                        30,332
                        
                        
                        
                        12,847
                        
                        
                        
                        38,901Over
      12 months
                        
                        
                        20,850
                        
                        
                        
                        17,263
                        
                        
                        
                        20,034Total
                        
                        $
                        94,079
                        
                        
                        $
                        72,406
                        
                        
                        $
                        107,390
  Short-Term
Borrowings and Repurchase Agreements
  Short-term
borrowings used to meet temporary funding needs consist of overnight and
short-term advances from the Federal Home Loan Bank, securities sold under
agreements to repurchase and overnight federal funds lines of credit. For 2008,
short-term borrowings averaged $265.5 million, a $57.4 million or 28% increase
from 2007. The weighted average rate paid during 2008 was 1.98% compared with
5.12% for 2007 for short-term borrowings. At December 31, 2008, short-term
borrowings totaled $300.1 million at an average rate of 0.57%. As of December
31, 2007, short-term borrowings totaled $217.3 million at an average rate of
3.59%. As of December 31, 2006, short-term borrowings totaled $112.8 million at
an average rate of 5.40%. The maximum short-term borrowings outstanding at any
month-end were $356.5 million in 2008, $249.4 million in 2007 and $227.1 million
in 2006. The maximum repurchase agree­ments outstanding at any month-end
were $55.0 million in 2006. There were no repurchase agreements outstanding
during any time in 2008 and 2007.
  Long-Term
Debt
  Long-term
debt totaled $79.4 million at December 31, 2008 and 2007. Our long-term debt
consists of Trust Capital Securities through Commerce Harrisburg Capital Trust
I, Commerce Harrisburg Capital Trust II and Commerce Harrisburg Capital Trust
III, our Delaware business trust subsidiaries as well as convertible borrowings.
At December 31, 2008, all of the Capital Trust Securities qualified as Tier I
capital for regulatory capital purposes. Proceeds of the trust capital
securities were used for general corporate purposes, including additional
capitalization of our wholly-owned banking subsidiary. As part of the Company’s
Asset/Liability management strategy, management utilized the Federal Home Loan
Bank convertible select borrowing product during the third quarter of 2007 with
the acquisition of a $25.0 million borrowing with a 5-year maturity and a
six month conversion term at an initial interest rate of 4.29% and a $25.0
million borrowing with a 2-year maturity and a three-month conversion term at an
initial interest rate of 4.49%. See Note 10 in the Notes to Consolidated Financial
Statementsfor the year ended December 31, 2008 for further analysis of
our long-term debt.
  Stockholders’
Equity and Capital Adequacy
  At
December 31, 2008, stockholders’ equity totaled $114.5 million, up $2.1 million,
or 2%, over stockholders’ equity at December 31, 2007. Increases in
stockholders’ equity was due to our net income for the year as well as proceeds
for shares issued under our stock purchase and stock option plans were partially
offset by a decline in the fair value of investment securities available for
sale. As a result of the increased unrealized losses on securities and strong
asset growth during the year, the ratio of stockholders’ equity as a percent of
total assets declined to 5.35% at December 31, 2008, from 5.68% at December 31,
2007. See Note 12 of Notes to
Consolidated Financial Statements for the year ended December 31, 2008,
included herein, for additional discussion regarding
  17
  Stockholders’
Equity. The average equity to assets ratio at December 31, 2008 was 5.57%
compared to 5.52% at December 31, 2007.
  Risk-based
capital provides the basis for which all banks are evaluated in terms of capital
adequacy. The risk-based capital standards require all banks to have Tier 1
capital of at least 4% and total capital, including Tier 1 capital, of at least
8% of risk-adjusted assets. Tier 1 capital includes common stockholders’ equity
and qualifying perpetual preferred stock together with related surpluses and
retained earnings. Total capital may be comprised of total Tier 1 capital plus
limited life preferred stock, qualifying debt instruments, and the allowance for
loan losses.
  Table 12
provides a comparison of the Bank’s risk-based capital ratios and leverage
ratios to the minimum regulatory requirements for the periods
indicated.
  
 TABLE12
 MinimumDecember
      31,
                          
                          
                          Regulatory2008
                          
                          
                          2007
                          
                          
                          RequirementsTier
      1 Capital
                          
                          
                          9.67
                          %
                          
                          
                          10.02
                          %
                          
                          
                          4.00
                          %Total
      Capital
                          
                          
                          10.68
                          
                          
                          
                          10.77
                          
                          
                          
                          8.00Leverage
      ratio
                            (to
      total average assets)
                          
                          
                          7.52
                          
                          
                          
                          7.24
                          
                          
                          
                          4.00
  At
December 31, 2008, the consolidated capital levels of the Company and of the
Bank met the regulatory definition of a “well-capitalized” financial
institution, i.e., a leverage capital ratio exceeding 5%, a Tier 1 risk-based
capital ratio exceeding 6%, and a total risk-based capital ratio exceeding
10%.
  Our
common stock trades on the NASDAQ Global Select Market under the symbol COBH.
The table below sets forth the prices on the NASDAQ Global Select Market known
to us for the period beginning January 1, 2007 through December 31, 2008. As of
December 31, 2008, there were approximately 2,200 holders of record of the
Company’s common stock.
  Sales
      PriceQuarter
      Ended:
                          
                          High
                          
                          
                          LowMarch
      31, 2008
                          
                          $
                          27.92
                          
                          
                          $
                          23.79June
      30, 2008
                          
                          
                          29.39
                          
                          
                          
                          24.01September
      30, 2008
                          
                          
                          33.82
                          
                          
                          
                          20.81December
      31, 2008
                          
                          
                          31.00
                          
                          
                          
                          22.23March
      31, 2007
                          
                          $
                          29.26
                          
                          
                          $
                          26.09June
      30, 2007
                          
                          
                          29.28
                          
                          
                          
                          25.20September
      30, 2007
                          
                          
                          31.65
                          
                          
                          
                          22.35December
      31, 2007
                          
                          
                          33.11
                          
                          
                          
                          27.46
   18
  The
following graph shows the yearly percentage change in the Company’s cumulative
total shareholder return on its common stock from December 31, 2003 to December
31, 2008 compared with the cumulative total return of a NASDAQ Bank Index and
the NASDAQ Composite Market Index.
   
   We offer
a Dividend Reinvestment and Stock Purchase Plan by which dividends on our Common
Stock and optional cash payments of up to $10,000 per month may be invested in
our Common Stock at a 3% discount to the market price and without payment of
brokerage commissions.
   Interest
Rate Sensitivity
  The
management of interest rate sensitivity seeks to avoid fluctuating net interest
margins and to provide consistent net interest income through periods of
changing interest rates.
  Our risk
of loss arising from adverse changes in the fair value of financial instruments,
or market risk, is composed primarily of interest rate risk. The primary
objective of our asset/liability management activities is to maximize net
interest income while maintaining acceptable levels of interest rate risk. Our
Asset/Liability Committee (ALCO) is responsible for establishing policies to
limit exposure to interest rate risk, and to ensure procedures are established
to monitor compliance with those policies. Our Board of Directors reviews the
guidelines established by ALCO.
  An
interest rate sensitive asset or liability is one that, within a defined time
period, either matures or experiences an interest rate change in line with
general market interest rates. Historically, the most common method of
estimating interest rate risk was to measure the maturity and repricing
relationships between interest-earning assets and interest-bearing liabilities
at specific points in time, referred to as “GAP,” typically one year. Under this
method, a company is considered liability sensitive when the amount of its
interest-bearing liabilities exceeds the amount of its interest-earning assets
within the one-year horizon. However, assets and liabilities with similar
repricing characteristics may not reprice at the same time or to the same
degree. As a result, our GAP does not necessarily predict the impact of changes
in general levels of interest rates on net interest income. Table 13 shows our
GAP position as of December 31, 2008. The repricing assumptions used in the
table are as follows:
  ·
              Fixed
      rate loans receivable are scheduled according to their contractual
      amortization and payment schedules specific to each loan. A market
      consensus Constant Prepayment Rate is applied to Residential Mortgage
      Fixed rate loans.
  ·
              Floating
      rate loans receivable are scheduled in the 1-90 day category as they are
      tied to a floating index such as New York Prime and available for
      immediate repricing.
   19
  ·
              Securities
      with pre-payment characteristics such as mortgage-backed securities and
      collateralized mortgage obligations are scheduled based upon their
      remaining weighted average lives as calculated utilizing a market
      consensus Constant Prepayment Rate. Securities with call options are
      analyzed in the context of the existing interest rate environment to
      estimate the likelihood of their call, and to project their resulting
      payment schedule. All other securities are assumed to reprice at their
      contractual maturity.
  ·
              Fixed
      rate transaction accounts are scheduled to reprice in accordance with
      their estimated decay rates as determined in a core deposit study produced
      by an independent consultant. Floating rate transaction accounts are
      scheduled in the 1-90 day category as they are tied to a floating index
      such as the 91 Day Treasury bill.
  ·
              Time
      deposit accounts, short-term borrowings, and trust capital securities are
      scheduled based upon their contractual maturity
  dates.
  
 TABLE13
 December
      31, 2008(dollars
      in thousands)
                                  
                                  1
      – 90
                                    Days
                                  
                                  
                                  91
      – 180
                                    Days
                                  
                                  
                                  181
      – 365
                                    Days
                                  
                                  
                                  1
      – 5
                                    Years
                                  
                                  
                                  Beyond
      5
                                    Years
                                  
                                  
                                  TotalInterest-earning
      assets:Loans
      receivable
                                  
                                  $
                                  537,534
                                  
                                  
                                  $
                                  60,923
                                  
                                  
                                  $
                                  94,778
                                  
                                  
                                  $
                                  573,955
                                  
                                  
                                  $
                                  213,741
                                  
                                  
                                  $
                                  1,480,931Securities
                                  
                                  
                                  167,622
                                  
                                  
                                  
                                  24,218
                                  
                                  
                                  
                                  38,768
                                  
                                  
                                  
                                  311,132
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  541,740Total
      interest-earning assets
                                  
                                  
                                  705,156
                                  
                                  
                                  
                                  85,141
                                  
                                  
                                  
                                  133,546
                                  
                                  
                                  
                                  885,087
                                  
                                  
                                  
                                  213,741
                                  
                                  
                                  
                                  2,022,671Interest-bearing
      liabilities:Transaction
      accounts, excluding DDA
                                  
                                  
                                  620,163
                                  
                                  
                                  
                                  30,060
                                  
                                  
                                  
                                  36,091
                                  
                                  
                                  
                                  168,474
                                  
                                  
                                  
                                  269,057
                                  
                                  
                                  
                                  1,123,845Time
      deposits
                                  
                                  
                                  65,460
                                  
                                  
                                  
                                  33,299
                                  
                                  
                                  
                                  57,771
                                  
                                  
                                  
                                  73,054
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  229,584Short-term
      borrowings
                                  
                                  
                                  300,125
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  300,125Long-term
      debt
                                  
                                  
                                  0
                                  
                                  
                                  
                                  0
                                  
                                  
                                  
                                  25,000
                                  
                                  
                                  
                                  25,000
                                  
                                  
                                  
                                  29,400
                                  
                                  
                                  
                                  79,400Total
      interest-bearing liabilities
                                  
                                  
                                  985,748
                                  
                                  
                                  
                                  63,359
                                  
                                  
                                  
                                  118,862
                                  
                                  
                                  
                                  266,528
                                  
                                  
                                  
                                  298,457
                                  
                                  
                                  
                                  1,732,954Period
      GAP
                                  
                                  
                                  (280,592
                                  )
                                  
                                  
                                  21,782
                                  
                                  
                                  
                                  14,684
                                  
                                  
                                  
                                  618,559
                                  
                                  
                                  
                                  (84,716
                                  )
                                  
                                  $
                                  289,717Cumulative
      GAP
                                  
                                  $
                                  (280,592
                                  )
                                  
                                  $
                                  (258,810
                                  )
                                  
                                  $
                                  (244,126
                                  )
                                  
                                  $
                                  374,433
                                  
                                  
                                  $
                                  289,717Cumulative
      RSA / RSL
                                  
                                  
                                  71.54
                                  %
                                  
                                  
                                  75.33
                                  %
                                  
                                  
                                  79.10
                                  %
                                  
                                  
                                  126.10
                                  %
                                  
                                  
                                  116.72
                                  %
  Notes:
Securities are reported at fare value  for purposes of this table. RSA
means rate sensitive assets; RSL means rate sensitive liabilities.
  Shortcomings
are inherent in any GAP analysis since certain assets and liabilities may not
move proportionately as interest rates change. As the interest rate environment
has become more volatile, we have continued to place greater reliance on
interest income sensitivity modeling and less on GAP reporting.
  Our
management understands that the preparation of GAP reports can only provide a
guide to the impact of the movement of interest rates. Modeling is the best
means to predict the movement in interest rates. This is true because even with
the achievement of a perfectly matched balance sheet (per a GAP report), we may
be subject to interest rate risk due to: differences in the timing of repricing,
basis risk, market risk, customer ability to prepay loans or withdraw funds and
yield curve risk.
  Our
management believes the simulation of net interest income in different interest
rate environments provides a more meaningful measure of interest rate risk.
Income simulation analysis captures not only the potential of all assets and
liabilities to mature or reprice, but also the probability that they will do so.
Income simulation also attends to the relative interest rate sensitivities of
these items, and projects their behavior over an extended period of time.
Finally, income simulation permits management to assess the probable effects on
the balance sheet not only of changes in interest rates, but also of proposed
strategies for responding to them.
  Our
income simulation model analyzes interest rate sensitivity by projecting net
interest income over the next 24 months in a flat rate scenario versus net
interest income in alternative interest rate scenarios. Our management
continually reviews and refines its interest rate risk management process in
response to the changing economic climate. Currently, our model projects a 200
basis point increase and a 100 basis point decrease during the next year, with
rates remaining constant in the second year. The 100 basis point decrease
scenario represents a change in risk measurement adapted by management in the
second quarter of 2008.
   Our
Asset/Liability Committee (ALCO) policy has established that income sensitivity
will be considered acceptable if net interest income in the above mentioned
interest rate scenario is within 4% of forecasted net interest income in the
first year and within 5% using a two-year time frame.
   20
  The
following table compares the impact on forecasted net income at December 31,
2008 of a plus 200 and minus 100 basis point (bp) change in interest rates to
the impact at December 31, 2007 in the plus 200 and minus 200 bp
scenarios.
  Plus
      200
                        
                        
                        Minus
      100
                        
                        
                        Minus
      200December
      31, 2008:Twelve
      Months
                        
                        
                        0.3
                        %
                        
                        
                        (0.6
                        )%
                        
                        
                        n/aTwenty-Four
      Months
                        
                        
                        3.1
                        %
                        
                        
                        (2.3
                        )%
                        
                        
                        n/aDecember
      31, 2007:Twelve
      Months
                        
                        
                        (1.9
                        )%
                        
                        
                        n/a
                        
                        
                        
                        1.9
                        %Twenty-Four
      Months
                        
                        
                        (0.5
                        )%
                        
                        
                        n/a
                        
                        
                        
                        0.5
                        %
  Management
continues to evaluate strategies in conjunction with the Company’s ALCO to
effectively manage the interest rate risk position. Such strategies could
include the sale of a portion of our available for sale investment portfolio,
the use of risk management tools such as interest rate swaps and caps, adjusting
the investment leverage position funded by short-term borrowings or fixing the
cost of our short-term borrowings.
  Many
assumptions were used by us to calculate the impact of changes in interest
rates. Actual results may not be similar to our projections due to several
factors including the timing and frequency of rate changes, market conditions
and the shape of the yield curve. In general, a flattening of the yield curve
would result in reduced net interest income compared to a normal-shaped interest
rate curve scenario and proportionate rate shift assumptions. Actual results may
also differ due to Management's actions, if any, in response to the changing
rates.
  Management
also monitors interest rate risk by utilizing a market value of equity model.
The model assesses the impact of a change in interest rates on the market value
of all our assets and liabilities, as well as any off balance sheet items. The
model calculates the market value of our assets and liabilities in excess of
book value in the current rate scenario, and then compares the excess of market
value over book value given an immediate 200 basis point increase and a 100
basis point decrease in rates. Our ALCO policy indicates that the level of
interest rate risk is unacceptable if the immediate change would result in the
loss of 40% or more of the excess of market value over book value in the current
rate scenario.  At December 31, 2008, the market value of equity
calculation, when utilizing the normal practice of valuing all investments based
on spot prices obtained in the marketplace, indicates an unacceptable level of
interest rate risk in the plus 200 basis point scenario.  It is the
Bank’s opinion that spot prices for securities in the Private Label CMO
portfolio at December 31, 2008 were not indicative of their true fair value, as
the marketplace for these instruments was displaced.  The Bank
estimated alternative fair values for Private Label CMOs, incorporating
acceptable methodology outlined in FAS 157 (3).  When utilizing the
results of this alternative fair value methodology, the negative variability in
the market value of equity in the plus 200 basis point scenario is reduced by
approximately 62%, and is within acceptable limits.  The market value
of equity in the minus 100 basis point scenario is within acceptable policy
limits utilizing either traditional valuation methodology or the alternative
methodology for Private Label CMOs.
  The
market value of equity model reflects certain estimates and assumptions
regarding the impact on the market value of our assets and liabilities given an
immediate plus 200 or minus 100 bp change in rates. One of the key assumptions
is the market value assigned to our core deposits, or the core deposit premium.
Using an independent consultant, we have completed and updated comprehensive
core deposit studies in order to assign our own core deposit premiums as
permitted by regulation. The studies have consistently confirmed management’s
assertion that our core deposits have stable balances over long periods of time,
are relatively insensitive to changes in interest rates and have significantly
longer average lives and durations than our loans and investment securities.
Thus, these core deposit balances provide an internal hedge to market
fluctuations in our fixed rate assets. Management believes the core deposit
premiums produced by its market value of equity model at December 31, 2008
provide an accurate assessment of our interest rate risk.
  Liquidity
  The
objective of liquidity management is to ensure our ability to meet our financial
obligations. These obligations include the payment of deposits on demand at
their contractual maturity; the repayment of borrowings as they mature; the
payment of lease obligations as they become due; the ability to fund new and
existing loans and other funding commitments; and the ability to take advantage
of new business opportunities. Our ALCO is responsible for implementing the
policies and guidelines of our board governing liquidity.
  Liquidity
sources are found on both sides of the balance sheet. Liquidity is provided on a
continuous basis through scheduled and unscheduled principal reductions and
interest payments on outstanding loans and investments. Liquidity is also
provided through the availability and maintenance of a strong base of core
customer deposits; maturing short-term assets; the ability to sell marketable
securities; short-term borrowings and access to capital markets.
  Liquidity
is measured and monitored daily, allowing management to better understand and
react to balance sheet trends. On a monthly basis, a comprehensive liquidity
analysis is reviewed by our Board of Directors. The analysis provides a summary
of the current liquidity measurements, projections and future liquidity
positions given various levels of liquidity stress. Management also maintains a
  21
  detailed
liquidity contingency plan designed to respond to an overall decline in the
condition of the banking industry or a problem specific to the
Company.
  The
Consolidated Statements of Cash Flows provide additional information on our
sources and uses of funds. From a funding standpoint, we have been able to rely
over the years on a stable base of strong “core” deposit growth. Cash from
operating activities during 2008 declined to $3.5 million from $23.2 million
during 2007. This decrease was primarily attributed to the timing of loan sales
and resultant higher 2008 balance in loans held for sale. Investing activities
resulted in a net cash outflow of $162.4 million during 2008 compared to $126.3
million in 2007, primarily due to the strong loan growth. Financing activities
resulted in a net inflow of $157.4 million in 2008 compared to $101.6 million in
2007. The cash inflow in 2008 was mostly from an increase in short-term
borrowings of $82.8 million and an increase in deposits of $73.1
million.
  At
December 31, 2008, liquid assets (defined as cash and cash equivalents,
short-term investments, mortgages available for sale, securities available for
sale, and non-mortgage-backed securities held to maturity due in one year or
less) totaled $399.4 million, or 19%, of total assets. This compares to $444.9
million, or 23%, of total assets, at December 31, 2007.
  Our
investment portfolio consists mainly of mortgage-backed securities, which do not
have bullet final maturities. Cash flows from such investments are
dependent upon the performance of the underlying mortgage loans, and are
generally influenced by the level of interest rates. As rates increase, cash
flows generally decrease as prepayments on the underlying mortgage loans slow.
As rates decrease, cash flows generally increase as prepayments increase. We
also maintain secondary sources of liquidity consisting of federal funds lines
of credit, repurchase agreements, and borrowing capacity at the Federal Home
Loan Bank, which can be drawn upon if needed. As of December 31, 2008, our total
potential liquidity through these secondary sources was $627.7 million of which
$277.6 million was currently available, as compared to $694.2 million at
December 31, 2007 of which $426.8 million was currently available.
  Two other
key statistics that are utilized in the liquidity measurement and management
process are the available liquidity statistic and the contingency liquidity
ratio.  Available liquidity is defined as the sum of cash and due from
banks net of the Federal Reserve Bank’s reserve requirement, plus federal funds
sold, the market value of non-pledged investment securities, and unused
borrowing capacity.  The contingency liquidity ratio is defined as the
sum of unencumbered investment securities and federal funds sold divided by
total deposits.  Available liquidity totaled $330.9 million at
December 31, 2008, down $192.9 million from December 31, 2007 due to investment
portfolio run-off and a lower level of unused borrowing capacity that resulted
from loan growth out pacing deposit growth.  The contingency liquidity
ratio measured 10.9% at year-end 2008 versus 12.1% at year-end
2007.  The decrease in this ratio reflected investment portfolio
run-off that was not reinvested.  The lower levels of these two
liquidity measurement statistics are coupled with the current distressed market
environment which has adversely impacted the pricing of Collateralized Mortgage
Obligation (CMO) securities in the Bank’s investment portfolio and impedes our
inclination to act on a sale of CMO securities in the available for sale
portfolio for liquidity purposes.  Current economic conditions and the
lack of a liquid market could affect our ability to sell these securities, as
well as the value we would be able to realize.  The Bank continues to
evaluate alternative sources of liquidity, and recently undertook a $15.0
million unsecured line of credit with the Atlantic Central Bankers
Bank.  The Bank has also opted to participate in the Temporary
Liquidity Guarantee Program which provides 100% federal insurance coverage for
any individual non-interest demand checking account and low-interest NOW
checking account whose balance exceeds $250,000.  The Bank is also
currently evaluating the recently developed Capital Assistance Program which
offers tier 1 capital assistance in the form of convertible preferred
stock.
  The
Company and the Bank’s liquidity are managed separately. On an unconsolidated
basis, the principal source of our revenue is dividends paid to the Company by
the Bank. The Bank is subject to regulatory restrictions on its ability to pay
dividends to the Company. The Company’s net cash outflows consist principally of
interest on the trust-preferred securities, dividends on the preferred stock and
unallocated corporate expenses.
  Aggregate
Contractual Obligations
  The
following table represents our on-and–off balance sheet aggregate contractual
obligations to make future payments as of December 31, 2008:
 
 TABLE14
 December
      31, 2008(in
      thousands)
                          
                          Less
      than
                            1
      Year
                          
                          
                          1
      to 3
                            Years
                          
                          
                          3
      to 5
                            Years
                          
                          
                          Over
      5
                            Years
                          
                          
                          TotalTime
      Deposits
                          
                          $
                          156,530
                          
                          
                          $
                          57,312
                          
                          
                          $
                          15,742
                          
                          
                          $
                          0
                          
                          
                          $
                          229,584Long-Term
      Debt
                          
                          
                          25,000
                          
                          
                          
                          0
                          
                          
                          
                          25,000
                          
                          
                          
                          29,400
                          
                          
                          
                          79,400Fiserv
      Obligation
                          
                          $
                          6,309
                          
                          
                          $
                          8,238
                          
                          
                          $
                          6,736
                          
                          
                          $
                          6,629
                          
                          
                          $
                          27,912Operating
      Leases
                          
                          
                          2,288
                          
                          
                          
                          4,371
                          
                          
                          
                          4,081
                          
                          
                          
                          26,678
                          
                          
                          
                          37,418Sponsorship
      Obligation
                          
                          
                          467
                          
                          
                          
                          467
                          
                          
                          
                          467
                          
                          
                          
                          932
                          
                          
                          
                          2,333Total
                          
                          $
                          190,594
                          
                          
                          $
                          70,388
                          
                          
                          $
                          52,026
                          
                          
                          $
                          63,639
                          
                          
                          $
                          376,647
  For
further discussion regarding our commitments and contingencies, please see Notes
7 and 18 in the Notes to
Consolidated Financial Statementsfor December 31, 2008, included
herein.
  22
   Off-Balance
Sheet Arrangements
  In the
conduct of ordinary business operations we routinely enter into contracts for
services. These contracts may require payment for services to be provided in the
future and may also contain penalty clauses for the early termination of the
contract. Management is not aware of any additional commitments or contingent
liabilities, which may have a material adverse impact on our liquidity or
capital resources.
   On
November 10, 2008, we announced that we have signed a definitive agreement and
plan of merger, to acquire Republic First Bancorp, Inc. (“Republic First”)
through the issuance of 0.34 to 0.38 shares of Pennsylvania Commerce common
stock for each share of Republic First common stock outstanding immediately
prior to completion of the merger.  Republic First, with total assets
of approximately $952.0 million as of December 31, 2008, will be merged with and
into Pennsylvania Commerce.  This transaction is expected to close in
the second quarter 2009, subject to regulatory and shareholder approval for both
companies
  We are
also party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of our customers. These financial
instruments include commitments to extend credit and standby letters of credit.
See Note 5 in the Notes to the
Consolidated Financial Statementsfor December 31, 2008, included herein,
for additional information.
   Forward-Looking
      Statements
  The
Company may, from time to time, make written or oral “forward-looking
statements”, including statements contained in the Company’s filings with the
Securities and Exchange Commission (including the annual report on Form 10-K and
the exhibits thereto), in its reports to stockholders and in other
communications by the Company, which are made in good faith by the Company
pursuant to the “safe harbor” provisions of the Private Securities Litigation
Reform Act of 1995.
  These
forward-looking statements include statements with respect to the Company’s
beliefs, plans, objectives, goals, expectations, anticipations, estimates and
intentions that are subject to significant risks and uncertainties and are
subject to change based on various factors (some of which are beyond the
Company’s control). The words “may”, “could”, “should”, “would”, “believe”,
“anticipate”, “estimate”, “expect”, “intend”, “plan” and similar expressions are
intended to identify forward-looking statements. The following factors, among
others, including those discussed in Item 1A “Risk Factors” and Item 7
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and elsewhere in this annual report could cause the Company’s
financial performance to differ materially from that expressed in such
forward-looking statements:
  ·
              the
      Company’s ability to successfully transition all services currently
      provided to it, by TD Bank, N.A. and Commerce Bancorp LLC (formerly
      Commerce Bancorp, Inc.) to the Company’s new service provider, Fiserv
      Solutions, Inc.
  ·
              the
      receipt of a $6 million fee from TD Bank if the transition of all services
      is completed by the required dates as called for in the Transition
      Agreement between the two parties;
  ·
              whether
      the transactions contemplated by the merger agreement with Republic First
      will be approved by the shareholders of both companies and by the
      applicable federal, state and local regulatory
  authorities;
  ·
              the
      Company’s ability to complete the proposed merger with Republic First
      Bancorp, Inc., to integrate successfully Republic First’s assets,
      liabilities, customers, systems and management personnel into the
      Company’s operations, and to realize expected cost savings and revenue
      enhancements within expected
timeframes;
  ·
              the
      possibility that expected Republic First merger-related charges are
      materially greater than forecasted or that final purchase price
      allocations based on fair value of the acquired assets and liabilities at
      the effective date of the merger and related adjustments to yield and/or
      amortization of the acquired assets and liabilities are materially
      different from those forecasted;
  ·
              adverse
      changes in the Company’s or Republic First’s loan portfolios and the
      resulting credit risk-related losses and
  expenses;
  ·
              the
      effects of, and changes in, trade, monetary and fiscal policies, including
      interest rate policies of the Board of Governors of the Federal Reserve
      System;
  ·
              general
      economic or business conditions, either nationally, regionally or in the
      communities in which either the Company or Republic First does business,
      may be less favorable than expected, resulting in, among other things, a
      deterioration in credit quality or a reduced demand for
      credit;
  ·
              continued
      levels of loan quality and volume
origination;
  ·
              the
      adequacy of loss reserves;
  ·
              the
      impact of changes in financial services’ laws and regulations (including
      laws concerning taxes, banking, securities and
  insurance);
  ·
              the
      willingness of customers to substitute competitors’ products and services
      for the Company’s products and services and vice
  versa;
  23
  ·
              unanticipated
      regulatory or judicial proceedings;
  ·
              interest
      rate, market and monetary
fluctuations;
  ·
              the
      timely development of competitive new products and services by the Company
      and the acceptance of such products and services by
    customers;
  ·
              changes
      in consumer spending and saving habits relative to the financial services
      we provide;
  ·
              effect
      of terrorists attacks and threats of actual
war;
  ·
              and
      the success of the Company at managing the risks involved in the
      foregoing.
  Because
such forward-looking statements are subject to risks and uncertainties, actual
results may differ materially from those expressed or implied by such
statements. The foregoing list of important factors is not exclusive and you are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date of this document. The Company does not undertake to
update any forward-looking statements, whether written or oral, that may be made
from time to time by or on behalf of the Company. For information concerning
events or circumstances after the date of this report, refer to the Company’s
filings with the Securities and Exchange Commission (“SEC”).
  Impact
of Inflation and Changing Prices
  Interest
rates have a more significant impact on our performance than do the effects of
general levels of inflation, since most of our assets and liabilities are
monetary in nature. Interest rates do not necessarily move in the same direction
or in the same magnitude as the prices of goods and services as measured by the
Consumer Price Index. The liquidity and maturity structure of our assets and
liabilities are critical to the maintenance of acceptable performance
levels.
  Quantitative
and Qualitative Disclosures about Market Risk
  Our
exposure to market risk principally includes interest rate risk, which was
previously discussed. Historically, our net interest margin has remained fairly
stable; our net interest margin for the year ended December 31, 2008 was 4.09%,
an increase of 79 basis points from 3.30% for the year ended December 31, 2007.
See the section titled “Net Interest Income and Net Interest Margin” in this
Management’s Discussion and Analysis for further discussion regarding our net
interest margin performance.
  Currently,
we have 99% of our deposits in accounts which we consider core deposits. These
accounts, which have a relatively low cost of deposits, have historically
contributed significantly to the net interest margin.
  24
   Pennsylvania
Commerce Bancorp, Inc.
 Report
on Management’s Assessment of Internal Control Over
 Financial
Reporting
   Pennsylvania
Commerce Bancorp, Inc. is responsible for the preparation, integrity, and fair
presentation of the consolidated financial statements included in this annual
report.  The consolidated financial statements and notes included in
this annual report have been prepared in conformity with United States generally
accepted accounting principles and necessarily include some amounts that are
based on management’s best estimates and judgments.
   We, as
management of Pennsylvania Commerce Bancorp, Inc., are responsible for
establishing and maintaining effective internal control over financial reporting
that is designed to produce reliable financial statements in conformity with
United States generally accepted accounting principles.  Internal
control over financial reporting includes those policies and procedures that
pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and disposition of the assets of the Company;
provide reasonable assurance that the transactions are recorded as necessary to
permit preparation of financial statement in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
only being made in accordance with authorizations of management and directors of
the Company; and provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company’s
assets that could have a material effect on the financial
statements.  The system of internal control over financial reporting
as it relates to the financial statements is evaluated for effectiveness by
management and tested for liability through a program of internal
audits.  Actions are taken to correct potential deficiencies as they
are identified.
   Any
system of internal control, no matter how well designed, has inherent
limitations, including the possibility that a control can be circumvented or
overridden and misstatements due to error or fraud may occur and not be
detected.  Also, because of changes in conditions, internal control
effectiveness may vary over time.  Accordingly, even an effective
system of internal control will provide only reasonable assurance with respect
to financial statement preparation.
   Management
assessed the Company’s system of internal control over financial reporting as of
December 31, 2008, in relation to criteria for effective internal control over
financial reporting as described in Internal Control – Integrated
Framework, issued by the Committee of Sponsoring Organizations of the
Treadway Commission.  Based on this assessment, management concludes
that, as of December 31, 2008, its system of internal control over financial
reporting is effective and meets the criteria of Internal Control – Integrated
Framework.
   Beard  Miller  Company  LLP,
an independent registered public accounting
firm,   has   audited  the  Consolidated  Financial  Statements  of  the
Corporation for the year ended December 31, 2008, appearing elsewhere in
this  annual  report,  and  has  issued  an  attestation  report  on
the
effectiveness  of  the  Corporation's  internal  control  over
financial reporting  as  of December 31, 2008, as stated in
their report, which is included herein.
  
  
 /s/ Gary L. NalbandianGary
      L. NalbandianChairman,
      President and Chief Executive Officer(Principal
      Executive Officer)/s/ Mark A. ZodyMark
      A. ZodyExecutive
      Vice President and Chief Financial Officer(Principal
      Financial and Accounting Officer)
  
  March 12,
2009
   25
    Report
of Independent Registered Public Accounting Firm
  To the
Board of Directors and Stockholders
 of
Pennsylvania Commerce Bancorp, Inc.
 Harrisburg,
Pennsylvania
  We have
audited the accompanying consolidated balance sheets of Pennsylvania Commerce Bancorp,
Inc. and subsidiaries as of December 31, 2008 and 2007, and the related
consolidated statements
of income, stockholders’ equity and cash flows for each of the years in the
three-year period ended
December 31, 2008. Pennsylvania Commerce Bancorp, Inc.’s management is
responsible for these financial
statements. Our responsibility is to express an opinion on these 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.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures
in the financial statements. An audit also includes 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 Pennsylvania Commerce Bancorp, Inc. and its
subsidiaries as of
December 31, 2008 and 2007, and the results of their operations and their cash
flows for each of the years in
the three-year period ended December 31, 2008 in conformity with accounting
principles generally
accepted in the United States of America.
  We also
have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), Pennsylvania Commerce Bancorp, Inc.’s internal control
over financial reporting
as of December 31, 2008, based on criteria established in Internal Control – Integrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our
report dated March 16, 2009 expressed an unqualified opinion.
  /s/ Beard
Miller Company LLP
  Beard
Miller Company LLP
 Harrisburg,
Pennsylvania
 March 16,
2009
  26
  Report
of Independent Registered Public Accounting Firm
  To the
Board of Directors and Stockholders
 of
Pennsylvania Commerce Bancorp, Inc.
 Harrisburg,
Pennsylvania
  We have
audited Pennsylvania Commerce Bancorp, Inc.’s (the “Corporation”) internal
control over
financial reporting as of December 31, 2008, based on criteria established in
Internal
Control – Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission
(COSO). Pennsylvania Commerce Bancorp, Inc.’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of
internal control over financial reporting included in the accompanying Report on
Management’s Assessment
of Internal Control over Financial Reporting. Our responsibility is to express
an opinion on the
Corporation’s internal control over financial reporting based on our
audit.
  We
conducted our audit 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 effective internal control over financial reporting was
maintained in all
material respects. Our audit of internal control over financial reporting
included obtaining an understanding
of internal control over financial reporting, assessing the risk that a material
weakness exists,
and testing and evaluating the design and operating effectiveness of internal
control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances.
We believe that our audit provides a reasonable basis for our
opinion.
  A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external
purposes in accordance with generally accepted accounting principles. A
company’s internal control
over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that
receipts and expenditures of the company are being made only in accordance with
authorizations of
management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a
material effect on the financial statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect
misstatements. 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 our
opinion, Pennsylvania Commerce Bancorp, Inc. maintained, in all material
respects, effective
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal
Control – Integrated Frameworkissued by the Committee of Sponsoring
Organizations of the Treadway
Commission (COSO).
   We have
also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated balance sheets and the related
consolidated statements of
income, stockholders’ equity and cash flows of Pennsylvania Commerce Bancorp,
Inc. and subsidiaries, and our
report dated March 16, 2009 expressed an unqualified opinion.
   /s/ Beard
Miller Company LLP
   Beard
Miller Company LLP
 Harrisburg,
Pennsylvania
 March 16,
2009
 27




Consolidated
Balance Sheets


December
      31,(in
      thousands, except share and per share amounts)
            
            2008
            
            
            2007AssetsCash
      and cash equivalents
            
            $
            49,511
            
            
            $
            50,955Securities,
      available for sale at fair value
            
            
            341,656
            
            
            
            387,166Securities,
      held to maturity at cost(fair
      value 2008: $154,357;  2007: $256,248)
            
            
            152,587
            
            
            
            257,467Loans,
      held for sale
            
            
            41,148
            
            
            
            14,143Loans
      receivable, net of allowance for loan losses(allowance
      2008: $16,719;  2007: $10,742)
            
            
            1,423,064
            
            
            
            1,146,629Restricted
      investments in bank stocks
            
            
            21,630
            
            
            
            18,234Premises
      and equipment, net
            
            
            87,059
            
            
            
            89,307Other
      assets
            
            
            23,872
            
            
            
            15,110Total
      assets
            
            $
            2,140,527
            
            
            $
            1,979,011Liabilities
      and Stockholders’ EquityDeposits:Noninterest-bearing
            
            $
            280,556
            
            
            $
            271,894Interest-bearing
            
            
            1,353,429
            
            
            
            1,289,002Total
      deposits
            
            
            1,633,985
            
            
            
            1,560,896Short-term
      borrowings and repurchase agreements
            
            
            300,125
            
            
            
            217,335Long-term
      debt
            
            
            79,400
            
            
            
            79,400Other
      liabilities
            
            
            12,547
            
            
            
            9,045Total
      liabilities
            
            
            2,026,057
            
            
            
            1,866,676Stockholders’
      Equity:Preferred
      stock – Series A noncumulative; $10.00 par value;1,000,000
      shares authorized; 40,000 shares issued and outstanding
            
            
            400
            
            
            
            400Common
      stock – $1.00 par value; 10,000,000 shares authorized;(issued
      and outstanding shares 2008: 6,446,421;  2007:
      6,313,663)
            
            
            6,446
            
            
            
            6,314Surplus
            
            
            73,221
            
            
            
            70,610Retained
      earnings
            
            
            51,683
            
            
            
            38,862Accumulated
      other comprehensive loss
            
            
            (17,280
            )
            
            
            (3,851
            )Total
      stockholders’ equity
            
            
            114,470
            
            
            
            112,335Total
      liabilities and stockholders’ equity
            
            $
            2,140,527
            
            
            $
            1,979,011







See
accompanying notes.






28









Consolidated Statements of
      IncomeYears
      Ended December 31,(in
      thousands, except per share amounts)
            
            2008
            
            
            2007
            
            
            2006Interest
      IncomeLoans
      receivable, including fees:Taxable
            
            $
            79,247
            
            
            $
            76,753
            
            
            $
            64,592Tax-exempt
            
            
            3,427
            
            
            
            2,109
            
            
            
            1,029Securities:Taxable
            
            
            28,401
            
            
            
            37,060
            
            
            
            38,845Tax-exempt
            
            
            65
            
            
            
            65
            
            
            
            85Total
      interest income
            
            
            111,140
            
            
            
            115,987
            
            
            
            104,551Interest
      ExpenseDeposits
            
            
            22,211
            
            
            
            42,197
            
            
            
            39,762Short-term
      borrowings
            
            
            5,349
            
            
            
            10,804
            
            
            
            10,267Long-term
      debt
            
            
            4,875
            
            
            
            3,494
            
            
            
            1,731Total
      interest expense
            
            
            32,435
            
            
            
            56,495
            
            
            
            51,760Net
      interest income
            
            
            78,705
            
            
            
            59,492
            
            
            
            52,791Provision
      for loan losses
            
            
            7,475
            
            
            
            1,762
            
            
            
            1,634Net
      interest income after provision for loan losses
            
            
            71,230
            
            
            
            57,730
            
            
            
            51,157Noninterest
      IncomeService
      charges and other fees
            
            
            23,929
            
            
            
            20,688
            
            
            
            16,816Other
      operating income
            
            
            923
            
            
            
            702
            
            
            
            640Gains
      on sales of loans
            
            
            738
            
            
            
            1,262
            
            
            
            1,136Gains
      (losses) on sales/call of securities
            
            
            (157
            )
            
            
            171
            
            
            
            160Total
      noninterest income
            
            
            25,433
            
            
            
            22,823
            
            
            
            18,752Noninterest
      ExpensesSalaries
      and employee benefits
            
            
            38,085
            
            
            
            34,495
            
            
            
            30,864Occupancy
            
            
            8,087
            
            
            
            7,560
            
            
            
            6,568Furniture
      and equipment
            
            
            4,307
            
            
            
            4,075
            
            
            
            3,587Advertising
      and marketing
            
            
            2,747
            
            
            
            3,334
            
            
            
            2,971Data
      processing
            
            
            7,234
            
            
            
            6,501
            
            
            
            5,420Postage
      and supplies
            
            
            1,878
            
            
            
            1,963
            
            
            
            1,621Regulatory
      assessments and related fees
            
            
            2,834
            
            
            
            3,062
            
            
            
            511Telephone
            
            
            2,214
            
            
            
            2,386
            
            
            
            1,152Core
      system conversion/branding
            
            
            935
            
            
            
            -
            
            
            
            -Merger/acquisition
            
            
            491
            
            
            
            -
            
            
            
            -Other
            
            
            9,097
            
            
            
            7,431
            
            
            
            6,600Total
      noninterest expenses
            
            
            77,909
            
            
            
            70,807
            
            
            
            59,294Income
      before taxes
            
            
            18,754
            
            
            
            9,746
            
            
            
            10,615Provision
      for federal income taxes
            
            
            5,853
            
            
            
            2,745
            
            
            
            3,361Net
      income
            
            $
            12,901
            
            
            $
            7,001
            
            
            $
            7,254Net
      Income per Common ShareBasic
            
            $
            2.02
            
            
            $
            1.11
            
            
            $
            1.18Diluted
            
            
            1.97
            
            
            
            1.07
            
            
            
            1.12Average
      Common and Common Equivalent Shares OutstandingBasic
            
            
            6,356
            
            
            
            6,237
            
            
            
            6,099Diluted
            
            
            6,520
            
            
            
            6,462
            
            
            
            6,381







See
accompanying notes.


29




Consolidated
Statements of Stockholders’ Equity




(dollars in
      thousands)
            
            
            Preferred
              Stock
            
            
            
            Common
              Stock
            
            
            
            Surplus
            
            
            
            Retained
              Earnings
            
            
            
            Accumulated Other
              Comprehensive(Loss)
            
            
            
            TotalJanuary
      1, 2006
            
            $
            400
            
            
            $
            6,014
            
            
            $
            64,859
            
            
            $
            24,767
            
            
            $
            (4,397
            )
            
            $
            91,643Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            7,254
            
            
            
            -
            
            
            
            7,254Change
      in unrealized gains (losses) on securities,
              net
      of taxes
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (57
            )
            
            
            (57
            )Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            7,197Dividends
      declared on preferred stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (80
            )
            
            
            -
            
            
            
            (80
            )Common
      stock of 95,561 shares issued under
              stock
      option plans, including tax benefit of $513
            
            
            -
            
            
            
            96
            
            
            
            877
            
            
            
            -
            
            
            
            -
            
            
            
            973Common
      stock of 210 shares issued under employee
              stock
      purchase plan
            
            
            -
            
            
            
            -
            
            
            
            6
            
            
            
            -
            
            
            
            -
            
            
            
            6Proceeds
      from issuance of 39,525 shares of common
              stock
      in connection with dividend reinvestment
              and
      stock purchase plan
            
            
            -
            
            
            
            39
            
            
            
            1,001
            
            
            
            -
            
            
            
            -
            
            
            
            1,040Common
      stock share-based awards
            
            
            -
            
            
            
            -
            
            
            
            329
            
            
            
            -
            
            
            
            -
            
            
            
            329December
      31, 2006
            
            
            400
            
            
            
            6,149
            
            
            
            67,072
            
            
            
            31,941
            
            
            
            (4,454
            )
            
            
            101,108Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            7,001
            
            
            
            -
            
            
            
            7,001Change
      in unrealized gains (losses) on securities,
              net
      of taxes
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            603
            
            
            
            603Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            7,604Dividends
      declared on preferred stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (80
            )
            
            
            -
            
            
            
            (80
            )Common
      stock of 106,260 shares issued under stock
              option
      plans, including tax benefit of $368
            
            
            -
            
            
            
            106
            
            
            
            1,294
            
            
            
            -
            
            
            
            -
            
            
            
            1,400Common
      stock of 220 shares issued under employee
              stock
      purchase plan
            
            
            -
            
            
            
            -
            
            
            
            6
            
            
            
            -
            
            
            
            -
            
            
            
            6Proceeds
      from issuance of 58,028 shares of common
              stock
      in connection with dividend reinvestment
              and
      stock purchase plan
            
            
            -
            
            
            
            59
            
            
            
            1,519
            
            
            
            -
            
            
            
            -
            
            
            
            1,578Common
      stock share-based awards
            
            
            -
            
            
            
            -
            
            
            
            719
            
            
            
            -
            
            
            
            -
            
            
            
            719December
      31, 2007
            
            
            400
            
            
            
            6,314
            
            
            
            70,610
            
            
            
            38,862
            
            
            
            (3,851
            )
            
            
            112,335Comprehensive
      income:Net
      income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            12,901
            
            
            
            -
            
            
            
            12,901Change
      in unrealized gains (losses) on securities,
              net
      of taxes
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (13,429
            )
            
            
            (13,429
            )Total
      comprehensive (loss)
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (528
            )Dividends
      declared on preferred stock
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (80
            )
            
            
            -
            
            
            
            (80
            )Common
      stock of 95,386 shares issued under stock
              option
      plans, including tax benefit of $102
            
            
            -
            
            
            
            95
            
            
            
            548
            
            
            
            -
            
            
            
            -
            
            
            
            643Common
      stock of 160 shares issued under employee
              stock
      purchase plan
            
            
            -
            
            
            
            -
            
            
            
            4
            
            
            
            -
            
            
            
            -
            
            
            
            4Proceeds
      from issuance of 37,212 shares of common
              stock
      in connection with dividend reinvestment
              and
      stock purchase plan
            
            
            -
            
            
            
            37
            
            
            
            917
            
            
            
            -
            
            
            
            -
            
            
            
            954Common
      stock share-based awards
            
            
            -
            
            
            
            -
            
            
            
            1,142
            
            
            
            -
            
            
            
            -
            
            
            
            1,142December
      31, 2008
            
            $
            400
            
            
            $
            6,446
            
            
            $
            73,221
            
            
            $
            51,683
            
            
            $
            (17,280
            )
            
            $
            114,470




See
accompanying notes.




30







Consolidated
Statements of Cash Flows


(in
thousands)
            
            Years Ended December
      31,2008
            
            
            2007
            
            
            2006Operating
      ActivitiesNet
      income
            
            $
            12,901
            
            
            $
            7,001
            
            
            $
            7,254Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
            
            
            7,475
            
            
            
            1,762
            
            
            
            1,634Provision
      for depreciation and amortization
            
            
            5,007
            
            
            
            4,789
            
            
            
            4,004Deferred
      income taxes
            
            
            (2,215
            )
            
            
            73
            
            
            
            1,319Amortization
      of securities premiums and accretion of discounts, net
            
            
            450
            
            
            
            567
            
            
            
            776Net
      (gains) losses on sales and calls of securities
            
            
            157
            
            
            
            (171
            )
            
            
            (160
            )Proceeds
      from sales of loans originated for sale
            
            
            60,620
            
            
            
            86,604
            
            
            
            93,789Loans
      originated for sale
            
            
            (86,897
            )
            
            
            (84,301
            )
            
            
            (97,524
            )Gains
      on sales of loans originated for sale
            
            
            (738
            )
            
            
            (1,262
            )
            
            
            (1,136
            )Loss
      on disposal of equipment
            
            
            0
            
            
            
            0
            
            
            
            270Stock-based
      compensation
            
            
            1,142
            
            
            
            719
            
            
            
            329Amortization
      of deferred loan origination fees and costs
            
            
            1,726
            
            
            
            1,858
            
            
            
            2,174(Increase)
      decrease in other assets
            
            
            406
            
            
            
            2,904
            
            
            
            (5,847
            )Increase
      (decrease) in other liabilities
            
            
            3,502
            
            
            
            2,647
            
            
            
            (518
            )Net
      cash provided by operating activities
            
            
            3,536
            
            
            
            23,190
            
            
            
            6,364Investing
      ActivitiesSecurities
      held to maturity:Proceeds
      from principal repayments, calls and maturities
            
            
            113,348
            
            
            
            149,790
            
            
            
            44,923Proceeds
      from sales
            
            
            1,840
            
            
            
            0
            
            
            
            2,081Purchases
            
            
            (10,571
            )
            
            
            (87,590
            )
            
            
            (60,400
            )Securities
      available for sale:Proceeds
      from principal repayments and maturities
            
            
            47,627
            
            
            
            55,423
            
            
            
            112,533Purchases
            
            
            (23,212
            )
            
            
            (49,949
            )
            
            
            (124,527
            )Proceeds
      from sales of loans receivable
            
            
            1,806
            
            
            
            2,683
            
            
            
            1,181Net
      increase in loans receivable
            
            
            (287,430
            )
            
            
            (179,720
            )
            
            
            (162,473
            )Net
      purchase of restricted investments in bank stock
            
            
            (3,396
            )
            
            
            (6,507
            )
            
            
            (265
            )Proceeds
      from sale of premises and equipment and foreclosed real
    estate
            
            
            479
            
            
            
            62
            
            
            
            827Purchases
      of premises and equipment
            
            
            (2,867
            )
            
            
            (10,479
            )
            
            
            (22,516
            )Net
      cash used by investing activities
            
            
            (162,376
            )
            
            
            (126,287
            )
            
            
            (208,636
            )Financing
      ActivitiesNet
      increase in demand, interest checking, money market, and savings
      deposits
            
            
            9,247
            
            
            
            3,270
            
            
            
            249,695Net
      increase (decrease) in time deposits
            
            
            63,842
            
            
            
            (59,151
            )
            
            
            (3,978
            )Net
      increase (decrease) in short-term borrowings
            
            
            82,790
            
            
            
            104,535
            
            
            
            (45,100
            )Proceeds
      from long-term debt
            
            
            0
            
            
            
            50,000
            
            
            
            15,800Proceeds
      from common stock options exercised
            
            
            541
            
            
            
            1,032
            
            
            
            460Proceeds
      from dividend reinvestment and common stock purchase plan
            
            
            954
            
            
            
            1,578
            
            
            
            1,040Tax
      benefit on exercise of stock options
            
            
            102
            
            
            
            368
            
            
            
            513Cash
      dividends on preferred stock
            
            
            (80
            )
            
            
            (80
            )
            
            
            (80
            )Net
      cash provided by financing activities
            
            
            157,396
            
            
            
            101,552
            
            
            
            218,350Increase
      (decrease) in cash and cash equivalents
            
            
            (1,444
            )
            
            
            (1,545
            )
            
            
            16,078Cash
      and cash equivalents at beginning of year
            
            
            50,955
            
            
            
            52,500
            
            
            
            36,422Cash
      and cash equivalents at year-end
            
            $
            49,511
            
            
            $
            50,955
            
            
            $
            52,500





See
accompanying notes.




31




Notes to
Consolidated Financial Statements




1.Summary of Significant
Accounting Policies




Nature
of Operations and Basis of Presentation




The
consolidated financial statements presented include the accounts of Pennsylvania
Commerce Bancorp, Inc. (the Company) and its wholly-owned subsidiary Commerce
Bank/Harrisburg (Commerce or Bank). All material intercompany transactions have
been eliminated. The Company was formed July 1, 1999 and is subject to
regulation of the Federal Reserve Bank.




The
Company is a one-bank holding company head­quartered in Harrisburg,
Pennsylvania and provides full banking services through its subsidiary Commerce
Bank. As a Pennsylvania state chartered bank, Commerce is subject to regulation
of the Pennsylvania Department of Banking and the Federal Deposit Insurance
Corporation. The Bank serves primarily the Harrisburg, York, Reading and
Lancaster markets of South Central Pennsylvania.




Estimates




The
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. These principles require
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and require disclosure of contingent assets and
liabilities. In the opinion of management, all adjustments considered necessary
for fair presentation have been included and are of a normal, recurring nature.
Actual results could differ from these estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, impaired loans, the valuation of
deferred tax assets, and the valuation of securities available for
sale.




Significant
Group Concentrations of Credit Risk




Most of
the Company’s activities are with customers located within the South Central
Pennsylvania Region. Note 3 discusses the types of securities that the Company
invests in. Notes 4 and 6 discuss the types of lending that the Company engages
in as well as loan concentrations. The Company does not have any significant
concentrations to any one customer.




Securities




Securities
classified as held to maturity are those debt securities that the Company has
both the intent and ability to hold to maturity regardless of changes in market
conditions, liquidity needs, or general economic conditions. These securities
are carried at cost adjusted for amortization of premium and accretion of
discount, computed by the interest method over the estimated average life of the
securities.




Securities
classified as available for sale are those debt securities that the Company
intends to hold for an indefinite period of time, but not necessarily to
maturity. Any decision to sell a security classified as available for sale would
be based on various factors, including significant movements in interest rates,
changes in the maturity mix of the Company’s assets and liabilities, liquidity
needs, regulatory capital considerations, and other similar factors. Securities
available for sale are carried at fair value. Unrealized gains or losses are
reported in other comprehensive income, net of the related deferred tax effect.
Realized gains or losses, determined on the basis of the cost of specific
securities sold, are included in earnings. Premiums and discounts are recognized
in interest income using the interest method over the estimated average life of
the securities. Declines in the fair value of held-to-maturity and
available-for-sale securities below their cost that are deemed to be other than
temporary are reflected in earnings as realized losses. In estimating
other-than-temporary impairment losses, management considers (1) adverse changes
in the general market condition of the industry in which the investment is
related, (2) the financial condition and near-term prospects of the issuer, (3)
the seniority of the tranche owned by the Bank in relation to the entire bond
issue, (4) current prepayment behavior, (5) current credit agency ratings, (6)
the credit support available in the bond structure to absorb losses, and (7)
each of the following with respect to the underlying collateral: (a) delinquency
percentages and trends, (b) weighted average loan-to-value ratios, (c) weighted
average FICO scores, and (d) the level of foreclosure and OREO activity. Also
considered is the intent and ability of the Company to retain its investment in
the issuer for a period of time sufficient to allow for any anticipated recovery
in fair value.




Management
determines the appropriate classification of debt securities at the time of
purchase and re-evaluates such designation as of each balance sheet
date.




Loans
Receivable




Loans
receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at their outstanding
unpaid principal balances, net of an allowance for loan losses and any deferred
fees and costs. Interest income is accrued on the unpaid principal balance. Loan
origination fees and costs are deferred and recognized as an adjustment of the
yield (interest income) of the related loans. The Bank is generally amortizing
these amounts over the contractual life of the loan or the call
date.






32




The
accrual of interest is generally discontinued when the contractual payment of
principal or interest has become 90 days past due or management has serious
doubts about further collectibility of principal or interest, even though the
loan is currently performing. A loan may remain on accrual status if it is in
the process of collection and is either guaranteed or well secured. When a loan
is placed on nonaccrual status, unpaid interest credited to income in the
current year is reversed and unpaid interest accrued in prior years is charged
against the allowance for loan losses. Interest received on nonaccrual loans
generally is either applied against principal or reported as interest income,
according to management’s judgment as to the collectibility of principal. 
When a
loan is considered impaired and it is also in non accrual status, the unpaid
interest is treated the same as it is for a non accrual loan.  If a
loan is considered impaired and accruing, interest is recognized as
accrued.Generally, loans are restored to accrual status when the
obligation is brought current, has performed in accordance with the contractual
terms for a reasonable period of time and the ultimate collectibility of the
total contractual principal and interest is no longer in doubt.




Allowance
for Loan Losses




The
allowance for loan losses is established through provisions for loan losses
charged against income. Loans deemed to be uncollectible are charged against the
allowance for loan losses, and subsequent recoveries, if any, are credited to
the allowance. The evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.




The
allowance consists of specific and general components. The specific component
relates to loans that are classified impaired. For such loans, an allowance is
established when the discounted cash flows or collateral value or observable
market price of the impaired loan is lower than the carrying value of that loan.
The general component covers non-classified loans and is based on historical
loss experience adjusted for qualitative factors. Additionally, the general
component is maintained to cover uncertainties that could affect management’s
estimates of probable losses. This component reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for estimating
losses in the portfolio.




The
allowance for loan losses is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated. Management’s periodic
evaluation of the adequacy of the allowance is based on the Bank’s past loan
loss experience, known and inherent risks in the portfolio, adverse situations
that may affect the borrower’s ability to repay, the estimated value of any
underlying collateral, composition of the loan portfolio, current economic
conditions, and other relevant factors. This evaluation is inherently subjective
as it requires material estimates that may be susceptible to change, including
the amounts and timing of future cash flows expected to be received on impaired
loans. A loan is considered impaired when, based on current information and
events, it is probable that the Bank will be unable to collect the scheduled
payments of principal or interest when due according to the contractual terms of
the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value and the probability of collecting
scheduled principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not classified
as impaired. Management determines the significance of payment delays and
payment shortfalls on a case-by-case basis, taking into consideration all of the
circumstances surrounding the loan and the borrower, including the length of the
delay, the reasons for the delay, the borrower’s prior payment record and the
amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial, commercial
mortgage and construction loans by either the present value of expected future
cash flows discounted at the loan’s effective interest rate, the loan’s
obtainable market price or the fair value of the collateral if the loan is
collateral dependent.




All
nonaccrual loans, including any non-homogenous portfolio residential mortgages
and home equity loans with balances greater than $25,000,are evaluated
individually to determine whether a valuation allowance is necessary due to
collateral deficiencies that may exist within the loan. Large groups of smaller
balance homogeneous loans are collectively evaluated for impairment, unless such
loans are the subject of a restructuring agreement.




Loans
Held for Sale




Loans
held for sale are comprised of student loans and selected residential loans the
Company originates with the intention of selling in the future. Occasionally,
loans held for sale also include selected small business administration loans
and business and industry loans that the Company decides to sell. These loans
are carried at the lower of cost or estimated fair value, calculated in the
aggregate.




Restricted
Investments in Bank Stock




Prior to
2008, restricted investments in bank stocks included Federal Home Loan Bank of
Pittsburgh (FHLB) and Federal Reserve Bank (FRB) stocks. At December 31,
2008, restricted investments in bank stocks included FHLB stock only. During the
fourth quarter of 2008, the Bank applied for and was granted a change from a
national bank charter to a Pennsylvania state bank charter. At the same time,
the Bank’s primary federal regulator changed from the FRB to the Federal Deposit
Insurance Corporation (FDIC). Therefore, the Bank was required to redeem $2.8
million of FRB stock. Federal law requires a member institution of the FHLB
system to hold stock of its district FHLB according to a predetermined formula.
At December 31, 2008, $18.8 million of the Company’s $21.6 million of FHLB stock
was purchased to cover the Company’s borrowing level on its credit line at the
FHLB. The stock is carried at cost.




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






33




The
Company believes no impairment charge is necessary related to the FHLB
restricted stock as of December 31, 2008.




Advertising
Costs




The
Company follows the policy of charging the costs of advertising to expense as
incurred.




Income
Taxes




Deferred
income taxes are provided on the liability method whereby deferred tax assets
are recognized for deductible temporary differences and deferred tax liabilities
are recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets and liabilities are adjusted through the provision
for income taxes for the effects of changes in tax laws and rates on the date of
enactment.




Effective
January 1, 2007, the Company adopted the provisions of FASB Interpretation No.
48, “Accounting for Uncertainty in Income Taxes”. As a result of the Company’s
evaluation of the implementation of FIN 48, no significant income tax
uncertainties were identified.  The Company did not recognize any income
tax interest or penalties for the years ended December 31, 2008, 2007 and
2006. The tax years subject to examination by the taxing authorities are
calendar years 2005 through 2008.




Bank
Premises and Equipment




Bank
premises and equipment are carried at cost less accumulated depreciation and
amortization. Depreciation is charged to operations over the estimated useful
lives of the respective assets. Leasehold improvements are amortized over the
terms of the respective leases or the estimated useful lives of the
improvements, whichever is shorter. Depreciation and amortization are determined
on the straight-line method for financial reporting purposes, and accelerated
methods for income tax purposes.




Foreclosed
Assets




Assets
acquired through, or in lieu of, loan foreclosure are held for sale and are
initially recorded at fair value at the date of foreclosure, establishing a new
cost basis. Subsequent to foreclosure, valuations are periodically performed by
management and the assets are carried at the lower of carrying amount or fair
value, less estimated costs to sell the asset.  Losses on
foreclosed real estate were $303,000 as stated in the Consolidated Statement of
Income under other non interest expense for year ended December 31, 2008.Revenue and expenses from operations and changes in the valuation
allowance are included in net expenses from foreclosed assets. Foreclosed assets
are included in other assets. Foreclosed real estate assets totaled $743,000 as
of December 31, 2008 as compared to $489,000 as of December 31,
2007.




Transfers
of Financial Assets




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




Per
Share Data




Basic
earnings per share represent income available to common stockholders divided by
the weighted-average number of common shares outstanding during the period.
Diluted earnings per share reflect additional common shares that would have been
outstanding if dilutive potential common shares had been issued as well as any
adjustments to income that would result from the assumed issuance. Potential
common shares that may be issued by the Company relate solely to outstanding
stock options, and are determined using the treasury stock method.




Off
Balance Sheet Financial Instruments




In the
ordinary course of business, the Company has entered into off balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit, and standby letters of credit. Such financial instruments are
recorded on the balance sheet when they become payable by the borrower to the
Company.




Cash
Flow Information




For
purposes of the statements of cash flows, the Company considers cash and due
from banks and federal funds sold as cash and cash equivalents. Generally,
federal funds, a component of cash and cash equivalents are purchased and
sold for one-day periods. Cash paid during the years ended December 31, 2008,
2007, and 2006 for interest expense on deposits, borrowings and debt was $32.2
million, $56.4 million, and $51.5 million respectively. Income taxes paid
totaled $8.0 million, $1.7 million, and $2.7 million in 2008, 2007, and 2006,
respectively.






34




Stock-Based
Compensation




Effective
January 1, 2006, the Company adopted Financial Accounting Standards Board (FASB)
Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) using the modified
prospective method. FAS 123(R) requires compensation costs related to
share-based payment transactions to be recognized in the income statement (with
limited exceptions) based on the grant-date fair value of the stock-based
compensation issued. Compensation costs are recognized over the period that an
employee provides service in exchange for the award.




The cash
flows resulting from the tax benefits due to deductions in excess of the
compensation cost recognized for options (excess tax benefits) are classified as
financing cash flows.




Recent
Accounting Standard




FASB
Statement No. 141 (R) “Business Combinations” was issued in December of
2007. This Statement establishes principles and requirements for how the
acquirer of a business recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquiree. The Statement also provides guidance for recognizing
and measuring the goodwill acquired in the business combination and determines
what information to disclose to enable users of the financial statements to
evaluate the nature and financial effects of the business combination. The
guidance will impact business combinations which occur after January 1,
2009.  Given that FASB Statement No.  141(R) will require the
expensing of direct acquisition costs, the Company expensed such costs in 2008
that were incurred in conjunction with the pending acquisition described in Note
23.




Segment
Reporting




Commerce
acts as an independent community financial services provider, and offers
traditional banking and related financial services to individual, business and
government customers. Through its stores, the Company offers a full array of
commercial and retail financial services.




Management
does not separately allocate expenses, including the cost of funding loan
demand, between the commercial and retail operations of the Company. As such,
discrete financial information is not available and segment reporting would not
be meaningful.




Reclassifications




Certain
amounts in the 2006 and 2007 financial statements have been reclassified to
conform to the 2008 presentation format. Such reclassifications had no impact on
the Company’s net income.




2.Restrictions on Cash and Due
from Bank Accounts




The Bank
is required to maintain average reserves, in the form of cash and balances with
the Federal Reserve Bank, against its deposit liabilities. The average amount of
these reserve balances maintained for 2008 and 2007 was approximately $7.8
million and $24.8 million, respectively.




3.Securities




The
amortized cost and fair value of securities are summarized in the following
tables.




December
      31, 2008(in
      thousands)
            
            Amortized
      Cost
            
            
            Gross
      Unrealized Gains
            
            
            Gross
      Unrealized Losses
            
            
            Fair
      ValueAvailable
      for Sale:U.S.
      Government Agency securities
            
            $
            5,000
            
            
            $
            2
            
            
            $
            0
            
            
            $
            5,002Mortgage-backed
      securities
            
            
            363,241
            
            
            
            2,253
            
            
            
            (28,840
            )
            
            
            336,654Total
            
            $
            368,241
            
            
            $
            2,255
            
            
            $
            (28,840
            )
            
            $
            341,656Held
      to Maturity:U.S.
      Government Agency securities
            
            $
            36,500
            
            
            $
            258
            
            
            $
            0
            
            
            $
            36,758Municipal
      securities
            
            
            1,623
            
            
            
            12
            
            
            
            0
            
            
            
            1,635Mortgage-backed
      securities
            
            
            112,472
            
            
            
            2,049
            
            
            
            (557
            )
            
            
            113,964Corporate
      debt securities
            
            
            1,992
            
            
            
            8
            
            
            
            0
            
            
            
            2,000Total
            
            $
            152,587
            
            
            $
            2,327
            
            
            $
            (557
            )
            
            $
            154,357








35





December
      31, 2007(in
      thousands)
                    
                    Amortized
      Cost
                    
                    
                    Gross
      Unrealized Gains
                    
                    
                    Gross
      Unrealized Losses
                    
                    
                    Fair
      ValueAvailable
      for Sale:U.S.
      Government Agency securities
                    
                    $
                    5,000
                    
                    
                    $
                    0
                    
                    
                    $
                    (42
                    )
                    
                    $
                    4,958Mortgage-backed
      securities
                    
                    
                    388,000
                    
                    
                    
                    375
                    
                    
                    
                    (6,167
                    )
                    
                    
                    382,208Total
                    
                    $
                    393,000
                    
                    
                    $
                    375
                    
                    
                    $
                    (6,209
                    )
                    
                    $
                    387,166Held
      to Maturity:U.S.
      Government Agency securities
                    
                    $
                    133,303
                    
                    
                    $
                    606
                    
                    
                    $
                    (163
                    )
                    
                    $
                    133,746Municipal
      securities
                    
                    
                    1,621
                    
                    
                    
                    16
                    
                    
                    
                    0
                    
                    
                    
                    1,637Mortgage-backed
      securities
                    
                    
                    116,058
                    
                    
                    
                    213
                    
                    
                    
                    (1,545
                    )
                    
                    
                    114,726Corporate
      debt securities
                    
                    
                    6,485
                    
                    
                    
                    70
                    
                    
                    
                    (416
                    )
                    
                    
                    6,139Total
                    
                    $
                    257,467
                    
                    
                    $
                    905
                    
                    
                    $
                    (2,124
                    )
                    
                    $
                    256,248




The
amortized cost and fair value of debt securities at December 31, 2008 by
contractual maturity are shown in the following table. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations.




Available
      for Sale
            
            
            Held
      to Maturity(in
      thousands)
            
            Amortized
              Cost
            
            
            Fair Value
            
            
            Amortized Cost
            
            
            Fair ValueDue
      in one year or less
            
            $
            0
            
            
            $
            0
            
            
            $
            1,500
            
            
            $
            1,502Due
      after one year through five years
            
            
            0
            
            
            
            0
            
            
            
            7,646
            
            
            
            7,674Due
      after five years through ten years
            
            
            5,000
            
            
            
            5,002
            
            
            
            15,000
            
            
            
            15,099Due
      after ten years
            
            
            0
            
            
            
            0
            
            
            
            15,969
            
            
            
            16,1185,000
            
            
            
            5,002
            
            
            
            40,115
            
            
            
            40,393Mortgage-backed
      securities
            
            
            363,241
            
            
            
            336,654
            
            
            
            112,472
            
            
            
            113,964Total
            
            $
            368,241
            
            
            $
            341,656
            
            
            $
            152,587
            
            
            $
            154,357




There
were no sales of securities in the available for sale portfolio in 2008. There
was one sale in the held to maturity portfolio during the second quarter of
2008. The Company sold a $2.0 million corporate debt security due to
significant deterioration in the creditworthiness of the issuer. A pretax loss
of $157,000 was recognized on this sale during the second quarter of
2008.




There
were no sales of securities in the available for sale or held to maturity
portfolios in 2007. There was $171,000 in premiums on the call of two securities
realized in net income for 2007.




There
were no sales of securities in the available for sale portfolio in 2006. A gross
gain of $80,000 was realized on the sale of one security from the held to
maturity portfolio. This sale consisted of a $2.1 million debt security which
was sold due to the expected and impending call of the security by the issuer.
The sale was near the call date and changes in market interest rates had no
effect on the security’s fair value. The amount of gain on sale was essentially
the same as the call premium that would have been recognized on the call date.
An $80,000 premium on the call of another debt security was also realized in net
income for 2006.




At
December 31, 2008 and 2007, securities with a carrying value of $320.3 million
and $455.4 million respectively, were pledged to secure public deposits and for
other purposes as required or permitted by law.






36




The
following table shows the Company’s investments’ gross unrealized losses and
fair value, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position.




December
      31, 2008Less
      than 12 months
                  
                  
                  12
      months or more
                  
                  
                  Total(in
      thousands)
                  
                  Fair
      Value
                  
                  
                  Unrealized
      Losses
                  
                  
                  Fair
      Value
                  
                  
                  Unrealized
      Losses
                  
                  
                  Fair
      Value
                  
                  
                  Unrealized
      LossesAvailable
      for Sale:Mortgage-backed
      securities
                  
                  $
                  60,927
                  
                  
                  $
                  (5,025
                  )
                  
                  $
                  144,387
                  
                  
                  $
                  (23,815
                  )
                  
                  $
                  205,314
                  
                  
                  $
                  (28,840
                  )Total
                  
                  $
                  60,927
                  
                  
                  $
                  (5,025
                  )
                  
                  $
                  144,387
                  
                  
                  $
                  (23,815
                  )
                  
                  $
                  205,314
                  
                  
                  $
                  (28,840
                  )Held
      to Maturity:Mortgage-backed
      securities
                  
                  $
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  4,916
                  
                  
                  $
                  (557
                  )
                  
                  $
                  4,916
                  
                  
                  $
                  (557
                  )Total
                  
                  $
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  4,916
                  
                  
                  $
                  (557
                  )
                  
                  $
                  4,916
                  
                  
                  $
                  (557
                  )December
      31, 2007Less
      than 12 months
                  
                  
                  12
      months or more
                  
                  
                  Total(in
      thousands)
                  
                  Fair
      Value
                  
                  
                  Unrealized
      Losses
                  
                  
                  Fair
      Value
                  
                  
                  Unrealized
      Losses
                  
                  
                  Fair
      Value
                  
                  
                  Unrealized
      LossesAvailable
      for Sale:U.S.
      Government Agency securities
                  
                  $
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  4,958
                  
                  
                  $
                  (42
                  )
                  
                  $
                  4,958
                  
                  
                  $
                  (42
                  )Mortgage-backed
      securities
                  
                  
                  80,732
                  
                  
                  
                  (1,110
                  )
                  
                  
                  226,261
                  
                  
                  
                  (5,057
                  )
                  
                  
                  306,993
                  
                  
                  
                  (6,167
                  )Total
                  
                  $
                  80,732
                  
                  
                  $
                  (1,110
                  )
                  
                  $
                  231,219
                  
                  
                  $
                  (5,099
                  )
                  
                  $
                  311,951
                  
                  
                  $
                  (6,209
                  )Held
      to Maturity:U.S.
      Government Agency securities
                  
                  $
                  9,990
                  
                  
                  $
                  (9
                  )
                  
                  $
                  59,846
                  
                  
                  $
                  (154
                  )
                  
                  $
                  69,836
                  
                  
                  $
                  (163
                  )Mortgage-backed
      securities
                  
                  
                  10
                  
                  
                  
                  0
                  
                  
                  
                  88,362
                  
                  
                  
                  (1,545
                  )
                  
                  
                  88,372
                  
                  
                  
                  (1,545
                  )Corporate
      debt securities
                  
                  
                  1,580
                  
                  
                  
                  (416
                  )
                  
                  
                  0
                  
                  
                  
                  0
                  
                  
                  
                  1,580
                  
                  
                  
                  (416
                  )Total
                  
                  $
                  11,580
                  
                  
                  $
                  (425
                  )
                  
                  $
                  148,208
                  
                  
                  $
                  (1,699
                  )
                  
                  $
                  159,788
                  
                  
                  $
                  (2,124
                  )




At
December 31, 2008, eight mortgage-backed securities were in an unrealized loss
position for less than twelve months. At the same date, thirty-two
mortgage-backed securities have been in a continuous unrealized loss position
for twelve months or more.


Our
investment securities portfolio consists primarily of U.S. Government agency
securities, U.S. Government sponsored agency mortgage-backed obligations and
private-label collateralized mortgage obligations (CMO’s). The securities of the
U.S. Government sponsored agencies and the U.S. Government mortgage-backed
securities have little, if any, credit risk because they are either backed by
the full faith and credit of the U.S. Government or their principal and interest
payments are guaranteed by an agency of the U.S. Government. Private label CMO’s
are not backed by the full faith and credit of the U.S. Government nor are their
principal and interest payments guaranteed. Historically, most private label
CMO’s have carried an AAA insurance rating on the underlying issuer, however,
the sub-prime mortgage problems and collapse in the residential housing market
in the U.S. throughout 2008 have led to ratings downgrades and subsequent
other-than-temporary impairment of many types of CMO’s.
   The
unrealized losses in the Company’s investment portfolio at December 31, 2008
were associated with two different types of securities. The first type includes
eight floating rate government agency sponsored collateralized mortgage
obligations (CMO’s), all of which have yields that are indexed to a spread over
the one month London Interbank Offered Rate (LIBOR). Management believes that
the unrealized losses on the Company’s investment in these federal agency CMO’s
was caused by the overall very low level of market interest rates, including
LIBOR. The Company purchased those investments at a discount relative to their
face amount, and the contractual cash flows of those investments are guaranteed
by an agency of the U.S. government. Accordingly, it is expected that the
securities would not be settled at a price less than the amortized cost of the
Company’s investment. Because management believes the decline in fair value is
attributable to changes in interest rates and not credit quality, and because
the Company has the ability and intent to hold those investments until a
recovery of fair value, which may be maturity, the Company does not consider
those investments to be other-than-temporarily impaired at December 31,
2008.
   The
second type of security in the Company’s investment portfolio with unrealized
losses at December 31, 2008 were private label CMO’s. As of December 31, 2008,
Commerce Bank owned thirty-two CMO securities in its investment portfolio with a
total book value of $160.4 million.  Management performs periodic
assessments of these securities for other-than-temporary impairment. See Note 1
for a list of considerations management utilizes in its
assessment.  To help with this assessment, management requested an
independent third party (the third party) with expertise regarding CMO
securities to prepare an analysis of all private-label CMO’s held in the Bank’s
investment portfolio.  The third party produced a book which detailed
historical performance for each CMO dating back to the bonds issuance as well as
a separate collateral default analysis with various levels of loss severity for
each bond. The third party also assigned each bond to one of four categories
based upon their knowledge and analysis of the bonds.  They ranked 7
of the Bank’s private-label CMO’s as excellent, 20 of them as very good, 5 of
them as fair and none were rated as poor.  Management discussed the
characteristics and performance of each of the fair-rated bonds with a CMO
analyst employed by the third party to gain better insight into the risks and
probability of loss potential associated with each bond.
  While
each of these five bonds has experienced an increase in delinquency, foreclosure
and OREO activity, none has yet experienced default rates high enough, in
management’s opinion, to warrant impairment of the tranche owned by the Bank at
this time.  Also, at this time there appears to be sufficient credit
support built into the structure of each bond to absorb losses ranging from 6%
to 9% of the remaining balance before impairment could begin to affect the
tranches owned by the Bank.  Two of the bonds were recently downgraded
by Fitch rating service, one to BBB and the other to BB status.  These
bonds are split-rated as S&P and Moody’s continue to rate them above
investment grade.  The downgrading by one of the three rating service
agencies does not necessarily indicate current impairment in management’s
opinion.
  Management
also applied a pricing methodology as permitted by FAS #157(3) to the Bank’s
entire private-label CMO portfolio in an effort to provide what may be more
reasonable pricing of these bonds at December 31, 2008 in a more normalized
trading market.   The results produced much higher market prices
as of 12/31/08 than were obtained by way of matrix pricing the securities with
street bids.  Although the accounting guidance would permit the Bank
to utilize these higher prices, management has elected to utilize the lower
matrix pricing for its year-end financial statements.
  In
summary, based upon a detailed analysis, management does not believe that the
decreased market prices associated with any of the Bank’s private label CMO
investments represent other-than-temporary impairment as of December 31,
2008.


37




4.Loans Receivable and
Allowance for Loan Losses




A summary
of loans receivable is as follows:




December
      31,(in
      thousands)
            
            2008
            
            
            2007Real
      Estate:Commercial
      Mortgage
            
            $
            599,321
            
            
            $
            430,778Construction
      and Land Development
            
            
            54,075
            
            
            
            54,475Residential
      Mortgage
            
            
            86,490
            
            
            
            80,575Tax-Exempt
            
            
            96,506
            
            
            
            53,690Commercial
      Business
            
            
            195,258
            
            
            
            192,390Consumer
            
            
            237,628
            
            
            
            211,536Commercial
      Lines of Credit
            
            
            170,505
            
            
            
            133,9271,439,783
            
            
            
            1,157,371Less:
      Allowance for Loan Losses
            
            
            16,719
            
            
            
            10,742Net
      Loans Receivable
            
            $
            1,423,064
            
            
            $
            1,146,629




The
following is a summary of the transactions in the allowance for loan
losses.




Years
      Ended December 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Balance
      at beginning of year
            
            $
            10,742
            
            
            $
            9,685
            
            
            $
            9,231Provision
      charged to expense
            
            
            7,475
            
            
            
            1,762
            
            
            
            1,634Recoveries
            
            
            170
            
            
            
            72
            
            
            
            105Loans
      charged off
            
            
            (1,668
            )
            
            
            (777
            )
            
            
            (1,285
            )Balance
      at end of year
            
            $
            16,719
            
            
            $
            10,742
            
            
            $
            9,685




At
December 31, 2008 and 2007, the recorded investment in loans considered to be
impaired under FASB Statement No. 114 “Accounting by Creditors for Impairment of
a Loan” totaled $41.8 million and $9.1 million, respectively. At December 31,
2008, $12.7 million of impaired loans have a specific valuation allowance of
$3.7 million as compared to $1.3 million of impaired loans having a specific
valuation allowance of $536,000 at December 31, 2007. Nonaccrual loans at
December 31, 2008 and 2007 totaled $27.1 million and $2.9 million, respectively.
Loans past due 90 days or more and still accruing interest totaled $0 at both
December 31, 2008 and December 31, 2007.




Impaired
loans averaged approximately $21.0 million, $11.7 million and $10.5 million
during 2008, 2007 and 2006, respectively. Interest income recognized on these
loans amounted to $1.9 million, $883,000 and $1.1 million during 2008, 2007 and
2006, respectively.




Certain
directors and executive officers of the Company, including their associates and
companies, have loans with the Bank. Such loans were made in the ordinary course
of business at the Bank’s normal credit terms including interest rate and
collateralization, and do not represent more than a normal risk of collection.
Total loans to these persons and companies amounted to approximately $15.1
million and $14.9 million at December 31, 2008 and 2007, respectively. During
2008, $5.9 million of new advances were made and repayments totaled $5.7
million.




5.Loan Commitments and Standby
Letters of Credit




Loan
commitments are made to accommodate the financial needs of Commerce’s customers.
Standby letters of credit commit the Bank to make payments on behalf of
customers when certain specified future events occur. They primarily are issued
to facilitate the customers’ normal course of business transactions.
Historically, almost all of the Bank’s standby letters of credit expire
unfunded.




Both
types of lending arrangements have credit risk essentially the same as that
involved in extending loans to customers and are subject to the Bank’s normal
credit policies. Letter of credit commitments are agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Since many of the commitments are expected to expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee.




Outstanding
letters of credit written are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The majority of these
standby letters of credit expire within the next twenty-four months. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending other loan commitments. The Bank requires collateral
supporting these letters of credit as deemed necessary. Management believes that
the proceeds obtained through a liquidation of such collateral would be
sufficient to cover the maximum potential amount of future payments required
under the corresponding guarantees. The amount of the liability as of December
31, 2008 as well as at December 31, 2007 for guarantees under standby
letters of credit issued was $0.






38




The
Bank’s maximum exposure to credit loss for loan commitments (unfunded loans and
unused lines of credit, including home equity lines of credit) and standby
letters of credit outstanding were as follows:




December
      31,(in
      thousands)
            
            2008
            
            
            2007Commitments
      to grant loans
            
            $
            3,885
            
            
            $
            5,537Unfunded
      commitments of existing commercial loans
            
            
            361,951
            
            
            
            309,134Unfunded
      commitments of existing consumer loans
            
            
            63,785
            
            
            
            59,970Standby
      letters of credit
            
            
            41,771
            
            
            
            37,004Total
            
            $
            471,392
            
            
            $
            411,645




6.Concentrations of Credit
Risk




The
Company’s loan portfolio is principally to borrowers throughout Cumberland,
Dauphin, York, Lebanon, Lancaster and Berks counties of Pennsylvania where it
has full-service stores. Commercial real estate loans and loan commitments for
commercial real estate projects aggregated $722.0 million at December 31,
2008.




Commercial
real estate loans are collateralized by the related project (principally office
buildings, multifamily residential, land development, and other properties) and
the Company generally requires loan-to-value ratios of no greater than 80%.
Collateral requirements on such loans are determined on a case-by-case basis
based on management’s credit evaluations of the respective
borrowers.




7.Bank Premises, Equipment and
Leases




Bank
premises and equipment are stated at cost less accumulated depreciation.
Depreciation expense for 2008, 2007 and 2006 was $5.0 million, $4.8 million
and $4.0 million, respectively, and is
computed on the straight-line method over the following estimated useful lives
of the related assets:




YearsBuildings
      and leasehold improvements
            1 -
      40Furniture,
      fixtures and equipment
            1 -
      15Computer
      equipment and software
            3 -
      8




A summary
of premises and equipment is as follows:




December
      31,(in
      thousands)
                  
                  2008
                  
                  
                  2007Land
                  
                  $
                  15,386
                  
                  
                  $
                  15,386Buildings
                  
                  
                  66,841
                  
                  
                  
                  66,217Construction
      in process
                  
                  
                  972
                  
                  
                  
                  1,010Leasehold
      improvements
                  
                  
                  2,396
                  
                  
                  
                  2,346Furniture,
      fixtures and equipment
                  
                  
                  25,920
                  
                  
                  
                  24,052111,515
                  
                  
                  
                  109,011Less
      accumulated depreciation and amortization
                  
                  
                  24,456
                  
                  
                  
                  19,704$
                  87,059
                  
                  
                  $
                  89,307




Land,
buildings, and equipment are leased under non­cancelable operating lease
agreements that expire at various dates through 2033. Total rental expense for
operating leases in 2008, 2007, and 2006 was $2.7 million, $2.6 million, and
$2.3 million, respectively. At December 31, 2008, future minimum lease payments
for noncancelable operating leases are payable as follows:




(in
      thousands)2009
            $   2,2882010
            2,1852011
            2,1862012
            2,0532013
            2,028Thereafter
            26,678Total
      minimum lease payments
            $
      37,418







39




8.Deposits




The
composition of deposits is as follows:




December
      31,(in
      thousands)
            
            2008
            
            
            2007Noninterest
      bearing demand
            
            $
            280,556
            
            
            $
            271,894Interest
      checking and money market
            
            
            732,234
            
            
            
            747,550Savings
            
            
            391,611
            
            
            
            375,710Time
      certificates $100,000 or more
            
            
            94,079
            
            
            
            72,406Other
      time certificates
            
            
            135,505
            
            
            
            93,336$
            1,633,985
            
            
            $
            1,560,896




At
December 31, 2008, the scheduled maturities of time deposits are as
follows:




(in
      thousands)2009
            $
      156,5302010
            32,1082011
            25,2042012
            2,6562013
            13,086$
      229,584




9.Short-term
Borrowings




Short-term
borrowings consist of securities sold under agreements to repurchase and lines
of credit. The Bank has a line of credit commitment from the Federal Home Loan
Bank (FHLB) for borrowings up to $563 million and certain qualifying assets of
the Bank collateralize the line. There was $300.1 million outstanding at
December 31, 2008 and $191.8 million outstanding at December 31, 2007 on this
line of credit. At December 31, 2008 and December 31, 2007 the Bank had
availability under one repurchase agreement to borrow up to $50 million of which
$0 was outstanding. The Company did not have any securities pledged at December
31, 2008 and 2007 under these repurchase agreements. The Bank has a $25 million
line of credit from TD Bank, N.A. of which $0 was outstanding at December 31,
2008. At December 31, 2007, $25.5 million was outstanding on this line of credit
which, at that time, was a $50 million line. The Bank will discontinue this line
of credit arrangement in 2009 as it transitions its relationship away from TD
Bank, N.A. In addition to the previously mentioned sources, the Bank has a $15.0
million federal funds line of credit with another correspondent bank of which
there was $0 outstanding at December 31, 2008 and December 31, 2007,
respectively.  The weighted average interest rate of total short-term
borrowings was 0.57% at December 31, 2008 and 3.59% at December 31,
2007.




10. Long-term
Debt




As part
of the Company’s Asset/Liability management strategy, management utilized the
Federal Home Loan Bank convertible select borrowing product during the third
quarter of 2007 when it obtained $25.0 million in borrowings with a 5 year
maturity and a six month conversion term at an initial interest rate of 4.29%
and a $25.0 million borrowing with a 2 year maturity and a three month
conversion term at an initial interest rate of 4.49%. At December 31, 2008, all
$50.0 million of convertible select borrowings were outstanding at their
respective initial interest rates.




On June
15, 2000, the Company issued $5 million of 11% fixed rate Trust Capital
Securities to Commerce Bancorp, Inc. (now known as Commerce Bancorp LLC) through
Trust I, a Delaware business trust subsidiary. The Trust Capital Securities
evidence a preferred ownership interest in the Trust, of which the Company owns
100% of the common equity. The proceeds from the issuance of the Trust Capital
Securities were invested in substantially similar Junior Subordinated Debt of
the Company. The Company unconditionally guarantees the Trust Capital
Securities. Interest on the debt is payable quarterly in arrears on March 31,
June 30, September 30, and December 31 of each year. The Trust Capital
Securities are scheduled to mature on June 15, 2030. The Trust Capital
Securities may be redeemed in whole or in part at the option of the Company on
or after June 15, 2010 at 105.50% of the principal plus accrued interest, if
any. The redemption price declines by 0.55% on June 15 of each year from 2011
through 2020 at which time the securities may be redeemed at 100% of the
principal plus accrued interest, if any, to the date fixed for redemption,
subject to certain conditions. All $5 million of the Trust Capital Securities
qualified as Tier 1 capital for regulatory capital purposes.




On
September 28, 2001, the Company issued $8 million of 10% fixed rate Trust
Capital Securities to Commerce Bancorp LLC through Trust II, a Delaware business
trust subsidiary. The issuance of the Trust Capital Securities has similar
properties as Trust I. The Trust Capital Securities evidence a preferred
ownership interest in the Trust II of which the Company owns 100% of the common
equity. The proceeds from the issuance of the Trust Capital Securities were
invested in substantially similar Junior Subordinated Debt of the Company. The
Company unconditionally guarantees the Trust Capital Securities. Interest on the
debt is payable quarterly with similar terms as in Trust I. The Trust Capital
Securities are scheduled to mature on September 28, 2031. The Trust Capital
Securities may be redeemed in whole or in part at the option of the Company on
or after September 28, 2011 at 105.00% of the principal plus accrued
interest, if any. The redemption price declines by 0.50% on September 28 of each
year from 2012 through 2021 at which time the securities may be redeemed at 100%
of the principal plus accrued interest, if any, to the date fixed for
redemption, subject to certain conditions. All $8 million of the Trust Capital
Securities qualified as Tier 1 capital for regulatory capital
purposes.






40




On
September 29, 2006, the Company issued $15 million of 7.75% fixed rate Trust
Capital Securities to Commerce Bank, N.A. through Trust III, a Delaware business
trust subsidiary. Commerce Bank, N.A. subsequently changed its name to TD Bank,
N.A. as the result of the purchase of its holding company, Commerce Bancorp,
Inc., by a wholly-owned subsidiary of the Toronto-Dominion Bank. The issuance of
the Trust Capital Securities has similar properties as Trust I and Trust
II. The Trust Capital Securities evidence a preferred ownership interest in
Trust III of which the Company owns 100% of the common equity. The proceeds from
the issuance of the Trust Capital Securities were invested in substantially
similar Junior Subordinated Debt of the Company. The Company unconditionally
guarantees the Trust Capital Securities. Interest on the debt is payable
quarterly with similar terms as in Trust I and Trust II. The Trust Capital
Securities are scheduled to mature on September 29, 2036. The Trust Capital
Securities may be redeemed in whole or in part at the option of the Company on
or after September 29, 2011 at 100.00% of the principal plus accrued
interest, if any. All $15 million of the Trust Capital Securities qualified as
Tier 1 capital for regulatory capital purposes.




The
remaining $1.4 million in long-term debt represents the Company’s ownership
interest in the non-bank subsidiary Trusts, which the Company was required to
deconsolidate in 2004 as a result of FASB Interpretation No. 46 “Consolidation
of Variable Interest Entities, an Interpretation of ARB No. 51”.




The
scheduled maturities for long-term debt over the next five years and
thereafter are as follows:





(in
      thousands)2009
            $
      25,0002012
            25,000Thereafter
            29,400$
      79,400




11. Income
Taxes




A
reconciliation of the provision for income taxes and the amount that would have
been provided at statutory rates is as follows:




Years
      Ended December 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Provision
      at statutory rate on pretax income
            
            $
            6,564
            
            
            $
            3,314
            
            
            $
            3,715Tax-exempt
      income on loans and investments
            
            
            (1,087
            )
            
            
            (647
            )
            
            
            (339
            )Other
            
            
            376
            
            
            
            78
            
            
            
            (15
            )$
            5,853
            
            
            $
            2,745
            
            
            $
            3,361




The
statutory tax rate used to calculate the provision in 2008 and 2006 was 35% and
a 34% statutory tax rate was used in 2007 due to the projected pretax
consolidated earnings of the Company.






The
components of income tax expense are as follows:




Years
      Ended December 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Current
            
            $
            8,068
            
            
            $
            2,672
            
            
            $
            2,042Deferred
      expense (benefit)
            
            
            (2,215
            )
            
            
            73
            
            
            
            1,319$
            5,853
            
            
            $
            2,745
            
            
            $
            3,361









41






The
components of the net deferred tax assets were as follows:




December
      31,(in
      thousands)
            
            2008
            
            
            2007Deferred
      tax assets:Allowance
      for loan losses
            
            $
            5,852
            
            
            $
            3,652Unrealized
      losses on securities
            
            
            9,305
            
            
            
            1,984Other
            
            
            495
            
            
            
            271Total
      deferred tax assets
            
            
            15,652
            
            
            
            5,907Deferred
      tax liabilities:Premises
      and equipment
            
            
            (2,772
            )
            
            
            (2,428
            )Prepaid
      expenses
            
            
            (267
            )
            
            
            (414
            )Deferred
      loan fees
            
            
            (1,051
            )
            
            
            (1,039
            )Total
      deferred tax liabilities
            
            
            (4,090
            )
            
            
            (3,881
            )Net
      deferred tax assets
            
            $
            11,562
            
            
            $
            2,026




A tax
benefit of $55,000 was recognized on net securities losses during 2008 and tax
expense of $58,000 and $56,000 was recognized on net securities gains during
2007 and 2006, respectively. For 2008, the Company will receive a tax benefit on
its federal income tax return totaling $102,000, and for 2007 and 2006, the
Company received a tax benefit on its federal income tax return totaling
$368,000 and $513,000, respectively for the exercise of non-qualified stock
options and disqualified dispositions of employee stock from options
exercised.




12. Stockholders’
Equity




At
December 31, 2008 and 2007, Commerce Bancorp LLC, owned 40,000 shares of the
Company’s Series A $10 par value noncumulative nonvoting preferred
stock.  Warrants that entitled Commerce Bancorp LLC to
purchase 287,332 shares of the Company’s common stock, exercisable at $3.48 per
share, in the event of a “change in control” (as defined in the Warrant
Agreement) expired on October 7, 2008. None of these warrants were exercised
during 2008, 2007, or 2006. The preferred stock is redeemable at the option of
the Company at the price of $25 per share plus any unpaid dividends. Dividends
on the preferred stock are payable quarterly at a rate of $2 per share per
annum.




The
Company has implemented a dividend reinvestment and stock purchase plan. Holders
of common stock may participate in the plan in which reinvested dividends and
voluntary cash payments of up to $10,000 per month may be reinvested in
additional common shares at a 3% discount from the current market price.
Employees who have been continuously employed for at least one year are also
eligible to participate in the plan under the same terms as listed above for
shareholders. A total of 37,372, 58,248 and 39,735 common shares were issued
pursuant to this plan in 2008, 2007, and 2006, respectively. At
December 31, 2008, the Company had reserved approximately 255,000 common
shares to be issued in connection with the plan.




13. Earnings per
Share




The
following table sets forth the computation of basic and diluted earnings per
share.




For
      the Years Ended December 31,2008
            2007
            2006(in
      thousands, except
              per
      share amounts)
            Income
            Shares
            Per
      Share Amount
            Income
            Shares
            Per
      Share Amount
            Income
            Shares
            Per
      Share AmountBasic
      earnings per share:Net
      income
            $
      12,901
            
            
            $
      7,001
            
            
            $
      7,254Preferred
      stock dividends
            (80)
            
            
            (80)
            
            
            (80)Income
      available to common stockholders
            12,821
            6,356
            $
      2.02
            6,921
            6,237
            $
      1.11
            7,174
            6,099
            $
      1.18Effect
      of dilutive securities:Stock
      options
            
            164
            
            
            225
            
            
            282Diluted
      earnings per share:Income
      available to common stockholders plus assumed conversions
            $
      12,821
            6,520
            $
      1.97
            $
      6,921
            6,462
            $
      1.07
            $
      7,174
            6,381
            $
      1.12






42




There
were 533,966 options excluded from the computation of diluted earnings per share
for the year ended December 31, 2008 which were exercisable  between the
prices of $27.00 and $33.50 per option. There were 228,311 options excluded from
the computation of diluted earnings per share for the year ended December 31,
2007 which were exercisable between the prices of $29.92 and $33.50 per
option. There were 268,530 options excluded from the computation of diluted
earnings per share for the year ended December 31, 2006 which were exercisable
between the prices of $29.92 and $33.50 per option.




14. Stock Option
Plans




In 2005,
the Board of Directors adopted and the Company’s shareholders approved the
adoption of the 2006 Employee Stock Option Plan for the officers and employees
of the Company. The Plan commenced January 1, 2006 and replaced the 1996
Employee Stock Option Plan, which expired December 31, 2005. The Plan covers
1,000,000 authorized shares of common stock which includes an additional 500,000
of authorized shares added to the plan approved in May 2008 by vote of the
stockholders reserved for issuance upon exercise of options granted or
available for grant to employees and will expire on December 31, 2015. The Plan
provides that the option price of qualified incentive stock options will be
fixed by the Board of Directors, but will not be less than 100% of the fair
market value of the stock at the date of grant. In addition, the Plan provides
that the option price of nonqualified stock options (NQSO’s) also will be fixed
by the Board of Directors, however for NQSO’s the option price may be less than
100% of the fair market value of the stock at the date of grant. Options granted
are exercisable one year after the grant date, will vest over a four-year
period, and expire ten years after the grant date.




In 2000,
the Board of Directors adopted and the Company’s shareholders approved the
adoption of the 2001 Directors’ Stock Option Plan. The Plan commenced January 1,
2001 and replaced the 1990 Directors’ Stock Option Plan, which expired December
31, 2000. The Plan covers 343,100 authorized shares of common stock which
includes an additional 100,000 of authorized shares added to the plan approved
in May 2008 by vote of the stockholders reserved for issuance upon exercise of
options granted or available for grant to non-employee directors and will expire
on December 31, 2010. Under the Company’s Directors’ Stock Option Plan, each
non-employee director of the Company who is not regularly employed on a salaried
basis by the Company may be entitled to an option to acquire shares, as
determined by the Board of Directors, of the Company’s common stock during each
year in which the Director serves on the Board. The Plan provides that the
option price will be fixed by the Board of Directors, but will not be less than
100% of the fair market value of the stock on the date of the grant. Options
granted through December 16, 2004 are exercisable from the earlier of (1) one
year after the date of the option grant, or (2) the date of a change in
control of the Bank. As a result of a plan amendment adopted on December 17,
2004, all options granted subsequent to that date will vest over a four-year
period.




As of
December 31, 2008, there was $2.8 million of total unrecognized compensation
cost related to nonvested stock option awards. This cost is expected to be
recognized over an additional 2.5 year period. Cash received from the
exercise of options for 2008, 2007, and 2006 was $541,000, $1.0 million and
$460,000, respectively.




The fair
value of each option grant was established at the date of grant using the
Black-Scholes option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options, which have no
vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including
the stock price volatility. Because the Company's stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of the Company’s
stock options. The Black-Scholes model used the following weighted-average
assumptions for 2008, 2007, and 2006 respectively: risk-free interest rates
of 3.3%, 4.7% and 4.6%; volatility factors of the expected market price of the
Company's common stock of .29, .19 and .19; weighted average expected lives of
the options of 8.2 years for the three years presented and no cash dividends.
Based upon these assumptions, the weighted average fair value of options granted
was $10.66, $10.21, and $11.11 for the years ended December 31, 2008, 2007 and
2006, respectively.




The
Company recorded compensation expense of approximately $1.1 million for the year
ended December 31, 2008 compared to $719,000 and $329,000 for the years ended
December 31, 2007 and 2006, respectively. The tax benefit associated with
compensation expense was $170,000, $116,000 and $51,000 for 2008, 2007 and 2006,
respectively.






43




Stock
options transactions under the Plans were as follows:




Years
      Ended December 31,2008
            2007
            2006Options
            Weighted
      Avg. Exercise Price
            Options
            Weighted
      Avg. Exercise Price
            Options
            Weighted
      Avg. Exercise PriceOutstanding
      at beginning of year
            924,215
            $
      22.19
            933,726
            $
      20.18
            921,966
            $
      17.18Granted
            174,325
            27.00
            164,250
            28.51
            153,650
            31.18Exercised
            (133,232)
            11.53
            (133,098)
            13.27
            (118,672)
            9.61Forfeited
            (21,393)
            29.61
            (40,663)
            30.64
            (23,218)
            28.08Outstanding
      at end of year
            943,915
            $
      24.42
            924,215
            $
      22.19
            933,726
            $
      20.18Exercisable
      at December 31
            601,805
            $
      22.23
            673,063
            $
      19.43
            786,526
            $18.11Options
      available for grant at December 31
            781,786Weighted-average
      fair value of options granted during the year
            
            $
      10.66
            
            $
      10.21
            
            $
      11.11




Options
exercisable and outstanding at December 31, 2008 had an intrinsic value of $3.6
million. The intrinsic value of options exercised was $2.0 million in 2008, $1.9
million in 2007 and $2.4 million in 2006.




The
Company allows for the option exercise to be paid for in cash or in whole or in
part with Commerce stock owned by the optionee.  The value of the
stock used to exercise the options is the fair market value on the date of
exercise.  Stock option exercises paid for with the Company’s stock
were 37,846 shares, 26,838 shares, and 23,111 shares for the years ended
December 31, 2008, 2007 and 2006, respectively.
  Exercise
prices for options outstanding as of December 31, 2008 are presented in the
following table.




Options
      Outstanding
            Weighted
      Avg. Exercise Price
            Weighted
      Avg.
              Remaining
      Contractual
              Life
            Options
      Exercisable
            Weighted
      Avg. Exercise PriceOptions
      with exercise prices ranging from $6.93 to $16.41
            180,781
            $
      13.06
            2.2
      Years
            180,781
            $
      13.06Options
      with exercise prices ranging from $16.42 to $25.38
            228,618
            21.45
            4.5
      Years
            228,243
            21.45Options
      with exercise prices ranging from $25.39 to $33.50
            534,516
            29.52
            7.9
      Years
            192,781
            31.76Total
      options outstanding with exercise prices ranging from $6.93 to
      $33.50
            943,915
            $
      24.42
            6.0
      Years
            601,805
            $
      22.23




The
remaining weighted average remaining contractual life for options
exercisable at December 31, 2008 is 4.5 years.




Number
      of Shares
            Weighted
      Avg. Grant Date Fair ValueNon-vested
      options, December 31, 2007
            251,152
            $  10.75Granted
            174,325
            10.66Vested
            (70,759)
            9.71Forfeited/expired
            (12,608)
            10.88Non-vested
      options, December 31, 2008
            342,110
            $
      10.92




15. Regulatory
Matters




Regulatory
authorities restrict the amount of cash dividends the Bank can declare without
prior regulatory approval. Presently, the Bank cannot declare cash dividends in
one year in excess of its net profits for the current year plus its retained net
profits for the two preceding years, less any required transfers to surplus. In
addition, dividends paid by the Bank to the Corporation would be prohibited if
the effect thereof would cause the Bank’s capital to be reduced below applicable
minimum capital requirements.




The
Company and the Bank are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of 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 the
Company and the Bank to maintain minimum amounts and ratios (set forth below) of
total and Tier 1 capital (as defined in the regulations) to risk-weighted
assets, and of Tier 1 capital to average assets. Management believes, as of
December 31, 2008, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.






44




As of
December 31, 2008 the Bank was categorized as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based,
and Tier 1 leverage ratios as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed the Bank’s category.




The
following table presents the risk-based and leverage capital amounts and ratios
at December 31, 2008 and 2007 for the Company and the Bank.




Actual
            For
      Capital
              Adequacy
      Purposes
            To
      Be WellCapitalized
              Under
      Prompt Corrective
              Action
      Provisions(dollars
      in thousands)
            Amount
            Ratio
            
            
            Amount
            
            Ratio
            
            
            Amount
            
            RatioCompany
              As
      of December 31, 2008Risk
      based capital ratios:Total
      capital
            $
      176,469
            10.68
            %
            ≥
            $
      132,189
            ≥
            8.0
            %
            ≥
            N/A
            ≥
            N/ATier
      1 capital
            159,750
            9.67
            
            ≥
            66,094
            ≥
            4.0
            
            ≥
            N/A
            ≥
            N/ALeverage
      ratio
            159,750
            7.52
            
            ≥
            84,922
            ≥
            4.0
            
            ≥
            N/A
            ≥
            N/ABank
              As
      of December 31, 2008Risk
      based capital ratios:Total
      capital
            $
      176,322
            10.68
            %
            ≥
            $
      132,059
            ≥
            8.0
            %
            ≥
            $165,074
            ≥
            10.0
            %Tier
      1 capital
            159,603
            9.67
            
            ≥
            66,030
            ≥
            4.0
            
            ≥
            99,044
            ≥
            6.0Leverage
      ratio
            159,603
            7.52
            
            ≥
            84,857
            ≥
            4.0
            
            ≥
            106,071
            ≥
            5.0Company
              As
      of December 31, 2007Risk
      based capital ratios:Total
      capital
            $
      154,928
            10.78
            %
            ≥
            $
      114,948
            ≥
            8.0
            %
            ≥
            N/A
            ≥
            N/ATier
      1 capital
            144,186
            10.03
            
            ≥
            57,474
            ≥
            4.0
            
            ≥
            N/A
            ≥
            N/ALeverage
      ratio
            144,186
            7.26
            
            ≥
            79,480
            ≥
            4.0
            
            ≥
            N/A
            ≥
            N/ABank
              As
      of December 31, 2007Risk
      based capital ratios:Total
      capital
            $
      154,556
            10.77
            %
            ≥
            $
      114,818
            ≥
            8.0
            %
            ≥
            $143,522
            ≥
            10.0
            %Tier
      1 capital
            143,814
            10.02
            
            ≥
            57,409
            ≥
            4.0
            
            ≥
            86,113
            ≥
            6.0Leverage
      ratio
            143,814
            7.24
            
            ≥
            79,415
            ≥
            4.0
            
            ≥
            99,269
            ≥
            5.0




16. Employee Benefit
Plan




The
Company has established a 401(k) Retirement Savings Plan for all of its
employees who meet eligibility require­ments. Employees may contribute up to
15% of their salary to the Plan. The Company will provide a discretionary
matching contribution for up to 6% of each employee’s salary. In 2008, 2007, and
2006, the Company’s matching contribution was established at 50% of the
employees’ salary deferral. The amount charged to expense was $407,000,
$347,000, and $407,000 in 2008, 2007, and 2006, respectively.




17. Comprehensive
Income




Accounting
principles generally require that recognized revenue, expenses, gains, and
losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income are components of comprehensive
income. The only comprehensive income item that the Company presently has is
unrealized gains (losses) on securities available for sale. The federal income
taxes allocated to the unrealized gains (losses) are presented in the table
below.




Years
      Ended December 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Unrealized
      holding gains (losses) arising during the year
            
            $
            (20,751
            )
            
            $
            1,017
            
            
            $
            (88
            )Income
      tax effect
            
            
            7,322
            
            
            
            (414
            )
            
            
            31Net
      of tax amount
            
            $
            (13,429
            )
            
            $
            603
            
            
            $
            (57
            )








45




18. Commitments and
Contingencies




In
January 2005, the Company entered into an agreement for naming rights to
Commerce Bank Park located on Harrisburg City Island, Harrisburg, Pennsylvania.
Commerce Bank Park is home of the Harrisburg Senators, an AA team affiliated
with Major League Baseball. The term of the naming rights agreement is 15 years
with a total obligation of $3.5 million spread over the term.




The
Company has purchased the land at the corner of Carlisle Road and Alta Vista
Road in Dover Township, York County, Pennsylvania. The Company plans to
construct a full-service store on this property to be opened in the
future.




The
Company has entered into a land lease for the premises located at 2121 Lincoln
Highway East, East Lampeter Township, Lancaster County, Pennsylvania. The
Company plans to construct a full service store on this property to be opened in
the future.




The
Company has purchased land at 105 N. George Street, York City, York County,
Pennsylvania. The Company plans to open a store on this property to be opened in
the future.




On
November 10, 2008, Commerce announced it had entered into a services agreement
with Fiserv Solutions, Inc. (Fiserv). The agreement, effective November 7, 2008,
is for a period of seven years, subject to automatic renewal for additional
terms of two years unless either party gives the other written notice of
non-renewal at least 180 days prior to the expiration date of the term. The
agreement will allow the Bank to transition to Fiserv many of the services that
have been provided by Commerce Bank, N.A., now known as TD Bank, N.A.  The
initial investment with Fiserv is $3.4 million with an expected obligation for
support, license fees and processing services of $24.6 million over the next 7
years. The various services include: core system hosting, item processing,
deposit and loan processing, electronic banking, data warehousing and other
banking functions. The transition is expected to be completed either late second
quarter or early third quarter 2009.




In
addition, the Company is also subject to certain routine legal proceedings and
claims arising in the ordinary course of business. It is management’s opinion
that the ultimate resolution of these claims will not have a material adverse
effect on the Company’s financial position and results of
operations.




19. Related Party
Transactions




Commerce
Bancorp LLC (a 10.3% shareholder of common stock and 100% shareholder of Series
A preferred stock of the Company), through an affiliate (TD Bank, N.A., a
national bank located in Cherry Hill, New Jersey), provides various services to
the Company. These services include maintenance to the store LAN network, proof
and encoding services, deposit account statement rendering, ATM/VISA card
processing, data processing, advertising support, implementation of new software
for systems, and call center support. The Company paid approximately $4.7
million, $4.4 million, and $3.1 million for services provided by TD Bank, N.A.
during 2008, 2007, and 2006, respectively. Insurance premiums and commissions,
which are paid to a subsidiary of Commerce Bancorp, LLC, are included in the
total amount paid. At December 31, 2008 and December 31, 2007, there were no
participation balances outstanding.




On and
effective as of December 30, 2008, the Company and the Bank entered into a
Transition Agreement with TD Bank N.A. and Commerce Bancorp, LLC (formerly
Commerce Bancorp, Inc. and together with TD Bank, N.A., “TD”).  The
Transition Agreement terminated the Network Agreement dated January 1, 1997, as
thereafter amended in April 2002 and September 29, 2004 (the “Network
Agreement”) and the Master Services Agreement dated July 21, 2006 and its
addenda (the “Master Services Agreement”) by and between the Company, the Bank
and/or TD (and/or their predecessors). With timely advance notice by TD under
the Network and Master Services agreements, the agreements would have otherwise
terminated on December 31, 2009.  The agreements are being terminated
prior to such date in connection with the March 2008 merger of Commerce Bancorp,
Inc. into a subsidiary of TD Bank N.A.




The
Network Agreement granted to the Company and the Bank, inter alia, the right to
use the name “Commerce Bank” and the red “C” logo.  Under the Master
Services Agreement, TD performed a broad range of administrative and data
processing services for the Bank.




Pursuant
to the Transition Agreement, TD will provide to the Bank certain transaction
services, representing a continuation of the services provided to the Bank under
the terms of the Master Services Agreement until July 15, 2009 or at the Bank’s
option, until August 15, 2009, and certain tail services until August 15, 2009,
at which time TD will discontinue the provision of all such services, which will
thereafter be provided to the Bank by other service providers.  If all
services provided by TD under the Transition Agreement (except tail services)
are terminated by or on July 15, 2009, and if all tail services terminate by or
on August 15, 2009, TD will pay to the Bank a fee in the amount of $6.0 million
(“Incentive Fee”).  The Incentive Fee will be reduced to $3.25 million
if all services other than tail services terminate on or after July 16, 2009 but
by or on August 15, 2009 and if all tail services terminate by or on August 15,
2009.  No Incentive Fee will be paid by TD if the above deadlines are
not met, unless such failure is due to delays caused by TD.




A federal
funds line of credit was established in 2007 with Commerce Bank, N.A. in the
amount of $50 million, which could be drawn upon if needed. In 2008, the amount
of the line was reduced to $25 million when The Toronto-Dominion Bank acquired
Commerce Bancorp, Inc., the parent of the former Commerce Bank, N.A. The balance
was $0 at December 31, 2008 and $25.5 million at December 31, 2007.






46




The
Company has engaged in certain transactions with entites,
which are considered related parties. Payments for goods and services,
including legal services, to these related parties totaled $756,000, $355,000
and $340,000, in 2008, 2007 and 2006, respectively. Management believes
disbursements made to related parties were substantially equivalent to those
that would have been paid to unaffiliated companies for similar goods and
services.




Note
20. Fair Value Measurements
  The
Company uses its best judgment in estimating the fair value of the Company’s
financial instruments; however, there are inherent weaknesses in any estimation
technique due to assumptions that are susceptible to significant
change.  Therefore, for substantially all financial instruments, the
fair value estimates herein are not necessarily indicative of the amounts the
Bank could have realized in a sale transaction on the dates
indicated.  The estimated fair value amounts have been measured as of
their respective year-ends and have not been re-evaluated or updated for
purposes of these financial statements subsequent to those respective
dates.  As such, the estimated fair values of these financial
instruments subsequent to the respective reporting dates may be different than
the amounts reported at each year-end.
  In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement No. 157, Fair
Value Measurements (“SFAS 157”), which defines fair value, establishes a
framework for measuring fair value under  Generally Accepted
Accounting Principles (“GAAP”), and expands disclosures about fair value
measurements.  SFAS 157 applies to other accounting pronouncements
that require or permit fair value measurements.  The Company adopted
SFAS 157 effective for its fiscal year beginning January 1,
2008.
  In
December 2007, the FASB issued FASB Staff Position 157-2, Effective Date of FASB Statement No.
157 (“FSP 157-2”).  FSP 157-2 delays the effective date of SFAS
157 for all non-financial assets and liabilities, except those that are
recognized or disclosed at fair value on a recurring basis (at least annually)
to fiscal years beginning after November 15, 2008 and interim periods
within those fiscal years.  As such, the Company only partially
adopted the provisions of SFAS 157, and will begin to account and report for
non-financial assets and liabilities in 2009.  In October 2008, the
FASB issued FASB Staff Position 157-3,Determining the Fair Value of a
Financial Asset When the Market for that Asset is Not Active
(“FSP 157-3”), to clarify the application of the provisions of
SFAS 157 in an inactive market and how an entity would determine fair value
in an inactive market.  FSP 157-3 is effective immediately and
applies to the Company’s December 31, 2008 consolidated financial
statements.  The adoption of SFAS 157 and FSP 157-3 had no
impact on the amounts reported in the financial statements.
  SFAS 157
establishes a fair value hierarchy that prioritizes the inputs to valuation
methods used to measure fair value.  The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1 measurements) and the lowest priority to unobservable
inputs (Level 3 measurements).  The three levels of the fair value
hierarchy under SFAS 157 are 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 with little or no
      market activity).
  An
asset’s or liability’s level within the fair value hierarchy is based on the
lowest level of input that is significant to the fair value
measurement.
  
 47
   For
financial assets measured at fair value on a recurring basis, the fair value
measurements by level within the fair value hierarchy used at December 31, 2008
are as follows:
  
 
 Description
                                                              
                                                              
                                                              
                                                              December 31,
                                                                2008
                                                              
                                                              
                                                              
                                                              
                                                              (Level
      1)
                                                                  Quoted
      Prices
                                                                  in
      Active
                                                                  Markets
      for Identical Assets
                                                              
                                                              
                                                              
                                                              
                                                              (Level
      2)
                                                                  Significant
                                                                  Other
                                                                  Observable
                                                                  Inputs
                                                              
                                                              
                                                              
                                                              
                                                              (Level
      3)
                                                                  Significant
                                                                  Unobservable
                                                                  Inputs(In
      Thousands)Securities
      available for sale
                                                              
                                                              
                                                              $
                                                              341,656
                                                              
                                                              
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              
                                                              $
                                                              341,656
                                                              
                                                              
                                                              
                                                              $
                                                              -
 
 For
financial assets measured at fair value on a nonrecurring basis, the fair value
measurements by level within the fair value hierarchy used at December 31, 2008
are as follows:
  (In
      Thousands)
 
 
 Description
                                                    
                                                    
                                                    
                                                    December 31,
                                                      2008
                                                    
                                                    
                                                    
                                                    
                                                    (Level
      1) Quoted Prices in Active Markets for Identical
    Assets
                                                    
                                                    
                                                    
                                                    
                                                    (Level
      2) Significant
                                                      Other
                                                      Observable
                                                      Inputs
                                                    
                                                    
                                                    
                                                    
                                                    (Level
      3)
                                                        Significant
                                                        Unobservable
      InputsImpaired
      loans
                                                    
                                                    
                                                    $
                                                    9,034
                                                    
                                                    
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    
                                                    $
                                                    9,034
 
 As
discussed above, the Company has delayed its disclosure requirements of
non-financial assets and liabilities.  Certain foreclosed real estate
with write-downs subsequent to foreclosure is carried at fair value at the
balance sheet date for which the Company has not yet adopted the provisions of
SFAS 157.
  The
following information should not be interpreted as an estimate of the fair value
of the entire Company since a fair value calculation is only provided for a
limited portion of the Company’s assets and liabilities.  Due to a
wide range of valuation techniques and the degree of subjectivity used in making
the estimates, comparisons between the Company’s disclosures and those of other
companies may not be meaningful.  The following methods and
assumptions were used to estimate the fair values of the Company’s financial
instruments at December 31, 2008 and 2007:
  Cash
and Cash Equivalents (Carried at Cost)
  The
carrying amounts reported in the balance sheet for cash and short-term
instruments approximate those assets’ fair values.
  Securities
  The fair
value of securities available for sale (carried at fair value) and held to
maturity (carried at amortized cost) 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.  The Company has not identified any
investments where fair values were based on Level 3 inputs.
  Loans
Held for Sale (Carried at Lower of Cost or Fair Value)
  The fair
value of loans held for sale is determined, when possible, using quoted
secondary-market prices.  If no such quoted prices exist, the fair
value of a loan is determined using quoted prices for a similar loan or loans,
adjusted for the
  48
  specific
attributes of that loan.  The Company did not write down any loans
held for sale during the years ended December 31, 2008 and 2007.
  Loans
Receivable (Carried at Cost)
  The fair
values of loans are estimated using discounted cash flow analyses, using market
rates at the balance sheet date that reflect the credit and interest rate-risk
inherent in the loans.  Projected future cash flows are calculated
based upon contractual maturity, projected repayments and prepayments of
principal.  Generally, for variable rate loans that reprice frequently
and with no significant change in credit risk, fair values are based on carrying
values.
  Impaired
Loans (Generally Carried at Fair Value)
  Impaired
loans are those that are accounted for under FASB Statement No. 114,Accounting by Creditors for
Impairment of a Loan(“SFAS 114”),in which the Bank has
measured impairment generally based on the fair value of the loan’s
collateral.  Fair value is generally determined based upon independent
third-party appraisals of the properties, or discounted cash flows based upon
the expected proceeds.  These assets are included as Level 3 fair
values, based upon the lowest level of input that is significant to the fair
value measurements.  The fair value consists of the loan balances of
$12.7 million, net of a valuation allowance of $3.7
million.  Additional provisions for loan losses of $3.2 million were
recorded during the period.
  Restricted
Investment in Bank Stock (Carried at Cost)
  The
carrying amount of restricted investment in bank stock approximates fair value,
and considers the limited marketability of such securities.  The
restricted investments in bank stock consisted of Federal Reserve Bank and
Federal Home Loan Bank stock at December 31, 2007 and Federal Home Loan Bank
stock as of December 31, 2008.
  Accrued
Interest Receivable and Payable (Carried at Cost)
  The
carrying amount of accrued interest receivable and accrued interest payable
approximates its fair value.
  Deposit
Liabilities (Carried at Cost)
  The fair
values disclosed for demand deposits (e.g., interest and noninterest checking,
passbook savings and money market accounts) are, by definition, equal to the
amount payable on demand at the reporting date (i.e., their carrying
amounts).  Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered in the market on certificates to a schedule of
aggregated expected monthly maturities on time deposits.
  Short-Term
Borrowings (Carried at Cost)
  The
carrying amounts of short-term borrowings approximate their fair
values.
  Long-Term
Debt (Carried at Cost)
  Fair
values of FHLB advances are estimated using discounted cash flow analysis, based
on quoted prices for new FHLB advances with similar credit risk characteristics,
terms and remaining maturity. These prices obtained from this active market
represent a fair value that is deemed to represent the transfer price if the
liability were assumed by a third party.  Other long-term debt was
estimated using discounted cash flow analysis, based on quoted prices from a
third party broker for new debt with similar characteristics, terms and
remaining maturity.  The price for the other long-term debt was
obtained in an inactive market where these types of instruments are not traded
regularly.
  Off-Balance
Sheet Financial Instruments (Disclosed at Cost)
  Fair
values for the Bank’s off-balance sheet financial instruments (lending
commitments and letters of credit) are based on fees currently charged in the
market to enter into similar agreements, taking into account, the remaining
terms of the agreements and the counterparties’ credit standing.
  49
 
  The
estimated fair values of the Company’s financial instruments were as follows at
December 31, 2008 and 2007.
  2008
                                            
                                            
                                            2007(in
      thousands)
                                            
                                            Carrying
                                              Amount
                                            
                                            
                                            Fair
                                              Value
                                            
                                            
                                            Carrying
                                              Amount
                                            
                                            
                                            Fair
                                              ValueFinancial
      assets:Cash
      and cash equivalents
                                            
                                            $
                                            49,511
                                            
                                            
                                            $
                                            49,511
                                            
                                            
                                            $
                                            50,955
                                            
                                            
                                            $
                                            50,955Securities
                                            
                                            
                                            494,243
                                            
                                            
                                            
                                            496,013
                                            
                                            
                                            
                                            644,633
                                            
                                            
                                            
                                            643,414Loans,
      net (including loans held for sale)
                                            
                                            
                                            1,464,212
                                            
                                            
                                            
                                            1,472,037
                                            
                                            
                                            
                                            1,160,772
                                            
                                            
                                            
                                            1,165,793Restricted
      investments in bank stock
                                            
                                            
                                            21,630
                                            
                                            
                                            
                                            21,630
                                            
                                            
                                            
                                            18,234
                                            
                                            
                                            
                                            18,234Accrued
      interest receivable
                                            
                                            
                                            7,686
                                            
                                            
                                            
                                            7,686
                                            
                                            
                                            
                                            8,799
                                            
                                            
                                            
                                            8,799Financial
      liabilities:Deposits
                                            
                                            $
                                            1,633,985
                                            
                                            
                                            $
                                            1,636,027
                                            
                                            
                                            $
                                            1,560,896
                                            
                                            
                                            $
                                            1,560,303Long-term
      debt
                                            
                                            
                                            79,400
                                            
                                            
                                            
                                            71,424
                                            
                                            
                                            
                                            79,400
                                            
                                            
                                            
                                            79,428Short-term
      borrowings
                                            
                                            
                                            300,125
                                            
                                            
                                            
                                            300,125
                                            
                                            
                                            
                                            217,335
                                            
                                            
                                            
                                            217,335Accrued
      interest payable
                                            
                                            
                                            1,164
                                            
                                            
                                            
                                            1,164
                                            
                                            
                                            
                                            989
                                            
                                            
                                            
                                            989Off-balance
      sheet instruments:Standby
      letters of credit
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            -Commitments
      to extend credit
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -
 
  50




21. Quarterly Financial
Data (unaudited)




The
following represents summarized unaudited quarterly financial data of the
Company which, in the opinion of management, reflects adjustments (comprising
only normal recurring accruals) necessary for fair presentation (in thousands,
except per share amounts):




Three
      Months EndedDecember
      31
            
            
            September
      30
            
            
            June
      30
            
            
            March
      312008Interest
      income
            
            $
            27,865
            
            
            $
            28,030
            
            
            $
            27,088
            
            
            $
            28,157Interest
      expense
            
            
            6,482
            
            
            
            8,378
            
            
            
            8,001
            
            
            
            9,574Net
      interest income
            
            
            21,383
            
            
            
            19,652
            
            
            
            19,087
            
            
            
            18,583Provision
      for loan losses
            
            
            3,400
            
            
            
            1,700
            
            
            
            1,400
            
            
            
            975Losses
      on sales/call of securities
            
            
            0
            
            
            
            0
            
            
            
            (157
            )
            
            
            0Provision
      for federal income taxes
            
            
            1,239
            
            
            
            1,523
            
            
            
            1,597
            
            
            
            1,494Net
      income
            
            
            2,756
            
            
            
            3,433
            
            
            
            3,506
            
            
            
            3,206Net
      income per share:Basic
            
            $
            0.43
            
            
            $
            0.54
            
            
            $
            0.55
            
            
            $
            0.50Diluted
            
            
            0.42
            
            
            
            0.52
            
            
            
            0.54
            
            
            
            0.492007Interest
      income
            
            $
            29,885
            
            
            $
            29,450
            
            
            $
            28,865
            
            
            $
            27,787Interest
      expense
            
            
            13,065
            
            
            
            14,260
            
            
            
            14,611
            
            
            
            14,559Net
      interest income
            
            
            16,820
            
            
            
            15,190
            
            
            
            14,254
            
            
            
            13,228Provision
      for loan losses
            
            
            245
            
            
            
            537
            
            
            
            500
            
            
            
            480Gains
      (losses) on sales of securities
            
            
            0
            
            
            
            0
            
            
            
            0
            
            
            
            171Provision
      for federal income taxes
            
            
            1,069
            
            
            
            780
            
            
            
            580
            
            
            
            316Net
      income
            
            
            2,467
            
            
            
            1,851
            
            
            
            1,571
            
            
            
            1,112Net
      income per share:Basic
            
            $
            0.39
            
            
            $
            0.29
            
            
            $
            0.25
            
            
            $
            0.18Diluted
            
            
            0.38
            
            
            
            0.28
            
            
            
            0.24
            
            
            
            0.17






51




22. Condensed Financial
Statements of Parent Company




Balance
Sheets




December
      31,(in
      thousands)
            
            2008
            
            
            2007AssetsCash
            
            $
            797
            
            
            $
            883Investment
      in subsidiaries:Banking
      subsidiary
            
            
            142,323
            
            
            
            139,963Non-banking
      subsidiaries
            
            
            1,400
            
            
            
            1,400Other
      assets
            
            
            395
            
            
            
            230Total
      assets
            
            $
            144,915
            
            
            $
            142,476LiabilitiesLong-term
      debt
            
            $
            29,400
            
            
            $
            29,400Other
      liabilities
            
            
            1,045
            
            
            
            741Total
      liabilities
            
            
            30,445
            
            
            
            30,141Stockholders’
      EquityPreferred
      stock
            
            
            400
            
            
            
            400Common
      stock
            
            
            6,446
            
            
            
            6,314Surplus
            
            
            73,221
            
            
            
            70,610Retained
      earnings
            
            
            51,683
            
            
            
            38,862Accumulated
      other comprehensive loss
            
            
            (17,280
            )
            
            
            (3,851
            )Total
      stockholders’ equity
            
            
            114,470
            
            
            
            112,335Total
      liabilities and stockholders’ equity
            
            $
            144,915
            
            
            $
            142,476






52






Statements
of Income




Years
      Ended December 31,(in
      thousands)
            
            2008
            
            
            2007
            
            
            2006Income:Dividends
      from bank subsidiary
            
            $
            2,337
            
            
            $
            2,018
            
            
            $
            1,725Interest
      income
            
            
            124
            
            
            
            124
            
            
            
            782,461
            
            
            
            2,142
            
            
            
            1,803Expenses:Interest
      expense
            
            
            2,645
            
            
            
            2,645
            
            
            
            1,731Other
            
            
            1,265
            
            
            
            491
            
            
            
            6773,910
            
            
            
            3,136
            
            
            
            2,408Loss
      before income (taxes) benefit and equity in undistributed net income of
      subsidiaries
            
            
            (1,449
            )
            
            
            (994
            )
            
            
            (605
            )Income
      (taxes) benefit
            
            
            1,304
            
            
            
            1,029
            
            
            
            812(145
            )
            
            
            35
            
            
            
            207Equity
      in undistributed net income of bank subsidiary
            
            
            13,046
            
            
            
            6,966
            
            
            
            7,047Net
      income
            
            $
            12,901
            
            
            $
            7,001
            
            
            $
            7,254





Statements
of Cash Flows




Years
      Ended December 31,(in
      thousands)
            2008
            
            2007
            
            2006Operating
      Activities:Net
      Income
            $   12,901
            
            $    7,001
            
            $    7,254Adjustments
      to reconcile net income to net cash provided by operating
      activities:Amortization
      of financing costs
            8
            
            8
            
            6Stock-based
      compensation
            1,142
            
            719
            
            329Increase
      in other liabilities
            304
            
            338
            
            20(Increase)
      decrease in other assets
            (173)
            
            (23)
            
            10Equity
      in undistributed net income of bank subsidiary
            (13,046)
            
            (6,966)
            
            (7,047)Net
      cash provided by operating activities
            1,136
            
            1,077
            
            572Investing
      Activities:Investment
      in bank subsidiary
            (2,637)
            
            (3,329)
            
            (16,829)Investment
      in nonbank subsidiary
            -
            
            -
            
            (800)Net
      cash (used) by investing activities
            (2,637)
            
            (3,329)
            
            (17,629)Financing
      Activities:Proceeds
      from common stock options exercised
            541
            
            1,032
            
            460Proceeds
      from issuance of common stock under stock purchase plan
            954
            
            1,578
            
            1,040Proceeds
      from issuance of long-term debt
            -
            
            -
            
            15,800Cost
      of issuing long-term debt
            -
            
            -
            
            (43)Cash
      dividends on preferred stock and cash in lieu of fractional
      shares
            (80)
            
            (80)
            
            (80)Net
      cash provided by financing activities
            1,415
            
            2,530
            
            17,177Increase
      (decrease) in cash and cash equivalents
            (86)
            
            278
            
            120Cash
      and cash equivalents at beginning of the year
            883
            
            605
            
            485Cash
      and cash equivalents at end of year
            $       797
            
            $       883
            
            $       605




23. Pending
Acquisition




On
November 7, 2008 the Company announced that it has entered into a plan of merger
to acquire Republic First Bancorp, Inc. (Republic First) which is headquartered
in Philadelphia, Pennsylvania.  Republic First, with total assets of
approximately $952.0 million as of December 31, 2008, will be merged with and
into Pennsylvania Commerce Bancorp and the combined company will be named Metro
Bancorp, Inc.  The new company will have $3.2 billion in assets and 45
offices in Pennsylvania and New Jersey combined.
 
 Under the
terms of the merger agreement, for each share of Republic First common stock
owned immediately prior to completion of the merger, Republic First shareholders
will receive between 0.34 and 0.38 of a share of the Company’s common stock,
calculated on the basis of $10.00 per share of Republic First common
stock.  The actual exchange ratio will be based on the average closing
price of the Company’s common stock for a set period of twenty (20) consecutive
trading days preceding the effective date of merger.
 
 The
merger will be accounted for under the purchase method of accounting; a such
term is defined under the accounting principles generally accepted in the United
States of America.  The merge is also subject to regulatory and
shareholder approval for both companies and is expected to be completed during
the second quarter of 2009.


53