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**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

# **FORM 10-Q**

 

**(Mark One)**

 
| **x** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|------------|---------------------------------------------------------------------------------------------------------|

 

**For the quarterly period endedSeptember 30, 2009**

 

**OR**

 
| **o** | ** ** | **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 COUNTYCORPORATION**

(Exact name of Registrant as specified in its charter)

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

 

**9 North High Street, WestChester, Pennsylvania 19380**

(Address of principal executive office)

(Zip code)

 

**(484) 881-4000**

(Registrant’s telephone number, including area code)

 

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). Yes o  No o

 

Indicate by checkmark 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 o                     |   | Accelerated filer x         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filer o                       |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                        |

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes o  No x

 

Thenumber of shares outstanding of Common Stock of the registrant as of November 9,2009 was 6,303,731.

 

 

 

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**INDEX**

 
| ** **    | ** **             | ** **   | ** **                                                                | ** **   | **Page**     |
|---------------|------------------------|--------------|---------------------------------------------------------------------------|--------------|--------------|
| Part I.  | FINANCIAL  INFORMATION |         |                                                                      |
|          |                   |         |                                                                      |         |         |
|          | Item 1 -               |         | Financial  Statements                                                     |         |         |
|          |                   |         | Consolidated  Balance Sheets                                              |         |         |
|          |                   |         | September 30,  2009 (unaudited) and December 31, 2008           |         | 2            |
| ** **    |                   | ** **   |                                                                      | ** **   |         |
|          |                   |         | Consolidated  Statements of Income                                        |         |         |
|          |                   |         | Three  and Nine Months Ended September 30, 2009 and 2008 (unaudited) |         | 3            |
|          |                   |         |                                                                      |         |         |
|          |                   |         | Consolidated  Statements of Cash Flows                                    |         |         |
|          |                   |         | Nine  Months Ended September 30, 2009 and 2008 (unaudited)           |         | 4            |
|          |                   |         |                                                                      |         |         |
|          |                   |         | Consolidated  Statements of Stockholders’ Equity                     |         |         |
|          |                   |         | Nine  Months Ended September 30, 2009 and 2008 (unaudited)           | ** **   | 5            |
|          |                   |         |                                                                      |         |         |
|          |                   |         | Notes  to Consolidated Financial Statements (unaudited)                   | ** **   | 6            |
|          |                   |         |                                                                      |         |         |
|          | Item 2 -               |         | Management’s  Discussion and Analysis of                             |         |         |
|          |                   |         | Financial  Condition and Results of Operations                            | ** **   | 26           |
|          |                   |         |                                                                      |         |         |
|          | Item  3 -              |         | Quantitative  and Qualitative Disclosures About Market Risk               | ** **   | 42           |
|          |                   |         |                                                                      |         |         |
|          | Item 4 -               |         | Controls &  Procedures                                           |         | 42           |
|          |                   |         |                                                                      |         |         |
| Part II. | OTHER INFORMATION      |         |                                                                      |
|          |                   |         |                                                                      |         |         |
|          | Item 1 -               |         | Legal Proceedings                                                         |         | 43           |
|          |                   |         |                                                                      |         |         |
|          | Item 1A -              |         | Risk Factors                                                              |         | 43           |
|          |                   |         |                                                                      |         |         |
|          | Item  2 -              |         | Unregistered  Sales of Equity Securities and Use of Proceeds              |         | 44           |
|          |                   |         |                                                                      |         |         |
|          | Item  3 -              |         | Defaults  Upon Senior Securities                                          |         | 44           |
|          |                   |         |                                                                      |         |         |
|          | Item  4 -              |         | Submission  of Matters to a Vote of Security Holders                      |         | 45           |
|          |                   |         |                                                                      |         |         |
|          | Item 5 -               |         | Other Information                                                         |         | 45           |
| *** ***  | *** ***           | *** *** | *** ***                                                              | *** *** | *** *** |
|          | Item 6 -               |         | Exhibits                                                                  |         | 45           |
|          |                   |         |                                                                      |         | *** *** |
|          | Signatures             |         |                                                                      |         | 46           |
|          |                   |         |                                                                      |         |         |
|          | Exhibits               |         |                                                                      |         | 47           |

 

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**FORWARD-LOOKING STATEMENTS**

 

This Quarterly Report on Form 10-Qcontains “forward-looking statements.” These forward-looking statements are made in good faith pursuant to the “safeharbor” provisions of the Private Securities Litigation Reform Act of1995.  The words “may,” “could,” “should,”“would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” andsimilar expressions are intended to identify forward-looking statements. Referencesto “we,” “our” and the “Corporation” refer to First Chester County Corporation,together in each case with our consolidated subsidiaries unless the contextsuggests otherwise.

 

Theforward-looking statements contained in this Quarterly Report on Form 10-Qare based on current expectations, estimates, forecasts and projections aboutthe industry in which we operate and management’s beliefs and assumptions.These statements are not guarantees of future performance and involve risks,uncertainties and assumptions that are difficult to predict. Therefore, actualoutcomes and results may differ materially from what is expressed or forecastedin such forward-looking statements, including as a result of risks discussed in“Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K forthe fiscal year ended December 31, 2008 and in this Quarterly Report on Form 10-Q.

 

1

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  Financial Statements**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                                                                                                                                    | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                    | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                        |       |                   |       |                  |       |
| Cash and due from banks                                                                                                                                       |       | $                      | 19,107     |                  | $          | 24,939 |   |
| Federal funds sold and other overnight investments                                                                                                            |       | 2,347                  |       | 4,884                 |       |
| Interest bearing deposits                                                                                                                                     |       | 1,497                  |       | 65,327                |       |
| Total cash and cash equivalents                                                                                                                               |       | 22,951                 |       | 95,150                |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Investment securities available-for-sale, at fair  value                                                                                                      |       | 89,866                 |       | 114,584               |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Mortgage loans held for sale                                                                                                                                  |       | 187,521                |       | 90,940                |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Loans and leases                                                                                                                                              |       | 957,502                |       | 940,083               |       |
| Less: allowance for loan and lease losses                                                                                                                     |       | (23,434                | )          | (10,335               | )          |
| Net loans and leases                                                                                                                                          |       | 934,068                |       | 929,748               |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Premises and equipment, net                                                                                                                                   |       | 23,142                 |       | 22,076                |       |
| Net deferred tax asset                                                                                                                                        |       | 11,746                 |       | 8,585                 |       |
| Due from mortgage investors                                                                                                                                   |       | —                 |       | 9,036                 |       |
| Bank owned life insurance                                                                                                                                     |       | 1,437                  |       | 1,398                 |       |
| Goodwill                                                                                                                                                      |       | 8,079                  |       | 5,906                 |       |
| Other real estate owned                                                                                                                                       |       | 3,062                  |       | 1,872                 |       |
| Other assets                                                                                                                                                  |       | 24,809                 |       | 20,883                |       |
| Total assets                                                                                                                                                  |       | $                      | 1,306,681  |                  | $          | 1,300,178 |   |
| LIABILITIES                                                                                                                                                   |       |                   |       |                  |       |
| Deposits                                                                                                                                                      |       |                   |       |                  |       |
| Non-interest-bearing                                                                                                                                          |       | $                      | 153,299    |                  | $          | 146,248 |   |
| Interest-bearing (including certificates of deposit  over $100 of $173,135 and $100,018 at September 30, 2009 and December 31,  2008, respectively) |       | 832,815                |       | 868,944               |       |
| Total deposits                                                                                                                                                |       | 986,114                |       | 1,015,192             |       |
| Federal Home Loan Bank advances and other  borrowings                                                                                                         |       | 202,123                |       | 171,170               |       |
| Subordinated debentures                                                                                                                                       |       | 20,795                 |       | 15,465                |       |
| Other liabilities                                                                                                                                             |       | 16,271                 |       | 13,034                |       |
| Total liabilities                                                                                                                                             |       | 1,225,303              |       | 1,214,861             |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Commitments and contingencies — See Note 14                                                                                                              |       |                   |       |                  |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| STOCKHOLDERS’ EQUITY                                                                                                                                     |       |                   |       |                  |       |
| Common stock, par value $1.00; authorized  25,000,000 shares; Outstanding, 6,331,975 at September 30, 2009 and  December 31, 2008                   |       | 6,332                  |       | 6,332                 |       |
| Additional paid-in capital                                                                                                                                    |       | 23,515                 |       | 24,708                |       |
| Retained earnings                                                                                                                                             |       | 50,589                 |       | 57,899                |       |
| Accumulated other comprehensive loss                                                                                                                          |       | (523                   | )          | (3,292                | )          |
| Treasury stock, at cost: 24,200 shares and 92,931  shares at September 30, 2009 and December 31, 2008, respectively                                 |       | (374                   | )          | (1,815                | )          |
| Total First Chester County Corporation  stockholders’ equity                                                                                             |       | 79,539                 |       | 83,832                |       |
| Non-controlling interests                                                                                                                                     |       | 1,839                  |       | 1,485                 |       |
| Total stockholders’ equity                                                                                                                               |       | 81,378                 |       | 85,317                |       |
|                                                                                                                                                          |       |                   |       |                  |       |
| Total liabilities and stockholders’ equity                                                                                                               |       | $                      | 1,306,681  |                  | $          | 1,300,178 |   |

 

The accompanying notes are anintegral part of these statements.

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF INCOME**

(**UNAUDITED**)

 
| ** **                                                            | ** ** | **Three  Months Ended** | ** ** | **Nine  Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
| **(Dollars  in thousands - except per share)**                        | ** ** | **2009**                | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| INTEREST INCOME                                                       |       |                    |       |                   |       |   |   |   |   |
| Loans and leases, including fees                                      |       | $                       | 13,565     |                   | $          | 12,418 |   | $ | 40,136 |   | $ | 36,836 |   |
| Mortgage loans held for sale                                          |       | 2,866                   |       | 3                      |       | 7,805 |   | 9 |   |
| Investment securities                                                 |       | 764                     |       | 1,255                  |       | 2,991 |   | 3,836 |   |
| Federal funds sold and deposits in banks                              |       | 5                       |       | 200                    |       | 50 |   | 1,068 |   |
| Total interest income                                                 |       | 17,200                  |       | 13,876                 |       | 50,982 |   | 41,749 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| INTEREST EXPENSE                                                      |       |                    |       |                   |       |   |   |   |   |
| Deposits                                                              |       | 3,512                   |       | 3,647                  |       | 11,866 |   | 12,099 |   |
| Subordinated debt                                                     |       | 295                     |       | 209                    |       | 721 |   | 683 |   |
| Federal Home Loan Bank and other borrowings                           |       | 1,559                   |       | 1,470                  |       | 4,712 |   | 4,390 |   |
| Total interest expense                                                |       | 5,366                   |       | 5,326                  |       | 17,299 |   | 17,172 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| Net interest income                                                   |       | 11,834                  |       | 8,550                  |       | 33,683 |   | 24,577 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| Provision for loan and lease losses                                   |       | 14,678                  |       | 290                    |       | 17,637 |   | 950 |   |
| Net interest income (loss) after provision for loan  and lease losses |       | (2,844                  | )          | 8,260                  |       | 16,046 |   | 23,627 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| NON-INTEREST INCOME                                                   |       |                    |       |                   |       |   |   |   |   |
| Wealth management and advisory services                               |       | 965                     |       | 994                    |       | 2,931 |   | 3,069 |   |
| Service charges on deposit accounts                                   |       | 669                     |       | 657                    |       | 1,960 |   | 1,853 |   |
| Gains on sales of investment securities, net                          |       | 1                       |       | 89                     |       | 1 |   | 273 |   |
| Operating lease rental income                                         |       | 314                     |       | 328                    |       | 999 |   | 967 |   |
| Net gains (losses) on fixed assets and OREO                           |       | 162                     |       | (123                   | )          | 279 |   | (33 | ) |
| Loan fees and other                                                   |       | 738                     |       | 118                    |       | 3,574 |   | 298 |   |
| Net gain from mortgage banking activities                             |       | 10,231                  |       | 33                     |       | 34,492 |   | 197 |   |
| Bank owned life insurance                                             |       | 13                      |       | 46                     |       | 39 |   | 203 |   |
| Asset impairment                                                      |       | (1,576                  | )          | (1,267                 | )          | (1,576 | ) | (1,267 | ) |
| Other                                                                 |       | 521                     |       | 452                    |       | 1,574 |   | 1,395 |   |
| Total non-interest income                                             |       | 12,038                  |       | 1,327                  |       | 44,273 |   | 6,955 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| NON-INTEREST EXPENSE                                                  |       |                    |       |                   |       |   |   |   |   |
| Salaries and employee benefits                                        |       | 14,948                  |       | 4,847                  |       | 42,718 |   | 13,845 |   |
| Occupancy, equipment and data processing                              |       | 3,207                   |       | 1,434                  |       | 8,877 |   | 4,342 |   |
| Depreciation expense on operating leases                              |       | 259                     |       | 273                    |       | 828 |   | 799 |   |
| FDIC deposit insurance                                                |       | 422                     |       | 136                    |       | 1,897 |   | 347 |   |
| Bank shares tax                                                       |       | 207                     |       | 207                    |       | 674 |   | 592 |   |
| Professional services                                                 |       | 2,039                   |       | 449                    |       | 4,962 |   | 1,368 |   |
| Marketing                                                             |       | 337                     |       | 171                    |       | 1,161 |   | 704 |   |
| Other real estate expense                                             |       | 35                      |       | 12                     |       | 142 |   | 16 |   |
| Other                                                                 |       | 1,923                   |       | 1,103                  |       | 5,580 |   | 3,071 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| Total non-interest expense                                            |       | 23,377                  |       | 8,632                  |       | 66,839 |   | 25,084 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| (Loss) income before income taxes                                     |       | (14,183                 | )          | 955                    |       | (6,520 | ) | 5,498 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| INCOME TAXES                                                          |       | (4,960                  | )          | 148                    |       | (2,965 | ) | 1,329 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| Net (loss) income including noncontrolling  interests                 |       | $                       | (9,223     | )                      | $          | 807 |   | $ | (3,555 | ) | $ | 4,169 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| Less: Net income from non-controlling interests                       |       | 494                     |       | —                 |       | 1,363 |   | — |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| NET (LOSS) INCOME FOR FIRST CHESTER COUNTY  CORPORATION               |       | $                       | (9,717     | )                      | $          | 807 |   | $ | (4,918 | ) | $ | 4,169 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| PER SHARE DATA                                                        |       |                    |       |                   |       |   |   |   |   |
| Net (loss) income per share (Basic)                                   |       | $                       | (1.54      | )                      | $          | 0.16 |   | $ | (0.78 | ) | $ | 0.80 |   |
| Net (loss) income per share (Diluted)                                 |       | $                       | (1.54      | )                      | $          | 0.16 |   | $ | (0.78 | ) | $ | 0.80 |   |
| Dividends declared                                                    |       | $                       | 0.140      |                   | $          | 0.140 |   | $ | 0.420 |   | $ | 0.420 |   |
|                                                                  |       |                    |       |                   |       |   |   |   |   |
| Basic weighted average shares outstanding                             |       | 6,306,889               |       | 5,188,562              |       | 6,272,682 |   | 5,184,173 |   |
| Diluted weighted average shares outstanding                           |       | 6,306,899               |       | 5,197,787              |       | 6,272,682 |   | 5,200,200 |   |

 

The accompanying notes are anintegral part of these statements.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(**UNAUDITED**)

** **
| ** **                                                                                          | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                          | ** ** | **September 30,** | ** ** |
| **(Dollars in thousands)**                                                                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
| OPERATING ACTIVITIES                                                                                |       |                   |       |   |   |
| Net(loss) income                                                                                    |       | $                      | (4,918     | ) | $ | 4,169 |   |
| Adjustments to reconcile net (loss) income to net  cash (used in) provided by operating activities: |       |                   |       |   |   |
| Depreciation                                                                                        |       | 2,728                  |       | 1,848 |   |
| Provision for loan and lease losses                                                                 |       | 17,637                 |       | 950 |   |
| Amortization of investment security premiums and  accretion of discounts, net                       |       | 300                    |       | 250 |   |
| Amortization of deferred loan fees                                                                  |       | (728                   | )          | (570 | ) |
| Losses on sales of investment securities available  for sale, net                                   |       | (1                     | )          | (273 | ) |
| Net (gain) loss from on fixed assets and OREO                                                       |       | (279                   | )          | 33 |   |
| Net gain from mortgage banking activities                                                           |       | (34,492                | )          | (197 | ) |
| Proceeds from the sale of mortgage loans held for  sale                                             |       | 1,897,596              |       | 12,038 |   |
| Origination of mortgage loans held for sale                                                         |       | (1,950,649             | )          | (12,303 | ) |
| Net cash paid for the settlement of derivative  contracts                                           |       | (277                   | )          | — |   |
| Stock-based compensation expense                                                                    |       | 147                    |       | 132 |   |
| Loss on investment securities                                                                       |       | 1,576                  |       | 850 |   |
| Increase in other assets                                                                            |       | (16,432                | )          | (824 | ) |
| Increase (decrease) in other liabilities                                                            |       | 2,369                  |       | (1,645 | ) |
|                                                                                                |       |                   |       |   |   |
| Net cash (used in) provided by operating activities                                                 |       | (85,423                | )          | 4,458 |   |
|                                                                                                |       |                   |       |   |   |
| INVESTING ACTIVITIES                                                                                |       |                   |       |   |   |
| Net increase in loans                                                                               |       | (24,587                | )          | (64,589 | ) |
| Proceeds from the sale of portfolio loans                                                           |       | 3,479                  |       | — |   |
| Proceeds from sales of investment securities  available-for-sale                                    |       | 33,641                 |       | 21,414 |   |
| Proceeds from maturities prepayments and calls of  investment securities available-for-sale         |       | 10,048                 |       | 11,877 |   |
| Purchases of investment securities  available-for-sale                                              |       | (16,649                | )          | (42,557 | ) |
| Purchase of BOLI (Bank Owned Life Insurance)                                                        |       | —                 |       | (10,000 | ) |
| Proceeds from the sale of OREO                                                                      |       | 5,060                  |       | — |   |
| Purchase of premises and equipment                                                                  |       | (3,794                 | )          | (3,752 | ) |
| Proceeds from the sale of premises and equipment                                                    |       | 114                    |       | 119 |   |
|                                                                                                |       |                   |       |   |   |
| Net cash provided by (used in) investing activities                                                 |       | 7,312                  |       | (87,488 | ) |
|                                                                                                |       |                   |       |   |   |
| FINANCING ACTIVITIES                                                                                |       |                   |       |   |   |
| Change in subsidiary’s shares from non-controlling  interest                                   |       | 354                    |       | — |   |
| Increase in short term Federal Home Loan Bank and  other short term borrowings                      |       | 49,700                 |       | — |   |
| Increase in long term Federal Home Loan Bank and  other borrowings                                  |       | 58,300                 |       | 111,500 |   |
| Repayment of long term Federal Home Loan Bank and  other borrowings                                 |       | (77,047                | )          | (78,300 | ) |
| Proceeds from issuance of subordinated debentures                                                   |       | 5,330                  |       | — |   |
| Net(decrease) increase in deposits                                                                  |       | (29,077                | )          | 56,621 |   |
| Cash dividends paid                                                                                 |       | (1,759                 | )          | (2,179 | ) |
| Net treasury stock transactions                                                                     |       | 111                    |       | 26 |   |
|                                                                                                |       |                   |       |   |   |
| Net cash provided by financing activities                                                           |       | 5,912                  |       | 87,668 |   |
|                                                                                                |       |                   |       |   |   |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                               |       | (72,199                | )          | 4,638 |   |
|                                                                                                |       |                   |       |   |   |
| Cash and cash equivalents at beginning of period                                                    |       | 95,150                 |       | 53,360 |   |
|                                                                                                |       |                   |       |   |   |
| Cash and cash equivalents at end of period                                                          |       | $                      | 22,951     |   | $ | 57,998 |   |

 

The accompanying notes are an integral part of these statements.

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

(**UNAUDITED**)

 
| ** **                                                         | ** ** | ** **       | ** ** | ** **     | ** **  | ** **     | ** ** | ** **        | ** ** | **Accumulated**   | ** **   | ** **      | ** ** | ** **             | ** ** | ** **        | ** **   | ** ** | ** **  |
|--------------------------------------------------------------------|------------|------------------|------------|----------------|-------------|----------------|------------|-------------------|------------|-------------------|--------------|-----------------|------------|------------------------|------------|-------------------|--------------|------------|-------------|
| ** **                                                         | ** ** | ** **       | ** ** | ** **     | ** **  | **Additional** | ** ** | ** **        | ** ** | **Other**         | ** **   | ** **      | ** ** | **Non-**               | ** ** | **Total**         | ** **   | ** ** | ** **  |
| ** **                                                         | ** ** | **Common Stock** | ** ** | **Paid-in**    | ** **  | **Retained**   | ** ** | **Comprehensive** | ** ** | **Treasury**      | ** **   | **Controlling** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** **   |
| **(Dollars in thousands)**                                         | ** ** | **Shares**       | ** ** | **Par  Value** | ** **  | **Capital**    | ** ** | **Earnings**      | ** ** | **Income/(loss)** | ** **   | **Stock**       | ** ** | **Interest**           | ** ** | **Equity**        | ** **   | **Income** | ** **  |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Balance  January 1, 2008                                      |       | 5,279,815        |       | $              |  5,280 |           | $          |  11,113      |       | $                 |  55,347 |            | $          |  (1,207           | )          | $                 |  (2,554 | )          | —      |   | $ |  67,979 |   |   |   |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Net  income                                                        |       | —           |       | —         |        | —         |       | 4,169             |       | —            |         | —          |       | —                 |       | 4,169             |         | 4,169      |        |
| Cash  dividends declared                                           |       | —           |       | —         |        | —         |       | (2,179            | )          | —            |         | —          |       | —                 |       | (2,179            | )            | —     |        |
| Other  comprehensive income                                        |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Net  unrealized losses on investment securities Available-for-sale |       | —           |       | —         |        | —         |       | —            |       | (2,775            | )            | —          |       | —                 |       | (2,775            | )            | (2,775     | )           |
| Treasury  stock transactions                                       |       | —           |       | —         |        | (719           | )          | —            |       | —            |         | 746             |       | —                 |       | 27                |         | —     |        |
| Stock  based compensation                                          |       |             |       |           |        | 132            |       |              |       |              |         |            |       |                   |       | 132               |         |       |        |
| Total  comprehensive income                                        |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         | $          |  1,394 |   |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Balance  September 30, 2008                                   |       | 5,279,815        |       | $              |  5,280 |           | $          |  10,526      |       | $                 |  57,337 |            | $          |  (3,982           | )          | $                 |  (1,808 | )          | —      |   | $ |  67,353 |   |   |   |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Balance  January 1, 2009                                      |       | 6,331,975        |       | $              |  6,332 |           | $          |  24,708      |       | $                 |  57,899 |            | $          |  (3,292           | )          | $                 |  (1,815 | )          | $           |  1,485 |   | $ |  85,317 |   |   |   |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Cumulative  effect adjustment under FASB no. 156                   |       |             |       |           |        |           |       | 240               |       |              |         |            |       |                   |       | 240               |         |       |        |
| Balance  January 1, 2009, as adjusted                         |       | 6,331,975        |       | 6,332          |        | 24,708         |       | 58,139            |       | (3,292            | )            | (1,815          | )          | 1,485                  |       | 85,557            |         |       |        |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Change  in subsidiary shares from non-controlling interest         |       | —           |       | —         |        | —         |       | —            |       | —            |         | —          |       | (1,009                 | )          | (1,009            | )            |       |        |
| Net  income (loss)                                                 |       | —           |       | —         |        | —         |       | (4,918            | )          | —            |         | —          |       | 1,363                  |       | (3,555            | )            | (3,555     | )           |
| Cash  dividends declared                                           |       | —           |       | —         |        | —         |       | (2,632            | )          | —            |         | —          |       | —                 |       | (2,632            | )            |       |        |
| Other  comprehensive income                                        |       | —           |       | —         |        | —         |       | —            |       | —            |         | —          |       | —                 |       | —            |         |       |        |
| Net  unrealized gains on investment securities available-for-sale  |       | —           |       | —         |        | —         |       | —            |       | 2,769             |         | —          |       | —                 |       | 2,769             |         | 2,769      |        |
| Treasury  stock transactions                                       |       | —           |       | —         |        | (1,330         | )          | —            |       | —            |         | 1,441           |       | —                 |       | 111               |         | —     |        |
| Stock  based Compensation                                          |       | —           |       | —         |        | 147            |       | —            |       | —            |         | —          |       | —                 |       | 147               |         | —     |        |
| Stock  based Compensation Tax Benefit                              |       | —           |       | —         |        | (10            | )          | —            |       | —            |         | —          |       | —                 |       | (10               | )            | —     |        |
| Total  comprehensive loss                                          |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         | $          |  (786  | ) |
|                                                               |       |             |       |           |        |           |       |              |       |              |         |            |       |                   |       |              |         |       |        |
| Balance  September 30, 2009                                   |       | 6,331,975        |       | $              |  6,332 |           | $          |  23,515      |       | $                 |  50,589 |            | $          |  (523             | )          | $                 |  (374   | )          | $           |  1,839 |   | $ |  81,378 |   |   |   |

 

The accompanyingnotes are an integral part of these statements.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.**            **SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Basis of presentation**

 

The foregoing unaudited financial statements have been prepared inaccordance with accounting principles generally accepted in the United States (“GAAP”)for interim financial information.  Inthe opinion of Management, all adjustments (consisting only of normal recurringadjustments) necessary for a fair presentation of the financial position andthe results of operations for the interim period presented have beenincluded.  These interim financial statementsshould be read in conjunction with the consolidated financial statements andfootnotes thereto included in our Annual Report on Form 10-K for the yearended December 31, 2008 (our “2008 Annual Report”).

 

The results of operations for the three and nine month periods ended September 30,2009 are not necessarily indicative of the results to be expected for the fullyear.  Information regarding risks anduncertainties that could cause actual results to vary materially from our priorperformance may be found in Part I, Item 1A of our 2008 Annual Report.

 

The consolidated financial statements includethe accounts of First Chester County Corporation (the “Corporation”) and FirstNational Bank of Chester County (the “Bank”). All material intercompany balances and transactions have been eliminatedin consolidation.

 

The Corporation completed its acquisition of American Home Bank (“AHB”) on December 31, 2008, and, accordingly, the December 31, 2008 and the September 30, 2009 consolidated balance sheets reflect the addition of assets acquired and liabilities assumed in this acquisition. The results of operations presented in the consolidated income statement for the three and nine months ended September 30, 2009 include the results of operations from AHB.

 

As a result of theacquisition of AHB’s operations, the Corporation reports the following newlines in the income statement:

 

·                  Loan fees and other consist mainly offees earned at the inception of a loan as well as fees earned on the servicingof loan portfolios not owned by the Bank. Loan fees and other also includesgains and losses on the Bank’s mortgage servicing rights.

 

·                  Net gain from mortgage banking activitiesconsists of unrealized gains and losses on interest rate lock commitments,loans held for sale, and forward sale commitments combined with realized gainsand losses on the actual sale of the loan and the settlement of forward salecommitments.

 

**Recent accounting pronouncements**

 

In August 2009, the FASB issued AccountingStandards Update No. 2009-05, “Measuring Liabilities at Fair Value” (“ASU2009-5”). ASU 2009-5 provides amendments to Subtopic 820-10, “Fair ValueMeasurement and Disclosure — Overall” for the fair value measurement ofliabilities. It provides clarification that in circumstances in which a quotedprice in an active market for identical liabilities is not available, areporting entity is required to measure fair value using quoted prices ofidentical liabilities when traded as an asset, quoted prices for similarliabilities when traded as an asset, or other valuation techniques that areconsistent with the principles of Topic 820. ASU 2009-5 is effective forinterim reporting periods beginning after August 2009. Although we arestill evaluating the impact that ASU 2009-5 will have, we do not expect thatthe guidance will have a material impact on our consolidated financialstatements.

 

In June 2009, the FASB issued Statement ofFinancial Accounting Standard No. 168, “The FASB Accounting StandardsCodification and the hierarchy of Generally Accepted Accounting Principles,” (“SFASNo. 168”). The standard, which replaces Statement No. 162,establishes the FASB**Accounting Standards Codification (ASC)which will become the source of authoritative U.S. generally acceptedaccounting principles recognized by the FASB. SFAS No. 168 is effectivefor interim and annual financial periods ending after September 15, 2009.We adopted the provisions of SFAS No. 168 for the three and nine monthsended September 2009. The adoption of this statement did not have amaterial effect on our consolidated financial statements.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

In June 2009, the FASB issued Statement ofFinancial Accounting Standard No. 167, “Amendments to FASB Interpretation No. 46(R),”(“SFAS No. 167”). This Statement amends Interpretation 46(R) toreplace the quantitative-based risks and rewards calculation for determiningwhich enterprise, if any, has a controlling financial interest in a variableinterest entity with an approach focused on, among other things, identifyingwhich enterprise has the power to direct the activities of a variable interestentity that most significantly impact the entity’s economic performance. Thestatement also requires additional disclosures about an enterprise’sinvolvement in variable interest entities. SFAS No. 167 has not beensuperseded by the FASB Accounting Standards Codification and therefore is stillauthoritative. SFAS No. 167 is effective for interim and annual financialperiods beginning after November 15, 2009. Although we have not yetdetermined the impact that SFAS No. 167 will have, we do not expect thatthe statement will have a material impact on our consolidated financialstatements.

 

In June 2009, theFASB issued Statement of Financial Accounting Standard No. 166, “Accountingfor Transfers of Financial Assets, an amendment of FASB Statement No. 140,”(“SFAS No. 166”). This statement clarifies existing and establishes newrequirements and objectives for transactions to qualify for “sale accounting”treatment. SFAS No. 166 has not been superseded by the FASB AccountingStandards Codification and therefore is still authoritative. SFAS No. 166is effective for interim and annual financial periods beginning after November 15,2009. Although we have not yet determined the impact that SFAS No. 166will have, we do not expect that the statement will have a material impact onour consolidated financial statements.

 

In May 2009, theFASB issued guidance on accounting and disclosure for subsequent events. Thisguidance has been incorporated into the FASB Codification under accountingstandard codification (“ASC”) 855 — “Subsequent Events.” ASC 855 establishesgeneral standards of accounting for and disclosure of events that occur afterthe balance sheet date but before financial statements are issued or areavailable to be issued. The guidance under ASC 855 is effective for interim orannual financial periods ending after June 15, 2009. We adopted theprovisions of ASC 855 in June 2009. The adoption of this guidance did nothave a material effect on our consolidated financial statements. We added thesubsequent events disclosure that is required by this statement to ourconsolidated financial statements.

 

In April 2009, theFASB issued guidance on other-than temporary impairment for investmentsecurities.  This guidance has beenincorporated into the FASB Codification under ASC 320-10 — “Investments — Debtsand Equity Securities.” ASC 320-10 amends the other-than-temporary impairmentguidance for investments and changes some of the investment financial statementdisclosure requirements. ASC 320-10 is effective for interim reporting periodsending after June 15, 2009. We adopted the other-than temporary impairmentguidance of ASC 320-10 in June 2009. The adoption of this guidance did nothave a material effect on our consolidated financial statements. In accordancewith the requirements of ASC 320-10 we analyzed the other than temporaryimpairment charge that the Corporation took in the third quarter of 2008 andconcluded that the charge taken was entirely due to an other than temporarycredit loss as opposed to other factors. Accordingly, no adjustment was made tothe other than temporary charge taken in the third quarter of 2008.  Weadded the investment disclosures that are required by this guidance to Footnote3 of these consolidated financial statements.

 

In April 2009, theFASB issued guidance on interim disclosure about the fair value of financialinstruments. This guidance was incorporated into the FASB Codification underASC 825-10 — “Financial Instruments.” The guidance expands disclosures for fairvalue of financial instruments by requiring certain fair value disclosures forinterim periods that were previously only required annually. The interim fairvalue disclosure requirements of ASC 825-10 are effective for interim reportingperiods ending after June 15, 2009. We adopted the interim reportingrequirements of ASC 825-10 in June 2009. The adoption of this statementdid not have a material effect on our consolidated financial statements. Weadded the required fair market value disclosure that is required by thisstatement to Footnote 10 of these consolidated financial statements.

 

In April 2009, theFASB issued guidance on determining fair value when the volume and level ofactivity for an asset or liability have significantly decreased as well as guidanceon identifying transactions that are not orderly. This new guidance wasincorporated into the FASB Codification under ASC 820-10 — “Fair ValueMeasurements and Disclosures” and providesguidance for estimating fair value in accordance with previously existing fairvalue guidance when the volume and level of activity for the asset or liabilityhave significantly decreased.  ASC 820-10also includes guidance on identifying circumstances that indicate a transactionis not orderly. The new guidance is effective for interim

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

 

and annual reportingperiods ending after June 15, 2009. We adopted the new guidance of ASC820-10 in June 2009.  The adoption of this guidance did not havea material impact on our consolidated financial statements.

 

In January 2009, theFASB issued amendments to previously issued impairment guidance on purchasedbeneficial interests and beneficial interests that continue to be held by atransferor in securitized financial assets. The new guidance was incorporatedinto the FASB Codification under ASC 325-40 — “Beneficial Interests inSecuritized Financial Assets.” The purpose of this guidance was to achieve amore consistent evaluation of whether there is an OTTI for the debt securitiesunder the scope of debt securities that fall within the scope of ASC 325-40 andthe debt securities not within the scope of ASC 325-40 that would fall underthe scope of 320-10, “Investments in Debt and Equity Securities.” The guidanceis effective for interim and annual reporting periods ending after December 15,2008. We adopted the new provisions of ASC 325-40 as of January 1, 2009.The adoption of this guidance did not have an impact on our consolidatedfinancial statements.

 

In September 2008,the FASB issued guidance that amended previously issued guidance concerningderivatives and hedging activities as well as disclosure requirements forguarantees. This new guidance was incorporated into the FASB Codification underASC 850-10 — “Derivatives and Hedging” and requires disclosures by sellers ofcredit derivatives, including credit derivatives embedded in a hybridinstrument. The guidance also requires an additional disclosure about thecurrent status of the payment/performance risk of a guarantee.  Thenew guidance is effective for annual or interim reporting periods ending after November 15,2008. We adopted the new provisions of ASC 850-10 as of January 1, 2009.The adoption of this guidance did not have an impact on our consolidatedfinancial statements.

 

In June 2008,the FASB issued guidance on determiningwhether instruments granted in share-based payment transactions areparticipating securities. This new guidance was incorporated into the FASBCodification under ASC 260-10 — “Earnings Per Share” and addressedwhether instruments granted in share-based payment transactions areparticipating securities prior to vesting and, therefore, need to be includedin the calculation of earnings per share (EPS). The new guidance of ASC 260-10 is effective for financialstatements issued for fiscal years beginning after December 15, 2008 withprior period EPS data adjusted retrospectively to conform to its provisions.The adoption of this guidance did not have a material impact on ourconsolidated financial statements.

 

In March 2008, theFASB issued new requirements for disclosuresabout derivative instruments and hedging activities. This new guidancewas incorporated into the FASB Codification under ASC 815-10 — “Derivatives andHedging” and amends the disclosure requirements for derivative instruments andhedging activities. The new disclosure requirements are effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008.  The adoption of these requirementsdid not have a material impact on our consolidated financial statements.

 

In February 2008,the FASB amended previously issued accounting guidance for new fair valuerequirements by delaying the effective date of new accounting guidance issuedunder FAS 157 for all nonfinancial assets and nonfinancial liabilities, exceptthose that are recognized or disclosed at fair value on a recurring basis (atleast annually) to fiscal years beginning after November 15, 2008, andinterim periods within those fiscal years. FAS 157 was superseded by FASBCodification ASC 820-10. The adoption of this guidance did not have a materialimpact on our consolidated financial statements.

 

In December 2007,the FASB issued new guidance on accounting for business combinations thatreplaced SFAS 141, “Business Combinations.” The new guidance was incorporated into the FASB Codification under ASC805 — “Business Combinations” and retains the fundamental requirements of SFAS141 that the acquisition method of accounting (which SFAS 141 called the “purchasemethod”) be used for all business combinations and for an acquirer to beidentified for each business combination. This guidance also establishes principles and requirements for how theacquirer: a) recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree; b) recognizes and measures the goodwill acquired inthe business combination or a gain from a bargain purchase and c) determineswhat information to disclose to enable users of the financial statements toevaluate the nature and financial effects of the business combination. The newguidance will apply prospectively to business combinations for which theacquisition date is on or after the first annual reporting period beginning onor after December 15, 2008.  Weadopted the provisions of ASC 805 as of January 1, 2009. The adoption ofFASB ASC 805 did not have a material impact on our consolidated financialstatements.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

In December 2007, the FASB issued new guidance on accounting andpresenting non-controlling interests in consolidated financial statements. Thenew guidance was incorporated in the FASB Codification under ASC 810-10 — “Consolidation”and amends previously existing guidance by establishing accounting andreporting standards for the noncontrolling (minority) interest in a subsidiaryand for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary is anownership interest in the consolidated entity that should be reported as equityin the consolidated financial statements. The new guidance is effective for fiscal years beginning on or after December 15,2008. We adopted the new provisions of ASC 810-10 on January 1, 2009 andaccordingly, changed the way in which we report minority interest in ourbalance sheet and income statement. We now include minority interest in theequity section of the balance sheet and present net income attributable tonon-controlling interests above net income in the income statement.

 

**2.**            **ACQUISITION**

 

On December 31, 2008,the Corporation completed its acquisition of AHB. This acquisition was intendedto diversify the Bank’s products, services, and sources of income as well as toexpand the Bank’s geographic footprint. As a result of the merger,each outstanding share of AHB common stock was converted into the right toreceive either $11.00 in cash or 0.70 shares of FCCC common stock, plus cash inlieu of fractional shares. Pursuant to the allocation procedures set forth inthe Merger Agreement, 1,052,160 shares of First Chester County Corporation (“FCCC”)common stock were issuable to the holders of 90% of AHB’s outstanding commonstock and $1.8 million was payable to the holders of 10% of AHB’s outstandingcommon stock. In addition, pursuant to the terms of the Merger Agreement, eachAHB option to purchase shares of AHB common stock at the effective time of theMerger converted into an option to purchase such number of shares of FCCCcommon stock equal to the number of shares of the AHB option multiplied by0.7000, rounded down to the nearest whole share, at an exercise price equal tothe exercise price of the AHB option at the effective time of the Mergerdivided by 0.7000, rounded up to the nearest whole cent. Each outstanding AHBwarrant at the effective time of the Merger was cancelled and converted intothe right to receive cash in the amount equal to the difference between the AHBwarrant strike price and $11.00.

 

The AHB merger wasaccounted for under the purchase method of accounting in accordance with SFAS No. 141,“Business Combinations.”  The purchaseprice has been allocated to the assets acquired and the liabilities assumedbased on their estimated fair values at the merger date. In accordance withSFAS No. 141, certain deal costs and other cash paid are capitalizedas part of the total purchase price. Goodwill resulted from the acquisition.

 

During the nine monthsended September 30, 2009 the goodwill from the AHB acquisition wasadjusted to reflect adjustments to the purchase price allocation. Thefollowing shows the prior and current balance of goodwill:

 

(Dollarsin thousands)

 
| ** **                            | ** ** | **Goodwill  Balance** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
|                                  |       |                  |       |
| December 31,  2008               |       | $                     | 5,906      |   |
|                                  |       |                  |       |
| Adjustment  to consideration paid (A) |       | 1,600                 |       |
|                                  |       |                  |       |
| Other  adjustments (B)                |       | 573                   |       |
|                                  |       |                  |       |
| September 30,  2009              |       | $                     | 8,079      |   |

 

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(A)           During the first quarter of 2009, theCorporation recorded a $1.6 million purchase accounting adjustment related toadditional consideration identified for the acquisition. This amount relates tothe lump sum payments to former executive officers of AHB in connection withthe finalization of the AHB Management Incentive Plan (as described in theCorporation’s Current Report on Form 8-K filed on May 5, 2009). Thefull amount of this additional consideration was allocated to goodwill.

 

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**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

(B)             Other adjustments relate to amountsrecorded in the second quarter of 2009 to updated acquisition date valuationestimates of certain assets and liabilities including other real estate owned,deferred rent, expense accruals and deferred tax assets.

 

**3.**            **INVESTMENT SECURITIES**

 

The Corporation’s investment portfolio consists of the followingcategories of securities:

 

·                  US Treasury - Consists ofdebt securities issued by the US Government.

 

·                  US GovernmentAgency Notes - Consists of debt instruments issued by USGovernment agencies such as the Federal Home Loan Bank and Freddie Mac.

 

·                  US GovernmentAgency Mortgage Backed Securities - Consists of residentialmortgage pass-through securities and collateralized mortgage obligations “CMOs”issued by US government agencies such as GNMA, FNMA and Freddie Mac. The GNMApass-through securities or the underlying GNMA securities backing the CMOs areguaranteed by the US Government, while the FNMA and Freddie Mac pass-throughsecurities or the underlying FNMA and Freddie Mac securities backing the CMOsare guaranteed by the respective US Government agency.

 

·                  CollateralizedMortgage Obligations - Residential — Consists of private labelCMOs backed by non-government agency residential mortgage pools.

 

·                  CollateralizedMortgage Obligations - Commercial — Consists of private labelCMOs backed by non-government agency commercial mortgage pools.

 

·                  State andMunicipal— Consists of securities issued by state, city orlocal governments.

 

·                  Corporate DebtSecurities — Consists of corporate debt securities.

 

·                  Bank equitysecurities — Consists of equity securities of banks, bankholding companies or bank trust preferred securities.

 

·                  Other EquitySecurities — Consists primarily of equity securities of theFederal Reserve and the Federal Home Loan Bank.

 

The amortized cost, grossunrealized gains and losses, and fair market value of the Corporation’savailable-for-sale securities at September 30, 2009 and December 31,2008 are summarized as follows:

 

(Dollars in thousands)

 
| ** **                                        | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| **As of September 30, 2009**                 | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
|                                              |       |          |       |           |       |           |       |       |       |
| US  Treasury                                      |       | $             | 5,004      |           | $          | 17             |       | $          | —     |   | $ | 5,021 |   |
| US  Government agency notes                       |       | 6,372         |       | 11             |       | (7             | )          | 6,376      |       |
| US Government agency mortgage-backed securities   |       | 47,780        |       | 1,561          |       | —         |       | 49,341     |       |
| Collateralized mortgage obligations - Residential |       | 1,340         |       | 1              |       | (252           | )          | 1,089      |       |
| Collateralized mortgage obligations - Commercial  |       | 1,004         |       | —         |       | (411           | )          | 593        |       |
| State and municipal                               |       | 5,840         |       | 56             |       | —         |       | 5,896      |       |
| Corporate debt securities                         |       | 11,212        |       | —         |       | (1,791         | )          | 9,421      |       |
| Bank equity securities                            |       | 1,210         |       | 50             |       | (27            | )          | 1,233      |       |
| Other equity securities                           |       | 10,896        |       | —         |       | —         |       | 10,896     |       |
|                                              |       | $             | 90,658     |           | $          | 1,696          |       | $          | (2,488     | ) | $ | 89,866 |   |

 

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**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

(Dollarsin thousands)

 
| ** **                                        | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| **As of December 31, 2008**                  | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
|                                              |       |          |       |           |       |           |       |       |       |
| US  Government agency notes                       |       | $             | 8,300      |           | $          | 134            |       | $          | —     |   | $ | 8,434 |   |
| US Government agency mortgage-backed securities   |       | 56,033        |       | 984            |       | (102           | )          | 56,915     |       |
| Collateralized mortgage obligations - Residential |       | 1,630         |       | —         |       | (426           | )          | 1,204      |       |
| Collateralized mortgage obligations - Commercial  |       | 1,004         |       | —         |       | (594           | )          | 410        |       |
| State and municipal                               |       | 10,327        |       | 74             |       | —         |       | 10,401     |       |
| Corporate debt securities                         |       | 28,455        |       | —         |       | (4,052         | )          | 24,403     |       |
| Bank equity securities                            |       | 2,811         |       | 50             |       | (892           | )          | 1,969      |       |
| Other equity securities                           |       | 10,848        |       | —         |       | —         |       | 10,848     |       |
|                                              |       | $             | 119,408    |           | $          | 1,242          |       | $          | (6,066     | ) | $ | 114,584 |   |

 

The amortized cost and estimated fair value of debt securitiesclassified as available-for-sale at September 30, 2009, by contractualmaturity, are shown in the following table. Expected maturities will differ from contractual maturities becauseborrowers may have the right to call or prepay obligations with or without callor prepayment penalties.

 

(Dollarsin thousands)

 
| ** **                              | ** ** | **Amortized** | ** **   | **Fair**  | ** ** |
|-----------------------------------------|------------|---------------|--------------|-----------|------------|
| ** **                              | ** ** | **Cost**      | ** **   | **Value** | ** ** |
| Due in one year or less                 |       | $             | 1,075        |      | $          | 1,081 |   |
| Due after one year through five years   |       | 18,491        |         | 17,276    |       |
| Due after five years through ten years  |       | 7,872         |         | 7,776     |       |
| Due after ten years                     |       | 990           |         | 581       |       |
|                                    |       | 28,428        |         | 26,714    |       |
| Mortgage-backed securities and CMOs     |       | 50,124        |         | 51,023    |       |
| Bank equity and other equity securities |       | 12,106        |         | 12,129    |       |
|                                    |       | $             |  90,658 |      | $          | 89,866 |   |

 

Proceedsfrom the sale of investment securities available for sale for the three andnine months ended September 30, 2009 were $33.6 million and $866 thousand,respectively. Proceeds from the sale of investment securities available forsale for the three and nine months ended September 30, 2008 were $8.2million and $21.4 million, respectively. Gross gains from the sale of investment securities for the three andnine month periods ended September 30, 2009 were $1,000 and $392,000,respectively.  Gross losses for the sameperiod in 2009 were $0 and $391,000, respectively.  Gross gains from the sales of investmentsecurities for the three and nine month periods ended September 30, 2008 were$89,000 and $370,000, respectively. Gross losses for the same period were $0 and $97,000, respectively.  These securities were sold at fair valueswhich approximated the Corporation’s amortized cost.  The Corporation uses the specificidentification method to determine the cost of the securities sold. Theprincipal amount of investment securities pledged to secure public deposits andfor other purposes required or permitted by law was $77.7 million at September 30,2009 and $89.0 million at December 31, 2008. There were no securities heldfrom a single issuer that represented more than 10% of stockholders’ equity.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Thetable below indicates the length of time individual securities have been in acontinuous unrealized loss position at September 30, 2009.

 

(Dollarsin thousands)

 
| ** **                                              | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**      | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|----------------|------------|
| **Description of**                                      | ** ** | **Number of**           | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Securities**                                          | ** ** | **Securities**          | ** ** | **Value**               | ** ** | **Losses**     | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| US Government agency notes                              |       | 1                       |       | $                       | 2,307      |           | $          | (7 | ) | $ | — |   | $ | — |   | $ | 2,307 |   | $ | (7 | ) |
|                                                    |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Collateralized mortgage  obligations – Residential |       | 3                       |       | 7                       |       | —         |       | 765 |   | (252 | ) | 772 |   | (252 | ) |
| Collateralized mortgage  obligations – Commercial  |       | 1                       |       | —                  |       | —         |       | 593 |   | (411 | ) | 593 |   | (411 | ) |
|                                                    |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Corporate debt securities                               |       | 8                       |       | —                  |       | —         |       | 9,421 |   | (1,791 | ) | 9,421 |   | (1,791 | ) |
|                                                    |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Bank equity securities                                  |       | 2                       |       | 3                       |       | (1             | )          | 225 |   | (26 | ) | 228 |   | (27 | ) |
|                                                    |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Total temporarily impaired  investment securities       |       | 15                      |       | $                       | 2,317      |           | $          | (8 | ) | $ | 11,004 |   | $ | (2,480 | ) | $ | 13,321 |   | $ | (2,488 | ) |

 

The table below indicates the length of time individual securities havebeen in a continuous unrealized loss position at December 31, 2008.

 

(Dollars in thousands)

 
| ** **                                             | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**      | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|----------------|------------|
| **Description of**                                     | ** ** | **Number of**           | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Securities**                                         | ** ** | **Securities**          | ** ** | **Value**               | ** ** | **Losses**     | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| US Government agency mortgage-backed securities        |       | 6                       |       | $                       | 6,253      |           | $          | (100 | ) | $ | 536 |   | $ | (2 | ) | $ | 6,789 |   | $ | (102 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Collateralized mortgage obligations – Residential |       | 3                       |       | 429                     |       | (402           | )          | 767 |   | (24 | ) | 1,196 |   | (426 | ) |
| Collateralized mortgage obligations – Commercial  |       | 1                       |       | —                  |       | —         |       | 409 |   | (594 | ) | 409 |   | (594 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Corporate debt securities                              |       | 21                      |       | 17,176                  |       | (1,575         | )          | 7,227 |   | (2,477 | ) | 24,403 |   | (4,052 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Bank equity securities                                 |       | 5                       |       | —                  |       | —         |       | 1,620 |   | (892 | ) | 1,620 |   | (892 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Total temporarily impaired investment securities       |       | 36                      |       | $                       | 23,858     |           | $          | (2,077 | ) | $ | 10,559 |   | $ | (3,989 | ) | $ | 34,417 |   | $ | (6,066 | ) |

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Other than Temporary Impairment**

 

Management recorded a $1.6 million charge toearnings in the third quarter of 2009 for an other than temporary impairment  (“OTTI”) on four bankequity securities held in the Corporation’s available for sale investmentportfolio. The 2008 consolidated statement of income included an $850,000non-cash pretax other than temporary impairment loss on a $1.0 million LehmanBrothers note held in the Bank’s available for sale investment portfolio. Thissecurity has since matured and the remaining $150,000 carrying value is carriedas a receivable in the Corporation’s Other Asset line of the BalanceSheet.  Management believes that thereare no additional securities that were other than temporarily impaired as of September 30,2009 and December 31, 2008.

 

Management uses a multi-factor approach to determine whether a securityis other than temporarily impaired. This approach is applied to each individualsecurity. The approach incorporates ideas and concepts outlined in relevantaccounting guidance and include such factors as:

 

·                  The length of time and the extent towhich the market value has been less than cost;

·                  The financial condition of the securityissuer as well as near and long-term prospect for the issuer;

·                  The rating of the security;

·                  Historic volatility and movement in thefair market value of the security; and

·                  Adverse conditions relative to the security,issue or industry.

 

Management also consultswith an outside investment advisor in addressing whether securities in a lossposition are other than temporarily impaired. Specific conclusions for eachcategory of securities with an unrealized loss position are summarized below:

 

*Collateralized MortgageObligations (“CMO”) — Residential and Commercial*

 

There are a total of four private label CMO securitiesthat had unrealized loss positions at September 30, 2009.Three of the securities had a AAA ratingfrom S&P and one had an AA rating from S&P. All contractual cash flowshave been received on these securities. All of these issuances havesubordinated tranches supporting principal. In addition, we conducted duediligence of publicly available information regarding these securities and nomaterial information came to our attention that would indicate an inability torecover our basis in these securities. The depreciation on two of thesecurities accounted for 99% of the total depreciation within this category.For these securities, we reviewed and considered information about theunderlying collateral as well as loss and prepayment stress test informationperformed by professional investment advisors. This information indicatedlikelihood that subordinate tranches of the CMO provide sufficient protectionto the Bank’s senior tranches such that management can conclude that theprobability of suffering a principal loss is unlikely. Because the Company doesnot intend to sell these securities and it is more likely than not that theCompany will not be required to sell the securities before recovery of itsamortized cost basis, which may be maturity, it does not consider theseinvestments to be other-than-temporarily impaired at September 30,2009.

 

*Corporate Debt Securities*

 

There are a total of eight securities in this categorythat had unrealized loss positions at September 30, 2009. All of thesesecurities are obligations of well-known, established companies or subsidiariesthereof. All contractual cash flows have been received on these securities.Depreciation on six of the securities accounted for 98% of the totaldepreciation in this category. For these six securities Management reviewedrating agency information and noted that five of the six securities hadinvestment grade ratings from Moody’s. We reviewed current news and filings aswell as the length and duration of the depreciation and concluded that therewas no information that would indicate a going concern or other issue thatwould impair our ability to recover our cost basis. Management performedadditional analysis on the security that was not investment grade, whichincluded reviewing analysis from our third party investment advisor as well ascurrent news and filings. The conclusion drawn from this information was thatthere was no information that indicated a going concern or other issue thatwould impair our ability to recover our cost basis. Because the Corporationdoes not intend to sell these securities and it is not more likely than notthat the Corporation will be required to sell the securities before recovery ofits amortized cost basis, it does not consider these investments to beother-than-temporarily impaired at September 30, 2009.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

*BankEquity Securities*

 

The Corporation recordeda $1.6 million other than temporary impairment charge on four securities inthis category in the third quarter of 2009. The securities are publicallytraded stock of well-known, established bank holding companies. During thequarter, Management concluded that the impairment on the securities is otherthan temporary mainly due to continued deterioration of the financial conditionof these companies and Management’s conclusion that the Corporation may nolonger have the intent to hold these securities until anticipated recovery. The$1.6 million loss is presented on the Asset impairment line of the incomestatement.

 

**4.**            **LOANSAND LEASES**

 

The following chartspresent information about major loan classifications as well as impaired loansand lease balances as of September 30, 2009 and December 31, 2008:

 

(Dollarsin thousands)

 

September 30,2009

 
| ** **                                   | ** ** | ** **  | ** ** | ** **       | ** ** | ** **    | ** ** | **Specific**    | ** ** |
|----------------------------------------------|------------|-------------|------------|------------------|------------|---------------|------------|-----------------|------------|
| ** **                                   | ** ** | ** **  | ** ** | ** **       | ** ** | **Number of** | ** ** | **Allowance**   | ** ** |
| ** **                                   | ** ** | **Loan**    | ** ** | **Impaired**     | ** ** | **Impaired**  | ** ** | **on Impaired** | ** ** |
| **(Dollars in thousands)**                   | ** ** | **Balance** | ** ** | **Loan Balance** | ** ** | **Loans**     | ** ** | **Loans**       | ** ** |
|                                         |       |        |       |             |       |          |       |            |       |
| Commercial  loans                            |       | $           | 346,174    |             | $          | 14,963        |       | 14              |       | $ | 2,919 |   |
| Real  estate – commercial               |       | 298,495     |       | 8,548            |       | 5             |       | 4,180           |       |
| Real  estate – commercial construction  |       | 66,255      |       | 2,300            |       | 2             |       | 85              |       |
| Real  estate – residential              |       | 79,793      |       | 1,004            |       | 3             |       | 250             |       |
| Real  estate – residential construction |       | 40,604      |       | 4,086            |       | 12            |       | 1,725           |       |
| Consumer  loans                              |       | 123,447     |       | 1,466            |       | 24            |       | 263             |       |
| Lease  financing receivables                 |       | 2,734       |       | 126              |       | 2             |       | —          |       |
|                                         |       |        |       |             |       |          |       |            |       |
| Totals                                       |       | $           | 957,502    |             | $          | 32,493        |       | 62              |       | $ | 9,422 |   |

 

(Dollarsin thousands)

 

December 31, 2008

 
| ** **                                   | ** ** | ** **  | ** ** | ** **       | ** ** | ** **    | ** ** | **Specific**    | ** ** |
|----------------------------------------------|------------|-------------|------------|------------------|------------|---------------|------------|-----------------|------------|
| ** **                                   | ** ** | ** **  | ** ** | ** **       | ** ** | **Number of** | ** ** | **Allowance**   | ** ** |
| ** **                                   | ** ** | **Loan**    | ** ** | **Impaired**     | ** ** | **Impaired**  | ** ** | **on Impaired** | ** ** |
| **(Dollars in thousands)**                   | ** ** | **Balance** | ** ** | **Loan Balance** | ** ** | **Loans**     | ** ** | **Loans**       | ** ** |
|                                         |       |        |       |             |       |          |       |            |       |
| Commercial  loans                            |       | $           | 327,472    |             | $          | 3,632         |       | 20              |       | $ | 285 |   |
| Real  estate – commercial               |       | 280,549     |       | 1,650            |       | 2             |       | 126             |       |
| Real  estate – commercial construction  |       | 69,057      |       | —           |       | —        |       | —          |       |
| Real  estate – residential              |       | 87,413      |       | 3,876            |       | 13            |       | 350             |       |
| Real  estate – residential construction |       | 45,466      |       | —           |       | —        |       | —          |       |
| Consumer  loans                              |       | 125,318     |       | 1,166            |       | 30            |       | 95              |       |
| Lease  financing receivables                 |       | 4,808       |       | 190              |       | 4             |       | —          |       |
|                                         |       |        |       |             |       |          |       |            |       |
| Totals                                       |       | $           | 940,083    |             | $          | 10,514        |       | 69              |       | $ | 856 |   |

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

The following chartpresents changes in the allowance for loan and lease losses for the nine monthsended September 30, 2009 and 2008:

 
| ** **                              | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **September 30,** | ** ** |
| **(Dollars in thousands)**              | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Balance at beginning of  year           |       | $                      | 10,335     |   | $ | 7,817 |   |
| Provision charged to operating expenses |       | 17,637                 |       | 950 |   |
| Recoveries                              |       | 339                    |       | 233 |   |
| Loans charged-off                       |       | (4,549                 | )          | (423 | ) |
| Allowance adjustment – Other       |       | (328                   | )          | 60 |   |
| Balance at end of year                  |       | $                      | 23,434     |   | $ | 8,637 |   |

 

**5.**            **OTHERREAL ESTATE OWNED**

 

Other real estateowned (“OREO”) represents property owned by the Bank following default by theborrowers. OREO property acquired through foreclosure is initially transferredat fair value based on an appraised value less estimated cost to dispose.Adjustments are subsequently made to mark the property below this amount ifcircumstances warrant.  Losses arisingfrom foreclosure transactions are charged against the allowance for loanlosses. Costs to maintain real estate owned and any subsequent gains or lossesare included in the Corporation’s results of operations. The followingtable summarizes properties held as OREO as of September 30, 2009 and December 31,2008:

 

(Dollarsin thousands)

 
| ** **                | ** ** | **September 30,  2009** | ** ** | **Number  of  properties** | ** ** | **December 31,  2008** | ** ** | **Number  of  properties** | ** ** |
|---------------------------|------------|------------------------------|------------|----------------------------|------------|-----------------------------|------------|----------------------------|------------|
| Land                      |       | $                            | 50         |                       | 1          |                        | $          | —                     |       | — |   |
| Residential  Construction |       | 280                          |       | 1                          |       | —                      |       | —                     |       |
| Residential 1-4 family    |       | 2,732                        |       | 10                         |       | 1,872                       |       | 9                          |       |
| Total                     |       | $                            | 3,062      |                       | 12         |                        | $          | 1,872                      |       | 9 |   |

 

**6.**            **BORROWINGS**

 

In April 2009,the Corporation completed the placement of $5,175,000 aggregate liquidationamount of fixed rate trust preferred securities (the “Trust PreferredSecurities”), through a newly formed subsidiary, First Chester County CapitalTrust IV, a wholly owned Delaware statutory trust (the “Trust”). In connectionwith the sale of the Trust Preferred Securities, the Corporation issued$5,330,000 of junior subordinated deferrable interest debentures (the “Debentures”)to the Trust. The Trust Preferred Securities and the Debentures have a 30 yearmaturity, and carry a fixed rate of interest of 12%. The Corporation hasretained the right to redeem the Trust Preferred Securities at par (plusaccrued but unpaid interest) on any interest payment date on or after April 28,2014.

 

During2009, the Bank began borrowing from the Federal Reserve. The balance of theseovernight borrowings was $51.7 million at September 30, 2009, compared to$0 at December 31, 2008. The rate paid on these borrowings is 0.50%.

 

**7.**            **DERIVATIVEINSTRUMENTS**

 

TheBank, as part of its mortgage banking activities, originates fixed-rate 1-4unit residential loans for sale in the secondary market.  At the time of origination, Managementidentifies loans that are expected to be sold in the near future.  These warehoused loans have been classifiedas mortgage loans held for sale in the consolidated balance sheet.  These loans expose the Bank to variability intheir fair value due to changes in interest rates.  If interest rates increase, the value of theloans decreases.  Conversely, if interestrates decrease, the value of the loans increases.

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

TheBank enters into rate lock commitments to extend credit to borrowers at aspecified interest rate upon the ultimate funding of the loan.  These rate lock commitments are generally 30days for a permanent loan and can range up to 360 days for a constructionloan.  Unfunded loans for whichcommitments have been entered into are called “pipeline loans.”  Some of these rate lock commitments willultimately expire without being completed. To the extent that a loan is ultimately granted and the borrowerultimately accepts the terms of the loan, these rate lock commitments exposethe Bank to variability in their fair value due to changes in interestrates.  If interest rates increase, thevalue of these rate lock commitments decreases. Conversely, if interest rates decrease, the value of these rate lockcommitments increases.

 

Loancommitments relate to the origination of mortgage loans that will be held forsale and are accounted for as derivative instruments.  Such commitments are recorded at fair valueas derivative assets or liabilities, with changes in fair value recorded in theNet gain from mortgage activities line of the income statement.

 

Tomitigate the effect of this interest rate risk on both the held for sale loansand interest rate lock commitments, the Bank enters into offsetting derivativecontracts, primarily forward loan sale commitments. These forward salescommitments lock in the price for the sale of specific loans or loans to befunded under specific interest rate lock commitments or for a generic group ofloans with similar characteristics. Mandatory forward sales commitments are agreements to sell a certainnotional amount of loans at a specified future time period at a specifiedprice.  The Bank incurs a penalty forfailure to follow through with the commitment. Best efforts forward sales commitments also result in direct or indirectfinancial penalties for failure to follow through if the related loans close.  The fair value of forward loan salescommitments that hedge warehouse loans and interest rate lock commitments, aswell as interest rate lock commitments themselves, are summarized as follows atSeptember 30, 2009.  The fair valuesof all of these items are recorded on the balance sheet within other assets andother liabilities as these items are financial derivatives.

 

Although the purpose ofthese derivative instruments is to economically hedge certain risks, there areno hedge designations under FASB ASC 815-10 (“Statement No. 133”).

 

The fair value ofderivative instruments not designated as hedging instruments under FASB ASC815-10 at September 30, 2009 are presented in the following table:

 
| ** **                          | ** ** | **Asset Derivatives** | ** ** | **Liability Derivatives** | ** ** |
|-------------------------------------|------------|-----------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **Balance**           | ** ** | ** **                | ** ** | ** ** | ** ** | **Balance** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Sheet**             | ** ** | **Fair**                  | ** ** | **Notional** | ** ** | **Sheet** | ** ** | **Fair** | ** ** | **Notional** | ** ** |
| **(Dollars in thousands)**          | ** ** | **Location**          | ** ** | **Value**                 | ** ** | **Value** | ** ** | **Location** | ** ** | **Value** | ** ** | **Value** | ** ** |
|                                |       |                  |       |                      |       |   |   |   |   |   |   |   |   |
| Mandatory forward sales commitments |       | Other assets          |       | $                         | —     |   | $ | — |   | Other Liabilities |   | $ | 903 |   | $ | 52,250 |   |
| Interest rate lock commitments      |       | Other assets          |       | 2,411                     |       | 126,598 |   | Other Liabilities |   | — |   | — |   |
|                                     |            |                       |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

The fair value ofderivative instruments not designated as hedging instruments under FASB ASC815-10 at December 31, 2008 are presented in the following table:

 
| ** **                              | ** ** | **Asset Derivatives** | ** ** | **Liability Derivatives** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|---------------------------|------------|
| ** **                              | ** ** | **Balance**           | ** ** | ** **                | ** ** | ** ** | ** ** | **Balance** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Sheet**             | ** ** | **Fair**                  | ** ** | **Notional** | ** ** | **Sheet** | ** ** | **Fair** | ** ** | **Notional** | ** ** |
| **(Dollars in thousands)**              | ** ** | **Location**          | ** ** | **Value**                 | ** ** | **Value** | ** ** | **Location** | ** ** | **Value** | ** ** | **Value** | ** ** |
|                                    |       |                  |       |                      |       |   |   |   |   |   |   |   |   |
| Mandatory forward sales  commitments    |       | Other assets          |       | $                         | —     |   | $ | — |   | Other Liabilities |   | $ | 583 |   | $ | 30,250 |   |
| Best efforts forward sales  commitments |       | Other assets          |       | —                    |       | — |   | Other Liabilities |   | 35 |   | 84,282 |   |
| Interest rate lock  commitments         |       | Other assets          |       | 412                       |       | 23,064 |   | Other Liabilities |   | — |   | — |   |
|                                         |            |                       |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

**8.**            **EARNINGS (LOSS) PER SHARE**

 

**Three Months ended September 30, 2009**

 
| ** **                                 | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|--------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                 | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                 | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic  loss per share                      |       |            |       |              |       |          |       |
| Net  loss available to common stockholders |       | $               | (9,717     | )                 | 6,306,889  |          | $          | (1.54 | ) |
| Effect  of Dilutive Securities             |       |            |       |              |       |          |       |
| Options  to purchase common stock          |       | —          |       | —            |       |          |       |
| Diluted  loss per share                    |       |            |       |              |       |          |       |
| Net  loss available to common stockholders |       | $               | (9,717     | )                 | 6,306,889  |          | $          | (1.54 | ) |

 

----

| (1) | 234,109 anti-dilutive  weighted average shares have been excluded from this computation because the  option exercise price was greater than the average market price of the common  shares. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

**Nine Months ended September 30, 2009**

 
| ** **                                 | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|--------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                 | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                 | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic  loss per share                      |       |            |       |              |       |          |       |
| Net  loss available to common stockholders |       | $               | (4,918     | )                 | 6,272,682  |          | $          | (0.78 | ) |
| Effect  of Dilutive Securities             |       |            |       |              |       |          |       |
| Options  to purchase common stock          |       | —          |       | —            |       |          |       |
| Diluted  loss per share                    |       |            |       |              |       |          |       |
| Net  loss available to common stockholders |       | $               | (4,918     | )                 | 6,272,682  |          | $          | (0.78 | ) |

 

----

| (1) | 234,109 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. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Three Months ended September 30, 2008**

 
| ** **                                   | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|----------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                   | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                   | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic  earnings per share                    |       |            |       |              |       |          |       |
| Net  income available to common stockholders |       | $               | 807        |              | 5,188,562  |          | $          | 0.16 |   |
| Effect  of Dilutive Securities               |       |            |       |              |       |          |       |
| Options  to purchase common stock            |       | —          |       | 9,225             |       | —        |       |
| Diluted  earnings per share                  |       |            |       |              |       |          |       |
| Net  income available to common stockholders |       | $               | 807        |              | 5,197,787  |          | $          | 0.16 |   |

 

----

(1)          58,768 anti-dilutive weighted averageshares have been excluded from this computation because the option exerciseprice was greater than the average market price of the common shares.

 

**Nine Months ended September 30, 2008**

 
| ** **                                   | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|----------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                   | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                   | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic  earnings per share                    |       |            |       |              |       |          |       |
| Net  income available to common stockholders |       | $               | 4,169      |              | 5,184,173  |          | $          | 0.80 |   |
| Effect  of Dilutive Securities               |       |            |       |              |       |          |       |
| Options  to purchase common stock            |       | —          |       | 16,027            |       | —        |       |
| Diluted  earnings per share                  |       |            |       |              |       |          |       |
| Net  income available to common stockholders |       | $               | 4,169      |              | 5,200,200  |          | $          | 0.80 |   |

 

----

(1)          62,665 anti-dilutive weighted shares havebeen excluded from this computation because the option exercise price wasgreater than the average market price of the common shares.

 

**9.****        ****COMPREHENSIVE INCOME (LOSS)**

 

Components of comprehensive income (loss) are presented in thefollowing chart:

 
| ** **                                                        | ** ** | **Three  Months Ended** | ** ** | **Nine****Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                                                        | ** ** | **September 30,**  | ** ** | **September 30,**   | ** ** |
| ** **                                                        | ** ** | **2009**                | ** ** | **2008**                 | ** ** | **2009** | ** ** | **2008** | ** ** |
| Unrealized  gains (losses) on securities:                         |       |                    |       |                     |       |   |   |   |   |
| Unrealized  gains (losses) arising in period                      |       | $                       | 4,425      |                     | $          | (1,519 | ) | $ | 5,771 |   | $ | (3,627 | ) |
| Reclassification  adjustment                                      |       | (1,575                  | )          | (761                     | )          | (1,575 | ) | (577 | ) |
| Net  unrealized gain (loss)                                       |       | 2,850                   |       | (2,280                   | )          | 4,196 |   | (4,204 | ) |
| Other  comprehensive income (loss) before taxes                   |       | 2,850                   |       | (2,280                   | )          | 4,196 |   | (4,204 | ) |
| Income  tax (expense) benefit                                     |       | (969                    | )          | 775                      |       | (1,427 | ) | 1,429 |   |
| Other  comprehensive income (loss)                                |       | 1,881                   |       | (1,505                   | )          | 2,769 |   | (2,775 | ) |
| Net  (loss) income including non-controlling interests            |       | (9,223                  | )          | 807                      |       | (3,555 | ) | 4,169 |   |
| Comprehensive  (loss) income                                      |       | (7,342                  | )          | (698                     | )          | (786 | ) | 1,394 |   |
| Comprehensive  income attributable to non- controlling interests  |       | (494                    | )          | —                   |       | (1,363 | ) | — |   |
| Comprehensive  (loss) income for First Chester County Corporation |       | $                       | (7,836     | )                        | $          | (698 | ) | $ | (2,149 | ) | $ | 1,394 |   |

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**10.****      ****FAIR VALUE MEASUREMENT AND FAIRVALUE OF FINANCIAL INSTRUMENTS**

 

FASBASC 820-10 defines fair value as the exchange price that would be received foran asset or paid to transfer a liability (an exit price) in an orderlytransaction between market participants on the measurement date. FASB ASC820-10 also establishes a fair value hierarchy which requires an entity tomaximize the use of observable inputs and minimize the use of unobservableinputs when measuring fair value. FASB ASC 820-10 clarifies proper fair valuedetermination in a market that is not active and provides an example to illustratekey considerations in determining the fair value of a financial asset when themarket for that financial asset is not active. The Corporation considered therequirements of FASB ASC 820-10 when estimating fair value.

 

FASB ASC 825-10 — *Financial Instruments*permits entities to choose to measure many financial instruments and certainother items at fair value at specified election dates. The Corporation electedto account for loans held for sale under this election option.

 

FASBASC 820-10 describes three levels of inputs that may be used to measure fairvalue:

 

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

 

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

 

·                  Level 3: Significantunobservable inputs that reflect a company’s own assumptions about theassumptions that market participants would use in pricing an asset orliability.

 

TheCorporation used the following methods and significant assumptions to estimatefair value:

 

Securities: Investment securities available-for-sale arerecorded at fair value on a recurring basis. Fair value measurement is basedupon quoted prices, if available. If quoted prices are not available, fairvalues are measured using matrix pricing, which is a mathematical techniqueused widely in the industry to value debt securities without relyingexclusively on quoted prices for the specific securities but rather by relyingon the securities’ relationship to other benchmark quoted securities. Level 1securities include those traded on nationally recognized securities exchanges,U.S. Treasury and Agency securities, and money market funds. Level 2 securitiesinclude mortgage-backed securities issued by government sponsored entities,municipal bonds and corporate debt securities. Securities classified as Level 3include asset-backed securities in less liquid markets.

 

Loans held for sale: The fair value of loans held for sale isestimated by utilizing either: (i) the value of securities backed bysimilar mortgage loans, adjusted for certain factors to approximate the value ofa whole mortgage loan, including the value attributable to mortgage servicingand credit risk, (ii) current commitments to purchase loans or (iii) recentobservable market trades for similar loans, adjusted for credit risk and otherindividual loan characteristics.  As such, theCorporation classifies loans subjected to nonrecurring fair value adjustmentsas Level 2.

 

Loans and leases: The Corporation does not record loans atfair value on a recurring basis. However, from time to time, a loan is consideredimpaired and an allowance for loan losses is established. Loans for which it isprobable that payment of interest and principal will not be made in accordancewith the contractual terms of the loan agreement are considered impaired. Oncea loan is identified as individually impaired, management measures impairmentin accordance with FASB ASC 310. The fair value of impaired loans is estimatedusing one of several methods, including collateral value, market value ofsimilar debt, enterprise value, liquidation value and discounted cash flows.Those impaired loans not requiring an allowance represent loans for which thefair value of the expected repayments or collateral exceed the recordedinvestments in such loans. At September 30, 2009, substantially all of theimpaired loans were evaluated based on the fair value of the collateral. Inaccordance with FASB ASC 820-10 impaired loans where an allowance isestablished based on the fair value of collateral require classification in thefair value hierarchy. When the fair value of the collateral is based on anobservable market price or a current appraised value, the Corporation recordsthe impaired loan as nonrecurring Level 3.

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Other Real Estate Owned (“OREO”): OREO is adjusted to fairvalue upon transfer of the loans to foreclosed assets. Subsequently, OREO iscarried at the lower of carrying value or fair value. Fair value is based uponindependent market prices, appraised values of the collateral or management’sestimation of the value of the collateral. The Corporation records theforeclosed asset as nonrecurring Level 3.

 

Mortgage Servicing Rights (“MSRs”): To determine the fairvalue of MSRs, the Bank uses an independent third party to estimate the presentvalue of estimated future net servicing income. This valuation methodincorporates an assumption that market participants would use in estimatingfuture net servicing income, which include estimates of the cost to service,the discount rate, custodial earnings rate, an inflation rate, ancillaryincome, prepayment speeds, and default rates and losses. The fair value ofservicing rights was determined using discount rates ranging from 8.0% to10.4%, prepayment speeds ranging from 6.6% to 49.1% depending on thestratification of the specific right, and a weighted average default rate of16.5%. The Corporation records the MSR as a recurring Level 3.

 

Derivative instruments: The fair value of interestrate lock commitments and forward sales commitments are estimated using aprocess similar to mortgage loans held for sale. Interest rate lock commitmentsare recorded as a recurring Level 3. Loan commitments and best effortscommitments are assigned a probability that the related loan will be funded andthe commitment will be exercised. The Bank relies on historical “pull-through”percentages in establishing probability. Forward sale commitments are recordedas a recurring Level 2.

 

Thetable below presents the balance of assets and liabilities at September 30,2009, measured at fair value on a recurring basis:

 

*Dollars inthousands*

 
| ** **                               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Assets                                   |       |        |       |        |       |        |       |      |       |
| Investment securities available for sale |       | $           | 1,113      |        | $          | 88,753      |       | $         | —     |   | $ | 89,866 |   |
| Loans held for sale                      |       | —      |       | 187,521     |       | —      |       | 187,521   |       |
| Mortgage servicing rights                |       | —      |       | —      |       | 614         |       | 614       |       |
| Interest rate lock commitments           |       | —      |       | —      |       | 2,411       |       | 2,411     |       |
| Liabilities                              |       |        |       |        |       |        |       |      |       |
| Mandatory Forward Sales Commitments      |       | —      |       | 903         |       | —      |       | 903       |       |
|                                          |            |             |            |             |            |             |            |           |            |  |  |  |  |

 

Theaggregate unpaid principal balance of mortgage loans held for sale is $185.3million.

 

Thetable below presents the balance of assets and liabilities at September 30,2009, measured at fair value on a nonrecurring basis:

 

*Dollarsin thousands*

 
| ** **                       | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
|                             |       |        |       |        |       |        |       |      |       |
| Impaired loans & leases |       | $           | —     |        | $          | —      |       | $         | 23,071     |   | $ | 23,071 |   |
|                             |       |        |       |        |       |        |       |      |       |
| OREO                             |       | —      |       | —      |       | 3,062       |       | 3,062     |       |
|                                  |            |             |            |             |            |             |            |           |            |  |  |  |  |

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Thetable below presents the rollforward of assets that are valued usingsignificant unobservable inputs (Level 3) for the nine months ended September 30,2009:

 

*Dollarsin thousands*

 
| ** **                             | ** ** | **Mortgage  Servicing  Rights** | ** ** | **Interest Rate lock  Commitments** | ** ** | **Loans** | ** ** | **OREO** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|-------------------------------------|------------|-----------|------------|----------|------------|
| Beginning balance                      |       | $                               | 239        |                                | $          | 412       |       | $        | 9,658      |   | $ | 1,872 |   |
| Net transferred into (out  of) level 3 |       | 321                             |       | 1,999                               |       | 21,979    |       | 1,190    |       |
| Net unrealized gains  (losses)         |       | 54                              |       | —                              |       | (8,566    | )          | —   |       |
| Ending Balance                         |       | $                               | 614        |                                | $          | 2,411     |       | $        | 23,071     |   | $ | 3,062 |   |

 

The estimated fair values and carrying amounts of the balance sheet aresummarized as follows:

 

(Dollars inthousands)

 
| ** **                                                      | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                                      | ** ** | **Estimated**               | ** ** | **Carrying**               | ** ** | **Estimated** | ** ** | **Carrying** | ** ** |
| ** **                                                      | ** ** | **Fair Value**              | ** ** | **Amount**                 | ** ** | **Fair Value** | ** ** | **Amount** | ** ** |
| Financial Assets                                                |       |                        |       |                       |       |   |   |   |   |
| Cash and cash equivalents                                       |       | $                           | 22,951     |                       | $          | 22,951 |   | $ | 95,150 |   | $ | 95,150 |   |
| Investment securities available-for-sale                        |       | 89,866                      |       | 89,866                     |       | 114,584 |   | 114,584 |   |
| Loans held for sale                                             |       | 187,521                     |       | 187,521                    |       | 90,940 |   | 90,940 |   |
| Gross loans and leases                                          |       | 1,028,522                   |       | 957,502                    |       | 1,042,799 |   | 940,083 |   |
| Due from mortgage investors                                     |       | —                      |       | —                     |       | 9,036 |   | 9,036 |   |
| Mortgage servicing rights                                       |       | 614                         |       | 614                        |       | 239 |   | 239 |   |
| Derivative instruments                                          |       | 2,411                       |       | 2,411                      |       | 412 |   | 412 |   |
|                                                            |       |                        |       |                       |       |   |   |   |   |
| Financial Liabilities                                           |       |                        |       |                       |       |   |   |   |   |
| Deposits with no stated maturities                              |       | 539,461                     |       | 591,484                    |       | 524,737 |   | 563,501 |   |
| Deposits with stated maturities                                 |       | 392,819                     |       | 394,630                    |       | 451,691 |   | 451,691 |   |
| FHLB and other borrowings                                       |       | 199,378                     |       | 202,123                    |       | 167,766 |   | 171,170 |   |
| Subordinated debentures                                         |       | 20,795                      |       | 20,795                     |       | 15,465 |   | 15,465 |   |
| Derivative instruments                                          |       | 903                         |       | 903                        |       | 618 |   | 618 |   |
|                                                            |       |                        |       |                       |       |   |   |   |   |
| Off-Balance-Sheet                                               |       |                        |       |                       |       |   |   |   |   |
| Commitments to extend credit and outstanding  letters of credit |       | 238,812                     |       | —                     |       | 244,033 |   | — |   |
|                                                                 |            |                             |            |                            |            |  |  |  |  |  |  |  |  |

 

**11.****      ****SEGMENT REPORTING**

 

The Corporationhas determined that it has two operating and reporting segments: CommunityBanking and Mortgage Banking.

 

The Corporation’sCommunity Banking segment consists of commercial lending, commercialconstruction lending, commercial deposits, retail banking, as well as wealthmanagement. The Community Banking segment is managed as a single strategicunit, which generates revenue from a variety of products and services providedby the Corporation. For example, construction and commercial lending isdependent upon the ability of the Corporation to fund itself with retaildeposits and other borrowings and to manage interest rate and credit risk. Thissituation is also similar for consumer lending.

 

The Corporation’sMortgage Banking segment operates under the trade name, “American Home Bank, adivision of First National Bank of Chester County,” referred to herein as the “AHBDivision”. Its principal activities include providing mortgages and associatedproducts to customers and selling most of those mortgages into the secondarymarket on a servicing released basis. The AHB Division retains the servicing ona portion of the loans that it sells. The AHB Division

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

also holds someresidential mortgage and residential construction loans for investment. The AHBDivision was formed on December 31, 2008 following the acquisition ofAmerican Home Bank, National Association.

 

Reportablesegment-specific information and reconciliation to consolidated financialinformation is as follows:

 

(Dollars inthousands)

 
| ** **                  | ** ** | **As of  and for the three months ended September 30, 2009** | ** ** |
|-----------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                  | ** ** | **Community Banking**                                             | ** ** | **Mortgage Banking** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Segment**                                                       | ** ** | **Segment** | ** ** | **Consolidated** | ** ** |
|                        |       |                                                              |       |   |   |   |   |
| Total  assets               |       | $                                                                 | 979,116    |   | $ | 327,565 |   | $ | 1,306,681 |   |
|                        |       |                                                              |       |   |   |   |   |
| Net  interest income        |       | $                                                                 | 8,870      |   | $ | 2,964 |   | $ | 11,834 |   |
|                        |       |                                                              |       |   |   |   |   |
| Total  non-interest income  |       | $                                                                 | 973        |   | $ | 11,065 |   | $ | 12,038 |   |
| Total  non-interest expense |       | $                                                                 | 9,964      |   | $ | 13,413 |   | $ | 23,377 |   |
|                        |       |                                                              |       |   |   |   |   |
| Net  loss                   |       | $                                                                 | (8,765     | ) | $ | (952 | ) | $ | (9,717 | ) |

 

(Dollars inthousands)

 
| ** **                  | ** ** | **As of and for the nine months ended September 30, 2009** | ** ** |
|-----------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                  | ** ** | **Community Banking**                                           | ** ** | **Mortgage Banking** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | **Segment**                                                     | ** ** | **Segment** | ** ** | **Consolidated** | ** ** |
|                        |       |                                                            |       |   |   |   |   |
| Total  assets               |       | $                                                               | 979,116    |   | $ | 327,565 |   | $ | 1,306,681 |   |
|                        |       |                                                            |       |   |   |   |   |
| Net  interest income        |       | $                                                               | 25,780     |   | $ | 7,903 |   | $ | 33,683 |   |
|                        |       |                                                            |       |   |   |   |   |
| Total  non-interest income  |       | $                                                               | 6,092      |   | $ | 38,181 |   | $ | 44,273 |   |
| Total  non-interest expense |       | $                                                               | 29,452     |   | $ | 37,387 |   | $ | 66,839 |   |
|                        |       |                                                            |       |   |   |   |   |
| Net  (loss) income          |       | $                                                               | (8,218     | ) | $ | 3,300 |   | $ | (4,918 | ) |

 

Prior to theacquisition of American Home Bank at December 31, 2008, the Corporation’soperations consisted of the Community Banking segment. Accordingly, comparativeinformation for 2008 is not applicable.

 

**12.****      ****ACCOUNTING FOR STOCK-BASEDCOMPENSATION PLANS**

 

At September 30, 2009, the Corporation had one stock basedcompensation plan, pursuant to which, shares of the Corporation’s common stockcould be issued, subject to certain restrictions. The plan, adopted in 2005,allows the Corporation to grant up to 150,000 shares of restricted stock toemployees. During the nine months ended September 30, 2009, theCorporation granted 54,650 shares valued at $11.35 per share at the grant date.These shares, or a portion thereof will vest on the third anniversary of thegrant subject to certain employment and company performance requirements.During the nine months ended September 30, 2008, the Corporation granted34,500 shares valued at $17.80 per share at the grant date. These shares, or aportion thereof will vest on the third anniversary of the grant subject tocertain employment and company performance requirements. These restricted stockgrants are also subject to accelerated vesting of all or a portion of theshares upon the occurrence of certain events, as described more fully in ourProxy Statement for the 2009 Annual Meeting of Shareholders. A summary of theCorporation’s unvested restricted shares is as follows:

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

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

 
| ** **                           | ** ** | **Shares** | ** ** | **Grant Date Fair  Value** | ** ** | **Aggregate Intrinsic  Value  of Unvested Shares** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------------------------------|------------|
| Unvested at  January 1, 2009    |       | 44,075     |       | $                          | 18.74      |                                               |       |   |
| Granted                              |       | 54,650     |       | $                          | 11.35      |                                               |       |   |
| Vested                               |       | 6,400      |       | $                          | 21.05      |                                               |       |   |
| Forfeited                            |       | 6,000      |       | $                          | 14.58      |                                               |       |   |
| Unvested at  September 30, 2009 |       | 86,325     |       | $                          | 14.18      |                                               | $          | 861.5 |   |
|                                      |            |            |            |                            |            |                                                    |            |  |  |

 

The Corporation recorded approximately $147,000 and $132,000 ofrestricted stock expense for the nine months ended September 30, 2009 and2008, respectively.

 

The Corporation’s ability to issue stock options under the Corporation’s1995 Stock Option Plan has expired. However, outstanding stock options remainin effect according to their terms. Aggregated information regarding theCorporation’s Stock Option Plan as well as options assumed in connection withthe AHB acquisition as of September 30, 2009 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, 2009    |       | 298,034    |       | $                                       | 15.43      |                                                       |       |                            | $          | — |   |
| Granted                                |       | —     |       |                                    |       |                                                       |       |                            |       |
| Exercised                              |       | —     |       |                                    |       |                                                       |       |                            |       |
| Forfeited                              |       | —     |       |                                    |       |                                                       |       |                            |       |
| Expired                                |       | (63,925    | )          | $                                       | 14.09      |                                                       |       |                            |       |   |
| Outstanding at September 30, 2009 |       | 234,109    |       | $                                       | 15.80      |                                                       | 3.56       |                            | $          | — |   |
| Exercisable at September 30, 2009 |       | 234,109    |       | $                                       | 15.80      |                                                       | 3.56       |                            | $          | — |   |

 

There were no options granted during the nine months ended September 30,2009.  The total intrinsic value (marketvalue on date of exercise less grant price) of options exercised during thenine months ended September 30, 2008 was $0.

 

**13.****      ****CASH FLOW INFORMATION**

 

For purposes of reporting cash flows, cash and cash equivalents includecash on hand, amounts due from banks, and federal funds sold and overnightinvestments.  Generally, federal fundsand overnight investments are purchased and sold for one-day periods.  Cash paid for interest for the nine month periodsended September 30, 2009 and 2008 was $17.5 million and $17.7 million, respectively.  Cash paid for income taxes for the nine monthperiods ended September 30, 2009 and 2008 was $2.8 million and $2.3million, respectively. Loans transferred to OREO were $6.2 million andapproximately $427,000 for the nine months ended September 30, 2009 and2008, respectively.

 

**14.****      ****COMMITMENTSAND CONTINGENCIES**

 

**Reservefor Unfunded Commitments**

 

The Corporation maintainsa reserve for unfunded loan commitments and letters of credit which is reportedin other liabilities in the Unaudited Consolidated Statements of FinancialCondition consistent with ASC 825-10. As of the balance sheet date, theCorporation records estimated losses inherent with unfunded loan commitments inaccordance with ASC 450-20, and estimated future obligations under letters ofcredit in accordance with ASC 460-10. The methodology used to determine theadequacy of this reserve is integrated in the Corporation’s process forestablishing the allowance for loan losses and considers the probability offuture losses and obligations that may be incurred under these off-balancesheet agreements.  The reserve for unfunded loan commitments andletters of credit as of September 30, 2009 and December 31, 2008 wasapproximately $652,000 and $445,000, respectively. Management believes thisreserve level is sufficient to absorb estimated probable losses related tothese commitments.

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Loan Recourse**

 

The Corporation sells itsresidential mortgage loans on a non-recourse basis. The Corporation alsoprovides representations and warranties to purchasers and insurers of the loanssold. In the event of a breach of these representations and warranties, theCorporation may be required to repurchase a mortgage loan or indemnify thepurchaser, and any subsequent loss on the mortgage loan may be borne by theCorporation. If there is no breach of a representation and warranty provision,the Corporation has no obligation to repurchase the loan or indemnify theinvestor against loss. The unpaid principal balance of the loans sold by theCorporation represents the maximum potential exposure related torepresentations and warranty provisions; however, the Corporation cannotestimate its maximum exposure because it does not service all of the loans forwhich it has provided a representation or warranty. As of September 30,2009, the Corporation had a liability of $780,000 included in Other liabilitiesin the Consolidated Balance Sheet, for probable losses related to theCorporation’s recourse exposure.

 

**15.****      ****REGULATORYMATTERS**

 

On October 20, 2009,the Board of Directors of the Bank entered into an informal Memorandum ofUnderstanding (“MOU”) on October 16, 2009,with the Office of the Comptroller of the Currency(the “OCC”).  An MOU with regulatory authorities is an informalaction that is not published or publicly available and that is used whencircumstances warrant a milder form of action than a formal supervisory action,such as a formal written agreement or order. Among other things, under the MOU,the Bank has agreed to address the following matters:

 

·                  Develop a comprehensive three-year capital plan;

 

·                  Take action to protect criticized assets and adopt andimplement a program to eliminate the basis of criticism of such assets;

 

·                  Establish an effective program that provides for earlyproblem loan identification and a formal plan to proactively manage thoseassets;

 

·                  Review the adequacy of the Bank’s informationtechnology activities and Bank Secrecy Act compliance and approve writtenprograms of policies and procedures to provide for compliance; and

 

·                  Establish a Compliance Committee of the Board tomonitor and coordinate the Bank’s adherence to the provisions of the MOU.

 

The Board of Directorsand management have already initiated corrective actions to comply with theprovisions of the MOU.

 

Subsequent to September 30,2009, the OCC has also required the Bank to increase its Tier 1leverage capital ratio to not less than 8%, its Tier 1 risk-based capital ratioto not less than 10% and its total risk-based capital ratio to not less than12% by December 31, 2009.

 

The Company has alsoreceived notice from the Federal Reserve, the primary regulator of theCorporation, that the Federal Reserve must approve any dividends to be paid bythe Corporation in advance of the declaration or payment.

 

**16.****      ****SUBSEQUENTEVENTS**

 

The Corporation evaluatedits September 30, 2009 financial statements for subsequent events through November 13,2009.  The Corporation is not aware ofany subsequent events which would require recognition or disclosure in thefinancial statements other than those discussed below.

 

The Bank is currentlyundergoing a restructuring, which includes the previously announced appointmentof John A. Featherman, III as President, James M. Deitch as ChiefOperating Officer and Sheryl S. Vittitoe as Chief Financial Officer.  The restructuring will also include thetermination of certain Bank employees, including employees from its AHBDivision by year-end.  The Bank expectsto incur a charge of approximately $1.0 million in the fourth quarter for 

 

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**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

severance liability connectedwith this restructuring.  The Bank alsointends to reorganize its two current divisions into four divisions:Commercial, Consumer, Wealth Management and Administration. The Bank is closingthree branches as part of the restructuring; the Bank expects to incur a chargeof approximately $1.1 million in the fourth quarter related to branch closureexpenses, including estimated lease liabilities and write-off of certainleasehold improvements and fixed assets related to the branch closures.  The Bank is also closing 13 mortgage loanproduction offices related to Vision Mortgage Division of AHB related to therestructuring, and will close an additional six mortgage loan productionoffices operated as AHB production branches. The Bank will incur approximately $60,000 in charges related toseverance, lease obligations and the write off of leasehold improvements, andfixed assets related to such closures.

 

The Corporation borrowed an aggregate principal amount of$4.0 million during the second and third quarters of 2009 on an unsecured,short-term basis from two shareholders, with interest payable in each case at12% per annum. On October 20, 2009, the Corporation received a demand forpayment of $3.0 million principal amount of such borrowings in accordance withterms of the loans, with the demand payable on November 20, 2009. The other$1.0 million principal amount of unsecured loan originally matured on November 24,2009, but has been extended by the lender to May 24, 2010. The Corporation iscurrently attempting to negotiate to extend the maturity of the $3 million dueon November 20, 2009. If the Corporation is unable to extend the loans, theBank may need to dividend to the Corporation some or all of such funds. Underits informal MOU with the OCC, the Bank is required to obtain supervisoryapproval to dividend any funds to the Corporation. Any such dividend to theCorporation will directly affect the Bank’s capital and in turn, its fourthquarter regulatory capital ratios.

 

**17.****      ****RECLASSIFICATIONS**

 

Certain 2008numbers have been reclassified to conform with current period presentation.These reclassifications have no impact on net income or earnings per share.

 

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

 

This discussion isintended to further your understanding of the consolidated financial conditionand results of operations of First Chester County Corporation and its directand indirect subsidiaries. It should be read in conjunction with theconsolidated financial statements included in this report.

 

# **OVERVIEW**

# ** **

We strive to remain aleader in meeting the financial service needs of the local community and toprovide quality service to the individuals and businesses in our marketareas.  Historically, we have been acommunity-oriented provider of traditional banking products and services tobusiness organizations and individuals, including products such as residentialand commercial real estate loans, consumer loans and a variety of depositproducts.  We meet the needs of our localcommunity through a community-based and service-oriented approach to banking.

 

The Corporation completed its acquisition of AHB on December 31, 2008, and, accordingly, the December 31, 2008 and the September 30, 2009 consolidated balance sheets reflect the addition of assets acquired and liabilities assumed in this acquisition. The results of operations presented in the consolidated income statement for the three and nine months ended September 30, 2009 include the results of operations from AHB; however, the consolidated income statement for the three and nine months ended September 30, 2008 does not include the results of AHB.

 

The Corporation reporteda net loss of $9.7 million for the three months ended September 30, 2009as compared to $807 thousand of net income for the three months ended September 30,2008. Diluted loss per share for the three months ended September 30, 2009was $1.54 compared to diluted earnings per share of $0.16 for the same periodin 2008. Cash dividends declared for the three months ended September 30,2009 were $0.14 per share compared to $0.14 per share for the three monthsended September 30, 2008.

 

The Corporation reporteda net loss of $4.9 million for the nine months ended September 30, 2009 ascompared to $4.2 million of net income for the nine months ended September 30,2008. Diluted loss per share for the nine months ended September 30, 2009were $0.78 compared to diluted earnings per share of $0.80 for the same periodin 2008.  Cash dividends declared for thenine months ended September 30, 2009 were $0.42 per share compared to$0.42 per share for the nine months ended September 30, 2008.

 

The decrease in net income for the three and ninemonths ended September 30, 2009 was due primarily to an increase in theprovision for loan and lease losses combined with a $1.6 million other thantemporary impairment charge on the four equity securities in the Bank’savailable for sale investment portfolio. The decrease in net income was alsocaused by an increase in non-interest expense. The increase in the provisionwas driven by the ongoing impact from recessionary economic conditions whilethe increase in non-interest expense was due mainly to the addition of AHB’soperations as well as an increase in FDIC insurance expense. Offsetting theseimpacts were increases in non-interest income, mainly attributable to the netgains from the mortgage banking activities of the AHB Division, combined with anincrease in net interest income due mainly to the higher averageinterest-earning assets from the acquisition of AHB.

 

# **CRITICALACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES**

# ** **

The accounting andreporting policies of the Corporation conform with the accounting principlesgenerally accepted in the United States of America and general practices withinthe financial services industry.  The preparationof the financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the amounts reported in the financial statementsand the accompanying notes. Actual results could differ from those estimates.For a discussion of significant accounting policies please refer to thefootnotes to the Corporation’s consolidated financial statements included inthis Report and in our 2008 Annual Report.

 

**Investment Securities**

 

In accordance with FASBASC 320-10, the Corporation evaluates the individual securities making up theinvestment portfolio for other than temporary impairment on a quarterly basis.If a security is deemed to be other than temporarily impaired, the impairmentis recorded in non-interest income in the period in which it is recognized.Evaluating whether a security is other than temporarily impaired involves ahigh degree of judgment. Factors considered by management in determiningwhether a security is other than temporarily impaired include current andforecasted market conditions for that security as well as our ability andintent to hold the security until recovery.

 

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***Allowance for Loan and LeaseLosses***

* *

The Corporationconsiders that the determination of the allowance for loan and lease lossesinvolves a higher degree of judgment and complexity than its other significantaccounting policies.  The balance in theallowance for loan losses is determined based on Management’s review andevaluation of the loan and lease portfolio in relation to past loss experience,the size and composition of the portfolio, current economic events andconditions, and other pertinent factors, including Management’s assumptions asto future delinquencies, recoveries and losses. All of these factors may besusceptible to significant change.  Tothe extent actual outcomes differ from Management’s estimates, additionalprovisions for loan and lease losses may be required that would adverselyimpact earnings in future periods.

 

**Goodwill**

 

Goodwill was recorded asa result of the AHB acquisition. Goodwill is the excess of the purchase priceover the fair value of liabilities assumed over the fair value of tangible andidentifiable intangible assets acquired in a business combination. The goodwillacquired in the American Home Bank acquisition was all attributable to theMortgage Banking segment. Goodwill is not amortized but is tested forimpairment annually or more frequently if events or changes in circumstancesindicate that the asset might be impaired.  FASB ASC 350-10 outlinesa two-step goodwill impairment test.  Significant judgment is appliedwhen goodwill is assessed for impairment.  Step one, which is used toidentify potential impairment, compares the fair value of the reporting unitwith its carrying amount, including goodwill.  If the fair value of areporting unit exceeds its carrying value, goodwill of the reporting unit isconsidered not impaired and step two is therefore unnecessary.  Ifthe carrying amount of the reporting unit exceeds its implied fair value, thesecond step is performed to measure the amount of the impairment loss, ifany.  An implied loss is recorded to the extent that the carryingamount of goodwill exceeds its implied fair value.

 

The Corporation’s annualimpairment testing for goodwill was completed as of September 30, 2009. Aspart of its step one procedures to identify goodwill impairment, managementcompared the fair value of the Mortgage Banking segment to the carrying amountof its net assets, including goodwill. In performing step one, the Corporationestimated the fair value of the Mortgage Banking segment through a discountedeconomic value analysis based on internal forecasts, recent financials and theprojected outlook for the industry. No indication or determination ofgoodwill impairment at that date was evident. Management will continue tomonitor events that could impact this conclusion in future periods.

 

***Income Taxes***

* *

Under the liabilitymethod, deferred tax assets and liabilities are determined based on thedifference between the financial statement and tax basis of assets andliabilities.  Deferred tax assets aresubject to Management’s judgment based upon available evidence that futurerealization is more likely than not.  IfManagement determines that the Corporation may be unable to realize all or partof the net deferred tax assets in the future, a direct charge to income taxexpense may be required to reduce the recorded value of the net deferred taxasset to the expected realizable amount.

 

**FairValue Measurement**

 

FASB ASC 820-10 definesfair value as the exchange price that would be received for an asset or paid totransfer a liability (an exit price) in an orderly transaction between marketparticipants on the measurement date. FASB ASC 820-10 also establishes a fairvalue hierarchy which requires an entity to maximize the use of observableinputs and minimize the use of unobservable inputs when measuring fair value.FASB ASC 820-10 clarifies proper fair value determination in a market that isnot active and provides an example to illustrate key considerations indetermining the fair value of a financial asset when the market for thatfinancial asset is not active. The Corporation considered the requirements ofFASB ASC 820-10 when estimating fair value. *See* Footnote 10 of the Notes toConsolidated Financial Statements for further discussion on Fair ValueMeasurement.

 

**ACQUISITION**

 

EffectiveDecember 31, 2008, the Corporation completed its acquisition of AHB. Themortgage banking business of AHB is now operating as a division of the Bankunder the trade name, “American Home Bank, a Division of First National Bank ofChester County.” The Bank’s mortgage-banking activities include providingmortgages to customers and selling most of those mortgages into the secondarymarket on a servicing released basis. The Bank retains the servicing on aportion of the loans that it sells. The sourcing of mortgage loans is conductedthrough a direct, retail delivery channel comprised of retail 

 

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loanoffices, affiliated business arrangements with builders and realtors, and awholesale lending operation. The wholesale operation sources loans throughrelationships with unrelated mortgage brokers.

 

**SEGMENTINFORMATION**

 

The Corporation hasdetermined that it has two operating and reporting segments: Community Bankingand Mortgage Banking.

 

The Corporation’sCommunity Banking segment consists of commercial, commercial construction,retail banking and wealth management. The Community Banking segment is managedas a single strategic unit, which generates revenue from a variety of productsand services provided by the Corporation. For example, construction andcommercial lending is dependent upon the ability of the Corporation to funditself with retail deposits and other borrowings and to manage interest rateand credit risk. This situation is also similar for consumer lending.

 

The Corporation’sMortgage Banking segment operates under the trade name, “American Home Bank, adivision of First National Bank of Chester County,” referred to herein as (the “AHBDivision”). Its principal activities include providing residential mortgagesand associated products to customers and selling most of those mortgages intothe secondary market on a servicing released basis. The AHB Division retainsthe servicing on a portion of the loans that it sells. The AHB Division alsoholds some residential mortgage and construction loans. The AHB Division wasformed on December 31, 2008 following the acquisition of American HomeBank, National Association.

 

A summary ofsegment performance for the three and nine months ended September 30, 2009is presented in Note 11 to the Corporation’s Financial Statements.

 

The results presented inthe Net Interest Income, Interest Income, Interest Expense and Provision forLoan and Lease Losses sections present information for both the loans held inthe Community Banking segment as well as the Mortgage Banking segment. Factorsdriving net interest income and the provision for loan and lease losses aresimilar for the loans held in each of these segments, with the exception ofloans held for sale, which are not reserved for in the allowance for loan andlease losses, as they are carried at fair market value. Specific discussion ismade below where factors driving the specific components of non-interest incomeand expense for the operating segments differ from the consolidatedCorporation.

 

**SELECTED RATIOS**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Return  on Average Assets |       | (2.87                  | )%         | 0.32                  | %          | (0.49 | )% | 0.57 | % |
| Return  on Average Equity |       | (42.87                 | )%         | 4.65                  | %          | (7.42 | )% | 8.03 | % |
| Dividend  Payout Ratio    |       | (9.09                  | )%         | 89.96                 | %          | (53.52 | )% | 52.27 | % |
| Book Value Per Share      |       | $                      | 12.90      |                  | $          | 12.98 |   | $ | 12.90 |   | $ | 12.98 |   |
|                           |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

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The followingtable provides detail regarding the Corporation’s average balances withcorresponding interest income (on a tax-equivalent basis) and interest expenseas well as yield and cost information for the periods presented.

 

(Dollars in thousands)

 
| ** **                                                                                                       | ** ** | **Three Months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2009**                              | ** ** | **2008** | ** ** |
| ** **                                                                                                       | ** ** | **Average**                           | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                       | ** ** | **Balance**                           | ** ** | **Interest** | ** ** | **Rate%** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate%** | ** ** |
| ASSETS                                                                                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold, interest-bearing  deposits in banks and other overnight investments |       | $                                     | 4,552      |   | $ | 5 |   | 0.50 | % | $ | 32,732 |   | $ | 200 |   | 2.43 | % |
| Investment securities:                                                                                      |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                                          |       | 81,339                                |       | 711 |   | 3.47 | % | 95,261 |   | 1,157 |   | 4.83 | % |
| Tax-exempt (1)                                                                                              |       | 6,522                                 |       | 78 |   | 4.72 | % | 12,180 |   | 142 |   | 4.63 | % |
| Total investment securities                                                                            |       | 87,861                                |       | 789 |   | 3.56 | % | 107,441 |   | 1,299 |   | 4.81 | % |
|                                                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                                                                              |       | 236,970                               |       | 2,866 |   | 4.80 | % | 377 |   | 3 |   | 3.17 | % |
|                                                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases: (2)                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                                          |       | 929,161                               |       | 13,313 |   | 5.68 | % | 779,718 |   | 12,187 |   | 6.22 | % |
| Tax-exempt (1)                                                                                              |       | 20,102                                |       | 373 |   | 7.35 | % | 18,477 |   | 340 |   | 7.33 | % |
| Total loans and leases                                                                            |       | 949,263                               |       | 13,686 |   | 5.72 | % | 798,195 |   | 12,527 |   | 6.24 | % |
|                                                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                                                          |       | 1,278,646                             |       | 17,346 |   | 5.38 | % | 938,745 |   | 14,029 |   | 5.95 | % |
| Non-interest-earning assets                                                                                 |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses                                                               |       | (12,383                               | )          |   |   |   |   | (8,507 | ) |   |   |   |   |
| Cash and due from banks                                                                      |       | 17,010                                |       |   |   |   |   | 22,003 |   |   |   |   |   |
| Other assets                                                                                                |       | 59,184                                |       |   |   |   |   | 41,572 |   |   |   |   |   |
|                                                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                                                                |       | $                                     | 1,342,457  |   |   |   |   |   | $ | 993,813 |   |   |   |   |   |
|                                                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                        |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW, and money market Deposits                                                 |       | $                                     | 448,763    |   | $ | 941 |   | 0.83 | % | $ | 405,983 |   | $ | 1,646 |   | 1.61 | % |
| Certificates of deposit and other time                                                  |       | 409,779                               |       | 2,571 |   | 2.49 | % | 222,231 |   | 2,001 |   | 3.58 | % |
| Total interest-bearing deposits                                                                        |       | 858,542                               |       | 3,512 |   | 1.62 | % | 628,214 |   | 3,647 |   | 2.31 | % |
| Subordinated debt                                                                                           |       | 20,795                                |       | 295 |   | 5.63 | % | 15,465 |   | 209 |   | 5.38 | % |
| Federal Home Loan Bank advances and other borrowings                               |       | 202,854                               |       | 1,559 |   | 3.05 | % | 151,521 |   | 1,470 |   | 3.86 | % |
| Total interest-bearing liabilities                                                                     |       | 1,082,191                             |       | 5,366 |   | 1.97 | % | 795,200 |   | 5,326 |   | 2.66 | % |
| Non-interest-bearing liabilities:                                                                           |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing demand deposits                                                                   |       | 152,047                               |       |   |   |   |   | 119,885 |   |   |   |   |   |
| Other liabilities                                                                                           |       | 18,301                                |       |   |   |   |   | 9,325 |   |   |   |   |   |
| Total liabilities                                                                                           |       | 1,252,539                             |       |   |   |   |   | 924,410 |   |   |   |   |   |
| Stockholders’ equity                                                                                   |       | 89,918                                |       |   |   |   |   | 69,403 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                                              |       | $                                     | 1,342,457  |   |   |   |   |   | $ | 993,813 |   |   |   |   |   |
|                                                                                                             |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                                                                    |       |                                  |       | $ | 11,980 |   |   |   |   |   | $ | 8,703 |   |   |   |
| Net yield on interest-earning assets                                                         |       |                                  |       |   |   | 3.72 | % |   |   |   |   | 3.69 | % |

 

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(1)                     The indicated income and annual rate arepresented on a taxable equivalent basis using the federal marginal rate of 34%adjusted for the TEFRA 20% interest expense disallowance for 2009 and 2008.

 

(2)                     Non-accruing loans are included in theaverage balance.

 

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The followingtable provides detail regarding the Corporation’s average balances withcorresponding interest income (on a tax-equivalent basis) and interest expenseas well as yield and cost information for the periods presented.

 

(Dollars inthousands)

 
| ** **                                                                                                       | ** ** | **Nine Months ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                       | ** ** | **September 30,**     | ** ** |
| ** **                                                                                                       | ** ** | **2009**              | ** ** | **2008** | ** ** |
| ** **                                                                                                       | ** ** | **Average**           | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                       | ** ** | **Balance**           | ** ** | **Interest** | ** ** | **Rate%** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate%** | ** ** |
| ASSETS                                                                                                           |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold, interest-bearing  deposits in banks and other overnight investments |       | $                     | 15,615     |   | $ | 50 |   | 0.43 | % | $ | 45,773 |   | $ | 1,068 |   | 3.12 | % |
| Investment securities:                                                                                      |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                                          |       | 90,219                |       | 2,798 |   | 4.15 | % | 97,234 |   | 3,515 |   | 4.83 | % |
| Tax-exempt (1)                                                                                              |       | 7,879                 |       | 282 |   | 4.78 | % | 13,078 |   | 463 |   | 4.73 | % |
| Total investment securities                                                                            |       | 98,098                |       | 3,080 |   | 4.20 | % | 110,312 |   | 3,978 |   | 4.82 | % |
|                                                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                                                                              |       | 218,619               |       | 7,805 |   | 4.77 | % | 568 |   | 9 |   | 2.12 | % |
|                                                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases: (2)                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                                          |       | 924,397               |       | 39,375 |   | 5.70 | % | 753,950 |   | 36,134 |   | 6.40 | % |
| Tax-exempt (1)                                                                                              |       | 20,454                |       | 1,126 |   | 7.36 | % | 18,983 |   | 1,029 |   | 7.24 | % |
| Total loans and leases                                                                            |       | 944,851               |       | 40,501 |   | 5.73 | % | 772,933 |   | 37,163 |   | 6.42 | % |
|                                                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                                                          |       | 1,277,183             |       | 51,436 |   | 5.38 | % | 929,586 |   | 42,218 |   | 6.07 | % |
| Non-interest-earning assets                                                                                 |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses                                                               |       | (11,403               | )          |   |   |   |   | (8,122 | ) |   |   |   |   |
| Cash and due from banks                                                                      |       | 18,563                |       |   |   |   |   | 20,375 |   |   |   |   |   |
| Other assets                                                                                                |       | 55,785                |       |   |   |   |   | 38,797 |   |   |   |   |   |
|                                                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                                                                |       | $                     | 1,340,128  |   |   |   |   |   | $ | 980,636 |   |   |   |   |   |
|                                                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                        |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW, and money market                                                               |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                                                                         |       | $                     | 437,111    |   | $ | 3,187 |   | 0.97 | % | $ | 391,067 |   | $ | 5,287 |   | 1.81 | % |
| Certificates of deposit and other time                                                  |       | 428,945               |       | 8,679 |   | 2.71 | % | 226,362 |   | 6,812 |   | 4.02 | % |
| Total interest-bearing deposits                                                                        |       | 866,056               |       | 11,866 |   | 1.83 | % | 617,429 |   | 12,099 |   | 2.62 | % |
| Subordinated debt                                                                                           |       | 18,585                |       | 721 |   | 5.18 | % | 15,465 |   | 683 |   | 5.90 | % |
| Federal Home Loan Bank advances and other borrowings                               |       | 201,852               |       | 4,712 |   | 3.12 | % | 150,129 |   | 4,390 |   | 3.91 | % |
| Total interest-bearing liabilities                                                                     |       | 1,086,493             |       | 17,299 |   | 2.13 | % | 783,023 |   | 17,172 |   | 2.93 | % |
| Non-interest-bearing liabilities:                                                                           |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing demand deposits                                                                   |       | 148,424               |       |   |   |   |   | 118,776 |   |   |   |   |   |
| Other liabilities                                                                                           |       | 16,555                |       |   |   |   |   | 9,577 |   |   |   |   |   |
| Total liabilities                                                                                           |       | 1,251,472             |       |   |   |   |   | 911,376 |   |   |   |   |   |
| Stockholders’ equity                                                                                   |       | 88,656                |       |   |   |   |   | 69,260 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                                              |       | $                     | 1,340,128  |   |   |   |   |   | $ | 980,636 |   |   |   |   |   |
|                                                                                                             |       |                  |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                                                                    |       |                  |       | $ | 34,137 |   |   |   |   |   | $ | 25,046 |   |   |   |
| Net yield on interest-earning assets                                                         |       |                  |       |   |   | 3.57 | % |   |   |   |   | 3.60 | % |

 

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(1)          The indicated income and annual rate arepresented on a taxable equivalent basis using the federal marginal rate of 34%adjusted for the TEFRA 20% interest expense disallowance for 2009 and 2008.

 

(2)          Non-accruing loans are included in theaverage balance.

 

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**NETINTEREST INCOME**

 

Net interestincome is the difference between interest income earned on interest-earningassets and interest expense paid on interest-bearing liabilities. Net interestincome on a tax equivalent basis for the three-month period ended September 30,2009 was $12.0 million, an increase of 37.7% from $8.7 million for the sameperiod in 2008.  Net interest income on atax equivalent basis for the nine month period ended September 30, 2009was $34.1 million, an increase of 36.3% from $25.0 million for the same periodin 2008.  The net yield oninterest-earning assets, on a tax-equivalent basis, was 3.72% for thethree-month period ended September 30, 2009, compared to 3.69% for thesame period in 2008, an increase of 3 basis points (one basis point is equal to1/100 of a percent).  For the nine monthperiod ended September 30, 2009, the net yield on interest earning assetsdecreased 3 basis points to 3.57% from 3.60% during the same period in 2008.

 

The yield earned onaverage interest-earning assets was 5.38% for the three month period ended September 30,2009, compared to 5.95% for the same period in 2008, a decrease of 57 basispoints. For the nine month period ended September 30, 2009, the yieldearned on interest earning assets decreased 69 basis points to 5.38% from 6.07%during the same period in 2008.

 

Average interest-earningassets increased approximately $339.9 million or 36.2% to $1.3 billion for thethree-months ended September 30, 2009 from $938.7 million in the sameperiod last year.  The increase inaverage interest-earning assets for the three-month period ended September 30,2009 was the result of a $236.6 million increase in Loans held for salecombined with a 18.9% or $151.1 million increase in average total Loans andleases. These increases were partially offset by an 18.2% or $19.6 milliondecrease in average investment securities and an 86.1% or $28.2 milliondecrease in the average Federal funds sold and interest bearing deposits inbanks balance.

 

For the nine month periodended September 30, 2009, average interest-earning assets increasedapproximately $347.6 million or 37.4% to $1.3 billion from $929.6 million inthe same period last year.  The increasein average interest-earning assets for the nine month period ended September 30,2009 was the result of a $218.1 million increase in Loans held for salecombined with a 22.2% or $171.9 million increase in average total Loans and leases.These increases were partially offset by an 11.1% or $12.2 million decrease inaverage investment securities and a 65.9% or $30.2 million decrease in theaverage Federal funds sold and interest bearing deposits in banks balance.

 

Average interest-bearingliabilities increased approximately $287.0 million or 36.1% to $1.1 billion forthe three months ended September 30, 2009, from $795.2 million in the sameperiod in 2008.  The increase in averageinterest-bearing liabilities for the three-month period was the result of a$230.3 million or 36.7% increase in interest-bearing deposits, combined with a$51.3 million or 33.9% increase in Federal Home Loan Bank (“FHLB”) advances andother borrowings and a $5.3 million or 34.5% increase in subordinated debentures.

 

For the nine monthperiod ended September 30, 2009, average interest-bearing liabilitiesincreased approximately $303.5 million or 38.8% to $1.1 billion from $783.0million in the same period in 2008.  Theincrease in average interest-bearing liabilities for the nine month period wasthe result of a $248.6 million or 40.3% increase in interest-bearing deposits,combined with a $51.7 million or 34.5% increase in FHLB advances and otherborrowings and a $3.1 million or 20.2% increase in subordinated debentures.

 

**INTEREST INCOME**

 

Interest income onfederal funds sold and interest-bearing deposits in banks for the three andnine month periods ended September 30, 2009 decreased 97.5% and 95.3% toapproximately $5,000 and $50,000, respectively, when compared to the sameperiods in 2008.  The decrease ininterest income on federal funds sold and interest-bearing deposits in banksfor the three and nine month periods is primarily the result of a $28.2 millionand $30.2 million decrease in the average federal funds sold and interestbearing deposits at banks balances from the same periods in 2008 combined witha 193 and 269 basis point decrease on the rates earned on these assets. Thedecrease in these balances occurred as available liquidity was utilized to fundthe increase in loans held for sale. The decrease in rate was primarily aresult of Federal Reserve actions to reduce market interest rates coupled withManagement’s decision to invest available cash in more secure, but loweryielding, overnight investment alternatives.

 

On a tax equivalentbasis, interest income on investment securities decreased by 39.3% orapproximately $510,000 to $789,000 for the three month period ended September 30,2009 from $1.3 million for the same period in 2008.  For the nine month period ended September 30,2009, interest income on investment securities decreased 22.6% or approximately$898,000 to $3.1 million from $4.0 million when compared to the same period in2008.  The decreases for the three andnine month periods were the result of a 125 and 62 basis point decrease in theyield earned on investment securities, respectively. 

 

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This was combined with$19.6 million and $12.2 million decreases in average total investment securitybalances for the three and nine month periods, respectively. The decrease ininvestment security balances reflects Management’s decision to reduce the Bank’sexposure to corporate bonds.

 

Interest income on loansheld for sale increased to $2.9 million during the three month period ended September 30,2009.  For the nine month period ended September 30,2009, interest income on loans held for sale increased to $7.8 million.  These increases were due to a significantincrease in the average loans held for sale balance.  Average loans held for sale for the three andnine months periods ended September 30, 2009 were $237.0 million and$218.6 million as compared to approximately $377,000 and $568,000 for the sameperiods in 2008. This increase was due to increased volume in residentialmortgage loan originations resulting from the AHB acquisition. $89.5 million ofloans held for sale were acquired at December 31, 2008 through theacquisition. The increase in the average balance during 2009 as compared to theDecember 31, 2008 level was attributable to an increase in residentialmortgage origination volume throughout 2009. The increase in origination volumewas caused by the refinancing boom driven by low interest rates.

 

Interest income on loans,on a tax equivalent basis, generated by the Corporation’s loan portfolioincreased 9.3% or $1.2 million to $13.7 million for the three month periodended September 30, 2009 compared to $12.5 million for the three monthsended September 30, 2008.  For thenine month period ended September 30, 2009, interest income on loans, on atax equivalent basis increased 9.0% or $3.3 million when compared to the sameperiod in 2008.  These increases ininterest income for the three and nine month periods ended September 30,2009 were primarily due to a $151 million or 18.9% increase in average loansoutstanding for the three month period and a $171.9 million or 22.2% increasein average loans outstanding for the nine month period as compared to the sameperiods in 2008. These increases in average loan balances were primarily due tothe AHB acquisition. $110.9 million of loans were acquired at December 31,2008 through the acquisition. The impact from the increase in average loanbalances was partially offset by a decrease in the tax equivalent yield earnedon average loans outstanding, which decreased by 52 and 69 basis points to5.72% and 5.73% for the three and nine month periods ended September 30,2009 from 6.24% and 6.42% for the same periods in 2008. This rate decrease isthe result of Federal Reserve actions to reduce market interest rates.

 

**INTEREST EXPENSE**

 

Interest expense ondeposit accounts decreased by approximately $135,000 or 3.7% to $3.5 millionfor the three-month period ended September 30, 2009 from $3.6 million forthe same period in 2008.  Interestexpense on deposit accounts decreased approximately $233,000 or 1.9% to $11.9million for the nine months ended September 30, 2009 compared to the sameperiod in 2008.  The decreases for thethree and nine month periods were primarily due to a decrease in the averageinterest rates paid on interest-bearing deposits. The average rate paid for thethree month period in 2009 was 1.62%, a 69 basis point decrease from 2.31% in2008. The average rate paid for the nine month period in 2009 was 1.83%, an 79basis point decrease from 2.62% in 2008. These rate decreases were primarilythe result of Federal Reserve actions to reduce market interest rates. Theimpact from rate decreases was partially offset by increases in averageinterest-bearing deposit balances. These balances increased $230.3 million forthe three month period to $858.5 million in 2009 from $628.2 million in 2008.These balances increased $248.6 million for the nine month period to $866.1million in 2009 from $617.4 million in 2008. The increase in average interest bearing deposit balances was primarilydue to the AHB acquisition. $186.7 million of interest bearing deposit balanceswere acquired at December 31, 2008 through the acquisition. The increasewas also due to stronger consumer demand for traditional interest-bearingdeposit products.

 

Interest expense onsubordinated debentures increased approximately $86,000 to approximately$295,000 for the three-month period ended September 30, 2009 fromapproximately $209,000 for the same period in 2008.  This increase was mainly due to an increasein the average balance of subordinated debentures caused by the issuance of a $5.3million junior subordinated debenture in April 2009. This new issuancecarries a 12% fixed interest rate which is currently higher than the averagerate paid on our other subordinated debentures. The rates paid on othersubordinated debenture issuances are primarily based on three month LIBOR. Thetotal average rate paid on subordinated debentures for the three months ended September 30,2009 increased 25 basis points from 5.38% in 2008 to 5.63% in 2009 primarilydue to the higher rate on the new issuance partially offset by a decrease inthe 3 month LIBOR between the two periods. Interest expense on subordinateddebentures increased approximately $38,000 to approximately $721,000 for thenine month period ended September 30, 2009 from approximately $683,000 forthe same period in 2008. The decrease for the nine month period is primarilydue to a 72 basis point decrease in the average interest rate paid on thesedebentures. The rate decrease was mainly due to a decrease in the 3 month LIBORbetween the two periods, partially offset by the higher rate on the April 2009new issuance.

 

Interest expense on FHLBand other borrowings increased by approximately $89,000 or 6.1% to $1.6 millionfor the three-month period ended September 30, 2009 from $1.5 million forthe same period in 2008. Interest expense on FHLB and other borrowings for thenine months ended September 30, 2009 increased approximately $322,000 or7.3% to $4.7 million from 

 

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$4.4 million in 2008.These increases in interest expense were primarily due to increases in theaverage balances of these funding sources in 2009 as compared to 2008. Theaverage balance of FHLB and other borrowings for the three months ended September 30,2009 increased by 33.9% or $51.3 million between the two periods. Averagebalances of these funding sources for the nine month period increased 34.5% or$51.7 million between the two periods. The increase in average FHLB and other borrowings was partially due tothe AHB acquisition. $36.6 million of FHLB and other borrowings balances wereacquired at December 31, 2008 through the acquisition. The increase inthese borrowings from December 31, 2008 through September 30, 2009was also due to an increase in borrowings from the FHLB and Federal Reserve tofund the increase in loans held for sale.

 

FHLB and other borrowingsare a favorable alternative to deposits to support asset growth. The impactfrom the average balance increase was partially offset by a decrease in theaverage rate paid on these borrowings. The average rate paid was 3.05% for thethree months ended September 30, 2009, a decrease of 81 basis points from3.86% during the same period in 2008. The average rate paid on these borrowingswas 3.12% for the nine months ended September 30, 2009, a decrease of 79basis points from 3.91% during the same period in 2008. The lower average ratepaid was primarily a result of Federal Reserve actions to reduce marketinterest rates.

 

**PROVISION FOR LOAN AND LEASELOSSES**

 

During the three and nine months ended September 30,2009, the Corporation recorded $14.7 million and $17.6 million in provision forloan and lease losses, respectively, as compared to approximately $290,000 and$950,000 for the same period in 2008. The increase in the provision for loanand lease losses was driven mainly by an increase in non-performing, impaired,and classified loan balances as well as an increase in charge-offs, all mainlydue to the effects of a recessionary economy. In addition, Management hasidentified a material weakness in internal controls related to the design andimplementation of policies to promptly identify problem loans and to quantifythe elements of risk in problem loans. The weakness caused a failure to accurately identify problem loans on atimely basis and a failure to accurately estimate the risk in the portfolio;this in turn caused a failure to accurately determine the appropriate Allowancefor Loan and Lease Losses.  Managementalso discovered a monitoring weakness that contributed to the characterizationof the status of certain loans to be classified as fully performing, when infact these loans were not. Additional information about our material weaknessin internal control and our remediation plan is provided in Item 4, “Controlsand Procedures.”  The percentage ofnon-performing loans to gross loans was 3.39% at September 30, 2009compared to 1.21% at December 31, 2008 and 0.40% at September 30,2008. The allowance for loan and lease losses as a percentage of gross loansand leases at September 30, 2009 was 2.45% compared to 1.10% at December 31,2008 and 1.07% at September 30, 2008. Net charge-offs for the nine monthsended September 30, 2009 were $4.2 million compared to approximately$190,000 for the same period in 2008.

 

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

 

The following chartpresents an analysis of the Allowance for Loan and Lease Losses:

 

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| ** **                                                                           | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                           | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Balance  at beginning of period                                                      |       | $                                           | 12,016     |                                       | $          | 8,433 |   | $ | 10,335 |   | $ | 7,817 |   |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Provision  charged to operating expense                                              |       | 14,678                                      |       | 290                                        |       | 17,637 |   | 950 |   |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Recoveries  of loans previously charged-off                                          |       | 90                                          |       | 36                                         |       | 339 |   | 233 |   |
| Loans  charged-off                                                                   |       | (3,183                                      | )          | (147                                       | )          | (4,549 | ) | (423 | ) |
| Net  loan charge-offs                                                                |       | (3,093                                      | )          | (111                                       | )          | (4,210 | ) | (190 | ) |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Allowance  other adjustment (1)                                                      |       | (167                                        | )          | 25                                         |       | (328 | ) | 60 |   |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Balance  at end of period                                                            |       | $                                           | 23,434     |                                       | $          | 8,637 |   | $ | 23,434 |   | $ | 8,637 |   |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Period-end  loans outstanding                                                        |       | $                                           | 957,502    |                                       | $          | 808,621 |   | $ | 957,502 |   | $ | 808,621 |   |
| Average  loans outstanding                                                           |       | $                                           | 949,263    |                                       | $          | 798,195 |   | $ | 944,851 |   | $ | 772,933 |   |
|                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Allowance  for loan and lease losses as a percentage of period-end loans outstanding |       | 2.45                                        | %          | 1.07                                       | %          | 2.45 | % | 1.07 | % |
| Net  charge-offs to average loans outstanding                                        |       | 0.33                                        | %          | 0.01                                       | %          | 0.45 | % | 0.02 | % |

 

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

 

Non-performingloans and leases include those on non-accrual status, loans past due 90 days ormore and still accruing, troubled debt restructurings and other loans deemedimpaired.  The Corporation’s policy is towrite down all non-performing loans to net realizable value.  Non-performing loans are generallycollateralized and are in the process of collection.  Non-accrual loans reduce the Corporation’searnings because interest income is not earned on such assets. The non-accrualloan and lease balance at September 30, 2009 was $15.8 million as comparedto $10.5 million at December 31, 2008 and $3.1 million at September 30,2008. Non-accrual loans and leases have increased during 2009 over 2008 becauseof the effects of a recessionary economy.

 

Other real estateowned (“OREO”) represents property owned by the Bank following default by theborrowers. OREO property acquired through foreclosure is initially transferredat fair value based on an appraised value less estimated cost to dispose.Adjustments are subsequently made to mark the property below this amount ifcircumstances warrant.  Losses arisingfrom foreclosure transactions are charged against the allowance for loanlosses. Costs to maintain real estate owned and any subsequent gains or lossesare included in the Corporation’s results of operations. The total OREObalance at September 30, 2009 was $3.1 million as compared to $1.9 millionat December 31, 2008 and approximately $346,000 at September 30,2008. OREO balances have increased during 2009 over 2008 because of increasedforeclosure activity, stemming from the recessionary economic conditions.

 

The following chartpresents detailed information regarding non-performing loans and leases andOREO:

 

(Dollars in thousands)

** **
| ** **                                                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                              | ** ** | **2009**               | ** ** | **2008**              | ** ** | **2008** | ** ** |
|                                                                                    |       |                   |       |                  |       |   |   |
| Past  due over 90 days and still accruing                                               |       | $                      | —     |                  | $          | 209 |   | $ | 870 |   |
| Non-accrual  loans and leases (1)                                                       |       | 15,787                 |       | 3,057                 |       | 10,514 |   |
| Restructured  and other impaired loans                                                  |       | 16,706                 |       | —                |       | — |   |
| Total  non-performing loans and leases                                                  |       | 32,493                 |       | 3,266                 |       | 11,384 |   |
|                                                                                    |       |                   |       |                  |       |   |   |
| Other  real estate owned                                                                |       | 3,062                  |       | 346                   |       | 1,872 |   |
| Total  non-performing assets                                                            |       | $                      | 35,555     |                  | $          | 3,612 |   | $ | 13,256 |   |
|                                                                                    |       |                   |       |                  |       |   |   |
| Non-performing  loans and leases as a percentage of total loans and leases              |       | 3.39                   | %          | 0.40                  | %          | 1.21 | % |
|                                                                                    |       |                   |       |                  |       |   |   |
| Allowance  for loan and lease losses as a percentage of non-performing loans and leases |       | 72.12                  | %          | 264.43                | %          | 90.78 | % |
|                                                                                    |       |                   |       |                  |       |   |   |
| Non-performing  assets as a percentage of total loans and other real estate owned       |       | 3.70                   | %          | 0.45                  | %          | 1.41 | % |
|                                                                                    |       |                   |       |                  |       |   |   |
| Allowance  for loan and lease losses as a percentage of non-performing assets           |       | 65.91                  | %          | 239.12                | %          | 77.96 | % |

 

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

 

The Corporationidentifies a loan as impaired when it is probable that interest and principalwill not be collected according to the contractual terms of the loan agreement.With the exception of troubled debt restructurings, the accrual of interest isdiscontinued on impaired loans and no income is recognized until all recordedamounts of interest and principal are recovered in full.

 

FASB Accounting StandardsCodification 310-10-35 “Receivables” requires the Corporation to individuallyexamine loans where it is probable that we will be unable to collect allcontractual interest and principal payments according to the contractual termsof the loan agreement and assess for impairment. The balance of impaired loanswas $32.5 million, $10.5 million, and $3.6 million at September 30, 2009, December 31,2008, and September 30, 2008, respectively.  The associated specific reserve for impairedloans was approximately $9.4 million, $856,000, and $233,000 at September 30,2009, December 31, 2008, and September 30, 2008, respectively.

 

For the three and ninemonth periods ended September 30, 2009, activity in the allowance forimpaired loan losses includes a provision of $7.4 million and $8.6 million,respectively, and charge-offs of $1.6 million and $2.9 million,respectively.  There were no recoveriesfor the three and nine months periods ended September 30, 2009.  Contractual interest not accrued on theseloans amounted to approximately $287,000 and $874,000 for the three and ninemonths ended September 30, 2009. Total cash collected on impaired loans for the three and nine monthsperiod ended September 30, 2009 was approximately $984,000 and $2.7million, respectively, all of which was applied to principal.  Loans returned to performing for the threeand nine months ended September 30, 2009 were approximately $106,000 and$799,000.Included inthe September 30, 2009 impaired loans balance are three commercial andcommercial real estate loans totaling $7.3 million for which original loanterms have been modified due to the borrowers’ financial difficulties.  As of September 30, 2009 these loans areperforming under the re-negotiated terms and as such are not classified asnon-accrual.  Two of the loans areclassified below as commercial real estate and are related to one commercialrelationship.  These loans total $5.6million of which the Corporation has allocated a specific reserve of $2.7million.  The remaining loan of $1.7million is a commercial loan which has been evaluated for impairment and hasresulted in no specific reserve.  Themajority of the remaining increase in the commercial impaired loans at September 30,2009 is attributable to one commercial relationship in the amount of $8.4million with a specific reserve of $2.0 million.  The loan is currently performing andmanagement continues to closely monitor the relationship.

 

For the three and ninemonth periods ended September 30, 2008, activity in the allowance forimpaired loan losses includes a provision of approximately $184,000 and$213,000, respectively, and charge-offs of $0 and approximately $6,000,respectively. There were no recoveries for the three-month period ended September 30,2008.  Contractual interest amounted toapproximately $42,000 and $98,000 for the three and nine months ended September 30,2008.  Total cash collected onnon-accrual loans for the three and nine months ended September 30, 2008was approximately $262,000 and $354,000 all of which was applied toprincipal.  Loans that returned toperforming for the three and nine months ended September 30, 2008 wereapproximately $140,000 and $160,000.

 

The following chartspresent additional information about impaired loans and lease balances as of September 30,2009 and December 31, 2008:

 

September 30, 2009

 
| ** **                                   | ** ** | ** **  | ** ** | ** **       | ** ** | **Number of** | ** ** | **Specific**    | ** ** |
|----------------------------------------------|------------|-------------|------------|------------------|------------|---------------|------------|-----------------|------------|
| ** **                                   | ** ** | **Loan**    | ** ** | **Impaired**     | ** ** | **Impaired**  | ** ** | **Allowance**   | ** ** |
| **(Dollars in thousands)**                   | ** ** | **Balance** | ** ** | **Loan Balance** | ** ** | **Loans**     | ** ** | **on Impaired** | ** ** |
| ** **                                   |       |        |       |             |       |          |       |            |       |
| Commercial  loans                            |       | $           | 346,174    |             | $          | 14,963        |       | 14              |       | $ | 2,919 |   |
| Real  estate – commercial               |       | 298,495     |       | 8,548            |       | 5             |       | 4,180           |       |
| Real  estate – commercial construction  |       | 66,255      |       | 2,300            |       | 2             |       | 85              |       |
| Real  estate – residential              |       | 79,793      |       | 1,004            |       | 3             |       | 250             |       |
| Real  estate – residential construction |       | 40,604      |       | 4,086            |       | 12            |       | 1,725           |       |
| Consumer  loans                              |       | 123,447     |       | 1,466            |       | 24            |       | 263             |       |
| Lease  financing receivables                 |       | 2,734       |       | 126              |       | 2             |       | —          |       |
|                                         |       |        |       |             |       |          |       |            |       |
| Totals                                       |       | $           | 957,502    |             | $          | 32,493        |       | 62              |       | $ | 9,422 |   |

 

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December 31, 2008

 
| ** **                                   | ** ** | ** **  | ** ** | ** **       | ** ** | **Number of** | ** ** | **Specific**    | ** ** |
|----------------------------------------------|------------|-------------|------------|------------------|------------|---------------|------------|-----------------|------------|
| ** **                                   | ** ** | **Loan**    | ** ** | **Impaired**     | ** ** | **Impaired**  | ** ** | **Allowance**   | ** ** |
| **(Dollars in thousands)**                   | ** ** | **Balance** | ** ** | **Loan Balance** | ** ** | **Loans**     | ** ** | **on Impaired** | ** ** |
|                                         |       |        |       |             |       |          |       |            |       |
| Commercial  loans                            |       | $           | 327,472    |             | $          | 3,632         |       | 20              |       | $ | 285 |   |
| Real  estate – commercial               |       | 280,549     |       | 1,650            |       | 2             |       | 126             |       |
| Real  estate – commercial construction  |       | 69,057      |       | —           |       | —        |       | —          |       |
| Real  estate – residential              |       | 87,413      |       | 3,876            |       | 13            |       | 350             |       |
| Real  estate – residential construction |       | 45,466      |       | —           |       | —        |       | —          |       |
| Consumer  loans                              |       | 125,318     |       | 1,166            |       | 30            |       | 95              |       |
| Lease  financing receivables                 |       | 4,808       |       | 190              |       | 4             |       | —          |       |
|                                         |       |        |       |             |       |          |       |            |       |
| Totals                                       |       | $           | 940,083    |             | $          | 10,514        |       | 69              |       | $ | 856 |   |

 

**NON-INTERESTINCOME**

** **

Total non-interestincome increased $10.7 million to $12.0 million for the three months ended September 30,2009, compared to $1.3 million for the same period in 2008.  Total non-interest income increased $37.3million to $44.3 million for the nine months ended September 30, 2009,compared to $7.0 million for the same period in 2008.

 

Of these increases in noninterest income, net gain from mortgage banking activity accounted for $10.2million and $34.3 million for the three and nine months ended September 30,2009, respectively. Net gain from mortgage banking activities relates to theMortgage Banking segment and consists of unrealized gains and losses oninterest rate lock commitments, loans held for sale, and forward salecommitments combined with realized gains and losses on the actual sale of theloan and the settlement of forward sale commitments. The increase in the netgain from mortgage banking activities during the same periods in 2008 wasprimarily from the addition of the AHB’s residential mortgage operations.

 

The distinguishingactivity within the Mortgage Banking segment is the origination and sale ofresidential mortgage and construction loans. This activity drives the net gainon mortgage banking activity line of the income statement. For the three andnine months ended September 30, 2009, this line was positively impacted bythe actions of the Federal Reserve to reduce market rates.  These actions resulted in mortgage interestrates declining, beginning in December 2008.  The decline in rates was advantageous toconsumers, leading many borrowers to refinance their existing mortgageloan.  The increase in refinance activityreduced the negative impact from weak new and existing home sale sectors.  The residential mortgage division originated$1.95 billion of loans during the nine months ended September 30, 2009with refinance activity accounting for 64%, or $1.25 billion of the total.  Loans for the purchase of new or existinghomes totaled $645 million, or 33% of total originations, while loans toindividual borrowers for construction of single-family residences were $52million, or 3% of total originations.

 

Loan fees and other wasapproximately $738,000 and $3.6 million for the three and nine months ended September 30,2009, compared to approximately $118,000 and $298,000 during the same period in2008. Loan fees and other primarily relate to the Mortgage Banking segment andconsist mainly of fees earned at the inception of a loan as well as fees earnedon the servicing of residential loan portfolios not owned by the Bank. Loanfees and other also includes gains and losses on the Bank’s mortgage servicingrights. The increase in loan servicing fees was due to the addition of the AHBdivision’s mortgage operations.

 

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During the third quarter of 2009, the Corporationrecorded a $1.6 million other than temporary impairment charge on four bankingsecurities in the third quarter of 2009. The securities are publically tradedstock of well-known, established bank holding companies. During the quarter,Management concluded that the impairment on the securities is other thantemporary mainly due to continued deterioration of the financial condition ofthese companies and Management’s conclusion that the Corporation may no longerhave the intent to hold these securities until anticipated recovery.

 

Asset impairment of $1.3 million in 2008 related tothe write-down of certain securities in 2008. In the third quarter of 2008, theCorporation recorded an approximately $850,000 pre-tax other than temporaryimpairment loss on a $1.0 million Lehman Brothers note held in the Bank’sinvestment portfolio. In the third quarter of 2008, the Corporation alsorecorded a pretax loss of approximately $417,000 on a $13.9 million overnightinvestment in the Reserve Primary Fund. The Reserve Primary Fund was a shortterm overnight money market fund designed to maintain a constant $1.00 pershare value. The Bank typically used this type of fund to invest excessovernight cash. During the third quarter of 2008, the Fund’s value fell below$1.00 per share due to underlying Lehman Brothers commercial paper in the fund.The Fund is currently in process of liquidation. The Bank wrote its $13.9million investment down to $13.5 million in the third quarter of 2008 andsubsequently received $12.5 million over the remainder of 2008 and 2009. TheBank fully expects to realize the remaining $1.0 million.

 

Wealth management andadvisory services revenue remained relatively flat for the three months ended September 30,2009, as compared to 2008 but decreased approximately $138,000 or 4.5% to $2.9million for the nine months ended September 30, 2009 from $3.1 millionduring the same period in 2008. Wealth management and advisory services revenueis based largely on the market value of assets under management.  The decrease in wealth management andadvisory services revenue for the nine months ended September 30, 2009 wasprimarily due to a decrease in the average market value of these assets betweenthe two periods. The decline in market value was driven by a decline in themarket values of the underlying securities within the assets under management.

 

The Corporation recognizeda net gain of approximately $1,000 on sales of investment securities during thethree month period ended September 30, 2009, compared with a net gain ofapproximately $89,000 during the same period in 2008.  The Corporation recognized a net gain of approximately$1,000 on sales of investment securities during the nine month period ended September 30,2009, compared with a net gain of approximately $273,000 during the same periodin 2008.  These net gains and losses weretaken as a result of normal portfolio management.

 

Gains on fixed assets andOREO increased approximately $285,000 and $312,000 for the three and ninemonths ended September 30, 2009 as compared to 2008. These increases weredue primarily to an approximately $114,000 gain from the sale of operatinglease equipment in the third quarter of 2009 combined with an approximately$169,000 loss recorded in the third quarter of 2008 from the write-down to fairmarket value of two OREO properties.

 

Other non-interest incomeincreased 15.3% or approximately $69,000 to $521,000 for the three-month periodended September 30, 2009.  Othernon-interest income increased approximately $179,000 or 12.8% to $1.6 millionfor the nine months ended September 30, 2009, compared to same period in2008.  The increase for the three andnine month periods are primarily due to increases in various fee income earnedfrom the AHB operations.

 

Wealth management andadvisory services revenue, service charges on deposit accounts, gains andlosses on investment securities, operating lease rental income, gains on thesale of fixed assets and OREO and nearly all of other non-interest income areincluded within the results of the community banking segment. Nearly all of loanservicing fees and other and all of net gain from mortgage banking activitiesare included within the mortgage banking segment.

 

**NON-INTEREST EXPENSE**

 

Total non-interestexpense increased $14.7 million to $23.4 million for the three-month periodended September 30, 2009, compared to $8.6 million during the same periodin 2008.  Total non-interest expenseincreased $41.8 million to $66.8 million for the nine months ended September 30,2009, from $25.1 million during the same period in 2008.

 

Salaries and employeebenefits increased $10.1 million to $14.9 million for the three month periodended September 30, 2009 compared to the same period in 2008. Salaries andemployee benefits increased $28.9 million to $42.7 million for the nine monthperiod ended September 30, 2009 compared to the same period in 2008. Thehigher salary and benefits expense was primarily due to the addition of the AHBoperations at December 31, 2008.

 

Salaries and relatedexpenses allocable to the Mortgage Banking segment consist of commissions paidto employees involved in the loan origination process, as well as compensation,payroll taxes and benefits paid to employees in the mortgage productionoperations and allocations for overhead.

 

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Salaries directlyattributable to the Mortgage Banking segment totaled $8.5 million for thequarter and $24.7 million for the nine months ended September 30, 2009. Ofthese amounts, variable compensation, that is compensation paid to loanoriginators, accounted for $5.4 million, or 64% of the total for the threemonths ended and $16.6 million or 67% for the nine months ended September 30,2009. This variable compensation amounts to 0.85% of total originations, a ratetypical in the mortgage banking industry.

 

Net occupancy, equipmentand data processing expense increased $1.8 million or 123.6% to $3.2 millionfor the three months ended September 30, 2009, when compared to the sameperiod in 2008.  Net occupancy, equipmentand data processing expense increased $4.5 million or 104.4% to $8.9 millionduring the nine months ended September 30, 2009, when compared to the sameperiod in 2008.  Approximately $1.4million and $3.6 million of these increases were due to the addition of AHB’soperations for the three and nine months ended September 30, 2009.Occupancy, equipment and data processing expense from AHB’s operations includethe operations of administrative facilities as well as two branches combinedwith IT systems operations. The increase was also attributable to the openingof the new Jennersville grocery store branch as well as the opening of the newOne North High Street administrative complex in the first quarter of 2009. Theyear to date 2009 expense also includes approximately $187,000 ofmerger-related IT system conversion expense recorded in the second quarter of2009.

 

FDIC insurance premiums increased approximately$286,000 or 210.3% to approximately $422,000 for the three months ended September 30,2009, from approximately $136,000 during the same period in 2008.  FDIC insurance premiums increased $1.6million or 446.7% to $1.9 million for the nine month period ended September 30,2009, from approximately $347,000 during the same period in 2008.  In 2008 and 2009, the FDIC adopted rules thatincreased FDIC premiums significantly for all banks for assessment periodsbeginning in the first quarter of 2009. In addition, the FDIC instituted aspecial assessment for all banks for the second quarter of 2009. FDIC DepositInsurance expense for the nine months ended September 30, 2009 includesapproximately $673,000 for this special assessment, recorded in the secondquarter of 2009. The increased premium as well as the special assessment willcause the Bank’s 2009 FDIC premiums and assessment expense to increasesignificantly over 2008.

 

Professional servicesexpense increased $1.6 million to $2.0 million for the three month period endedSeptember 30, 2009 from $449 thousand for the same period in 2008.  Professional services expense increased $3.6million or 262.7% to $5.0 million for the nine month period ended September 30,2009 from $1.4 million for the same period in 2008.  Approximately $1.0 million and $2.8 millionof the increase in professional fees are due to increased legal, consulting andaudit fees from the addition of AHB’s operations. The balance of the increasewas due to increased legal, audit and consulting fees related to theintegration of AHB, as well as other company initiatives.

 

Marketing expenseincreased approximately $166,000 or 97.1% to approximately $337,000 for thethree month period ended September 30, 2009, from approximately $171,000for the same period in 2008.  Marketingexpense increased approximately $457,000 or 64.9% to $1.2 million for the ninemonth period ended September 30, 2009, from approximately $704,000 for thesame period in 2008. The increases for the three and nine month periods wereprimarily due to the addition of AHB’s operations.

 

Total other non-interestexpense increased approximately $820,000 or 74.3% to $1.9 million for thethree-month period ended September 30, 2009, from $1.1 million for thesame period in 2008.  Total othernon-interest expense increased $2.5 million or 81.7% to $5.6 million for thenine month period ended September 30, 2009 from $3.1 million for the sameperiod in 2008. Most of the increases are due to the addition of AHB’soperations.

 

**INCOME TAXES**

 

Income tax expense for the three months ended September 30,2009 was a $5.0 million benefit compared to approximately $148,000 of expensefor same period in 2008. Income tax expense was a $3.0 million benefit for thenine months ended September 30, 2009, compared to a $1.3 million expensefor the same periods in 2008. Income tax expense is negative for the three andnine month periods in 2009 because of a net operating loss combined with theeffect of permanent tax benefit items.

 

**LIQUIDITY MANAGEMENT AND INTERESTRATE SENSITIVITY**

 

**Liquidity Management**

 

The objective of liquidity management is toensure the availability of sufficient cash flows to meet all financialcommitments and to capitalize on opportunities for business expansion.  Liquidity management addresses theCorporation’s ability to meet 

 

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depositwithdrawals either on demand or at contractual maturity, to repay borrowings asthey mature and to make new loans and investments as opportunities arise.  Liquidity is managed on a daily basis enablingManagement to monitor changes in liquidity and to react accordingly tofluctuations in market conditions.  Theprimary sources of liquidity for the Corporation are funding available from thegrowth of the existing deposit base, new deposits, FHLB, Federal Reserve andcash flow from the investment and loan portfolios.  The Corporation considers funds from suchsources to comprise its “core” funding sources because of the historicalstability of such sources of funds. Additional liquidity comes from the Corporation’s non-interest bearingdemand deposit accounts and credit facilities. Other deposit sources include a tiered savings product and certificatesof deposit in excess of $100,000. Details of core deposits, non-interestbearing demand deposit accounts, and other deposit sources are highlighted inthe following table:

 

(Dollars inthousands)

 
| ** **                          | ** ** | **For  the Nine Months Ended  September 30, 2009** | ** ** | **For  the Year Ended**********December 31, 2008** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **Average**                                             | ** ** | **Effective**                                           | ** ** | **Average** | ** ** | **Effective** | ** ** |
| ** **                          | ** ** | **Balance**                                             | ** ** | **Yield**                                               | ** ** | **Balance** | ** ** | **Yield** | ** ** |
| **DEPOSIT TYPE**                    |       |                                                    |       |                                                    |       |   |   |   |   |
| NOW Accounts                        |       | $                                                       | 188,693    |                                                    | 0.83       | % | $ | 179,512 |   | 1.64 | % |
| Money Market                        |       | 159,486                                                 |       | 1.21                                                    | %          | 117,393 |   | 2.46 | % |
| Statement Savings                   |       | 41,026                                                  |       | 0.58                                                    | %          | 40,300 |   | 0.70 | % |
| Other Savings                       |       | 1,844                                                   |       | 0.97                                                    | %          | 2,802 |   | 1.50 | % |
| Tiered Savings                      |       | 46,062                                                  |       | 1.09                                                    | %          | 48,915 |   | 1.30 | % |
| Total NOW Savings, and Money Market |       | 437,111                                                 |       | 0.97                                                    | %          | 388,922 |   | 1.75 | % |
|                                |       |                                                    |       |                                                    |       |   |   |   |   |
| CDs Less than $100,000              |       | 290,260                                                 |       | 2.64                                                    | %          | 162,650 |   | 3.73 | % |
| CDs Greater than $100,000           |       | 138,685                                                 |       | 2.84                                                    | %          | 74,822 |   | 3.90 | % |
| Total CDs                           |       | 428,945                                                 |       | 2.71                                                    | %          | 237,472 |   | 3.78 | % |
|                                |       |                                                    |       |                                                    |       |   |   |   |   |
| Total Interest Bearing Deposits     |       | 866,056                                                 |       |                                                    |       | 626,394 |   |   |   |
|                                |       |                                                    |       |                                                    |       |   |   |   |   |
| Non-Interest Bearing                |       |                                                    |       |                                                    |       |   |   |   |   |
| Demand Deposits                     |       | 148,424                                                 |       |                                                    |       | 120,941 |   |   |   |
|                                |       |                                                    |       |                                                    |       |   |   |   |   |
| Total Deposits                      |       | $                                                       | 1,014,480  |                                                    |       |   | $ | 747,335 |   |   |   |

 

The Bank maintainsseveral credit facilities with the FHLB as well as the Federal Reserve andother Banking institutions.  During thethree and nine month periods ended September 30, 2009, average FHLBadvances and other borrowings were $202.9 million and $201.9 million,respectively, and consisted of term advances with a variety of maturities.  The average interest rate paid on theseadvances was 3.05% during the third quarter of 2009.  The Bank currently has a maximum borrowingcapacity with FHLB of approximately $340.0 million.  FHLB advances are collateralized by a pledgeon the Bank’s portfolio of unencumbered investment securities, certain mortgageloans, and a lien on the Bank’s FHLB stock. The Bank also has $245.9 million ofborrowing capacity with the Federal Reserve. Federal Reserve borrowings arecollateralized by a pledge on certain mortgage loans and a lien on the Bank’sFederal Reserve stock.

 

**InterestRate Sensitivity**

 

The goal ofinterest rate sensitivity management is to avoid fluctuating net interest margins,and to enhance consistent growth of net interest income through periods ofchanging interest rates.  Suchsensitivity is measured as the difference in the volume of assets andliabilities in the existing portfolio that are subject to repricing in a futuretime period.  The Corporation’s netinterest rate sensitivity gap within one year is a negative $289.3 million or22.1% of total assets at September 30, 2009, compared with a negative$292.9 million or 22.5% of total assets at December 31, 2008.  The Corporation’s gap position is one toolused to evaluate interest rate risk and the stability of net interestmargins.  Another tool that managementuses to evaluate interest rate risk is a computer simulation model thatassesses the impact of changes in interest rates on net interest income undervarious interest rate forecasts and scenarios. Management has set acceptable limits of risk within its Asset 

 

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LiabilityCommittee (“ALCO”) policy and monitors the results of the simulations againstthese limits quarterly.  As of the mostrecent quarter-end, all results are within policy limits and indicate anacceptable level of interest rate risk. Management monitors interest rate riskas a regular part of corporate operations****with theintention of maintaining a stable net interest margin. The following tablepresents our interest rate sensitivity analysis as of September 30, 2009:

 

(Dollars in thousands)

 
| ** **                                                        | ** ** | ** **   | ** ** | **Two**        | ** ** | **Over**  | ** ** | ** **    | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|--------------|------------|----------------|------------|-----------|------------|---------------|------------|------------|------------|
| ** **                                                        | ** ** | **Within**   | ** ** | **through**    | ** ** | **five**  | ** ** | **Non-rate**  | ** ** | ** ** | ** ** |
| ** **                                                        | ** ** | **one year** | ** ** | **five years** | ** ** | **years** | ** ** | **sensitive** | ** ** | **Total**  | ** ** |
| ASSETS                                                            |       |         |       |           |       |      |       |          |       |       |       |
| Federal funds sold and overnight investments                      |       | $            | 2,347      |           | $          | —    |       | $             | —     |       | $          | — |   | $ | 2,347 |   |
| Investment securities                                             |       | 58,706       |       | 14,858         |       | 4,173     |       | 12,129        |       | 89,866     |       |
| Interest bearing deposits in banks                                |       | 1,497        |       | —         |       | —    |       | —        |       | 1,497      |       |
| Loans held for sale                                               |       | 187,521      |       | —         |       | —    |       | —        |       | 187,521    |       |
| Net loans and leases                                              |       | 396,012,     |       | 402,514        |       | 158,976   |       | (23,434       | )          | 934,068    |       |
| Cash and due from banks                                           |       | —       |       | —         |       | —    |       | 19,107        |       | 19,107     |       |
| Premises and equipment                                            |       | —       |       | —         |       | —    |       | 23,142        |       | 23,142     |       |
| Other assets                                                      |       | —       |       | —         |       | —    |       | 49,133        |       | 49,133     |       |
| Total assets                                                      |       | $            | 646,083    |           | $          | 417,372   |       | $             | 163,149    |       | $          | 80,077 |   | $ | 1,306,681 |   |
|                                                              |       |         |       |           |       |      |       |          |       |       |       |
| LIABILITIES AND CAPITAL                                           |       |         |       |           |       |      |       |          |       |       |       |
| Non-interest bearing deposits                                     |       | $            | —     |           | $          | —    |       | $             | —     |       | $          | 153,299 |   | $ | 153,299 |   |
| Interest bearing deposits                                         |       | 791,799      |       | 33,809         |       | 7,208     |       | —        |       | 832,816    |       |
| FHLB advances and otherBorrowings                                 |       | 128,107      |       | 74,016         |       | —    |       | —        |       | 202,123    |       |
| Subordinated debentures                                           |       | 15,465       |       | —         |       | 5,330     |       | —        |       | 20,795     |       |
| Other liabilities                                                 |       | —       |       | —         |       | —    |       | 16,270        |       | 16,270     |       |
| Capital                                                           |       | —       |       | —         |       | —    |       | 81,378        |       | 81,378     |       |
| Total liabilities & capital                              |       | $            | 935,371    |           | $          | 107,825   |       | $             | 12,538     |       | $          | 250,947 |   | $ | 1,306,681 |   |
| Net interest rate sensitivity gap                                 |       | $            | (289,288   | )              | $          | 309,547   |       | $             | 150,611    |       | $          | (170,870 | ) |   |   |
| Cumulative interest rate sensitivity gap                          |       | $            | (289,288   | )              | $          | 20,259    |       | $             | 150,611    |       | $          | — |   |   |   |
| Cumulative interest rate sensitivity gap divided by  total assets |       | (22.1        | )%         | 1.6            | %          | 13.1      | %          |          |       |       |       |

# ** **

**BRANCHING,TECHNOLOGY AND CAPITAL PROJECTS**

 

During the firstquarter of 2009, the Bank completed renovations on a new office buildinglocated at One North High Street in West Chester, PA. The building, along withand adjacent to our main branch and existing facility at Nine North High Streetwill serve as the Corporation’s headquarters. During the first quarter of 2009, the Bank also opened a new grocerystore branch in Jennersville, PA. Technological improvements, includingenhanced security over customer information, a more proactive disaster recoverysystem and an improved infrastructure to support more internet banking productsare also expected in the future. We are continuously looking for appropriateopportunities to expand our branch system and invest in technology to betterserve our customers.

 

**CAPITAL****ADEQUACY**

 

The Corporation issubject to Risk-Based Capital Guidelines adopted by the Federal Reserve Boardfor bank holding companies.  The Bank isalso subject to similar capital requirements adopted by the OCC. Under theserequirements, the regulatory agencies have set minimum thresholds for Tier ICapital, Total Capital, and Leverage ratios. At September 30, 2009, both the Corporation’s and the Bank’scapital exceeded all minimum regulatory requirements, and the Bank wasconsidered “well capitalized” as defined in the regulations issued pursuant tothe FDIC Improvement Act of 1992. Subsequent to September 30, 2009,the OCC is requiring the Bank to increase its Tier 1 leverage capitalratio to not less than 8%, its Tier 1 risk-based capital ratio to not less than10% and its total risk-based capital ratio to not less than 12% by December 31,2009.

 

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InApril 2009, the Corporation completed the placement of $5,175,000aggregate liquidation amount of fixed rate trust preferred securities (the “TrustPreferred Securities”), through a newly formed subsidiary, First Chester CountyCapital Trust IV, a wholly owned Delaware statutory trust (the “Trust”). Inconnection with the sale of the Trust Preferred Securities, the Corporationissued $5,330,000 of junior subordinated deferrable interest debentures (the “Debentures”)to the Trust. The Trust Preferred Securities and the Debentures have a 30 yearmaturity, and carry a fixed rate of interest of 12.0%. The Corporation hasretained the right to redeem the Trust Preferred Securities at par (plusaccrued but unpaid interest) on any interest payment date on or after April 28,2014.

 

The Corporation’s trustpreferred subsidiaries are deconsolidated in accordance with GAAP and therelated securities qualify as Tier 1 capital under federal regulatoryguidelines.  These instruments are subject to a 25% capitallimitation under risk-based capital guidelines developed by the Federal ReserveBoard. In March 2005, the Federal Reserve Board amended its risk-basedcapital standards to expressly allow the continued limited inclusion ofoutstanding and prospective issuances of trust preferred securities in a bankholding company’s Tier 1 capital, subject to tightened quantitative limits. TheFederal Reserve’s amended rule was to become effective March 31,2009, and would have limited trust preferred securities and other restrictedcore capital elements to 25% of all core capital elements, net of goodwill lessany associated deferred tax liability.  On March 16, 2009, theFederal Reserve Board extended for two years the ability of bank holdingcompanies to include restricted core capital elements as Tier 1 capital up to25% of all core capital elements, including goodwill. The portion that exceedsthe 25% capital limitation qualifies as Tier 2, or supplementary capital of theCorporation. At September 30, 2009, the entire $20.8 million in trustpreferred securities qualify as Tier 1.

 
| ** **                     | ** ** | **As of September 30,** | ** ** | **As of December 31,** | ** ** | **“Well  Capitalized”** | ** ** |
|--------------------------------|------------|------------------------------|------------|-----------------------------|------------|-----------------------------------|------------|
| ** **                     | ** ** | **2009**                     | ** ** | **2008**                    | ** ** | **2008**                          | ** ** | **Requirements (1)** | ** ** |
| Corporation                    |       |                         |       |                        |       |                              |       |   |   |
| Leverage Ratio                 |       | 7.02                         | %          | 8.66                        | %          | 9.87                              | %          | N/A |   |
| Tier I Capital Ratio           |       | 8.96                         | %          | 10.04                       | %          | 9.14                              | %          | N/A |   |
| Total Risk-Based Capital Ratio |       | 10.23                        | %          | 11.10                       | %          | 10.15                             | %          | N/A |   |
| Bank                           |       |                         |       |                        |       |                              |       |   |   |
| Leverage Ratio                 |       | 7.21                         | %          | 8.03                        | %          | 9.95                              | %          | 5.00 | % |
| Tier I Capital Ratio           |       | 9.21                         | %          | 9.31                        | %          | 9.40                              | %          | 6.00 | % |
| Total Risk-Based Capital Ratio |       | 10.47                        | %          | 10.38                       | %          | 10.42                             | %          | 10.00 | % |

 

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(1)   Subsequent to September 30, 2009,the OCC required the Bank to increase its Tier 1 leverage capitalratio to not less than 8%, its Tier 1 risk-based capital ratio to not less than10% and its total risk-based capital ratio to not less than 12% by December 31,2009.

 

**REGULATORY MATTERS**

 

On October 16,2009, the Board of Directors of the Bank entered into an MOU with theOCC.  An MOU with regulatory authorities is an informal action thatis not published or publicly available and that is used when circumstanceswarrant a milder form of action than a formal supervisory action, such as aformal written agreement or order. Among other things, under the MOU, the Bankhas agreed to address the following matters:

 

·      Develop a comprehensive three-year capital plan;

 

·      Take action to protect criticized assets and adopt andimplement a program to eliminate the basis of criticism of such assets;

 

·      Establish an effective program that provides for earlyproblem loan identification and a formal plan to proactively manage thoseassets;

 

·      Review the adequacy of the Bank’s informationtechnology activities and Bank Secrecy Act compliance and approve writtenprograms of policies and procedures to provide for compliance; and

 

·      Establish a Compliance Committee of the Board tomonitor and coordinate the Bank’s adherence to the provisions of the MOU.

 

The Board of Directors and management have already initiated correctiveactions to comply with the provisions of the MOU.

 

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Subsequent to September 30,2009, the OCC has also required the Bank to increase its Tier 1leverage capital ratio to not less than 8%, its Tier 1 risk-based capital ratioto not less than 10% and its total risk-based capital ratio to not less than12% by December 31, 2009.

 

The Company hasalso received notice from the Federal Reserve, the primary regulator of the Corporation,that the Federal Reserve must approve any dividends to be paid by theCorporation in advance of the declaration or payment of the dividend.

 

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

 

There have been nomaterial changes in the Corporation’s assessment of its sensitivity to marketrisk since its presentation in the 2008 Annual Report. Please refer to Item 7Aof the Corporation’s 2008 Annual Report for more information.

 

**ITEM4.  CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures**

 

As of September 30,2009, the end of the period covered by this Quarterly Report on Form 10-Q,an evaluation of the effectiveness of our disclosure controls and procedures(as defined in Rules 13(a)-15(e) and 15(d)-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) wasperformed under the supervision and with the participation of Management,including our President and CEO, Chief Operating Officer and our ChiefFinancial Officer. Based on that evaluation and the identification of thematerial weakness in our internal control over financial reporting as describedbelow, Management has concluded that our disclosure controls and procedureswere not effective to ensure that information required to be disclosed by us inthe reports that we file or submit under the Exchange Act is (i) recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and (ii) accumulatedand communicated to  Management asappropriate to allow timely decisions regarding required disclosures.

 

**Changesin Internal Control over Financial Reporting**

 

Management has identifieda material weakness in internal controls related to the design andimplementation of policies to promptly identify problem loans and to quantifythe elements of risk in problem loans. The weakness caused a failure to accurately identify problem loans on atimely basis and a failure to accurately estimate the risk in the portfolio;this in turn caused a failure to accurately determine the appropriate Allowancefor Loan and Lease Losses.  We alsodiscovered a monitoring weakness that contributed to the characterization ofthe status of certain loans to be classified as fully performing, when in factthese loans were not.  The Corporationengaged a nationally recognized, third-party loan review advisor to carefullyevaluate the Bank’s loan portfolio as well as recommend changes to the CreditAdministration process.  This evaluationcovered all of the Bank’s larger customers and resulted in an evaluation ofmore than 75% of the dollar value of the Bank’s commercial loan portfolio. As aresult, the Bank increased the Allowance for Loan and Lease Losses to $23.4million after completing its own analysis and receiving and incorporating theresults of the third-party review.

 

**Remediation of Material Weakness**

 

In response to thematerial weakness identified, the following summarizes the activities andprocedures that will be utilized to remediate the material weakness, includingchanges specifically made during the period covered by this report.

 

·      We have separated the CreditAdministration function from the Lending function to segregate these duties andto improve internal controls.

·      We plan to add an experienced CreditAdministration Senior Officer to improve our problem loan identification, loanrisk grading effectiveness, credit administration effectiveness and to furthersegregate the loan approval process.

·      We are evaluating credit concentrationsin the commercial real estate area and plan to limit growth in this area

·      We have developed a more effectiveprocess for estimating the allowance for loan and lease losses. The specificelements of improvement are:

·      The involvement of more experiencedpersonnel, including the Chief Operating Officer and the Chief Credit AdministrationOfficer in the accumulation of information and the development of theestimation of the periodic allowance for loan and lease losses. Theseindividuals evaluate the reasonableness of loan grade factors, the appropriateallocated reserve amounts and individual loan impairment amounts as part of theprocess.

 

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·      Timely monitoring of past due accountsand customer contacts (primarily by Credit Administration), which increases theearly identification of loan grading differences and more timely identificationof loans for impairment evaluation.

·      We will continue to utilize anIndependent Loan Review Advisory firm to assist us in identifying, evaluatingand risk grading our loans for the foreseeable future.

·      We continue to assess current lending andcredit administration policies and procedures, and are revising them asnecessary to develop and implement policies and procedures that will promote aculture of compliance and accountability.

 

The Board of Directors isactively monitoring these remediation efforts and may direct additionalmeasures as deemed appropriate. We cannot be certain how long it will take tofully implement the remediation plan, whether the remediation plan will beeffective to maintain adequate controls over our financial process andreporting in the future, or whether the remediation plan will be sufficient toaddress and eliminate the material weakness.

 

Except for the matters discussed above there were nochanges in our internal control over financial reporting that occurred during,or subsequent to, the period covered by this report that have materiallyaffected, or are reasonably likely to materially affect, the internal controlenvironment over financial reporting.

 

**PART II - OTHER INFORMATION**

 

**Item 1.****                   ****Legal Proceedings**

 

There are no material pending legal proceedings, otherthan ordinary routine litigation incidental to the business, to which theCorporation, or any of its subsidiaries, is a party or of which any of theirrespective property is the subject.

 

**Item 1A.****                ****Risk Factors**

 

Fora summary of risk factors relevant to our operations, see Part 1, Item 1A,“Risk Factors” in our 2008 Annual Report on Form 10-K for the year ended December 31,2008.  There are no material changes inthe risk factors relevant to our operations, except as discussed below.

 

**We presentlyare subject to, and in the future may become subject to, regulatory enforcementactions that could have a material adverse effect on our business, operations,financial condition, results of operations or the value of our common stock.**

 

Under federal and statelaws and regulations pertaining to the safety and soundness of insureddepository institutions, various state regulators (for state chartered banks),the Federal Reserve (for bank holding companies), the Office of the Comptrollerof the Currency (for national banks) and separately the Federal DepositInsurance Corporation (“FDIC”) as the insurer of bank deposits, have theauthority to compel or restrict certain actions on our part if they determinethat we have insufficient capital or are otherwise operating in a manner thatmay be deemed to be inconsistent with safe and sound banking practices. Underthis authority, our bank regulators can require us to enter into informal orformal enforcement orders, including board resolutions, memoranda of understanding,written agreements and consent or cease and desist orders, pursuant to which wewould be required to take identified corrective actions to address citedconcerns and to refrain from taking certain actions.

 

In October 2009, themembers of the Board of Directors of the Bank entered into an MOU with the OCCto address certain issues that arose in the Bank’s most recent regulatoryexamination. The issues required to be addressed by management include, amongother matters, to improve our loan portfolio and credit risk management andrelated policies and procedures, address liquidity management and current andfuture capital requirements, and strengthen enterprise risk management and BankSecrecy Act practices. In November 2009, the OCC also required the Bank toincrease its Tier 1 leverage capital ratio to not less than 8%, its Tier 1risk-based capital ratio to not less than 10% and its total risk-based capitalratio to not less than 12% by December 31, 2009.

 

If we are unable tocomply with the terms of the MOU, or if we are unable to comply with the termsof any future regulatory orders to which we may become subject, then we couldbecome subject to additional, heightened supervisory actions and orders,possibly including cease and desist orders, prompt corrective actions and/orother regulatory enforcement actions. If our regulators were to take suchadditional supervisory actions, then we could, among other things, becomesubject to significant restrictions on our ability to develop any new business,as well as restrictions on our existing business. The terms of any suchsupervisory action could have a material adverse effect on our business,operating flexibility, financial condition and the value of our common stock.

 

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**We are required to maintain capital to meetregulatory requirements, and if we fail to maintain sufficient capital, whetherdue to losses, an inability to raise additional capital or otherwise, ourfinancial condition, liquidity and results of operations, as well as ourregulatory requirements, would be adversely affected.**

 

Both we and theBank must meet regulatory capital requirements and maintain sufficientliquidity. The OCC recently required that the Bank achieve a Tier 1 leveragecapital ratio of not less than 8%, its Tier 1 risk-based capital ratio of notless than 10% and its total risk-based capital ratio of not less than 12% by December 31,2009, which are higher than the stated minimum capital ratios. Our ability toraise additional capital, when and if needed, will depend on conditions in thecapital markets, economic conditions and a number of other factors, includinginvestor perceptions regarding the banking industry and market conditions, andgovernmental activities, many of which are outside our control, and on ourfinancial condition and performance. Accordingly, we cannot assure you that wewill be able to raise additional capital if needed or on terms acceptable tous. If we fail to meet these capital and other regulatory requirements we maybe subject to further enforcement actions pursuant to which we would berequired to take identified corrective actions to address cited concerns and torefrain from taking certain actions. These actions may materially and adversely affect our financialcondition, liquidity and results of operations.

 

Our failure to remain “wellcapitalized” for bank regulatory purposes could affect customer confidence, ourability to grow, our costs of funds and FDIC insurance costs, our ability topay dividends on our common stock, our ability to make distributions on ourtrust preferred securities, our ability to make acquisitions, our interestrates and our business, results of operation and financial conditions,generally.

 

**We depend primarily on dividends from the Bank forcash revenues, but those dividends are subject to restrictions under the MOUand bank regulations.**

 

Our ability to satisfy our obligations and pay cash dividends to ourshareholders is primarily dependent on the earnings of and dividends from theBank. However, payment of dividends by the Bank is limited by our MOU with the OCCand by dividend restrictions and capital requirements imposed by bankregulations. Under the MOU, the Bank is required to request supervisoryapproval to dividend any funds to us. We currently have $3.0 million ofunsecured short-term borrowings which are due to be paid on November 20, 2009.In the event the Bank is not permitted by the OCC to dividend funds to us inconnection with this debt repayment, we may be in default under the terms ofthe loans. More generally, in the event the Bank is unable to pay dividends tous, we may not be able to service our debt, pay our obligations or paydividends on our common stock.

 

**Ourdisclosure controls and procedures and internal control over financialreporting were determined not to be effective as of September 30, 2009, asevidenced by a material weakness that existed in our internal controls. Ourdisclosure controls and procedures and internal control over financialreporting may not be effective in future periods, as a result of newlyidentified material weakness in internal controls.**

 

Effective internalcontrol over financial reporting is necessary for compliance with theSarbanes-Oxley Act of 2002 and appropriate financial reporting. Management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Internal control over financial reporting is a process,under the supervision of the Corporation’s Chief Executive Officer and ChiefFinancial Officer, designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of  our financial statements for externalreporting purposes in accordance with GAAP. As disclosed in this QuarterlyReport on Form 10-Q, management’s assessment of our internal control overfinancial reporting identified a material weakness as discussed in *Item 4. Controls and Procedures*. Amaterial weakness is a deficiency in internal control over financial reporting,such that there is a reasonable possibility that a material misstatement of theCorporation’s annual or interim financial statements will not be prevented or detectedon a timely basis. See *Item 4. Controlsand Procedures*of this Form 10-Q for remediation status of the materialweakness identified. However, there can be no assurance that additionalmaterial weaknesses will not be identified in the future. We are committed tocontinuing to improve our internal control processes and we will continue todiligently and vigorously review our financial reporting controls andprocedures. As we continue to evaluate and improve our internal control overfinancial reporting, we may determine to take additional measures to addressinternal control deficiencies or determine to modify certain of the remediationmeasures described herein. We will continue to be at an increased risk that ourfinancial statements could contain errors that will be undetected, and we willcontinue to incur significant expense and management burdens associated withthe additional procedures required to prepare our consolidated financialstatements.

 

**Item 2.****                   ****Unregistered Sales ofEquity Securities and Use of Proceeds**

 

The Corporation announcedon November 16, 2007, a program to repurchase up to $10.0 million of theCorporation’s Common Stock. This program expires in November 2009. Thisprogram replaced a previous program that expired in October 2007. Nopurchases have been made under the program during the three months ended September 30,2009.

 

There were no sales bythe Corporation of unregistered securities during the three months ended September 30,2009.

 

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

 

None.

 

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**Item 4.****   ****Submission of Matters to aVote of Security Holders**

 

The SpecialMeeting of Shareholders of the Corporation was held on September 1, 2009(the “Meeting”).  Notice of the Meetingwas mailed to shareholders of record on or about August 6, 2009, togetherwith proxy solicitation materials prepared in accordance with Section 14(a) ofthe Securities Exchange Act of 1934, as amended, and the regulationspromulgated there under.

 

There were twomatters submitted to a vote of shareholders at the meeting.

 

1.     To amend the Corporation’s By-Laws topermit the issuance of uncertificated shares (“Proposal One”)

 

2.     To amend the Corporation’s Articles ofIncorporation and By-Laws to permit the Board of Directors the flexibility, ifneeded, to amend the By-Laws (“Proposal Two”).

 

Therewas no solicitation in opposition to either of the matters submitted tovote.  Both of the matters werepassed.  The number of votes cast for oragainst as well as the number of abstentions for each of the matters were asfollows:

 
| **Nominee**   | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|---------------|------------|-----------|------------|-------------|------------|-------------|------------|
|          |       |      |       |        |       |        |       |
| Proposal  One |       | 4,655,462 |       | 170,115     |       | 33,136      |       |
|          |       |      |       |        |       |        |       |
| Proposal  Two |       | 3,958,263 |       | 867,973     |       | 32,475      |       |

 

There was no otherbusiness that came before the meeting or matters incident to the conduct of theMeeting.

 

**Item 5.****        ****Other Information**

 

TheBank is currently undergoing a restructuring, which includes the previouslyannounced appointment of John A. Featherman, III as President, James M. Deitchas Chief Operating Officer and Sheryl S. Vittitoe as Chief Financial Officer.The restructuring will also include the termination of certain Bank employees,including employees from its AHB Division by yearend. The Bank expects to incura charge of approximately $1.0 million in the fourth quarter for severanceliability connected with this restructuring. The Bank also intends toreorganize its two current divisions into four divisions: Commercial, Consumer,Wealth Management and Administration. The Bank is closing three branches aspart of the restructuring; the Bank expects to incur a charge of approximately$1.1 million in the fourth quarter related to branch closure expenses,including estimated lease liabilities and write-off of certain leaseholdimprovements and fixed assets related to the branch closures. The Bank is alsoclosing 13 mortgage loan production offices related to Vision Mortgage Divisionof AHB related to the restructuring, and will close an additional six mortgageloan production offices operated as AHB production branches. The Bank willincur approximately $60,000 in charges related to severance, lease obligationsand the write off of leasehold improvements, and fixed assets related to suchclosures.

 

The Corporation borrowedan aggregate principal amount of $4.0 million during the second and thirdquarters of 2009 on an unsecured, short-term basis from two shareholders, withinterest payable in each case at 12% per annum. On October 20, 2009, theCorporation received a demand for payment of $3.0 million principal amount ofsuch borrowings in accordance with terms of the loans, with the demand payableon November 20, 2009. The other $1.0 million principal amount of unsecured loanoriginally matured on November 24, 2009, but has been extended by the lender toMay 24, 2010. The Corporation is currently attempting to negotiate to extendthe maturity of the $3 million due on November 20, 2009. If the Corporation isunable to extend the loans, the Bank may need to dividend to the Corporationsome or all of such funds. Under its informal MOU with the OCC, the Bank isrequired to obtain supervisory approval to dividend any funds to theCorporation. Any such dividend to the Corporation will directly affect theBank’s capital and in turn, its fourth quarter regulatory capital ratios.

 

**Item 6.****        ****Exhibits**

 

The following exhibits,which are furnished with this Quarterly Report or incorporated herein byreference, are filed as part of this Quarterly Report.

** **
| 3.1  |   | Amended Articles of  Incorporation (incorporated herein by reference to Exhibit 3.1 to the  Corporation’s Quarterly Report on Form 10-Q for the quarter ended  March 31, 2004, filed May 14, 2004.) |
|------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2  |   | Amendment to the Articles  of Incorporation (incorporation herein by reference to Exhibit 3.2 to  the Corporation’s Form 8-A, filed October 22, 2009.)                                                   |
| 3.3  |   | Amended and Restated  Bylaws (incorporated herein by reference to Exhibit 3.3 to the  Corporation’s Form 8-A, filed October 22, 2009.)                                                                   |
| 31.1 |   | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002*                                                                                                                   |
| 31.2 |   | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002*                                                                                                                   |
| 32.1 |   | Certification  of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002*                                                                                                                   |
| 32.2 |   | Certification  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002*                                                                                                                   |

 

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*Filed herewith.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

**FIRST CHESTER COUNTY CORPORATION**

 
| November 13,  2009 | /s/ John A.  Featherman, III                       |
|-------------------------|---------------------------------------------------------|
|                    | John A.  Featherman, III                           |
|                    | Chairman, Chief  Executive Officer & President |
|                    |                                                    |
|                    |                                                    |
| November 13,  2009 | /s/ Sheryl S. Vittitoe                                  |
|                    | Sheryl S. Vittitoe                                      |
|                    | Chief Financial Officer                                 |
|                    | (Principal Financial  and Accounting Officer)           |

 

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**INDEXTO EXHIBITS**

** **
| **Exhibit Number** | ** ** | **Exhibit**                                                                                                                                                                                                                  |
|-------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                     |       | Amended  Articles of Incorporation (incorporated herein by reference to  Exhibit 3.1 to the Corporation’s Quarterly Report on Form 10-Q for  the quarter ended March 31, 2004, filed May 14, 2004.) |
| 3.2                     |       | Amendment  to the Articles of Incorporation (incorporation herein by reference to  Exhibit 3.2 to the Corporation’s Form 8-A, filed October 22,  2009.)                                                  |
| 3.3                     |       | Amended  and Restated Bylaws (incorporated herein by reference to Exhibit 3.3 to  the Corporation’s Form 8-A, filed October 22, 2009.)                                                                   |
| 31.1                    |       | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002*                                                                                                                   |
| 31.2                    |       | Certification  of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002*                                                                                                                   |
| 32.1                    |       | Certification  of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002*                                                                                                                   |
| 32.2                    |       | Certification  of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002*                                                                                                                   |

 

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*Filed herewith.

 

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