UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


———————————


FORM
10-K





xANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For
the Fiscal Year Ended December 31, 2008


OR


oTRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For
the transition period from _________ to __________.




Commission
File Number 000-30707


First
Northern Community Bancorp


(Exact
name of Registrant as specified in its charter)





California
            68-0450397(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification Number)





195
      N. First St., Dixon, CA
            95620(Address
      of principal executive offices)
            (Zip
      Code)





707-678-3041


(Registrant’s
telephone number including area code)





Securities
      registered pursuant to Section 12(b) of the Act:
            NoneSecurities
      registered pursuant to Section 12(g) of the Act:
            Common
      Stock, no par value
              (Title
      of Class)





Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act.


Yes
o                    No
x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.


Yes
o                    No
x





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.


Yes
x                    No
o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K.  x




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.


Large
accelerated filer oAccelerated
filer  xNon-accelerated
filer  o      Smaller
reporting company  o





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes
o                    No
x





The
aggregate market value of the Common Stock held by non-affiliates of the
registrant on June 30, 2008 (based upon the last reported sales price of such
stock on the OTC Bulletin Board on June 30, 2008) was $103,291,164.




The
number of shares of Common Stock outstanding as of March 12, 2009 was
8,654,288.




DOCUMENTS
INCORPORATED BY REFERENCE




Items 10,
11, 12 (as to security ownership of certain beneficial owners and management),
13 and 14 of Part III incorporate by reference information from the
registrant’s proxy statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for the registrant’s
2009 Annual Meeting of Shareholders





TABLE
OF CONTENTS








PART I
                      PageItem   1
                      Business
                      3Item   1A
                      Risk
      Factors
                      18Item   1B
                      Unresolved
      Staff Comments
                      24Item   2
                      Properties
                      24Item   3
                      Legal
      Proceedings
                      24PART IIItem   5
                      Market
      for Registrant's Common Equity,  Related Stockholder Matters and
      Issuer Purchases of Equity Securities
                      24Item   6
                      Selected
      Financial Data
                      26Item   7
                      Management's
      Discussion and Analysis of Financial Condition and Results of
      Operation
                      27Item   7A
                      Quantitative
      and Qualitative Disclosures About Market Risk
                      50Item   8
                      Financial
      Statements and Supplementary Data
                      53Item   9
                      Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                      90Item   9A
                      Controls
      and Procedures
                      90Item   9B
                      Other
      Information
                      91PART IIIItem
      10
                      Directors,
      Executive Officers and Corporate Governance
                      91Item
      11
                      Executive
      Compensation
                      91Item
      12
                      Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                      92Item
      13
                      Certain
      Relationships and Related Transactions and Director
      Independence
                      92Item
      14
                      Principal
      Accountant Fees and Services
                      92PART IVItem
      15
                      Exhibits
      and Financial Statement Schedules
                      93Signatures
                      95








2
  This
Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which are subject to the
“safe harbor” created by those sections.  Forward-looking statements
include the information concerning possible or assumed future results of
operations of the Company set forth under the heading “Management's Discussion
and Analysis of Financial Condition and Results of
Operations.”  Forward-looking statements can be identified by the fact
that they do not relate strictly to historical or current facts. Often they
include words such as “expect,” “anticipate,” “intend,” “plan,” “believe,”
estimate,” “consider,” or words of similar meaning, or future or conditional
verbs such as “will”, “would”, “should”, “could”, “might”, or
“may.  These forward-looking statements involve certain risks and
uncertainties that could cause actual results to differ materially from those in
the forward-looking statements.  Such risks and uncertainties include,
but are not limited to, the risks discussed in Part I, Item 1A under the caption
“Risk Factors” and other risk factors discussed elsewhere in this
Report.   All of these forward-looking statements are based on
assumptions about an uncertain future and are based on information available to
us at the date of these statements.   The Company undertakes no
obligation to update any forward-looking statements to reflect events or
circumstances arising after the date on which they are made.
 
 
 PART I
 
 ITEM
1 - BUSINESS
 
 
 Unless
otherwise indicated, all information herein has been adjusted to give effect to
our two-for-one stock split in 2005 and stock dividends.
 
 First
Northern Bank of Dixon (“First Northern” or the “Bank”) was established in 1910
under a California state charter as Northern Solano Bank, and opened for
business on February 1st of that year.  On January 2, 1912, the First
National Bank of Dixon was established under a federal charter, and until 1955,
the two entities operated side by side under the same roof and with the same
management.  In an effort to increase efficiency of operation, reduce
operating expense, and improve lending capacity, the two banks were consolidated
on April 8, 1955, with the First National Bank of Dixon as the surviving
entity.
 
 On
January 1, 1980, the Bank’s federal charter was relinquished in favor of a
California state charter, and the Bank’s name was changed to First Northern Bank
of Dixon.
 
 In April
of 2000, the shareholders of First Northern approved a corporate reorganization,
which provided for the creation of a bank holding company, First Northern
Community Bancorp (the “Company”).  The objective of this
reorganization, which was effected May 19, 2000, was to enable the Bank to
better compete and grow in its competitive and rapidly changing
marketplace.  As a result of the reorganization, the Bank is a wholly
owned and principal operating subsidiary of the Company.
 
 First
Northern engages in the general commercial banking business throughout the
California Counties of Solano, Yolo, Placer and Sacramento.
 
 The
Company’s and the Bank’s Administrative Offices are located in Dixon,
California.  Also located in Dixon are the back office functions of
the Information Services/Central Operations Department and the Central Loan
Department.
 
 The Bank
has eleven full service branches.  Four are located in the Solano
County cities of Dixon, Fairfield, and Vacaville (2).  Four branches
are located in the Yolo County cities of Winters, Davis, West Sacramento and
Woodland. One branch is located in Downtown Sacramento in Sacramento County, and
one branch is located in the city of Roseville in Placer County.  The
Bank also has two satellite banking offices inside retirement communities in the
city of Davis. In addition, the Bank has real estate loan offices in Davis,
Folsom and Roseville that originate residential mortgages and construction
loans. The Bank also has a Small Business Administration (“SBA”) Loan Department
and an Asset Management & Trust Department in Downtown Sacramento that serve
the Bank’s entire market area.
 
 First
Northern is in the commercial banking business, which includes accepting demand,
interest bearing transaction, savings, and time deposits, and making commercial,
consumer, and real estate related loans.  It also offers installment
note collection, issues cashier’s checks, sells travelers’ checks, rents safe
deposit boxes, and provides other customary banking services.  The
Bank is a member of the Federal Deposit Insurance Corporation (“FDIC”) and each
depositor’s account is insured up to $250,000 through December 31, 2009 at which
time the insurance coverage is expected to return to $100,000.
  3
   First
Northern also offers a broad range of alternative investment products and
services.  The Bank offers these services through an arrangement with
Raymond James Financial Services, Inc., an independent broker/dealer and a
member of NASD and SIPC. All investments and/or financial services offered by
representatives of Raymond James Financial Services, Inc. are not insured by the
FDIC.
 
 The Bank
offers equipment leasing and limited international banking services through
third parties.
 
 The
operating policy of the Bank since its inception has emphasized serving the
banking needs of individuals and small- to medium-sized
businesses.  In Dixon, this has included businesses involved in crop
and livestock production.  Historically, the economy of the Dixon area
has been primarily dependent upon agricultural related sources of income and
most employment opportunities have also been related to
agriculture.  Since 2000, Dixon has been growing and becoming more
diverse with noticeable expansion in the areas of industrial, commercial, retail
and residential housing projects.
 
 Agriculture
continued to be a significant factor in the Bank’s business after the opening of
the first branch office in Winters in 1970.  A significant step was
taken in 1976 to reduce the Company’s dependence on agriculture with the opening
of the Davis Branch.
 
 The Davis
economy is supported significantly by the University of California, Davis. In
1981, a branch was opened in South Davis, and was consolidated into the main
Davis Branch in 1986.
 
 In 1983,
the West Sacramento Branch was opened.  The West Sacramento economy is
built primarily around transportation and distribution related
business.  This addition to the Bank’s market area further reduced the
Company’s dependence on agriculture.
 
 In order
to accommodate the demand of the Bank’s customers for long-term residential real
estate loans, a Real Estate Loan Office was opened in
1983.   This office is centrally located in Davis, and has
enabled the Bank to access the secondary real estate market.
 
 The
Vacaville Branch was opened in 1985.  Vacaville is a rapidly growing
community with a diverse economic base including a California state prison, food
processing, distribution, shopping centers (Factory Outlet Stores), medical,
biotech and other varied industries.
 
 In 1994,
the Fairfield Branch was opened.  Fairfield has also been a rapidly
growing community bounded by Vacaville to its east.  Its diverse
economic base includes military (Travis AFB), food processing (an Anheuser-Busch
plant), retail (Solano Mall), manufacturing, medical, agriculture, and other
varied industries.  Fairfield is the county seat of Solano
County.
 
 A real
estate loan production office was opened in El Dorado Hills, in April 1996, to
serve the growing mortgage loan demand in the foothills area east of
Sacramento.  This office was moved to Folsom in 2006, a more central
location for serving Folsom, Rancho Cordova, and the west slope of El Dorado
County.
 
 The SBA
Loan Department was opened in April 1997 in Sacramento to serve the small
business and industrial loan demand throughout the Bank’s entire market
area.
 
 In June
of 1997, the Bank’s seventh branch was opened in Woodland, the county seat of
Yolo County.  Woodland is an expanding and diversified city with an
economy dominated by agribusiness, retail services, and a healthy industrial
sector.
 
 The
Bank’s eighth branch, the Downtown Financial Center, opened in July of 2000 in
Vacaville to serve the business and individual financial needs on the west side
of Interstate-80.  Also in July of 2000, in an adjacent office, the
Bank opened its third real estate loan production office.  The
Vacaville real estate loan office was closed in 2007 in response to the current
dramatic slowdown in the housing market. ecks es ofe I found.  How
does it look for including in our 10-K.
 Two
satellite banking offices of the Bank’s Davis Branch were opened in 2001 in the
Davis senior living communities of Covell Gardens and the University Retirement
Community.
 
 In
December of 2001, Roseville became the site of the Bank’s fourth real estate
loan production office.  This office serves the residential mortgage
loan needs throughout Placer County.
  4
  
 In March
of 2002, the Bank opened its ninth branch in a new class-A commercial building
located on the harbor in Suisun City.  After five years in operation
and slower than anticipated city growth, in 2007 the Bank decided to close its
Suisun City Branch and serve the Branch’s customers out of its Fairfield
Branch.  The Fairfield Branch was expanded and remodeled to
accommodate the additional customers and to include an investment &
brokerage services office.
 
 In
October of 2002, the Bank opened its tenth branch on a prominent corner in
Downtown Sacramento to serve Sacramento Metro’s business center and its
employees.  The Bank’s Asset Management & Trust Department,
located on the mezzanine of the Downtown Sacramento Branch, was opened in 2002
to serve the trust and fiduciary needs of the Bank’s entire market
area.  Fiduciary services are offered to individuals, businesses,
governments and charitable organizations in the Solano, Yolo, Sacramento, Placer
and El Dorado County regions.
 
 In August
of 2003, a full service real estate loan production office was opened in
Woodland.  This loan office is located within the same commercial
office complex as the Bank’s Woodland Branch.  The Bank’s history of
servicing the Woodland community, coupled with the continued growth of the
Woodland housing market, prompted this decision to expand the Bank’s real estate
loan services for the community.  The economic recession of 2008,
spurred on by falling real estate values, created the need to close the Woodland
Real Estate Loan Office in July 2008.  A real estate mortgage loan
representative continues to serve the Woodland market.
 
 The Bank
expanded its presence in Placer County in January 2005 by opening a full service
branch on a prominent corner in the rapidly growing business district of
Roseville.
 
 In the
fourth quarter of 2006, the Bank opened its Folsom Financial Center which houses
a full service branch, a real estate loan production office, and an investment
& brokerage services office.  Due to a slowdown in the economy and
strong local competition for financial services, in June 2008, it was decided
that the Bank’s Folsom deposit and loan customers could be consolidated into the
Bank’s Roseville and Downtown Sacramento Branches.  In October 2008,
the Folsom Investment & Brokerage Services team moved out of the space it
occupied within the former Folsom Branch to share a suite with the Folsom Real
Estate Loan team just a couple of doors down the hall.
 
 In late
2007, First Northern Bank seized an opportunity in Auburn to acquire several key
personnel from a highly respected local bank that had just merged with a large
conglomerate bank.  While First Northern scouted for a branch site,
the ‘Auburn team’ worked from the Bank’s Roseville Branch to develop business in
Auburn.  In June 2008, the Bank opened its Auburn Financial Center in
a temporary location within a busy retail shopping center along Highway
49.  The Financial Center houses a full service branch and an
Investment & Brokerage Services Office.  Auburn is the county seat
of Placer County.
 
 Through
this period of change and diversification, the Bank’s strategic focus, which
emphasizes serving the banking needs of individuals and small-to medium-sized
businesses, has not changed.  The Bank takes real estate, crop
proceeds, securities, savings and time deposits, automobiles, and equipment as
collateral for loans.
 
 Most of
the Bank’s deposits are attracted from the market of northern and central Solano
County and southern and central Yolo County.  The Company believes
that the Bank’s deposit base does not involve any undue concentration levels
from one or a few major depositors.
 
 As of
December 31, 2008, the Company and the Bank employed 228 full-time equivalent
staff.  The Company and the Bank consider their relationship with
their employees to be good and have not experienced any interruptions of
operations due to labor disagreements.
 
 First
Northern has historically experienced seasonal swings in both deposit and loan
volumes due primarily to general economic factors and specific economic factors
affecting our customers.  Deposits have typically hit lows in February
or March and have peaked in November or December.  Loans typically
peak in the late spring and hit lows in the fall as crops are harvested and
sold.  Since the real estate and agricultural economies generally
follow the same seasonal cycle, they experience the same deposit and loan
fluctuations.
 
  5
  
 Available
Information
 
 The
Company’s internet address is www.thatsmybank.com,
and the Company makes available free of charge on this website its Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form  8-K and amendments to those reports, as soon as reasonably
practicable after the Company electronically files such material with, or
furnishes it to, the SEC.  These filings are also accessible on the
SEC's website at www.sec.gov.  The
information found on the Company’s website shall not be deemed incorporated by
reference by any general statement incorporating by reference this report into
any filing under the Securities Act of 1933 or under the Securities Exchange Act
of 1934 and shall not otherwise be deemed filed under such Acts.
 
 The
Effect of Government Policy on Banking
 
 The
earnings and growth of the Bank are affected not only by local market area
factors and general economic conditions, but also by government monetary and
fiscal policies.  For example, the Board of Governors of the Federal
Reserve System (the “FRB”) influences the supply of money through its open
market operations in U.S. Government securities, adjustments to the discount
rates applicable to borrowings by depository institutions and others and
establishment of reserve requirements against both member and non-member
financial institutions’ deposits.  Such actions significantly affect
the overall growth and distribution of loans, investments and deposits and also
affect interest rates charged on loans and paid on deposits.  The
nature and impact of future changes in such policies on the business and
earnings of the Company cannot be predicted. Additionally, state and federal tax
policies can impact banking organizations.
 
 As a
consequence of the extensive regulation of commercial banking activities in the
United States, the business of the Company is particularly susceptible to being
affected by the enactment of federal and state legislation which may have the
effect of increasing or decreasing the cost of doing business, modifying
permissible activities or enhancing the competitive position of other financial
institutions. Any change in applicable laws, regulations or policies may have a
material adverse effect on the business, financial condition or results of
operations, or prospects of the Company.
 
 Regulation
and Supervision of Bank Holding Companies
 
 The
Company is a bank holding company subject to the Bank Holding Company Act of
1956, as amended (the “BHCA”).  The Company reports to, registers
with, and may be examined by, the FRB.  The FRB also has the authority
to examine the Company’s subsidiaries.  The costs of any examination
by the FRB are payable by the Company.
 
 The
Company is a bank holding company within the meaning of Section 3700 of the
California Financial Code.  As such, the Company and the Bank are
subject to examination by, and may be required to file reports with, the
California Commissioner of Financial Institutions (the
“Commissioner”).
 
 The FRB
has significant supervisory and regulatory authority over the Company and its
affiliates.  The FRB requires the Company to maintain certain levels
of capital.  See “Capital Standards” below
for more information.  The FRB also has the authority to take
enforcement action against any bank holding company that commits any unsafe or
unsound practice, or violates certain laws, regulations or conditions imposed in
writing by the FRB.  See “Prompt Corrective Action
and Other Enforcement Mechanisms” below for more
information.  According to FRB policy, bank holding companies are
expected to act as a source of financial and managerial strength to subsidiary
banks, and to commit resources to support subsidiary banks.  This
support may be required at times when a bank holding company may not be able to
provide such support.
 
 Under the
BHCA, a company generally must obtain the prior approval of the FRB before it
exercises a controlling influence over a bank, or acquires, directly or
indirectly, more than 5% of the voting shares or substantially all of the assets
of any bank or bank holding company.  Thus, the Company is required to
obtain the prior approval of the FRB before it acquires, merges or consolidates
with any bank or bank holding company.  Any company seeking to
acquire, merge or consolidate with the Company also would be required to obtain
the prior approval of the FRB.
  6
  
 The
Company is generally prohibited under the BHCA from acquiring ownership or
control of more than 5% of the voting shares of any company that is not a bank
or bank holding company and from engaging directly or indirectly in activities
other than banking, managing banks, or providing services to affiliates of the
holding company.  However, a bank holding company, with the approval
of the FRB, may engage, or acquire the voting shares of companies engaged, in
activities that the FRB has determined to be so closely related to banking or
managing or controlling banks as to be a proper incident thereto.  A
bank holding company must demonstrate that the benefits to the public of the
proposed activity will outweigh the possible adverse effects associated with
such activity.
 
 The
Gramm-Leach-Bliley Act of 1999 (“GLBA”) eliminated many of the restrictions
placed on the activities of bank holding companies that become financial holding
companies.  Among other things, GLBA repealed certain Glass-Steagall
Act restrictions on affiliations between banks and securities firms, and amended
the BHCA to permit bank holding companies that are financial holding companies
to engage in activities, and acquire companies engaged in activities, that
are:  financial in nature (including insurance underwriting, insurance
company portfolio investment, financial advisor, securities underwriting,
dealing and market-making, and merchant banking activities); incidental to
financial activities; or complementary to financial activities if the FRB
determines that they pose no substantial risk to the safety or soundness of
depository institutions or the financial system in general.  The
Company has not become a financial holding company. GLBA also permits national
banks to engage in activities considered financial in nature through a financial
subsidiary, subject to certain conditions and limitations and with the approval
of the Comptroller of the Currency.
 
 A bank
holding company may acquire banks in states other than its home state without
regard to the permissibility of such acquisitions under state law, but subject
to any state requirement that the bank has been organized and operating for a
minimum period of time, not to exceed five years, and the requirement that the
bank holding company, prior to or following the proposed acquisition, controls
no more than 10% of the total amount of deposits of insured depository
institutions in the United States and no more than 30% of such in that state (or
such lesser or greater amount set by state law).  Banks may also merge
across state lines, thereby creating interstate
branches.  Furthermore, a bank is able to open new branches in a state
in which it does not already have banking operations, if the laws of such state
permit such de novo branching.
 
 Under
California law, (a) out-of-state banks that wish to establish a California
branch office to conduct core banking business must first acquire an existing
California bank or industrial bank, which has existed for at least five years,
by merger or purchase, (b) California state-chartered banks are empowered to
conduct various authorized branch-like activities on an agency basis through
affiliated and unaffiliated insured depository institutions in California and
other states, and (c) the Commissioner is authorized to approve an interstate
acquisition or merger which would result in a deposit concentration in
California exceeding 30% if the Commissioner finds that the transaction is
consistent with public convenience and advantage.  However, a state
bank chartered in a state other than California may not enter California by
purchasing a California branch office of a California bank or industrial bank
without purchasing the entire entity or by establishing a de novo California
bank.
 
 The FRB
generally prohibits a bank holding company from declaring or paying a cash
dividend which would impose undue pressure on the capital of subsidiary banks or
would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position.  The
FRB's policy is that a bank holding company should not continue its existing
rate of cash dividends on its common stock unless its net income is sufficient
to fully fund each dividend and its prospective rate of earnings retention
appears consistent with its capital needs, asset quality and overall financial
condition.  The Company is also subject to restrictions relating to
the payment of dividends under California corporate law.  See
“Restrictions on Dividends and Other Distributions” below for additional
restrictions on the ability of the Company and the Bank to pay
dividends.
 
 Transactions
between the Company and the Bank are subject to a number of other restrictions.
FRB policies forbid the payment by bank subsidiaries of management fees, which
are unreasonable in amount or exceed the fair market value of the services
rendered (or, if no market exists, actual costs plus a reasonable
profit).  Subject to certain limitations, depository institution
subsidiaries of bank holding companies may extend credit to, invest in the
securities of, purchase assets from, or issue a guarantee, acceptance, or letter
of credit on behalf of, an affiliate, provided that the aggregate of such
transactions with affiliates may not exceed 10% of the capital stock and surplus
of the institution, and the aggregate of such transactions with all affiliates
may not exceed 20% of the capital stock and surplus of such
institution.  The Company may only borrow from depository institution
subsidiaries of the Company if the loan is secured by marketable obligations
with a value of a designated amount in excess of the loan.  Further,
the Company may not sell a low-quality asset to the Bank.
  7
  
 Bank
Regulation and Supervision
 
 The Bank
is subject to regulation, supervision and regular examination by the California
Department of Financial Institutions (“DFI”) and the FDIC and the Company by the
FRB.  The regulations of these agencies affect most aspects of the
Company’s business and prescribe permissible types of loans and investments, the
amount of required reserves, requirements for branch offices, the permissible
scope of the Company’s activities and various other
requirements.  While the Bank is not a member of the FRB, it is also
directly subject to certain regulations of the FRB dealing primarily with check
clearing activities, establishment of banking reserves, Truth-in-Lending
(Regulation Z), Truth-in-Savings (Regulation DD), and Equal Credit Opportunity
(Regulation B).  In addition, the banking industry is subject to
significantly increased regulatory controls and processes regarding Bank Secrecy
Act and anti-money laundering laws.  In recent years, a number of
banks and bank holding companies announced the imposition of regulatory
sanctions, including regulatory agreements and cease and desist orders and, in
some cases, fines and penalties by the bank regulators due to failures to comply
with the Bank Secrecy Act and other anti-money laundering
legislation.  In a number of these cases, the fines and penalties have
been significant.  Failure to comply with these additional
requirements may also adversely affect the ability to obtain regulatory
approvals for future initiatives requiring regulatory approval, including
acquisitions.
 
 Under
California law, the Bank is subject to various restrictions on, and requirements
regarding, its operations and administration including the maintenance of branch
offices and automated teller machines, capital and reserve requirements,
deposits and borrowings, stockholder rights and duties, and investment and
lending activities.
 
 California
law permits a state chartered bank to invest in the stock and securities of
other corporations, subject to a state chartered bank receiving either general
authorization or, depending on the amount of the proposed investment, specific
authorization from the Commissioner.  Federal banking laws, however,
impose limitations on the activities and equity investments of state chartered,
federally insured banks.  The FDIC rules on investments prohibit a
state bank from acquiring an equity investment of a type, or in an amount, not
permissible for a national bank.  Non-permissible investments must
have been divested by state banks no later than December 19,
1996.  FDIC rules also prohibit a state bank from engaging as a
principal in any activity that is not permissible for a national bank, unless
the bank is adequately capitalized and the FDIC approves the activity after
determining that such activity does not pose a significant risk to the deposit
insurance fund.  The FDIC rules on activities generally permit
subsidiaries of banks, without prior specific FDIC authorization, to engage in
those activities that have been approved by the FRB for bank holding companies
because such activities are so closely related to banking to be a proper
incident thereto.  Other activities generally require specific FDIC
prior approval and the FDIC may impose additional restrictions on such
activities on a case-by-case basis in approving applications to engage in
otherwise impermissible activities.
 
 The
USA Patriot Act
 
 Title III
of the United and Strengthening America by Providing Appropriate Tools Required
to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) includes
numerous provisions for fighting international money laundering and blocking
terrorism access to the U.S. financial system.  The USA Patriot Act
requires certain additional due diligence and record keeping practices,
including, but not limited to, new customers, correspondent and private banking
accounts.  In March 2006, President
Bush signed into law a renewal of the USA Patriot Act.
 
 Part of
the USA Patriot Act is the International Money Laundering Abatement and
Financial Anti-Terrorism Act of 2001 (“IMLAFATA”).  Among its
provisions, IMLAFATA requires each financial institution to: (i) establish an
anti-money laundering program; (ii) establish appropriate anti-money laundering
policies, procedures and controls; (iii) appoint a Bank Secrecy Act officer
responsible for day-to-day compliance; and (iv) conduct independent
audits.  In addition, IMLAFATA contains a provision encouraging
cooperation among financial institutions, regulatory authorities and law
enforcement authorities with respect to individuals, entities and organizations
engaged in, or reasonably suspected of engaging in, terrorist acts or money
laundering activities.  IMLAFATA expands the circumstances under which
funds in a bank account may be forfeited and requires covered financial
institutions to respond under certain circumstances to requests for information
from federal banking agencies within 120 hours.  IMLAFATA also amends
the BHCA and the Bank Merger Act to require the federal banking agencies to
consider the effectiveness of a financial institution's anti-money laundering
activities when reviewing an application under these Acts.
  8
  
 Pursuant
to IMLAFATA, the Secretary of the Treasury, in consultation with the heads of
other government agencies, has adopted and proposed special measures applicable
to banks, bank holding companies, and/or other financial
institutions.  These measures include enhanced record keeping and
reporting requirements for certain financial transactions that are of primary
money laundering concern, due diligence requirements concerning the beneficial
ownership of certain types of accounts, and restrictions or prohibitions on
certain types of accounts with foreign financial institutions.
 
 Privacy
Restrictions
 
 GLBA, in
addition to the previous described changes in permissible non-banking activities
permitted to banks, bank holding companies and financial holding companies, also
requires financial institutions in the U.S. to provide certain privacy
disclosures to customers and consumers, to comply with certain restrictions on
the sharing and usage of personally identifiable information, and to implement
and maintain commercially reasonable customer information safeguarding
standards.
 
 The
Company believes that it complies with all provisions of GLBA and all
implementing regulations, and the Bank has developed appropriate policies and
procedures to meet its responsibilities in connection with the privacy
provisions of GLBA.
 
 In
October 2007, the federal bank regulatory agencies adopted final rules
implementing the affiliate marketing provisions of the Fair and Accurate Credit
Transactions Act of 2003, which amended the Fair Credit Reporting Act
(FCRA).  The final rules, which became effective on January 1, 2008,
impose a prohibition, subject to certain exceptions, on a financial institution
using certain information received from an affiliate to make a solicitation to a
consumer unless the consumer is given notice and a reasonable opportunity to opt
out of such solicitations, and the consumer does not opt out.  The
final rules apply to information obtained from the consumer’s transactions or
account relationships with an affiliate, any application the consumer submitted
to an affiliate, and third-party sources, such as credit reports, if the
information is to be used to send marketing solicitations.  The rules
do not supersede or affect a consumer’s existing right under other provisions of
the FCRA to opt out of the sharing between a financial institution and its
affiliates of consumer information other than information relating solely to
transactions or experiences between the consumer and the financial institution
or its affiliates.
 
 California
and other state legislatures have adopted privacy laws, including laws
prohibiting sharing of customer information without the customer’s prior
permission.  These laws may make it more difficult for the Company to
share information with its marketing partners, reduce the effectiveness of
marketing programs, and increase the cost of marketing programs.
 
 Capital
Standards
 
 The
federal banking agencies have risk-based capital adequacy guidelines intended to
provide a measure of capital adequacy that reflects the degree of risk
associated with a banking organization's operations for both transactions
reported on the balance sheet as assets and transactions, such as letters of
credit, and recourse arrangements, which are recorded as off-balance-sheet
items.  Under these guidelines, nominal dollar amounts of assets and
credit equivalent amounts of off-balance-sheet items are multiplied by one of
several risk adjustment percentages, which range from 0% for assets with low
credit risk, such as certain U.S. government securities, to 100% for assets with
relatively higher credit risk, such as certain loans.
 
 In
determining the capital level the Bank is required to maintain, the federal
banking agencies do not, in all respects, follow generally accepted accounting
principles (“GAAP”) and have special rules which have the effect of reducing the
amount of capital that will be recognized for purposes of determining the
capital adequacy of the Bank.
 
 
  9
  
 A banking
organization's risk-based capital ratios are obtained by dividing its qualifying
capital by its total risk-adjusted assets and off-balance-sheet
items.  The regulators measure risk-adjusted assets and
off-balance-sheet items against both total qualifying capital (the sum of Tier 1
capital and limited amounts of Tier 2 capital) and Tier 1
capital.  Tier 1 capital consists of common stock, retained earnings,
non-cumulative perpetual preferred stock, trust preferred securities (for up to
25% of total tier 1 capital), other types of qualifying preferred stock and
minority interests in certain subsidiaries, less most other intangible assets
and other adjustments.  Net unrealized losses on available-for-sale
equity securities with readily determinable fair value must be deducted in
determining Tier 1 capital.  For Tier 1 capital purposes, deferred tax
assets that can only be realized if an institution earns sufficient taxable
income in the future are limited to the amount that the institution is expected
to realize within one year, or 10% of Tier 1 capital, whichever is
less.  Tier 2 capital may consist of a limited amount of the allowance
for possible loan and lease losses, term preferred stock and other types of
preferred stock and trust preferred securities not qualifying as Tier 1 capital,
term subordinated debt and certain other instruments with some characteristics
of equity.  The inclusion of elements of Tier 2 capital are subject to
certain other requirements and limitations of the federal banking
agencies.  The federal banking agencies require a minimum ratio of
qualifying total capital to risk-adjusted assets and off-balance-sheet items of
8%, and a minimum ratio of Tier 1 capital to adjusted average risk-adjusted
assets and off-balance-sheet items of 4%.
 
 Under
FDIC regulations, there are also two rules governing minimum capital levels that
FDIC-supervised banks must maintain against the risks to which they are
exposed.  The first rule makes risk-based capital standards consistent
for two types of credit enhancements (i.e., recourse arrangements and direct
credit substitutes) and requires different amounts of capital for different risk
positions in asset securitization transactions.  The second rule
permits limited amounts of unrealized gains on debt and equity securities to be
recognized for risk-based capital purposes as of September 1,
1998.  The FDIC rules also provide that a qualifying institution that
sells small business loans and leases with recourse must hold capital only
against the amount of recourse retained.  In general, a qualifying
institution is one that is well capitalized under the FDIC's prompt corrective
action rules.  The amount of recourse that can receive the
preferential capital treatment cannot exceed 15% of the institution's total
risk-based capital.
 
 Effective
January 1, 2002, the federal banking agencies, including the FDIC, adopted new
regulations to change their regulatory capital standards to address the
treatment of recourse obligations, residual interests and direct credit
substitutes in asset securitizations that expose banks primarily to credit
risk.  Capital requirements for positions in securitization
transactions are varied according to their relative risk exposures, while
limited use is permitted of credit ratings from rating agencies, a banking
organization’s qualifying internal risk rating system or qualifying
software.  The regulation requires a bank to deduct from Tier 1
capital, and from assets, all credit-enhancing interest only-strips, whether
retained or purchased that exceed 25% of Tier 1
capital.  Additionally, a bank must maintain dollar-for-dollar
risk-based capital for any remaining credit-enhancing interest-only strips and
any residual interests that do not qualify for a ratings-based
approach.  The regulation specifically reserves the right to modify
any risk-weight, credit conversion factor or credit equivalent amount, on a
case-by-case basis, to take into account any novel transactions that do not fit
well into the currently defined categories.
 
 In
addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to adjusted
average total assets, referred to as the leverage capital ratio.  For
a banking organization rated in the highest of the five categories used by
regulators to rate banking organizations, the minimum lever­age ratio of
Tier 1 capital to total assets must be 3%.  It is improbable; however,
that an institution with a 3% leverage ratio would receive the highest rating by
the regulators since a strong capital position is a significant part of the
regulators' rating.  For all banking organizations not rated in the
highest category, the minimum leverage ratio must be at least 100 to 200 basis
points above the 3% minimum.  Thus, the effective minimum leverage
ratio, for all practical purposes, must be at least 4% or 5%.  In
addition to these uniform risk-based capital guidelines and leverage ratios that
apply across the industry, the regulators have the discretion to set individual
minimum capital requirements for specific institutions at rates significantly
above the minimum guidelines and ratios.
  10
  
 As of
December 31, 2008, the Company’s and the Bank’s capital ratios exceeded
applicable regulatory requirements.
 
 The
following tables present the capital ratios for the Company and the Bank,
compared to the standards for well-capitalized bank holding companies and
depository institutions, as of December 31, 2008 (amounts in thousands
except percentage amounts).
 
 The
      CompanyAdequatelyActual
                          
                          
                          CapitalizedCapital
                          
                          
                          Ratio
                          
                          
                          RatioLeverage
                          
                          $
                          58,760
                          
                          
                          
                          8.8
                          %
                          
                          
                          4.0
                          %Tier 1
      Risk-Based
                          
                          
                          58,760
                          
                          
                          
                          10.1
                          %
                          
                          
                          4.0
                          %Total
      Risk-Based
                          
                          
                          66,107
                          
                          
                          
                          11.4
                          %
                          
                          
                          8.0
                          %
 
 The
      BankAdequately
                  
                  
                  WellActual
                  
                  
                  Capitalized
                  
                  
                  CapitalizedCapital
                  
                  
                  Ratio
                  
                  
                  Ratio
                  
                  
                  RatioLeverage
                  
                  $
                  58,377
                  
                  
                  
                  8.7
                  %
                  
                  
                  4.0
                  %
                  
                  
                  5.0
                  %Tier 1
      Risk-Based
                  
                  
                  58,377
                  
                  
                  
                  10.1
                  %
                  
                  
                  4.0
                  %
                  
                  
                  6.0
                  %Total
      Risk-Based
                  
                  
                  65,724
                  
                  
                  
                  11.3
                  %
                  
                  
                  8.0
                  %
                  
                  
                  10.0
                  %
 
 
 The
federal banking agencies must take into consideration concentrations of credit
risk and risks from non-traditional activities, as well as an institution's
ability to manage those risks, when determining the adequacy of an institution's
capital.  This evaluation will be made as a part of the institution's
regular safety and soundness examination.  The federal banking
agencies must also consider interest rate risk (when the interest rate
sensitivity of an institution's assets does not match the sensitivity of its
liabilities or its off-balance-sheet position) in evaluating a Bank’s capital
adequacy.
 
 Prompt
Corrective Action and Other Enforcement Mechanisms
 
 The
Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)
requires each federal banking agency to take prompt corrective action to resolve
the problems of insured depository institutions, including but not limited to
those that fall below one or more prescribed minimum capital
ratios.  The law required each federal banking agency to promulgate
regulations defining the following five categories in which an insured
depository institution will be placed, based on the level of its capital ratios:
well capitalized, adequately capitalized, under­capitalized, significantly
undercapitalized and critically undercapitalized.
 
 Under the
prompt corrective action provisions of FDICIA, an insured depository institution
generally will be classified in the following categories based on the capital
measures indicated below:
 
 “Well capitalized”
                    Total
      risk-based capital of 10%;
                    Tier 1
      risk-based capital of 6%; and
                    Leverage
      ratio of 5%.
                  “Adequately capitalized”
                    Total
      risk-based capital of 8%;
                    Tier 1
      risk-based capital of 4%; and
                    Leverage
      ratio of 4%.
 
 “Undercapitalized”
                    Total
      risk-based capital less than 8%;
                    Tier 1
      risk-based capital less than 4%; or
                    Leverage
      ratio less than 4%.
                  “Significantly
      undercapitalized”
                    Total
      risk-based capital less than 6%;
                    Tier 1
      risk-based capital less than 3%; or
                    Leverage
      ratio less than 3%.
 
 “Critically undercapitalized”
                  Tangible
      equity to total assets less than 2%.
 
 
  11
  
 An
institution that, based upon its capital levels, is classified as “well
capitalized,” “adequately capitalized” or “under­capitalized” may be treated
as though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that
an unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment.  At each successive lower capital category, an insured
depository institution is subject to more restrictions.  Management
believes that at December 31, 2008, the Company and the Bank met the
requirements for “well capitalized” institutions.
 
 In
addition to measures taken under the prompt corrective action provisions,
commercial banking organizations may be subject to potential enforcement actions
by the federal regulators for unsafe or unsound practices in conducting their
businesses or for violations of any law, rule, regulation or any condition
imposed in writing by the agency or any written agreement with the
agency.  Enforcement actions may include the imposition of a
conservator or receiver, the issuance of a cease-and-desist order that can be
judicially enforced, the termination of insurance of deposits (in the case of a
depository institution), the imposition of civil money penalties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the issuance of removal and prohibition orders against
institution-affiliated parties and the enforcement of such actions through
injunctions or restraining orders based upon a judicial determination that the
agency would be harmed if such equitable relief was not
granted.  Additionally, a holding company’s inability to serve as a
source of strength to its subsidiary banking organizations could serve as an
additional basis for a regulatory action against the holding
company.
 
 Safety
and Soundness Standards
 
 FDICIA
also implemented certain specific restrictions on transactions and required
federal banking regulators to adopt overall safety and soundness standards for
depository institutions related to internal control, loan underwriting and
documentation and asset growth.  Among other things, FDICIA limits the
interest rates paid on deposits by undercapitalized institutions, restricts the
use of brokered deposits, limits the aggregate extensions of credit by a
depository institution to an executive officer, director, principal shareholder
or related interest, and reduces deposit insurance coverage for deposits offered
by undercapitalized institutions for deposits by certain employee benefits
accounts.
 
 The
federal banking agencies may require an institution to submit to an acceptable
compliance plan as well as have the flexibility to pursue other more appropriate
or effective courses of action given the specific circumstances and severity of
an institution's non-compliance with one or more standards.
 
 Restrictions
on Dividends and Other Distributions
 
 The power
of the board of directors of an insured depository institution to declare a cash
dividend or other distribution with respect to capital is subject to statutory
and regulatory restrictions which limit the amount available for such
distribution depending upon the earnings, financial condition and cash needs of
the institution, as well as general business conditions.  FDICIA
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
 
 The
federal banking agencies also have authority to prohibit a depository
institution from engaging in business practices, which are considered to be
unsafe or unsound, possibly including payment of dividends or other payments
under certain circumstances even if such payments are not expressly prohibited
by statute.
 
 In
addition to the restrictions imposed under federal law, banks chartered under
California law generally may only pay cash dividends to the extent such payments
do not exceed the lesser of retained earnings of the bank’s net income for its
last three fiscal years (less any distributions to shareholders during such
period).  In the event a bank desires to pay cash dividends in excess
of such amount, the bank may pay a cash dividend with the prior approval of the
Commissioner in an amount not exceeding the greatest of the bank’s retained
earnings, the bank’s net income for its last fiscal year, or the bank’s net
income for its current fiscal year.
  12
  Premiums for Deposit Insurance
 The Bank
is a member of the Deposit Insurance Fund (DIF) maintained by the FDIC. Through
the DIF, the FDIC insures the deposits of the Bank up to prescribed limits for
each depositor.  The DIF was formed March 31, 2006, upon the merger of
the Bank Insurance Fund (“BIF’) and the Savings Association Insurance Fund
(“SAIF) in accordance with the Federal Deposit Insurance Reform Act of
2005.  To maintain the DIF, member institutions are assessed an
insurance premium based on their deposits and their institutional risk category.
The FDIC determines an institution’s risk category by combining its supervisory
ratings with its financial ratios and other risk measures.
  The
Federal Deposit Insurance Reform Act of 2005, as implemented by the FDIC,
adopted a new schedule of rates that the FDIC can adjust up or down, depending
on the revenue needs of the insurance fund.  To offset assessments, a
member institution may apply certain one time credits, based on the
institution’s (or its successor’s) assessment base as of the end of 1996. An
institution may apply available credits up to 100% of assessments in 2007, and
up to 90% of assessments in each of 2008, 2009 and 2010.  Although an
FDIC credit for prior contributions offset most of the assessment for 2007, the
insurance assessments the Bank will pay has increased our costs starting in
2008.  This new assessment system has resulted in annual assessments
on deposits of the Bank of approximately $456,000.  Any further
increases in the deposit insurance assessments the Bank pays would further
increase our costs.
  The FDIC
may terminate a depository institution’s deposit insurance upon a finding that
the institution’s financial condition is unsafe or unsound or that the
institution has engaged in unsafe or unsound practices or has violated any
applicable rule, regulation, order or condition enacted or imposed by the
institution’s regulatory agency.  The termination of deposit insurance
for the Bank would have a material adverse effect on our business and
prospects.
  The
Deposit Insurance Funds Act of 1996 (the “Deposit Funds Act”) separated the
Financing Corporation (“FICO”) assessment to service the interest on FICO bond
obligations from the BIF and SAIF assessments.  The FICO annual
assessment on individual depository institutions is in addition to the amount,
if any, paid for deposit insurance according to the FDIC’s risk-based assessment
rate schedules. FICO assessment rates may be adjusted quarterly by the
FDIC.  The current FICO assessment rate is 1.14 cents per $100 of
deposits. In addition, the FDIC has authority to impose special assessments from
time to time, subject to certain limitations specified in the Deposit Funds
Act.
 
 The FDIC
has recently determined that the reserve ratio for the DIF was 0.76 percent as
of September 30, 2008 and 0.40 percent as of December 31, 2008 (preliminary),
the lowest reserve ratio for the combined bank and thrift insurance fund since
1993. The FDIC is required to establish and implement a plan within 90 days to
restore the reserve ratio to 1.15 percent within five years (subject to
extension due to extraordinary circumstances). For the quarter beginning January
1, 2009, the FDIC has raised the base annual assessment rate for institutions in
Risk Category I to between 12 and 14 basis points and in Risk Categories II, III
and IV to 17, 35 and 50 basis points, respectively. An institution’s assessment
rate could be lowered by as much as two basis points based on the ratio of its
long-term unsecured debt to deposits or, for smaller institutions, by the ratio
of its Tier 1 capital in excess of 15 percent to deposits. The assessment rate
would be adjusted towards the maximum rate for Risk Category I institutions that
have a high level of brokered deposits or have experienced higher levels of
asset growth (other than through acquisitions) and could be increased by as much
as 10 basis points for institutions in Risk Categories II, III and IV whose
ratio of brokered deposits to deposits exceeds 10 percent. An institution’s base
assessment rate would also be increased if an institution’s ratio of secured
liabilities (including Federal Home Loan Bank advances) to deposits exceeds 15
percent. The maximum adjustment for secured liabilities for institutions in Risk
Categories I, II, III and IV would be 7, 10, 15 and 22.5 basis points,
respectively. On February 27, 2009, the Board of Directors of the FDIC voted to
amend the restoration plan for the Deposit Insurance Fund, adopt an interim rule
(subject to comment) imposing an emergency special assessment on insured
institutions of 20 basis points on June 30, 2009 (to be collected on September
30, 2009), implement changes to the risk-based assessment system, and set rates
beginning the second quarter of 2009. The FDIC extended the restoration plan
period to seven years, concluding that the problems facing the financial
services sector and the economy at large constitute extraordinary circumstances
permitting such extension. The interim rule would also permit the FDIC to impose
an emergency special assessment after June 30, 2009, of up to 10 basis points if
necessary to maintain public confidence in federal deposit insurance or if the
reserve ratio of the Deposit Insurance Fund falls to a level which shall be zero
or close to negative at the end of a calendar quarter.
  
 13
   The
amended restoration plan was accompanied by a final rule that sets assessment
rates and makes adjustments designed to improve how the assessment system
differentiates for risk. Under the final rule, banks in Risk Category I will pay
initial base assessment rates ranging from 12 to 16 basis points on an annual
basis, beginning on April 1, 2009, while the base annual assessment rates for
institutions in Risk Categories II, III and IV will be adjusted to 22, 32 and 45
basis points, respectively. The final rule provides incentives in the form of a
reduction in assessment rates for institutions that hold long-term unsecured
debt and provides for increases in the base assessment rates for institutions
that rely significantly on brokered deposits or secured liabilities. In
addition, to the extent that assessments of participants in the Temporary
Liquidity Guarantee Program (described in “Government Responses to Recent
Economic Crisis” below) are insufficient to cover the expenses or losses arising
from the Temporary Liquidity Guarantee Program, the FDIC may impose one or more
emergency special assessments on all FDIC-insured depository institutions. Each
such special assessment will be computed with reference to the amount by which
an insured depository institution’s average total assets exceed the sum of the
institution’s average total tangible equity and average total subordinated
debt.
 
 Community
Reinvestment Act and Fair Lending
 
 The Bank
is subject to certain fair lending requirements and reporting obligations
involving home mortgage lending operations and Community Reinvestment Act
(“CRA”) activities.  The CRA generally requires the federal banking
agencies to evaluate the record of a financial institution in meeting the credit
needs of the Bank’s local communities, including low- and moderate-income
neighborhoods.  In addition to substantive penalties and corrective
measures that may be required for a violation of certain fair lending laws, the
federal banking agencies may take compliance with such laws and CRA into account
when regulating and supervising other activities, particularly applications
involving business expansion such as acquisitions or de novo
branching.
 
 Sarbanes
– Oxley Act
 
 On July
30, 2002, President Bush signed into law The Sarbanes-Oxley Act of
2002.  This legislation addressed accounting oversight and corporate
governance matters among public companies, including:
 
 ·
              the
      creation of a five-member oversight board that sets standards for
      accountants and has investigative and disciplinary
  powers;
 ·
              the
      prohibition of accounting firms from providing various types of consulting
      services to public clients and requires accounting firms to rotate
      partners among public client assignments every five
  years;
 ·
              increased
      penalties for financial crimes;
 ·
              expanded
      disclosure of corporate operations and internal controls and certification
      of financial statements;
 ·
              enhanced
      controls on, and reporting of, insider trading;
  and
 ·
              prohibition
      on lending to officers and directors of public companies, although the
      Bank may continue to make these loans within the constraints of existing
      banking regulations.
 
 Among
other provisions, Section 302(a) of the Sarbanes-Oxley Act requires that our
Chief Executive Officer and Chief Financial Officer certify that our quarterly
and annual reports do not contain any untrue statement or omission of a material
fact.  Specific requirements of the certifications include having
these officers confirm that they are responsible for establishing, maintaining
and regularly evaluating the effectiveness of our disclosure controls and
procedures; they have made certain disclosures to our auditors and Audit
Committee about our internal controls; and they have included information in our
quarterly and annual reports about their evaluation and whether there have been
significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to their
evaluation.
 
 In
addition, Section 404 of the Sarbanes-Oxley Act and the SEC’s rules and
regulations thereunder require our management to evaluate, with the
participation of our principal executive and principal financial officers, the
effectiveness, as of the end of each fiscal year, of our internal control over
financial reporting.  Our management must then provide a report of
management on our internal control over financial reporting that contains, among
other things, a statement of their responsibility for establishing and
maintaining adequate internal control over financial reporting, and a statement
identifying the framework they used to evaluate the effectiveness of our
internal control over financial reporting.
  14
  
 Government
Responses to Recent Economic Crisis
  The
current economic crisis has negatively affected the U.S. and international
financial markets. The magnitude of this financial crisis has prompted a variety
of actions by the U.S. Government to respond to the challenges presented by
these economic and financial developments.
  The
Emergency Economic Stabilization Act of 2008 (the EESA) which was enacted on
October 3, 2008, is a response to the recent financial crises affecting the
banking system and financial markets and going concern threats to investment
banks and other financial institutions. Pursuant to the EESA, the maximum
deposit insurance amount was temporarily increased from $100,000 to $250,000 per
depositor through December 31, 2009. On October 14, 2008, the FDIC announced the
establishment of a Temporary Liquidity Guarantee Program under which the FDIC
will fully guarantee until December 31, 2009, all non-interest-bearing
transaction accounts of insured depository institutions that do not opt out of
the program by December 5, 2008. Pursuant to the Temporary Liquidity Guarantee
Program, the FDIC will also guarantee newly issued senior unsecured debt of
participating financial institutions and their qualifying holding companies.
Institutions which participate in the Temporary Liquidity Guarantee Program are
assessed at the rate of ten basis points for transaction account balances in
excess of $250,000 and at the rate, on an annualized basis, of 50 to 100 basis
points of the amount of debt issued (on a sliding scale, depending on length of
maturity of the debt).
  As a part
of EESA, the U.S. Treasury has enacted a voluntary Capital Purchase Program
under its Troubled Asset Relief Program (TARP) pursuant to which the Treasury
will purchase up to $250 billion in senior preferred stock of qualifying U.S.
financial institutions. The nine largest banks in the U.S. initially agreed to
participate in this program, with the U.S. Treasury purchasing an aggregate of
$125 billion in senior preferred stock in such banks and allocating an
additional $125 billion in senior preferred stock in other banking institutions.
The purpose of the program is to provide substantial new capital to the U.S.
banking industry. Many banks and bank holding companies have participated in
such program. On January 15, 2009, the Senate voted to approve the release of an
additional $350 billion in TARP funds. On March 13, 2009, pursuant to TARP, we
sold approximately $17.4 million in preferred shares to the Treasury. See
“Recent Events” below for additional information.
  In
February 2009, the Treasury outlined the “Financial Stability Plan: Deploying
our Full Arsenal to Attack the Credit Crisis on All Fronts.” The Financial
Stability Plan includes a wide variety of measures intended to address the
domestic and global financial crisis and deterioration of credit markets. Many
aspects of the Financial Stability Plan are conceptual in nature and contemplate
future specific regulations and further regulatory and legislative enactment.
Some of the key aspects of the Financial Stability Plan include:
  ·
              requiring
      banking institutions with assets in excess of $100 billion to undergo a
      forward-looking comprehensive “stress test” and providing such
      institutions with access to a U.S. Treasury-provided “capital buffer” to
      help absorb losses if the results of the test indicate that additional
      capital is needed and it cannot be obtained in the private
      sector;
  ·
              instituting
      a public-private investment fund which will be designed to involve both
      public and private capital and public financing for the acquisition of
      troubled and illiquid assets in the banking
  sector;
  ·
              substantial
      expenditures to support government-sponsored enterprises in the housing
      sector and a commitment of funds to help prevent avoidable foreclosures of
      owner-occupied residential real
estate;
  ·
              a
      consumer and business lending initiative intended to support the purchase
      of loans by providing financing to private investors to help unfreeze and
      lower interest rates for auto, small business, credit card and other
      consumer and business credit;
  ·
              increased
      transparency and disclosure of exposure on bank balance
      sheets;
  ·
              various
      corporate governance and executive compensation regulations, including
      requiring “say on pay” proposals for institutions receiving
      funds.
  As we
have less than $100 billion in assets we do not believe that the stress test and
U.S. Treasury-provided capital program will be applicable to the
Bank.
   15
  
 On
February 17, 2009 President Obama signed into law the American Recovery and
Reinvestment Act of 2009 (ARRA) in an attempt to reverse the recent U.S.
economic downturn. A large portion of the ARRA is devoted to new federal
spending programs designed to increase economic output, decrease unemployment
and invest in national infrastructure. Of the $787 billion in federal spending
appropriated by the ARRA, $286 billion will be devoted to tax cuts, $120 billion
will be used to fund infrastructure projects and $381 billion will be allocated
for social programs and other spending. While ARRA is not directly aimed at
regulating the financial services industry, it is possible that this level of
federal spending could indirectly impact the financial services
industry.
 
 Pending
Legislation and Regulations
 
 In
addition to the recent legislation discussed above, proposals to change the
laws, regulations and policies impacting the banking and financial services
industry are frequently introduced in Congress, in the state legislatures and
before the various bank regulatory agencies.  If enacted, such
legislation could significantly change the competitive environment in which the
Company operates.  The likelihood and timing of any such changes and
the impact such changes might have on the competitive situation, financial
condition or results of operations of the Company cannot be
predicted.
 
 Competition
 
 In the
past, an independent bank’s principal competitors for deposits and loans have
been other banks (particularly major banks), savings and loan associations and
credit unions.  For agricultural loans, the Bank also competes with
constituent entities with the Federal Farm Credit System.  To a lesser
extent, competition was also provided by thrift and loans, mortgage brokerage
companies and insurance companies.  Other institutions, such as
brokerage houses, mutual fund companies, credit card companies, and even retail
establishments have offered new investment vehicles, which also compete with
banks for deposit business.  The direction of federal legislation in
recent years seems to favor competition among different types of financial
institutions and to foster new entrants into the financial services
market.
 
 The
enactment of GLBA is the latest evidence of this trend, and it is anticipated
that this trend will continue as financial services institutions combine to take
advantage of the elimination of the barriers against such affiliations. The
enactment of the federal Interstate Banking and Branching Act in 1994 and the
California Interstate Banking and Branching Act of 1995 have increased
competition within California.  Recent legislation has also made it
easier for out-of-state credit unions to conduct business in California and
allows industrial banks to offer consumers more lending
products.  Moreover, regulatory reform, as well as other changes in
federal and California law will also affect competition.  The
availability of banking services over the Internet or “e-banking” has continued
to expand.  While the impact of these changes, and of other proposed
changes, cannot be predicted with certainty, it is clear that the business of
banking in California will remain highly competitive.
 
 We also
compete for deposits and loans with much larger financial institutions.
Competition in our industry is likely to further intensify as a result of recent
adverse economic and financial market conditions which has led to increased
consolidation of financial services companies, including large consolidations of
significance in our market area (such as JPMorgan Chase’s acquisition of
Washington Mutual and Wells Fargo Bank’s acquisition of Wachovia
Bank).  In order to compete with major financial institutions and
other competitors in its primary service areas, the Bank relies upon the
experience of its executive and senior officers in serving business clients, and
upon its specialized services, local promotional activities and the personal
contacts made by its officers, directors and employees.
  For
customers whose loan demand exceeds the Bank’s legal lending limit, the Bank may
arrange for such loans on a participation basis with correspondent
banks.  The seasonal swings discussed earlier have, in the past, had
some impact on the Bank’s liquidity.  The management of investment
maturities, sale of loan participations, federal fund borrowings, qualification
for funds under the Federal Reserve Bank’s seasonal credit program, and the
ability to sell mortgages in the secondary market is intended to allow the Bank
to satisfactorily manage its liquidity.
  16
  
 Recent
Events
 
 On
February 26, 2009, at a Special Meeting of Shareholders, our shareholders
approved amendments to our Articles of Incorporation necessary to allow us to
participate in the Treasury’s TARP Capital Purchase Program. Specifically, these
amendments authorized our Board of Directors to issue shares of preferred stock
to the Treasury and created an exemption to the preemptive rights provision of
our Articles of Incorporation with respect to the TARP financing.
  On March
13, 2009 (the “Closing Date”), we issued and sold, and the Treasury purchased,
(1) 17,390 shares (the “Preferred Shares”) of the Company’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series A, liquidation preference of $1,000
per share, and (2) a ten-year warrant (the “Warrant”) to purchase up to 352,977
shares of the Company’s common stock, without par value (“Common Stock”), at an
exercise price of $7.39 per share, for an aggregate purchase price of $17.39
million in cash.
  The
securities were sold in a private placement exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
  Cumulative
dividends on the Preferred Shares will accrue on the liquidation preference at a
rate of 5% per annum for the first five years, and at a rate of 9% per annum
thereafter, if, as and when declared by the Company’s Board of Directors out of
funds legally available therefore. The Preferred Shares have no maturity date
and rank senior to the Common Stock with respect to the payment of dividends and
distributions and amounts payable upon liquidation, dissolution and winding up
of the Company. Subject to the approval of the Board of Governors of the Federal
Reserve System, the Preferred Shares are redeemable at the option of the Company
at any time at 100% of their liquidation preference.
  The
Treasury may not transfer a portion or portions of the Warrant with respect to,
and/or exercise the Warrant for more than one-half of, the 352,977 shares of
Common Stock issuable upon exercise of the Warrant, in the aggregate, until the
earlier of (i) the date on which the Company has redeemed the Preferred Shares
and (ii) December 31, 2009. In the event the Company redeems the Preferred
Shares pursuant to the terms of the TARP Capital Purchase Program prior to
December 31, 2009, the number of the shares of Common Stock underlying the
portion of the Warrant then held by the Treasury will be reduced by one-half of
the shares of Common Stock originally covered by the Warrant.
  The
Purchase Agreement pursuant to which the Preferred Shares and the Warrant were
sold contains limitations on the payment of dividends on the Common Stock,
including with respect to the payment of cash dividends (but does not affect our
ability to declare and pay stock dividends) and on the Company’s ability to
repurchase its Common Stock, and subjects the Company to certain of the
executive compensation limitations included in EESA. As a condition to the
closing of the transaction, each of Ownen J. Onsum, Louise A. Walker, Patrick S.
Day and Robert M. Walker, the Company’s Senior Executive Officers (as defined in
the Purchase Agreement) (the “Senior Executive Officers”), executed a waiver
(the “Waiver”) voluntarily waiving any claim against the Treasury or the Company
for any changes to such Senior Executive Officer’s compensation or benefits that
are required to comply with the regulation issued by the Treasury under the TARP
Capital Purchase Program as published in the Federal Register on October 20,
2008 and acknowledging that the regulation may require modification of the
compensation, bonus, incentive and other benefit plans, arrangements and
policies and agreements (including so-called “golden parachute” agreements)
(collectively, “Benefit Plans”) as they relate to the period the Treasury holds
any equity or debt securities of the Company acquired through the TARP Capital
Purchase Program.
  
 17
 
  ITEM
1A – RISK FACTORS
 
 In
addition to factors mentioned elsewhere in this Report, the factors contained
below, among others, could cause our financial condition and results of
operations to be materially and adversely affected.  If this were to
happen, the value of our common stock could decline, perhaps significantly, and
you could lose all or part of your investment.
 
 The
U.S Economy Has Experienced a Slowing of Economic Growth, Volatility in the
Financial Markets, and Significant Deterioration in Sectors of the U.S.
Residential Real Estate Markets, All of Which Present Challenges for the Banking
and Financial Services Industry and for the Bank
 
 Commencing
in 2007 and continuing through 2009, certain adverse financial developments have
impacted the U.S. economy and financial markets and present challenges for the
banking and financial services industry and for the Bank. These developments
include a general slowing of economic growth in the U.S. which has prompted the
Congress to adopt an economic stimulus bill which President Bush signed into law
on February 13, 2008, and which prompted the Federal Reserve Board to
decrease its discount rate and the federal funds rate several times in the first
quarter of 2008.  These developments have contributed to substantial
volatility in the equity securities markets, as well as volatility and a
tightening of liquidity in the credit markets.  In addition, financial
and credit conditions in the domestic residential real estate markets have
deteriorated significantly, particularly in the subprime
sector.  These conditions in turn have led to significant
deterioration in certain financial markets, particularly the markets for
subprime residential mortgage-backed securities and for collateralized debt
obligations backed by residential mortgage-backed securities. The magnitude of
this financial crisis has prompted a variety of actions by the U.S. Government
to respond to the challenges presented by these economic and financial
developments. These recent actions are discussed in Part I under the caption
“Business—Government Responses to Recent Economic Crisis.”  This
financial crisis presents significant challenges for the U.S. banking and
financial services industry and for the Bank.  While it is difficult
to predict how long these conditions will exist and how and the extent to which
the Bank may be affected, these factors will continue to present risks for some
time for the industry and the Bank’s financial condition, results of operations,
cash flows and business prospects.
 
 The
Bank is Subject to Lending Risks of Loss and Repayment Associated with
Commercial Banking Activities
 
 The
Bank’s business strategy is to focus on commercial business loans (which
includes agricultural loans), construction loans and commercial and multi-family
real estate loans.  The principal factors affecting the Bank’s risk of
loss in connection with commercial business loans include the borrower's ability
to manage its business affairs and cash flows, general economic conditions and,
with respect to agricultural loans, weather and climate
conditions.  Loans secured by commercial real estate are generally
larger and involve a greater degree of credit and transaction risk than
residential mortgage (one to four family) loans.  Because payments on
loans secured by commercial and multi-family real estate properties are often
dependent on successful operation or management of the underlying properties,
repayment of such loans may be dependent on factors other than the prevailing
conditions in the real estate market or the economy.  Real estate
construction financing is generally considered to involve a higher degree of
credit risk than long-term financing on improved, owner-occupied real
estate.  Risk of loss on a construction loan is dependent largely upon
the accuracy of the initial estimate of the property's value at completion of
construction or development compared to the estimated cost (including interest)
of construction.  If the estimate of value proves to be inaccurate,
the Bank may be confronted with a project which, when completed, has a value
which is insufficient to assure full repayment of the construction
loan.
 
 Although
the Bank manages lending risks through its underwriting and credit
administration policies, no assurance can be given that such risks will not
materialize, in which event, the Company’s financial condition, results of
operations, cash flows and business prospects could be materially adversely
affected.
  18
  
 The
Bank’s Dependence on Real Estate Lending Increases Our Risk of
Losses
 
 At
December 31, 2008, approximately 70% of the Bank’s loans (excluding loans
held-for-sale) were secured by real estate.  The value of the Bank’s
real estate collateral has been, and could in the future continue to be,
adversely affected by the economic recession and resulting adverse impact on the
real estate market in Northern California.  See “The U.S. Economy Has
Experienced a Slowing of Economic Growth, Volatility in the Financial Markets
and Significant Deterioration in Sectors of the U.S. Residential Real Estate
Markets, All of Which Present Challenges for the Banking and Financial Services
Industry and for the Bank” above, and “Adverse California Economic Conditions
Could Adversely Affect the Bank’s Business” below.
 
 The
Bank’s primary lending focus has historically been commercial (including
agricultural), construction and real estate mortgage.  At December 31,
2008, real estate mortgage (excluding loans held-for-sale) and construction
loans comprised approximately 57% and 13%, respectively, of the total loans in
the Bank’s portfolio.  At December 31, 2008, all of the Bank’s real
estate mortgage and construction loans and approximately 9% of its commercial
loans were secured fully or in part by deeds of trust on underlying real
estate.  The Company’s dependence on real estate increases the risk of
loss in both the Bank’s loan portfolio and its holdings of other real estate
owned if economic conditions in Northern California further deteriorate in the
future.  Further deterioration of the real estate market in Northern
California would have a material adverse effect on the Company’s business,
financial condition and results of operations.  See “Adverse California
Economic Conditions Could Adversely Affect the Bank’s Business”
below.
 
 Adverse
California Economic Conditions Could Adversely Affect the Bank’s
Business
 
 The
Bank’s operations and a substantial majority of the Bank’s assets and deposits
are generated and concentrated primarily in Northern California, particularly
the counties of Placer, Sacramento, Solano and Yolo, and are likely to remain so
for the foreseeable future.  At December 31, 2008, approximately 70%
of the Bank’s loan portfolio (excluding loans held-for-sale) consisted of real
estate-related loans, all of which were secured by collateral located in
Northern California.  As a result, a further downturn in the economic
conditions in Northern California may cause the Bank to incur losses associated
with high default rates and decreased collateral values in its loan
portfolio.  Economic conditions in California are subject to various
uncertainties at this time, including the significant deterioration in the
California real estate market and housing industry.  Under the budget
plan approved by the California Legislature and signed by Governor Arnold
Schwarzenegger on February 20, 2009, the State of California will reduce
services, increase sales and income taxes and other fees and take other expense
reduction measures. In addition, California will fund a portion of the deficit
through additional borrowings, which may include Revenue Anticipation Warrants,
a relatively high-cost form of financing. Further, the budget requires
California voter approval of ballot measures during a special election to be
held on May 19, 2009. The measures would set a cap on state spending and
institute a “rainy day” fund for periods of fiscal difficulty for the State’s
budget, authorize the State to sell bonds based on future lottery revenue, shift
money from certain social programs, guarantee additional funds for schools and
freeze lawmakers’ pay when the State runs a deficit. Rejection of any of the
revenue-related ballot measures would likely result in budget deficits which
would need to be addressed later in 2009. The financial and economic
consequences of this situation cannot be predicted with any certainty at this
time.  If economic conditions in California decline further it is
expected that the Bank’s level of problem assets would
increase.  California real estate is also subject to certain natural
disasters, such as earthquakes, floods and mudslides, which are typically not
covered by the standard hazard insurance policies maintained by
borrowers.  Uninsured disasters may make it difficult or impossible
for borrowers to repay loans made by the Bank.  The occurrence of
natural disasters in California could have a material adverse effect on the
Company’s financial condition, results of operations, cash flows and business
prospects.
   19
  
 The
Bank is Subject to Interest Rate Risk
  The
income of the Bank depends to a great extent on “interest rate differentials”
and the resulting net interest margins (i.e., the difference between the
interest rates earned on the Bank’s interest-earning assets such as loans and
investment securities, and the interest rates paid on the Bank’s
interest-bearing liabilities such as deposits and borrowings).  These
rates are highly sensitive to many factors, which are beyond the Bank’s control,
including, but not limited to, general economic conditions and the policies of
various governmental and regulatory agencies, in particular, the
FRB.  The Bank is generally adversely affected by declining interest
rates.  Changes in the relationship between short-term and long-term
market interest rates or between different interest rate indices can also impact
our interest rate differential, possibly resulting in a decrease in our interest
income relative to interest expense.  In addition, changes in monetary
policy, including changes in interest rates, influence the origination of loans,
the purchase of investments and the generation of deposits and affect the rates
received on loans and investment securities and paid on deposits, which could
have a material adverse effect on the Company’s business, financial condition
and results of operations.  See “Quantitative and Qualitative
Disclosures About Market Risk” below.
  Potential
Volatility of Deposits May Increase Our Cost of Funds
 
 At
December 31, 2008, 10% of the dollar value of the Company’s total deposits was
represented by time certificates of deposit in excess of
$100,000.  These deposits are considered volatile and could be subject
to withdrawal.  Withdrawal of a material amount of such deposits would
adversely impact the Company’s liquidity, profitability, business prospects,
results of operations and cash flows.
 
 Our
Ability to Pay Dividends is Subject to Legal Restrictions
 
 As a bank
holding company, our cash flow typically comes from dividends of the
Bank.  Various statutory and regulatory provisions restrict the amount
of dividends the Bank can pay to the Company without regulatory
approval.  The ability of the Company to pay cash dividends in the
future also depends on the Company’s profitability, growth and capital
needs.  In addition, California law restricts the ability of the
Company to pay dividends.  No assurance can be given that the Company
will pay any dividends in the future or, if paid, such dividends will not be
discontinued.  See “Business - Restrictions
on Dividends and Other Distributions” above.
 
 Competition
Adversely Affects our Profitability
 
 In
California generally, and in the Bank’s primary market area specifically, major
banks dominate the commercial banking industry.  By virtue of their
larger capital bases, such institutions have substantially greater lending
limits than those of the Bank.  Competition is likely to further
intensify as a result of recent adverse economic and financial market conditions
which has led to increased consolidation of financial services companies,
including large consolidations of significance in our market area (such as
JPMorgan Chase’s acquisition of Washington Mutual and Wells Fargo Bank’s
acquisition of Wachovia Bank).  In obtaining deposits and making
loans, the Bank competes with these larger commercial banks and other financial
institutions, such as savings and loan associations, credit unions and member
institutions of the Farm Credit System, which offer many services that
traditionally were offered only by banks.  Using the financial holding
company structure, insurance companies and securities firms may compete more
directly with banks and bank holding companies.  In addition, the Bank
competes with other institutions such as mutual fund companies, brokerage firms,
and even retail stores seeking to penetrate the financial services
market.  Also, technology and other changes increasingly allow parties
to complete financial transactions electronically, and in many cases, without
banks. For example, consumers can pay bills and transfer funds over the internet
and by telephone without banks.  Non-bank financial service providers
may have lower overhead costs and are subject to fewer regulatory
constraints.  If consumers do not use banks to complete their
financial transactions, we could potentially lose fee income, deposits and
income generated from those deposits.  During periods of declining
interest rates, competitors with lower costs of capital may solicit the Bank’s
customers to refinance their loans.  Furthermore, during periods of
economic slowdown or recession, the Bank’s borrowers may face financial
difficulties and be more receptive to offers from the Bank’s competitors to
refinance their loans.  No assurance can be given that the Bank will
be able to compete with these lenders.  See “Business - Competition”
above.
   20
  
 Government
Regulation and Legislation Could Adversely Affect Us
  The
Company and the Bank are subject to extensive state and federal regulation,
supervision and legislation, which govern almost all aspects of the operations
of the Company and the Bank.  The business of the Bank is particularly
susceptible to being affected by the enactment of federal and state legislation,
which may have the effect of increasing the cost of doing business, modifying
permissible activities or enhancing the competitive position of other financial
institutions.  Such laws are subject to change from time to time and
are primarily intended for the protection of consumers, depositors and the
deposit insurance fund and not for the benefit of shareholders of the
Company.  Regulatory authorities may also change their interpretation
of these laws and regulations.  The Company cannot predict what effect
any presently contemplated or future changes in the laws or regulations or their
interpretations would have on the business and prospects of the Company, but it
could be material and adverse.  See “Bank Regulation and
Supervision” above.
 
 We
maintain systems and procedures designed to comply with applicable laws and
regulations. However, some legal/regulatory frameworks provide for the
imposition of criminal or civil penalties (which can be substantial) for
noncompliance.  In some cases, liability may attach even if the
noncompliance was inadvertent or unintentional and even if compliance systems
and procedures were in place at the time.  There may be other negative
consequences from a finding of noncompliance, including restrictions on certain
activities and damage to the Company’s reputation.
  Our Controls and Procedures May Fail
or be Circumvented
  The
Company maintains controls and procedures to mitigate against risks such as
processing system failures and errors, and customer or employee fraud, and
maintains insurance coverage for certain of these risks.  Any system
of controls and procedures, however well designed and operated, is based in part
on certain assumptions and can provide only reasonable, not absolute, assurances
that the objectives of the system are met.  Events could occur which
are not prevented or detected by the Company’s internal controls or are not
insured against or are in excess of the Company’s insurance
limits.  Any failure or circumvention of the Company’s controls and
procedures or failure to comply with regulations related to controls and
procedures could have a material adverse effect on the Company’s business,
results of operations and financial condition.
 
 Recent
Changes in Deposit Insurance Premiums Could Adversely Affect Our
Business
  In 2006,
the FDIC created a new assessment system designed to more closely tie what banks
pay for deposit insurance to the risks they pose and adopted a new base schedule
of rates that the FDIC can adjust up or down depending on the revenue needs of
the insurance fund.  Although an FDIC credit for prior contributions
offset most of the assessment for 2007, the insurance assessments the Bank will
pay has increased our costs starting in 2008.  This new assessment
system has resulted in annual assessments on deposits of the Bank of
approximately $456,000.  In addition, as discussed above in Part I
under the caption “Business—Premiums for Deposit Insurance,” the FDIC has taken
recent steps which could further increase deposit premiums and is contemplating
further increases and a special assessment.  Any further increases in
the deposit insurance assessments the Bank pays would further increase our
costs.
  Negative
Public Opinion Could Damage Our Reputation and Adversely Affect Our
Earnings
  Reputational
risk, or the risk to our earnings and capital from negative public opinion, is
inherent in our business. Negative public opinion can result from the actual or
perceived manner in which we conduct our business activities, management of
actual or potential conflicts of interest and ethical issues and our protection
of confidential client information.  Negative public opinion can
adversely affect our ability to keep and attract customers and employees and can
expose us to litigation and regulatory action.  We take steps to
minimize reputation risk in the way we conduct our business activities and deal
with our clients and communities.
 
 Our
Business Could Suffer if We Fail to Attract and Retain Skilled
Personnel
 
 The
Company’s future success depends to a significant extent on the efforts and
abilities of our executive officers.  The loss of the services of
certain of these individuals, or the failure of the Company to attract and
retain other qualified personnel, could have a material adverse effect on the
Company’s business, financial condition and results of
operations.
  21
  
 The
Continuing War on Terrorism Could Adversely Affect U.S. and Global Economic
Conditions
 
 Acts or
threats of terrorism and actions taken by the U.S. or other governments as a
result of such acts or threats and other international hostilities may result in
a disruption of U.S. economic and financial conditions and could adversely
affect business, economic and financial conditions in the U.S. generally and in
our principal markets.  The war in Iraq has also generated various
political and economic uncertainties affecting the global and U.S.
economies.
 
 Changes
in Accounting Standards Could Materially Impact Our Financial
Statements
 
 The
Company’s financial statements are presented in accordance with accounting
principles generally accepted in the United States of America (“US
GAAP”).  The financial information contained within our financial
statements is, to a significant extent, financial information that is based on
approximate measures of the financial effects of transactions and events that
have already occurred.  A variety of factors could affect the ultimate
value that is obtained either when earning income, recognizing an expense,
recovering an asset or relieving a liability.  Along with other
factors, we use historical loss factors to determine the inherent loss that may
be present in our loan portfolio.  Actual losses could differ
significantly from the historical loss factors that we use.  Other
estimates that we use are fair value of our securities and expected useful lives
of our depreciable assets.  We have not entered into derivative
contracts for our customers or for ourselves, which relate to interest rate,
credit, equity, commodity, energy, or weather-related indices.  US
GAAP itself may change from one previously acceptable method to another
method.  Although the economics of our transactions would be the same,
the timing of events that would impact our transactions could
change.  Accounting standards and interpretations currently affecting
the Company and its subsidiaries may change at any time, and the Company’s
financial condition and results of operations may be adversely
affected.  In some cases, we could be required to apply a new or
revised standard retroactively, resulting in our restating prior period
financial statements.
 
 Increases
in the Allowance for Loan Losses Would Adversely Affect the Bank’s Financial
Condition and Results of Operations
 
 The
Bank’s allowance for estimated losses on loans was approximately $14.4 million,
or 2.71% of total loans, at December 31, 2008, compared to $10.9 million, or
2.13% of total loans, at December 31, 2007, and 101% of total non-performing
loans at December 31, 2008, compared to 70% of total non-performing loans at
December 31, 2007.  Material future additions to the allowance for
estimated losses on loans may be necessary if material adverse changes in
economic conditions occur and the performance of the Bank’s loan portfolio
deteriorates.  In addition, an allowance for losses on other real
estate owned may also be required in order to reflect changes in the markets for
real estate in which the Bank’s other real estate owned is located and other
factors which may result in adjustments which are necessary to ensure that the
Bank’s foreclosed assets are carried at the lower of cost or fair value, less
estimated costs to dispose of the properties.  Moreover, the FDIC and
the DFI, as an integral part of their examination process, periodically review
the Bank’s allowance for estimated losses on loans and the carrying value of its
assets.  Increases in the provisions for estimated losses on loans and
foreclosed assets would adversely affect the Bank’s financial condition and
results of operations.  See “Management's Discussion
and Analysis of Financial Condition and Results of Operations - Summary of Loan
Loss Experience” below.
 
 Future
Sales of Shares of the Company’s Common Stock Could Have a Material Adverse
Effect on the Market Price of the Common Stock
 
 As of
December 31, 2008, the Company had 8,608,802 shares of Common Stock outstanding,
all of which are eligible for sale in the public market without
restriction.  Future sales of substantial amounts of the Company’s
Common Stock, or the perception that such sales could occur, could have a
material adverse effect on the market price of the Common Stock.  In
addition, options to acquire up to 7.6% of the unissued authorized shares of
Common Stock at exercise prices ranging from $3.80 to $24.70 have been issued to
directors and employees of the Company, over the past nine (9) years, under the
Company’s 2000 and 2006 Stock Option Plans and Outside Directors 2000 and 2006
Non-statutory Stock Option Plans, and options to acquire up to an additional
10.5% of the unissued authorized shares of Common Stock are reserved for
issuance under such plans.  In addition, on March 13, 2009, as part of
our TARP financing, we issued a ten-year warrant to the Treasury to purchase up
to 352,977 shares of the Company’s common stock, without par value, at an
exercise price of $7.39 per share.  No prediction can be made as to
the effect, if any, that future sales of shares, or the availability of shares
for future sale, will have on the market price of the Company’s Common
Stock.  See
“Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities” below.
  22
   There
is a Limited Public Market for the Company’s Common Stock which May Make it
Difficult for Shareholders to Dispose of Their Shares
 
 The
Company’s common stock is not listed on any exchange.  However, trades
may be reported on the OTC Bulletin Board under the symbol
“FNRN”.  The Company is aware that Howe Barnes Hoefer & Arnett,
Stone & Youngberg, Wedbush Morgan Securities and Monroe Securities, Inc.,
all currently make a market in the Company’s common stock.  Management
is aware that there are also private transactions in the Company’s common
stock.  However, the limited trading market for the Company’s common
stock may make it difficult for shareholders to dispose of their
shares.  Also, the price of the Company’s common stock may be affected
by general market price movements as well as developments specifically related
to the financial services sector, including interest rate movements, quarterly
variations, or changes in financial estimates by securities analysts and a
significant reduction in the price of the stock of another participant in the
financial services industry, as well as the level of repurchases of Company
stock by the Company pursuant to its stock repurchase program.
 
 Advances
and Changes in Technology, and the Company’s Ability to Adapt Its Technology,
could Impact Its Ability to Compete and Its Business and Operations
 
 Advances
and changes in technology can significantly impact the business and operations
of the Company.  The Company faces many challenges including the
increased demand for providing computer access to Company accounts and the
systems to perform banking transactions electronically.  The Company’s
merchant processing services require the use of advanced computer hardware and
software technology and rapidly changing customer and regulatory
requirements.  The Company’s ability to compete depends on its ability
to continue to adapt its technology on a timely and cost-effective basis to meet
these requirements.  In addition, the Company’s business and
operations are susceptible to negative impacts from computer system failures,
communication and energy disruption and unethical individuals with the
technological ability to cause disruptions or failures of the Company’s data
processing systems.
 
 Environmental
Hazards Could Have a Material Adverse Effect on the Company’s Business,
Financial Condition and Results of Operations
 
 The
Company, in its ordinary course of business, acquires real property securing
loans that are in default, and there is a risk that hazardous substances or
waste, contaminants or pollutants could exist on such properties.  The
Company may be required to remove or remediate such substances from the affected
properties at its expense, and the cost of such removal or remediation may
substantially exceed the value of the affected properties or the loans secured
by such properties.  Furthermore, the Company may not have adequate
remedies against the prior owners or other responsible parties to recover its
costs.  Finally, the Company may find it difficult or impossible to
sell the affected properties either prior to or following any such
removal.  In addition, the Company may be considered liable for
environmental liabilities in connection with its borrowers' properties, if,
among other things, it participates in the management of its borrowers'
operations.  The occurrence of such an event could have a material
adverse effect on the Company’s business, financial condition, results of
operations and cash flows.
 
 Shareholders
of the Company Will Experience Dilution if Outstanding Options and Warrants are
Exercised
 
 As of
December 31, 2008, the Company had outstanding options to purchase an aggregate
of 564,145 shares of Common Stock at exercise prices ranging from $3.80 to
$24.70 per share, or a weighted average exercise price per share of
$10.55.  In addition, on March 13, 2009, as part of our TARP
financing, we issued a ten-year warrant to the Treasury to purchase up to
352,977 shares of the Company’s common stock, without par value, at an exercise
price of $7.39 per share. It has been Treasury’s past practice to exercise TARP
warrants shortly after closing the TARP financing.  To the extent such
options and warrants are exercised, shareholders of the Company will experience
dilution.  See “Market for Registrant's
Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities” below.
   23
  
 ITEM
1B – UNRESOLVED STAFF COMMENTS
 
 None.
 
 ITEM
2 – PROPERTIES
 
 The
Company and the Bank are engaged in the banking business through 16 offices in
five counties in Northern California operating out of four offices in Solano
County, eight in Yolo County, two in Sacramento County and two in Placer
County.  In addition, the Company owns four vacant lots, three in
northern Solano County and one in eastern Sacramento County, for possible future
bank sites.  The Company and the Bank believe all of their offices are
constructed and e quipped to meet prescribed security requirements.
 
 The Bank
owns three branch office locations and two administrative facilities and leases
13 facilities.  Most of the leases contain multiple renewal options
and provisions for rental increases, principally for changes in the cost of
living index, property taxes and maintenance.
 
 ITEM
3 - LEGAL PROCEEDINGS
 
 Neither
the Company nor the Bank is a party to any material pending legal proceeding,
nor is any of their property the subject of any material pending legal
proceeding, except ordinary routine litigation arising in the ordinary course of
the Bank's business and incidental to its business, none of which is expected to
have a material adverse impact upon the Company's or the Bank's business,
financial position or results of operations.
 
 
 PART II
 
 ITEM
5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
 
 The
Company’s common stock is not listed on any exchange, nor is it included on
NASDAQ.  However, trades may be reported on the OTC Bulletin Board
under the symbol “FNRN”.  The Company is aware that Howe Barnes Hoefer
& Arnett, Stone & Youngberg, Wedbush Morgan Securities and Monroe
Securities, Inc., all currently make a market in the Company’s common
stock.  Management is aware that there are also private transactions
in the Company’s common stock, and the data set forth below may not reflect all
such transactions.
 
 The
following table summarizes the range of reported high and low bid quotations of
the Company’s Common Stock for each quarter during the last two fiscal years and
is based on information provided by Stone & Youngberg.  The
quotations reflect the price that would be received by the seller without retail
mark-up, mark-down or commissions and may not have represented actual
transactions:
 
 QUARTER/YEAR
                      
                      HIGH*
                      
                      LOW*4th
      Quarter 2008
                      
                      $  9.62
                      
                      $  5.773rd
      Quarter 2008
                      
                      $10.00
                      
                      $  8.652nd
      Quarter 2008
                      
                      $13.70
                      
                      $  9.861st  Quarter
      2008
                      
                      $16.06
                      
                      $13.224th
      Quarter 2007
                      
                      $17.14
                      
                      $14.293rd
      Quarter 2007
                      
                      $17.23
                      
                      $14.292nd
      Quarter 2007
                      
                      $17.46
                      
                      $15.731st  Quarter
      2007
                      
                      $20.11
                      
                      $16.78
 
 *  Price
adjusted for dividends.
 
 As of
December 31, 2008, there were approximately 1,294 holders of record of the
Company’s common stock, no par value, which is the only class of equity
securities authorized or issued.
 
 
 
 24
 
 
 In the
last two fiscal years the Company has declared the following stock
dividends:
 
 Shareholder
                          Record Date
                        
                        Dividend
                          Percentage
                        
                        Date
                          PayableFebruary
      27, 2009
                        
                        4%
                        
                        March
      31, 2009February
      29, 2008
                        
                        6%
                        
                        March
      31, 2008February
      28, 2007
                        
                        6%
                        
                        March
      30, 2007
 
 The
Company does not expect to pay a cash dividend in the foreseeable
future.  Our ability to declare and pay dividends is affected by
certain regulatory restrictions.  See“Business – Restrictions
on Dividends and Other Distributions” and “– Recent Events” above.
 
 Purchases
of Equity Securities by the Issuer or Affiliated Purchasers
 
 On
September 22, 2007, the Company approved a new stock repurchase program
effective September 22, 2007 to replace the Company’s previous stock repurchase
plan that commenced May 1, 2006.  The new stock repurchase program,
which will remain in effect until September 21, 2009, allows repurchases by the
Company in an aggregate of up to 4% of the Company’s outstanding shares of
common stock over each rolling twelve-month period.  The Company
repurchased no shares of the Company’s outstanding common stock during the
fourth quarter ended December 31, 2008.  Our Tarp financing restricts
our ability to repurchase our common stock, see “Business – Recent Events”
above.
 
  The
Company made no purchases of its common stock during the quarter ended December
31, 2008:
  Period
                                        
                                        Total
      number of shares purchased
                                        
                                        Average
      price paid per share
                                        
                                        Total
      Number of shares purchased as part of publicly announced plan or
      program
                                        
                                        Maximum
      number of shares that may yet be purchased under the plans or
      programsOctober
      1 – October 31, 2008
                                        
                                        —
                                        
                                        —
                                        
                                        —
                                        
                                        128,885November
      1 – November 30,  2008
                                        
                                        —
                                        
                                        —
                                        
                                        —
                                        
                                        231,806December
      1 – December 31,  2008
                                        
                                        —
                                        
                                        —
                                        
                                        —
                                        
                                        258,239Total
                                        
                                        —
                                        
                                        —
                                        
                                        —
                                        
                                        258,239
  
  
 
  25
  
 ITEM
6 - SELECTED FINANCIAL DATA
 
 The
selected consolidated financial data below have been derived from the Company’s
audited consolidated financial statements.  The selected consolidated
financial data set forth below as of December 31, 2005, and 2004 have been
derived from the Company’s historical financial statements not included in this
Report.  The financial information for 2008, 2007 and 2006 should be
read in conjunction with “Management's Discussion and Analysis of Financial
Condition and Results of Operations,” which is in Part II (Item 7) of this
Report and with the Company’s audited consolidated financial statements and the
notes thereto, which are included in Part II (Item 8) of this
Report.
 
 Consolidated Financial Data
as of and for the years ended December 31,
 (in
thousands, except share and per share amounts)
 
 2008
                        
                        
                        2007
                        
                        
                        2006
                        
                        
                        2005
                        
                        
                        2004Interest
      Income and Loan Fees
                        
                        $
                        38,871
                        
                        
                        $
                        48,594
                        
                        
                        $
                        48,070
                        
                        
                        $
                        40,902
                        
                        
                        $
                        31,619Interest
      Expense
                        
                        
                        (6,375
                        )
                        
                        
                        (11,738
                        )
                        
                        
                        (9,426
                        )
                        
                        
                        (5,729
                        )
                        
                        
                        (3,426
                        )Net
      Interest Income
                        
                        
                        32,496
                        
                        
                        
                        36,856
                        
                        
                        
                        38,644
                        
                        
                        
                        35,173
                        
                        
                        
                        28,193Provision
      for Loan Losses
                        
                        
                        (16,164
                        )
                        
                        
                        (4,795
                        )
                        
                        
                        (735
                        )
                        
                        
                        (600
                        )
                        
                        
                        (207
                        )Net
      Interest Income after Provision for Loan Losses
                        
                        
                        16,332
                        
                        
                        
                        32,061
                        
                        
                        
                        37,909
                        
                        
                        
                        34,573
                        
                        
                        
                        27,986Other
      Operating Income
                        
                        
                        6,313
                        
                        
                        
                        7,160
                        
                        
                        
                        5,289
                        
                        
                        
                        5,720
                        
                        
                        
                        5,214Other
      Operating Expense
                        
                        
                        (27,654
                        )
                        
                        
                        (28,803
                        )
                        
                        
                        (29,219
                        )
                        
                        
                        (26,813
                        )
                        
                        
                        (22,943
                        )(Loss)
      Income before Taxes
                        
                        
                        (5,009
                        )
                        
                        
                        10,418
                        
                        
                        
                        13,979
                        
                        
                        
                        13,480
                        
                        
                        
                        10,257Benefit
      / (Provision) for Taxes
                        
                        
                        3,635
                        
                        
                        
                        (3,137
                        )
                        
                        
                        (5,169
                        )
                        
                        
                        (4,792
                        )
                        
                        
                        (3,550
                        )Net
      (Loss) / Income
                        
                        $
                        (1,374
                        )
                        
                        $
                        7,281
                        
                        
                        $
                        8,810
                        
                        
                        $
                        8,688
                        
                        
                        $
                        6,707Basic
      (Loss) / Income Per Share
                        
                        $
                        (0.15
                        )
                        
                        $
                        0.79
                        
                        
                        $
                        0.95
                        
                        
                        $
                        0.93
                        
                        
                        $
                        0.71Diluted
      (Loss) / Income Per Share
                        
                        $
                        (0.15
                        )
                        
                        $
                        0.77
                        
                        
                        $
                        0.90
                        
                        
                        $
                        0.89
                        
                        
                        $
                        0.70Total
      Assets
                        
                        $
                        670,802
                        
                        
                        $
                        709,895
                        
                        
                        $
                        685,225
                        
                        
                        $
                        660,647
                        
                        
                        $
                        629,503Total
      Investments
                        
                        $
                        42,106
                        
                        
                        $
                        74,849
                        
                        
                        $
                        76,273
                        
                        
                        $
                        48,788
                        
                        
                        $
                        55,154Total
      Loans, including Loans Held-for-Sale, net
                        
                        $
                        519,160
                        
                        
                        $
                        499,314
                        
                        
                        $
                        480,009
                        
                        
                        $
                        460,501
                        
                        
                        $
                        433,421Total
      Deposits
                        
                        $
                        584,718
                        
                        
                        $
                        622,671
                        
                        
                        $
                        603,682
                        
                        
                        $
                        581,781
                        
                        
                        $
                        557,186Total
      Equity
                        
                        $
                        62,029
                        
                        
                        $
                        63,975
                        
                        
                        $
                        61,990
                        
                        
                        $
                        56,802
                        
                        
                        $
                        51,901Weighted
      Average Shares of Common Stock outstanding used for Basic (Loss) Income
      Per Share Computation 1
                        
                        
                        8,931,906
                        
                        
                        
                        9,165,198
                        
                        
                        
                        9,300,785
                        
                        
                        
                        9,362,585
                        
                        
                        
                        9,416,114Weighted
      Average Shares of Common Stock outstanding used for Diluted (Loss) Income
      Per Share Computation 1
                        
                        
                        8,931,906
                        
                        
                        
                        9,438,217
                        
                        
                        
                        9,757,490
                        
                        
                        
                        9,748,112
                        
                        
                        
                        9,649,601(Loss)
      Return on Average Total Assets
                        
                        
                        (0.20
                        %)
                        
                        
                        1.05
                        %
                        
                        
                        1.32
                        %
                        
                        
                        1.35
                        %
                        
                        
                        1.14
                        %Net
      (Loss) Income/Average Equity
                        
                        
                        (2.17
                        %)
                        
                        
                        11.59
                        %
                        
                        
                        14.90
                        %
                        
                        
                        16.17
                        %
                        
                        
                        13.73
                        %Net
      (Loss) Income/Average Deposits
                        
                        
                        (0.23
                        %)
                        
                        
                        1.19
                        %
                        
                        
                        1.49
                        %
                        
                        
                        1.52
                        %
                        
                        
                        1.28
                        %Average
      Loans/Average Deposits
                        
                        
                        87.21
                        %
                        
                        
                        79.75
                        %
                        
                        
                        81.20
                        %
                        
                        
                        79.44
                        %
                        
                        
                        75.81
                        %Average
      Equity to Average Total Assets
                        
                        
                        9.39
                        %
                        
                        
                        9.06
                        %
                        
                        
                        8.87
                        %
                        
                        
                        8.37
                        %
                        
                        
                        8.32
                        %
 
 1.  All
      years have been restated to give retroactive effect for stock dividends
      issued and stock splits.
 
  26
  
 ITEM
7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
 
 This
report includes forward-looking statements, which include forecasts of our
financial results and condition, expectations for our operations and business,
and our assumptions for those forecasts and expectations.  Do not rely
unduly on forward-looking statements. Actual results might differ significantly
from our forecasts and expectations. Please refer to Part I, Item 1A “Risk
Factors” for a discussion of some factors that may cause results to
differ.
 
 Introduction
 
 This
overview of Management’s Discussion and Analysis highlights selected information
in this annual report and may not contain all of the information that is
important to you.  For a more complete understanding of trends,
events, commitments, uncertainties, liquidity, capital resources and critical
accounting estimates, you should carefully read this entire annual
report.
 
 Our
subsidiary, First Northern Bank of Dixon, is a California state-chartered bank
that derives most of its revenues from lending and deposit taking in the
Sacramento Valley region of Northern California.  Interest rates,
business conditions and customer confidence all affect our ability to generate
revenues.  In addition, the regulatory environment and competition can
challenge our ability to generate those revenues.
 
 Financial
highlights for 2008 include:
 
 The
Company reported a net loss of $1.37 million, a 118.9% decrease compared to net
income of $7.28 million for 2007.  Net loss per common share for 2008
of $0.15 resulted in a decrease of 119.0% compared to net income per common
share of $0.79 for 2007, and net loss per common share on a fully diluted basis
was $0.15 for 2008, a decrease of 119.5% compared to net income per common share
on a fully diluted basis of $0.77 for 2007.
 
 Loans
(including loans held-for-sale) increased to $519.2 million at December 31,
2008, a 4.0% increase from $499.3 million at December 31,
2007.  Commercial loans totaled $111.5 million at December 31,
2008, down 0.7% from $112.3 million a year earlier; agriculture loans were $38.3
million, up 4.2% from $36.8 million at December 31, 2007; real estate
construction loans were $67.2 million, down 26.9% from $91.9 million at
December 31, 2007; and real estate mortgage loans were $297.2 million, up
17.5% from $253.0 million a year earlier.
 
 Average
deposits decreased to $588.2 million during 2008, a $24.5 million or 4.0%
decrease from 2007.
 
 The
Company reported average total assets of $674.8 million at December 31,
2008, down 2.7% from $693.4 million a year earlier.
 
 The
provision for loan losses in 2008 totaled $16,164,000, an increase of 237.1%
from $4,795,000 in 2007.  Net charge-offs were $12,605,000 in 2008
compared to $2,280,000 in 2007.  The increase in the provision for
loan losses and increase in net charge-offs can be primarily attributed to
increased charge-offs combined with increased loan volume.
 
 Net
interest income totaled $32.5 million for 2008, a decrease of 11.8% from $36.9
million in 2007, primarily due to decreased loan rates and decreased Federal
Funds volume and rates, which was partially offset by decreased deposit rates
and increased loan volume.
 
 Other
operating income totaled $6.3 million for the year ended December 31, 2008,
a decrease of 11.8% from $7.2 million for the year ended December 31,
2007.  The decrease was due primarily to increases in write-downs of
other real estate owned properties, which was partially offset by increased
service charges on deposit accounts and investment and brokerage
income.
 
 Other
operating expenses totaled $27.7 million for 2008, down 4.0% from $28.8 million
in 2007.  Contributing to the decrease was decreased salaries and
employee benefits and advertising costs, which was partially offset by increased
data processing expenses.
 
 In 2009,
the Company intends to continue its long-term strategy of maintaining deposit
growth to fund growth in loans and other earning assets and intends to identify
opportunities for growing other operating income in areas such as Asset
Management and Trust and Investment and Brokerage Services, and deposit fee
income, while remaining conscious of the need to maintain appropriate expense
levels.
 
 
 27
   On March
13, 2009, the Company raised $17.39 million from the Treasury in a TARP
financing. See Part I “Business—Recent Events,” above for additional
information.
  Critical
Accounting Policies and Estimates
 
 The
Company’s discussion and analysis of its financial condition and results of
operations are based upon the Company’s consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States.  The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, income and expenses, and related disclosure of
contingent assets and liabilities.  On an on-going basis, the Company
evaluates its estimates, including those related to the allowance for loan
losses, other real estate owned, investments and income taxes.  The
Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other
sources.  Actual results may differ from these estimates under
different assumptions or conditions.
 
 The
Company’s most significant estimates are approved by its senior management
team.  At the end of each financial reporting period, a review of
these estimates is presented to the Company’s Board of Directors.
 
 The
Company believes the following critical accounting policy affects its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.  The Company believes the allowance for loan
losses accounting policy is critical because the loan portfolio represents the
largest asset type on the consolidated balance sheet.  The Company
maintains an allowance for loan losses resulting from the inability of borrowers
to make required loan payments. Loan losses are charged off against the
allowance, while recoveries of amounts previously charged off are credited to
the allowance.  A provision for loan losses is charged to operations
based on the Company’s periodic evaluation of the factors mentioned below, as
well as other pertinent factors.  The allowance for loan losses
consists of an allocated component and a general component.  The
components of the allowance for loan losses represent an estimation done
pursuant to either Statement of Financial Accounting Standards No. (“SFAS”) 5,
Accounting for Contingencies, or SFAS 114, Accounting by Creditors for
Impairment of a Loan.  The allocated component of the allowance for
loan losses reflects expected losses resulting from analyses developed through
specific credit allocations for individual loans and historical loss experience
for each loan category.  The specific credit allocations are based on
regular analyses of all loans where the internal credit rating is at or below a
predetermined classification.  These analyses involve a high degree of
judgment in estimating the amount of loss associated with specific loans,
including estimating the amount and timing of future cash flows and collateral
values.  The historical loan loss element is determined using analysis
that examines loss experience.
 
 The
allocated component of the allowance for loan losses also includes consideration
of concentrations and changes in portfolio mix and volume.  The
general portion of the allowance reflects the Company’s estimate of probable
inherent but undetected losses within the portfolio due to uncertainties in
economic conditions, delays in obtaining information, including unfavorable
information about a borrower’s financial condition, the difficulty in
identifying triggering events that correlate perfectly to subsequent loss rates,
and risk factors that have not yet manifested themselves in loss allocation
factors.  Uncertainty surrounding the strength and timing of economic
cycles also affects estimates of loss.  There are many factors
affecting the allowance for loan losses; some are quantitative while others
require qualitative judgment.  Although the Company believes its
process for determining the allowance adequately considers all of the potential
factors that could potentially result in credit losses, the process includes
subjective elements and may be susceptible to significant change.  To
the extent actual outcomes differ from Company estimates, additional provision
for credit losses could be required that could adversely affect earnings or
financial position in future periods.
 
 Other-than-temporary
Impairment in Investment Securities
 
 At each
financial statement date, we assess whether declines in the fair value of
held-to-maturity and available for-sale securities below their costs are deemed
to be other than temporary. We consider, among other things, (i) the length of
time and the extent to which the fair value has been less than cost, (ii) the
financial condition and near-term prospects of the issuer, and (iii) our intent
and ability to retain the investment for a period of time sufficient to allow
for any anticipated recovery in fair value.
  
 28
   Evidence evaluated includes, but is not
limited to, the remaining payment terms of the instrument and economic factors
that are relevant to the collectability of the instrument, such as current
prepayment speeds, the current financial condition of the issuer(s), industry
analyst reports, credit ratings, credit default rates, interest rate trends and
the value of any underlying collateral. Other than-temporary-impairment results
in a charge to earnings and the corresponding establishment of a new costbasis for the
security.
 
 Share-Based
Payment
 
 On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 123R, “Share-Based Payments,” which requires that all share-based
payments, including stock options and non-vested restricted common shares, be
recognized as an expense in the income statement based on the grant-date fair
value of the award with a corresponding increase to common stock.
 
 We
determine the fair value of stock options at grant date using the Black-Scholes
pricing model that takes into account the stock price at the grant date, the
exercise price, the expected dividend yield, stock price volatility and the
risk-free interest rate over the expected life of the option.  The
Black-Scholes model requires the input of highly subjective assumptions
including the expected life of the stock-based award and stock price volatility.
The estimates used in the model involve inherent uncertainties and the
application of Management's judgment.  As a result, if other
assumptions had been used, our recorded stock-based compensation expense could
have been materially different from that reflected in these financial
statements.  The fair value of non-vested restricted common shares
generally equals the stock price at grant date. In addition, we are required to
estimate the expected forfeiture rate and only recognize expense for those
share-based awards expected to vest.  If our actual forfeiture rate is
materially different from the estimate, the share-based compensation expense
could be materially different.  For additional discussion of SFAS
No.123R, see Note 13 to the Consolidated Financial Statements in this Form
10-K.
 
 Accounting
for Income Taxes
 
 Income
taxes reported in the financial statements are computed based on an asset and
liability approach in accordance with FASB Statement No. 109, Accounting for
Income Taxes CSFAS No. 109J. We recognize the amount of taxes payable or
refundable for the current year, and deferred tax assets and liabilities for the
expected future tax consequences that have been recognized in the financial
statements.  Under this method, deferred tax assets and liabilities
are determined based on the differences between the financial statements and tax
basis of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse.  We record net
deferred tax assets to the extent it is more likely than not that they will be
realized.  In evaluating our ability to recover the deferred tax
assets, Management considers all available positive and negative evidence,
including scheduled reversals of deferred tax liabilities, projected future
taxable income, tax planning strategies and recent financial
operations.  In projecting future taxable income, Management develops
assumptions including the amount of future state and federal pretax operating
income, the reversal of temporary differences, and the implementation of
feasible and prudent tax planning strategies.  These assumptions
require significant judgment about the forecasts of future taxable income and
are consistent with the plans and estimates being used to manage the underlying
business. The Company files consolidated federal and combined state income tax
returns.
 
 The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes,” on January 1, 2007, which clarifies the accounting
for uncertainty in income taxes recognized in an enterprise's financial
statements in accordance with FASB No. 109.
 
 FIN 48
establishes a "more-likely-than-not" recognition threshold that must be met
before a tax benefit can be recognized in the financial statements. For tax
positions that meet the more-likely-than-not threshold, an enterprise may
recognize only the largest amount of tax benefit that is greater than fifty
percent likely of being realized upon ultimate settlement with the taxing
authority. As a result of the implementation of FIN 48, the Company recognized
an increase for unrecognized tax benefits. To the extent tax authorities
disagree with these tax positions, our effective tax rates could be materially
affected in the period of settlement with the taxing authorities. For additional
discussion of FIN 48, see Note 9 to the Consolidated Financial Statements
in this Form 10-K.
  29
  
 Prospective
Accounting Pronouncements
 
 In
December 2007, the FASB issued SFAS No. 141R, Business Combinations, which
requires most identifiable assets, liabilities, non-controlling interests, and
goodwill acquired in a business combination to be recorded at “full fair value”
at the acquisition date.  SFAS No. 141R applies to all business
combinations, including combinations among mutual entities and combinations by
contract alone. Under SFAS No. 141R, all business combinations will be accounted
for by applying the acquisition method.  SFAS No. 141R is effective
for periods beginning on or after December 15, 2008. Earlier application is
prohibited.  SFAS No. 141R will be applied to business combinations
occurring after the effective date.  The Company currently does not
have any business combination contemplated that are expected to be closed after
the effective date; therefore, the adoption of SFAS No. 141R will not have an
impact, if any, on the consolidated financial statements or results of
operations of the Company.
 
 In
December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB No. 110”),
Certain Assumptions Used in
Valuation Methods, which extends the use of the “simplified” method,
under certain circumstances, in developing an estimate of expected term of
“plain vanilla” share options in accordance with SFAS No. 123R. Prior to SAB No.
110, SAB No. 107 stated that the simplified method was only available for grants
made up to December 31, 2007.  The Company currently plans to continue
to use the simplified method in developing an estimate of expected term of stock
options.
 
 In June,
2008, the FASB issued FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating Securities,
(“FSP EITF 03-6-1”). The Staff Position provides that unvested share-based
payment awards that contain non-forfeitable rights to dividends or dividend
equivalents are participating securities and must be included in the earnings
per share computation. FSP EITF 03-6-1 is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those years. All prior-period earnings per share data presented must be
adjusted retrospectively. Early application is not permitted. The adoption of
the Staff Position will have no material effect on the Company’s financial
position, results of operations or cash flows.
 
 The FASB
has issued FASB Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principals (SFAS 162).  SFAS 162 is intended to
improve financial statements that are presented in conformity with U.S.
generally accepted accounting principals for nongovernmental
entities.  SFAS 162 is effective 60 days following the SEC’s approval
of the PCAOB amendments to AU Section 411, The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting
Principals.  Management does not believe the adoption of SFAS
162 will have a material impact on the Company’s financial
statements.
 
 In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities (“SFAS 161”). SFAS 161 requires
enhanced disclosures about an entity’s derivative and hedging activities and
thereby improving the transparency of financial reporting. It is intended to
enhance the current disclosure framework in SFAS 133 by requiring that
objectives for using derivative instruments be disclosed in terms of underlying
risk and accounting designation. This disclosure better conveys the purpose of
derivative use in terms of the risks that the entity is intending to manage.
SFAS 161 was effective for the Company on January 1, 2009 and will result in
additional disclosures if the Company enters into any material derivative or
hedging activities.
 
 
 30
 
  STATISTICAL
INFORMATION AND DISCUSSION
 
 The
following statistical information and discussion should be read in conjunction
with the Selected Financial Data included in Part II  (Item 6) and the
audited consolidated financial statements and accompanying notes included in
Part II (Item 8) of this Annual Report on Form 10-K.
 
 The
following tables present information regarding the consolidated average assets,
liabilities and stockholders’ equity, the amounts of interest income from
average earning assets and the resulting yields, and the amount of interest
expense paid on interest-bearing liabilities.  Average loan balances
include non-performing loans.  Interest income includes proceeds from
loans on non-accrual status only to the extent cash payments have been received
and applied as interest income.  Tax-exempt income is not shown on a
tax equivalent basis.
 
 Distribution
of Assets, Liabilities and Stockholders' Equity;
 Interest
Rates and Interest Differential
 (Dollars
in thousands)
 
 2008
                          
                          
                          2007
                          
                          
                          2006Average
                          
                          
                          
                          
                          
                          Average
                          
                          
                          
                          
                          
                          AverageBalance
                          
                          
                          Percent
                          
                          
                          Balance
                          
                          
                          Percent
                          
                          
                          Balance
                          
                          
                          PercentASSETSCash
      and Due From Banks
                          
                          $
                          37,971
                          
                          
                          
                          5.63
                          %
                          
                          $
                          32,518
                          
                          
                          
                          4.69
                          %
                          
                          $
                          29,934
                          
                          
                          
                          4.49
                          %Federal
      Funds Sold
                          
                          
                          26,808
                          
                          
                          
                          3.97
                          %
                          
                          
                          52,359
                          
                          
                          
                          7.55
                          %
                          
                          
                          61,904
                          
                          
                          
                          9.29
                          %Investment
      Securities
                          
                          
                          57,123
                          
                          
                          
                          8.46
                          %
                          
                          
                          86,046
                          
                          
                          
                          12.41
                          %
                          
                          
                          64,770
                          
                          
                          
                          9.72
                          %Loans  1
                          
                          
                          512,987
                          
                          
                          
                          76.02
                          %
                          
                          
                          488,704
                          
                          
                          
                          70.48
                          %
                          
                          
                          478,908
                          
                          
                          
                          71.88
                          %Stock
      in Federal Home Loan Bank andother
      equity securities, at cost
                          
                          
                          2,253
                          
                          
                          
                          0.33
                          %
                          
                          
                          2,146
                          
                          
                          
                          0.31
                          %
                          
                          
                          2,087
                          
                          
                          
                          0.31
                          %Other
      Real Estate Owned
                          
                          
                          3,691
                          
                          
                          
                          0.55
                          %
                          
                          
                          784
                          
                          
                          
                          0.11
                          %
                          
                          
                          78
                          
                          
                          
                          0.01
                          %Other
      Assets
                          
                          
                          33,993
                          
                          
                          
                          5.04
                          %
                          
                          
                          30,882
                          
                          
                          
                          4.45
                          %
                          
                          
                          28,672
                          
                          
                          
                          4.30
                          %Total
      Assets
                          
                          $
                          674,826
                          
                          
                          
                          100.00
                          %
                          
                          $
                          693,439
                          
                          
                          
                          100.00
                          %
                          
                          $
                          666,353
                          
                          
                          
                          100.00
                          %LIABILITIES &STOCKHOLDERS' EQUITYDeposits:Demand
                          
                          $
                          173,332
                          
                          
                          
                          25.69
                          %
                          
                          $
                          185,563
                          
                          
                          
                          26.77
                          %
                          
                          $
                          187,766
                          
                          
                          
                          28.18
                          %Interest-Bearing
      Transaction Deposits
                          
                          
                          128,690
                          
                          
                          
                          19.07
                          %
                          
                          
                          130,608
                          
                          
                          
                          18.83
                          %
                          
                          
                          95,180
                          
                          
                          
                          14.28
                          %Savings
      & MMDAs
                          
                          
                          171,465
                          
                          
                          
                          25.41
                          %
                          
                          
                          179,425
                          
                          
                          
                          25.87
                          %
                          
                          
                          190,036
                          
                          
                          
                          28.52
                          %Time
      Certificates
                          
                          
                          114,742
                          
                          
                          
                          17.00
                          %
                          
                          
                          117,178
                          
                          
                          
                          16.90
                          %
                          
                          
                          116,787
                          
                          
                          
                          17.53
                          %Borrowed
      Funds
                          
                          
                          17,095
                          
                          
                          
                          2.53
                          %
                          
                          
                          10,504
                          
                          
                          
                          1.51
                          %
                          
                          
                          11,350
                          
                          
                          
                          1.70
                          %Other
      Liabilities
                          
                          
                          6,147
                          
                          
                          
                          0.91
                          %
                          
                          
                          7,347
                          
                          
                          
                          1.06
                          %
                          
                          
                          6,113
                          
                          
                          
                          0.92
                          %Stockholders'
      Equity
                          
                          
                          63,355
                          
                          
                          
                          9.39
                          %
                          
                          
                          62,814
                          
                          
                          
                          9.06
                          %
                          
                          
                          59,121
                          
                          
                          
                          8.87
                          %Total
      Liabilities & Stockholders’ Equity
                          
                          $
                          674,826
                          
                          
                          
                          100.00
                          %
                          
                          $
                          693,439
                          
                          
                          
                          100.00
                          %
                          
                          $
                          666,353
                          
                          
                          
                          100.00
                          %1. Average
      balances for loans include loans held-for-sale and non-accrual loans and
      are net of the allowance for loan losses.
 
  31
  Net Interest EarningsAverage Balances, Yields and
      Rates(Dollars
      in thousands)
 
 2008
                                                                                              
                                                                                              
                                                                                              2007
                                                                                              
                                                                                              
                                                                                              2006Yields
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              Yields
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              YieldsInterest
                                                                                              
                                                                                              
                                                                                              Earned/
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              Interest
                                                                                              
                                                                                              
                                                                                              Earned/
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              Interest
                                                                                              
                                                                                              
                                                                                              Earned/Average
                                                                                              
                                                                                              
                                                                                              Income/
                                                                                              
                                                                                              
                                                                                              Rates
                                                                                              
                                                                                              
                                                                                              Average
                                                                                              
                                                                                              
                                                                                              Income/
                                                                                              
                                                                                              
                                                                                              Rates
                                                                                              
                                                                                              
                                                                                              Average
                                                                                              
                                                                                              
                                                                                              Income/
                                                                                              
                                                                                              
                                                                                              RatesAssets
                                                                                              
                                                                                              Balance
                                                                                              
                                                                                              
                                                                                              Expense
                                                                                              
                                                                                              
                                                                                              Paid
                                                                                              
                                                                                              
                                                                                              Balance
                                                                                              
                                                                                              
                                                                                              Expense
                                                                                              
                                                                                              
                                                                                              Paid
                                                                                              
                                                                                              
                                                                                              Balance
                                                                                              
                                                                                              
                                                                                              Expense
                                                                                              
                                                                                              
                                                                                              PaidLoans
      1
                                                                                              
                                                                                              $
                                                                                              512,987
                                                                                              
                                                                                              
                                                                                              $
                                                                                              33,282
                                                                                              
                                                                                              
                                                                                              
                                                                                              6.49
                                                                                              %
                                                                                              
                                                                                              $
                                                                                              488,704
                                                                                              
                                                                                              
                                                                                              $
                                                                                              39,220
                                                                                              
                                                                                              
                                                                                              
                                                                                              8.03
                                                                                              %
                                                                                              
                                                                                              $
                                                                                              478,908
                                                                                              
                                                                                              
                                                                                              $
                                                                                              39,082
                                                                                              
                                                                                              
                                                                                              
                                                                                              8.16
                                                                                              %Loan
      Fees
                                                                                              
                                                                                              
                                                                                              —
                                                                                              
                                                                                              
                                                                                              
                                                                                              1,795
                                                                                              
                                                                                              
                                                                                              
                                                                                              0.35
                                                                                              %
                                                                                              
                                                                                              
                                                                                              —
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,268
                                                                                              
                                                                                              
                                                                                              
                                                                                              0.46
                                                                                              %
                                                                                              
                                                                                              
                                                                                              —
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,812
                                                                                              
                                                                                              
                                                                                              
                                                                                              0.59
                                                                                              %Total
      Loans, IncludingLoan
      Fees
                                                                                              
                                                                                              
                                                                                              512,987
                                                                                              
                                                                                              
                                                                                              
                                                                                              35,077
                                                                                              
                                                                                              
                                                                                              
                                                                                              6.84
                                                                                              %
                                                                                              
                                                                                              
                                                                                              488,704
                                                                                              
                                                                                              
                                                                                              
                                                                                              41,488
                                                                                              
                                                                                              
                                                                                              
                                                                                              8.49
                                                                                              %
                                                                                              
                                                                                              
                                                                                              478,908
                                                                                              
                                                                                              
                                                                                              
                                                                                              41,894
                                                                                              
                                                                                              
                                                                                              
                                                                                              8.75
                                                                                              %Federal
      Funds Sold
                                                                                              
                                                                                              
                                                                                              26,808
                                                                                              
                                                                                              
                                                                                              
                                                                                              519
                                                                                              
                                                                                              
                                                                                              
                                                                                              1.94
                                                                                              %
                                                                                              
                                                                                              
                                                                                              52,359
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,660
                                                                                              
                                                                                              
                                                                                              
                                                                                              5.08
                                                                                              %
                                                                                              
                                                                                              
                                                                                              61,904
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,986
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.82
                                                                                              %Due
      From Banks
                                                                                              
                                                                                              
                                                                                              13,428
                                                                                              
                                                                                              
                                                                                              
                                                                                              557
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.15
                                                                                              %
                                                                                              
                                                                                              
                                                                                              5,922
                                                                                              
                                                                                              
                                                                                              
                                                                                              273
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.61
                                                                                              %
                                                                                              
                                                                                              
                                                                                              —
                                                                                              
                                                                                              
                                                                                              
                                                                                              —
                                                                                              
                                                                                              
                                                                                              
                                                                                              —Investment
      Securities:Taxable
                                                                                              
                                                                                              
                                                                                              27,578
                                                                                              
                                                                                              
                                                                                              
                                                                                              1,344
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.87
                                                                                              %
                                                                                              
                                                                                              
                                                                                              56,350
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,789
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.95
                                                                                              %
                                                                                              
                                                                                              
                                                                                              50,958
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,448
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.80
                                                                                              %Non-taxable2
                                                                                              
                                                                                              
                                                                                              29,545
                                                                                              
                                                                                              
                                                                                              
                                                                                              1,254
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.24
                                                                                              %
                                                                                              
                                                                                              
                                                                                              29,696
                                                                                              
                                                                                              
                                                                                              
                                                                                              1,271
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.28
                                                                                              %
                                                                                              
                                                                                              
                                                                                              13,812
                                                                                              
                                                                                              
                                                                                              
                                                                                              636
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.60
                                                                                              %Total
      Investment Securities
                                                                                              
                                                                                              
                                                                                              57,123
                                                                                              
                                                                                              
                                                                                              
                                                                                              2,598
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.55
                                                                                              %
                                                                                              
                                                                                              
                                                                                              86,046
                                                                                              
                                                                                              
                                                                                              
                                                                                              4,060
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.72
                                                                                              %
                                                                                              
                                                                                              
                                                                                              64,770
                                                                                              
                                                                                              
                                                                                              
                                                                                              3,084
                                                                                              
                                                                                              
                                                                                              
                                                                                              4.76
                                                                                              %Other
      Earning Assets
                                                                                              
                                                                                              
                                                                                              2,253
                                                                                              
                                                                                              
                                                                                              
                                                                                              120
                                                                                              
                                                                                              
                                                                                              
                                                                                              5.33
                                                                                              %
                                                                                              
                                                                                              
                                                                                              2,146
                                                                                              
                                                                                              
                                                                                              
                                                                                              113
                                                                                              
                                                                                              
                                                                                              
                                                                                              5.27
                                                                                              %
                                                                                              
                                                                                              
                                                                                              2,087
                                                                                              
                                                                                              
                                                                                              
                                                                                              106
                                                                                              
                                                                                              
                                                                                              
                                                                                              5.08
                                                                                              %Total
      Earning Assets
                                                                                              
                                                                                              
                                                                                              612,599
                                                                                              
                                                                                              
                                                                                              $
                                                                                              38,871
                                                                                              
                                                                                              
                                                                                              
                                                                                              6.35
                                                                                              %
                                                                                              
                                                                                              
                                                                                              635,177
                                                                                              
                                                                                              
                                                                                              $
                                                                                              48,594
                                                                                              
                                                                                              
                                                                                              
                                                                                              7.65
                                                                                              %
                                                                                              
                                                                                              
                                                                                              607,669
                                                                                              
                                                                                              
                                                                                              $
                                                                                              48,070
                                                                                              
                                                                                              
                                                                                              
                                                                                              7.91
                                                                                              %Cash
      and Due from Banks
                                                                                              
                                                                                              
                                                                                              24,543
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              26,596
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              29,934Premises
      and Equipment
                                                                                              
                                                                                              
                                                                                              8,355
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              8,123
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              8,188Other
      Real Estate Owned
                                                                                              
                                                                                              
                                                                                              3,691
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              784
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              78Interest
      Receivableand
      Other Assets
                                                                                              
                                                                                              
                                                                                              25,638
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              22,759
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              20,484Total
      Assets
                                                                                              
                                                                                              $
                                                                                              674,826
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              $
                                                                                              693,439
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              
                                                                                              $
                                                                                              666,353
 
 1.  Average
      balances for loans include loans held-for-sale and non-accrual loans and
      are net of the allowance for loan losses, but
      non-accrued interest  thereon is
  excluded.2.  Interest
      income and yields on tax-exempt securities are not presented on a tax
      equivalent basis.
 
  32
 Continuation
of
 Net Interest
Earnings
 Average Balances, Yields and
Rates
 (Dollars
in thousands)
 
 2008
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2007
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2006Yields
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Yields
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                YieldsInterest
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Earned/
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Interest
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Earned/
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Interest
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Earned/Liabilities
      and
                                                                                                                                                                                
                                                                                                                                                                                Average
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Income/
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Rates
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Average
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Income/
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Rates
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Average
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Income/
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                RatesStockholders'
      Equity
                                                                                                                                                                                
                                                                                                                                                                                Balance
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Expense
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Paid
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Balance
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Expense
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Paid
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Balance
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                Expense
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                PaidInterest-Bearing
      Deposits:Interest-BearingTransaction
      Deposits
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                128,690
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                930
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                0.72
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                130,608
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                2,840
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.17
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                95,180
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                1,568
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.65
                                                                                                                                                                                %Savings
      & MMDAs
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                171,465
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1,726
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.01
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                179,425
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                4,034
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.25
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                190,036
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3,813
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.01
                                                                                                                                                                                %Time
      Certificates
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                114,742
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3,147
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.74
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                117,178
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                4,551
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3.88
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                116,787
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3,682
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3.15
                                                                                                                                                                                %Total
      Interest-Bearing Deposits
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                414,897
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                5,803
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.40
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                427,211
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                11,425
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.67
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                402,003
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                9,063
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.25
                                                                                                                                                                                %Borrowed
      Funds
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                17,095
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                572
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3.35
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                10,504
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                313
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.98
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                11,350
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                363
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                3.20
                                                                                                                                                                                %Total
      Interest-BearingDeposits
      and Funds
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                431,992
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                6,375
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.48
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                437,715
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                11,738
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.68
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                413,353
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                9,426
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                2.28
                                                                                                                                                                                %Demand
      Deposits
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                173,332
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                —
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                —
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                185,563
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                —
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                —
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                187,766
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                —
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                —Total
      Deposits andBorrowed
      Funds
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                605,324
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                6,375
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.05
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                623,278
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                11,738
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.88
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                601,119
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                9,426
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                1.57
                                                                                                                                                                                %Accrued
      Interest andOther
      Liabilities
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                6,147
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                7,347
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                6,113Stockholders'
      Equity
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                63,355
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                62,814
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                59,121Total
      Liabilities andStockholders'
      Equity
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                674,826
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                693,439
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                666,353Net
      Interest Income andNet
      Interest Margin 1
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                32,496
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                5.30
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                36,856
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                5.80
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                $
                                                                                                                                                                                38,644
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                6.36
                                                                                                                                                                                %Net
      Interest Spread 2
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                4.87
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                4.97
                                                                                                                                                                                %
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                
                                                                                                                                                                                5.63
                                                                                                                                                                                %
 
 1.  Net
interest margin is computed by dividing net interest income by total average
interest-earning assets.
 
 2.  Net
interest spread represents the average yield earned on interest-earning assets
less the average rate paid on interest-bearing liabilities.
  33
 
 Analysis of
Changes
 in Interest Income and
Interest Expense
 (Dollars
in thousands)
 
 Following
is an analysis of changes in interest income and expense (dollars in thousands)
for 2008 over 2007 and 2007 over 2006.  Changes not solely due to
interest rate or volume have been allocated proportionately to interest rate and
volume.
 
 2008
      Over 2007
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    2007
      Over 2006Interest
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    InterestVolume
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    Rate
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    Change
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    Volume
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    Rate
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    Change(Decrease)
      Increase inInterest
      Income:Loans
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    2,077
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (8,015
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (5,938
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    626
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (488
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    138Loan
      Fees
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (473
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    —
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (473
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (544
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    —
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (544
                                                                                                                                    )Federal
      Funds Sold
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (945
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (1,196
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (2,141
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (502
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    176
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (326
                                                                                                                                    )Due
      From Banks
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    308
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (24
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    284
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    273
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    —
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    273Investment
      Securities
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (1,321
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (141
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (4,162
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    1,002
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (26
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    976Other
      Assets
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    6
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    1
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    7
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    3
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    4
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    7$
                                                                                                                                    (348
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (9,375
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (9,723
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    858
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (334
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    524(Decrease)
      Increase inInterest
      Expense:Deposits:Interest-BearingTransaction
      Deposits
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (41
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (1,869
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (1,910
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    689
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    583
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    1,272Savings
      & MMDAs
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (172
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (2,136
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (2,308
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (194
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    415
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    221Time
      Certificates
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (93
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (1,311
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (1,404
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    12
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    857
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    869Borrowed
      Funds
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    216
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    43
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    259
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (26
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (24
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    (50
                                                                                                                                    )$
                                                                                                                                    (90
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (5,273
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (5,363
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    481
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    1,831
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    2,312(Decrease)
      Increase inNet
      Interest Income
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (258
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (4,102
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (4,360
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    377
                                                                                                                                    
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (2,165
                                                                                                                                    )
                                                                                                                                    
                                                                                                                                    $
                                                                                                                                    (1,788
                                                                                                                                    )
 
 
  34
 
  INVESTMENT
PORTFOLIO
 
 Composition
of Investment Securities
 
 The mix
of investment securities held by the Company at December 31, for the previous
three fiscal years is as follows (dollars in thousands):
 
 2008
                        
                        
                        2007
                        
                        
                        2006Investment
      securities available for sale:U.S.
      Treasury Securities
                        
                        $
                        274
                        
                        
                        $
                        263
                        
                        
                        $
                        253Securities
      of U.S. GovernmentAgencies
      and Corporations
                        
                        
                        2,039
                        
                        
                        
                        20,139
                        
                        
                        
                        31,703Obligations
      of State &Political
      Subdivisions
                        
                        
                        26,231
                        
                        
                        
                        37,057
                        
                        
                        
                        30,193Mortgage
      Backed Securities
                        
                        
                        13,562
                        
                        
                        
                        17,390
                        
                        
                        
                        12,031Total
      Investments
                        
                        $
                        42,106
                        
                        
                        $
                        74,849
                        
                        
                        $
                        74,180
 
 Maturities
of Investment Securities
 
 The
following table is a summary of the relative maturities (dollars in thousands)
and yields of the Company’s investment securities as of December 31,
2008.  The yields on tax-exempt securities are shown on a tax
equivalent basis.
 Period to
Maturity
 
 Within
      One Year
                                                                    
                                                                    
                                                                    After
      One But
                                                                      Within
      Five Years
                                                                    
                                                                    
                                                                    After
      Five But
                                                                      Within
      Ten YearsSecurity
                                                                    
                                                                    Amount
                                                                    
                                                                    
                                                                    Yield
                                                                    
                                                                    
                                                                    Amount
                                                                    
                                                                    
                                                                    Yield
                                                                    
                                                                    
                                                                    Amount
                                                                    
                                                                    
                                                                    YieldU.S.
      Treasury Securities
                                                                    
                                                                    $
                                                                    —
                                                                    
                                                                    
                                                                    
                                                                    —
                                                                    
                                                                    
                                                                    $
                                                                    274
                                                                    
                                                                    
                                                                    
                                                                    5.00
                                                                    %
                                                                    
                                                                    $
                                                                    —
                                                                    
                                                                    
                                                                    
                                                                    —Securities
      of U.S. GovernmentAgencies
      and Corporations
                                                                    
                                                                    
                                                                    1,001
                                                                    
                                                                    
                                                                    
                                                                    3.82
                                                                    %
                                                                    
                                                                    
                                                                    1,038
                                                                    
                                                                    
                                                                    
                                                                    3.75
                                                                    %
                                                                    
                                                                    
                                                                    —
                                                                    
                                                                    
                                                                    
                                                                    —Obligations
      of State &Political
      Subdivisions
                                                                    
                                                                    
                                                                    2,190
                                                                    
                                                                    
                                                                    
                                                                    7.59
                                                                    %
                                                                    
                                                                    
                                                                    4,349
                                                                    
                                                                    
                                                                    
                                                                    7.35
                                                                    %
                                                                    
                                                                    
                                                                    6,525
                                                                    
                                                                    
                                                                    
                                                                    6.71
                                                                    %Mortgage
      Backed Securities
                                                                    
                                                                    
                                                                    6
                                                                    
                                                                    
                                                                    
                                                                    6.63
                                                                    %
                                                                    
                                                                    
                                                                    13,556
                                                                    
                                                                    
                                                                    
                                                                    4.62
                                                                    %
                                                                    
                                                                    
                                                                    —
                                                                    
                                                                    
                                                                    
                                                                    —TOTAL
                                                                    
                                                                    $
                                                                    3,197
                                                                    
                                                                    
                                                                    
                                                                    6.41
                                                                    %
                                                                    
                                                                    $
                                                                    19,217
                                                                    
                                                                    
                                                                    
                                                                    5.20
                                                                    %
                                                                    
                                                                    $
                                                                    6,525
                                                                    
                                                                    
                                                                    
                                                                    6.71
                                                                    %
 
  After
      Ten Years
                                        
                                        
                                        TotalSecurity
                                        
                                        Amount
                                        
                                        
                                        Yield
                                        
                                        
                                        Amount
                                        
                                        
                                        YieldU.S.
      Treasury Securities
                                        
                                        $
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        $
                                        274
                                        
                                        
                                        
                                        5.00
                                        %Securities
      of U.S. GovernmentAgencies  and
      Corporations
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        2,039
                                        
                                        
                                        
                                        3.78
                                        %Obligations
      of State &Political
      Subdivisions
                                        
                                        
                                        13,167
                                        
                                        
                                        
                                        6.49
                                        %
                                        
                                        
                                        26,231
                                        
                                        
                                        
                                        6.78
                                        %Mortgage
      Backed Securities
                                        
                                        
                                        —
                                        
                                        
                                        
                                        —
                                        
                                        
                                        
                                        13,562
                                        
                                        
                                        
                                        4.62
                                        %TOTAL
                                        
                                        $
                                        13,167
                                        
                                        
                                        
                                        6.49
                                        %
                                        
                                        $
                                        42,106
                                        
                                        
                                        
                                        5.93
                                        %
 
  35
  
 LOAN
PORTFOLIO
 
 Composition of
Loans
 
 The mix
of loans, net of deferred origination fees and costs and allowance for loan
losses and excluding loans held-for-sale, at December 31, for the previous five
fiscal years is as follows (dollars in thousands):
 
 December
      31,2008
                
                
                2007
                
                
                2006Balance
                
                
                Percent
                
                
                Balance
                
                
                Percent
                
                
                Balance
                
                
                PercentCommercial
                
                $
                111,485
                
                
                
                21.6
                %
                
                $
                112,295
                
                
                
                22.6
                %
                
                $
                97,268
                
                
                
                20.5
                %Agriculture
                
                
                38,314
                
                
                
                7.4
                %
                
                
                36,772
                
                
                
                7.4
                %
                
                
                38,607
                
                
                
                8.1
                %Real
      Estate Mortgage
                
                
                294,980
                
                
                
                57.0
                %
                
                
                251,672
                
                
                
                50.5
                %
                
                
                227,552
                
                
                
                47.9
                %Real
      Estate Construction
                
                
                67,225
                
                
                
                13.0
                %
                
                
                91,901
                
                
                
                18.4
                %
                
                
                106,752
                
                
                
                22.4
                %Installment
                
                
                4,964
                
                
                
                1.0
                %
                
                
                5,331
                
                
                
                1.1
                %
                
                
                5,370
                
                
                
                1.1
                %TOTAL
                
                $
                516,968
                
                
                
                100.0
                %
                
                $
                497,971
                
                
                
                100.0
                %
                
                $
                475,549
                
                
                
                100.0
                %
 
 2005
                  
                  
                  2004Balance
                  
                  
                  Percent
                  
                  
                  Balance
                  
                  
                  PercentCommercial
                  
                  $
                  87,091
                  
                  
                  
                  19.1
                  %
                  
                  $
                  89,721
                  
                  
                  
                  20.9
                  %Agriculture
                  
                  
                  32,808
                  
                  
                  
                  7.2
                  %
                  
                  
                  32,910
                  
                  
                  
                  7.7
                  %Real
      Estate Mortgage
                  
                  
                  228,524
                  
                  
                  
                  50.1
                  %
                  
                  
                  216,846
                  
                  
                  
                  50.4
                  %Real
      Estate Construction
                  
                  
                  103,422
                  
                  
                  
                  22.7
                  %
                  
                  
                  85,584
                  
                  
                  
                  19.9
                  %Installment
                  
                  
                  4,216
                  
                  
                  
                  0.9
                  %
                  
                  
                  4,641
                  
                  
                  
                  1.1
                  %TOTAL
                  
                  $
                  456,061
                  
                  
                  
                  100.0
                  %
                  
                  $
                  429,702
                  
                  
                  
                  100.0
                  %
 
 Commercial
loans are primarily for financing the needs of a diverse group of businesses
located in the Bank’s market area.  The Bank also makes loans to
individuals for investment purposes.  Most of these loans are
relatively short-term (an overall average life of approximately two years) and
secured by various types of collateral.  Real estate construction
loans are generally for financing the construction of single-family residential
homes for well-qualified individuals and builders.  These loans are
secured by real estate and have short maturities.
 
 As shown
in the comparative figures for loan mix during 2008 and 2007, total loans
increased as a result of increases in agriculture loans and real estate mortgage
loans, which were partially offset by decreases in commercial loans, real estate
construction loans and installment loans.
 
 
 
 36
 
  Maturities and Sensitivities
of Loans to Changes in Interest Rates
 
 Loan
maturities of the loan portfolio at December 31,2008 are as follows
(dollars in
thousands)
(excludes loans held-for-sale):
 
 Maturing
                                      
                                      Fixed
      Rate
                                      
                                      
                                      Variable
      Rate
                                      
                                      
                                      TotalWithin
      one year
                                      
                                      $
                                      41,960
                                      
                                      
                                      $
                                      144,002
                                      
                                      
                                      $
                                      185,962After
      one year through five years
                                      
                                      
                                      60,205
                                      
                                      
                                      
                                      115,996
                                      
                                      
                                      
                                      176,201After
      five years
                                      
                                      
                                      30,263
                                      
                                      
                                      
                                      124,542
                                      
                                      
                                      
                                      154,805Total
                                      
                                      $
                                      132,428
                                      
                                      
                                      $
                                      384,540
                                      
                                      
                                      $
                                      516,968
 
 
 Non-accrual, Past Due, OREO
and Restructured Loans
 
 It is the
Bank’s policy to recognize interest income on an accrual
basis.  Accrual of interest is suspended when a loan has been in
default as to principal or interest for 90 days, unless well secured by
collateral believed by management to have a fair market value that at least
equals the book value of the loan plus accrued interest receivable and in the
process of collection.  Real estate acquired through foreclosure is
written down to its estimated fair market value at the time of acquisition and
is carried as a non-earning asset until sold.  Any write-down at the
time of acquisition is charged against the allowance for loan losses; subsequent
write-downs or gains or losses upon disposition are credited or charged to
non-interest income/expense.  The Bank has made no foreign
loans.
 
 The
following table shows the aggregate amounts of assets (dollars in thousands) in
each category at December 31, for the years indicated:
 
 2008
                                                
                                                
                                                2007
                                                
                                                
                                                2006
                                                
                                                
                                                2005
                                                
                                                
                                                2004Non-accrual
      Loans
                                                
                                                $
                                                13,545
                                                
                                                
                                                $
                                                15,173
                                                
                                                
                                                $
                                                3,399
                                                
                                                
                                                $
                                                2,073
                                                
                                                
                                                $
                                                4,90790
      Days Past Due But Still Accruing
                                                
                                                
                                                713
                                                
                                                
                                                
                                                263
                                                
                                                
                                                
                                                37
                                                
                                                
                                                
                                                178
                                                
                                                
                                                
                                                55Total
      Non-performing Loans
                                                
                                                
                                                14,258
                                                
                                                
                                                
                                                15,436
                                                
                                                
                                                
                                                3,436
                                                
                                                
                                                
                                                2,251
                                                
                                                
                                                
                                                4,962Other
      Real Estate Owned
                                                
                                                
                                                4,368
                                                
                                                
                                                
                                                879
                                                
                                                
                                                
                                                375
                                                
                                                
                                                
                                                268
                                                
                                                
                                                
                                                —Total
      Non-performing Assets
                                                
                                                $
                                                18,626
                                                
                                                
                                                $
                                                16,315
                                                
                                                
                                                $
                                                3,811
                                                
                                                
                                                $
                                                2,519
                                                
                                                
                                                $
                                                4,962Performing
      Restructured Loans
                                                
                                                $
                                                2,682
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                —
                                                
                                                
                                                $
                                                —
 
 If
interest on non-accrual loans had been accrued, such interest income would have
approximated $1,501,000, $814,000, and $280,000 during the years ended December
31, 2008, 2007 and 2006, respectively.  Income actually recognized for
these loans approximated $181,000, $73,000 and $113,000 for the years ended
December 31, 2008, 2007 and 2006, respectively.
 
 There was
a $2,311,000 increase in non-performing assets for 2008 over 2007.  At
December 31, 2008, non-performing assets included six non-accrual commercial
loans totaling $2,619,000, six non-accrual commercial real estate loans totaling
$4,184,000 and eleven non-accrual residential construction loans totaling
$6,309,000, one residential mortgage loan totaling $334,000 and one non-accrual
installment loan totaling $99,000.  Additional non-performing assets
included loans past due more than 90 days totaling $713,000. Other Real Estate
Owned ("OREO") properties totaled $4,368,000 at December 31, 2008. The Bank's
management believes that the $13,545,000 in non-accrual loans are adequately
collateralized or guaranteed by a governmental entity.  No assurance
can be given that the existing or any additional collateral will be sufficient
to secure full recovery of the obligations owed under these loans.
 
 The
Company had loans 90 days past due and still accruing totaling $713,000,
$263,000 and $37,000 at December 31, 2008, 2007 and 2006,
respectively.
 
 The
Company had loans restructured and in compliance with modified terms totaling
$2,682,000 at December 31, 2008.  The Company had no restructured
loans at December 31, 2007 and 2006, respectively.
  
 37
   OREO is
made up of property that the Company has acquired by deed in lieu of foreclosure
or through foreclosure proceedings, and property that the Company does not hold
title to but is in actual control of, known as in-substance
foreclosure.  The estimated fair value of the property is determined
prior to transferring the balance to OREO.  The balance transferred to
OREO is the lesser of the estimated fair market value of the property, or the
book value of the loan, less estimated cost to sell.  A write-down may
be deemed necessary to bring the book value of the loan equal to the appraised
value. Appraisals or loan officer evaluations are then done periodically
thereafter charging any additional write-downs to the appropriate expense
account.
 
 OREO
amounted to $4,368,000, $879,000 and $375,000 for the periods ended December 31,
2008, 2007 and 2006, respectively.  The increase in OREO loans at
December 31, 2008 from the balance at December 31, 2007 was due to the transfer
of twelve real estate construction loans, two real estate development loans and
one commercial loan to OREO, which was partially offset by the sales of six real
estate construction properties and one commercial real estate
property.
 
 Potential Problem
Loans
 
 In
addition to the non-performing assets described above, the Bank's Branch
Managers each month submit to the Loan Committee of the Board of Directors a
report detailing the status of those loans that are past due over sixty days and
each quarter a report detailing the status of those loans that are classified as
such.  Also included in the report are those loans that are not
necessarily past due, but the branch manager is aware of problems with these
loans which may result in a loss.
 
 The
monthly Allowance for Loan Loss Analysis Report is prepared based upon the
Problem Loan Report, internal loan rating, regulatory classifications and loan
review classification and is reviewed by the Management Loan Committee of the
Bank.  The Directors Loan Committee reviewed the Allowance for Loan
Loss Analysis Report, dated December 31, 2008, on January 22,
2009.  This report included all non-performing loans reported in the
table on the previous page and other potential problem
loans.  Excluding the non-performing loans cited previously, loans
totaling $39,067,000 were classified as potential problem loans.  Of
these loans, loans totaling $33,720,000 are adequately collateralized or
guaranteed, and the remaining loans totaling $5,347,000 may have some loss
potential which management believes is sufficiently covered by the Bank’s
existing loan loss reserve (Allowance for Loan Losses).  The ratio of
the Allowance for Loan Losses to total loans at December 31, 2008 was
2.71%.
 
   38
  
 SUMMARY OF LOAN LOSS
EXPERIENCE
 
  The
Company’s allowance for credit losses is maintained at a level considered
adequate to provide for losses that can be estimated based upon specific and
general conditions.  These include conditions unique to individual
borrowers, as well as overall credit loss experience, the amount of past due,
nonperforming loans and classified loans, recommendations of regulatory
authorities, prevailing economic conditions and other factors.  A
portion of the allowance is specifically allocated to classified loans whose
full collectability is uncertain.  Such allocations are determined by
Management based on loan-by-loan analyses.  In addition, loans with
similar characteristics not usually criticized using regulatory guidelines are
analyzed based on the historical loss rates and delinquency trends, grouped by
the number of days the payments on these loans are delinquent.  Last,
allocations are made to non-criticized and classified commercial loans and
residential real estate loans based on historical loss rates, and other
statistical data.  The remainder of the allowance is considered to be
unallocated.  The unallocated allowance is established to provide for
probable losses that have been incurred as of the reporting date but not
reflected in the allocated allowance.  It addresses additional
qualitative factors consistent with Management’s analysis of the level of risks
inherent in the loan portfolio, which are related to the risks of the Company’s
general lending activity.  Included in the unallocated allowance is
the risk of losses that are attributable to national or local economic or
industry trends which have occurred but have yet been recognized in past loan
charge-off history (external factors).  The external factors evaluated
by the Company include: economic and business conditions, external competitive
issues, and other factors.  Also included in the unallocated allowance
is the risk of losses attributable to general attributes of the Company’s loan
portfolio and credit administration (internal factors).  The internal
factors evaluated by the Company include: loan review system, adequacy of
lending Management and staff, loan policies and procedures, problem loan trends,
concentrations of credit, and other factors.  By their nature, these
risks are not readily allocable to any specific loan category in a statistically
meaningful manner and are difficult to quantify with a specific
number.  Management assigns a range of estimated risk to the
qualitative risk factors described above based on Management’s judgment as to
the level of risk, and assigns a quantitative risk factor from the range of loss
estimates to determine the appropriate level of the unallocated portion of the
allowance.  Management considers the $14,435,000 allowance for credit
losses to be adequate as a reserve against losses as of December 31,
2008.
  
 
   39
  
 Analysis of the Allowance
for Loan Losses
 (Dollars
in thousands)
 
 2008
                      
                      
                      2007
                      
                      
                      2006
                      
                      
                      2005
                      
                      
                      2004Balance
      at Beginning of Year
                      
                      $
                      10,876
                      
                      
                      $
                      8,361
                      
                      
                      $
                      7,917
                      
                      
                      $
                      7,445
                      
                      
                      $
                      7,006Provision
      for Loan Losses
                      
                      
                      16,164
                      
                      
                      
                      4,795
                      
                      
                      
                      735
                      
                      
                      
                      600
                      
                      
                      
                      207Loans
      Charged-Off:Commercial
                      
                      
                      (2,224
                      )
                      
                      
                      (1,428
                      )
                      
                      
                      (572
                      )
                      
                      
                      (670
                      )
                      
                      
                      (122
                      )Agriculture
                      
                      
                      (88
                      )
                      
                      
                      (82
                      )
                      
                      
                      (57
                      )
                      
                      
                      —
                      
                      
                      
                      (214
                      )Real
      Estate Mortgage
                      
                      
                      (299
                      )
                      
                      
                      (249
                      )
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Real
      Estate Construction
                      
                      
                      (10,265
                      )
                      
                      
                      (537
                      )
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Installment
      Loans to Individuals
                      
                      
                      (448
                      )
                      
                      
                      (764
                      )
                      
                      
                      (431
                      )
                      
                      
                      (185
                      )
                      
                      
                      (46
                      )Total
      Charged-Off
                      
                      
                      (13,324
                      )
                      
                      
                      (3,060
                      )
                      
                      
                      (1,060
                      )
                      
                      
                      (855
                      )
                      
                      
                      (382
                      )Recoveries:Commercial
                      
                      
                      153
                      
                      
                      
                      256
                      
                      
                      
                      561
                      
                      
                      
                      64
                      
                      
                      
                      199Agriculture
                      
                      
                      56
                      
                      
                      
                      200
                      
                      
                      
                      —
                      
                      
                      
                      663
                      
                      
                      
                      399Real
      Estate Mortgage
                      
                      
                      32
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Real
      Estate Construction
                      
                      
                      159
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Installment
      Loans to Individuals
                      
                      
                      319
                      
                      
                      
                      324
                      
                      
                      
                      208
                      
                      
                      
                      —
                      
                      
                      
                      16Total
      Recoveries
                      
                      
                      719
                      
                      
                      
                      780
                      
                      
                      
                      769
                      
                      
                      
                      727
                      
                      
                      
                      614Net  (Charge-Offs)
      Recoveries
                      
                      
                      (12,605
                      )
                      
                      
                      (2,280
                      )
                      
                      
                      (291
                      )
                      
                      
                      (128
                      )
                      
                      
                      232Balance
      at End of Year
                      
                      $
                      14,435
                      
                      
                      $
                      10,876
                      
                      
                      $
                      8,361
                      
                      
                      $
                      7,917
                      
                      
                      $
                      7,445Ratio
      of Net (Charge-Offs) RecoveriesDuring
      the Year to Average LoansOutstanding
      During the Year
                      
                      
                      (2.46
                      %)
                      
                      
                      (0.47
                      %)
                      
                      
                      (0.06
                      %)
                      
                      
                      (0.03
                      %)
                      
                      
                      0.06
                      %
 
 
  40
  
 Allocation of the Allowance
for Loan Losses
 
 The
Allowance for Loan Losses has been established as a general component available
to absorb probable inherent losses throughout the Loan Portfolio.  The
following table is an allocation of the Allowance for Loan Losses balance on the
dates indicated (dollars in thousands):
   December
      31, 2008
                  
                  
                  December
      31, 2007
                  
                  
                  December
      31, 2006Allocation
      of Allowance for Loan Losses Balance
                  
                  
                  Loans
      as a % of Total Loans
                  
                  
                  Allocation
      of Allowance for Loan Losses Balance
                  
                  
                  Loans
      as a % of Total Loans
                  
                  
                  Allocation
      of Allowance for Loan Losses Balance
                  
                  
                  Loans
      as a % of Total LoansLoan
      Type:Commercial
                  
                  $
                  4,909
                  
                  
                  
                  21.6
                  %
                  
                  $
                  2,884
                  
                  
                  
                  22.5
                  %
                  
                  $
                  2,037
                  
                  
                  
                  20.5
                  %Agriculture
                  
                  
                  643
                  
                  
                  
                  7.4
                  %
                  
                  
                  865
                  
                  
                  
                  7.4
                  %
                  
                  
                  1,133
                  
                  
                  
                  8.1
                  %Real
      Estate Mortgage
                  
                  
                  4,491
                  
                  
                  
                  57.0
                  %
                  
                  
                  3,470
                  
                  
                  
                  50.5
                  %
                  
                  
                  3,016
                  
                  
                  
                  47.9
                  %Real
      Estate    Construction
                  
                  
                  3,113
                  
                  
                  
                  13.0
                  %
                  
                  
                  2,947
                  
                  
                  
                  18.5
                  %
                  
                  
                  1,535
                  
                  
                  
                  22.4
                  %Installment
                  
                  
                  1,279
                  
                  
                  
                  1.0
                  %
                  
                  
                  710
                  
                  
                  
                  1.1
                  %
                  
                  
                  640
                  
                  
                  
                  1.1
                  %Total
                  
                  $
                  14,435
                  
                  
                  
                  100.0
                  %
                  
                  $
                  10,876
                  
                  
                  
                  100.0
                  %
                  
                  $
                  8,361
                  
                  
                  
                  100.0
                  %
 
 
 December
      31, 2005
                  
                  
                  December
      31, 2004Allocation
      of Allowance for Loan Losses Balance
                  
                  
                  Loans
      as a % of Total Loans
                  
                  
                  Allocation
      of Allowance for Loan Losses Balance
                  
                  
                  Loans
      as a % of Total LoansLoan
      Type:Commercial
                  
                  $
                  1,779
                  
                  
                  
                  19.1
                  %
                  
                  $
                  1,726
                  
                  
                  
                  20.9
                  %Agriculture
                  
                  
                  1,518
                  
                  
                  
                  7.2
                  %
                  
                  
                  1,484
                  
                  
                  
                  7.7
                  %Real
      Estate Mortgage
                  
                  
                  3,003
                  
                  
                  
                  50.1
                  %
                  
                  
                  2,766
                  
                  
                  
                  50.4
                  %Real
      Estate Construction
                  
                  
                  1,001
                  
                  
                  
                  22.7
                  %
                  
                  
                  668
                  
                  
                  
                  19.9
                  %Installment
                  
                  
                  616
                  
                  
                  
                  0.9
                  %
                  
                  
                  801
                  
                  
                  
                  1.1
                  %Total
                  
                  $
                  7,917
                  
                  
                  
                  100.0
                  %
                  
                  $
                  7,445
                  
                  
                  
                  100.0
                  %
 
  The Bank
believes that any breakdown or allocation of the allowance into loan categories
lends an appearance of exactness, which does not exist, because the allowance is
available for all loans.  The allowance breakdown shown above is
computed taking actual experience into consideration but should not be
interpreted as an indication of the specific amount and allocation of actual
charge-offs that may ultimately occur.
  41
  
 Deposits
 
 The
following table sets forth the average amount and the average rate paid on each
of the listed deposit categories (dollars in thousands) during the periods
specified:
 
 2008
                
                
                2007
                
                
                2006Average
      Amount
                
                
                Average
      Rate
                
                
                Average
      Amount
                
                
                Average
      Rate
                
                
                Average
      Amount
                
                
                Average
      RateDeposit
      Type:Non-interest-Bearing
      Demand
                
                $
                173,332
                
                
                
                —
                
                
                $
                185,563
                
                
                
                —
                
                
                $
                187,766
                
                
                
                —Interest-Bearing
      Demand (NOW)
                
                $
                128,690
                
                
                
                .72
                %
                
                $
                130,608
                
                
                
                2.17
                %
                
                $
                95,180
                
                
                
                1.65
                %Savings
      and MMDAs
                
                $
                171,465
                
                
                
                1.01
                %
                
                $
                179,425
                
                
                
                2.25
                %
                
                $
                190,036
                
                
                
                2.01
                %Time
                
                $
                114,742
                
                
                
                2.74
                %
                
                $
                117,178
                
                
                
                3.88
                %
                
                $
                116,787
                
                
                
                3.15
                %
 
 
 The
following table sets forth by time remaining to maturity the Bank’s time
deposits in the amount of $100,000 or more (dollars in thousands) as of December
31, 2008:
 
 Three
      months or less
                  
                  $
                  27,753Over
      three months through twelve months
                  
                  
                  26,595Over
      twelve months
                  
                  
                  5,248Total
                  
                  $
                  59,596
 
 
 Short-Term
Borrowings
 
 Short-term
borrowings at December 31, 2008 and 2007 consisted of secured borrowings from
the U.S. Treasury in the amounts of $584,000 and $878,000,
respectively.  The funds are placed at the discretion of the U.S.
Treasury and are callable on demand by the U.S. Treasury.  At December
31, 2008, the Bank had no Federal Funds purchased.
 
 Additional
short-term borrowings available to the Company consist of a line of credit and
advances from the Federal Home Loan Bank (“FHLB”) secured under terms of a
blanket collateral agreement by a pledge of FHLB stock and certain other
qualifying collateral such as commercial and mortgage loans.  At
December 31, 2008, the Company had a current collateral borrowing capacity from
the FHLB of $77,846,000.  The Company also has unsecured formal lines
of credit totaling $15,500,000 with correspondent banks.
 
 
 Long-Term
Borrowings
 
 Long-term
borrowings consisted of Federal Home Loan Bank advances, totaling $17,675,000
and $9,885,000, respectively, at December 31, 2008 and 2007.  Such
advances ranged in maturity from 0.2 years to 3.4 years at a weighted average
interest rate of 3.61% at December 31, 2008.  Maturity ranged from 0.4
years to 1.3 years at a weighted average interest rate of 2.90% at December 31,
2007.  Average outstanding balances were $16,519,000 and $10,008,000,
respectively, during 2008 and 2007.  The weighted average interest
rate paid was 3.42% in 2008 and 2.91% in 2007.
  42
  
 Overview
 
 Year Ended December 31, 2008
Compared to Year Ended December 31, 2007
 
 Net loss
for the year ended December 31, 2008, was $1,374,000, representing a decrease of
$8,655,000, or 118.9%, compared to net income of $7,281,000 for the year ended
December 31, 2007.  The decrease in net income is principally
attributable to an increase of $11,369,000 in the provision for loan losses, a
$4,360,000 decrease in net interest income and a $1,734,000 decrease in gains /
write-downs on other real estate owned, which was partially offset by an
increase of $658,000 in other income, a $284,000 increase in service charges on
deposit accounts, a $771,000 decrease in salaries and employee benefits, a
$168,000 decrease in advertising, a $227,000 decrease in other expense and a
$6,772,000 decrease in the provision for income taxes.
 
  Total
assets decreased by $39.1 million, or 5.5%, to $670.8 million as of December 31,
2008 compared to $709.9 million at December 31, 2007.  The decrease in
total assets was mainly due to a $32.7 million decrease in investment
securities, a $26.9 million decrease in cash and due from banks and a $6.1
million decrease in federal funds sold, which was partially offset by a $19.8
million increase in net loans (including loans held-for-sale) and a $3.5 million
increase in other real estate owned.  Total deposits decreased $38.0
million, or 6.1%, to 584.7 million as of December 31, 2008 compared to $622.7
million at December 31, 2007.  Other borrowings increased by $2.4
million, or 15.3%, to $18.3 million as of December 31, 2008 compared to $15.8
million at December 31, 2007.
  
 
 Year Ended December 31, 2007
Compared to Year Ended December 31, 2006
 
 Net
income for the year ended December 31, 2007, was $7,281,000, representing a
decrease of $1,529,000, or 17.4%, over net income of $8,810,000 for the year
ended December 31, 2006.  The decrease in net income is principally
attributable to an increase of $4,060,000 in the provision for loan losses, a
$1,788,000 decrease in net interest income, an increase of $244,000 in data
processing expense and a $489,000 increase in other operating expense, which was
partially offset by an increase of $1,871,000 in other operating income, a
$1,215,000 decrease in salaries and employee benefits, and a $2,032,000 decrease
in the provision for income taxes.
 
  Total
assets increased by $24.7 million, or 3.6%, to $709.9 million as of December 31,
2007 compared to $685.2 million at December 31, 2006.  The increase in
total assets was mainly due to a $19.3 million growth in net loans (including
loans held-for-sale) and a $16.6 million increase in cash and due from banks
offset by a 15.5 million reduction in federal funds sold.  The growth
in total assets was financed primarily by the increase in deposits of $19.0
million and other borrowings of $4.9 million.
   43
  
 Results of
Operations
 
 Net Interest
Income
 
 Net
interest income is the excess of interest and fees earned on the Bank’s loans,
investment securities, federal funds sold and banker's acceptances over the
interest expense paid on deposits, mortgage notes and other borrowed
funds.  It is primarily affected by the yields on the Bank’s
interest-earning assets and loan fees and interest-bearing liabilities
outstanding during the period.  The $4,360,000 decrease in the Bank’s
net interest income in 2008 from 2007 was due to the effects lower loan rates
and lower loan fees, which were partially offset by real estate loan volumes
combined with lower levels of investment securities and lower Federal Funds
rates and volumes, which was partially offset by lower core deposit funding
costs.  The $1,788,000 decrease in the Bank’s net interest income in
2007 from 2006 was due to the effects of a higher level of core deposits and
higher funding costs, lower loan rates and lower loan fees, which were partially
offset by strong commercial and real estate loan volumes combined with higher
levels of investment securities.  The “Analysis of Changes in Interest
Income and Interest Expense” set forth on page 34 of this Annual Report on Form
10-K identifies the effects of interest rates and loan/deposit
volume.  Another factor that affected the net interest income was the
average earning asset to average total asset ratio.  This ratio was
90.8% in 2008, 91.6% in 2007 and 91.2% in 2006.
 
 Interest
income on loans (including loan fees) was $35,077,000 for 2008, representing a
decrease of $6,411,000, or 15.5%, from $41,488,000 for 2007.  This
compared to a decrease in 2007 of $406,000, or 1.0%, from $41,894,000 for
2006.  The decreased interest income on loans in 2008 over 2007 was
the result of a 154 basis point decrease in loan interest rates, combined with a
decrease of approximately $473,000 in loan fees, which was partially offset by a
5.0% increase in loan volume.  Loan fee comparisons were impacted by a
net decrease in deferred loan fees and costs of $473,000 in 2008, and a net
decrease of $196,000 in 2007.
 
 Average
outstanding federal funds sold fluctuated during this period, ranging from
$26,808,000 in 2008 to $52,359,000 in 2007 and $61,904,000, in
2006.  At December 31, 2008, federal funds sold were
$40,860,000.  Federal funds are used primarily as a short-term
investment to provide liquidity for funding of loan commitments or to
accommodate seasonal deposit fluctuations.  Federal funds sold yields
were 1.94%, 5.08% and 4.82% for 2008, 2007 and 2006, respectively.
 
 The
average total level of investment securities decreased $28,923,000 in 2008 to
$57,123,000 from $86,046,000 in 2007 and increased $21,276,000 in 2007 to
$86,046,000 from $64,770,000 in 2006.  The level of interest income
attributable to investment securities decreased to $2,598,000 in 2008 from
$4,060,000 in 2007 and $4,060,000 in 2007 from $3,084,000 in 2006, due to the
effects of interest rates and volume.  The Bank’s strategy for this
period emphasized the use of the investment portfolio to maintain the Bank’s
increased loan demand.  The Bank intends to continue to reinvest
maturing securities to provide future liquidity while attempting to reinvest the
cash flows in short duration securities that provide higher cash flow for
reinvestment in a higher interest rate instrument.  Investment
securities yields were 4.55%, 4.72% and 4.76% for 2008, 2007 and 2006,
respectively.
 
 Total
interest expense decreased to $6,375,000 in 2008 from $11,738,000 in 2007, and
increased to $11,738,000 in 2007 from $9,426,000 in 2006, representing a 45.7%
decrease in 2008 over 2007 and a 24.5% increase in 2007 over
2006.  The decrease in total interest expense from 2008 to 2007 was
due to decreases in interest rates paid on deposits.  The increase in
total interest expense from 2007 to 2006 was due to increases in volume combined
with increases in interest rates paid on deposits.
 
   44
  
 The mix
of deposits for the previous three years is as follows (dollars in
thousands):
 
 2008
                
                
                2007
                
                
                2007Average
      Balance
                
                
                Percent
                
                
                Average
      Balance
                
                
                Percent
                
                
                Average
      Balance
                
                
                PercentNon-interest-Bearing
      Demand
                
                $
                173,332
                
                
                
                29.5
                %
                
                $
                185,563
                
                
                
                30.3
                %
                
                $
                187,766
                
                
                
                31.9
                %Interest-Bearing
      Demand (NOW)
                
                
                128,690
                
                
                
                21.9
                %
                
                
                130,608
                
                
                
                21.3
                %
                
                
                95,180
                
                
                
                16.1
                %Savings
      and MMDAs
                
                
                171,465
                
                
                
                29.1
                %
                
                
                179,425
                
                
                
                29.3
                %
                
                
                190,036
                
                
                
                32.2
                %Time
                
                
                114,742
                
                
                
                19.5
                %
                
                
                117,178
                
                
                
                19.1
                %
                
                
                116,787
                
                
                
                19.8
                %Total
                
                $
                588,229
                
                
                
                100.0
                %
                
                $
                612,774
                
                
                
                100.0
                %
                
                $
                589,769
                
                
                
                100.0
                %
 
 The three
years ended December 31, 2008 have been characterized by fluctuating interest
rates.  Loan rates and deposit rates decreased in 2008 and loan rates
decreased and deposit rates increased in 2007.  The net spread between
the rate for total earning assets and the rate for total deposits and borrowed
funds decreased 10 basis points in the period from 2008 to 2007 and decreased 66
basis points in the period from 2007 to 2006.
 
 The
Bank’s net interest margin (net interest income divided by average earning
assets) was 5.30% in 2008, 5.80% in 2007, and 6.36% in 2006.  The
decrease in net interest margin was due to lowering loan rates which was only
partially offset by lower deposit rates.  Going forward into the first
half of 2009, it is Bank management’s belief that net interest income and net
interest margin will continue to fluctuate due to the unstable rate
environment.
 
 Provision for Loan
Losses
 
 The
provision for loan losses is established by charges to earnings based on
management's overall evaluation of the collectability of the loan
portfolio.  Based on this evaluation, the provision for loan losses
increased to $16,164,000 in 2008 from $4,795,000 in 2007, primarily as a result
of loan quality and loan growth in the Bank’s loan portfolio.  The
amount of loans charged-off increased in 2008 to $13,324,000 from $3,060,000 in
2007, and recoveries decreased to $719,000 in 2008 from $780,000 in
2007.  The increase in charge-offs was due, for the most part, to an
increase in charge-offs of commercial loans and real estate construction
loans.  The ratio of the Allowance for Loan Losses to total loans at
December 31, 2008 was 2.71% compared to 2.13% at December 31,
2007.  The ratio of the Allowance for Loan Losses to total non-accrual
loans and loans past due 90 days or more at December 31, 2008 was 101% compared
to 70% at December 31, 2007.
 
 The
provision for loan losses increased to $4,795,000 in 2007 from $735,000 in 2006,
primarily as a result of loan growth and loan quality in the Bank’s loan
portfolio.  The amount of loans charged-off increased in 2007 to
$3,060,000 from $1,060,000 in 2006, and recoveries increased to $780,000 in 2007
from $769,000 in 2006.  The increase in charge-offs was due, for the
most part, to an increase in charge-offs of commercial loans, real estate
mortgage loans, real estate construction loans and installment loans to
individuals.  The ratio of the Allowance for Loan Losses to total
loans at December 31, 2007 was 2.13% compared to 1.73% at December 31,
2006.  The ratio of the Allowance for Loan Losses to total non-accrual
loans and loans past due 90 days or more at December 31, 2007 was 70% compared
to 243% at December 31, 2006.
 
 
 
 45
   Other Operating Income and
Expenses
 
 Other
operating income consisted primarily of service charges on deposit accounts, net
gains on sales of investment securities, net realized gains on loans held for
sale, gains and/or write-downs on other real estate owned, and other
income.  Service charges on deposit accounts increased $284,000 in
2008 over 2007 and $630,000 in 2007 over 2006.  The increase in 2008
was due, for the most part, to increased service charges on regular and business
checking accounts.  Realized gains on sale of investment securities
decreased $69,000 in 2008 over 2007 and increased $638,000 in 2007 over
2006.  The decrease in 2008 was due to fewer sales of
securities.  Net realized gains on loans held-for-sale increased
$14,000 in 2008 over 2007 and increased $196,000 in 2007 over
2006.  The increase in 2008 was due, for the most part, to an increase
in sold loans.  Gains on other real estate owned decreased $251,000 in
2008 over 2007 and increased $347,000 in 2007 over 2006.  The decrease
in 2008 was due to lower gains on sales of foreclosed residential properties in
2008 compared to 2007.  Other income increased $658,000 in 2008 over
2007 and increased $60,000 in 2007 over 2006.  The increase in 2008
was due, for the most part, to an increase in investment brokerage services
income.
 
 Other
operating expenses consisted primarily of salaries and employee benefits,
occupancy and equipment expense, data processing expense, stationery and
supplies expense, advertising, OREO expenses and write-downs and other
expenses.  Other operating expenses increased to $29,137,000 in 2008
from $28,803,000 in 2007, and decreased to $28,803,000 in 2007 from $29,219,000
in 2006, representing an increase of $334,000, or 1.2% in 2008 over 2007, and
decrease of $416,000, or 1.4% in 2007 over 2006.
 
 Following
is an analysis of the increase or decrease in the components of other operating
expenses (dollars in thousands) during the periods specified:
 2008
      over 2007
                  
                  
                  2007
      over 2006Amount
                  
                  
                  Percent
                  
                  
                  Amount
                  
                  
                  PercentSalaries
      and Employee Benefits
                  
                  $
                  (771
                  )
                  
                  
                  (4.7
                  %)
                  
                  $
                  (1,215
                  )
                  
                  
                  (7.0
                  %)Occupancy
      and Equipment
                  
                  
                  28
                  
                  
                  
                  0.8
                  %
                  
                  
                  (19
                  )
                  
                  
                  (0.5
                  %)Data
      Processing
                  
                  
                  87
                  
                  
                  
                  5.3
                  %
                  
                  
                  244
                  
                  
                  
                  17.6
                  %Stationery
      and Supplies
                  
                  
                  (89
                  )
                  
                  
                  (15.9
                  %)
                  
                  
                  36
                  
                  
                  
                  6.9
                  %Advertising
                  
                  
                  (168
                  )
                  
                  
                  (19.0
                  %)
                  
                  
                  (9
                  )
                  
                  
                  (1.0
                  %)Directors
      Fees
                  
                  
                  (9
                  )
                  
                  
                  (4.1
                  %)
                  
                  
                  58
                  
                  
                  
                  35.8
                  %OREO
      Expense and Write-downs
                  
                  
                  1,549
                  
                  
                  
                  3,520.5
                  %
                  
                  
                  44
                  
                  
                  
                  100.0
                  %Other
      Expense
                  
                  
                  (293
                  )
                  
                  
                  (5.3
                  %)
                  
                  
                  445
                  
                  
                  
                  8.7
                  %Total
                  
                  $
                  334
                  
                  
                  
                  1.2
                  %
                  
                  $
                  (416
                  )
                  
                  
                  (1.4
                  %)
 
 
 In 2008,
salaries and employee benefits decreased $771,000 to $15,469,000 from
$16,240,000 for 2007.  This decrease was due, for the most part, to
decreased incentive compensation and profit sharing payments, which was
partially offset by increases in regular salaries.  Increases in the
data processing area were attributed to continued emphasis on Internet-related
products and security services and network improvements.  Decreases in
stationary and supplies were attributed to a decrease in the usage of office
supplies.  Decreases in advertising costs were due to a decrease in
printed materials and related costs.  Increases in OREO expense and
write-downs were due to expenses and write-downs related to foreclosed real
estate properties.
 
 In 2007,
salaries and employee benefits decreased $1,215,000 to $16,240,000 from
$17,455,000 for 2006.  This decrease was due, for the most part, to
decreased incentive compensation and profit sharing payments, which was
partially offset by increases in regular salaries, stock compensation expense,
retirement compensation expense and group insurance.  Increases in the
data processing area were attributed to continued emphasis on Internet-related
products and security services and network improvements.  Increases in
stationary and supplies were attributed to an increase in the usage of office
supplies.  Increases in director fees were due to increased directors’
meetings.     Increases in OREO expense and write-downs
were due to expenses related to foreclosed real estate properties.
 
 
 46
 
 Income
Taxes
 
 The
provision for income taxes is primarily affected by the tax rate, the level of
earnings before taxes and the amount of lower taxes provided by non-taxable
earnings.  In 2008, taxes decreased $6,772,000 to a benefit of
$3,635,000 from an expense of $3,137,000 for 2007.  In 2007, taxes
decreased $2,032,000 to $3,137,000 from $5,169,000 for
2006.  Non-taxable municipal bond income was $1,254,000, $1,271,000,
and $636,000 for the years ended December 31, 2008, 2007, and 2006,
respectively.
 
 Liquidity, Contractual
Obligations, Commitments, Off-Balance Sheet Arrangements and Capital
Resources
 
 Liquidity
is defined as the ability to generate cash at a reasonable cost to fulfill
lending commitments and support asset growth, while satisfying the withdrawal
demands of customers and any borrowing requirements.  The Bank’s
principal sources of liquidity are core deposits and loan and investment
payments and prepayments.  Providing a secondary source of liquidity
is the available-for-sale investment portfolio.  As a final source of
liquidity, the Bank can exercise existing credit arrangements.
 
 The
Company’s primary source of liquidity on a stand-alone basis is dividends from
the Bank.  As discussed in Part I (Item 1) of this Annual Report on
Form 10-K, dividends from the Bank are subject to regulatory
restrictions.
 
 As
discussed in Part I (Item 1) of this Annual Report on Form 10-K, the Bank
experiences seasonal swings in deposits, which impact
liquidity.  Management has adjusted to these seasonal swings by
scheduling investment maturities and developing seasonal credit arrangements
with the Federal Reserve Bank and Federal Funds lines of credit with
correspondent banks.  In addition, the ability of the Bank’s real
estate department to originate and sell loans into the secondary market has
provided another tool for the management of liquidity.  As of December
31, 2008, the Company has not created any special purpose entities to securitize
assets or to obtain off-balance sheet funding.
 
 The
liquidity position of the Bank is managed daily, thus enabling the Bank to adapt
its position according to market fluctuations.  Liquidity is measured
by various ratios, the most common of which is the ratio of net loans (including
loans held-for-sale) to deposits.  This ratio was 88.8% on December
31, 2008, 80.2% on December 31, 2007, and 79.6% on December 31, 2006. At
December 31, 2008 and 2007, the Bank’s ratio of core deposits to total assets
was 78.3% and 77.9%, respectively.  Core deposits are important in
maintaining a strong liquidity position as they represent a stable and
relatively low cost source of funds. The Bank’s liquidity position decreased
slightly in 2008; management believes that it remains adequate.  This
is best illustrated by the change in the Bank’s net non-core and net short-term
non-core funding dependence ratio, which explain the degree of reliance on
non-core liabilities to fund long-term assets.  At December 31, 2008,
the Bank’s net core funding dependence ratio, the difference between non-core
funds, time deposits $100,000 or more and brokered time deposits under $100,000,
and short-term investments to long-term assets, was 8.95%, compared to 0.09% in
2007.  The Bank’s net short-term non-core funding dependence ratio,
non-core funds maturing within one year, including borrowed funds, less
short-term investments to long-term assets equaled 6.01% at the end of 2008,
compared to -1.78% at year-end 2007.  These ratios indicated at
December 31, 2008, the Bank had minimal reliance on non-core deposits and
borrowings to fund the Bank’s long-term assets, namely loans and
investments.  The Bank believes that by maintaining adequate volumes
of short-term investments and implementing competitive pricing strategies on
deposits, it can ensure adequate liquidity to support future
growth.  The Bank also believes that its liquidity position remains
strong to meet both present and future financial obligations and commitments,
events or uncertainties that have resulted or are reasonably likely to result in
material changes with respect to the Bank’s liquidity.
 
 
 47
 
  The
Company has various financial obligations, including contractual obligations and
commitments that may require future cash payments.  The following
table presents, as of December 31, 2008, the Company’s significant fixed and
determinable contractual obligations to third parties by payment date (amounts
in thousands):
 
 Payments
      due by periodContractual
      Obligations
                    
                    Total
                    
                    
                    Less
      than 1 year
                    
                    
                    1-3
      years
                    
                    
                    3-5
      years
                    
                    
                    More
      than 5 yearsDeposits
      without a stated maturity (a)
                    
                    $
                    460,881
                    
                    
                    
                    460,881
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Certificates
      of Deposit (a)
                    
                    
                    123,848
                    
                    
                    
                    114,406
                    
                    
                    
                    7,646
                    
                    
                    
                    1,796
                    
                    
                    
                    —Short-Term
      Borrowings (a)
                    
                    
                    584
                    
                    
                    
                    584
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Long-Term
      Borrowings (b)
                    
                    
                    19,092
                    
                    
                    
                    7,197
                    
                    
                    
                    2,427
                    
                    
                    
                    9,468
                    
                    
                    
                    —Operating
      Leases
                    
                    
                    6,159
                    
                    
                    
                    1,216
                    
                    
                    
                    2,009
                    
                    
                    
                    1,602
                    
                    
                    
                    1,332Purchase
      Obligations
                    
                    
                    1,564
                    
                    
                    
                    1,564
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Total
                    
                    $
                    612,128
                    
                    
                    
                    585,848
                    
                    
                    
                    12,082
                    
                    
                    
                    12,866
                    
                    
                    
                    1,332
 
 (a)Excludes
      interest
 (b)Includes
      interest on fixed rate obligations.
 
 The
Company’s operating lease obligations represent short-term and long-term lease
and rental payments for facilities, certain software and data processing and
other equipment.  Purchase obligations represent obligations under
agreements to purchase goods or services that are enforceable and legally
binding on the Company and that specify all significant terms, including: fixed
or minimum quantities to be purchased; fixed, minimum or variable price
provisions; and the approximate timing of the transaction.  The
purchase obligation amounts presented above primarily relate to certain
contractual payments for services provided for information technology, capital
expenditures, and the outsourcing of certain operational
activities.
 
 The
Company’s long-term borrowing consists of FHLB fixed-rate
obligations.  FHLB advances are collateralized by qualifying
residential real estate loans and commercial loans.
 
 The
Company’s borrowed funds consist of secured borrowings from the U.S. Treasury.
These borrowings are collateralized by qualifying securities.  The
funds are placed at the discretion of the U.S. Treasury and are callable on
demand by the U.S. Treasury.
 
 The
following table details the amounts and expected maturities of commitments as of
December 31, 2008 (amounts in thousands):
 
 Maturities
      by periodCommitments
                    
                    Total
                    
                    
                    Less
      than 1 year
                    
                    
                    1-3
      years
                    
                    
                    3-5
      years
                    
                    
                    More
      than 5 yearsCommitments
      to extend creditCommercial
                    
                    $
                    78,449
                    
                    
                    
                    68,932
                    
                    
                    
                    6,498
                    
                    
                    
                    1,220
                    
                    
                    
                    1,799Agriculture
                    
                    
                    38,456
                    
                    
                    
                    29,398
                    
                    
                    
                    6,658
                    
                    
                    
                    384
                    
                    
                    
                    2,016Real
      Estate Mortgage
                    
                    
                    65,904
                    
                    
                    
                    3,406
                    
                    
                    
                    12,867
                    
                    
                    
                    13,237
                    
                    
                    
                    36,394Real
      Estate Construction
                    
                    
                    13,573
                    
                    
                    
                    10,182
                    
                    
                    
                    269
                    
                    
                    
                    53
                    
                    
                    
                    3,069Installment
                    
                    
                    2,233
                    
                    
                    
                    1,503
                    
                    
                    
                    730
                    
                    
                    
                    —
                    
                    
                    
                    —Commitments
      to sell loans
                    
                    
                    9,764
                    
                    
                    
                    9,764
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Standby
      Letters of Credit
                    
                    
                    5,715
                    
                    
                    
                    5,675
                    
                    
                    
                    —
                    
                    
                    
                    40
                    
                    
                    
                    —Total
                    
                    $
                    214,094
                    
                    
                    
                    128,860
                    
                    
                    
                    27,022
                    
                    
                    
                    14,934
                    
                    
                    
                    43,278
 
 Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.
  
 48
 
 The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit in the form of loans or through standby letters of
credit.  These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts recognized in the balance
sheet.  The contract amounts of those instruments reflect the extent
of involvement the Company has in particular classes of financial
instruments.  These loans have been sold to third parties without
recourse, subject to customary default, representations and warranties, recourse
for breaches of the terms of the sales contracts and payment default
recourse.
 
  Financial
instruments, whose contract amounts represent credit risk at December 31 of
the indicated years, are as follows (amounts in thousands):
 
 2008
                  
                  
                  2007Undisbursed
      loan commitments
                  
                  $
                  198,615
                  
                  
                  $
                  214,274Standby
      letters of credit
                  
                  
                  5,715
                  
                  
                  
                  15,188Commitments
      to sell loans
                  
                  
                  9,764
                  
                  
                  
                  250$
                  214,094
                  
                  
                  $
                  229,712
 
 The Bank
expects its liquidity position to remain strong in 2009 as the Bank expects to
continue to grow into existing markets.  The stock market has weakened
considerably this past year and, while the Bank did not experience a dramatic
outflow of deposits, the potential of additional outflows still exists if the
stock market improves.  Regardless of the outcome, the Bank believes
that it has the means to provide adequate liquidity for funding normal
operations in 2009.
 
 The Bank
believes a strong capital position is essential to the Bank’s continued growth
and profitability.  A solid capital base provides depositors and
shareholders with a margin of safety, while allowing the Bank to take advantage
of profitable opportunities, support future growth and provide protection
against any unforeseen losses.
 
 At
December 31, 2008, stockholders’ equity totaled $62.0 million, an decrease of
$2.0 million from $64.0 million at December 31, 2007. A net loss of $1.4
million in 2008 and stock repurchases of $1.4 million, were the primary factors
contributing to the decrease.  Also affecting capital in 2008 was paid
in capital in the amount of $0.7 million resulting from stock options exercised,
employee stock purchases, stock plan accruals and related tax benefits, and an
increase in other comprehensive income of $0.2 million, consisting of retirement
plan equity adjustments, which were partially offset by unrealized losses on
investment securities available-for-sale.  The Bank’s Tier 1 Leverage
Capital ratio at year-end 2008 was 8.7% and was 9.0% for 2007.
 
 On June
22, 2007, the Company approved a stock repurchase program effective June 22,
2007 to replace the Company’s previous stock purchase plan that commenced May 1,
2006.  The stock repurchase program, which will remain in effect until
June 21, 2009, allows repurchases by the Company in an aggregate of up to 4.0%
of the Company’s outstanding shares of common stock over each rolling
twelve-month period.  The Company’s previous stock purchase plan had
allowed repurchases by the Company in an aggregate of up to 2.5% of the
Company’s outstanding shares of common stock over each rolling twelve-month
period.  During 2008, the Bank paid $0.1 million in dividends to the
Company to help fund the repurchase of 85,415 shares of the Company’s
outstanding common stock.  During 2007, the Bank paid $6.0 million in
dividends to the Company to fund the repurchase of 370,716 shares of the
Company’s outstanding common stock.  The purpose of the stock
repurchase program is to give management the ability to more effectively manage
capital and create liquidity for shareholders who want to sell their
stock.  Management believes that the stock repurchase program has been
a prudent use of excess capital.
 
 The
capital of the Bank historically has been maintained at a level that is in
excess of regulatory guidelines.  The policy of annual stock dividends
has, over time, allowed the Bank to match capital and asset growth through
retained earnings and a managed program of geographic growth.
  49
  
 ITEM
7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 Market
risk is the risk to a bank’s financial position resulting from adverse changes
in market rates or prices, such as interest rates, foreign exchange rates or
equity prices.  The Bank has no exposure to foreign currency exchange
risk or any specific exposure to commodity price risk.  The Bank’s
major area of market risk exposure is interest rate risk (“IRR”).  The
Bank’s exposure to IRR can be explained as the potential for change in the
Bank’s reported earnings and/or the market value of its net
worth.  Variations in interest rates affect earnings by changing net
interest income and the level of other interest-sensitive income and operating
expenses.  Interest rate changes also affect the underlying economic
value of the Bank’s assets, liabilities and off-balance sheet
items.  These changes arise because the present value of future cash
flows, and often the cash flows themselves, changes with the interest
rates.  The effects of the changes in these present values reflect the
change in the Bank’s underlying economic value and provide a basis for the
expected change in future earnings related to the interest rate.  IRR
is inherent in the role of banks as financial intermediaries; however, a bank
with a high IRR level may experience lower earnings, impaired liquidity and
capital positions, and most likely, a greater risk of
insolvency.  Therefore, banks must carefully evaluate IRR to promote
safety and soundness in their activities.
 
 The
responsibility for the Bank’s market risk sensitivity management has been
delegated to the Asset/Liability Committee (“ALCO”).  Specifically,
ALCO utilizes computerized modeling techniques to monitor and attempt to control
the influence that market changes have on rate sensitive assets and rate
sensitive liabilities.
 
 Market
risk continues to be a major focal point of regulatory emphasis.  In
accordance with regulation, each bank is required to develop an IRR management
program depending on its structure, including certain fundamental components,
which are mandatory to ensure IRR management.  These elements include
appropriate board and management oversight, as well a comprehensive risk
management process that effectively identifies, measures, monitors and controls
risk.  Should a bank have material weaknesses in its risk management
process or high exposure relative to its capital, the bank regulatory agencies
will take action to remedy these shortcomings.  Moreover, the level of
a bank’s IRR exposure and the quality of its risk management process is a
determining factor when evaluating a bank’s capital adequacy.
  50
  
 The Bank
utilizes the tabular presentation alternative in complying with quantitative and
qualitative disclosure rules.
 
 The
following tables summarize the expected maturity, principal repricing, principal
repayment and fair value of the financial instruments that are sensitive to
changes in interest rates.
 
 Interest
      Rate Sensitivity Analysis at December 31,
2008
 (Dollars
in thousands)
 
 Expected
      Maturity/Repricing/Principal PaymentIn
      Thousands
                  
                  Within
      1 Year
                  
                  
                  1
      Year to 3 Years
                  
                  
                  3
      Years to 5 Years
                  
                  
                  After
      5 Years
                  
                  
                  Total
      Balance
                  
                  
                  Fair ValueInterest-Sensitive
      Assets:Federal
      funds sold
                  
                  $
                  40,860
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  40,860
                  
                  
                  
                  40,860Average
      interest rate
                  
                  
                  0.13
                  %
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  0.13
                  %
                  
                  
                  —Due
      from interest bearing
                  
                  $
                  1,750
                  
                  
                  
                  750
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,500
                  
                  
                  
                  2,535Average
      interest rate
                  
                  
                  4.94
                  %
                  
                  
                  4.85
                  %
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  4.91
                  %
                  
                  
                  —Fixed
      rate securities
                  
                  $
                  3,197
                  
                  
                  
                  11,530
                  
                  
                  
                  7,687
                  
                  
                  
                  19,692
                  
                  
                  
                  42,106
                  
                  
                  
                  42,106Average
      interest rate
                  
                  
                  6.41
                  %
                  
                  
                  5.20
                  %
                  
                  
                  5.20
                  %
                  
                  
                  6.56
                  %
                  
                  
                  5.94
                  %
                  
                  
                  —Other
      equity securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,311
                  
                  
                  
                  2,311
                  
                  
                  
                  2,311Average
      interest rate
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  3.81
                  %
                  
                  
                  3.81
                  %
                  
                  
                  —Fixed
      rate loans (1)
                  
                  $
                  41,960
                  
                  
                  
                  31,375
                  
                  
                  
                  28,830
                  
                  
                  
                  30,263
                  
                  
                  
                  132,428
                  
                  
                  
                  132,347Average
      interest rate
                  
                  
                  5.08
                  %
                  
                  
                  7.24
                  %
                  
                  
                  6.66
                  %
                  
                  
                  6.00
                  %
                  
                  
                  6.15
                  %
                  
                  
                  —Variable
      rate loans (1)
                  
                  $
                  144,002
                  
                  
                  
                  70,519
                  
                  
                  
                  45,477
                  
                  
                  
                  124,542
                  
                  
                  
                  384,540
                  
                  
                  
                  384,602Average
      interest rate
                  
                  
                  5.63
                  %
                  
                  
                  6.11
                  %
                  
                  
                  6.27
                  %
                  
                  
                  5.96
                  %
                  
                  
                  5.90
                  %
                  
                  
                  —Loans
      held-for-sale
                  
                  $
                  2,192
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  2,192
                  
                  
                  
                  2,192Average
      interest rate
                  
                  
                  5.67
                  %
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  5.67
                  %
                  
                  
                  —Interest-Sensitive
      Liabilities:NOW
      account deposits (2)
                  
                  $
                  7,335
                  
                  
                  
                  11,318
                  
                  
                  
                  7,609
                  
                  
                  
                  97,352
                  
                  
                  
                  123,614
                  
                  
                  
                  113,151Average
      interest rate
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  —Money
      market deposits (2)
                  
                  $
                  11,620
                  
                  
                  
                  17,430
                  
                  
                  
                  12,588
                  
                  
                  
                  55,195
                  
                  
                  
                  96,833
                  
                  
                  
                  90,090Average
      interest rate
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  0.10
                  %
                  
                  
                  —Savings
      deposits (2)
                  
                  $
                  5,879
                  
                  
                  
                  8,824
                  
                  
                  
                  5,883
                  
                  
                  
                  38,237
                  
                  
                  
                  58,823
                  
                  
                  
                  55,731Average
      interest rate
                  
                  
                  0.15
                  %
                  
                  
                  0.15
                  %
                  
                  
                  0.15
                  %
                  
                  
                  0.15
                  %
                  
                  
                  0.15
                  %
                  
                  
                  —Certificates
      of deposit
                  
                  $
                  113,886
                  
                  
                  
                  7,808
                  
                  
                  
                  1,912
                  
                  
                  
                  242
                  
                  
                  
                  123,848
                  
                  
                  
                  124,789Average
      interest rate
                  
                  
                  1.96
                  %
                  
                  
                  2.97
                  %
                  
                  
                  3.72
                  %
                  
                  
                  2.12
                  %
                  
                  
                  2.05
                  %
                  
                  
                  —Borrowed
      funds
                  
                  $
                  7,259
                  
                  
                  
                  4,000
                  
                  
                  
                  7,000
                  
                  
                  
                  —
                  
                  
                  
                  18,259
                  
                  
                  
                  19,025Average
      interest rate
                  
                  
                  2.85
                  %
                  
                  
                  3.61
                  %
                  
                  
                  4.13
                  %
                  
                  
                  —
                  
                  
                  
                  3.51
                  %
                  
                  
                  —Interest-Sensitive
      Off-Balance Sheet Items:Commitments
      to lend
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  198,615
                  
                  
                  
                  1,490Standby
      letters of credit
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  $
                  5,715
                  
                  
                  
                  57
 
 (1)Based
      upon contractual maturity dates and interest rate
    repricing.
 (2)NOW,
      money market and savings deposits do not carry contractual maturity
      dates.  The actual maturities of NOW, money market and savings
      deposits could vary substantially if future withdrawals differ from the
      Company’s historical
experience.
  51
  
 At
December 31, 2008, federal funds sold of $40.9 million with a yield of 0.13%,
due from interest bearing banks of $1.8 million with a weighted-average yield of
4.94% and investments of $3.2 million with a weighted-average, tax equivalent
yield of 6.41% were scheduled to mature within one year.  In addition,
net loans (including loans held-for-sale) of $188.2 million with a
weighted-average yield of 5.50% were scheduled to mature or reprice within the
same time-frame.  Overall, interest-earning assets scheduled to mature
within one year totaled $234.0 million with a weighted-average, tax-equivalent
yield of 4.70%.  With respect to interest-bearing liabilities, based
on historical withdrawal patterns, NOW accounts, money market and savings
deposits of $24.8 million with a weighted-average cost of 0.11% were scheduled
to mature within one year.  Certificates of deposit totaling $113.9
million with a weighted-average cost of 1.96% were scheduled to mature in the
same time-frame. In addition, borrowed funds totaling $7.3 million with a
weighted-average cost of 2.85% were scheduled to mature within one
year.  Total interest-bearing liabilities scheduled to mature within
one year equaled $146.0 million with a weighted-average cost of
1.69%.
 
 Historical
withdrawal patterns with respect to interest-bearing and non-interest-bearing
transaction accounts are not necessarily indicative of future performance as the
volume of cash flows may increase or decrease.  Loan information is
presented based on payment due dates and repricing dates, which may differ
materially from actual results due to prepayments.
 
 The Bank
seeks to control IRR by matching assets and liabilities.  One tool
used to ensure market rate return is variable rate loans.  Loans
totaling $188.2 million or 36.2% of the total loan portfolio (including loans
held-for-sale)   at December 31, 2008 are subject to repricing
within one year.  Loan maturities in the after five year category
increased to $154.8 million at December 31, 2008 from $110.7 million at December
31, 2007.
 
 The Bank
is required by FASB 115 to mark to market the Available-for-Sale investments at
the end of each quarter.  Mark to market adjustments resulted in a
reduction of $249,000 in other comprehensive income as reflected in the December
31, 2008 consolidated balance sheet.  Mark to market adjustments
during the year ended December 31, 2007 resulted in an increase of $338,000 in
other comprehensive income.  These adjustments were the result of
fluctuating interest rates.
  52
  
 ITEM
8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
 In
response to this Item, the information set forth on pages 56 through 95 in this
Annual Report is incorporated herein by reference.
 
 Financial Statements
Filed:
 
 Management’s
      Report
              Page
      54Report
      of Independent Registered Public Accounting Firm
              Page
      55Consolidated
      Balance Sheets as of December 31, 2008 and 2007
              Page
      56Consolidated
      Statements of Operations for Years ended December 31, 2008, 2007, and
      2006
              Page
      57Consolidated
      Statements of Stockholders' Equity and Comprehensive Income for Years
      ended December 31, 2008, 2007, and 2006
              Page
      58Consolidated
      Statements of Cash Flows for Years ended December 31, 2008, 2007, and
      2006
              Page
      59Notes
      to Consolidated Financial Statements
              Page
      60
 
  53
  
 Management’s
Report
  FIRST
NORTHERN COMMUNITY BANCORP AND SUBSIDIARY
 MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
 Management
of First Northern Community Bancorp and subsidiary (the "Company") is
responsible for establishing and maintaining effective internal control over
financial reporting. 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 accounting principles generally accepted in the United States of
America.
 
 Under the
supervision and with the participation of management, including the principal
executive officer and principal financial officer, the Company conducted an
evaluation of the effectiveness of internal control over financial reporting
based on the framework in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway
Commission.  Based on this evaluation under the framework in Internal
Control – Integrated Framework, management of the Company has concluded the
Company maintained effective internal control over financial reporting, as such
term is defined in Securities Exchange Act of 1934 Rules 13a-15(f), as of
December 31, 2008.
 
 Internal
control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal
control over financial reporting is a process that involves human diligence and
compliance and is subject to lapses in judgment and breakdowns resulting from
human failures. Internal control over financial reporting can also be
circumvented by collusion or improper management override.  Because of
such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process.  Therefore, it is possible to design into
the process safeguards to reduce, though not eliminate, this risk.
 
 Management
is also responsible for the preparation and fair presentation of the
consolidated financial statements and other financial information contained in
this report.  The accompanying consolidated financial statements were
prepared in conformity with accounting principles generally accepted in the
United States of America and include, as necessary, best estimates and judgments
by management.  MOSS ADAMS LLP, an independent registered public
accounting firm, has audited the Company’s consolidated financial statements as
of and for the year ended December 31, 2008, and the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2008, as
stated in their report, which is included herein.
 70
  
  /s/ Owen J. OnsumOwen
      J. OnsumPresident/Chief
      Executive Officer/Director(Principal
      Executive Officer)/s/ Louise A. WalkerLouise
      A. WalkerSenior
      Executive Vice President/Chief Financial Officer(Principal
      Financial Officer)
  
  March 13,
2009
   54
  Report
of Independent Registered Public Accounting Firm
 
 To The
Board of Directors and Stockholders
 First
Northern Community Bancorp:
 
 We have
audited the accompanying consolidated balance sheets of First Northern Community
Bancorp and subsidiary (the Company) as of December 31, 2008 and 2007 and the
related consolidated statements of operations, stockholders’ equity and
comprehensive income (loss) and cash flows for each of the years in the
three-year period ended December 31, 2008. We have also audited First Northern
Community Bancorp’s internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). First Northern Community Bancorp’s management is responsible for these
financial statements, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on these
financial statements and an opinion on the effectiveness of the Company’s
internal control over financial reporting 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 audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. 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.
An audit of internal control over financial reporting includes obtaining an
understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk, and performing
such other procedures as we considered necessary in the circumstances. We
believe that our audits provide a reasonable basis for our
opinions.
 
 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 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 the
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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Northern
Community Bancorp and subsidiary as of December 31, 2008 and 2007 and the
results of their operations and 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.  Also,
in our opinion First Northern Community Bancorp maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control – Integrated Framework
issued by the COSO.
 
 As
discussed in Notes 1 and 7 to the consolidated financial statements, effective
January 1, 2008, the Company adopted Statement of Financial Accounting Standard
(SFAS) no. 157, “Fair Value Measurements” and Emerging Issues Task Force (EITF)
06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects
of Endorsement Split-Dollar Life Insurance Arrangements”.
  /s/ MOSS ADAMS LLP
 
 Stockton, California
 March 13,
2009
  55
   FIRST
      NORTHERN COMMUNITY BANCORPAND
      SUBSIDIARYConsolidated
      Balance SheetsDecember
      31, 2008 and 2007(in
      thousands, except share amounts)
 
 
 
 2008
                        
                        
                        2007AssetsCash
      and due from banks
                        
                        $
                        25,150
                        
                        
                        $
                        52,090Federal
      funds sold
                        
                        
                        40,860
                        
                        
                        
                        46,940Investment
      securities – available-for-sale, at fair value (includes securities
      pledged to creditors with the right to sell or repledge of $21,071 and
      $2,016, respectively)
                        
                        
                        42,106
                        
                        
                        
                        74,849Loans
      (net of allowance for loan losses of $14,435 at December 31, 2008 and
      $10,876 at December 31, 2007)
                        
                        
                        516,968
                        
                        
                        
                        497,971Loans
      held-for-sale
                        
                        
                        2,192
                        
                        
                        
                        1,343Stock
      in Federal Home Loan Bank and other equity   securities, at
      cost
                        
                        
                        2,311
                        
                        
                        
                        2,199Premises
      and equipment, net
                        
                        
                        7,620
                        
                        
                        
                        7,872Other
      real estate owned
                        
                        
                        4,368
                        
                        
                        
                        879Other
      assets
                        
                        
                        29,227
                        
                        
                        
                        25,752Total
      assets
                        
                        $
                        670,802
                        
                        
                        $
                        709,895Liabilities
      and Stockholders' EquityDeposits:Demand
                        
                        $
                        181,600
                        
                        
                        $
                        193,258Interest-bearing
      transaction deposits
                        
                        
                        123,614
                        
                        
                        
                        135,381Savings
      and MMDAs
                        
                        
                        155,656
                        
                        
                        
                        178,137Time,
      under $100,000
                        
                        
                        64,252
                        
                        
                        
                        46,411Time,
      $100,000 and over
                        
                        
                        59,596
                        
                        
                        
                        69,484Total
      Deposits
                        
                        
                        584,718
                        
                        
                        
                        622,671FHLB
      advances and other borrowings
                        
                        
                        18,259
                        
                        
                        
                        15,832Accrued
      interest payable and other liabilities
                        
                        
                        5,796
                        
                        
                        
                        7,417Total
      Liabilities
                        
                        
                        608,773
                        
                        
                        
                        645,920Stockholders'
      Equity:Common
      stock, no par value; 16,000,000 shares authorized; 8,608,802 and 8,169,772
      shares issued and outstanding in 2008 and 2007,
    respectively;
                        
                        
                        58,983
                        
                        
                        
                        50,956Additional
      paid-in capital
                        
                        
                        977
                        
                        
                        
                        977Retained
      earnings
                        
                        
                        2,026
                        
                        
                        
                        12,209Accumulated
      other comprehensive income (loss), net
                        
                        
                        43
                        
                        
                        
                        (167
                        )Total
      stockholders’ equity
                        
                        
                        62,029
                        
                        
                        
                        63,975Commitments
      and contingenciesTotal
      liabilities and stockholders’ equity
                        
                        $
                        670,802
                        
                        
                        $
                        709,895See
      accompanying notes to consolidated financial statements.
  56
   FIRST
      NORTHERN COMMUNITY BANCORPAND
      SUBSIDIARYConsolidated
      Statements of OperationsYears
      Ended December 31, 2008, 2007 and 2006
                        (in
      thousands, except share amounts)2008
                      
                      
                      2007
                      
                      
                      2006Interest
      income:Interest
      and fees on loans
                      
                      $
                      35,077
                      
                      
                      $
                      41,488
                      
                      
                      $
                      41,894Federal
      funds sold
                      
                      
                      519
                      
                      
                      
                      2,660
                      
                      
                      
                      2,986Due
      from interest bearing
                      
                      
                      557
                      
                      
                      
                      273
                      
                      
                      
                      —Investment
      securities:Taxable
                      
                      
                      1,344
                      
                      
                      
                      2,789
                      
                      
                      
                      2,448Non-taxable
                      
                      
                      1,254
                      
                      
                      
                      1,271
                      
                      
                      
                      636Other
      earning assets
                      
                      
                      120
                      
                      
                      
                      113
                      
                      
                      
                      106Total
      interest income
                      
                      
                      38,871
                      
                      
                      
                      48,594
                      
                      
                      
                      48,070Interest
      expense:Time
      deposits $100,000 and over
                      
                      
                      2,056
                      
                      
                      
                      3,019
                      
                      
                      
                      2,315Other
      deposits
                      
                      
                      3,747
                      
                      
                      
                      8,406
                      
                      
                      
                      6,748Other
      borrowings
                      
                      
                      572
                      
                      
                      
                      313
                      
                      
                      
                      363Total
      interest expense
                      
                      
                      6,375
                      
                      
                      
                      11,738
                      
                      
                      
                      9,426Net
      interest income
                      
                      
                      32,496
                      
                      
                      
                      36,856
                      
                      
                      
                      38,644Provision
      for loan losses
                      
                      
                      16,164
                      
                      
                      
                      4,795
                      
                      
                      
                      735Net
      interest income after provisionfor
      loan losses
                      
                      
                      16,332
                      
                      
                      
                      32,061
                      
                      
                      
                      37,909Other
      operating income:Service
      charges on deposit accounts
                      
                      
                      3,734
                      
                      
                      
                      3,450
                      
                      
                      
                      2,820Net
      realized gains on available-for-sale securities
                      
                      
                      569
                      
                      
                      
                      638
                      
                      
                      
                      —Net
      realized gains on loans held-for-sale
                      
                      
                      255
                      
                      
                      
                      241
                      
                      
                      
                      45Net
      realized gains on other real estate owned
                      
                      
                      102
                      
                      
                      
                      353
                      
                      
                      
                      6Other
      income
                      
                      
                      3,136
                      
                      
                      
                      2,478
                      
                      
                      
                      2,418Total
      other operating income
                      
                      
                      7,796
                      
                      
                      
                      7,160
                      
                      
                      
                      5,289Other
      operating expenses:Salaries
      and employee benefits
                      
                      
                      15,469
                      
                      
                      
                      16,240
                      
                      
                      
                      17,455Occupancy
      and equipment
                      
                      
                      3,682
                      
                      
                      
                      3,654
                      
                      
                      
                      3,673Data
      processing
                      
                      
                      1,715
                      
                      
                      
                      1,628
                      
                      
                      
                      1,384Stationery
      and supplies
                      
                      
                      471
                      
                      
                      
                      560
                      
                      
                      
                      524Advertising
                      
                      
                      717
                      
                      
                      
                      885
                      
                      
                      
                      894Directors
      fees
                      
                      
                      211
                      
                      
                      
                      220
                      
                      
                      
                      162OREO
      expense and write-downs
                      
                      
                      1,593
                      
                      
                      
                      44
                      
                      
                      
                      —Other
                      
                      
                      5,279
                      
                      
                      
                      5,572
                      
                      
                      
                      5,127Total
      other operating expenses
                      
                      
                      29,137
                      
                      
                      
                      28,803
                      
                      
                      
                      29,219(Loss)
      income before income tax (benefit) expense
                      
                      
                      (5,009
                      )
                      
                      
                      10,418
                      
                      
                      
                      13,979(Benefit)
      provision for income tax
                      
                      
                      (3,635
                      )
                      
                      
                      3,137
                      
                      
                      
                      5,169Net
      (loss) income
                      
                      $
                      (1,374
                      )
                      
                      $
                      7,281
                      
                      
                      $
                      8,810Basic
      (loss) income per share
                      
                      $
                      (0.15
                      )
                      
                      $
                      0.79
                      
                      
                      $
                      0.95Diluted
      (loss) income per share
                      
                      $
                      (0.15
                      )
                      
                      $
                      0.77
                      
                      
                      $
                      0.90See
      accompanying notes to consolidated financial statements.
  57
 FIRST
      NORTHERN COMMUNITY BANCORPAND
      SUBSIDIARYConsolidated
      Statements of Stockholders' Equity and Comprehensive
IncomeYears
      Ended December 31, 2008, 2007 and 2006(in
      thousands, except share amounts)AccumulatedCommon
      Stock
                      
                      
                      Comprehensive
                      
                      
                      Additional
                      
                      
                      
                      
                      
                      OtherIncome
                      
                      
                      Paid-in
                      
                      
                      Retained
                      
                      
                      ComprehensiveDescription
                      
                      Shares
                      
                      
                      Amounts
                      
                      
                      (Loss)
                      
                      
                      Capital
                      
                      
                      Earnings
                      
                      
                      Income (Loss)
                      
                      
                      TotalBalance
      at December 31, 2005
                      
                      
                      7,558,759
                      
                      
                      $
                      36,100
                      
                      
                      
                      
                      
                      $
                      977
                      
                      
                      $
                      19,606
                      
                      
                      $
                      119
                      
                      
                      $
                      56,802Comprehensive
      income:Net
      income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      8,810
                      
                      
                      
                      
                      
                      
                      
                      8,810
                      
                      
                      
                      
                      
                      
                      
                      8,810Other
      comprehensive loss:Unrealized
      holding losses arising during the current period, net of tax effect of
      $75
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (112
                      )Total
      other comprehensive loss, net of tax effect of $75
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (112
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (112
                      )
                      
                      
                      (112
                      )Comprehensive
      income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      8,698Directors’
      and officers’ retirement plan equity adjustments, net of tax effect of
      $341
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (512
                      )
                      
                      
                      (512
                      )6%
      stock dividend
                      
                      
                      455,472
                      
                      
                      
                      12,525
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (12,525
                      )
                      
                      
                      
                      
                      
                      
                      —Cash
      in lieu of fractional shares
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (15
                      )
                      
                      
                      
                      
                      
                      
                      (15
                      )Accrued
      compensation
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (84
                      )
                      
                      
                      
                      
                      
                      
                      (84
                      )Stock-based
      compensation and related tax benefits
                      
                      
                      
                      
                      
                      
                      817
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      817Common
      shares issued, including tax benefits
                      
                      
                      122,399
                      
                      
                      
                      472
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      472Stock
      repurchase and retirement
                      
                      
                      (155,678
                      )
                      
                      
                      (4,188
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (4,188
                      )Balance
      at December 31, 2006
                      
                      
                      7,980,952
                      
                      
                      $
                      45,726
                      
                      
                      
                      
                      
                      
                      $
                      977
                      
                      
                      $
                      15,592
                      
                      
                      $
                      (505
                      )
                      
                      $
                      61,990Comprehensive
      income:Net
      income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      7,281
                      
                      
                      
                      
                      
                      
                      
                      7,281
                      
                      
                      
                      
                      
                      
                      
                      7,281Other
      comprehensive (loss) income:Unrealized
      holding losses arising during the current period, net of tax effect of
      $30
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (45
                      )Reclassification
      adjustment due to gains realized, net of tax effect of
$255
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      383Total
      other comprehensive income, net of tax effect of $225
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      338
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      338
                      
                      
                      
                      338Comprehensive
      income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      7,6196%
      stock dividend
                      
                      
                      476,976
                      
                      
                      
                      10,851
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (10,851
                      )
                      
                      
                      
                      
                      
                      
                      —Cash
      in lieu of fractional shares
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (13
                      )
                      
                      
                      
                      
                      
                      
                      (13
                      )Stock-based
      compensation and related tax benefits
                      
                      
                      
                      
                      
                      
                      705
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      705Common
      shares issued, including tax benefits
                      
                      
                      82,560
                      
                      
                      
                      525
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      525Stock
      repurchase and retirement
                      
                      
                      (370,716
                      )
                      
                      
                      (6,851
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (6,851
                      )Balance
      at December 31, 2007
                      
                      
                      8,169,772
                      
                      
                      $
                      50,956
                      
                      
                      
                      
                      
                      
                      $
                      977
                      
                      
                      $
                      12,209
                      
                      
                      $
                      (167
                      )
                      
                      $
                      63,975Cumulative
      effect of adoption of EITF 06-04
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (158
                      )
                      
                      
                      
                      
                      
                      
                      (158
                      )Comprehensive
      loss:Net
      loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (1,374
                      )
                      
                      
                      
                      
                      
                      
                      (1,374
                      )
                      
                      
                      
                      
                      
                      
                      (1,374
                      )Other
      comprehensive income (loss):Unrealized
      holding gains arising during the current period, net of tax effect of
      $62
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      92Reclassification
      adjustment due to gains realized, net of tax effect of
$228
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (341
                      )Directors’
      and officers’ retirement plan equity adjustments, net of tax effect of
      $306
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      459Total
      other comprehensive income, net of tax effect of $140
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      210
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      210
                      
                      
                      
                      210Comprehensive
      loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (1,164
                      )6%
      stock dividend
                      
                      
                      488,234
                      
                      
                      
                      8,642
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (8,642
                      )
                      
                      
                      
                      
                      
                      
                      —Cash
      in lieu of fractional shares
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (9
                      )
                      
                      
                      
                      
                      
                      
                      (9
                      )Stock-based
      compensation and related tax benefits
                      
                      
                      
                      
                      
                      
                      519
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      519Common
      shares issued, including tax benefits
                      
                      
                      36,211
                      
                      
                      
                      225
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      225Stock
      repurchase and retirement
                      
                      
                      (85,415
                      )
                      
                      
                      (1,359
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (1,359
                      )Balance
      at December 31, 2008
                      
                      
                      8,608,802
                      
                      
                      $
                      58,983
                      
                      
                      
                      
                      
                      
                      $
                      977
                      
                      
                      $
                      2,026
                      
                      
                      $
                      43
                      
                      
                      $
                      62,029See
      accompanying notes to consolidated financial statements.
  
   58
  
 FIRST
      NORTHERN COMMUNITY BANCORPAND
      SUBSIDIARYConsolidated
      Statements of Cash FlowsYears
      Ended December 31, 2008, 2007 and 2006(in
      thousands, except share amounts)2008
                  
                  
                  2007
                  
                  
                  2006Cash
      flows from operating activities:Net
      (loss) income
                  
                  $
                  (1,374
                  )
                  
                  $
                  7,281
                  
                  
                  $
                  8,810Adjustments
      to reconcile net income to net cash provided byoperating
      activities:Provision
      for loan losses
                  
                  
                  16,164
                  
                  
                  
                  4,795
                  
                  
                  
                  735Stock
      plan accruals
                  
                  
                  497
                  
                  
                  
                  523
                  
                  
                  
                  395Tax
      benefit for stock options
                  
                  
                  22
                  
                  
                  
                  182
                  
                  
                  
                  422Depreciation
      and amortization
                  
                  
                  1,045
                  
                  
                  
                  1,112
                  
                  
                  
                  1,041Accretion
      and amortization, net
                  
                  
                  (47
                  )
                  
                  
                  (149
                  )
                  
                  
                  (96
                  )Net
      realized gains on available-for-sale securities
                  
                  
                  (569
                  )
                  
                  
                  (638
                  )
                  
                  
                  —Net
      realized gains on loans held-for-sale
                  
                  
                  (255
                  )
                  
                  
                  (241
                  )
                  
                  
                  (45
                  )Gain
      on sale of OREO properties
                  
                  
                  (102
                  )
                  
                  
                  (353
                  )
                  
                  
                  (6
                  )Write-downs
      of OREO properties
                  
                  
                  1,484
                  
                  
                  
                  —
                  
                  
                  
                  —Net
      loss (gain) on sale of bank premises and equipment
                  
                  
                  19
                  
                  
                  
                  (2
                  )
                  
                  
                  —Benefit
      from deferred income taxes
                  
                  
                  (2,162
                  )
                  
                  
                  (2,085
                  )
                  
                  
                  (503
                  )Proceeds
      from sales of loans held-for-sale
                  
                  
                  35,816
                  
                  
                  
                  36,776
                  
                  
                  
                  38,386Originations
      of loans held-for-sale
                  
                  
                  (36,410
                  )
                  
                  
                  (36,310
                  )
                  
                  
                  (38,361
                  )Decrease
      in deferred loan origination fees and costs, net
                  
                  
                  (539
                  )
                  
                  
                  (196
                  )
                  
                  
                  (355
                  )Increase
      in accrued interest receivable and other  assets
                  
                  
                  (824
                  )
                  
                  
                  (1,203
                  )
                  
                  
                  (2,016
                  )(Decrease)
      increase in accrued interest payable and other liabilities
                  
                  
                  (1,621
                  )
                  
                  
                  (1,155
                  )
                  
                  
                  1,477Net
      cash provided by operating activities
                  
                  
                  11,144
                  
                  
                  
                  8,337
                  
                  
                  
                  9,884Cash
      flows from investing activities:Proceeds
      from maturities of available-for-sale securities
                  
                  
                  9,992
                  
                  
                  
                  14,205
                  
                  
                  
                  12,900Proceeds
      from sales of available-for-sale securities
                  
                  
                  32,764
                  
                  
                  
                  20,140
                  
                  
                  
                  —Principal
      repayments on available-for-sale securities
                  
                  
                  4,010
                  
                  
                  
                  3,461
                  
                  
                  
                  1,989Purchase
      of available-for-sale securities
                  
                  
                  (13,822
                  )
                  
                  
                  (37,125
                  )
                  
                  
                  (42,503
                  )Net
      (increase) decrease in other interest earnings assets
                  
                  
                  (112
                  )
                  
                  
                  (106
                  )
                  
                  
                  38Net
      increase in loans
                  
                  
                  (41,417
                  )
                  
                  
                  (24,633
                  )
                  
                  
                  (19,975
                  )Purchases
      of bank premises and equipment
                  
                  
                  (812
                  )
                  
                  
                  (924
                  )
                  
                  
                  (790
                  )Proceeds
      from sale of bank premises and equipment
                  
                  
                  —
                  
                  
                  
                  2
                  
                  
                  
                  —Proceeds
      from sale of OREO
                  
                  
                  1,924
                  
                  
                  
                  353
                  
                  
                  
                  6Net
      cash used in investing activities
                  
                  
                  (7,473
                  )
                  
                  
                  (24,627
                  )
                  
                  
                  (48,335
                  )Cash
      flows from financing activities:Net
      (decrease) increase in deposits
                  
                  
                  (37,953
                  )
                  
                  
                  18,989
                  
                  
                  
                  21,901Net
      increase (decrease) in FHLB advances and other borrowings
                  
                  
                  2,427
                  
                  
                  
                  4,851
                  
                  
                  
                  (3,988
                  )Cash
      dividends paid in lieu of fractional shares
                  
                  
                  (9
                  )
                  
                  
                  (13
                  )
                  
                  
                  (15
                  )Common
      stock issued
                  
                  
                  225
                  
                  
                  
                  525
                  
                  
                  
                  472Tax
      benefit for stock options
                  
                  
                  (22
                  )
                  
                  
                  (182
                  )
                  
                  
                  (422
                  )Repurchase
      of common stock
                  
                  
                  (1,359
                  )
                  
                  
                  (6,851
                  )
                  
                  
                  (4,188
                  )Net
      cash (used in) provided by financing activities
                  
                  
                  (36,691
                  )
                  
                  
                  17,319
                  
                  
                  
                  13,760Net
      change in cash and cash equivalents
                  
                  
                  (33,020
                  )
                  
                  
                  1,029
                  
                  
                  
                  (24,691
                  )Cash
      and cash equivalents at beginning of year
                  
                  
                  99,030
                  
                  
                  
                  98,001
                  
                  
                  
                  122,692Cash
      and cash equivalents at end of year
                  
                  $
                  66,010
                  
                  
                  $
                  99,030
                  
                  
                  $
                  98,001See
      accompanying notes to consolidated financial statements.
 
  59
 
 FIRST
      NORTHERN COMMUNITY BANCORPAND
      SUBSIDIARYNotes
      to Consolidated Financial StatementsYears
      Ended December 31, 2008, 2007 and 2006
                (in
      thousands, except share amounts)
 
  (1)
              Summary
      of Significant Accounting Policies
  First
Northern Community Bancorp (the “Company”) is a bank holding company whose only
subsidiary, First Northern Bank of Dixon (the “Bank”), a California state
chartered bank, conducts general banking activities, including collecting
deposits and originating loans, and serves Solano, Yolo, Sacramento, Placer and
El Dorado Counties.  All intercompany transactions between the Company
and the Bank have been eliminated in consolidation.
  The
accounting and reporting policies of the Company conform with accounting
principles generally accepted in the United States of America.  In
preparing the consolidated financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period.  Actual results could differ from those estimates applied
in the preparation of the accompanying consolidated financial statements. For
the Company the most significant accounting estimate is the allowance for loan
losses.  See
footnote (1) (e).  A summary of the significant accounting policies
applied in the preparation of the accompanying consolidated financial statements
follows.
  (a)
              Cash
      Equivalents
  For
purposes of the consolidated statements of cash flows, the Company considers due
from banks, federal funds sold for one-day periods and short-term bankers
acceptances to be cash equivalents.
  (b)
              Investment
      Securities
  Investment
securities consist of U.S. Treasury securities, U.S. Agency securities,
obligations of states and political subdivisions, obligations of U.S.
Corporations, mortgage backed securities and other securities.  At the
time of purchase of a security the Company designates the security as
held-to-maturity or available-for-sale, based on its investment objectives,
operational needs and intent to hold.  The Company does not purchase
securities with the intent to engage in trading activity.
  Held-to-maturity
securities are recorded at amortized cost, adjusted for amortization or
accretion of premiums or discounts.  Available-for-sale securities are
recorded at fair value with unrealized holding gains and losses, net of the
related tax effect, reported as a separate component of stockholders’ equity
until realized.
  A decline
in the market value of any available-for-sale or held-to-maturity security below
cost that is deemed other than temporary results in a charge to earnings and the
corresponding establishment of a new cost basis for the
security.  Premiums and discounts are amortized or accreted over the
life of the related held-to-maturity or available-for-sale security as an
adjustment to yield using the effective interest method.  Dividend and
interest income are recognized when earned.  Realized gains and losses
for securities classified as available-for-sale and held-to-maturity are
included in earnings and are derived using the specific identification method
for determining the cost of securities sold.
  Derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and hedging activities are
recognized as either assets or liabilities in the balance sheet and measured at
fair value.  The Company did not hold any derivatives at December 31,
2008 and 2007.
   60
  
 (c)
              Loans
  Loans are
reported at the principal amount outstanding, net of deferred loan fees and the
allowance for loan losses.  A loan is considered impaired when, based
on current information and events; it is probable that the Company will be
unable to collect all amounts due according to the contractual terms of the loan
agreement, including scheduled interest payments.  For a loan that has
been restructured, the contractual terms of the loan agreement refer to the
contractual terms specified by the original loan agreement, not the contractual
terms specified by the restructuring agreement.  An impaired loan is
measured based upon the present value of future cash flows discounted at the
loan’s effective rate, the loan’s observable market price, or the fair value of
collateral if the loan is collateral dependent. Interest on impaired loans is
recognized on a cash basis.  If the measurement of the impaired loan
is less than the recorded investment in the loan, an impairment is recognized by
a charge to the allowance for loan losses.
  Unearned
discount on installment loans is recognized as income over the terms of the
loans by the interest method.  Interest on other loans is calculated
by using the simple interest method on the daily balance of the principal amount
outstanding.
  Loan fees
net of certain direct costs of origination, which represent an adjustment to
interest yield are deferred and amortized over the contractual term of the loan
using the interest method.
  Loans on
which the accrual of interest has been discontinued are designated as
non-accrual loans.  Accrual of interest on loans is discontinued
either when reasonable doubt exists as to the full and timely collection of
interest or principal or when a loan becomes contractually past due by ninety
days or more with respect to interest or principal.  When a loan is
placed on non-accrual status, all interest previously accrued but not collected
is reversed against current period interest income.  Interest accruals
are resumed on such loans only when they are brought fully current with respect
to interest and principal and when, in the judgment of management, the loans are
estimated to be fully collectible as to both principal and
interest.  Restructured loans are loans on which concessions in terms
have been granted because of the borrowers’ financial
difficulties.  Interest is generally accrued on such loans in
accordance with the new terms.
  (d)
              Loans
      Held-for-Sale
  Loans
originated and held-for-sale are carried at the lower of cost or estimated
market value in the aggregate.  Net unrealized losses are recognized
through a valuation allowance by charges to income.
  (e)
              Allowance
      for Loan Losses
  The
allowance for loan losses is established through a provision charged to
expense.  Loan losses are charged off against the allowance for loan
losses when management believes that the collectability of the principal is
unlikely.  The allowance is an amount that management believes will be
adequate to absorb losses inherent in existing loans and overdrafts on
evaluations of collectability and prior loss experience.  The
evaluations take into consideration such factors as changes in the nature and
volume of the portfolio, overall portfolio quality, loan concentrations,
specific problem loans, commitments, and current and anticipated economic
conditions that may affect the borrowers’ ability to pay.  While
management uses these evaluations to determine the allowance for loan losses,
additional provisions may be necessary based on changes in the factors used in
the evaluations.
  Material
estimates relating to the determination of the allowance for loan losses are
particularly susceptible to significant change in the near
term.  Management believes that the allowance for loan losses is
adequate.  While management uses available information to recognize
losses on loans, future additions to the allowance may be necessary based on
changes in economic conditions and other factors.  In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank’s allowance for loan losses.  Such
agencies may require the Bank to recognize additional allowance based on their
judgment about information available to them at the time of their
examination.
   61
  
 (f)
              Premises
      and Equipment
  Premises
and equipment are stated at cost, less accumulated
depreciation.  Depreciation is computed substantially by the
straight-line method over the estimated useful lives of the related
assets.  Leasehold improvements are depreciated over the estimated
useful lives of the improvements or the terms of the related leases, whichever
is shorter.  The useful lives used in computing depreciation are as
follows:
  Buildings
      and improvements
              
              15
      to 50 yearsFurniture
      and equipment
              
              3
      to 10 years
 
 (g)
              Other
      Real Estate Owned
  Other
real estate acquired by foreclosure is carried at the lower of the recorded
investment in the property or its fair value less estimated selling
costs.  Prior to foreclosure, the value of the underlying loan is
written down to the fair value of the real estate to be acquired by a charge to
the allowance for loan losses, if necessary.  Fair value of other real
estate owned is generally determined based on an appraisal of the
property.  Any subsequent operating expenses or income, reduction in
estimated values and gains or losses on disposition of such properties are
included in other operating expenses.
  Revenue
recognition on the disposition of real estate is dependent upon the transaction
meeting certain criteria relating to the nature of the property sold and the
terms of the sale.  Under certain circumstances, revenue recognition
may be deferred until these criteria are met.
  The Bank
held other real estate owned (OREO) in the amount of $4,368 and $879 as of
December 31, 2008 and 2007, respectively.  The Bank had no allowance
for losses on OREO recorded for these years.
  (h)
              Impairment
      of Long-Lived Assets and Long-Lived Assets to Be Disposed
    Of
  Long-lived
assets and certain identifiable intangibles are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable.  Recoverability of assets to be held and used
is measured by a comparison of the carrying amount of an asset to future net
cash flows expected to be generated by the asset.  If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets.  Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell.
  (i)
              Gain
      or Loss on Sale of Loans and Servicing
Rights
  Retained
interests in loans sold are measured by allocating the previous carrying amount
of the transferred assets between the loans sold and retained interests, if any,
based on their relative fair value at the date of transfer.  Fair
values are estimated using discounted cash flows based on a current market
interest rate.
 
 A sale is
recognized when the transaction closes and the proceeds are other than
beneficial interests in the assets sold.  A gain or loss is recognized
to the extent that the sales proceeds and the fair value of the servicing asset
exceed or are less than the book value of the loan.  Additionally, a
normal cost for servicing the loan is considered in the determination of the
gain or loss.
  When
servicing rights are sold, a gain or loss is recognized at the closing date to
the extent that the sales proceeds, less costs to complete the sale, exceed or
are less than the carrying value of the servicing rights held.
  Transfers
and servicing of financial assets and extinguishments of liabilities are
accounted for and reported based on consistent application of a
financial-components approach that focuses on control.  Transfers of
financial assets that are sales are distinguished from transfers that are
secured borrowings.  Retained interests (mortgage servicing rights) in
loans sold are measured by allocating the previous carrying amount of the
transferred assets between the loans sold and retained interest, if any, based
on their relative fair value at the date of transfer.  Fair values are
estimated using discounted cash flows based on a current market interest
rate.
  62
  
 The
Company recognizes a gain and a related asset for the fair value of the rights
to service loans for others when loans are sold.  The Company sold
substantially all of its conforming long-term residential mortgage loans
originated during the years ended December 31, 2008, 2007 and 2006 for cash
proceeds equal to the fair value of the loans.
 
 The
recorded value of mortgage servicing rights is included in other assets, and is
amortized in proportion to, and over the period of, estimated net servicing
revenues.  The Company assesses capitalized mortgage servicing rights
for impairment based upon the fair value of those rights at each reporting
date.  For purposes of measuring impairment, the rights are stratified
based upon the product type, term and interest rates.  Fair value is
determined by discounting estimated net future cash flows from mortgage
servicing activities using discount rates that approximate current market rates
and estimated prepayment rates, among other assumptions.  The amount
of impairment recognized, if any, is the amount by which the capitalized
mortgage servicing rights for a stratum exceeds their fair
value.  Impairment, if any, is recognized through a valuation
allowance for each individual stratum.
 
 The
Company had mortgage loans held-for-sale of $2,192 and $1,343 at December 31,
2008 and 2007, respectively.  At December 31, 2008 and 2007, the
Company serviced real estate mortgage loans for others of $122,734 and $116,310,
respectively.
 
 Mortgage
servicing rights as of December 31, 2008 were $893.  The balance as of
December 31, 2007 was $956.
 
 (j)
              Income
      Taxes
  The
Company accounts for income taxes under the asset and liability
method.  Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and tax credit
carry forwards.  Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
  On July
15, 2002, the Bank made a $2,355 equity investment in a partnership, which owns
low-income affordable housing projects that generate tax benefits in the form of
federal and state housing tax credits.  On December 31, 2004, the Bank
transferred the amortized cost of the equity investment to a similar equity
investment partnership which owns low income affordable housing projects that
generate tax benefits in the form of federal and state tax
credits.  As a limited partner investor in this partnership, the
Company receives tax benefits in the form of tax deductions from partnership
operating losses and federal and state income tax credits.  The
federal and state income tax credits are earned over a 10-year period as a
result of the investment property meeting certain criteria and are subject to
recapture for non-compliance with such criteria over a 15-year
period.  The expected benefit resulting from the low-income housing
tax credits is recognized in the period for which the tax benefit is recognized
in the Company’s consolidated tax returns.  This investment is
accounted for using the effective yield method and is recorded in other assets
on the balance sheet.  Under the effective yield method, the Company
recognizes tax credits as they are allocated and amortizes the initial cost of
the investment to provide a constant effective yield over the period that tax
credits are allocated to the Company.  The effective yield is the
internal rate of return on the investment, based on the cost of the investment
and the guaranteed tax credits allocated to the Company.  Any expected
residual value of the investment was excluded from the effective yield
calculation.  Cash received from operations of the limited partnership
or sale of the property, if any, will be included in earnings when realized or
realizable.
  63
  
 (k)
              Stock
      Option Plan
  On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
(“SFAS”) No. 123R, “Share-Based Payments,” which addresses the accounting for
stock-based payment transactions whereby an entity receives employee services in
exchange for equity instruments, including stock options.  The Company
has elected the modified prospective transition method as permitted under SFAS
No. 123R, and accordingly prior periods have not been restated to reflect the
impact of SFAS No. 123R.  The modified prospective transition method
requires that stock-based compensation expense be recorded for all new and
unvested stock options that are ultimately expected to vest as the requisite
service is rendered beginning on January 1, 2006.  The Company issues
new shares of common stock upon the exercise of stock options.  See Note 13 of Notes to
Consolidated Financial Statements (page 81).
  (l)
              Earnings
      Per Share (EPS)
 
 Basic EPS
includes no dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution of securities that could
share in the earnings of an entity.  See Note 10 of Notes to
Consolidated Financial Statements (page 80).
 
 (m)
              Comprehensive
      Income
 
 Accounting
principles generally accepted in the United States require that recognized
revenue, expenses, gains and losses be included in net
income.  Although certain changes in assets and liabilities, such as
unrealized gain 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.
  (n)
              Fiduciary
      Powers
 
 On July
1, 2002, the Bank received trust powers from applicable regulatory agencies and
on that date began to offer fiduciary services for individuals, businesses,
governments and charitable organizations in the Solano, Yolo, Sacramento, Placer
and El Dorado County areas.  The Bank’s full-service asset management
and trust department, which offers and manages such fiduciary services, is
located in downtown Sacramento.
 
 (o)
              Impact
      of Recently Issued Accounting
Standards
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS
No. 157 defines fair value, establishes a framework for measuring fair value and
expands disclosures about fair value measurements. SFAS No. 157 establishes a
fair value hierarchy about the assumptions used to measure fair value and
clarifies assumptions about risk and the effect of a restriction on the sale or
use of an asset. The standard was effective for the Company in the fiscal year
beginning January 1, 2008.  The adoption of SFAS No. 157 did not have
a material impact on the Company’s financial position and results of
operations.  See footnote 7 “Fair Value Measurement” for further
information.
 
 In
February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of
FASB Statement No. 157.  This FSP delays the effective date of FAS 157
for all non-financial assets and non-financial 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 with those fiscal years.  The
expected impact of adoption will not be material.
 
 On
October 10, 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active. The FSP clarifies
the application of FASB Statement No. 157, Fair Value Measurements, in a market
that is not active and provides an example to illustrate key considerations in
determining the fair value of a financial asset when the market for that
financial asset is not active. The FSP is effective immediately, and includes
prior period financial statements that have not yet been issued, and therefore
the Company is subject to the provision of the FSP effective September 30, 2008.
The implementation of FSP FAS 157-3 did not affect the Company’s fair value
measurement as of September 30, 2008.
 
 
 64
   In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” Under this Standard, the Company
may elect to report many financial instruments and certain other assets and
liabilities at fair value on an instrument-by-instrument basis with changes in
value reported in earnings each reporting period.  This election is
irrevocable. SFAS No. 159 provides an opportunity to mitigate volatility in
reported earnings that is caused by measuring hedged assets and liabilities that
were previously required to use a different accounting method than the related
hedging contracts when the complex provisions of SFAS No. 133 hedge accounting
are not met.  SFAS No. 159 was effective for the Company in the fiscal
year beginning January 1, 2008.  The Company did not choose to report
additional assets and liabilities at fair value other than those required to be
accounted at fair value prior to the adoption of SFAS No. 159.  The
adoption of SFAS No. 159 did not have a material impact on the Company’s
financial position and results of operations.
 
 In
September 2006, the Emerging Issues Task Force issued EITF Issue No. 06-4,
“Accounting for Deferred Compensation and Postretirement Benefit Aspects of
Endorsement Split-Dollar Life Insurance Arrangements.”  This consensus
concludes that for a split-dollar life insurance arrangement within the scope of
this Issue, an employer should recognize a liability for future benefits in
accordance with SFAS No. 106 (if, in substance, a postretirement benefit plan
exits) or APB Opinion No. 12 (if the arrangement is, in substance, an individual
deferred compensation contract) based on the substantive agreement with the
employee.  The consensus was effective for the Company in the fiscal
year beginning January 1, 2008.  The adoption of EITF 06-4 did not
have a material impact on the Company’s financial position and results of
operations.
 
 In
November 2007, EITF Issue No. 07-6, Accounting for the Sale of Real Estate
Subject to the Requirements of FASB Statement No. 66, Accounting for Sales of
Real Estate, When the Agreement Includes a Buy-Sell Clause, was issued. The Task
Force reached a consensus that a buy-sell clause in a sale of real estate that
otherwise qualifies for partial sale accounting does not by itself constitute a
form of continuing involvement that would preclude partial sale accounting under
SFAS No. 66, Accounting for Sales of Real Estate.  However, continuing
involvement could be present if the buy-sell clause in conjunction with other
implicit and explicit terms of the arrangement indicate that the seller has an
obligation to repurchase the property, the terms of the transaction allow the
buyer to compel the seller to repurchase the property, or the seller can compel
the buyer to sell its interest in the property back to the seller. The consensus
is effective for fiscal years beginning after December 15, 2007.  The
consensus applies to new assessments made under SFAS No. 66 after January 1,
2008.  The adoption of EITF Issue No. 07-6 did not have a material
impact on the Company’s financial position and results of
operations.
 
 In
December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in
Consolidated Financial Statements, which will require non-controlling interests
(previously referred to as minority interests) to be treated as a separate
component of equity, not as a liability or other item outside of permanent
equity.  SFAS No. 160 applies to the accounting for non-controlling
interests and transactions with non-controlling interest holders in consolidated
financial statements. SFAS No. 160 is effective for periods beginning on or
after December 15, 2008.  Earlier application is
prohibited.  SFAS No. 160 will be applied prospectively to all
non-controlling interests, including any that arose before the effective date
except that comparative period information must be recast to classify
non-controlling interests in equity, attribute net income and other
comprehensive income to non-controlling interests, and provide other disclosures
required by SFAS No. 160.  The Company does not expect the adoption of
SFAS No. 160 to have any material impact on the consolidated financial
statements or results of operations of the Company.
 
 (p)
              Reclassifications
 
 Certain
reclassifications have been made to the prior years’ financial statements to
conform to the current year’s presentation.
 
 (2)
              Cash
      and Due from Banks
  The Bank
is required to maintain reserves with the Federal Reserve Bank based on a
percentage of deposit liabilities. No aggregate reserves were required at
December 31, 2008 and 2007.  The Bank has met its average reserve
requirements during 2008 and 2007 and the minimum required balance at December
31, 2008 and 2007.
  65
   (3)
              Investment
      Securities
  The
amortized cost, unrealized gains and losses and estimated market values of
investments in debt and other securities at December 31, 2008 are summarized as
follows:
  Amortized
      cost
                  
                  
                  Unrealized
      gains
                  
                  
                  Unrealized
      losses
                  
                  
                  Estimated
      market valueInvestment
      securities available for sale:U.S.
      Treasury securities
                  
                  $
                  249
                  
                  
                  $
                  25
                  
                  
                  $
                  —
                  
                  
                  $
                  274Securities
      of U.S. government agencies and corporations
                  
                  
                  2,018
                  
                  
                  
                  21
                  
                  
                  
                  —
                  
                  
                  
                  2,039Obligations
      of states and political subdivisions
                  
                  
                  26,345
                  
                  
                  
                  244
                  
                  
                  
                  (358
                  )
                  
                  
                  26,231Mortgage
      backed securities
                  
                  
                  13,223
                  
                  
                  
                  369
                  
                  
                  
                  (30
                  )
                  
                  
                  13,562Total
      debt securities
                  
                  $
                  41,835
                  
                  
                  $
                  659
                  
                  
                  $
                  (388
                  )
                  
                  $
                  42,106
 
 The
amortized cost, unrealized gains and losses and estimated market values of
investments in debt and other securities at December 31, 2007 are
summarized as follows:
  Amortized
      cost
                  
                  
                  Unrealized
      gains
                  
                  
                  Unrealized
      losses
                  
                  
                  Estimated
      market valueInvestment
      securities available for sale:U.S.
      Treasury securities
                  
                  $
                  249
                  
                  
                  $
                  14
                  
                  
                  $
                  —
                  
                  
                  $
                  263Securities
      of U.S. government agencies and corporations
                  
                  
                  19,960
                  
                  
                  
                  189
                  
                  
                  
                  (10
                  )
                  
                  
                  20,139Obligations
      of states and political subdivisions
                  
                  
                  36,675
                  
                  
                  
                  446
                  
                  
                  
                  (64
                  )
                  
                  
                  37,057Mortgage
      backed securities
                  
                  
                  17,278
                  
                  
                  
                  116
                  
                  
                  
                  (4
                  )
                  
                  
                  17,390Total
      debt securities
                  
                  $
                  74,162
                  
                  
                  $
                  765
                  
                  
                  $
                  (78
                  )
                  
                  $
                  74,849
  
  Gross
realized gains from sales of available-for-sale securities were $666, $638 and
$0 for the years ended December 31, 2008, 2007 and 2006,
respectively.  Gross realized losses from sales of available-for-sale
securities were $97, $-0- and $-0- for the years ended December 31, 2008, 2007
and 2006, respectively.
 
 The
amortized cost and estimated market value of debt and other securities at
December 31, 2008, by contractual maturity, are shown in the following
table:
  Amortized
                    cost
                  
                  
                  Estimated
      market
                    valueDue
      in one year or less
                  
                  $
                  3,191
                  
                  
                  $
                  3,197Due
      after one year through five years
                  
                  
                  18,756
                  
                  
                  
                  19,217Due
      after five years through ten years
                  
                  
                  6,545
                  
                  
                  
                  6,525Due
      after ten years
                  
                  
                  13,343
                  
                  
                  
                  13,167$
                  41,835
                  
                  
                  $
                  42,106
 
 
 Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.  Securities due after one year
through five years included mortgage-backed securities totaling
$13,556.  The maturities on these securities were based on the average
lives of the securities.
  66
   An
analysis of gross unrealized losses of the available-for-sale investment
securities portfolio as of December 31, 2008, follows:
  Less
      than 12 months
                
                
                12
      months or more
                
                
                TotalFair
      Value
                
                
                Unrealized
      losses
                
                
                Fair
      Value
                
                
                Unrealized
      losses
                
                
                Fair
      Value
                
                
                Unrealized
      lossesObligations
      of states and political subdivisions
                
                
                4,888
                
                
                
                (197
                )
                
                
                5,454
                
                
                
                (161
                )
                
                
                10,342
                
                
                
                (358
                )Mortgage
      backed securities
                
                
                1,638
                
                
                
                (30
                )
                
                
                30
                
                
                
                —
                
                
                
                1,668
                
                
                
                (30
                )Total
                
                $
                6,526
                
                
                $
                (227
                )
                
                $
                5,484
                
                
                $
                (161
                )
                
                $
                12,010
                
                
                $
                (388
                )
 
 
 
 No
decline in value was considered “other than temporary” during
2008.  Twenty securities that had a fair market value of $6,526 and a
total unrealized loss of $227 have been in an unrealized loss position for less
than twelve months as of December 31, 2008.  In addition, fifteen
securities with a fair market value of $5,484 and a total unrealized loss of
$161 that have been in an unrealized loss position for more than twelve months
as of December 31, 2008.  Due to the fact the Company has the ability
and intent to hold these investments until a market price recovery or maturity,
these investments are not considered other-than-temporarily
impaired.
 
 An
analysis of gross unrealized losses of the available-for-sale investment
securities portfolio as of December 31, 2007, follows:
  Less
      than 12 months
                
                
                12
      months or more
                
                
                TotalFair
      Value
                
                
                Unrealized
      losses
                
                
                Fair
      Value
                
                
                Unrealized
      losses
                
                
                Fair
      Value
                
                
                Unrealized
      lossesSecurities
      of U.S. government agencies and corporations
                
                $
                —
                
                
                $
                —
                
                
                $
                5,981
                
                
                
                (10
                )
                
                
                5,981
                
                
                
                (10
                )Obligations
      of states and political subdivisions
                
                
                8,341
                
                
                
                (56
                )
                
                
                979
                
                
                
                (8
                )
                
                
                9,320
                
                
                
                (64
                )Mortgage
      backed securities
                
                
                1,759
                
                
                
                (4
                )
                
                
                79
                
                
                
                —
                
                
                
                1,838
                
                
                
                (4
                )Total
                
                $
                10,100
                
                
                $
                (60
                )
                
                $
                7,039
                
                
                $
                (18
                )
                
                $
                17,139
                
                
                $
                (78
                )
 
 
 
 No
decline in value was considered “other than temporary” during
2007.  Twenty-one securities that had a fair market value of $10,100
and a total unrealized loss of $60 have been in an unrealized loss position for
less than twelve months as of December 31, 2007.  In addition, ten
securities with a fair market value of $7,039 and a total unrealized loss of $18
that have been in an unrealized loss position for more than twelve months as of
December 31, 2007.  Due to the fact the Company has the ability and
intent to hold these investments until a market price recovery or maturity,
these investments were not considered other-than-temporarily
impaired.
 
 Investment
securities carried at $21,071 and $23,360 at December 31, 2008 and 2007,
respectively, were pledged to secure public deposits or for other purposes as
required or permitted by law.
   67
  
 (4)
              Loans
  The
composition of the Company’s loan portfolio, at December 31, is as
follows:
  2008
                  
                  
                  2007Commercial
                  
                  $
                  114,693
                  
                  
                  $
                  114,957Agriculture
                  
                  
                  39,413
                  
                  
                  
                  37,647Real
      estate:Mortgage
                  
                  
                  303,444
                  
                  
                  
                  257,647Construction
                  
                  
                  69,156
                  
                  
                  
                  94,090Installment
      and other loans
                  
                  
                  5,113
                  
                  
                  $
                  5,461$
                  531,819
                  
                  
                  
                  509,802Allowance
      for loan losses
                  
                  
                  (14,435
                  )
                  
                  
                  (10,876
                  )Net
      deferred origination fees and costs
                  
                  
                  (416
                  )
                  
                  
                  (955
                  )Loans,
      net
                  
                  $
                  516,968
                  
                  
                  $
                  497,971
 
 As of
December 31, 2008, approximately 13% of the Company’s loans are for real estate
construction.  Additionally approximately 57% of the Company’s loans
are mortgage type loans which are secured by residential real
estate.  Approximately 29% of the Company’s loans are for general
commercial uses including professional, retail, agricultural and small
businesses.  Generally, real estate loans are secured by real property
and other loans are secured by funds on deposit, business or personal
assets.  Repayment is generally expected from the proceeds of the
sales of property for real estate construction loans, and from cash flows of the
borrower for other loans.  The Company’s access to this collateral is
through foreclosure and/or judicial procedures.  The Company’s
exposure to credit loss if the real estate or other security proved to be of no
value is the outstanding loan balance.
 
 Loans
that were sold and were being serviced by the Company totaled approximately
$122,734 and $116,310 at December 31, 2008 and 2007, respectively.
  In
September 2007, the Company transferred approximately $2,892 from its loans
held-for-sale portfolio to its loans held-for-investment portfolio.
  Non-accrual
loans totaled approximately $13,545 $15,173 and $3,399 at December 31, 2008,
2007 and 2006, respectively.  If interest on these non-accrual loans
had been accrued, such income would have approximated $1,501, $814 and $280
during the years ended December 31, 2008, 2007 and 2006,
respectively.  The average outstanding balance of non-accrual loans
was approximately $14,351, $7,822 and $2,710, on which $181, $73, and $113 of
interest income was recognized for the years ended December 31, 2008, 2007 and
2006, respectively.
  Loans 90
days past due and still accruing totaled approximately $713 and $263 at December
31, 2008 and 2007, respectively.
  The
Company had loans restructured and in compliance with modified terms totaling
$2,682, at December 31, 2008.  The Company did not restructure any
loans in 2007.
  Impaired
loans are loans for which it is probable that the Company will not be able to
collect all amounts due.  Impaired loans totaled approximately $13,545
and $15,173 at December 31, 2008 and 2007, respectively, and had related
valuation allowances of approximately $-0- and $272 at December 31, 2008 and
2007, respectively.  The average outstanding balance of impaired loans
was approximately $14,351 and $7,822 for the years ended December 31, 2008 and
2007, respectively.
  Loans in
the amount of $187,736 and $169,648 at December 31, 2008 and 2007, respectively,
were pledged under a blanket collateral lien to secure actual and potential
borrowings from the Federal Home Loan Bank.
 
  68
  
 Changes
in the allowance for loan losses for the following years ended December 31, are
summarized as follows:
 
 2008
                  
                  
                  2007
                  
                  
                  2006Balance,
      beginning of year
                  
                  $
                  10,876
                  
                  
                  $
                  8,361
                  
                  
                  $
                  7,917Provision
      for loan losses
                  
                  
                  16,164
                  
                  
                  
                  4,795
                  
                  
                  
                  735Loans
      charged-off
                  
                  
                  (13,324
                  )
                  
                  
                  (3,060
                  )
                  
                  
                  (1,060
                  )Recoveries
      of loans previously charged-off
                  
                  
                  719
                  
                  
                  
                  780
                  
                  
                  
                  769Balance,
      end of year
                  
                  $
                  14,435
                  
                  
                  $
                  10,876
                  
                  
                  $
                  8,361
 
 
 (5)
              Premises
      and Equipment
  Premises
and equipment consist of the following at December 31 of the indicated
years:
  2008
                  
                  
                  2007Land
                  
                  $
                  2,718
                  
                  
                  $
                  2,718Buildings
                  
                  
                  4,720
                  
                  
                  
                  4,477Furniture
      and equipment
                  
                  
                  11,068
                  
                  
                  
                  10,634Leasehold
      improvements
                  
                  
                  1,787
                  
                  
                  
                  1,75520,293
                  
                  
                  
                  19,584Less
      accumulated depreciation and amortization
                  
                  
                  12,673
                  
                  
                  
                  11,712$
                  7,620
                  
                  
                  $
                  7,872
 
  Depreciation
and amortization expense, included in occupancy and equipment expense, was
$1,045, $1,112 and $1,041 for the years ended December 31, 2008, 2007 and 2006,
respectively.
 
 
 (6)
              Other
      Assets
  Other
assets consisted of the following at December 31 of the indicated
years:
  2008
                  
                  
                  2007Accrued
      interest
                  
                  $
                  2,524
                  
                  
                  $
                  3,636Software,
      net of amortization
                  
                  
                  340
                  
                  
                  
                  387Officer’s
      Life Insurance
                  
                  
                  11,059
                  
                  
                  
                  10,408Prepaid
      and other
                  
                  
                  5,906
                  
                  
                  
                  3,842Investment
      in Limited Partnerships
                  
                  
                  1,573
                  
                  
                  
                  1,604Deferred
      tax assets, net (see Note 9)
                  
                  
                  7,825
                  
                  
                  
                  5,875$
                  29,227
                  
                  
                  $
                  25,752
 
  The
Company amortizes capitalized software costs on a straight-line basis using a
useful life from three to five years.
  Software
amortization expense, included in other operating expense, was $241, $235 and
$243 for the years ended December 31, 2008, 2007 and 2006,
respectively.
   69
  
 (7)
              Fair
      Value Measurement
 
 The
Company utilizes fair value measurements to record fair value adjustments to
certain assets and liabilities and to determine fair value disclosures.
Securities available-for-sale, trading securities and derivatives are recorded
at fair value on a recurring basis.  Additionally, from time to time,
the Company may be required to record at fair value other assets on a
non-recurring basis, such as loans held-for-sale, loans held-for-investment and
certain other assets.  These non-recurring fair value adjustments
typically involve application of lower of cost or market accounting or
write-downs of individual assets.
 
 Fair
Value Hierarchy
 
 Under
SFAS No. 157, the Company groups assets and liabilities at fair value in three
levels, based on the markets in which the assets and liabilities are traded and
the reliability of the assumptions used to determine fair
value.  These levels are:
 
 Level
      1
              
              Valuation
      is based upon quoted prices for identical instruments traded in active
      markets.Level
      2
              
              Valuation
      is based upon quoted prices for similar instruments in active markets,
      quoted prices for identical or similar instruments in markets that are not
      active and model-based valuation techniques for which all significant
      assumptions are observable or can be corroborated by observable market
      data.Level
      3
              
              Valuation
      is generated from model-based techniques that use at least one significant
      assumption not observable in the market.  These unobservable
      assumptions reflect estimates of assumptions that market participants
      would use in pricing the asset or liability.  Valuation
      techniques include use of option pricing models, discounted cash flow
      models and similar techniques and include management judgment and
      estimation which may be
significant.
 
 Following
is a description of valuation methodologies used for assets and liabilities
recorded at fair value.
 
 Investment Securities
Available-for-Sale
  Investment
securities available-for-sale are recorded at fair value on a recurring
basis.  Fair value measurement is based upon quoted market prices, if
available.  If quoted market prices are not available, fair values are
measured using independent pricing models or other model-based valuation
techniques such as the present value of future cash flows, adjusted for the
security’s credit rating, prepayment assumptions and other factors such as
credit loss assumptions.  Level 1 securities include those traded on
an active exchange, such as the New York Stock Exchange, U.S. Treasury
securities that are traded by dealers or brokers in active over-the-counter
markets and money market funds.  Level 2 securities include
mortgage-backed securities issued by government sponsored entities, municipal
bonds and corporate debt securities.  Securities classified as Level 3
include asset-backed securities in less liquid markets.
 
 Loans
Held-for-Sale
 
 Loans
held-for-sale are carried at the lower of cost or market value.  The
fair value of loans held-for-sale is based on what secondary markets are
currently offering for portfolios with similar characteristics.  As
such, the Company classifies loans subjected to non-recurring fair value
adjustments as Level 2.  At 12-31-08 there were no loans held-for-sale
that required a write-down.
  70
  
 Loans
 
 The
Company does not record loans at fair value on a recurring
basis.  However, from time to time, a loan is considered impaired and
an allowance for loan losses is established.  Loans for which it is
probable that payment of interest and principal will not be made in accordance
with the contractual terms of the loan agreement are considered
impaired.  Once a loan is identified as individually impaired, the
Company measures impairment in accordance with SFAS No. 114, “Accounting by
Creditors for Impairment of a Loan” (SFAS No. 114).  The fair value of
impaired loans is estimated using one of several methods, including collateral
value, market value of similar debt, enterprise value, liquidation value and
discounted cash flows.  Those impaired loans not requiring an
allowance represent loans for which the fair value of the expected repayments or
collateral exceed the recorded investments in such loans.  At December
31, 2008, substantially all of the total impaired loans were evaluated based on
the fair value of the underlying collateral securing the loan.  In
accordance with SFAS No. 157, impaired loans where an allowance is established
based on the fair value of collateral require classification in the fair value
hierarchy.  When the fair value of the collateral is based on an
observable market price or a current appraised value, the Company records the
impaired loan as non-recurring Level 2.  When an appraised value is
not available or management determines the fair value of the collateral is
further impaired below the appraised value and there is no observable market
price, the Company records the impaired loan as non-recurring Level
3.
 
 Loan Servicing
Rights
 
 Loan
servicing rights are subject to impairment testing.  A valuation
model, which utilizes a discounted cash flow analysis using interest rates and
prepayment speed assumptions currently quoted for comparable instruments and a
discount rate determined by management, is used in the completion of impairment
testing.  If the valuation model reflects a value less than the
carrying value, loan servicing rights are adjusted to fair value through a
valuation allowance as determined by the model.  As such, the Company
classifies loan servicing rights subjected to non-recurring fair value
adjustments as Level 3.
 
 Assets Recorded at Fair
Value on a Recurring Basis
 
 The table
below presents the recorded amount of assets and liabilities measured at fair
value on a recurring basis as of December 31, 2008 by SFAS No. 157 valuation
hierarchy.
 (in
      thousands)December
      31, 2008
                          
                          Total
                          
                          
                          Level
      1
                          
                          
                          Level
      2
                          
                          
                          Level
      3Investment
      securities available-for-sale
                          
                          $
                          42,106
                          
                          
                          $
                          —
                          
                          
                          $
                          42,106
                          
                          
                          $
                          —Total
      investments at fair value
                          
                          $
                          42,106
                          
                          
                          $
                          —
                          
                          
                          $
                          42,106
                          
                          
                          $
                          —
 
 Assets Recorded at Fair
Value on a Non-recurring Basis
 
 The
Company may be required, from time to time, to measure certain assets at fair
value on a non-recurring basis in accordance with U.S. GAAP.  These
include assets that are measured at the lower of cost or market that were
recognized at fair value below cost at the end of the period.
 
 Assets
measured at fair value on a non-recurring basis are included in the table below
by level within the fair value hierarchy as of December 31, 2008.
 (in
      thousands)December
      31, 2008
                          Total
                          
                          Level
      1
                          
                          Level
      2
                          
                          Level
      3Impaired
      loans
                          $   13,545
                          
                          $    —
                          
                          $    —
                          
                          $   13,545Loan
      servicing rights
                          893
                          
                          —
                          
                          —
                          
                          893Total
      impaired loans and loan servicing rights at fair value
                          $   14,438
                          
                          $    —
                          
                          $    —
                          
                          $   14,438
  71
  
 (8)
              Supplemental
      Compensation Plans
  
 EXECUTIVE
SALARY CONTINUATION PLAN
  Pension
Benefit Plans
 
 On July
19, 2001, the Company and the Bank approved an unfunded non-contributory defined
benefit pension plan (“Salary Continuation Plan”) and related split dollar plan
for a select group of highly compensated employees.  The plan provides
defined benefit levels between $50 and $125 depending on responsibilities at the
Bank.  The retirement benefits are paid for 10 years following
retirement at age 65.  Reduced retirement benefits are available after
age 55 and 10 years of service.
 
 Additionally,
the Company and the Bank adopted a new supplemental executive retirement plan
(“SERP”) in 2006.  The new plan is intended to integrate the various
forms of retirement payments offered to executives.  There are
currently three participants in the plan.
 
 The plan
benefit is calculated using 3-year average salary plus 7-year average bonus
(average compensation).  For each year of service the benefit formula
credits 2% of average compensation (2.5% for the CEO) up to a maximum of
50%.  Therefore, for an executive serving 25 years (20 for the CEO),
the target benefit is 50% of average compensation.
 
 The
target benefit is reduced for other forms of retirement income provided by the
Bank.  Reductions are made for 50% of the social security benefit
expected at age 65 and for the accumulated value of contributions the Bank makes
to the executive’s profit sharing plan.  For purposes of this
reduction, contributions to the profit sharing plan are accumulated each year at
a 3-year average of the yields on 10-year treasury
securities.  Retirement benefits are paid monthly for 120 months, plus
6 months for each full year of service over 10 years, up to a maximum of 180
months.
 
 Reduced
benefits are payable for retirement prior to age 65.  Should
retirement occur prior to age 65, the benefit determined by the formula
described above is reduced 5% for each year payments commence prior to age
65.  Therefore, the new SERP benefit is reduced 50% for retirement at
age 55.  No benefit is payable for voluntary terminations prior to age
55.
 
 Eligibility
to participate in the Salary Continuation Plan is limited to a select group of
management or highly compensated employees of the Bank that are designated by
the Board.
 
 
 
 72
 
 The Bank
uses a December 31 measurement date for these plans.
 
 For
      the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Change
      in benefit obligationBenefit obligation at beginning
      of year
                  
                  $
                  2,310
                  
                  
                  $
                  2,040
                  
                  
                  $
                  1,079Service cost
                  
                  
                  133
                  
                  
                  
                  121
                  
                  
                  
                  183Interest cost
                  
                  
                  119
                  
                  
                  
                  115
                  
                  
                  
                  65Amendments
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  798Plan loss
(gain)
                  
                  
                  (608
                  )
                  
                  
                  88
                  
                  
                  
                  (40
                  )Benefits Paid
                  
                  
                  (54
                  )
                  
                  
                  (54
                  )
                  
                  
                  (45
                  )Benefit
      obligation at end of year
                  
                  
                  1,900
                  
                  
                  
                  2,310
                  
                  
                  
                  2,040Change
      in plan assetsEmployer
      Contribution
                  
                  
                  54
                  
                  
                  
                  54
                  
                  
                  
                  45Benefits Paid
                  
                  
                  (54
                  )
                  
                  
                  (54
                  )
                  
                  
                  (45
                  )Fair
      value of plan assets at end of year
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —Reconciliation
      of funded statusFunded status
                  
                  $
                  (1,900
                  )
                  
                  $
                  (2,310
                  )
                  
                  $
                  (2,040
                  )Unrecognized net plan loss
      (gain)
                  
                  
                  (537
                  )
                  
                  
                  68
                  
                  
                  
                  (19
                  )Unrecognized prior service
      cost
                  
                  
                  759
                  
                  
                  
                  846
                  
                  
                  
                  933Net
      amount recognized
                  
                  $
                  (1,678
                  )
                  
                  $
                  (1,396
                  )
                  
                  $
                  (1,126
                  )Amounts
      recognized in the consolidatedbalance sheets consist
      of:Accrued benefit
      liability
                  
                  $
                  (1,900
                  )
                  
                  $
                  (2,310
                  )
                  
                  $
                  (2,040
                  )Intangible
asset
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Accumulated other comprehensive
      income
                  
                  
                  222
                  
                  
                  
                  914
                  
                  
                  
                  914Net
      amount recognized
                  
                  $
                  (1,678
                  )
                  
                  $
                  (1,396
                  )
                  
                  $
                  (1,126
                  )
 
  73
  
 For
      the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Components
      of net periodic benefit costService cost
                  
                  $
                  133
                  
                  
                  $
                  121
                  
                  
                  $
                  183Interest cost
                  
                  
                  119
                  
                  
                  
                  115
                  
                  
                  
                  65Amortization of prior service
      cost
                  
                  
                  87
                  
                  
                  
                  88
                  
                  
                  
                  13Net
      periodic benefit cost
                  
                  
                  339
                  
                  
                  
                  324
                  
                  
                  
                  261Additional amounts
      recognized
                  
                  
                  (2
                  )
                  
                  
                  —
                  
                  
                  
                  —Total
      benefit cost
                  
                  $
                  337
                  
                  
                  $
                  324
                  
                  
                  $
                  261Additional
      InformationMinimum benefit obligation at
      year end
                  
                  $
                  1,900
                  
                  
                  $
                  2,310
                  
                  
                  $
                  2,040Increase
      (decrease) in minimum liability included  in other comprehensive
      income
                  
                  $
                  (693
                  )
                  
                  $
                  539
                  
                  
                  $
                  893
 
 Assumptions
      used to determine benefit obligations at December 31
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006Discount rate used to determine
      net periodic benefit cost for years ended December 31
                  
                  
                  5.60
                  %
                  
                  
                  5.40
                  %
                  
                  
                  5.30
                  %Discount rate used to determine
      benefit obligations at December 31
                  
                  
                  5.60
                  %
                  
                  
                  5.40
                  %
                  
                  
                  5.40
                  %Future salary
      increases
                  
                  
                  4.00
                  %
                  
                  
                  6.00
                  %
                  
                  
                  6.00
                  %
 
 Plan
Assets
 
 The Bank
informally funds the liabilities of the Salary Continuation Plan through life
insurance purchased on the lives of plan participants.  This informal
funding does not meet the definition of plan assets within the meaning of
pension accounting standards.  Therefore, assets held for this purpose
are not disclosed as part of the Salary Continuation Plan.
 
 Cash
Flows
 
 Contributions
      and Estimated Benefit PaymentsFor
      unfunded plans, contributions to the Salary Continuation Plan are the
      benefit payments made to participants. The Bank paid $54 in benefit
      payments during fiscal 2008. The following benefit payments, which
      reflect expected future service, are expected to be paid in future fiscal
      years:Year ending December 31,
                      
                      Pension Benefits2009
                      
                      $
                      542010
                      
                      
                      542011
                      
                      
                      542012
                      
                      
                      822013
                      
                      
                      1662014-2018
                      
                      
                      1,191
 
 Disclosure
of settlements and curtailments:
 
 There
were no events during fiscal 2008 that would constitute a curtailment or
settlement within the meaning of SFAS No. 88.
  74
  
 DIRECTORS’
RETIREMENT PLAN
  Pension
Benefit Plans
 
 On July
19, 2001, the Company and the Bank approved an unfunded non-contributory defined
benefit pension plan ("Directors’ Retirement Plan") and related split dollar
plan for the directors of the Bank.  The plan provides a retirement
benefit equal to $1 per year of service as a director, up to a maximum benefit
amount of $15.  The retirement benefit is payable for 10 years
following retirement at age 65.  Reduced retirement benefits are
available after age 55 and 10 years of service.
 
 The Bank
uses a December 31 measurement date for the Directors’ Retirement
Plan.
 
 For
      the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Change
      in benefit obligationBenefit obligation at beginning
      of year
                  
                  $
                  539
                  
                  
                  $
                  469
                  
                  
                  $
                  402Service cost
                  
                  
                  58
                  
                  
                  
                  58
                  
                  
                  
                  54Interest cost
                  
                  
                  31
                  
                  
                  
                  27
                  
                  
                  
                  24Plan loss
(gain)
                  
                  
                  (73
                  )
                  
                  
                  —
                  
                  
                  
                  4Benefits paid
                  
                  
                  (15
                  )
                  
                  
                  (15
                  )
                  
                  
                  (15
                  )Benefit
      obligation at end of year
                  
                  $
                  540
                  
                  
                  $
                  539
                  
                  
                  $
                  469Change
      in plan assetsEmployer
      contribution
                  
                  $
                  15
                  
                  
                  $
                  15
                  
                  
                  $
                  15Benefits paid
                  
                  
                  (15
                  )
                  
                  
                  (15
                  )
                  
                  
                  (15
                  )Fair
      value of plan assets at end of year
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  —Reconciliation
      of funded statusFunded status
                  
                  $
                  (540
                  )
                  
                  $
                  (539
                  )
                  
                  $
                  (469
                  )Unrecognized net plan
      loss
                  
                  
                  (22
                  )
                  
                  
                  50
                  
                  
                  
                  50Net
      amount recognized
                  
                  $
                  (562
                  )
                  
                  $
                  (489
                  )
                  
                  $
                  (419
                  )Amounts
      recognized in the statement of financial position consist
    of:Accrued benefit
      liability
                  
                  $
                  (540
                  )
                  
                  $
                  (539
                  )
                  
                  $
                  (469
                  )Accumulated other comprehensive
      income
                  
                  
                  (22
                  )
                  
                  
                  50
                  
                  
                  
                  50Net
      amount recognized
                  
                  $
                  (562
                  )
                  
                  $
                  (489
                  )
                  
                  $
                  (419
                  )
 
  75
  
 For
      the Year Ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Components
      of net periodic benefit costService cost
                  
                  $
                  58
                  
                  
                  $
                  58
                  
                  
                  $
                  54Interest cost
                  
                  
                  31
                  
                  
                  
                  27
                  
                  
                  
                  24Recognized actuarial
      (gain)/loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  1Net
      periodic benefit cost
                  
                  
                  89
                  
                  
                  
                  85
                  
                  
                  
                  79Additional amounts
      recognized
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Total
      benefit cost
                  
                  $
                  89
                  
                  
                  $
                  85
                  
                  
                  $
                  79Additional
      InformationMinimum benefit obligation at
      year end
                  
                  $
                  540
                  
                  
                  $
                  539
                  
                  
                  $
                  469(Decrease) increase in minimum
      liability included in other comprehensive loss
                  
                  $
                  (73
                  )
                  
                  $
                  —
                  
                  
                  $
                  3
 
 Assumptions
      used to determine benefit obligations at December 31
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006Discount rate used to determine
      net periodic benefit cost for years ended December 31
                  
                  
                  5.40
                  %
                  
                  
                  5.20
                  %
                  
                  
                  5.30
                  %Discount rate used to determine
      benefit obligations at December 31
                  
                  
                  5.50
                  %
                  
                  
                  5.20
                  %
                  
                  
                  5.20
                  %
 
 Plan
Assets
 
 The Bank
informally funds the liabilities of the Directors’ Retirement Plan through life
insurance purchased on the lives of plan participants.  This informal
funding does not meet the definition of plan assets within the meaning of
pension accounting standards.  Therefore, assets held for this purpose
are not disclosed as part of the Directors’ Retirement Plan.
 
 Cash
Flows
 
 Contributions
      and Estimated Benefit PaymentsFor
      unfunded plans, contributions to the Directors’ Retirement Plan are the
      benefit payments made to participants. The Bank paid $15 in benefit
      payments during fiscal 2008. The following benefit payments, which
      reflect expected future service, are expected to be paid in future fiscal
      years:Year ending December 31,
                      
                      Pension Benefits2009
                      
                      $
                      152010
                      
                      
                      202011
                      
                      
                      402012
                      
                      
                      332013
                      
                      
                      312014-2018
                      
                      
                      410
 
 Disclosure
of settlements and curtailments:
 
 There
were no events during fiscal 2008 that would constitute a curtailment or
settlement within the meaning of SFAS No. 88.
  76
  
 EXECUTIVE
ELECTIVE DEFERRED COMPENSATION PLAN — 2001 EXECUTIVE DEFERRAL PLAN.
 
 On July
19, 2001, the Bank approved a revised Executive Elective Deferred Compensation
Plan, (the “2001 Executive Deferral Plan”) for certain officers to provide them
the ability to make elective deferrals of compensation due to tax law
limitations on benefit levels under qualified plans.  Deferred amounts
earn interest at an annual rate determined by the Bank’s Board.  The
plan is a non-qualified plan funded with Bank owned life insurance policies
taken on the life of the officer.   During the year ended
December 31, 2001, the Bank purchased insurance making a single-premium payment
aggregating $1,125, which is reported in other assets.  The Bank is
the beneficiary and owner of the policies.  The cash surrender value
of the related insurance policies as of December 31, 2008 and 2007 totaled
$1,889 and $1,821, respectively.  The accrued liability for the 2001
Executive Deferral Plan as of December 31, 2008 and 2007 totaled $59 and $233,
respectively.  The expenses for the 2001 Executive Deferral Plan for
the years ended December 31, 2008, 2007 and 2006 totaled $54, $54 and $43,
respectively.
 
 
 DIRECTOR
ELECTIVE DEFERRED FEE PLAN — 2001 DIRECTOR DEFERRAL PLAN.
 
 On July
19, 2001, the Bank approved a Director Elective Deferred Fee Plan (the “2001
Director Deferral Plan”) for directors to provide them the ability to make
elective deferrals of fees.  Deferred amounts earn interest at an
annual rate determined by the Bank’s Board.  The plan is a
non-qualified plan funded with Bank owned life insurance policies taken on the
life of the director.   The Bank is the beneficiary and owner of
the policies.  The cash surrender value of the related insurance
policies as of December 31, 2008 and 2007 totaled $100 and $96,
respectively.  The accrued liability for the 2001 Director Deferral
Plan as of December 31, 2008 and 2007 totaled $3 and $5,
respectively.  The expenses for the 2001 Director Deferral Plan for
the years ended December 31, 2008, 2007 and 2006 totaled $1, $1 and $1,
respectively.
  77
  
 (9)
              Income
      Taxes
  The
(benefit) provision for income tax expense consists of the following for the
years ended December 31:
  2008
                  
                  
                  2007
                  
                  
                  2006Current:Federal
                  
                  $
                  (1,464
                  )
                  
                  $
                  3,939
                  
                  
                  $
                  4,461State
                  
                  
                  (9
                  )
                  
                  
                  1,283
                  
                  
                  
                  1,211(1,473
                  )
                  
                  
                  5,222
                  
                  
                  
                  5,672Deferred:Federal
                  
                  
                  (1,365
                  )
                  
                  
                  (1,769
                  )
                  
                  
                  (112
                  )State
                  
                  
                  (797
                  )
                  
                  
                  (316
                  )
                  
                  
                  (391
                  )(2,162
                  )
                  
                  
                  (2,085
                  )
                  
                  
                  (503
                  )$
                  (3,635
                  )
                  
                  $
                  3,137
                  
                  
                  $
                  5,169
 
 The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007
consist of:
  2008
                  
                  
                  2007Deferred
      tax assets:Allowance
      for loan losses
                  
                  $
                  6,361
                  
                  
                  $
                  4,931Deferred
      compensation
                  
                  
                  459
                  
                  
                  
                  434Retirement
      compensation
                  
                  
                  922
                  
                  
                  
                  775Stock
      option compensation
                  
                  
                  719
                  
                  
                  
                  629Post
      retirement benefits
                  
                  
                  —
                  
                  
                  
                  197Current
      state franchise taxes
                  
                  
                  1
                  
                  
                  
                  404Non-accrual
      interest
                  
                  
                  22
                  
                  
                  
                  44Investment
      securities unrealized gains
                  
                  
                  55
                  
                  
                  
                  140Net
      operating loss
                  
                  
                  197
                  
                  
                  
                  —Tax
      credit carryovers
                  
                  
                  1,162
                  
                  
                  
                  —Other
                  
                  
                  524
                  
                  
                  
                  28Deferred
      tax assets
                  
                  
                  10,422
                  
                  
                  
                  7,582Less
      valuation allowance
                  
                  
                  —
                  
                  
                  
                  —Total
      deferred tax assets
                  
                  
                  10,422
                  
                  
                  
                  7,582Deferred
      tax liabilities:Fixed
      assets
                  
                  
                  1,572
                  
                  
                  
                  828FHLB
      dividends
                  
                  
                  260
                  
                  
                  
                  214Tax
      credit – loss on passthrough
                  
                  
                  235
                  
                  
                  
                  250Deferred
      loan costs
                  
                  
                  457
                  
                  
                  
                  304Post
      retirement benefits
                  
                  
                  41
                  
                  
                  
                  —Other
                  
                  
                  32
                  
                  
                  
                  111Total
      deferred tax liabilities
                  
                  
                  2,597
                  
                  
                  
                  1,707Net
      deferred tax assets (see Note 6)
                  
                  $
                  7,825
                  
                  
                  $
                  5,875
 
 Based
upon the level of historical taxable income and projections for future taxable
income over the periods during which the deferred tax assets are deductible,
management believes it is more likely than not the Company will realize the
benefits of these deductible differences.
  78
  
 A
reconciliation of income taxes computed at the federal statutory rate of 34% and
the provision for income taxes is as follows:
  2008
                  
                  
                  2007
                  
                  
                  2006Income
      tax expense at statutory rates
                  
                  $
                  (1,703
                  )
                  
                  $
                  3,542
                  
                  
                  $
                  4,753Reduction
      for tax exempt interest
                  
                  
                  (495
                  )
                  
                  
                  (523
                  )
                  
                  
                  (213
                  )State
      franchise tax, net of federal income tax benefit
                  
                  
                  (532
                  )
                  
                  
                  638
                  
                  
                  
                  541Cash
      surrender value of life insurance
                  
                  
                  (141
                  )
                  
                  
                  (140
                  )
                  
                  
                  (114
                  )Solar
      credit amortization
                  
                  
                  (578
                  )
                  
                  
                  (65
                  )
                  
                  
                  —Other
                  
                  
                  (186
                  )
                  
                  
                  (315
                  )
                  
                  
                  202(3,635
                  )
                  
                  $
                  3,137
                  
                  
                  $
                  5,169
 
 
 Accounting
for Uncertainty in Income Taxes
  The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes,” on January 1, 2007.  As a result of the
implementation of FIN 48, the Company recognized an increase for unrecognized
tax benefits.  A reconciliation of the beginning and ending amount of
unrecognized tax benefits is as follows:
  Balance
      at January 1, 2008
                  
                  $
                  122Additions
      for tax positions taken in the current period
                  
                  
                  —Reductions
      for tax positions taken in the current period
                  
                  
                  —Additions
      for tax positions taken in prior years
                  
                  
                  —Reductions
      for tax positions taken in prior years
                  
                  
                  —Decreases  related
      to settlements with taxing authorities
                  
                  
                  —Decreases
      as a result of a lapse in statue of limitations
                  
                  
                  —Balance
      at December 31, 2008
                  
                  $
                  122
  The
Company does not anticipate any significant increase or decrease in unrecognized
tax benefits during 2009.  If recognized, the entire amount of the
unrecognized tax benefits would affect the effective tax rate.
 
 The
Company classifies interest and penalties as a component of the provision for
income taxes.  At December 31, 2008, unrecognized interest and
penalties were $27 thousand.  The tax years ended December 31, 2007,
2006 and 2005 remain subject to examination by the Internal Revenue
Service.  The tax years ended December 31, 2007, 2006, 2005, and 2004
remain subject to examination by the California Franchise Tax
Board.  The deductibility of these tax positions will be determined
through examination by the appropriate tax jurisdictions or the expiration of
the tax statute of limitations.
  79
  
 (10)
              Outstanding
      Shares and Earnings Per Share
  On
January 22, 2009, the Board of Directors of the Company declared a 4% stock
dividend payable as of March 31, 2009 to shareholders of record as of
February 27, 2009.  All income per share amounts have been adjusted to
give retroactive effect to stock dividends and stock splits.
 
 Earnings
Per Share (“EPS”)
 
 2008
                  
                  
                  2007
                  
                  
                  2006Basic
      earnings per share:Net
      income
                  
                  $
                  (1,374
                  )
                  
                  $
                  7,281
                  
                  
                  $
                  8,810Weighted
      average common shares outstanding
                  
                  
                  8,931,906
                  
                  
                  
                  9,165,198
                  
                  
                  
                  9,300,985Basic
      EPS
                  
                  $
                  (0.15
                  )
                  
                  $
                  0.79
                  
                  
                  $
                  0.95Diluted
      earnings per share:Net
      income
                  
                  $
                  (1,374
                  )
                  
                  $
                  7,281
                  
                  
                  $
                  8,810Weighted
      average common shares outstanding
                  
                  
                  8,931,906
                  
                  
                  
                  9,165,198
                  
                  
                  
                  9,300,785Effect
      of dilutive options
                  
                  
                  —
                  
                  
                  
                  273,019
                  
                  
                  
                  456,7058,931,906
                  
                  
                  
                  9,438,217
                  
                  
                  
                  9,757,490Diluted
      EPS
                  
                  $
                  (0.15
                  )
                  
                  $
                  0.77
                  
                  
                  $
                  0.90
 Basic and
diluted earnings per share for the years ended December 31, were computed as
follows:
  
 Options
not included in the computation of diluted earnings per share because they would
have had an anti-dilutive effect amounted to 218,619 shares, 115,377 shares and
67,530 shares for the year ended December 31, 2008, 2007 and 2006,
respectively.
 
 
 Related
      Party Transactions
  The Bank,
in the ordinary course of business, has loan and deposit transactions with
directors and executive officers.  In management’s opinion, these
transactions were on substantially the same terms as comparable transactions
with other customers of the Bank.  The amount of such deposits totaled
approximately $3,263, $2,884 and 2,338 at December 31, 2008, 2007 and 2006,
respectively.
  
 The
following is an analysis of the activity of loans to executive officers and
directors for the years ended December 31:
  2008
                  
                  
                  2007
                  
                  
                  2006Outstanding
      balance, beginning of year
                  
                  $
                  2,699
                  
                  
                  $
                  273
                  
                  
                  $
                  304Credit
      granted
                  
                  
                  506
                  
                  
                  
                  3,005
                  
                  
                  
                  58Repayments
                  
                  
                  (382
                  )
                  
                  
                  (579
                  )
                  
                  
                  (89
                  )Outstanding
      balance, end of year
                  
                  $
                  2,823
                  
                  
                  $
                  2,699
                  
                  
                  $
                  273
 
 
 (12)
              Profit
      Sharing Plan
  The Bank
maintains a profit sharing plan for the benefit of its
employees.  Employees who have completed 12 months and 1,000 hours of
service are eligible.  Under the terms of this plan, a portion of the
Bank’s profits, as determined by the Board of Directors, will be set aside and
maintained in a trust fund for the benefit of qualified
employees.  Contributions to the plan, included in salaries and
employee benefits in the consolidated statements of operations, were $-0-,
$1,454 and $1,607 in 2008, 2007 and 2006, respectively.
   80
  
 (13)
              Stock
      Compensation Plans
  
 As of
December 31, 2008, the Company has the following share-based compensation
plans:
  The
Company has one fixed stock option plan. Under the 2006 Stock Incentive Plan,
the Company may grant option grants, stock appreciation rights, restricted stock
or stock units to an employee for an amount up to 25,000 total shares in any
calendar year.  With respect to awards granted to non-employee
directors under the Plan, no outside director can receive option grants, stock
appreciation rights, restricted stock or stock units in excess of 3,000 total
shares in any calendar year.  There are 856,441 shares authorized
under the plan.  The plan will terminate March 15,
2016.  The Compensation Committee of the Board of Directors is
authorized to prescribe the terms and conditions of each option, including
exercise price, vestings or duration of the option.  Generally, option
grants vest at a rate of 25% per year after the first anniversary of the date of
grant and restricted stock awards vest at a rate of 100% after four
years.  Options are granted with an exercise price of the fair value
of the related common stock on the date of grant.
  Stock
option and restricted stock activity for the Company’s Stock Incentive Plan
during the years indicated is as follows:
  Stock
      incentive
                    planNumber
      of shares
                  
                  
                  Weighted
      average exercise priceBalance
      at December 31, 2007
                  
                  
                  542,221
                  
                  
                  $
                  10.78Granted
                  
                  
                  31,464
                  
                  
                  
                  4.66Exercised
                  
                  
                  (9,243
                  )
                  
                  
                  3.76Cancelled
                  
                  
                  (297
                  )
                  
                  
                  21.83Balance
      at December 31, 2008
                  
                  
                  564,145
                  
                  
                  $
                  10.55
 
 The 2006
Stock Incentive Plan permits stock-for-stock exercises of
shares.  During 2008, employees tendered 2,432 (adjusted for stock
options exercised before stock dividend) mature shares in stock-for-stock
exercises.  Matured shares are those held by employees longer than six
months.
 
 The
following table presents information on stock options and restricted stock for
the year ended December 31, 2008:
  
 Number
      of Shares
                  
                  
                  Weighted
      Average Exercise Price
                  
                  
                  Aggregate
      Intrinsic Value
                  
                  
                  Weighted
      Average Remaining Contractual TermOptions
      exercised
                  
                  
                  9,243
                  
                  
                  $
                  3.76
                  
                  
                  $
                  97Stock
      options fully vested and expected to vest:
                  
                  
                  564,145
                  
                  
                  $
                  10.55
                  
                  
                  $
                  337
                  
                  
                  
                  4.85Stock
      options vested and currently exercisable:
                  
                  
                  437,669
                  
                  
                  $
                  9.55
                  
                  
                  $
                  157
                  
                  
                  
                  4.03
 
 The
aggregate intrinsic value of options exercised in calendar year 2008, 2007 and
2006 was $97, $944 and $2,427, respectively.
 
 The
weighted average fair value per share of options granted during the years ended
December 31 was $12.11 in 2008, $10.15 in 2007 and $7.75 in 2006.
 
 At
December 31, 2008, the range of exercise prices for all outstanding options
ranged from $0.00 to $3.96.
  81
  
 As of
December 31, 2008, there was $563 of total unrecognized compensation related to
non-vested stock options and restricted stock.  This cost is expected
to be recognized over a weighted average period of approximately 1.4
years.
 
 As of
December 31, 2008, there was $411 of recognized compensation related to
non-vested option grants and restricted stock awards.
 
 The
Company determines fair value at grant date using the Black-Scholes-Merton
pricing model that takes into account the stock price at the grant date, the
exercise price, the risk free interest rate, the volatility of the underlying
stock and the expected life of the option.
 
 The
weighted average assumptions used in the pricing model are noted in the
following table.  The expected term of options and restricted stock
granted is derived from historical data on employee exercise and post-vesting
employment termination behavior.  The risk free rate for periods
within the contractual life of the option is based on the U.S. Treasury yield
curve in effect at the time of the grant.  Expected volatility is
based on both the implied volatilities from the traded option on the Company’s
stock and historical volatility on the Company’s stock.
 
 For
options granted prior to January 1, 2006, and valued in accordance with FAS 123,
the expected volatility used to estimate the fair value of the options was based
solely on the historical volatility of the Company’s stock.  The
Company recognized option forfeitures as they occurred.
  The
Company expenses the fair value of the option and restricted stock on a straight
line basis over the vesting period.  The Company estimates forfeitures
and only recognizes expense for those shares expected to vest.  The
Company’s estimated forfeiture rate for 2008, based on historical forfeiture
experience, is approximately 0.0%.
   The
following table shows our weighted average assumptions used in valuing stock
options granted for the years ended December 31:
  2008
                  
                  
                  2007
                  
                  
                  2006Risk
      Free Interest Rate
                  
                  
                  2.76
                  %
                  
                  
                  4.67
                  %
                  
                  
                  4.57
                  %Expected
      Dividend Yield
                  
                  
                  0.00
                  %
                  
                  
                  0.00
                  %
                  
                  
                  0.00
                  %Expected
      Life in Years
                  
                  
                  5.00
                  
                  
                  
                  4.18
                  
                  
                  
                  4.67Expected
      Price Volatility
                  
                  
                  27.92
                  %
                  
                  
                  26.03
                  %
                  
                  
                  26.39
                  %
 
  Employee
      Stock Purchase Plan
  Under the
First Northern Community Bancorp 2006 Amended Employee Stock Purchase Plan (the
“Plan”), the Company is authorized to issue to an eligible employee shares of
common stock.  There are 280,900 shares authorized under the
Plan.  The Plan will terminate March 15, 2016.  The Plan is
implemented by participation periods of not more than twenty-seven months
each.  The Board of Directors determines the commencement date and
duration of each participation period.  An eligible employee is one
who has been continually employed for at least ninety (90) days prior to
commencement of a participation period.  Under the terms of the Plan,
employees can choose to have up to 10 percent of their compensation withheld to
purchase the Company’s common stock each participation period.  The
purchase price of the stock is 85 percent of the lower of the fair market value
on the last trading day before the Date of Participation or the fair market
value on the last trading day during the participation
period.  Approximately 63 percent of eligible employees are
participating in the Plan in the current participation period, which began
November 24, 2008 and will end November 23, 2009.
  Under the
Plan, at the annual stock purchase date of November 23, 2008, there were
$225 in contributions, and 31,113 shares were purchased at an average price of
$7.23, totaling $225.
   82
  
 (14)
              Short-Term
      and Long-Term Borrowings
  Short-term
borrowings at December 31, 2008 and 2007 consisted of secured borrowings from
the U.S. Treasury in the amounts of $584 and $878, respectively.  The
funds are placed at the discretion of the U.S. Treasury and are callable on
demand by the U.S. Treasury.  At December 31, 2008, the Bank had
Federal Funds purchased in the amount of $0.
 
 Additional
short-term borrowings available to the Company consist of a line of credit and
advances with the Federal Home Loan Bank (“FHLB”) secured under terms of a
blanket collateral agreement by a pledge of FHLB stock and certain other
qualifying collateral such as commercial and mortgage loans.  At
December 31, 2008, the Company had a current collateral borrowing capacity with
the FHLB of $77,846.  The Company also has unsecured formal lines of
credit totaling $15,500 with correspondent banks.
    
 
 (15)
              Commitments
      and Contingencies
  The
Company is obligated for rental payments under certain operating lease
agreements, some of which contain renewal options.  Total rental
expense for all leases included in net occupancy and equipment expense amounted
to approximately $1,327, $1,227, and $1,294 for the years ended December 31,
2008, 2007 and 2006, respectively.  At December 31, 2008, the future
minimum payments under non-cancelable operating leases with initial or remaining
terms in excess of one year were as follows:
  Year
      ending December 31:2009
                  
                  $
                  1,2162010
                  
                  
                  1,1092011
                  
                  
                  9002012
                  
                  
                  8332013
                  
                  
                  769Thereafter
                  
                  
                  1,332$
                  6,159
 
  At
December 31, 2008, the aggregate maturities for time deposits were as
follows:
  Year
      ending December 31:2009
                  
                  $
                  113,8862010
                  
                  
                  6,2422011
                  
                  
                  1,5662012
                  
                  
                  1,7772013
                  
                  
                  135Thereafter
                  
                  
                  242$
                  123,848
 
  The
Company is subject to various legal proceedings in the normal course of its
business.  In the opinion of management, after having consulted with
legal counsel, the outcome of the legal proceedings should not have a material
effect on the consolidated financial condition or results of operations of the
Company.
   83
  
 (16)
              Financial
      Instruments with Off-Balance Sheet
Risk
  The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit in the form of loans or through standby letters of
credit.  These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts recognized in the balance
sheet.  The contract amounts of those instruments reflect the extent
of involvement the Company has in particular classes of financial
instruments.
  The
Bank’s exposure to credit loss in the event of non-performance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual notional amount of those
instruments.  The Bank uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
  Financial
instruments, whose contract amounts represent credit risk at December 31 of
the indicated periods, were as follows:
  2008
                  
                  
                  2007Undisbursed
      loan commitments
                  
                  $
                  198,615
                  
                  
                  
                  214,274Standby
      letters of credit
                  
                  
                  5,715
                  
                  
                  
                  15,188Commitments
      to sell loans
                  
                  
                  9,764
                  
                  
                  
                  250$
                  214,094
                  
                  
                  
                  229,712
 
  Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.  The Bank evaluates
each customer’s creditworthiness on a case-by-case basis.  The amount
of collateral obtained, if deemed necessary by the Bank upon extension of
credit, is based on management’s credit evaluation.  Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment, and income-producing commercial properties.
  Standby
letters of credit are conditional commitments issued by the Bank to guarantee
the performance of a customer to a third party.  The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers.  The Bank issues both
financial and performance standby letters of credit.  The financial
standby letters of credit are primarily to guarantee payment to third
parties.  At December 31, 2008, there were no financial standby
letters of credit outstanding.  The performance standby letters of
credit are typically issued to municipalities as specific performance
bonds.  At December 31, 2008, there was $5,715 issued in performance
standby letters of credit and the Bank carried no liability.  The
terms of the guarantees will expire primarily in 2009.  The Bank has
experienced no draws on these letters of credit, and does not expect to in the
future; however, should a triggering event occur, the Bank either has collateral
in excess of the letter of credit or imbedded agreements of recourse from the
customer.  The Bank has set aside a reserve for unfunded commitments
in the amount of $1,021, which is recorded in “accrued interest payable and
other liabilities.”
  Commitments
to extend credit and standby letters of credit bear similar credit risk
characteristics as outstanding loans.  As of December 31, 2008, the
Company has no off-balance sheet derivatives requiring additional
disclosure.
   84
  
 (17)
              Capital
      Adequacy and Restriction on
Dividends
 
 The
Company is subject to various regulatory capital requirements administered by
the federal banking agencies.  Failure to meet minimum capital
requirements can initiate mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct material effect
on the Company’s consolidated financial statements.  Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company must meet specific capital guidelines that involve quantitative
measures of the Company’s assets, liabilities, and certain off-balance-sheet
items as calculated under regulatory accounting practices.  The
Company’s 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 Bank
to maintain minimum amounts and ratios (set forth in the table
below).
  First, a
bank must meet a minimum Tier I Capital ratio (as defined in the regulations)
ranging from 3% to 5% based upon the bank’s CAMELS (capital adequacy, asset
quality, management, earnings, liquidity and sensitivity to market risk)
rating.
  Second, a
bank must meet minimum Total Risk-Based Capital to risk-weighted assets ratio of
8%. Risk-based capital and asset guidelines vary from Tier I capital guidelines
by redefining the components of capital, categorizing assets into different risk
classes, and including certain off-balance sheet items in the calculation of the
capital ratio.  The effect of the risk-based capital guidelines is
that banks with high risk exposure will be required to raise additional capital
while institutions with low risk exposure could, with the concurrence of
regulatory authorities, be permitted to operate with lower capital
ratios.  In addition, a bank must meet minimum Tier I Leverage Capital
to average assets ratio.
  Management
believes, as of December 31, 2008, that the Bank meets all capital adequacy
requirements to which it is subject.  As of December 31, 2008, the
most recent notification from the Federal Deposit Insurance Corporation (“FDIC”)
categorized the Bank as “well capitalized” under the regulatory framework for
prompt corrective action.  To be categorized as well capitalized the
Bank must meet the minimum ratios as set forth above. As of the date hereof,
there have been no conditions or events since that notification that management
believes have changed the institution’s category.
  The
Company and the Bank had Tier I Leverage, Tier I risk-based and Total Risk-Based
capital above the “well capitalized” levels at December 31, 2008 and 2007,
respectively, as set forth in the following tables:
  The
      CompanyAdequately2008
                  
                  
                  2007
                  
                  
                  CapitalizedCapital
                  
                  
                  Ratio
                  
                  
                  Capital
                  
                  
                  Ratio
                  
                  
                  RatioTier
      1 Leverage Capital (to Average Assets)
                  
                  $
                  58,760
                  
                  
                  
                  8.8
                  %
                  
                  $
                  64,046
                  
                  
                  
                  9.1
                  %
                  
                  
                  4.0
                  %Tier 1
      Capital (to Risk Weighted Assets)
                  
                  
                  58,760
                  
                  
                  
                  10.1
                  %
                  
                  
                  64,046
                  
                  
                  
                  10.7
                  %
                  
                  
                  4.0
                  %Total
      Risk-Based Capital (to Risk Weighted Assets)
                  
                  
                  66,107
                  
                  
                  
                  11.4
                  %
                  
                  
                  71,336
                  
                  
                  
                  11.9
                  %
                  
                  
                  8.0
                  %
 
 The
      BankAdequately
                  
                  
                  Well2008
                  
                  
                  2007
                  
                  
                  Capitalized
                  
                  
                  CapitalizedCapital
                  
                  
                  Ratio
                  
                  
                  Capital
                  
                  
                  Ratio
                  
                  
                  Ratio
                  
                  
                  RatioTier
      1 Leverage Capital (to Average Assets)
                  
                  $
                  58,377
                  
                  
                  
                  8.7
                  %
                  
                  $
                  63,065
                  
                  
                  
                  9.0
                  %
                  
                  
                  4.0
                  %
                  
                  
                  5.0
                  %Tier 1
      Capital (to Risk Weighted Assets)
                  
                  
                  58,377
                  
                  
                  
                  10.1
                  %
                  
                  
                  63,065
                  
                  
                  
                  10.6
                  %
                  
                  
                  4.0
                  %
                  
                  
                  6.0
                  %Total
      Risk-Based Capital (to Risk Weighted Assets)
                  
                  
                  65,724
                  
                  
                  
                  11.3
                  %
                  
                  
                  70,335
                  
                  
                  
                  11.8
                  %
                  
                  
                  8.0
                  %
                  
                  
                  10.0
                  %
 
 Cash
dividends declared by the Bank are restricted under California State banking
laws to the lesser of the Bank’s retained earnings or the Bank’s net income for
the latest three fiscal years, less dividends previously declared during that
period.
  
 85
 
 (18)
              Fair
      Values of Financial Instruments
  The
following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
  Cash
      and Cash Equivalents
  The
carrying amounts reported in the balance sheet for cash and short-term
instruments are a reasonable estimate of fair value.
  Investment
      Securities
  Fair
values for investment securities are based on quoted market prices, where
available.  If quoted market prices are not available, fair values are
based on quoted market prices of comparable instruments.
  Federal
      Home Loan Bank and Other Equity
Securities
  The
carrying amounts reported in the balance sheet approximate fair
value.
  Loans
      Receivable
  For
variable-rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values.  The fair
values for other loans (e.g., commercial real estate and rental property
mortgage loans, commercial and industrial loans, and agricultural loans) are
estimated using discounted cash flow analyses, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality.  The carrying amount of accrued interest receivable
approximates its fair value.
  Commitments
      to Extend Credit and Standby Letters of
Credit
  The fair
value of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements
and the present creditworthiness of the counterparties.  For
fixed-rate loan commitments, fair value also considers the difference between
current levels of interest rates and the committed rates.  The fair
value of letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligation with the counterparties at the reporting date.
  Deposit
      Liabilities
  The fair
values disclosed for demand deposits (e.g., interest and non-interest 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).  The fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.  The carrying amount of accrued
interest payable approximates its fair value.
  FHLB
      Advances and Other Borrowings
  The fair
values of borrowed funds were estimated by discounting future cash flows related
to these financial instruments using current market rates for financial
instruments with similar characteristics.
  Limitations
  Fair
value estimates are made at a specific point in time, based on relevant market
information and information about the financial instrument.  These
estimates do not reflect any premium or discount that could result from offering
for sale at one time the Company’s entire holdings of a particular financial
instrument.  Because no market exists for a significant portion of the
Company’s financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other
factors.  These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be
determined with precision.  Changes in assumptions could significantly
affect the estimates.
   86
  
 Fair
value estimates are based on existing on-and off-balance sheet financial
instruments without attempting to estimate the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments.  Other significant assets and liabilities that
are not considered financial assets or liabilities include deferred tax
liabilities and premises and equipment.  In addition, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in many of the estimates.
  
  The
estimated fair values of the Company’s financial instruments for the years ended
December 31 are approximately as follows:
  2008
                  
                  
                  2007Carrying
      amount
                  
                  
                  Fair
                    value
                  
                  
                  Carrying
      amount
                  
                  
                  Fair
                    valueFinancial
      assets:Cash
      and federal funds sold
                  
                  $
                  66,010
                  
                  
                  $
                  66,010
                  
                  
                  $
                  99,030
                  
                  
                  $
                  99,030Investment
      securities
                  
                  
                  42,106
                  
                  
                  
                  42,106
                  
                  
                  
                  74,849
                  
                  
                  
                  74,849Other
      equity securities
                  
                  
                  2,311
                  
                  
                  
                  2,311
                  
                  
                  
                  2,199
                  
                  
                  
                  2,199Loans:Net
      loans
                  
                  
                  516,968
                  
                  
                  
                  516,949
                  
                  
                  
                  497,971
                  
                  
                  
                  497,405Loans
      held-for-sale
                  
                  
                  2,192
                  
                  
                  
                  2,192
                  
                  
                  
                  1,343
                  
                  
                  
                  1,343Financial
      liabilities:Deposits
                  
                  
                  584,718
                  
                  
                  
                  547,419
                  
                  
                  
                  622,671
                  
                  
                  
                  534,565FHLB
      advances and other borrowings
                  
                  
                  18,259
                  
                  
                  
                  19,025
                  
                  
                  
                  15,832
                  
                  
                  
                  15,849
 
  2008Contract
      amount
                    
                    
                    Fair
                      valueUnrecognized
      financial instruments:Commitments
      to extend credit
                    
                    $
                    198,615
                    
                    
                    $
                    1,490Standby
      letters of credit
                    
                    $
                    5,715
                    
                    
                    $
                    572007Contract
      amount
                    
                    
                    Fair
                      valueUnrecognized
      financial instruments:Commitments
      to extend credit
                    
                    $
                    214,274
                    
                    
                    $
                    1,607Standby
      letters of credit
                    
                    $
                    15,188
                    
                    
                    $
                    152
 
   87
  
 (19)  Supplemental
Consolidated Statements of Cash Flows Information
 
 Supplemental
disclosures to the Consolidated Statements of Cash Flows for the years ended
December 31, are as follows:
  2008
                  
                  
                  2007
                  
                  
                  2006Supplemental
      disclosure of cash flow information:Cash
      paid during the year for:Interest
                  
                  $
                  6,581
                  
                  
                  $
                  11,728
                  
                  
                  $
                  9,243Income
      taxes
                  
                  $
                  344
                  
                  
                  $
                  4,363
                  
                  
                  $
                  6,165Supplemental
      disclosure of non-cash investing and financing activities:Accrued
      compensation
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  (84
                  )Stock
      dividend distributed
                  
                  $
                  8,642
                  
                  
                  $
                  10,851
                  
                  
                  $
                  12,525Loans
      held-for-sale transferred to loans held-for-investment
                  
                  $
                  —
                  
                  
                  $
                  2,892
                  
                  
                  $
                  —Loans
      held-for-investment transferred to other real estate owned
                  
                  $
                  6,897
                  
                  
                  $
                  879
                  
                  
                  $
                  375
 
  
  (20)
              Quarterly
      Financial Information (Unaudited)
  
  March 31,
                  
                  
                  June 30,
                  
                  
                  September 30,
                  
                  
                  December 31,2008:Interest
      income
                  
                  $
                  10,683
                  
                  
                  $
                  9,518
                  
                  
                  $
                  9,856
                  
                  
                  $
                  8,814Net
      interest income
                  
                  
                  8,685
                  
                  
                  
                  8,016
                  
                  
                  
                  8,327
                  
                  
                  
                  7,468Provision
      for loan losses
                  
                  
                  3,659
                  
                  
                  
                  2,763
                  
                  
                  
                  3,638
                  
                  
                  
                  6,104Other
      operating income
                  
                  
                  2,203
                  
                  
                  
                  1,220
                  
                  
                  
                  1,044
                  
                  
                  
                  1,846Other
      operating expense
                  
                  
                  7,172
                  
                  
                  
                  7,327
                  
                  
                  
                  6,334
                  
                  
                  
                  6,821Income
      before taxes
                  
                  
                  57
                  
                  
                  
                  (854
                  )
                  
                  
                  (601
                  )
                  
                  
                  (3,611
                  )Net
      income
                  
                  
                  60
                  
                  
                  
                  (864
                  )
                  
                  
                  972
                  
                  
                  
                  (1,542
                  )Basic
      earnings per share
                  
                  
                  0.01
                  
                  
                  
                  (0.10
                  )
                  
                  
                  0.11
                  
                  
                  
                  (0.17
                  )Diluted
      earnings per share
                  
                  
                  0.01
                  
                  
                  
                  (0.10
                  )
                  
                  
                  0.11
                  
                  
                  
                  (0.17
                  )2007:Interest
      income
                  
                  $
                  12,192
                  
                  
                  $
                  12,388
                  
                  
                  $
                  12,321
                  
                  
                  $
                  11,693Net
      interest income
                  
                  
                  9,223
                  
                  
                  
                  9,201
                  
                  
                  
                  9,310
                  
                  
                  
                  9,122Provision
      for loan losses
                  
                  
                  (170
                  )
                  
                  
                  430
                  
                  
                  
                  990
                  
                  
                  
                  3,545Other
      operating income
                  
                  
                  1,498
                  
                  
                  
                  1,708
                  
                  
                  
                  1,800
                  
                  
                  
                  2,154Other
      operating expense
                  
                  
                  7,646
                  
                  
                  
                  7,427
                  
                  
                  
                  7,190
                  
                  
                  
                  6,540Income
      before taxes
                  
                  
                  3,245
                  
                  
                  
                  3,052
                  
                  
                  
                  2,930
                  
                  
                  
                  1,191Net
      income
                  
                  
                  2,090
                  
                  
                  
                  1,985
                  
                  
                  
                  2,019
                  
                  
                  
                  1,187Basic
      earnings per share
                  
                  
                  .23
                  
                  
                  
                  .21
                  
                  
                  
                  .22
                  
                  
                  
                  .13Diluted
      earnings per share
                  
                  
                  .22
                  
                  
                  
                  .21
                  
                  
                  
                  .21
                  
                  
                  
                  .13
 
   88
  
 (21)
              Parent
      Company Financial Information
  This
information should be read in conjunction with the other notes to the
consolidated financial statements. The following presents summary balance sheets
and summary statements of operations and cash flows information for the years
ended December 31:
  Balance
      Sheets
                  
                  2008
                  
                  
                  2007AssetsCash
                  
                  $
                  377
                  
                  
                  $
                  981Investment
      in wholly owned subsidiary
                  
                  
                  61,646
                  
                  
                  
                  62,994Other
      assets
                  
                  
                  6
                  
                  
                  
                  —Total
      assets
                  
                  $
                  62,029
                  
                  
                  $
                  63,975Liabilities
      and stockholders’ equityStockholders’
      equity
                  
                  
                  62,029
                  
                  
                  
                  63,975Total
      liabilities and stockholders’ equity
                  
                  $
                  62,029
                  
                  
                  $
                  63,975
 
  Statements
      of Operations
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006Dividends
      from subsidiary
                  
                  $
                  100
                  
                  
                  $
                  6,000
                  
                  
                  $
                  2,500Other
      operating expenses
                  
                  
                  (127
                  )
                  
                  
                  (114
                  )
                  
                  
                  (94
                  )Income
      tax benefit
                  
                  
                  53
                  
                  
                  
                  48
                  
                  
                  
                  39Income
      before undistributed earnings of subsidiary
                  
                  
                  26
                  
                  
                  
                  5,934
                  
                  
                  
                  2,445Equity
      in undistributed earnings of subsidiary
                  
                  
                  (1,400
                  )
                  
                  
                  1,347
                  
                  
                  
                  6,365Net
      income
                  
                  $
                  (1,374
                  )
                  
                  $
                  7,281
                  
                  
                  $
                  8,810
 
  Statements
      of Cash Flows
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006Net
      income
                  
                  $
                  (1,374
                  )
                  
                  $
                  7,281
                  
                  
                  $
                  8,810Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDecrease  in
      other assets
                  
                  
                  (6
                  )
                  
                  
                  —
                  
                  
                  
                  —Equity
      in undistributed earnings of subsidiary
                  
                  
                  1,400
                  
                  
                  
                  (1,347
                  )
                  
                  
                  (6,365
                  )Net
      cash provided by operating activities
                  
                  
                  20
                  
                  
                  
                  5,934
                  
                  
                  
                  2,445Cash
      flows from financing activities:Common
      stock issued and stock based compensation
                  
                  
                  744
                  
                  
                  
                  1,230
                  
                  
                  
                  1,288Stock
      repurchases
                  
                  
                  (1,359
                  )
                  
                  
                  (6,851
                  )
                  
                  
                  (4,188
                  )Cash
      in lieu of fractional shares
                  
                  
                  (9
                  )
                  
                  
                  (13
                  )
                  
                  
                  (15
                  )Net
      cash used in financing activities
                  
                  
                  (624
                  )
                  
                  
                  (5,634
                  )
                  
                  
                  (2,915
                  )Net
      change in cash
                  
                  
                  (604
                  )
                  
                  
                  300
                  
                  
                  
                  (470
                  )Cash
      at beginning of year
                  
                  
                  981
                  
                  
                  
                  681
                  
                  
                  
                  1,151Cash
      at end of year
                  
                  $
                  377
                  
                  
                  $
                  981
                  
                  
                  $
                  681
 
  89
  
 ITEM
9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
  None.
 
 
 ITEM
9A – CONTROLS AND PROCEDURES
 
 (a)  Disclosure controls and
procedures
 
 The
Company maintains “disclosure controls and procedures,” as such term is defined
in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934
(the “Exchange Act”), that are designed to ensure that information required to
be disclosed in reports that the Company files or submits under the Exchange Act
is recorded, processed, summarized, and reported within the time periods
specified in Securities and Exchange Commission rules and forms, and that such
information is accumulated and communicated to management, including the
Company’s chief executive officer and chief financial officer, as appropriate,
to allow timely decisions regarding required disclosure.  The
Company’s disclosure controls and procedures have been designed to meet and
management believes that they meet reasonable assurance
standards.  Based on their evaluation as of the end of the period
covered by this Annual Report on Form 10-K, the chief executive officer and
chief financial officer have concluded that the Company’s disclosure controls
and procedures were effective to ensure that material information relating to
the Company, including its consolidated subsidiary, is made known to them by
others within those entities.
 
 (b)  Internal
controls over financial reporting
 
 As
required by Rule 13a-15(d), management, including the Chief Executive Officer
and Chief Financial Officer, conducted an evaluation of our internal control
over financial reporting to determine whether any changes occurred during the
period covered by this Annual Report on Form 10-K that have materially affected,
or are reasonably likely to materially affect, the Company’s internal control
over financial reporting. Based on that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that there has been no such change during
the last quarter of the fiscal year covered by this Annual Report on Form 10-K
that has materially affected, or is reasonably likely to materially affect, the
Company’s internal control over financial reporting.  See
“Management’s Report” included in Item 8 for management’s report on the adequacy
of internal control over financial reporting. Also see “Report of Independent
Registered Public Accounting Firm” issued by MOSS ADAMS LLP included in Item
8.
 
  90
  
 ITEM
9B – OTHER INFORMATION
 
 None.
 
 
 
 PART III
 
 
 ITEM
10 – DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
 
 The
information called for by this item with respect to director and executive
officer information is incorporated by reference herein from the sections of the
Company’s proxy statement for the 2009 Annual Meeting of Shareholders entitled
“Executive Officers,” “Security Ownership of Certain Beneficial Owners and
Management,” “Executive Compensation” “Report of Audit Committee,” “Section
16(a) Beneficial Ownership Compliance” and “Nomination and Election of
Directors.”
 
 The
Company has adopted a Code of Conduct, which complies with the Code of Ethics
requirements of the Securities and Exchange Commission.  A copy of the
Code of Conduct is posted on the “Investor Relations” page of the Company’s
website, or is available, without charge, upon the written request of any
shareholder directed to Lynn Campbell, Corporate Secretary, First Northern
Community Bancorp, 195 North First Street, Dixon, California
95620.  The Company intends to disclose promptly any amendment to, or
waiver from any provision of, the Code of Conduct applicable to senior financial
officers, and any waiver from any provision of the Code of Conduct applicable to
directors, on the “Investor Relations” page of its website.
 
 The
Company’s website address is www.thatsmybank.com.
 
 
 ITEM
11 - EXECUTIVE COMPENSATION
 
 The
information called for by this item is incorporated by reference herein from the
sections of the Company’s proxy statement for the 2009 Annual Meeting of
Shareholders entitled “Compensation Committee Interlocks and Insider
Participation,” “Nomination and Election of Directors,” “Compensation
Discussion and Analysis,” “Compensation Committee Report,” “Transactions with
Related Persons,” “Director Compensation,” and “Executive
Compensation.”
  91
  
 ITEM
12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
 
 Information
concerning ownership of the equity stock of the Company by certain beneficial
owners and management is incorporated herein by reference from the sections of
the Company’s proxy statement for the 2009 Annual Meeting of Shareholders
entitled “Security Ownership of Management” and “Nomination and Election of
Directors.”
 
 Stock
Purchase Equity Compensation Plan Information
  The
following table shows the Company’s equity compensation plans approved by
security holders.  The table also indicates the number of securities
to be issued upon exercise of outstanding options, weighted-average exercise
price of outstanding options and the number of securities remaining available
for future issuance under the Company’s equity compensation plans as of December
31, 2008.  The plans included in this table are the Company’s 2000
Stock Option Plan and the Company’s 2006 Amended Employee Stock Purchase
Plan.  See
“Stock Compensation Plans” Note 13 of Notes to Consolidated Financial Statements
(page 79) included in this report.
  Plan
      category
              
              Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights
              
              Weighted-average
      exercise price of outstanding options, warrants and rights
              
              Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in the first
      column)Equity
      compensation plans approved by security holders
              
              564,145
              
              $
      10.55
              
              772,410Equity
      compensation plans not approved by security holders
              
              —
              
              —
              
              —Total
              
              564,145
              
              $
      10.55
              
              772,410
 
 
 
 ITEM
13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
 
 The
information called for by this item is incorporated herein by reference from the
sections of the Company’s proxy statement for the 2009 Annual Meeting of
Shareholders entitled “Director Independence” and “Transactions with Related
Persons.”
 
 
 ITEM
14 – PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
 The
information called for by this item is incorporated herein by reference from the
section of the Company’s proxy statement for the 2009 Annual Meeting of
Shareholders entitled “Audit and Non-Audit Fees.”
  92
  
 PART IV
 
 ITEM
15 – EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
 (a)(1)  Financial
Statements:
 
 Reference
is made to the Index to Financial Statements under Item 8 in Part II of this
Form 10-K.
 
 (a)(2)Financial
Statement Schedules:
 
 All
schedules to the Company’s Consolidated Financial Statements are omitted because
of the absence of the conditions under which they are required or because the
required information is included in the Consolidated Financial Statements or
accompanying notes.
 
 (a)(3)Exhibits:
  The
      following is a list of all exhibits filed as part of this Annual Report on
      Form 10-K:ExhibitExhibitNumber3.1
                    
                    Amended
      Articles of Incorporation of the Company – incorporated by reference to
      Exhibit 3.1 of the Registrant’s Annual Report on Form 10-K on
      December  31, 2006 and Exhibit 3.1 to the Company’s Current
      Report on Form 8-K dated March 9, 20093.2
                    
                    Certificate
      of Determination – incorporated by reference to Exhibit 3.2 to the
      Company’s Current Report on Form 10-K on December  31, 2006 and
      Exhibit 3.1 to the Company’s Current Report on Form 8-K dated March 9,
      20093.3
                    
                    Amended
      and Restated Bylaws of the Company – incorporated by reference to Exhibit
      3.1 of the Registrant’s Current Report on Form 8-K on September 15,
      200510.1
                    
                    First
      Northern Community Bancorp 2000 Stock Option Plan – incorporated herein by
      reference to Exhibit 4.1 of Registrant’s Registration Statement on Form
      S-8 on May 25, 2000 *10.2
                    
                    First
      Northern Community Bancorp Outside Directors 2000 Non-statutory Stock
      Option Plan – incorporated herein by reference to Exhibit 4.3 of
      Registrant’s Registration Statement on Form S-8 on May 25, 2000
      *10.3
                    
                    Amended
      First Northern Community Bancorp Employee Stock Purchase Plan -
      incorporated by reference to Appendix B of the Company’s Definitive Proxy
      Statement on Schedule 14A for its 2006 Annual Meeting of
      Shareholders10.4
                    
                    First
      Northern Community Bancorp 2000 Stock Option Plan Forms “Incentive Stock
      Option Agreement” and “Notice of Exercise of Stock Option” – incorporated
      herein by reference to Exhibit 4.2 of Registration Statement on Form S-8
      on May 25, 2000 *10.5
                    
                    First
      Northern Community Bancorp 2000 Outside Directors 2000 Non-statutory Stock
      Option Plan Forms “Non-statutory Stock Option Agreement” and “Notice of
      Exercise of Stock Option” – incorporated herein by reference to Exhibit
      4.4 of Registrant’s Registration Statement on Form S-8 May 25, 2000
      *10.6
                    
                    First
      Northern Community Bancorp 2000 Employee Stock Purchase Plan Forms
      “Participation Agreement” and “Notice of Withdrawal” – incorporated herein
      by reference to Exhibit 4.6 of Registration Statement on Form S-8 on May
      25, 2000 *10.7
                    
                    Amended
      and Restated Employment Agreement entered into as of July 23, 2001 by and
      between First Northern Bank of Dixon and Don Fish – incorporated herein by
      reference to Exhibit 10.1 to Quarterly Report on Form 10-Q for the quarter
      ended September 30, 2001 *
  93
  
 10.8
                      
                      Employment
      Agreement entered into as of July 23, 2001 by and between First Northern
      Bank of Dixon and Owen J. Onsum – incorporated herein by reference to
      Exhibit 10.2 of Registrant’s Quarterly Report on Form 10-Q for the quarter
      ended September 30, 2001 *10.9
                      
                      Employment
      Agreement entered into as of July 23, 2001 by and between First Northern
      Bank of Dixon and Louise Walker – incorporated herein by reference to
      Exhibit 10.3 of Registrant’s Quarterly Report on Form 10-Q for the quarter
      ended September 30, 2001 *10.10
                      
                      Employment
      Agreement entered into as of July 23, 2001 by and between First Northern
      Bank of Dixon and Robert Walker – incorporated herein by reference to
      Exhibit 10.4 of Registrant’s Quarterly Report on Form 10-Q for the quarter
      ended September 30, 2001 *10.11
                      
                      Form
      of Director Retirement and Split Dollar Agreements between First Northern
      Bank of Dixon and Lori J. Aldrete, Frank J. Andrews Jr., John M. Carbahal,
      Gregory DuPratt, John F. Hamel, Diane P. Hamlyn, Foy S. McNaughton,
      William Jones, Jr. and David Schulze – incorporated herein by reference to
      Exhibit 10.11 to Company’s Annual Report on Form 10-K for the year ended
      December 31, 2001 *10.12
                      
                      Form
      of Salary Continuation and Split Dollar Agreement between First Northern
      Bank of Dixon and Owen J. Onsum, Louise A. Walker, Don Fish, and Robert
      Walker – incorporated herein by reference to Exhibit 10.12 to Company’s
      Annual Report on Form 10-K for the year ended December 31, 2001
      *10.13
                      
                      Amended
      Form of Director Retirement and Split Dollar Agreements between First
      Northern Bank of Dixon and Lori J. Aldrete, Frank J. Andrews Jr., John M.
      Carbahal, Gregory DuPratt, John F. Hamel, Diane P. Hamlyn, Foy S.
      McNaughton, William Jones, Jr. and David Schulze – by reference to Exhibit
      10.13 to Registrant’s Annual Report on Form 10-K for the year ended
      December 31, 2004 *10.14
                      
                      Amended
      Form of Salary Continuation and Split Dollar Agreement between First
      Northern Bank of Dixon and Owen J. Onsum, Louise A. Walker, Don Fish, and
      Robert Walker – by reference to Exhibit 10.14 to Registrant’s Annual
      Report on Form 10-K for the year ended December 31, 2004
  *10.15
                      
                      Form
      of Salary Continuation Agreement between Pat Day and First Northern Bank
      of Dixon – incorporated herein by reference to Exhibit 10.15 to
      Registrant’s Annual Report on Form 10-K for the year ended December 31,
      2006 *10.16
                      
                      Form
      of Supplemental Executive Retirement Plan Agreement between First Northern
      Bank of Dixon and Owen J. Onsum and Louise A. Walker – provided
      herewith*10.17
                      
                      First
      Northern Bancorp 2006 Stock Incentive Plan – incorporated by reference to
      Appendix A of the Company’s Definitive Proxy Statement on Schedule 14A for
      its 2006 Annual Meeting of Shareholders *10.18
                      
                      First
      Northern Bank Annual Incentive Compensation Plan – incorporated
      herein by reference to Exhibit 10.18 to Registrant’s Annual Report on Form
      10-K for the year ended December 31, 2006 *11
                      
                      Statement
      of Computation of Per Share Earnings (See Page 64 of
      this Form 10-K)21
                      
                      Subsidiaries
      of the Company – provided herewith23.1
                      
                      Consent
      of independent registered public accounting firm – provided
      herewith31.1
                      
                      Rule
      13(a) – 14(a) / 15(d) –14(a) Certification of the Company’s Chief
      Executive Officer – provided herewith31.2
                      
                      Rule
      13(a) – 14(a) / 15(d) –14(a) Certification of the Company’s Chief
      Financial Officer – provided herewith32.1
                      
                      Section
      1350 Certification of the Chief Executive Officer – provided
      herewith32.2
                      
                      Section
      1350 Certification of the Chief Financial Officer – provided
      herewith*
      Management contract or compensatory plan, contract or
      arrangement.
 94
  
  SIGNATURES
   Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on March 13,
2009.
    FIRST
      NORTHERN COMMUNITY BANCORPBy:
                    /s/ Owen J. OnsumOwen
      J. OnsumPresident/Chief
      Executive Officer/Director(Principal
      Executive Officer)By:
                    /s/ Louise A. WalkerLouise
      A. WalkerSenior
      Executive Vice President/Chief Financial Officer(Principal
      Financial Officer)By:
                    /s/ Stanley R. BeanStanley
      R. BeanSenior
      Vice President/Controller(Principal
      Accounting
Officer)
  
   Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
  Name
                Title
                Date/s/
      LORI J. ALDRETE
                Director
                March
      13, 2009Lori
      J. Aldrete/s/
      FRANK J. ANDREWS, JR.
                Director
                March
      13, 2009Frank
      J. Andrews, Jr./s/
      JOHN M. CARBAHAL
                Director
      and Vice Chairman of the Board
                March
      13, 2009John
      M. Carbahal/s/
      GREGORY DUPRATT
                Director
      and Chairman of the Board
                March
      13, 2009Gregory
      DuPratt/s/
      JOHN F. HAMEL
                Director
                March
      13, 2009John
      F. Hamel/s/
      DIANE P. HAMLYN
                Director
                March
      13, 2009Diane
      P. Hamlyn/s/
      FOY S. MCNAUGHTON
                Director
                March
      13, 2009Foy
      S. McNaughton/s/
      DAVID W. SCHULZE
                Director
                March
      13, 2009David
      W. Schulze/s/
      ANDREW S. WALLACE
                Director
                March
      13,
2009