**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

(Mark One)

 

| (**X**) | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE |
|---------|----------------------------------------------------------|

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended**June 30, 2008**, OR

 

| ( ) | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE |
|-----|-----------------------------------------------------------|

|   | SECURITIES EXCHANGE ACT OF 1934 |
|--------|---------------------------------|

 

For the transition period from ____________ to ____________.

 

Commission File No.**0-12870**.

 

**FIRST CHESTER COUNTY CORPORATION**

(Exact name of Registrant as specified in its charter)

 

| **Pennsylvania**                |   | **23-2288763**      |
|---------------------------------|--------|---------------------|
| (State or other jurisdiction of |   | (I.R.S. Employer    |
| incorporation or organization)  |   | Identification No.) |

 

**                                                        9 North High Street, West Chester,        Pennsylvania**                         **19380**

|   | (Address of principal executive office) | (Zip code) |
|--------|-----------------------------------------|------------|

 

**(484) 881-4000**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __

 

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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ___ Accelerated filerXNon-accelerated filer (Do not check if a smaller reporting company _____ Smaller reporting company _____

 

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

 

The number of shares outstanding of Common Stock of the Registrant as of August 11, 2008 was5,188,670.

**INDEX**

|   | **PAGE** |
|--------|----------|

 

| Part I. | FINANCIAL INFORMATION |                                                          |
|---------|-----------------------|---------------------------------------------------------------|
|    |                  |                                                          |   |
|    | Item 1 -              | Financial Statements                                          |   |
|    |                  | Consolidated Balance Sheet                                    |   |
|    |                  | June 30, 2008 (unaudited) and December 31, 2007               | 3 |
|    |                  |                                                          |   |
|    |                  | Consolidated Statements of Income                             |   |
|    |                  | Three and Six Months Ended June 30, 2008 and 2007 (unaudited) | 4 |
|    |                  |                                                          |   |
|    |                  | Consolidated Statements of Cash Flows                         |   |
|    |                  | Six-Months Ended June 30, 2008 and 2007 (unaudited)           | 5 |
|    |                  |                                                          |   |
|    |                  | Consolidated Statements of Stockholders’ Equity         |   |
|    |                  | Six-Months Ended June 30, 2008 and 2007 (unaudited)           | 6 |
|    |                  |                                                          |   |
|    |                  | Notes to Consolidated Financial Statements                    | 7-12 |
|    |                  |                                                          |   |
|    | Item 2 -              | Management’s Discussion and Analysis of                 |   |
|    |                  | Financial Condition and Results of Operations                 | 13-27 |
|    |                  |                                                          |   |
|    | Item 3 -              | Quantitative and Qualitative Disclosures About Market Risk    | 28 |
|    |                  |                                                          |   |
|    | Item 4 -              | Controls & Procedures                                     | 28 |

 

| Part II. | OTHER INFORMATION |                                                        |
|----------|-------------------|-------------------------------------------------------------|
|     | Item 1 -          | Legal Proceedings                                           | 29 |
|     |              |                                                        |   |
|     | Item 1A -         | Risk Factors                                                |  

29 |
|     |              |                                                        |   |
|     | Item 2 -          | Unregistered Sales of Equity Securities and Use of Proceeds |  

29 |
|     |              |                                                        |   |
|     | Item 3 -          | Defaults Upon Senior Securities                             | 30 |
|     |              |                                                        |   |
|     | Item 4 -          | Submission of Matters to a Vote of Security Holders         | 30 |
|     |              |                                                        |   |
|     | Item 5 -          | Other Information                                           | 30 |
|     |              |                                                        |   |
|     | Item 6 -          | Exhibits                                                    |  

31 |
|     |              |                                                        |   |
|     | Signatures        |                                                        |  

32 |
|     |              |                                                        |   |
|     | Index to Exhibits |                                                        | 33 |
|     |              |                                                        |   |
|     | Exhibits          |                                                        |   |

 

 

2

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART I. FINANCIAL INFORMATION**

 

**                                                       ITEM 1. Financial Statements**

 

**CONSOLIDATED BALANCE SHEET**

 

| **(Dollars in thousands)**                                    | **June 30,**                          |   |                                        |
|---------------------------------------------------------------|---------------------------------------|--------|---------------------------------------------|
|                                                          | **2008**                              |   | **December 31,**                            |
|                                                          | **(unaudited)**                       |   | **2007**                                    |
| ASSETS                                                        |                                  |   |                                        |
| Cash and due from banks                                       | $     25,016 |   | $      28,884 |
| Federal funds sold and other overnight investments            | 16,688                                |   | 24,260                                      |
| Interest bearing deposits                                     | 454                                   |   | 216                                         |
|                                                          |                                  |   |                                        |
| Total cash and cash equivalents                               | 42,158                                |   | 53,360                                      |
|                                                          |                                  |   |                                        |
| Investment securities available-for-sale, at fair value       | 114,855                               |   | 97,977                                      |
|                                                          |                                  |   |                                        |
| Loans and leases                                              | 786,548                               |   | 743,440                                     |
| Less: allowance for loan and lease losses                     | (8,433)                               |   | (7,817)                                     |
|                                                          |                                  |   |                                        |
| Net loans and leases                                          | 778,115                               |   | 735,623                                     |
|                                                          |                                  |   |                                        |
| Premises and equipment, net                                   | 19,430                                |   | 17,560                                      |
| Net deferred tax asset                                        | 5,635                                 |   | 4,418                                       |
| Bank owned life insurance                                     | 10,157                                |   | -                                           |
| Other assets                                                  | 5,800                                 |   | 5,843                                       |
| Total assets                                                  | $  976,150                  |   | $   914,781                  |
| LIABILITIES                                                   |                                  |   |                                        |
| Deposits                                                      |                                  |   |                                        |
| Non-interest-bearing                                          | $    118,918      |   | $   124,199                  |
| Interest-bearing (including certificates of deposit over $100 |                                  |   |                                        |
| of $76,581 and $58,816 at June 30, 2008 and                   |                                  |   |                                        |
| December 31, 2007, respectively)                              | 610,428                               |   | 580,699                                     |
|                                                          |                                  |   |                                        |
| Total deposits                                                | 729,346                               |   | 704,898                                     |
| Federal Home Loan Bank and other borrowings                   | 153,102                               |   | 115,384                                     |
| Subordinated debt                                             | 15,465                                |   | 15,465                                      |
| Other liabilities                                             | 9,596                                 |   | 11,055                                      |
|                                                          |                                  |   |                                        |
| Total liabilities                                             | 907,509                               |   | 846,802                                     |
|                                                          |                                  |   |                                        |
| STOCKHOLDERS’ EQUITY                                    |                                  |   |                                        |
| Common stock, par value $1.00; authorized 25,000,000 shares;  |                                  |   |                                        |
| Outstanding, 5,279,815 at June 30, 2008 and December 31, 2007 | 5,280                                 |   | 5,280                                       |
| Additional paid-in capital                                    | 10,390                                |   | 11,113                                      |
| Retained earnings                                             | 57,256                                |   | 55,347                                      |
| Accumulated other comprehensive loss                          | (2,477)                               |   | (1,207)                                     |
| Treasury stock, at cost: 92,567 shares and 119,065 shares     |                                  |   |                                        |
| at June 30, 2008 and December 31, 2007, respectively          | (1,808)                               |   | (2,554)                                     |
|                                                          |                                  |   |                                        |
| Total stockholders’ equity                              | 68,641                                |   | 67,979                                      |
|                                                          |                                  |   |                                        |
| Total liabilities and stockholders’ equity              | $   976,150            |   | $   914,781                  |

 

 

                                                      The accompanying notes are an integral part of these statements.

 

3

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF INCOME**

(**UNAUDITED**)

 

| **(Dollars in thousands - except per share)**   | **Three Months Ended**  | **Six Months Ended** |
|-----------------------------------------------------------|------------------------------|----------------------|

|   | **                June 30,** | **June 30,** |
|--------|---------------------------------------------------------------------------------------------------------|--------------|

|                                                  | 2008                                      |   | 2007                                      |   | 2008                                      |   | 2007                                      |
|-------------------------------------------------------|-------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|--------|-------------------------------------------|
| INTEREST INCOME                                       |                                      |   |                                      |   |                                      |   |                                      |
| Loans and leases, including fees                      | $   12,028                 |   | $   12,647                 |   | $   24,424                 |   | $   24,551                 |
| Investment securities                                 | 1,351                                     |   | 1,028                                     |   | 2,581                                     |   | 2,050                                     |
| Federal funds sold and deposits in banks              | 417                                       |   | 648                                       |   | 868                                       |   | 1,245                                     |
| Total interest income                                 | 13,796                                    |   | 14,323                                    |   | 27,873                                    |   | 27,846                                    |
| INTEREST EXPENSE                                      |                                      |   |                                      |   |                                      |   |                                      |
| Deposits                                              | 3,954                                     |   | 5,246                                     |   | 8,452                                     |   | 10,140                                    |
| Subordinated debt                                     | 215                                       |   | 499                                       |   | 474                                       |   | 834                                       |
| Federal Home Loan Bank and other borrowings           | 1,478                                     |   | 624                                       |   | 2,920                                     |   | 1,218                                     |
| Total interest expense                                | 5,647                                     |   | 6,369                                     |   | 11,846                                    |   | 12,192                                    |
|                                                  |                                      |   |                                      |   |                                      |   |                                      |
| Net interest income                                   | 8,149                                     |   | 7,954                                     |   | 16,027                                    |   | 15,654                                    |
| Provision for loan and lease losses                   | 449                                       |   | -                                         |   | 660                                       |   | -                                         |
| Net interest income after provision                   |                                      |   |                                      |   |                                      |   |                                      |
| For loan and lease losses                             | 7,700                                     |   | 7,954                                     |   | 15,367                                    |   | 15,654                                    |
|                                                  |                                      |   |                                      |   |                                      |   |                                      |
| NON-INTEREST INCOME                                   |                                      |   |                                      |   |                                      |   |                                      |
| Wealth management and advisory services               | 1,080                                     |   | 1,069                                     |   | 2,075                                     |   | 2,046                                     |
| Service charges on deposit accounts                   | 643                                       |   | 569                                       |   | 1,196                                     |   | 1,107                                     |
| Gains (losses) on sales of investment securities, net | (78)                                      |   | -                                         |   | 184                                       |   | 2                                         |
| Operating lease rental income                         | 330                                       |   | 316                                       |   | 639                                       |   | 623                                       |
| Gains on the sale of fixed assets and OREO            | 45                                        |   | -                                         |   | 91                                        |   | -                                         |
| Gain and fees on the sales of loans                   | 94                                        |   | 351                                       |   | 164                                       |   | 419                                       |
| Bank owned life insurance                             | 92                                        |   | -                                         |   | 157                                       |   | -                                         |
| Other                                                 | 565                                       |   | 530                                       |   | 1,123                                     |   | 993                                       |
| Total non-interest income                             | 2,771                                     |   | 2,835                                     |   | 5,629                                     |   | 5,190                                     |
|                                                  |                                      |   |                                      |   |                                      |   |                                      |
| NON-INTEREST EXPENSE                                  |                                      |   |                                      |   |                                      |   |                                      |
| Salaries and employee benefits                        | 4,201                                     |   | 4,893                                     |   | 8,998                                     |   | 9,593                                     |
| Occupancy, equipment and data processing              | 1,470                                     |   | 1,278                                     |   | 2,908                                     |   | 2,632                                     |
| Depreciation expense on operating leases              | 271                                       |   | 261                                       |   | 526                                       |   | 519                                       |
| Bank shares tax                                       | 193                                       |   | 160                                       |   | 386                                       |   | 320                                       |
| Professional services                                 | 495                                       |   | 482                                       |   | 919                                       |   | 996                                       |
| Marketing                                             | 335                                       |   | 291                                       |   | 533                                       |   | 529                                       |
| Other                                                 | 1,040                                     |   | 936                                       |   | 2,183                                     |   | 1,843                                     |
| Total non-interest expense                            | 8,005                                     |   | 8,301                                     |   | 16,453                                    |   | 16,432                                    |
| Income before income taxes                            | 2,466                                     |   | 2,488                                     |   | 4,543                                     |   | 4,412                                     |
| INCOME TAXES                                          | 624                                       |   | 709                                       |   | 1,181                                     |   | 1,258                                     |
| NET INCOME                                            | $    1,842            |   | $    1,779            |   | $    3,362            |   | $    3,154            |
| PER SHARE DATA                                        |                                      |   |                                      |   |                                      |   |                                      |
| Net income per share (Basic)                          | $      0.36 |   | $      0.34 |   | $      0.65 |   | $      0.61 |
| Net income per share (Diluted)                        | $      0.35 |   | $      0.34 |   | $      0.65 |   | $      0.60 |
| Dividends declared                                    | $    0.140            |   | $    0.135            |   | $    0.280            |   | $    0.270            |
|                                                  |                                      |   |                                      |   |                                      |   |                                      |
| Basic weighted average shares outstanding             | 5,187,398                                 |   | 5,170,123                                 |   | 5,181,955                                 |   | 5,156,886                                 |
|                                                  |                                      |   |                                      |   |                                      |   |                                      |
| Diluted weighted average shares outstanding           | 5,206,736                                 |   | 5,230,283                                 |   | 5,202,278                                 |   | 5,222,362                                 |

 

                                                    The accompanying notes are an integral part of these statements.

 

4

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(**UNAUDITED**)

|   | **Six Months Ended** |
|--------|----------------------|

|   | **(Dollars in thousands)**   | **June30,** |
|--------|----------------------------------------|-------------|

|                                                                  | **2008**                                   |   | **2007**                                   |
|-----------------------------------------------------------------------|--------------------------------------------|--------|--------------------------------------------|
| OPERATING ACTIVITIES                                                  |                                       |   |                                       |
| Net income                                                            | $     3,362       |   | $     3,154       |
| Adjustments to reconcile net income to net cash (used in)             |                                       |   |                                       |
| provided by operating activities:                                     |                                       |   |                                       |
| Depreciation                                                          | 1,221                                      |   | 1,296                                      |
| Provision for loan and lease losses                                   | 660                                        |   | -                                          |
| Amortization of investment security premiums                          |                                       |   |                                       |
| and accretion of discounts, net                                       | 159                                        |   | 97                                         |
| Amortization of deferred loan fees and costs                          | (411)                                      |   | (31)                                       |
| Gains on sales of investment securities, net                          | (184)                                      |   | (2)                                        |
| Gains from sales of assets                                            | (91)                                       |   | -                                          |
| Gains and fees from the sale of loans                                 | (164)                                      |   | (419)                                      |
| Stock-based compensation expense                                      | 92                                    |   | 50                                    |
| Increase in other assets                                              | (677)                                      |   | (520)                                      |
| Increase (decrease) in other liabilities                              | (1,368)                                    |   | 528                                        |
|                                                                  |                                       |   |                                       |
| Net cash provided by operating activities                             | $      2,599 |   | $      4,153 |
|                                                                  |                                       |   |                                       |
| INVESTING ACTIVITIES                                                  |                                       |   |                                       |
| Net increase in loans                                                 | (52,213)                                   |   | (43,627)                                   |
| Proceeds from the sale of loans                                       | 9,636                                      |   | 17,762                                     |
| Proceeds from sales of investment securities available-for-sale       | 13,228                                     |   | 4,583                                      |
| Proceeds from maturities of investment securities available-for-sale  | 9,537                                      |   | 3,716                                      |
| Proceeds from maturities of investment securities held-to-maturity    | -                                          |   | 5                                          |
| Purchases of investment securities available-for-sale                 | (41,542)                                   |   | (13,888)                                   |
| Purchase of BOLI (Bank Owned Life Insurance)                          | (10,000)                                   |   | -                                          |
| Purchase of premises and equipment                                    | (3,139)                                    |   | (4,931)                                    |
| Proceeds from the sale of fixed assets                                | 48                                         |   | 91                                         |
|                                                                  |                                       |   |                                       |
| Net cash used in investing activities                                 | $  (74, 445)                     |   | $  (36,289)                      |
|                                                                  |                                       |   |                                       |
| FINANCING ACTIVITIES                                                  |                                       |   |                                       |
| Increase (decrease) in short term Federal Home Loan Bank              |                                       |   |                                       |
| and other short term borrowings                                       | -                                          |   | (5,266)                                    |
| Increase in long term Federal Home Loan Bank borrowings               | 51,500                                     |   | 15,000                                     |
| Repayment of long term Federal Home Loan Bank borrowings              | (13,782)                                   |   | (5,882)                                    |
| Net increase in deposits                                              | 24,448                                     |   | 69,538                                     |
| Cash dividends paid                                                   | (1,453)                                    |   | (1,391)                                    |
| Proceeds from issuance of guaranteed preferred beneficial interest in |                                       |   |                                       |
| Corporations subordinated debentures:                                 | -                                          |   | 5,155                                      |
| Net increase (decrease) in treasury stock transactions                | (69)                                       |   | (359)                                      |
|                                                                  |                                       |   |                                       |
| Net cash provided by financing activities                             | 60,644                                     |   | 76,795                                     |
|                                                                  |                                       |   |                                       |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                  | (11,202)                                   |   | 44,659                                     |
|                                                                  |                                       |   |                                       |
| Cash and cash equivalents at beginning of period                      | 53,360                                     |   | 72,341                                     |
|                                                                  |                                       |   |                                       |
| Cash and cash equivalents at end of period                            | $  42,158                        |   | $   117,000                 |

 

 

                                                  The accompanying notes are an integral part of these statements.

 

5

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY**

**(UNAUDITED)**

 

 

|                        |      |         |          |          | Accumulated    |           |                |          |
|-----------------------------|-----------|--------------|---------------|---------------|----------------|----------------|---------------------|---------------|
|                        |      |         | Additional    |          | Other          |           | Total               |          |
|                        | Common    | Stock        | Paid-in       | Retained      | Comprehensive  | Treasury       | Stockholders’ | Comprehensive |
| (Dollars in thousands)      | Shares    | Par Value    | Capital       | Earnings      | Loss           | Stock          | Equity              | Income        |
|                        |      |         |          |          |           |           |                |          |
| Balance January 1, 2007     | 5,279,815 | $ 5,280 | $ 11,939 | $ 50,486 | $ (1,473) | $ (2,970) | $ 63,262       |          |
|                        |      |         |          |          |           |           |                |          |
| Net income                  | -         | -            | -             | 3,154         | -              | -              | 3,154               | $ 3,154  |
| Cash dividends declared     | -         | -            | -             | (1,391)       | -              | -              | (1,391)             |          |
| Other comprehensive loss    |      |         |          |          |           |           |                |          |
| Net unrealized losses       |      |         |          |          |           |           |                |          |
| on investment securities    |      |         |          |          |           |           |                |          |
| available-for-sale          | -         | -            | -             | -             | (999)          | -              | (999)               | (999)         |
| Treasury stock transactions | -         | -            | (903)         | -             | -              | 594            | (309)               | -             |
| Total comprehensive income  |      |         |          |          |           |           |                | $ 2,155  |
|                        |      |         |          |          |           |           |                |          |
| Balance June 30, 2007       | 5,279,815 | $ 5,280 | $ 11,036 | $52,249       | $ (2,472) | $ (2,376) | $ 63,717       |          |
|                        |      |         |          |          |           |           |                |          |
|                        |      |         |          |          |           |           |                |          |
| Balance January 1, 2008     | 5,279,815 | $ 5,280 | $ 11,113 | $ 55,347 | $ (1,207) | $ (2,554) | $ 67,979       |          |
|                        |      |         |          |          |           |           |                |          |
| Net income                  | -         | -            | -             | 3,362         | -              | -              | 3,362               | $ 3,362  |
| Cash dividends declared     | -         | -            | -             | (1,453)       | -              | -              | (1,453)             |          |
| Other comprehensive loss    |      |         |          |          |           |           |                |          |
| Net unrealized losses       |      |         |          |          |           |           |                |          |
| on investment securities    |      |         |          |          |           |           |                |          |
| available-for-sale          | -         | -            | -             | -             | (1,270)        | -              | (1,270)             | (1,270)       |
| Treasury stock transactions | -         | -            | (723)         | -             | -              | 746            | 23                  | -             |
| Total comprehensive income  |      |         |          |          |           |           |                | $ 2,092  |
|                        |      |         |          |          |           |           |                |          |
| Balance June 30, 2008       | 5,279,815 | $ 5,280 | $ 10,390 | $ 57,256 | $ (2,477) | $ (1,808) | $ 68,641       |          |

 

                              The accompanying notes are an integral part of these statements.

 

6

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

| **1.** | **BASIS OF PRESENTATION** |
|--------|---------------------------|

 

The foregoing unaudited financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information. In the opinion of Management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position and the results of operations for the interim period presented have been        included. Operating results for the three and six months ended June 30, 2008 include a $417 thousand reduction of salary and benefits expense associated with loan origination costs not previously deferred in prior periods. Management has concluded that the impact of deferring this expense in the second quarter of 2008 is not material to the Corporation’s consolidated financial statements. These interim financial statements should be read in conjunction with the consolidated        financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2007 (our “2007 Annual Report”).

 

The results of operations for the three and six month periods ended June 30, 2008 are not necessarily indicative of the results to be expected for the full year. Information regarding risks and uncertainties that could cause actual results to vary materially from our prior performance may be found in Part I, Item 1A of our 2007 Annual Report.

 

| **2.** | **ACCOUNTING FOR STOCK-BASED COMPENSATION PLANS** |
|--------|---------------------------------------------------|

 

At June 30, 2008, the Corporation had one stock based compensation plan, pursuant to which, shares of the Corporation’s common stock could be issued, subject to certain restrictions. The plan, adopted in 2005, allows the Corporation to grant up to 150 thousand shares of restricted stock to employees. During the six months ended June 30, 2008, the Corporation granted 34,500 shares        valued at $17.80 per share at the grant date. These shares, or a portion thereof will vest on the third anniversary of the grant date subject to certain employment and company performance requirements. During the six months ended June 30, 2007, the Corporation granted 22,900 shares valued at $21.05 per share at the grant date. One third of these shares vest on each of the first three anniversaries of the date of the grant. These restricted stock grants are also subject to accelerated        vesting of all or a portion of the shares upon the occurrence of certain events, as described more fully in our proxy statement. A summary of the Corporation’s unvested restricted shares is as follows:

 

|   | (Dollars in thousands, except shares, and per share data) |
|--------|-----------------------------------------------------------|

 

|                        | Shares | Grant Date Fair

Value | Aggregate Intrinsic Value

of Unvested Shares |
|-----------------------------|--------|------------------------|-----------------------------------------------|
| Unvested at January 1, 2008 | 21,400 | $21.05                 | -                                             |
| Granted                     | 34,500 | $17.80                 |                                          |
| Vested                      | 7,138  | $21.05                 |                                          |
| Forfeited                   |   |                   |                                          |
| Unvested at June 30, 2008   | 48,762 | $21.05                 | $731.4                                        |

 

The Corporation recorded $92 thousand and $50 thousand of restricted stock expense for the six months ended June 30, 2008 and 2007, respectively.

 

The Corporation’s ability to issue stock options under the 1995 Stock Option Plan has expired. Outstanding stock options, however, remain in effect according to their terms. Aggregated information regarding the Corporation’s Stock Option Plan as of June 30, 2008 is presented below.

 

|   | (Dollars in thousands, except shares, per share and years data) |
|--------|-----------------------------------------------------------------|

 

|  

 

 

Options |  

 

 

Shares | Weighted-

Average

Exercise

Price | Weighted-Average

Remaining

Contractual

Term (years) |  

Aggregate

Intrinsic

Value |
|---------------------------------|--------------------------------|-------------------------------------|--------------------------------------------------------|-------------------------------------|
| Outstanding at January 1, 2008  | 208,308                        | $15.00                              | -                                                      | $437                                |
| Granted                         | -                              | -                                   | -                                                      | -                                   |
| Exercised                       | -                              | -                                   | -                                                      | -                                   |
| Forfeited                       | (9,152)                        | 18.59                               | -                                                      | -                                   |
| Expired                         | -                              | -                                   | -                                                      | -                                   |
| Outstanding at June 30, 2008    | 199,156                        | $14.84                              | 2.22                                                   | $33                                 |
| Exercisable at June 30, 2008    | 199,156                        | $14.84                              | 2.22                                                   | $33                                 |

 

 

7

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – Continued**

 

There were no options granted during the six months ended June 30, 2008. The total intrinsic value (market value on date of exercise less grant price) of options exercisable at June 30, 2008 is $33 thousand. As of January 1, 2007, there were no unvested options under the Corporation’s one stock option plan.

 

| **3.** | **EARNINGS PER SHARE** |
|--------|------------------------|

 

**Three Months ended June 30, 2008**

 

|                                        | Income       |   |          |   |        |
|---------------------------------------------|--------------|--------|---------------|--------|-------------|
|                                        | (thousands)  |   | Shares        |   | Per Share   |
|                                        | (numerator)  |   | (denominator) |   | Amount      |
| Basic earnings per share                    |         |   |          |   |        |
| Net income available to common stockholders | $ 1,842 |   | 5,187,398     |   | $ 0.36 |
| Effect of Dilutive Securities               |         |   |          |   |        |
| Options to purchase common stock            | -            |   | 19,338        |   | (.01)       |
| Diluted earnings per share                  |         |   |          |   |        |
| Net income available to common stockholders | $ 1,842 |   | 5,206,736     |   | $ 0.35 |

 

23,929 anti-dilutive weighted shares have been excluded from this computation because the option exercise price was greater than the average market price of the common shares.

 

**Six Months ended June 30, 2008**

 

|                                        | Income       |   |          |   |        |
|---------------------------------------------|--------------|--------|---------------|--------|-------------|
|                                        | (thousands)  |   | Shares        |   | Per Share   |
|                                        | (numerator)  |   | (denominator) |   | Amount      |
| Basic earnings per share                    |         |   |          |   |        |
| Net income available to common stockholders | $ 3,362 |   | 5,181,955     |   | $ 0.65 |
| Effect of Dilutive Securities               |         |   |          |   |        |
| Options to purchase common stock            | -            |   | 20,323        |   | (.00)       |
| Diluted earnings per share                  |         |   |          |   |        |
| Net income available to common stockholders | $ 3,362 |   | 5,202,278     |   | $ 0.65 |

 

23,935 anti-dilutive weighted shares have been excluded from this computation because the option exercise price was greater than the average market price of the common shares.

 

**Three Months ended June 30, 2007**

 

|                                        | Income       |   |          |   |        |
|---------------------------------------------|--------------|--------|---------------|--------|-------------|
|                                        | (thousands)  |   | Shares        |   | Per Share   |
|                                        | (numerator)  |   | (denominator) |   | Amount      |
| Basic earnings per share                    |         |   |          |   |        |
| Net income available to common stockholders | $ 1,779 |   | 5,170,123     |   | $ 0.34 |
| Effect of Dilutive Securities               |         |   |          |   |        |
| Options to purchase common stock            | -            |   | 60,160        |   | (.00)       |
| Diluted earnings per share                  |         |   |          |   |        |
| Net income available to common stockholders | $ 1,779 |   | 5,230,283     |   | $ 0.34 |

 

13,115 anti-dilutive weighted shares have been excluded from this computation because the option exercise price was greater than the average market price of the common shares.

 

 

 

 

8

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – Continued**

 

**Six Months ended June 30, 2007**

 

|                                        | Income       |   |          |   |        |
|---------------------------------------------|--------------|--------|---------------|--------|-------------|
|                                        | (thousands)  |   | Shares        |   | Per Share   |
|                                        | (numerator)  |   | (denominator) |   | Amount      |
| Basic earnings per share                    |         |   |          |   |        |
| Net income available to common stockholders | $ 3,154 |   | 5,156,886     |   | $ 0.61 |
| Effect of Dilutive Securities               |         |   |          |   |        |
| Options to purchase common stock            | -            |   | 65,476        |   | (.01)       |
| Diluted earnings per share                  |         |   |          |   |        |
| Net income available to common stockholders | $ 3,154 |   | 5,222,362     |   | $ 0.60 |

 

13,674 anti-dilutive weighted shares have been excluded from this computation because the option exercise price was greater than the average market price of the common shares.

 

 

| **4.** | **COMPREHENSIVE INCOME** |
|--------|--------------------------|

 

Components of comprehensive income are presented in the following chart:

 

|     | **Three Months Ended** | **Six Months Ended** |
|--------------------|------------------------|----------------------|

|   | **June 30,** | **June 30,** |
|--------|--------------|--------------|

|                                    | **2008**    |   | **2007**    |   | **2008**      |   | **2007**  |
|-----------------------------------------|-------------|--------|-------------|--------|---------------|--------|-----------|
| Unrealized (losses) on securities:      |        |   |        |   |          |   |      |
| Unrealized (losses) arising in period   | $ (2,118)   |   | $ (1,467)   |   | $ (2,108)     |   | $ (1,516) |
| Reclassification adjustment             | (78)        |   | -           |   | 184           |   | 2         |
| Net unrealized (loss)                   | (2,196)     |   | (1,467)     |   | (1,924)       |   | (1,514)   |
| Other comprehensive income before taxes | (2,196)     |   | (1,467)     |   | (1,924)       |   | (1,514)   |
| Income tax benefit                      | 747         |   | 499         |   | 654           |   | 515       |
| Other comprehensive (loss)              | (1,449)     |   | (968)       |   | (1,270)       |   | (999)     |
| Net income                              | 1,842       |   | 1,779       |   | 3,362         |   | 3,154     |
| Total comprehensive income              | $  393 |   | $  811 |   | $  2,092 |   | $ 2,155   |

 

 

| **5.** | **RECENT ACCOUNTING PRONOUNCEMENTS** |
|--------|--------------------------------------|

 

In December 2007, the SEC released Staff Accounting Bulletin SAB 110 (“SAB 110”), “Share Based Payment.” SAB 110 expresses the views of the SEC staff regarding the use of a simplified method, as discussed in SAB 107, in developing an estimate of the expected term of share options in accordance with SFAS 123R. This interpretation gives specific examples of when it        may be appropriate to use the simplified method of determining the expected term. SAB 110 is effective for fiscal years beginning on or after January 1, 2008. We adopted the provisions of SAB 110 on January 1, 2008. SAB 110 did not have a material impact on our consolidated financial statements.

 

 

 

 

 

 

9

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – Continued**

 

In December 2007, the FASB issued Statement No. 141(R) (“SFAS 141(R)”), “Business Combinations.” This Statement replaces SFAS 141, “Business Combinations.” This Statement retains the fundamental requirements in Statement 141 that the acquisition method of accounting (which Statement 141 called the “purchase method”) be used for all        business combinations and for an acquirer to be identified for each business combination. This Statement also establishes principles and requirements for how the acquirer: a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase and c) determines what information to        disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) will apply prospectively to business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2008. While the Corporation has not yet evaluated SFAS 141(R) for the impact, if any, that SFAS 141(R) will have on our consolidated financial statements, we will be required to expense        costs related to any acquisitions on or after January 1, 2009, rather than capitalize such costs as currently required.

 

In December 2007, the FASB issued Statement No. 160 (“SFAS 160”), “Noncontrolling Interests in Consolidated Financial Statements.” This Statement amends Accounting Research Bulletin 51 to establish accounting and reporting standards for the noncontrolling (minority) interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a        noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. The Corporation has not yet determined the impact, if any, that SFAS 160 will have on our consolidated financial statements.

 

In November 2007, the SEC released Staff Accounting Bulletin SAB 109 (“SAB 109”), “Written Loan Commitments Recorded at Fair Value Through Earnings.” This bulletin expresses the views of the SEC staff regarding written loan commitments that are accounted for at fair value through earnings under GAAP. SAB 09 is effective for fiscal years beginning after December        31, 2007. We adopted the provisions of SAB 109 on January 1, 2008. SAB 109 did not have a material impact on our consolidated financial statements.

 

In March 2007, the FASB ratified Emerging Issues Task Force, or EITF, Issue 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 requires companies to recognize the income tax benefit realized from dividends or dividend equivalents that are charged to retained earnings and paid to employees for nonvested equity-classified        employee share-based payment awards as an increase to additional paid-in capital. EITF 06-11 is effective for fiscal years beginning after September 15, 2007 (our fiscal year beginning January 1, 2008). We adopted the provisions of EITF 06-11 on January 1, 2008. EITF 06-11 did not have a material impact on our consolidated financial statements.

 

In February 2007, the FASB issued Statement No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. The statement defines items        eligible for the measurement option. A business entity shall report in earnings unrealized gains and losses on items for which the fair value option has been elected at each subsequent reporting date. We adopted the provisions of SFAS No. 159 on January 1, 2008. SFAS 159 did not have a material impact on our consolidated financial statements.

 

In September 2006, the FASB issued Statement No. 157 (“SFAS 157”), “*Fair Value Measurements.*”  This statement clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value        hierarchy that prioritizes the information used to develop those assumptions. The provisions of SFAS No. 157 are effective as of the beginning of our 2008 fiscal year.  We adopted the provisions of SFAS No. 157 on January 1, 2008. SFAS 157 did not have a material impact on our consolidated financial statements.

 

 

**** 

10

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – Continued**

| **6.** | **FAIR MARKET VALUE** |
|--------|-----------------------|

 

Statement 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Statement 157 also establishes a fair value hierarchy which requires an entity to maximize the        use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

The Company used the following methods and significant assumptions to estimate fair value.

 

Securities: Trading securities and investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying        exclusively on quoted prices for the specific securities but rather by relaying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury and Agency securities, 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: The fair value of loans held for sale is determined, when possible, using quoted secondary-market prices. If no such quoted price exists, the fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan. As such, the Company classifies loans subjected to nonrecurring fair value adjustments        as Level 2.

 

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, management measures impairment in accordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 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 March 31, 2008, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with SFAS 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        nonrecurring 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 nonrecurring Level 3.

 

Foreclosed assets: Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the        collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring 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 foreclosed asset as nonrecurring Level 3.

 

 

 

11

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – Continued**

 

The table below presents the balance of assets and liabilities at June 30, 2008 measured at fair value on a recurring basis:

 

 

| *Dollars in thousands*                   |   | Level 1 |   | Level 2  |   | Level 3 |   | June 30,                        2008                        Total |
|------------------------------------------|--------|---------|--------|----------|--------|---------|--------|-------------------------------------------------------------------|
| Investment securities available for sale |   | $2,114  |   | $112,741 |   | $ -     |   | $114,855                                                          |

 

 

The table below presents the balance of assets and liabilities at June 30, 2008 measured at fair value on a nonrecurring basis:

 

 

| *Dollars in thousands* |   | Level 1  |   | Level 2 |   | Level 3 |   | June 30,                    2008                    Total |
|------------------------|--------|---------------|--------|---------|--------|---------|--------|-----------------------------------------------------------|
| Loans                  |   |   $-     |   | $-      |   | $2,042  |   | $2,042                                                    |

 

| **7.** | **RECLASSIFICATIONS** |
|--------|-----------------------|

 

Certain 2007 numbers have been reclassified to conform with current period presentation. These reclassifications have no impact on net income or earnings per share.

 

12

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**ITEM 2.**  **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

This discussion is intended to further your understanding of the consolidated financial condition and results of operations of First Chester County Corporation and its direct and indirect wholly-owned subsidiaries, First National Bank of Chester County (the “Bank”), FNB Property Management, LLC, First National Insurance Services, LLC, Turks Head        Properties, Inc., Turks Head II, LLC, First Chester County Capital Trust I, First Chester County Capital Trust II, and First Chester County Capital Trust III, (collectively, the “Corporation”). This discussion should be read in conjunction with the consolidated financial statements included in this report.

 

In addition to historical information, this discussion and analysis contains statements relating to future results of the Corporation that are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can often be identified by the use of forward-looking terminology such as        “believes,” “expects,” “intends,” “may,” “will,” “should” “or anticipates” or similar terminology. These statements involve risks and uncertainties and are based on various assumptions. Although the Corporation believes that its expectations are based on reasonable assumptions, investors and prospective investors are cautioned that such statements are only projections, and that these risks and        uncertainties are all difficult to predict and most are beyond the control of the Corporation’s Management. Information about the primary risks and uncertainties that could cause the Corporation’s actual future results to differ materially from our historic results or the results described in forward-looking statements made in this report or presented elsewhere by Management from time to time are included in Part I, Item 1A of our Annual Report on Form 10-K for the year        ended December 31, 2007 (our “2007 Annual Report”). Material changes to such “risk factors” may be reported in subsequent Quarterly Reports on Form 10-Q in Part II, Item 1A. There have been no such changes from the risk factors set forth in our 2007 Annual Report.

 

The Corporation undertakes no obligation to publicly release any revisions to any forward-looking statements to reflect events or circumstances after the date of this Report.

 

**CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES**

 

The accounting and reporting policies of the Corporation conform with the accounting principles generally accepted in the United States of America and general practices within the financial services industry. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that        affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

 

**ALLOWANCE FOR LOAN AND LEASE LOSSES**

 

The Corporation considers that the determination of the allowance for loan and lease losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on Management’s review and evaluation of the loan and lease portfolio in relation to past loss experience, the size and composition of the        portfolio, current economic events and conditions, and other pertinent factors, including Management’s assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from Management’s estimates, additional provisions for loan and lease losses may be required that would adversely impact earnings in future periods.

 

 

13

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**INCOME TAXES**

 

Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets are subject to Management’s judgment based upon available evidence that future realization is more likely than not. If Management determines that the Corporation may be unable to realize all or part of the        net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.

 

**EARNINGS AND DIVIDEND SUMMARY**

 

Net income for the three months ended June 30, 2008 was $1.84 million, an increase of $63 thousand or 3.5% from $1.78 million for the same period in 2007. Net income for the six month period ended June 30, 2008 was $3.36 million, an increase of $208 thousand or 6.6% from $3.15 million for the same period in 2007. Diluted earnings per share for the three and six month periods ended June 30, 2008 were $0.35        and $0.65, respectively, compared to $0.34 and $0.60 for the same periods in 2007. Cash dividends declared for the three and six month periods ended June 30, 2008 were $0.140 and $0.280 per share compared to $0.135 and $0.270 per share for the three and six month periods ended June 30, 2007.

 

The increase in net income for the three months ended June 30, 2008 compared to the same period in 2007, was the result of an increase in net interest income combined with a decrease in non-interest expense and a decrease in taxes, offset in part by an increase in the provision and a decrease in non-interest income. The increase in net income for the six months ended June 30, 2008 compared to the same        period in 2007, was primarily the result of an increase in net interest income combined with an increase in non-interest income and a decrease in taxes, offset in part by an increase in the provision. During the second quarter of 2008, the company deferred certain loan origination costs that should have been deferred previously under SFAS 91. This resulted in a $417 thousand pretax reduction of salary and employee benefits expense in the second quarter of 2008. In addition, the 2007        results include $507 thousand of pretax gains and interest income recorded in second quarter of 2007 from the sale of a loan that had been on non-accrual status.

 

**SELECTED RATIOS**

 

|   | **                           Three Months Ended** | **Six Months Ended** |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------|

|                     |     | **June 30,           ** | **June 30,** |   |
|--------------------------|----------|--------------------------------------------------------------------------------|--------------|--------|
|                     | **2008** |                                                                           | **2007**     |   | **2008** |   | **2007** |
| Return on Average Assets | 0.74%    |                                                                           | 0.79%        |   | 0.69% |   | 0.71% |
| Return on Average Equity | 10.64%   |                                                                           | 11.14%       |   | 9.72% |   | 9.94% |
| Dividend Payout Ratio    | 39.40%   |                                                                           | 39.07%       |   | 43.19% |   | 44.12% |
| Book Value Per Share     | $13.23   |                                                                           | $12.31       |   | $13.23 |   | $12.31 |
|                          |          |                                                                                |              |        |  |  |  |  |  |  |  |

 

 

 

 

 

 

 

 

 

 

 

 

14

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**CONSOLIDATED AVERAGE BALANCE SHEET**

**AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES FOR THE**

**THREE MONTHS ENDED JUNE 30,**

 

|   |    2008 | 2007 |
|--------|-------------------|------|

| (Dollars in thousands)                                                                                                            |     |     |   |   |     |      |   |
|-----------------------------------------------------------------------------------------------------------------------------------|----------|----------|--------|--------|----------|-----------|--------|
|                                                                                                                              | Average  |     |   |   | Average  |      |   |
|                                                                                                                              | Balance  | Interest | Rate%  |   | Balance  | Interest  | Rate%  |
| ASSETS                                                                                                                            |     |     |   |   |     |      |   |
| Federal funds sold, interest-bearing                                                                               | $55,248  | $417     | 3.04%  |   | $48,629  | $648      | 5.34%  |
|                  deposits in banks and other |          |          |        |        |          |           |        |
|              overnight investments                          |          |          |        |        |          |           |        |
|            Investment securities:                                               |          |          |        |        |          |           |        |
| Taxable                                                                                                                           | 103,764  | 1,242    | 4.81%  |   | 79,424   | 945       | 4.77%  |
| Tax-exempt (1)                                                                                                               | 13,386   | 157      | 4.73%  |   | 10,760   | 118       | 4.39%  |
| Total investment securities                                                                                             | 117,150  | 1,399    | 4.80%  |   | 90,184   | 1,063     | 4.73%  |
|                                                                                                                              |     |     |   |   |     |      |   |
| Loans and leases: (2)                                                                                              |     |     |   |   |     |      |   |
| Taxable                                                                                                                           | 754,107  | 11,796   | 6.29%  |   | 700,310  | 12,464(3) | 7.14%  |
| Tax-exempt (1)                                                                                                               | 18,906   | 340      | 7.24%  |   | 14,541   | 267       | 7.36%  |
| Total loans and leases                                                                                             | 773,013  | 12,136   | 6.31%  |   | 714,851  | 12,731    | 7.14%  |
|                                                                                                                              |     |     |   |   |     |      |   |
| Total interest-earning assets                                                                                           | 945,411  | 13,952   | 5.94%  |   | 853,664  | 14,442    | 6.79%  |
| Non-interest-earning assets                                                                                                  |     |     |   |   |     |      |   |
| Allowance for loan and lease losses                                                                                | (7,972)  |     |   |   | (8,110)  |      |   |
| Cash and due from banks                                                                                       | 17,957   |     |   |   | 24,171   |      |   |
| Other assets                                                                                                                 | 39,775   |     |   |   | 28,521   |      |   |
|                                                                                                                              |     |     |   |   |     |      |   |
| Total assets                                                                                                                 | $995,171 |     |   |   | $898,246 |      |   |
|                                                                                                                              |     |     |   |   |     |      |   |
| LIABILITIES AND STOCKHOLDERS’                                                                                               |     |     |   |   |     |      |   |
| EQUITY                                                                                                                            |     |     |   |   |     |      |   |
| Savings, NOW, and money market                                                                                |     |     |   |   |     |      |   |
| deposits                                                                                                                          | $393,554 | $1,605   | 1.64%  |   | $363,365 | $2,213    | 2.44%  |
| Certificates of deposit and other time                                                                   | 235,775  | 2,349    | 4.01%  |   | 258,339  | 3,033     | 4.71%  |
| Total interest-bearing deposits                                                                                         | 629,329  | 3,954    | 2.53%  |   | 621,704  | 5,246     | 3.38%  |
| Subordinated debentures                                                                                                      | 15,465   | 215      | 5.59%  |   | 15,578   | 499(4)    | 12.85% |
| Federal Home Loan Bank advances                                                                               |     |     |   |   |     |      |   |
| and other borrowings                                                                                                    | 152,288  | 1,478    | 3.90%  |   | 66,174   | 624       | 3.78%  |
| Total interest-bearing liabilities                                                                                      | 797,082  | 5,647    | 2.85%  |   | 703,456  | 6,369     | 3.63%  |
| Non-interest-bearing liabilities:                                                                                            |     |     |   |   |     |      |   |
| Non-interest-bearing demand deposits                                                                                    | 119,951  |     |   |   | 123,926  |      |   |
| Other liabilities                                                                                                            | 8,877    |     |   |   | 6,959    |      |   |
| Total liabilities                                                                                                            | 925,910  |     |   |   | 834,341  |      |   |
| Stockholders’ equity                                                                                                   | 69,261   |     |   |   | 63,905   |      |   |
| Total liabilities and stockholders’ equity                                                              | $995,171 |     |   |   | $898,246 |      |   |
|                                                                                                                              |     |     |   |   |     |      |   |
| Net interest income                                                                                                     |     | $8,305   |   |   |     | $8,073    |   |
| Net yield on interest-earning assets                                                                          |     |     | 3.53%  |   |     |      | 3.79%  |

 

(1) The indicated income and annual rate are presented on a taxable equivalent basis using the federal marginal rate of 34%

      adjusted for the TEFRA Act 20% interest expense disallowance for 2008 and 2007.

|   | (2) | Non-accruing loans are included in the average balance. |
|--------|-----|---------------------------------------------------------|

|   | (3) | Includes $282 thousand of income related to the sale of a $5.9 million loan that had been on non-accrual status. |
|--------|-----|------------------------------------------------------------------------------------------------------------------|

(4) Includes $161 thousand of expense for accelerated amortization of issuance costs related to early redemption of debentures.

 

 

15

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**CONSOLIDATED AVERAGE BALANCE SHEET**

**AND TAXABLE EQUIVALENT INCOME/EXPENSE AND RATES FOR THE**

**SIX MONTHS ENDED JUNE 30,**

 

|   | 2008 | 2007 |
|--------|------|------|

| (Dollars in thousands)                                                                              |     |     |   |   |     |      |   |
|-----------------------------------------------------------------------------------------------------|----------|----------|--------|--------|----------|-----------|--------|
|                                                                                                | Average  |     |   |   | Average  |      |   |
|                                                                                                | Balance  | Interest | Rate%  |   | Balance  | Interest  | Rate%  |
| ASSETS                                                                                              |     |     |   |   |     |      |   |
| Federal funds sold, interest-bearing                                                 | $52,365  | $868     | 3.34%  |   | $47,179  | $1,245    | 5.32%  |
|             deposits in banks and other |          |          |        |        |          |           |        |
|             overnight investments       |          |          |        |        |          |           |        |
|          Investment securities:                             |          |          |        |        |          |           |        |
| Taxable                                                                                             | 98,231   | 2,358    | 4.83%  |   | 79,867   | 1,895     | 4.79%  |
| Tax-exempt (1)                                                                                 | 13,532   | 321      | 4.77%  |   | 10,215   | 220       | 4.35%  |
| Total investment securities                                                               | 111,763  | 2,679    | 4.82%  |   | 90,082   | 2,115     | 4.74%  |
|                                                                                                |     |     |   |   |     |      |   |
| Loans and leases: (2)                                                                |     |     |   |   |     |      |   |
| Taxable                                                                                             | 741,589  | 23,953   | 6.50%  |   | 692,969  | 24,224(3) | 7.05%  |
| Tax-exempt (1)                                                                                 | 19,239   | 689      | 7.20%  |   | 13,844   | 476       | 6.93%  |
| Total loans and leases                                                               | 760,828  | 24,642   | 6.51%  |   | 706,813  | 24,700    | 7.05%  |
|                                                                                                |     |     |   |   |     |      |   |
| Total interest-earning assets                                                             | 924,956  | 28,189   | 6.13%  |   | 844,074  | 28,060    | 6.70%  |
| Non-interest-earning assets                                                                    |     |     |   |   |     |      |   |
| Allowance for loan and lease losses                                                  | (7,928)  |     |   |   | (8,133)  |      |   |
| Cash and due from banks                                                         | 19,552   |     |   |   | 23,996   |      |   |
| Other assets                                                                                   | 37,395   |     |   |   | 26,553   |      |   |
|                                                                                                |     |     |   |   |     |      |   |
| Total assets                                                                                   | $973,975 |     |   |   | $886,490 |      |   |
|                                                                                                |     |     |   |   |     |      |   |
| LIABILITIES AND STOCKHOLDERS’                                                                 |     |     |   |   |     |      |   |
| EQUITY                                                                                              |     |     |   |   |     |      |   |
| Savings, NOW, and money market                                                  |     |     |   |   |     |      |   |
| deposits                                                                                            | $383,526 | $3,640   | 1.91%  |   | $361,641 | $4,278    | 2.39%  |
| Certificates of deposit and other time                                     | 228,451  | 4,812    | 4.24%  |   | 253,353  | 5,862     | 4.67%  |
| Total interest-bearing deposits                                                           | 611,977  | 8,452    | 2.78%  |   | 614,994  | 10,140    | 3.32%  |
| Subordinated debentures                                                                        | 15,465   | 474      | 6.16%  |   | 15,522   | 834(4)    | 10.84% |
| Federal Home Loan Bank advances                                                 |     |     |   |   |     |      |   |
| and other borrowings                                                                      | 149,425  | 2,920    | 3.93%  |   | 63,941   | 1,218     | 3.84%  |
| Total interest-bearing liabilities                                                        | 776,867  | 11,846   | 3.07%  |   | 694,457  | 12,192    | 3.54%  |
| Non-interest-bearing liabilities:                                                              |     |     |   |   |     |      |   |
| Non-interest-bearing demand deposits                                                      | 118,216  |     |   |   | 121,356  |      |   |
| Other liabilities                                                                              | 9,705    |     |   |   | 7,198    |      |   |
| Total liabilities                                                                              | 904,788  |     |   |   | 823,011  |      |   |
| Stockholders’ equity                                                                     | 69,187   |     |   |   | 63,479   |      |   |
| Total liabilities and stockholders’ equity                                | $973,975 |     |   |   | $886,490 |      |   |
|                                                                                                |     |     |   |   |     |      |   |
| Net interest income                                                                       |     | $16,343  |   |   |     | $15,868   |   |
| Net yield on interest-earning assets                                            |     |     | 3.55%  |   |     |      | 3.79%  |

 

(1) The indicated income and annual rate are presented on a taxable equivalent basis using the federal marginal rate of 34%

      adjusted for the TEFRA Act 20% interest expense disallowance for 2008 and 2007.

|   | (2) | Non-accruing loans are included in the average balance. |
|--------|-----|---------------------------------------------------------|

|   | (3) | Includes $282 thousand of income related to the sale of a $5.9 million loan that had been on non-accrual status. |
|--------|-----|------------------------------------------------------------------------------------------------------------------|

 

16

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**NET INTEREST INCOME**

 

Net interest income is the difference between interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities. Net interest income on a tax equivalent basis for the three month period ended June 30, 2008 was $8.3 million, an increase of 2.9% from $8.1 million for the same period in 2007. Net interest income on a tax equivalent basis for the six month period        ended June 30, 2008 was $16.3 million, an increase of 3.0% from $15.9 million for the same period in 2007.

 

The net yield on interest-earning assets, on a tax-equivalent basis, was 3.53% for the three month period ended June 30, 2008, compared to 3.79% for the same period in 2007, a decrease of 26 basis points, (one basis point is equal to 1/100 of a percent). For the six month period ended June 30, 2008, the net yield on interest earning assets decreased 24 basis points to 3.55% from 3.79% during the same        period in 2007.

 

Average interest-earning assets increased approximately $91.7 million or 10.7% to $945.4 million for the three months ended June 30, 2008 from $853.7 million in the same period last year. Average interest-earning assets increased approximately $80.9 million or 9.6% for the six months ended June 30, 2008 to $925.0 million from $844.1 million in the same period in 2007.

 

Average interest-bearing liabilities increased approximately $93.6 million or 13.3% to $797.1 million for the three months ended June 30, 2008, from $703.5 million for the same period in 2007. Average interest-bearing liabilities increased approximately $82.4 million or 11.9% to $776.9 million for the six months ended June 30, 2008, from $694.5 million for the same period in 2007.

 

17

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**INTEREST INCOME**

 

Interest income on Federal Funds sold and other overnight investments for the three and six month periods ended June 30, 2008, decreased $231 thousand and $377 thousand to $417 thousand and $868 thousand, respectively, when compared to the same periods in 2007. The decrease in interest income on Federal Funds sold and other overnight investments for the three and six month periods is primarily due to        decreases in the rates earned on these balances as a result of Federal Reserve actions to reduce market interest rates. The rates earned on these balances decreased 230 basis points and 198 basis points for the three and six months ended June 30, 2008, respectively, as compared to the same periods in 2007.

 

On a tax equivalent basis, interest income on investment securities increased 31.6% or $336 thousand to $1.4 million for the three month period ended June 30, 2008 when compared to the same period in 2007. For the six month period ended June 30, 2008, interest income on investment securities increased 26.7% or $564 thousand to $2.7 million from $2.1 million when compared to the same period in 2007. The        increase for the three month period is due to a 29.9% or $27.0 million increase of the average balance of investment securities, combined with a 7 basis point increase earned on these investments. The increase for the six month period ended June 30, 2008 is the result of a 24.1% or $21.7 million increase of the average balance of investment securities combined with an increase of 8 basis points on the rate earned on these investments.

 

Interest income on loans, on a tax equivalent basis, generated by the Corporation’s loan portfolio decreased $595 thousand or 4.7% to $12.1 million for the three months ended June 30, 2008, compared to the same period in 2007. Interest income on loans decreased $58 thousand or 0.2% to $24.6 million for the six months ended June 30, 2008, compared to the same period in 2007. The average yield earned        on loan and lease balances decreased 83 and 54 basis points for the three and six month periods, respectively, to 6.31% and 6.51%, respectively. Interest income for the three and six month periods ended June 30, 2007 includes the recognition of $282 thousand of income related to the sale of a $5.9 million loan that had been on non-accrual status. Excluding this item, interest income for the three months ended June 30, 2008 decreased $313 thousand or 2.5% over the same period in 2007.        This decrease is primarily due to decreases in the average yield earned on loan portfolio balances as a result of Federal Reserve actions to reduce market interest rates. The decrease was partially offset by increases in interest income from a $58.2 million or 8.1% increase in the average balance of loans and leases outstanding. Excluding the $282 thousand of income recognized in 2007, interest income for the six months ended June 30, 2008 increased $224 thousand or 0.9% over the same        period in 2007. This increase is mainly due to a $54.0 million or 7.6% increase in the average balance of loans and leases outstanding, partially offset by decreases in the average yield earned on loan and lease balances.

 

**INTEREST EXPENSE**

 

Interest expense on deposit accounts decreased $1.3 million or 24.6% to $4.0 million for the three months ended June 30, 2008 compared to the same period in 2007. Interest expense on deposit accounts decreased $1.7 million or 16.6% to $8.5 million for the six months ended June 30, 2008 compared to the same period in 2007. The decrease for the three months ended June 30, 2008 was due to an 85 basis point        decrease in the average interest rates paid on these deposits partially offset by a $7.6 million or 1.2% increase in average total interest-bearing deposits. This decrease for the six months ended June 30, 2008 was due to a 54 basis point decrease in the average interest rates paid on these deposits combined with a $3.0 million or 0.5% decrease in average total interest-bearing deposits. The decreases in the average interest rates paid on deposits is primarily the result of Federal        Reserve actions to reduce market

 

 

18

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

interest rates combined with the decrease in higher cost brokered CD balances. Deposit balances have been impacted from the Bank’s decision to replace higher cost brokered CDs with lower cost FHLB borrowings beginning in the second half of 2007. Excluding the decrease in average brokered CD balances, average total interest-bearing deposit balances would have increased by $71.1 million and $56.2        million for the three and six months ended, June 30, 2008, respectively, as compared to same periods in 2007.

 

Although market interest rates have declined, competition for deposits from other banks and non-banking institutions such as credit unions and mutual fund companies continues to be strong. This competition puts pressure on the pricing of the Corporation’s deposit base and on the cost of raising new deposits. As the Corporation competes for deposit dollars to fund its growth, alternative funding        sources continue to be explored.

 

Interest expense on subordinated debentures decreased $284 thousand to $215 thousand for the three month period ended June 30, 2008 from $499 thousand for the same period in 2007. Interest expense on subordinated debentures decreased $360 thousand to $474 thousand for the six month period ended June 30, 2008 from $834 thousand when compared to the same period in 2007. The decrease for the three and six        month periods ended June 30, 2008 was primarily due to a decrease in the average interest rate paid on these debentures resulting from market interest rate decreases. Interest expense on subordinated debentures for the three and six month periods ended June 30, 2007 includes a $161 thousand charge to interest expense recorded in the second quarter of 2007. The charge was for accelerated amortization of issuance costs related to the July 2007 early redemption of $5.2 million of        debentures that were issued by the First Chester County Corporation. The redemption of the debentures was coordinated with a new $5.2 million issuance on June 29, 2007. The new issuance bears an interest rate of 3 month LIBOR plus 140 basis points while the redeemed issuance had an interest rate of 3 month LIBOR plus 365 basis points.

 

Interest expense on Federal Home Loan Bank (“FHLB”) and other borrowings increased by $854 thousand or 136.7% to $1.5 million for the three month period ended June 30, 2008 from $624 thousand for the same period in 2007. This increase for the three month period ended June 30, 2008 is due to an $86.1 million or 130.1% increase in the average balances of these funding sources combined with a 12        basis point increase in the average interest rate paid on these borrowings. Interest expense on FHLB and other borrowings increased by $1.7 million or 139.7% to $2.9 million for the six month period ended June 30, 2008 from $1.2 million for the same period in 2007. This increase for the six month period ended June 30, 2008 is due to a $85.5 million or 133.7% increase in the average balances of these funding sources combined with a 9 basis point increase in the average interest rate paid        on these borrowing. FHLB borrowings have been an alternative to deposits to support loan growth.

 

**PROVISION FOR LOAN AND LEASE LOSSES**

 

During the three and six month periods ended June 30, 2008, the Corporation recorded a $449 and a $660 thousand provision for loan and lease losses compared to $0 for the same periods in 2007. The increase in the provision for loan and lease losses was driven mainly by loan growth combined with the effects of a slowing economy. The percentage of non-accrual loans to gross loans was .26% at June 30, 2008        as compared to .16% at December 31, 2007 and .17% at June 30, 2007. The allowance for loan and lease losses as a percentage of loans at June, 2008 was 1.07% compared to 1.05% at December 31, 2007 and 1.12% at June 30, 2007. Net charge-offs were $79 thousand for the six months ended June 30, 2008 as compared to $159 thousand in the same period in 2007.

 

 

19

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

The allowance for loan and lease losses is an amount that Management believes will be adequate to absorb possible loan losses on existing loans that may become uncollectible and is established based on Management’s evaluation of the collectability of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality,        adequacy of collateral, review of specific problem loans, and current economic conditions that may affect our borrowers’ ability to pay.

 

|   | **           Three Months    ** | **Six Months** |
|--------|-------------------------------------------------------------------------------------------------------|----------------|

|   | **    Ended** | **Ended** |
|--------|------------------------------|-----------|

|   | **       June 30,** | **         June 30,** |
|--------|---------------------------------------------------|--------------------------------------------------------------------|

|                                                      | **2008**                       |   | **2007**                       |   | **2008**                       |   | **2007**                       |
|-----------------------------------------------------------|--------------------------------|--------|--------------------------------|--------|--------------------------------|--------|--------------------------------|
|                                                      |                           |   |                           |   |                           |   |                           |
| Balance at beginning of period                            | $    7,930 |   | $    8,128 |   | $    7,817 |   | $    8,186 |
|                                                      |                           |   |                           |   |                           |   |                           |
| Provision charged to operating expense                    | 449                            |   | -                              |   | 660                            |   | -                              |
|                                                      |                           |   |                           |   |                           |   |                           |
| Recoveries of loans previously charged-off                | 97                             |   | 51                             |   | 197                            |   | 81                             |
| Loans charged-off                                         | (117)                          |   | (126)                          |   | (276)                          |   | (240)                          |
| Net loan (charge-offs) recoveries                         | (20)                           |   | (75)                           |   | (79)                           |   | (159)                          |
|                                                      |                           |   |                           |   |                           |   |                           |
| Allowance other adjustment (1)                            | 74                             |   | 6                              |   | 35                             |   | 32                             |
|                                                      |                           |   |                           |   |                           |   |                           |
| Balance at end of period                                  | $    8,433 |   | $    8,059 |   | $    8,433 |   | $    8,059 |
|                                                      |                           |   |                           |   |                           |   |                           |
| Period-end loans outstanding                              | $786,548                       |   | $720,530                       |   | $786,548                       |   | $720,530                       |
| Average loans outstanding                                 | $773,013                       |   | $714,851                       |   | $760,828                       |   | $706,813                       |
|                                                      |                           |   |                           |   |                           |   |                           |
| Allowance for loan and lease losses as a                  |                           |   |                           |   |                           |   |                           |
| percentage of period-end loans outstanding                | 1.07%                          |   | 1.12%                          |   | 1.07%                          |   | 1.12%                          |
| Net charge-offs (recoveries) to average loans outstanding | 0.00%                          |   | 0.01%                          |   | 0.01%                          |   | 0.02%                          |

(1) The “Allowance other adjustment” represents the reclassification of an allowance for possible losses on unfunded loans and unused lines of credit. These loans and lines of credit, although unfunded, have been committed to by the Bank.

 

Non-performing loans and leases include those on non-accrual status and loans past due 90 days or more and still accruing. The Corporation’s policy is to write down all non-performing loans and leases to net realizable value based on current assessments of the value of the collateral securing such loans and leases and leases. Non-performing loans and leases are generally collateralized and are in        the process of collection. Non-accrual loans and leases reduce the Corporation’s earnings because interest income is not earned on such assets.

 

The Corporation held one commercial property classified as other real estate owned (“OREO”) at June 30, 2008. The corporation held one OREO property as of June 30, 2007, and no OREO properties at December 31, 2007. OREO represents real estate owned by the Bank following default by the borrowers. OREO is recorded at the lower of carrying value or fair market value. Fair market value        is based primarily upon independent market prices or professional appraisals.OREO reduces the Corporation’s earnings because interest income is not earned on such assets.

 

20

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

The following chart represents detailed information regarding non-performing loans and leases and OREO:

 

| (Dollars in thousands)   |   | June 30,   | December 31, |
|------------------------------------|--------|----------------------|--------------|

 

|                                          | 2008    |   | 2007    |   | 2007    |
|-----------------------------------------------|---------|--------|---------|--------|---------|
|                                          |    |   |    |   |    |
| Past due over 90 days and still accruing      | $ 115   |   | $ 3,580 | (2)    | $ 142   |
| Non-accrual loans and leases (1)              | 2,042   |   | 1,241   |   | 1,194   |
| Total non-performing loans and leases         | 2,157   |   | 4,821   |   | 1,336   |
|                                          |    |   |    |   |    |
| Other real estate owned                       | 459     |   | 78      |   | -       |
| Total non-performing assets                   | $ 2,616 |   | $ 4,899 |   | $ 1,336 |
|                                          |    |   |    |   |    |
| Non-performing loans and leases as a          |    |   |    |   |    |
| percentage of total loans and leases          | 0.27%   |   | 0.67%   |   | 0.18%   |
|                                          |    |   |    |   |    |
| Allowance for loan and lease losses as a      |    |   |    |   |    |
| percentage of non-performing loans and leases | 390.89% |   | 167.16% |   | 585.10% |
|                                          |    |   |    |   |    |
| Non-performing assets as a percentage of      |    |   |    |   |    |
| total loans and other real estate owned       | 0.33%   |   | 0.68%   |   | 0.18%   |
|                                          |    |   |    |   |    |
| Allowance for loan and lease losses as a      |    |   |    |   |    |
| percentage of non-performing assets           | 322.38% |   | 164.49% |   | 585.10% |

 

|   | (1) | Generally, the Bank places a loan or lease in non-accrual status when principal or interest has                        been in default for a period of 90 days or more unless the loan is both well secured and in the                        process of collection. |
|--------|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | (2) | Includes one $2.9 million commercial loan that is secured by real estate. Subsequent to June                        30, 2007 this balance was collected. |
|--------|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Management is not aware of any loans or leases other than those included in these tables that would be considered potential problem loans and cause Management to have doubts as to the borrower’s ability to comply with loan repayment terms.

 

The Corporation identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The accrual of interest is discontinued on impaired loans and no income is recognized until all recorded amounts of interest and principal are recovered in full.

 

FASB 114 “Accounting by Creditors for Impairment of Loans” requires the Corporation to examine commercial and non-residential mortgage loans on non-accrual status for impairment. The balance of impaired loans was $2.0 million, $1.2 million, and $1.2 million at June 30, 2008, December 31, 2007, and June 30, 2007, respectively. The associated allowance for impaired loans was $60 thousand, $72        thousand, and $60 thousand at June 30, 2008, December 31, 2007, and June 30, 2007, respectively.

 

21

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

For the three and six month periods ended June 30, 2008, activity in the allowance for impaired loan losses includes a provision of $11 and $29 thousand, respectively, and charge-offs of $6 and $0, respectively. There were no recoveries for the three and six month periods ended June 30, 2008. Contractual interest amounted to $31 thousand and $56 thousand for the three and six months ended June 30, 2008,        respectively. Total cash collected on impaired loans for the three and six month periods ended June 30, 2008 was $41 thousand and $92 thousand all of which was applied to principal. Loans returned to performing for the three and six month periods ended June 30, 2008 was $20 thousand and $0 thousand.

 

**NON-INTEREST INCOME**

 

Total non-interest income decreased 2.3% or $64 thousand to $2.8 million for the three months ended June 30, 2008, when compared to the same period in 2007. Total non-interest income increased 8.5% or $439 thousand to $5.6 million for the six month period ended June 30, 2008, when compared to the same period in 2007. The various components of non-interest income are discussed below.

 

The largest component of non-interest income is wealth management and advisory services revenue, which increased $11 thousand or 1.0% to $1.1 million for the three month period ended June 30, 2008 from $1.1 million during the same period in 2007. Wealth management and advisory services revenue increased $29 thousand or 1.4% to $2.1 million for the six month period ended June 30, 2008 from $2.0 million        during the same period in 2007. Wealth management and advisory services revenue includes fee income from both the Wealth Management division of the Bank and the First National Financial Advisory Services subsidiary of the Bank. In the aggregate, wealth management and advisory services revenue consists primarily of fee income from services such as trust and portfolio management, estate management, insurance, full-service brokerage, financial planning and mutual fund services. Wealth        management and advisory services revenue is based partially on the market value of assets under management. The market value of assets under management at June 30, 2008 was $557.0 million compared to $566.0 million at June 30, 2007.

 

Service charges on deposit accounts increased $74 thousand or 13.0% to $643 thousand for the three month period ended June 30, 2008 compared to $569 thousand for the same period in 2008. For the six month period ended June 30, 2008, service charges on deposit accounts increased $89 thousand or 8.1% to $1.2 million compared to $1.1 million for the same period in 2007. The increase in service charges is        primarily due to an increase in charges on retail and commercial demand deposit accounts.

 

The corporation recognized a net loss of $78 thousand on sales of investment securities during the three month period ended June 30, 2008 compared with $0 during the same period in 2007. The corporation recognized a net gain of $184 thousand on sales of investment securities during the six month period ended June 30, 2008 compared with a net gain of $2 thousand during the same period in 2007. These net        gains and losses were taken as a result of normal portfolio management.

 

The Corporation has operating lease agreements with one customer. The income on these leases is classified as “Rental Income”. Rental Income on operating lease agreements increased $14 thousand or 4.4% to $330 thousand for the three months ended June 30, 2008 as compared to the same period in 2007. Rental Income on operating lease agreements increased $16 thousand or 2.6% to $639 thousand for        the for the six months ended June 30, 2008 as compared to the same period in 2007. This increase in rental income on operating lease agreements is the result of entering into a few additional operating leases with the existing lease customer.

 

22

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

Gains on the sale of fixed assets was $45 thousand and $91 thousand for the three and six month periods ended June 30, 2008 as compared to gains of $0 for the same periods in 2007. The gains recorded in 2008 was the amortization of a deferred gain attributable to the sale-leaseback transaction that occurred during 2007.

 

The three and six month periods ended June 30, 2007 includes a $225 thousand gain recorded in the second quarter of 2007 related to the sale of the $5.9 million loan as previously mentioned. Excluding this item, gains and fees on the sale of loans decreased $32 thousand or 27.0% for the three months ended June 30, 2008 and decreased $30 thousand or 15.5% for the six months ended June 30, 2008 compared to        the same periods in 2007.

 

Bank-owned life insurance (“BOLI”) income relates to a $10 million policy purchased in February 2008. BOLI involves the purchase of a life insurance policy on a group of employees. The Bank is the owner and beneficiary of the policy. The BOLI investment is carried on the balance sheet at the cash surrender value of the underlying policies. Income or loss resulting from increases or decreases        in the cash surrender value of the properties is recorded on the income statement. BOLI gains for the three and six month periods ended June 30, 2008 were $92 thousand and $157 thousand, respectively.

 

Other non-interest income increased $35 thousand or 6.6% to $565 thousand for the three months ended June 30, 2008 compared to same period in 2007. Other non-interest income increased $130 thousand or 13.1% to $1.1 million for the six months ended June 30, 2008 compared to same period in 2007. The increases in other non-interest income were primarily due to increases in lease referral fees and electronic        banking fees. Other non-interest income also includes ATM surcharge revenue, STAR/Visa Check Card revenue, safe deposit box income, merchant services income, loan fee income, miscellaneous loan income, rental income and other miscellaneous income.

 

**NON-INTEREST EXPENSE**

 

Total non-interest expense decreased $296 thousand or 3.6% to $8.0 million for the three months ended June 30, 2008, when compared to the same period in 2007. Total non-interest expense increased $21 thousand or 0.1% to $16.5 million for the six months ended June 30, 2008, when compared to the same period in 2007. The various components of non-interest expense are discussed below.

 

Salaries and employee benefits expense for the three and six month periods ended June 30, 2008 includes a $417 thousand reduction of salary and benefits expense associated with loan origination costs not previously deferred in prior periods. Excluding this item, salaries and employee benefits decreased $275 thousand or 5.6% for the three months ended June 30, 2008 compared to the same period in 2007.        Excluding the $417 thousand item, salaries and employee benefits decreased $178 thousand or 1.9% for the six month period ended June 30, 2008 compared to the same period in 2007.

 

Net occupancy, equipment and data processing expense increased $192 thousand or 15.0% to $1.5 million during the three months ended June 30, 2008 when compared to the same period in 2007. Net occupancy, equipment and data processing expense increased $276 thousand or 10.5% to $2.9 million during the six months ended June 30, 2008 when compared to the same period in 2007. The increase was mainly due to the        addition of the Longwood and Downingtown branches in the first quarter of 2008.

 

 

23

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND**

**RESULTS OF OPERATIONS – Continued**

 

Depreciation on operating leases increased $10 thousand or 3.8% to $271 thousand for the three months ended June 30, 2008 when compared to the same period in 2007. Depreciation on operating leases increased $7 thousand or 1.3% to $526 thousand for the six months ended June 30, 2008 when compared to the same period in 2007. This depreciation expense is the result of operating lease agreements the        Corporation has with one of our customers. The income associated with these operating leases is classified as Rental Income.

 

Expenses for professional services increased $13 thousand or 2.7% to $495 thousand for the three months ended June 30, 2008 when compared to the same period in 2007. Professional services expense decreased $77 thousand or 7.7% to $919 thousand for the six months ended June 30, 2008 when compared to the same period in 2007. The decrease in professional fees for the 6 month period is primarily due to a        reduction in legal fees related to additional costs incurred in the first quarter of 2007 from compliance with new SEC executive compensation reporting requirements.

 

Marketing expense increased $44 thousand or 15.1% for the three months ended June 30, 2008 and increased $4 thousand or .8% for the six months ended June 30, 2008 as compared to the same periods in 2007.

 

Total other non-interest expense increased $104 thousand or 11.1% to $1.0 million for the three-month period ended June 30, 2008 compared to the same periods in 2007. Total other non-interest expense increased $340 thousand or 18.4% to $2.2 million for the six months ended June 30, 2008 when compared to the same period in 2007. Other non-interest expense includes annual meeting and reports, trust        processing, postage, directors’ costs, telephone, travel and entertainment and operating supplies. The increase in other non-interest expense for the three and six month periods ended June 30, 2008 is primarily due to an increase in FDIC insurance premiums in 2008 as compared to 2007. FDIC insurance premium expense was $118 thousand and $212 thousand for the three and six month periods ended June 30, 2008, as compared to $21 thousand and $43 thousand for the same periods in 2007.        The increase reflects the impact of 2006 legislation that increased FDIC premiums for all commercial banks. This legislation provided an assessment credit for each insured bank. The Bank’s assessment credit offset a larger portion of the insurance premium expense in 2007 than in 2008 and was fully utilized in the first quarter of 2008. The increased premium does not indicate any change in the FDIC risk assessment for the Bank. The increase in other non-interest expense for the six        month period ended June 30, 2008 is also due to a $109 thousand charge taken in the first quarter of 2008 from the write-off of miscellaneous other assets.

 

**INCOME TAXES**

 

Income tax expense for the three and six month periods ended June 30, 2008 was $624 thousand and $1.2 million, compared to $709 thousand and $1.3 million for the same periods in 2007. This represents an effective tax rate of 25.3% and 26.0% for the three and six month periods ended June 30, 2008 compared with 28.5% and 28.5% for the same periods in 2007. The decreases in income tax expense for the three        and six month periods are mainly due to increases in permanent differences as a relative percentage of pretax income.

 

 

 

24

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**LIQUIDITY MANAGEMENT AND INTEREST RATE SENSITIVITY**

 

The objective of liquidity management is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for business expansion. Liquidity management addresses the Corporation’s ability to meet deposit withdrawals either on demand or at contractual maturity, to repay borrowings as they mature, and to make new loans and investments as        opportunities arise. Liquidity is managed on a daily basis enabling Management to monitor changes in liquidity and to react accordingly to fluctuations in market conditions. The primary sources of liquidity for the Corporation are funding available from deposit growth, FHLB Borrowings, and cash flow from the investment and loan portfolios. Deposits consist of NOW, money-market, savings, tiered savings, large and small dollar certificates of deposit, and non-interest bearing demand        deposit accounts. The Corporation considers funds from NOW, money market, savings and certificates less than $100,000 as “core” deposits because of the historical stability of such sources of funds. Details of core deposits, non-interest bearing demand deposit accounts, and other deposit sources are highlighted in the following table:

 

|   | For the Six Months Ended   | For the Year Ended |
|--------|--------------------------------------|--------------------|

| (Dollars in thousands) |   | June 30, 2008   | December 31, 2007 |
|------------------------|--------|---------------------------|-------------------|

 

|                            | Average        |   | Effective |   | Average        |   | Effective |
|---------------------------------|----------------|--------|-----------|--------|----------------|--------|-----------|
| **DEPOSIT TYPE**                | Balance        |   | Yield     |   | Balance        |   | Yield     |
| NOW Accounts                    | $ 173,269 |   | 1.75%     |   | $ 159,572 |   | 2.30%     |
| Money Market                    | 115,986        |   | 2.82%     |   | 97,726         |   | 4.19%     |
| Statement Savings               | 40,150         |   | 0.71%     |   | 43,270         |   | 0.79%     |
| Other Savings                   | 2,824          |   | 1.55%     |   | 1,514          |   | 1.52%     |
| Tiered Savings                  | 51,297         |   | 1.32%     |   | 64,485         |   | 1.45%     |
| Total NOW Savings,              | 383,526        |   | 1.91%     |   | 366,567        |   | 2.47%     |
| and Money Market                |           |   |      |   |           |   |      |
|                            |           |   |      |   |           |   |      |
| CDs Less than $100,000          | 159,056        |   | 4.21%     |   | 192,236        |   | 4.72%     |
| CDs Greater than $100,000       | 69,395         |   | 4.30%     |   | 52,342         |   | 4.58%     |
| Total CDs                       | 228,451        |   | 4.24%     |   | 244,578        |   | 4.69%     |
|                            |           |   |      |   |           |   |      |
| Total Interest Bearing Deposits | 611,977        |   |      |   | 611,145        |   |      |
|                            |           |   |      |   |           |   |      |
| Non-Interest Bearing            |           |   |      |   |           |   |      |
| Demand Deposits                 | 118,216        |   |      |   | 121,000        |   |      |
|                            |           |   |      |   |           |   |      |
| Total Deposits                  | $ 730,193 |   |      |   | $ 732,145 |   |      |

 

The Bank, as a member of FHLB, maintains several credit facilities. During the three and six month periods ended June 30, 2008, average FHLB advances were $152.3 million and $149.4 million, respectively, and consisted of term advances with a variety of maturities. The average interest rate on these advances was 3.9% and 3.9%, respectively. The Bank currently has a maximum borrowing capacity with FHLB of        approximately $221.4 million. FHLB advances are collateralized by a pledge on the Bank’s portfolio of unencumbered investment securities, certain mortgage loans, and a lien on the Bank’s FHLB stock.

 

 

25

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

To supplement the Corporation’s sources of liquidity, the Corporation has initiated the use of alternative funding sources such as brokered deposits and bringing off-balance sheet “swept” funds onto the balance sheet as deposits. Management has set limits for these funding sources and will manage the impact that such sources may have on liquidity and interest rate sensitivity.

 

The goal of interest rate sensitivity management is to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. Such sensitivity is measured as the difference in the volume of assets and liabilities in the existing portfolio that are subject to re-pricing in a future time period. The Corporation’s net interest rate        sensitivity gap within one year is a negative $280.7 million or 28.8% of total assets at June 30, 2008 compared with a negative $168.2 million or 18.4% of total assets at December 31, 2007. The Corporation’s gap position is one tool used to evaluate interest rate risk and the stability of net interest margins. Another tool that management uses to evaluate interest rate risk is a computer simulation model that assesses the impact of changes in interest rates on net interest income,        net-income under various interest rate forecasts and scenarios. Management has set acceptable limits of risk within its Asset Liability Committee (“ALCO”) policy and monitors the results of the simulations against these limits quarterly. As of the most recent quarter-end, all results are within policy limits and indicate an acceptable level of interest rate risk. Management monitors interest rate risk as a regular part of corporate operationswith the intention of maintaining        a stable net interest margin. The following table presents our interest sensitivity analysis as of June 30, 2008:

 

|                               |                                                                        |   | Two                                                                               |   | Over                                                                             |   |                                                                             |   |                                  |
|------------------------------------|-----------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|---------------------------------------|
| (Dollars in thousands)             | Within                                                                      |   | through                                                                           |   | five                                                                             |   | Non-rate                                                                         |   |                                  |
|                               | one year                                                                    |   | five years                                                                        |   | years                                                                            |   | sensitive                                                                        |   | Total                                 |
| ASSETS                             |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| Federal funds sold and             | $   16,688                                                   |   | $             -  |   | $             - |   | $             - |   | $     16,688 |
| overnight investments              |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| Investment securities              | 23,935                                                                      |   | 64,121                                                                            |   | 26,799                                                                           |   | -                                                                                |   | 114,855                               |
| Interest bearing deposits in banks | 454                                                                         |   | -                                                                                 |   | -                                                                                |   | -                                                                                |   | 454                                   |
| Net loans and leases               | 315,070                                                                     |   | 359,686                                                                           |   | 111,792                                                                          |   | (8,433)                                                                          |   | 778,115                               |
| Cash and due from banks            | -                                                                           |   | -                                                                                 |   | -                                                                                |   | 25,016                                                                           |   | 25,016                                |
| Premises and equipment             | -                                                                           |   | -                                                                                 |   | -                                                                                |   | 19,430                                                                           |   | 19,430                                |
| Other assets                       | -                                                                           |   | -                                                                                 |   | -                                                                                |   | 21,592                                                                           |   | 21,592                                |
| Total assets                       | $ 356,147                                                              |   | $ 423,807                                                                    |   | $ 138,591                                                                   |   | $    57,605                                                  |   | $ 976,150                        |
|                               |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| LIABILITIES AND CAPITAL            |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| Non-interest bearing deposits      | $             - |   | $              - |   | $             - |   | $   118,918                                                       |   | $   118,918            |
| Interest bearing deposits          | 587,576                                                                     |   | 18,603                                                                            |   | 4,249                                                                            |   | -                                                                                |   | 610,428                               |
| FHLB advances and other            | 33,809                                                                      |   | 116,768                                                                           |   | 2,525                                                                            |   | -                                                                                |   | 153,102                               |
| Junior subordinated debentures     | 15,465                                                                      |   | -                                                                                 |   | -                                                                                |   | -                                                                                |   | 15,465                                |
| Other liabilities                  | -                                                                           |   | -                                                                                 |   | 9,596                                                                            |   | -                                                                                |   | 9,596                                 |
| Capital                            | -                                                                           |   | -                                                                                 |   | -                                                                                |   | 68,641                                                                           |   | 68,641                                |
| Total liabilities & capital    | $  636,850                                                        |   | $ 135,371                                                                    |   | $    16,370                                                  |   | $  187,559                                                             |   | $ 976,150                        |
| Net interest rate                  |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| sensitivity gap                    | $(280,703)                                                                  |   | $ 288,436                                                                    |   | $  122,221                                                             |   | $(129,954)                                                                       |   |                                  |
| Cumulative interest rate           |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| sensitivity gap                    | $(280,703)                                                                  |   | $     7,733                                              |   | $  129,954                                                             |   | $             - |   |                                  |
| Cumulative interest rate           |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| sensitivity gap divided            |                                                                        |   |                                                                              |   |                                                                             |   |                                                                             |   |                                  |
| by total assets                    | (28.8%)                                                                     |   | 0.8%                                                                              |   | 13.3%                                                                            |   |                                                                             |   |                                  |

 

 

26

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – Continued**

 

**BRANCHING, TECHNOLOGY AND CAPITAL PROJECTS**

 

During the first quarter of 2008, the Bank opened two new branch facilities. The first, a newly constructed, full-service branch located in Kennett Square, Pennsylvania, features the Bank’s signature building design, first showcased by the Oxford Branch, which opened in 2005. The second, a full-service branch located in Downingtown, Pennsylvania, replaced the Coatesville Branch. The Coatesville        branch was closed in the first quarter of 2008. Technological improvements, including enhanced security over customer information, a more proactive disaster recovery system and an improved infrastructure to support more internet banking products are also expected in the future. We are continuously looking for opportunities to expand our branch system and invest in technology to better serve our customers.

 

**CAPITAL****ADEQUACY**

 

The Corporation is subject to Risk-Based Capital Guidelines adopted by the Federal Reserve Board for bank holding companies. The Corporation is also subject to similar capital requirements adopted by the Office of the Comptroller of the Currency. Under these requirements, the regulatory agencies have set minimum thresholds for Tier I Capital, Total Capital, and Leverage ratios. At June 30, 2007, both the        Corporation’s and the Bank’s capital exceeded all minimum regulatory requirements, and the Bank was considered “well capitalized” as defined in the regulations issued pursuant to the FDIC Improvement Act of 1992.

 

|   | As of June 30,   |          As of December 31,   |      "Well Capitalized" |
|--------|----------------------------|---------------------------------------------------------------------------------|---------------------------------------------|

|                           | 2008   |   | 2007   |   | 2007   |   | Requirements |
|--------------------------------|--------|--------|--------|--------|--------|--------|--------------|
| Corporation                    |   |   |   |   |   |   |         |
| Leverage Ratio                 | 8.58%  |   | 8.99%  |   | 9.22%  |   | N/A          |
| Tier I Capital Ratio           | 10.15% |   | 10.51% |   | 10.84% |   | N/A          |
| Total Risk-Based Capital Ratio | 11.22% |   | 11.62% |   | 11.92% |   | N/A          |
| Bank                           |   |   |   |   |   |   |         |
| Leverage Ratio                 | 8.02%  |   | 8.37%  |   | 8.58%  |   | 5.00%        |
| Tier I Capital Ratio           | 9.48%  |   | 9.78%  |   | 10.08% |   | 6.00%        |
| Total Risk-Based Capital Ratio | 10.55% |   | 10.90% |   | 11.18% |   | 10.00%       |

 

The Bank is not under any agreement with the regulatory authorities nor is it aware of any current recommendations by the regulatory authorities that, if they were to be implemented, would have a material affect on liquidity, capital resources, or operations of the Corporation.

 

 

27

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

There have been no material changes in the Corporation’s assessment of its sensitivity to market risk since its presentation in the 2007 Annual Report. Please refer to Item 7A on pages 36-38 of the Corporation’s 2007 Annual Report for more information.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures.**Included with this Quarterly Report as Exhibits 31.1, 31.2, and 31.3 are certifications (the “Section 302 Certifications”), one by each of our Chief Executive Officer, President and Chief Financial Officer (our principal executive, operating and financial officers, respectively, and, collectively, the “Principal        Officers”). This section of the Quarterly Report contains information concerning the evaluations of our disclosure controls and procedures and internal control over financial reporting that are referred to in the Section 302 Certifications. This information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

 

The SEC requires that as of the end of the quarter covered by this Report, our CEO and CFO evaluate the effectiveness of the design and operation of our disclosure controls and procedures and report on the effectiveness of the design and operation of our disclosure controls and procedures.

 

“Disclosure controls and procedures” mean the controls and other procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 (the “Exchange Act”), such as this Quarterly Report, is recorded, processed, summarized and reported within the time periods specified in the rules and        forms promulgated by the SEC. Disclosure controls and procedures are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the Principal Officers, as appropriate, to allow timely decisions regarding required disclosure.

 

**Management’s Report on Disclosure Controls and Procedures.**As required by Rule 13a-15(b), under the Exchange Act, Management, including our Principal Officers, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of the Corporation’s disclosure controls and procedures. Based on that evaluation, the Principal Officers        concluded that our disclosure controls and procedures were effective, as of June 30, 2008, at the reasonable assurance level, to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed and reported within the time periods specified in the SEC rules and regulations.

 

**Changes in internal control over financial reporting.**In connection with the ongoing review of the Corporation’s internal control over financial reporting (as defined in Rule 13a-15(d), under the Exchange Act), Management, including the Principal Officers, regularly assesses the adequacy of the Corporation’s internal control over financial reporting to determine        whether any changes occurred during the period covered by this Report that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.During the second quarter of 2008, there were no such changes.

 

 

 

 

 

28

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART II - OTHER INFORMATION**

 

| **Item 1.** | **Legal Proceedings** |
|-------------|-----------------------|

 

Various actions and proceedings are presently pending to which the Corporation is a party. These actions and proceedings arise out of routine operations and, in Management’s opinion, will not, either individually or in the aggregate, have a material adverse effect on the consolidated financial position of the Corporation and its subsidiaries.

 

| **Item 1A.** | **Risk Factors** |
|--------------|------------------|

 

Information regarding risk factors appears in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2007. There have been no material changes from the risk factors as disclosed in that report.

 

| **Item 2.** | **Unregistered Sales of Equity Securities and Use of Proceeds** |
|-------------|-----------------------------------------------------------------|

 

**ISSUER PURCHASES OF EQUITY SECURITIES**(1)

 

|  

 

Period    | (a)

Total Number of Shares (or

Units)

Purchased | (b)

Average

Price Paid

per Share

(or Unit) | (c)

Total Number of Shares (or Units) Purchased as Part

of Publicly Announced Plans

or Programs (1) | (d)

Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1) |
|---------------------------|----------------------------------------------------|------------------------------------------------|--------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------|
| April 1 to April 30, 2008 | --                                                 | --                                             | --                                                                                                     | $10,000,000                                                                                                                      |
| May 1 to May 31, 2008     | --                                                 | --                                             | --                                                                                                     | $10,000,000                                                                                                                      |
| June 1 to June 30, 2008   | --                                                 | --                                             | --                                                                                                     | $10,000,000                                                                                                                      |
| Total                     | --                                                 | --                                             | --                                                                                                     | $10,000,000                                                                                                                      |

 

(1) The Corporation announced on November 16, 2007 a program to repurchase up to $10.0 million of the Corporation’s Common Stock. This program replaced a previous program that expired in October 2007.

 

 

 

 

 

 

29

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

**PART II - OTHER INFORMATION - CONTINUED**

 

| **Item 3.** | **Defaults upon Senior Securities** |
|-------------|-------------------------------------|

 

None

 

| **Item 4.** | **Submission of Matters to a Vote of Security Holders** |
|-------------|---------------------------------------------------------|

 

The Annual Meeting of Shareholders of the Corporation was held on April 15, 2008 (the “Meeting”). Notice of the Meeting was mailed to shareholders of record on or about March 14, 2008, together with proxy solicitation materials prepared in accordance with Section 14(a) of the Securities Exchange Act of 1934, as amended, and the regulations promulgated there        under.

 

The only matter submitted to a vote of shareholders at the meeting was the election of four Class III directors.

 

There was no solicitation in opposition to the nominees of the Board of Directors for election to the Board of Directors. All four of the nominees were elected. The number of votes cast for or withheld as well as the number of abstentions and broker non-votes for each of the nominees for election to the Board of Directors were as follows:

 

 

| Nominee            |   | For            |   | Withheld |
|--------------------|--------|-----------------------------------------------------------------------|--------|----------|
|               |   |                                                                  |   |     |
| John A. Featherman |   | 4,202,514                                                             |   | 63,167   |
|               |   |                                                                  |   |     |
| John S. Halsted    |   | 3,801,971                                                             |   | 463,710  |
|               |   |                                                                  |   |     |
| J. Carol Hanson    |   | 4,213,005                                                             |   | 52,676   |
|               |   |                                                                  |   |     |
| Edward A. Leo      |   | 4,211,883                                                             |   | 53,798   |

 

 

The names of the other directors whose terms of office as directors continued after the meeting are as follow: John J. Ciccarone, Clifford E. DeBaptiste, Lynn Marie Johnson-Porter, John B. Waldron, Brian K. Campbell, M. Robert Clarke, Matthew S. Naylor, David L. Peirce and Kevin C. Quinn.

 

There was no other business that came before the meeting or matters incident to the conduct of the Meeting.

 

| **Item 5.** | **Other Information** |
|-------------|-----------------------|

 

None

 

 

 

 

30

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART II - OTHER INFORMATION - CONTINUED**

 

| **Item 6.** | **Exhibits** |
|-------------|--------------|

 

Exhibits marked as “(cp)” are management contracts or compensatory plans, contracts or arrangements in which a director or executive officer participates or may participate. Exhibits marked with an asterisk are filed with this report.

 

3(i).    Certificate of Incorporation. Copy of the Corporation’s Articles of Incorporation, as amended, is incorporated herein by reference to Exhibit 3 (i) to the Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004.

 

3(ii).  Bylaws of the Corporation, as amended. Copy of the Corporation’s Bylaws, as amended, is incorporated herein by reference to Exhibit 3(ii) to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

10.1 Employment agreement, dated as of June 27, 2008, between First Chester County Corporation and First National Bank of Chester County and John A. Featherman, Chairman and Chief Executive Officer. (CP)*

 

10.2 Employment agreement, dated as of June 27, 2008, between First Chester County Corporation and First National Bank of Chester County and Kevin C. Quinn, President. (CP)*

 

|   | 31.1 | Rule 13a-14(a) Certification of Chief Executive Officer* |
|--------|------|----------------------------------------------------------|

|   | 31.2 | Rule 13a-14(a) Certification of President* |
|--------|------|--------------------------------------------|

|   | 31.3 | Rule 13a-14(a) Certification of Chief Financial Officer* |
|--------|------|----------------------------------------------------------|

 

|   | 32.1 | Section 906 Certification of the Chief Executive Officer* |
|--------|------|-----------------------------------------------------------|

|   | 32.2 | Section 906 Certification of the President* |
|--------|------|---------------------------------------------|

|   | 32.3 | Section 906 Certification of the Chief Financial Officer* |
|--------|------|-----------------------------------------------------------|

 

 

31

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

**FIRST CHESTER COUNTY CORPORATION**

 

 

 

|            |                                                   |
|-----------------|--------------------------------------------------------|
| August 11, 2008 | ****__/s/ John A. Featherman**______________________** |
|            | ****John A. Featherman, III****                        |
|            | **Chief Executive Officer**                            |
|            |                                                   |
|            |                                                   |
|            |                                                   |
| August 11, 2008 | **__/s/ John E. Balzarini______________________**      |
|            | **John E. Balzarini**                                  |
|            | **Chief Financial Officer**                            |
|            | **(Principal Financial and Accounting Officer)**       |
|            |                                                   |

 

 

32

**INDEX TO EXHIBITS**

 

The following is a list of the exhibits filed with, or incorporated by reference into, this Report (those exhibits marked with an asterisk are filed herewith and those marked “(cp)” are management contracts or compensatory plans, contracts or arrangements in which a director or executive officer participates or may participate):

 

3(i).     Certificate of Incorporation. Copy of the Corporation’s Articles of Incorporation, as amended, is incorporated herein by reference to Exhibit 3 (i) to the Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2004.

 

3(ii).    Bylaws of the Corporation, as amended. Copy of the Corporation’s Bylaws, as amended, is incorporated herein by reference to Exhibit 3(ii) to the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2007.

 

10.1 Employment agreement, dated as of June 27, 2008, between First Chester County Corporation and First National Bank of Chester County and John A. Featherman, Chairman and Chief Executive Officer. (CP)*

 

10.2 Employment agreement, dated as of June 27, 2008, between First Chester County Corporation and First National Bank of Chester County and Kevin C. Quinn, President. (CP)*

 

|   | 31.1 | Rule 13a-14(a) Certification of Chief Executive Officer* |
|--------|------|----------------------------------------------------------|

|   | 31.2 | Rule 13a-14(a) Certification of President * |
|--------|------|---------------------------------------------|

|   | 31.3 | Rule 13a-14(a) Certification of Chief Financial Officer* |
|--------|------|----------------------------------------------------------|

 

|   | 32.1 | Section 906 Certification of the Chief Executive Officer* |
|--------|------|-----------------------------------------------------------|

|   | 32.2 | Section 906 Certification of the President* |
|--------|------|---------------------------------------------|

|   | 32.3 | Section 906 Certification of the Chief Financial Officer* |
|--------|------|-----------------------------------------------------------|

 

33