**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**UNITED        STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM        10-Q**

 

(Mark        One)

         

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

         

For the        quarterly period ended**March 31,        2008**, OR

         

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

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

         

For the        transition period from ____________ to ____________.

         

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

 

**FIRST CHESTER COUNTY CORPORATION**

(Exact        name of Registrant as specified in its charter)

 

 

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

 

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

(Address        of principal executive office) (Zip code)

 

**(484) 881-4000**

(Registrant’s telephone number, including area code)

 

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

 

Indicate        by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a        non-accelerated filer, or a smaller reporting company. See the definitions of “large        accelerated filer,” “accelerated filer,” and “smaller reporting        company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ___        Accelerated filerXNon-accelerated        filer (Do not check if a smaller reporting company _____ Smaller reporting company        _____

 

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

 

The        number of shares outstanding of Common Stock of the Registrant as of May 8, 2008 was        5,191,607.

 

1

**INDEX**

 

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

 

| Part I. | FINANCIAL INFORMATION |                                                                              |
|---------|-----------------------|-----------------------------------------------------------------------------------|
|    |                  |                                                                              |   |
|    | Item 1 -              | Financial Statements                                                              |   |
|    |                  | Consolidated Balance Sheet                                                        |   |
|    |                  | March 31, 2008 (unaudited) and December 31, 2007                                  | 3 |
|    |                  |                                                                              |   |
|    |                  | Consolidated Statements of Income                                                 |   |
|    |                  | Three-Months Ended March 31, 2008 and 2007                        (unaudited)     | 4 |
|    |                  |                                                                              |   |
|    |                  | Consolidated Statements of Cash Flows                                             |   |
|    |                  | Three-Months Ended March 31, 2008 and 2007                        (unaudited)     | 5 |
|    |                  |                                                                              |   |
|    |                  | Consolidated Statements of Stockholders’                        Equity      |   |
|    |                  | Three-Months Ended March 31, 2008 and 2007                        (unaudited)     | 6 |
|    |                  |                                                                              |   |
|    |                  | Notes to Consolidated Financial Statements                                        | 7-9 |
|    |                  |                                                                              |   |
|    | Item 2 -              | Management’s Discussion and Analysis of                                     |   |
|    |                  | Financial Condition and Results of Operations                                     | 10-23 |
|    |                  |                                                                              |   |
|    | Item 3 -              | Quantitative and Qualitative Disclosures About Market                        Risk | 24 |
|    |                  |                                                                              |   |
|    | Item 4 -              | Controls & Procedures                                                         | 24  |

 

| Part II. | OTHER INFORMATION |                                                                               |
|----------|-------------------|------------------------------------------------------------------------------------|
|     |              |                                                                               |   |
|     | Item 1 -          | Legal Proceedings                                                                  | 25 |
|     |              |                                                                               |   |
|     | Item 1A -         | Risk Factors                                                                       | 25 |
|     |              |                                                                               |   |
|     | Item 2 -          | Unregistered Sales of Equity Securities and Use of                        Proceeds | 25 |
|     |              |                                                                               |   |
|     | Item 3 -          | Defaults Upon Senior Securities                                                    | 26 |
|     |              |                                                                               |   |
|     | Item 4 -          | Submission of Matters to a Vote of Security                        Holders         | 26 |
|     |              |                                                                               |   |
|     | Item 5 -          | Other Information                                                                  | 26 |
|     |              |                                                                               |   |
|     | Item 6 -          | Exhibits                                                                           | 26 |
|     |              |                                                                               |   |
|     | Signatures        |                                                                               | 27 |
|     |              |                                                                               |   |
|     | Index to Exhibits |                                                                               | 28 |
|     |              |                                                                               |   |
|     | Exhibits          |                                                                               |  |
|     |              |                                                                               |   |
|     |              |                                                                               |   |

 

 

2

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART        I. FINANCIAL INFORMATION**

 

**ITEM 1.        Financial Statements**

 

**CONSOLIDATED BALANCE SHEET**

 

| **(Dollars in thousands)**                                                            | **March 31,**                         |   |                                        |
|---------------------------------------------------------------------------------------|---------------------------------------|--------|---------------------------------------------|
|                                                                                  | **2008**                              |   | **December 31,**                            |
|                                                                                  | **(unaudited)**                       |   | **2007**                                    |
| ASSETS                                                                                |                                  |   |                                        |
| Cash and due from banks                                                               | $     35,133 |   | $      28,884 |
| Federal funds sold and other overnight                        investments             | 75,400                                |   | 24,260                                      |
| Interest bearing deposits                                                             | 180                                   |   | 216                                         |
|                                                                                  |                                  |   |                                        |
| Total cash and cash equivalents                                                       | 110,713                               |   | 53,360                                      |
|                                                                                  |                                  |   |                                        |
| Investment securities available-for-sale, at fair                        value        | 110,796                               |   | 97,977                                      |
|                                                                                  |                                  |   |                                        |
| Loans and leases                                                                      | 750,625                               |   | 743,440                                     |
| Less: allowance for loan and lease losses                                             | (7,930)                               |   | (7,817)                                     |
|                                                                                  |                                  |   |                                        |
| Net loans and leases                                                                  | 742,695                               |   | 735,623                                     |
|                                                                                  |                                  |   |                                        |
| Premises and equipment, net                                                           | 18,501                                |   | 17,560                                      |
| Net deferred tax asset                                                                | 4,413                                 |   | 4,418                                       |
| Bank owned life insurance                                                             | 10,065                                |   | -                                           |
| Other assets                                                                          | 9,258                                 |   | 5,843                                       |
| Total assets                                                                          | $  1,006,441                |   | $   914,781                  |
| LIABILITIES                                                                           |                                  |   |                                        |
| Deposits                                                                              |                                  |   |                                        |
| Non-interest-bearing                                                                  | $    123,862      |   | $   124,199                  |
| Interest-bearing (including certificates of deposit over                        $100  |                                  |   |                                        |
| of $69,486 and $58,816 at March 31, 2008 and                                          |                                  |   |                                        |
| December 31, 2007, respectively)                                                      | 633,462                               |   | 580,699                                     |
|                                                                                  |                                  |   |                                        |
| Total deposits                                                                        | 757,324                               |   | 704,898                                     |
| Federal Home Loan Bank and other borrowings                                           | 152,368                               |   | 115,384                                     |
| Subordinated debt                                                                     | 15,465                                |   | 15,465                                      |
| Other liabilities                                                                     | 12,376                                |   | 11,055                                      |
|                                                                                  |                                  |   |                                        |
| Total liabilities                                                                     | 937,533                               |   | 846,802                                     |
|                                                                                  |                                  |   |                                        |
| STOCKHOLDERS’ EQUITY                                                            |                                  |   |                                        |
| Common stock, par value $1.00; authorized 25,000,000                        shares;   |                                  |   |                                        |
| Outstanding, 5,279,815 at March 31, 2008 and December 31,                        2007 | 5,280                                 |   | 5,280                                       |
| Additional paid-in capital                                                            | 10,354                                |   | 11,113                                      |
| Retained earnings                                                                     | 56,141                                |   | 55,347                                      |
| Accumulated other comprehensive loss                                                  | (1,028)                               |   | (1,207)                                     |
| Treasury stock, at cost: 89,789 shares and 119,065                        shares      |                                  |   |                                        |
| at March 31, 2008 and December 31, 2007,                        respectively          | (1,839)                               |   | (2,554)                                     |
|                                                                                  |                                  |   |                                        |
| Total stockholders’ equity                                                      | 68,908                                |   | 67,979                                      |
|                                                                                  |                                  |   |                                        |
| Total liabilities and stockholders’ equity                                      | $   1,006,441          |   | $   914,781                  |

 

 

The        accompanying notes are an integral part of these statements.

 

3

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

         

**CONSOLIDATED STATEMENTS OF INCOME**

(**UNAUDITED**)

 

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

|   | **March 31,** |
|--------|---------------|

 

|                                                                         | 2008                                      |   | 2007                                      |
|------------------------------------------------------------------------------|-------------------------------------------|--------|-------------------------------------------|
| INTEREST INCOME                                                              |                                      |   |                                      |
| Loans and leases, including fees                                             | $   12,396                 |   | $   11,904                 |
| Investment securities                                                        | 1,230                                     |   | 1,022                                     |
| Federal funds sold and deposits in banks                                     | 451                                       |   | 597                                       |
| Total interest income                                                        | 14,077                                    |   | 13,523                                    |
| INTEREST EXPENSE                                                             |                                      |   |                                      |
| Deposits                                                                     | 4,497                                     |   | 4,893                                     |
| Subordinated debt                                                            | 259                                       |   | 335                                       |
| Federal Home Loan Bank and other borrowings                                  | 1,443                                     |   | 595                                       |
| Total interest expense                                                       | 6,199                                     |   | 5,823                                     |
|                                                                         |                                      |   |                                      |
| Net interest income                                                          | 7,878                                     |   | 7,700                                     |
| Provision for loan and lease losses                                          | 211                                       |   | -                                         |
| Net interest income after provision                                          |                                      |   |                                      |
| For loan and lease losses                                                    | 7,667                                     |   | 7,700                                     |
|                                                                         |                                      |   |                                      |
| NON-INTEREST INCOME                                                          |                                      |   |                                      |
| Wealth management and advisory services                                      | 995                                       |   | 977                                       |
| Service charges on deposit accounts                                          | 553                                       |   | 539                                       |
| Gains (losses) on sales of investment securities,                        net | 262                                       |   | 2                                         |
| Operating lease rental income                                                | 310                                       |   | 308                                       |
| Gains (losses) on the sale of fixed assets and                        OREO   | 45                                        |   | -                                         |
| Gain and fees on the sales of loans                                          | 69                                        |   | 67                                        |
| Bank owned life insurance                                                    | 65                                        |   | -                                         |
| Other                                                                        | 559                                       |   | 462                                       |
| Total non-interest income                                                    | 2,858                                     |   | 2,355                                     |
|                                                                         |                                      |   |                                      |
| NON-INTEREST EXPENSE                                                         |                                      |   |                                      |
| Salaries and employee benefits                                               | 4,798                                     |   | 4,700                                     |
| Occupancy, equipment and data processing                                     | 1,438                                     |   | 1,354                                     |
| Depreciation expense on operating leases                                     | 255                                       |   | 258                                       |
| Bank shares tax                                                              | 192                                       |   | 160                                       |
| Professional services                                                        | 424                                       |   | 514                                       |
| Marketing                                                                    | 197                                       |   | 239                                       |
| Other                                                                        | 1,144                                     |   | 906                                       |
| Total non-interest expense                                                   | 8,448                                     |   | 8,131                                     |
| Income before income taxes                                                   | 2,077                                     |   | 1,924                                     |
| INCOME TAXES                                                                 | 557                                       |   | 548                                       |
| NET INCOME                                                                   | $    1,520            |   | $    1,376            |
| PER SHARE DATA                                                               |                                      |   |                                      |
| Net income per share (Basic)                                                 | $      0.29 |   | $      0.27 |
| Net income per share (Diluted)                                               | $      0.29 |   | $      0.26 |
| Dividends declared                                                           | $    0.140            |   | $    0.135            |
|                                                                         |                                      |   |                                      |
| Basic weighted average shares outstanding                                    | 5,176,512                                 |   | 5,143,502                                 |
|                                                                         |                                      |   |                                      |
| Diluted weighted average shares outstanding                                  | 5,203,441                                 |   | 5,214,646                                 |

 

The        accompanying notes are an integral part of these statements.

 

4

 

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(**UNAUDITED**)

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

|   | **(Dollars in                        thousands)**   | **       March                        31,** |
|--------|---------------------------------------------------------------|---------------------------------------------------------------------------|

         

|                                                                                        | **2008**                                   |   | **2007**                                   |
|---------------------------------------------------------------------------------------------|--------------------------------------------|--------|--------------------------------------------|
| OPERATING ACTIVITIES                                                                        |                                       |   |                                       |
| Net income                                                                                  | $     1,520       |   | $     1,376       |
| Adjustments to reconcile net income to net cash (used                        in)            |                                       |   |                                       |
| provided by operating activities:                                                           |                                       |   |                                       |
| Depreciation                                                                                | 593                                        |   | 664                                        |
| Provision for loan and lease losses                                                         | 211                                        |   | -                                          |
| Amortization of investment security premiums                                                |                                       |   |                                       |
| and accretion of discounts, net                                                             | 65                                         |   | 47                                         |
| Amortization of deferred loan fees                                                          | (48)                                       |   | (2)                                        |
| Gains on sales of investment securities, net                                                | (262)                                      |   | (2)                                        |
| Gains from sales of assets                                                                  | (45)                                       |   | -                                          |
| Increase in other assets                                                                    | (3,567)                                    |   | (273)                                      |
| Increase (decrease) in other liabilities                                                    | 1,366                                      |   | (762)                                      |
|                                                                                        |                                       |   |                                       |
| Net cash (used in) provided by operating                        activities                  | $      (167) |   | $      1,048 |
|                                                                                        |                                       |   |                                       |
| INVESTING ACTIVITIES                                                                        |                                       |   |                                       |
| Net increase in loans                                                                       | (7,235)                                    |   | (7,262)                                    |
| Proceeds from sales of investment securities                        available-for-sale      | 11,675                                     |   | 4,412                                      |
| Proceeds from maturities of investment securities                        available-for-sale | 6,816                                      |   | 1,771                                      |
| Proceeds from maturities of investment securities                        held-to-maturity   | -                                          |   | 5                                          |
| Purchases of investment securities                        available-for-sale                | (30,841)                                   |   | (4,502)                                    |
| Purchase of BOLI (Bank Owned Life Insurance)                                                | (10,000)                                   |   | -                                          |
| Purchase of premises and equipment                                                          | (1,582)                                    |   | (248)                                      |
| Proceeds from the sale of fixed assets                                                      | 48                                         |   | -                                          |
|                                                                                        |                                       |   |                                       |
| Net cash used in investing activities                                                       | $  (31,119)                      |   | $  (5,824)                       |
|                                                                                        |                                       |   |                                       |
| FINANCING ACTIVITIES                                                                        |                                       |   |                                       |
| Increase (decrease) in short term Federal Home Loan                        Bank             |                                       |   |                                       |
| and other short term borrowings                                                             | -                                          |   | (5,266)                                    |
| Increase in long term Federal Home Loan Bank                        borrowings              | 37,000                                     |   | 15,000                                     |
| Repayment of long term Federal Home Loan Bank                        borrowings             | (16)                                       |   | (1,581)                                    |
| Net increase in deposits                                                                    | 52,426                                     |   | 23,712                                     |
| Cash dividends paid                                                                         | (726)                                      |   | (697)                                      |
| Net increase (decrease) in treasury stock                        transactions               | (45)                                       |   | (31)                                       |
|                                                                                        |                                       |   |                                       |
| Net cash provided by financing activities                                                   | 88,639                                     |   | 31,137                                     |
|                                                                                        |                                       |   |                                       |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                                   | 57,353                                     |   | 26,361                                     |
|                                                                                        |                                       |   |                                       |
| Cash and cash equivalents at beginning of period                                            | 53,360                                     |   | 72,341                                     |
|                                                                                        |                                       |   |                                       |
| Cash and cash equivalents at end of period                                                  | $  110,713                       |   | $   98,702                  |

 

 

The        accompanying notes are an integral part of these statements.

 

5

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

|                        |      |         |          |          | Accumulated    |           |                |          |
|-----------------------------|-----------|--------------|---------------|---------------|----------------|----------------|---------------------|---------------|
|                        |      |         | Additional    |          | Other          |           | Total               |          |
|                        | Common    | Stock        | Paid-in       | Retained      | Comprehensive  | Treasury       | Stockholders’ | Comprehensive |
| (Dollars in thousands)      | Shares    | Par Value    | Capital       | Earnings      | Income/(loss)  | Stock          | Equity              | Income        |
|                        |      |         |          |          |           |           |                |          |
| Balance January 1, 2007     | 5,279,815 | $ 5,280 | $ 11,939 | $ 50,486 | $ (1,473) | $ (2,970) | $ 63,262       |          |
|                        |      |         |          |          |           |           |                |          |
| Net income                  | -         | -            | -             | 1,376         | -              | -              | 1,376               | $ 1,376  |
| Cash dividends declared     | -         | -            | -             | (697)         | -              | -              | (697)               |          |
| Other comprehensive income  |      |         |          |          |           |           |                |          |
| Net unrealized losses       |      |         |          |          |           |           |                |          |
| on investment securities    |      |         |          |          |           |           |                |          |
| available-for-sale          | -         | -            | -             | -             | (31)           | -              | (31)                | (31)          |
| Treasury stock transactions | -         | -            | (837)         | -             | -              | 807            | (30)                | -             |
| Total comprehensive income  |      |         |          |          |           |           |                | $ 1,345  |
|                        |      |         |          |          |           |           |                |          |
| Balance March 31, 2007      | 5,279,815 | $ 5,280 | $ 11,102 | $ 51,165 | $ (1,504) | $ (2,163) | $ 63,880       |          |
|                        |      |         |          |          |           |           |                |          |
|                        |      |         |          |          |           |           |                |          |
| Balance January 1, 2008     | 5,279,815 | $ 5,280 | $ 11,113 | $ 55,347 | $ (1,207) | $ (2,554) | $ 67,979       |          |
|                        |      |         |          |          |           |           |                |          |
| Net income                  | -         | -            | -             | 1,520         | -              | -              | 1,520               | $ 1,520  |
| Cash dividends declared     | -         | -            | -             | (726)         | -              | -              | (726)               |          |
| Other comprehensive income  |      |         |          |          |           |           |                |          |
| Net unrealized gains        |      |         |          |          |           |           |                |          |
| on investment securities    |      |         |          |          |           |           |                |          |
| available-for-sale          | -         | -            | -             | -             | 179            | -              | 179                 | 179           |
| Treasury stock transactions | -         | -            | (759)         | -             | -              | 715            | (44)                | -             |
| Total comprehensive income  |      |         |          |          |           |           |                | $ 1,699  |
|                        |      |         |          |          |           |           |                |          |
| Balance March 31, 2008      | 5,279,815 | $ 5,280 | $ 10,354 | $ 56,141 | $ (1,028) | $ (1,839) | $ 68,908       |          |

 

The        accompanying notes are an integral part of these statements.

 

6

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

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

         

The foregoing unaudited financial statements have been prepared in        accordance with generally accepted accounting principles for interim financial information.        In the opinion of Management, all adjustments (consisting only of normal recurring        adjustments) necessary for a fair presentation of the financial position and the results of        operations for the interim period presented have been included. These interim financial        statements should be read in conjunction with the consolidated financial statements and        footnotes thereto included in our Annual Report on Form 10-K for the year ended December        31, 2007 (our “2007 Annual Report”).

 

The results of operations for the three-month period ended March 31, 2008        are not necessarily indicative of the results to be expected for the full year. Information        regarding risks and uncertainties that could cause actual results to vary materially from        our prior performance may be found in Part I, Item 1A of our 2007 Annual Report.

         

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

         

At March 31, 2008, the Corporation had one stock based compensation plan,        pursuant to which, shares of the Corporation’s common stock could be issued, subject        to certain restrictions. The plan, adopted in 2005, allows the Corporation to grant up to        150 thousand shares of restricted stock to employees. During the three months ended March        31, 2008, the Corporation granted 34,500 shares valued at $17.80 per share at the grant        date. These shares, or a portion thereof will vest on the third anniversary of the grant        date subject to certain employment and company performance requirements. During the three        months ended March 31, 2007, the Corporation granted 22,900 shares valued at $21.05 per        share at the grant date. One third of these shares vest on each of the first three        anniversaries of the date of the grant. These restricted stock grants are also subject to        accelerated vesting of all or a portion of the shares upon the occurrence of certain        events, as described more fully in our proxy statement. A summary of the        Corporation’s unvested restricted shares is as follows:

         

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

         

|                        | Shares | Grant DateFair

Value | Aggregate Intrinsic Value

of Unvested Shares |
|-----------------------------|--------|-----------------------|-----------------------------------------------|
| Unvested at January 1, 2008 | 21,400 | $21.05                | -                                             |
| Granted                     | 34,500 | $17.80                |                                          |
| Vested                      | 7,138  | $21.05                |                                          |
| Forfeited                   |   |                  |                                          |
| Unvested at March 31, 2008  | 48,762 | $21.05                | $833.8                                        |

         

The Corporation recorded $46 thousand and $13 thousand of restricted stock        expense for the three months ended March 31, 2008 and 2007, respectively.

         

The Corporation’s ability to issue stock options under the 1995 Stock        Option Plan has expired. Outstanding stock options, however, remain in effect according to        their terms. Aggregated information regarding the Corporation’s Stock Option Plan as        of March 31, 2008 is presented below.

         

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

         

| Options                        | Shares  |  Weighted-Average      

  Exercise

Price | Weighted-AverageRemaining

Contractual

Term (years) |  

Aggregate

Intrinsic

Value |
|--------------------------------|---------|------------------------------------------------------------------------------------|------------------------------------------------------|-------------------------------------|
| Outstanding at January 1, 2008 | 208,308 | $15.00                                                                             | -                                                    | $437                                |
| Granted                        | -       | -                                                                                  | -                                                    | -                                   |
| Exercised                      | -       | -                                                                                  | -                                                    | -                                   |
| Forfeited                      | (9,152) | 18.59                                                                              | -                                                    | -                                   |
| Expired                        | -       | -                                                                                  | -                                                    | -                                   |
| Outstanding at March 31, 2008  | 199,156 | $14.84                                                                             | 2.46                                                 | $450                                |
| Exercisable at March 31, 2008  | 199,156 | $14.84                                                                             | 2.46                                                 | $450                                |

         

There were no options granted during the three months ended March 31, 2008.        The total intrinsic value (market value on date of exercise less grant price) of options        exercised during the year ended December 31, 2007 was $450 thousand. As of January 1, 2007,        there were no unvested options under the Corporation’s one stock option        plan.

 

7

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

         

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –        Continued**

         

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

         

**Three Months ended March 31, 2008**

         

|                                        | Income       |   |          |   |        |
|---------------------------------------------|--------------|--------|---------------|--------|-------------|
|                                        | (thousands)  |   | Shares        |   | Per Share   |
|                                        | (numerator)  |   | (denominator) |   | Amount      |
| Basic earnings per share                    |         |   |          |   |        |
| Net income available to common stockholders | $ 1,520 |   | 5,176,512     |   | $ 0.29 |
| Effect of Dilutive Securities               |         |   |          |   |        |
| Options to purchase common stock            | -            |   | 26,929        |   | (.00)       |
| Diluted earnings per share                  |         |   |          |   |        |
| Net income available to common stockholders | $ 1,520 |   | 5,203,441     |   | $ 0.29 |

         

27,242 anti-dilutive weighted shares have been excluded from this        computation because the option exercise price was greater than the average market price of        the common shares.

         

**Three Months ended March 31, 2007**

         

|                                        | Income       |   |          |   |        |
|---------------------------------------------|--------------|--------|---------------|--------|-------------|
|                                        | (thousands)  |   | Shares        |   | Per Share   |
|                                        | (numerator)  |   | (denominator) |   | Amount      |
| Basic earnings per share                    |         |   |          |   |        |
| Net income available to common stockholders | $ 1,376 |   | 5,143,502     |   | $ 0.27 |
| Effect of Dilutive Securities               |         |   |          |   |        |
| Options to purchase common stock            | -            |   | 71,144        |   | (.01)       |
| Diluted earnings per share                  |         |   |          |   |        |
| Net income available to common stockholders | $ 1,376 |   | 5,214,646     |   | $ 0.26 |

         

14,238 anti-dilutive weighted shares have been excluded from this        computation because the option exercise price was greater than the average market price of        the common shares.

         

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

         

Components of comprehensive income are presented in the following        chart:

 

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

|   | **                                    March 31,** |
|--------|---------------------------------------------------------------------------------------------------------------|

 

|                                        | **2008**                                      |   | **2007**                                                                                                                                    |
|---------------------------------------------|-----------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
| Unrealized gains (losses) on securities:    |                                          |   |                                                                                                                                        |
| Unrealized gains (losses) arising in period | $     10   |   |                                   $    (49)                           |
| Reclassification adjustment                 | 262                                 |   |                                            2 |
| Net unrealized gains (losses)               | 272                                 |   |                                         (47)                |
| Other comprehensive income before taxes     | 272                                 |   |                                         (47)                |
| Income tax benefit (expense)                | (93)                                     |   |                                          16            |
| Other comprehensive income (loss)           | 179                                 |   |                                         (31)                |
| Net income                                  | 1,520                               |   |              1,376                                                         |
| Total comprehensive income                  | $ 1,699                        |   |                                  $ 1,345                                                  |

         

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

         

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

 

8

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

         

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS –        Continued**

         

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

         

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

         

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

         

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

         

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

         

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

         

         

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

         

         

Statement 157 defines fair value as the exchange price that        would be received for an asset or paid to transfer a liability (an exit price) in the        principal or most advantageous market for the asset or liability in an orderly transaction        between market participants on the measurement date. Statement 157 also establishes a fair        value hierarchy which requires an entity to maximize the use of observable inputs and        minimize the use of unobservable inputs when measuring fair value. The standard describes        three levels of inputs that may be used to measure fair value:                  Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets        that the entity has the ability to access as of the measurement date.                  Level 2: Significant other observable inputs other than Level 1 prices, such as quoted        prices for similar assets or liabilities, quoted prices in markets that are not active, and        other inputs that are observable or can be corroborated by observable market data.                  Level 3: Significant unobservable inputs that reflect a company’s own assumptions        about the assumptions that market participants would use in pricing an asset or        liability.                  The Company used the following methods and significant assumptions to estimate fair        value.                  Securities: Trading securities and investment securities available-for-sale are recorded        at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if        available. If quoted prices are not available, fair values are measured using matrix        pricing, which is a mathematical technique used widely in the industry to value debt        securities without relying exclusively on quoted prices for the specific securities but        rather by relaying on the securities’ relationship to other benchmark quoted        securities. Level 1 securities include those traded on nationally recognized securities        exchanges, U.S. Treasury and Agency securities, and money market funds. Level 2 securities        include mortgage-backed securities issued by government sponsored entities, municipal bonds        and corporate debt securities. Securities classified as Level 3 include asset-backed        securities in less liquid markets.                  Loans held for sale: The fair value of loans held for sale is determined, when possible,        using quoted secondary-market prices. If no such quoted price exists, the fair value of a        loan is determined using quoted prices for a similar asset or assets, adjusted for the        specific attributes of that loan. As such, the Company classifies loans subjected to        nonrecurring fair value adjustments as Level 2.

Loans: The Company does not record loans at fair value on a        recurring basis. However, from time to time, a loan is considered impaired and an allowance        for loan losses is established. Loans for which it is probable that payment of interest and        principal will not be made in accordance with the contractual terms of the loan agreement        are considered impaired. Once a loan is identified as individually impaired, management        measures impairment in accordance with SFAS 114, “Accounting by Creditors for        Impairment of a Loan,” (SFAS 114). The fair value of impaired loans is estimated        using one of several methods, including collateral value, market value of similar debt,        enterprise value, liquidation value and discounted cash flows. Those impaired loans not        requiring an allowance represent loans for which the fair value of the expected repayments        or collateral exceed the recorded investments in such loans. At March 31, 2008,        substantially all of the total impaired loans were evaluated based on the fair value of the        collateral. In accordance with SFAS 157, impaired loans where an allowance is established        based on the fair value of collateral require classification in the fair value hierarchy.        When the fair value of the collateral is based on an observable market price or a current        appraised value, the Company records the impaired loan as nonrecurring Level 2. When an        appraised value is not available or management determines the fair value of the collateral        is further impaired below the appraised value and there is no observable market price, the        Company records the impaired loan as nonrecurring Level 3.                            Foreclosed assets: Foreclosed assets are adjusted to fair value upon transfer of the loans        to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying        value or fair value. Fair value is based upon independent market prices, appraised values        of the collateral or management’s estimation of the value of the collateral. When the        fair value of the collateral is based on an observable market price or a current appraised        value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised        value is not available or management determines the fair value of the collateral is further        impaired below the appraised value and there is no observable market price, the Company        records the foreclosed asset as nonrecurring Level 3.

         

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

         

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

 

9

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

         

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

         

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

         

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

         

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

 

**CRITICAL        ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES**

 

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

 

**ALLOWANCE FOR LOAN AND LEASE LOSSES**

 

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

 

10

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

**INCOME        TAXES**

 

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

 

**EARNINGS        AND DIVIDEND SUMMARY**

 

Net        income for the three months ended March 31, 2008 was $1.52 million, an increase of $144        thousand or 10.5% from $1.38 million for the same period in 2007. Diluted earnings per        share for the three months ended March 31, 2008 and 2007 were $0.29 and $0.26 respectively.        Cash dividends declared during the three month period ended March 31, 2008 and 2007 were        $0.140 and $0.135, respectively.

 

The        increase in net income for the first quarter 2008 as compared to the first quarter of 2007,        was primarily the result of an increase in net interest income combined with an increase in        non-interest income, offset by an increase in non-interest expense and an increase in the        provision for loan and lease losses. Interest income benefited from continued growth in the        loan and investment portfolios. Partially offsetting this increase in interest income was a        decrease in the rates earned on the variable portion of interest-earning assets. These rate        decreases were principally caused by market rate decreases driven by six Federal Reserve        federal funds rate cuts. Interest expense increased for the first quarter of 2008 as        compared to the first quarter of 2007, driven mainly by an increase in average borrowings.        The increase in non-interest income was primarily due to a $262.3 thousand gain on the sale        of investment securities recorded in the first quarter of 2008, while the increase in        non-interest expense was primarily due to higher salaries and employee benefits and higher        occupancy expense as well as higher FDIC insurance premiums in the first quarter of 2008 as        compared to the first quarter of 2007.

 

**SELECTED RATIOS**

 

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

|   | **                                    March 31,** |
|--------|---------------------------------------------------------------------------------------------------------------|

 

|                     | **2008**                                   | **2007** |
|--------------------------|--------------------------------------------|----------|
| **SELECTED RATIOS**      |                                       |     |
| Return on Average Assets | 0.64%                                      | 0.63%    |
| Return on Average Equity | 8.80%                                      | 8.73%    |
| Dividend Payout Ratio    | 47.76%                                     | 50.65%   |
| Book Value Per Share     | $13.28       | $12.32   |

 

         

         

         

11

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

         

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

 

**CONSOLIDATED AVERAGE BALANCE SHEET**

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

**THREE        MONTHS ENDED MARCH 31,**

 

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

 

| (Dollars in thousands)                                                                                                                                                                                                                                                                                                                                                                                                                         |                |     |   |   |     |     |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------|----------|--------|--------|----------|----------|--------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                           | Average             |     |   |   | Average  |     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                           | Balance        | Interest | Rate%  |   | Balance  | Interest | Rate%  |
| ASSETS                                                                                                                                                                                                                                                                                                                                                                                                                                         |                |     |   |   |     |     |   |
| Federal funds sold, interest-bearing                                                                                                                                                                                                                                                                                                                                                                                            |   $49,482 | $451     | 3.67%  |   | $45,713  | $597     | 5.29%  |
|                                        deposits in banks and other                                        overnight investments                                    Investment securities: |                |     |   |   |     |     |        |
| Taxable                                                                                                                                                                                                                                                                                                                                                                                                                                        |   92,698  | 1,116    | 4.84%  |   | 80,314   | 950      | 4.80%  |
| Tax-exempt (1)                                                                                                                                                                                                                                                                                                                                                                                                                            |  13,678        | 164      | 4.81%  |   | 9,665    | 102      | 4.30%  |
| Total investment securities                                                                                                                                                                                                                                                                                                                                                                                                          | 106,376             | 1,280    | 4.84%  |   | 89,979   | 1,052    | 4.74%  |
|                                                                                                                                                                                                                                                                                                                                                                                                                                           |                |     |   |   |     |     |   |
| Loans and leases: (2)                                                                                                                                                                                                                                                                                                                                                                                                           |                |     |   |   |     |     |   |
| Taxable                                                                                                                                                                                                                                                                                                                                                                                                                                        | 729,071             | 12,158   | 6.71%  |   | 685,548  | 11,760   | 6.96%  |
| Tax-exempt (1)                                                                                                                                                                                                                                                                                                                                                                                                                            | 19,572              | 348      | 7.15%  |   | 13,138   | 209      | 6.46%  |
| Total loans and leases                                                                                                                                                                                                                                                                                                                                                                                                          | 748,643             | 12,506   | 6.72%  |   | 698,686  | 11,969   | 6.95%  |
|                                                                                                                                                                                                                                                                                                                                                                                                                                           |                |     |   |   |     |     |   |
| Total interest-earning assets                                                                                                                                                                                                                                                                                                                                                                                                        | 904,501             | 14,237   | 6.33%  |   | 834,378  | 13,618   | 6.62%  |
| Non-interest-earning assets                                                                                                                                                                                                                                                                                                                                                                                                               |                |     |   |   |     |     |   |
| Allowance for loan and lease                        losses                                                                                                                                                                                                                                                                                                                                                                      | (7,884)             |     |   |   | (8,156)  |     |   |
| Cash and due from banks                                                                                                                                                                                                                                                                                                                                                                                                    | 21,148              |     |   |   | 23,820   |     |   |
| Other assets                                                                                                                                                                                                                                                                                                                                                                                                                              | 35,014              |     |   |   | 24,562   |     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                           |                |     |   |   |     |     |   |
| Total assets                                                                                                                                                                                                                                                                                                                                                                                                                              | $952,779            |     |   |   | $874,604 |     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                           |                |     |   |   |     |     |   |
| LIABILITIES AND STOCKHOLDERS’                                                                                                                                                                                                                                                                                                                                                                                                            |                |     |   |   |     |     |   |
| EQUITY                                                                                                                                                                                                                                                                                                                                                                                                                                         |                |     |   |   |     |     |   |
| Savings, NOW, and money market                                                                                                                                                                                                                                                                                                                                                                                             |                |     |   |   |     |     |   |
| deposits                                                                                                                                                                                                                                                                                                                                                                                                                                       | $373,498            | $2,035   | 2.19%  |   | $359,898 | $2,065   | 2.33%  |
| Certificates of deposit and other time                                                                                                                                                                                                                                                                                                                                                                                | 221,127             | 2,462    | 4.48%  |   | 248,311  | 2,828    | 4.62%  |
| Total interest-bearing deposits                                                                                                                                                                                                                                                                                                                                                                                                      | 594,625             | 4,497    | 3.04%  |   | 608,209  | 4,893    | 3.26%  |
| Subordinated debentures                                                                                                                                                                                                                                                                                                                                                                                                                   | 15,465              | 259      | 6.74%  |   | 15,465   | 335      | 8.79%  |
| Federal Home Loan Bank advances                                                                                                                                                                                                                                                                                                                                                                                            |                |     |   |   |     |     |   |
| and other borrowings                                                                                                                                                                                                                                                                                                                                                                                                                 | 146,564             | 1,443    | 3.96%  |   | 61,683   | 595      | 3.91%  |
| Total interest-bearing liabilities                                                                                                                                                                                                                                                                                                                                                                                                   | 756,654             | 6,199    | 3.30%  |   | 685,357  | 5,823    | 3.45%  |
| Non-interest-bearing liabilities:                                                                                                                                                                                                                                                                                                                                                                                                         |                |     |   |   |     |     |   |
| Non-interest-bearing demand deposits                                                                                                                                                                                                                                                                                                                                                                                                 | 116,481             |     |   |   | 118,757  |     |   |
| Other liabilities                                                                                                                                                                                                                                                                                                                                                                                                                         | 10,530              |     |   |   | 7,442    |     |   |
| Total liabilities                                                                                                                                                                                                                                                                                                                                                                                                                         | 883,665             |     |   |   | 811,556  |     |   |
| Stockholders’ equity                                                                                                                                                                                                                                                                                                                                                                                                                | 69,114              |     |   |   | 63,048   |     |   |
| Total liabilities and stockholders’ equity                                                                                                                                                                                                                                                                                                                                                                           | $952,779            |     |   |   | $874,604 |     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                           |                |     |   |   |     |     |   |
| Net interest income                                                                                                                                                                                                                                                                                                                                                                                                                  |                | $8,038   |   |   |     | $7,795   |   |
| Net yield on interest-earning assets                                                                                                                                                                                                                                                                                                                                                                                       |                |     | 3.57%  |   |     |     | 3.79%  |

 

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

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

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

 

12

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

**NET        INTEREST INCOME**

 

Net        interest income is the difference between interest income earned on interest-earning assets        and interest expense paid on interest-bearing liabilities. Net interest income on a tax        equivalent basis for the three-month period ended March 31, 2008 was $8.0 million, an        increase of 3.1% from $7.8 million for the same period in 2007. The net yield on        interest-earning assets, on a tax-equivalent basis, was 3.57% for the three-month period        ended March 31, 2008, compared to 3.79% for the same period in 2007, a decrease of 22 basis        points (one basis point is equal to 1/100 of a percent).

 

The        yield earned on interest-earning assets decreased 29 basis points to 6.33% in 2008 from        6.62% in 2007. The average yield paid on interest-bearing liabilities decreased 15 basis        points to 3.30% in 2008 from 3.45% in 2007.

 

Average        interest-earning assets increased approximately $70.1 million or 8.4% to $904.5 million for        the three-months ended March 31, 2008 from $834.4 million in the same period last year. The        increase in average interest-earning assets for the three-month period ended March 31, 2008        was the result of a 7.2% or $50.0 million increase in average total loans and leases        combined with an 8.2% or $3.8 million increase in the average Federal funds sold and        interest bearing deposits in banks balance, and a 18.2% or $16.4 million increase in        average investment securities.

 

Average        interest-bearing liabilities increased approximately $71.3 million or 10.4% to $756.7        million for the three-months ended March 31, 2008, from $685.4 million in the same period        in 2007. The increase in average interest-bearing liabilities for the three-month period        was the result of an $84.9 million or 137.6% increase in Federal Home Loan Bank (FHLB)        advances and other borrowings, partially off-set by a $13.6 million or 2.2% decrease in        interest-bearing deposits.

 

**INTEREST        INCOME**

 

Interest        income on Federal Funds sold, interest-bearing deposits in banks and other overnight        investments for the three-month period ended March 31, 2008 decreased 24.5% to $451        thousand when compared to the same period in 2007. The decrease in interest income on        Federal Funds sold, interest- bearing deposits in banks and other overnight investments for        the three-month period is the result of a 162 basis point decrease on the rates earned on        these assets as a result of Federal Reserve actions to reduce market interest rates. The        impact from these rate decreases was partially offset by an 8.2% or $3.8 million increase        in average balances of Federal Funds sold, interest-bearing deposits in banks and other        overnight investments.

 

On a tax        equivalent basis, interest income on investment securities increased by 21.7% or $228        thousand to $1.3 million for the three-month period ended March 31, 2008 from $1.1 million        for the same period in 2007. The increase was a result of an 18.2% or $16.4 million        increase in average total investment securities when compared to the same period in 2007.        The average yield on total investment securities also increased by 10 basis points to 4.84%        for the three-month period ended March 31, 2008 from 4.74% for the same period in        2007.

 

 

 

13

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

Interest        income on loans, on a tax equivalent basis, generated by the Corporation’s loan        portfolio increased 4.5% or $537 thousand to $12.5 million for the three-month period ended        March 31, 2008 compared to $12.0 million for the three months ended March 31, 2007. The        increase in interest income for the three-month period ended March 31, 2008 is primarily        the result of a $50.0 million or 7.2% increase in the average balance of loans outstanding.        In addition, the yield on average loans outstanding, on a tax equivalent basis, decreased        by 23 basis points to 6.72% for the three-month period ended March 31, 2008 from 6.95% for        the same period in 2007. This rate decrease is the result of Federal Reserve actions to        reduce market interest rates.

 

**INTEREST        EXPENSE**

 

Interest        expense on deposit accounts decreased by $396 thousand or 8.1% to $4.5 million for the        three-month period ended March 31, 2008 from $4.9 million for the same period in 2007. This        decrease was partially due to a $13.6 million or 2.2% decrease in average total        interest-bearing deposits between the two periods. This decrease in deposit balances was        partially due to the Bank’s decision to replace higher cost brokered CDs with lower        cost FHLB borrowings beginning in the second half of 2007. Excluding the decrease in        average brokered CD balances, average total interest-bearing deposits would have increased        by $41.3 million for the first quarter of 2008 as compared to the first quarter of 2007. In        addition, the average interest rates paid on total interest-bearing deposits decreased by        22 basis points to 3.04% for the three-month period ended March 31, 2008 from 3.26% for the        same period in 2007. This rate decrease is primarily the result of Federal Reserve actions        to reduce market interest rates combined with the decrease in higher cost brokered CD        balances.

 

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

 

Interest        expense on subordinated debentures decreased $76 thousand to $259 thousand for the        three-month period ended March 31, 2008 from $335 thousand for the same period in 2007. The        decrease for the three-month period ended March 31, 2008 was a direct result of a 205 basis        point decrease in the average interest rate paid on these debentures. This rate decrease        was primarily due to the $5 million redemption of Trust I in July, 2007 and the $5 million        issuance of Trust III in June, 2007. The new issuance bears an interest rate of 3 month        LIBOR plus 140 basis points while the redeemed issuance had an interest rate of 3 month        LIBOR plus 365 basis points. The rate decrease was also due to a decrease in the 3 month        LIBOR between the two periods. Average balances between the two periods remained unchanged        at $15.5 million.

 

Interest        expense on FHLB and other borrowings increased by $848 thousand or 142.5% to $1.4 million        for the three-month period ended March 31, 2008 from $595 thousand for the same period in        2007. Average balances of these funding sources increased by 137.6% or $84.9 million        between the two periods. The increase in the average balance was mainly due to the        Bank’s decision to replace higher cost brokered CDs with lower cost FHLB borrowings        beginning in the second half of 2007. FHLB borrowings have been a favorable alternative to        deposits to support asset growth.

 

 

14

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

         

**PROVISION FOR LOAN AND LEASE LOSSES**

 

During        the three months ended March 31, 2008 and 2007, the Corporation recorded a $211 thousand        provision for loan and lease losses as compared to $0 for the same period in 2007. The        increase in the provision for loan and lease losses was driven mainly by loan growth        combined with the effects of a slowing economy. The percentage of non-accrual loans to        gross loans was .21% at March 31, 2008 compared to .16% at December 31, 2007 and 1.04% at        March 31, 2007. The allowance for loan and lease losses as a percentage of loans at March        31, 2008 was 1.06% compared to 1.05% at December 31, 2007 and 1.16% at March 31, 2007. Net        charge-offs decreased to $59 thousand for the first quarter of 2008 as compared to $84        thousand in the first quarter of 2007.

 

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

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

|   | (Dollars in thousands)   |             March                        31, |
|--------|------------------------------------|----------------------------------------------------------------------------------------------------------|

 

|                                          | 2008                                                               |   | 2007                                                               |
|-----------------------------------------------|--------------------------------------------------------------------|--------|--------------------------------------------------------------------|
|                                          |                                                               |   |                                                               |
| Balance at beginning of period                | $          7,817 |   | $          8,186 |
|                                          |                                                               |   |                                                               |
| Provision charged to operating expense        | 211                                                                |   | 0                                                                  |
|                                          |                                                               |   |                                                               |
| Recoveries of loans previously charged-off    | 100                                                                |   | 30                                                                 |
| Loans charged-off                             | (159)                                                              |   | (114)                                                              |
| Net loan (charge-offs) recoveries             | (59)                                                               |   | (84)                                                               |
|                                          |                                                               |   |                                                               |
| Allowance other adjustment (1)                | (39)                                                               |   | 26                                                                 |
|                                          |                                                               |   |                                                               |
| Balance at end of period                      | $         7,930       |   | $         8,128       |
|                                          |                                                               |   |                                                               |
| Period-end loans outstanding                  | $     750,625                             |   | $     701,549                             |
| Average loans outstanding                     | $     748,643                             |   | $     698,686                             |
|                                          |                                                               |   |                                                               |
| Allowance for loan and lease losses as a      |                                                               |   |                                                               |
| percentage of period-end loans outstanding    | 1.06%                                                              |   | 1.16%                                                              |
| Net charge-offs (recoveries) to average loans |                                                               |   |                                                               |
| outstanding                                   | 0.01%                                                              |   | 0.01%                                                              |

 

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

 

 

 

 

15

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

The        Corporation holds one commercial property classified as other real estate owned        (“OREO”) at March 31, 2008. There were no OREO properties as of March 31, 2007,        and December 31, 2007. OREO represents real estate owned by the Bank following default by        the borrowers. OREO is recorded at estimated realizable value (net of estimated disposal        costs) based on professional appraisals. OREO reduces the Corporation’s earnings        because interest income is not earned on such assets.

 

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

 

| (Dollars in thousands)   | March 31,   |                                  December 31, |
|------------------------------------|-----------------------|--------------------------------------------------------------------------------------------|

 

|                                          | 2008                    |   | 2007                              |   | 2007                    |
|-----------------------------------------------|-------------------------|--------|-----------------------------------|--------|-------------------------|
|                                          |                    |   |                              |   |                    |
| Past due over 90 days and still accruing      | $    261 |   | $     30 |   | $    142 |
| Non-accrual loans and leases (1)              | 1,555                   |   | 7,262                             |   | 1,194                   |
| Total non-performing loans and leases         | 1,816                   |   | 7,292                             |   | 1,336                   |
|                                          |                    |   |                              |   |                    |
| Other real estate owned                       | 441                     |   | -                                 |   | -                       |
| Total non-performing assets                   | $ 2,257                 |   | $ 7,292                           |   | $ 1,336                 |
|                                          |                    |   |                              |   |                    |
| Non-performing loans and leases as a          |                    |   |                              |   |                    |
| percentage of total loans and leases          | 0.24%                   |   | 1.04%                             |   | 0.18%                   |
|                                          |                    |   |                              |   |                    |
| Allowance for loan and lease losses as a      |                    |   |                              |   |                    |
| percentage of non-performing loans and leases | 436.69%                 |   | 111.46%                           |   | 585.10%                 |
|                                          |                    |   |                              |   |                    |
| Non-performing assets as a percentage of      |                    |   |                              |   |                    |
| total loans and other real estate owned       | 0.30%                   |   | 1.04%                             |   | 0.18%                   |
|                                          |                    |   |                              |   |                    |
| Allowance for loan and lease losses as a      |                    |   |                              |   |                    |
| percentage of non-performing assets           | 351.36%                 |   | 111.46%                           |   | 585.10%                 |

         

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

 

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

 

16

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

FASB 114        “Accounting by Creditors for Impairment of Loans” requires the Corporation to        examine commercial and non-residential mortgage loans on non-accrual status for impairment.        The balance of impaired loans was $1.6 million, $1.2 million, and $7.3 million at March 31,        2008, December 31, 2007, and March 31, 2007, respectively. The associated allowance for        impaired loans was $40 thousand, $72 thousand, and $540 thousand at March 31, 2008,        December 31, 2007, and March 31, 2007, respectively.

 

For the        three-month period ended March 31, 2008, activity in the allowance for impaired loan losses        includes a provision of $18 and charge-offs of $0. There were no recoveries for the        three-month period ended March 31, 2008. Contractual interest amounted to $25 thousand for        the three-months ended March 31, 2008. Total cash collected on non-accrual loans for the        three-month period ended March 31, 2008 was $54 thousand all of which was applied to        principal. Loans returned to performing for the three-months ended March 31, 2008 was $20        thousand.

 

**NON-INTEREST INCOME**

 

Total        non-interest income increased 21.3% or $503 thousand to $2.9 million for the three months        ended March 31, 2008, compared to $2.4 million for the same period in 2007. The various        components of non-interest income are discussed below.

 

The        largest component of non-interest income is Wealth management and advisory services        revenue, which increased $18 thousand or 1.8% to $995 thousand for the three-months ended        March 31, 2008 from $977 thousand during the same period in 2007. Wealth management and        advisory services revenue includes fee income from both the Wealth Management division of        the Bank and the First National Financial Advisory Services subsidiary of the Bank. In        aggregate, Wealth management and advisory services revenue consists primarily of fee income        from services such as trust and portfolio management, estate management, insurance,        full-service brokerage, financial planning and mutual fund services. Wealth management and        advisory services revenue is based partially on the market value of assets under        management. The market value of assets under management at March 31, 2008 was $557.8 as        compared to $557.4 million at March 31, 2007.

 

Service        charges on deposit accounts increased $14 thousand or 2.6% to $553 thousand for the        three-month period ended March 31, 2008 compared to $539 thousand for the same period in        2007. The increase in service charges is primarily due to an increase in charges on retail        and commercial demand deposit accounts.

 

The        corporation recognized a net gain of $262 thousand on sales of investment securities during        the three-month period ended March 31, 2008 compared with a net gain of $2 thousand during        the same period in 2007. These net gains were taken as a result of normal portfolio        management.

 

 

17

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

The        Corporation has operating lease agreements with one customer. The income on these leases is        classified as “Rental Income”. Rental Income on operating lease agreements for        the three-month period ended March 31, 2008 was $310 thousand, an increase of $2 thousand        or 0.6% from $308 thousand during the same period in 2007.

 

Gains on        the sale of fixed assets and OREO was $45 thousand for the three-months ended March 31,        2008 as compared to gains of $0 for the same period in 2007. The gain recorded in 2008 is        the amortization of a deferred gain attributable to a sale-leaseback transaction that        occurred during 2007.

 

Gains        and fee income generated on the sale of loans for the three-month period ended March 31,        2008 increased $2 thousand from $67 thousand to $69 thousand compared to the same period in        2007.

 

Bank-owned life insurance (“BOLI”) income relates to a $10        million policy purchased in February 2008. BOLI involves the purchase of a life insurance        policy on a group of employees. The Bank is the owner and beneficiary of the policy. The        BOLI investment is carried on the balance sheet at the cash surrender value of the        underlying policies. Income or loss resulting from increases or decreases in the cash        surrender value of the properties is recorded on the income statement.

 

Other        non-interest income increased 21.0% or $97 thousand for the three-month period ended March        31, 2008 due mainly to increases in lease referral fees and electronic banking fees. Other        non-interest income also includes ATM surcharge revenue, STAR/Visa Check Card revenue, safe        deposit box income, merchant services income, loan fee income, miscellaneous loan income,        rental income, and other miscellaneous income.

 

**NON-INTEREST EXPENSE**

         

Total        non-interest expense increased $317 thousand or 3.9% to $8.5 million for the three-month        period ended March 31, 2008, compared to $8.13 million during the same period in 2007. The        various components of non-interest expense are discussed below.

 

Salaries        and employee benefits increased 2.1% or $98 thousand to $4.8 million for the three-month        period ended March 31, 2008 compared to the same periods in 2007. The higher salary and        benefits expense was primarily due to normal salary increases. Average headcount for the        two periods remained relatively flat.

         

Net        occupancy, equipment and data processing expense increased $84 thousand or 6.2% to $1.4        million for the three-month period ended March 31, 2008 when compared to the same periods        in 2007. The increase was mainly due to the addition of the Longwood and Downingtown        facilities in the first quarter of 2008.

 

Depreciation expense on operating leases decreased $3 thousand or 1.16% to        $255 thousand for the three-month period ended March 31, 2008 when compared to the same        period in 2007. This depreciation expense is the result of operating lease agreements the        Bank has with one of our customers. The income associated with these operating leases is        classified as Rental Income.

         

 

18

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

Professional services expense decreased $90 thousand or 17.5% to $424        thousand for the three-month period ended March 31, 2008 when compared to the same periods        in 2007. The decrease in professional fees is primarily due to a reduction in legal fees        related to additional costs incurred in the first quarter of 2007 from compliance with new        SEC executive compensation reporting requirements.

 

Total        other non-interest expense increased $238 thousand or 26.3% to $1.1 million for the        three-month period ended March 31, 2008 compared to the same periods in 2007. Other        non-interest expense includes annual meeting and reports, trust processing, postage,        directors’ costs, telephone, travel and entertainment and operating supplies. The        increase in other non-interest expense is primarily due to a $109 thousand charge taken in        the first quarter of 2008 from the write-off of miscellaneous other assets. The increase        was also due to an increase in FDIC insurance premiums in the first quarter of 2008 as        compared to the first quarter of 2007. FDIC insurance premium expense was $94 thousand for        the first quarter of 2008 as compared to $21 thousand for the first quarter of 2007. The        increase reflects the impact of 2006 legislation that increased FDIC premiums for all        commercial banks.  This legislation provided an assessment credit for each insured        bank.  The bank's assessment credit offset a larger portion of the insurance premium        expense in the first quarter of 2007 then in the first quarter of 2008 and was fully        utilized in the first quarter of 2008.  The increased premium does not indicate any        change in the FDIC risk assessment for the Bank.

 

**INCOME        TAXES**

 

Income        tax expense for the three-month period ended March 31, 2008 was $557 thousand, compared to        $548 thousand for the same period in 2007. This represents an effective tax rate of 26.8%        for the three-month period ended March 31, 2008 compared with 28.5% for the same periods in        2007.

 

 

 

 

 

 

 

 

 

 

 

 

 

19

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

**LIQUIDITY MANAGEMENT AND INTEREST RATE SENSITIVITY**

 

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

 

|   | For the Three Months Ended |       For the Year Ended |
|--------|----------------------------|---------------------------------------------------|

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

 

|                            | Average                     |   | Effective |   | Average                     |   | Effective |
|---------------------------------|-----------------------------|--------|-----------|--------|-----------------------------|--------|-----------|
| **DEPOSIT TYPE**                | Balance                     |   | Yield     |   | Balance                     |   | Yield     |
| NOW Accounts                    | $    167,885 |   | 2.04%     |   | $    159,572 |   | 2.30%     |
| Money Market                    | 110,483                     |   | 3.36%     |   | 97,726                      |   | 4.19%     |
| Statement Savings               | 39,668                      |   | 0.72%     |   | 43,270                      |   | 0.79%     |
| Other Savings                   | 2,801                       |   | 1.57%     |   | 1,514                       |   | 1.52%     |
| Tiered Savings                  | 52,661                      |   | 1.35%     |   | 64,485                      |   | 1.45%     |
| Total NOW Savings,              | 373,498                     |   | 2.19%     |   | 366,567                     |   | 2.47%     |
| and Money Market                |                        |   |      |   |                        |   |      |
|                            |                        |   |      |   |                        |   |      |
| CDs Less than $100,000          | 157,280                     |   | 4.46%     |   | 192,236                     |   | 4.72%     |
| CDs Greater than $100,000       | 63,847                      |   | 4.52%     |   | 52,342                      |   | 4.58%     |
| Total CDs                       | 221,127                     |   | 4.48%     |   | 244,578                     |   | 4.69%     |
|                            |                        |   |      |   |                        |   |      |
| Total Interest Bearing Deposits | 594,625                     |   |      |   | 611,145                     |   |      |
|                            |                        |   |      |   |                        |   |      |
| Non-Interest Bearing            |                        |   |      |   |                        |   |      |
| Demand Deposits                 | 116,481                     |   |      |   | 121,000                     |   |      |
|                            |                        |   |      |   |                        |   |      |
| Total Deposits                  | $    711,106 |   |      |   | $    732,145 |   |      |

 

 

 

 

 

20

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

The        Bank, as a member of FHLB, maintains several credit facilities. During the first quarter of        2008, average FHLB advances were $146.6 million and consisted of term advances with a        variety of maturities. The average interest rate on these advances was 4.0%. The Bank        currently has a maximum borrowing capacity with FHLB of approximately $236.9 million. FHLB        advances are collateralized by a pledge on the Bank’s portfolio of unencumbered        investment securities, certain mortgage loans, and a lien on the Bank’s FHLB        stock.

         

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

         

The goal        of interest rate sensitivity management is to avoid fluctuating net interest margins, and        to enhance consistent growth of net interest income through periods of changing interest        rates. Such sensitivity is measured as the difference in the volume of assets and        liabilities in the existing portfolio that are subject to repricing in a future time        period. The Corporation’s net interest rate sensitivity gap within one year is a        negative $263.7 million or 26.2% of total assets at March 31, 2008 compared with a negative        $168.2 million or 18.4% of total assets at December 31, 2007. The Corporation’s gap        position is one tool used to evaluate interest rate risk and the stability of net interest        margins. Another tool that management uses to evaluate interest rate risk is a computer        simulation model that assesses the impact of changes in interest rates on net interest        income, net-income under various interest rate forecasts and scenarios. Management has set        acceptable limits of risk within its Asset Liability Committee (“ALCO”) policy        and monitors the results of the simulations against these limits quarterly. As of the most        recent quarter-end, all results are within policy limits and indicate an acceptable level        of interest rate risk. Management monitors interest rate risk as a regular part of        corporate operationswith the intention of maintaining a stable net interest margin. The        following table presents our interest sensitivity analysis as of March 31, 2008:

 

 

 

 

 

 

 

 

 

 

21

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

|                               |                                                                             |   | Two                                                                                                      |   | Over                                                                              |   |                                                                             |   |                                  |
|------------------------------------|----------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------|--------|---------------------------------------|
| (Dollars in thousands)             | Within                                                                           |   | through                                                                                                  |   | five                                                                              |   | Non-rate                                                                         |   |                                  |
|                               | one year                                                                         |   | five years                                                                                               |   | years                                                                             |   | sensitive                                                                        |   | Total                                 |
| ASSETS                             |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| Federal funds sold and             | $   75,400                                                        |   | $             0                         |   | $             -0 |   | $             0 |   | $     75,400 |
| overnight investments              |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| Investment securities              | 26,376                                                                           |   | 52,731                                                                                                   |   | 31,689                                                                            |   | 0                                                                                |   | 110,796                               |
| Interest bearing deposits in banks | 180                                                                              |   | 0                                                                                                        |   | 0                                                                                 |   | 0                                                                                |   | 180                                   |
| Net loans and leases               | 288,672                                                                          |   | 355,767                                                                                                  |   | 106,186                                                                           |   | (7,930)                                                                          |   | 742,695                               |
| Cash and due from banks            | 0                                                                                |   | 0                                                                                                        |   | 0                                                                                 |   | 35,133                                                                           |   | 35,133                                |
| Premises and equipment             | 0                                                                                |   | 0                                                                                                        |   | 0                                                                                 |   | 18,501                                                                           |   | 18,501                                |
| Other assets                       | 0                                                                                |   | 0                                                                                                        |   | 0                                                                                 |   | 23,736                                                                           |   | 23,736                                |
| Total assets                       | $ 390,628                                                                   |   | $ 408,498                                                                                           |   | $ 137,875                                                                    |   | $    69,440                                                  |   | $ 1,006,441                      |
|                               |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| LIABILITIES AND CAPITAL            |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| Non-interest bearing deposits      | $             0 |   | $                                     0 |   | $             0  |   | $   123,862                                                       |   | $   123,862            |
| Interest bearing deposits          | 610,013                                                                          |   | 18,987                                                                                                   |   | 4,462                                                                             |   | 0                                                                                |   | 633,462                               |
| FHLB advances and other            | 28,817                                                                           |   | 121,132                                                                                                  |   | 2,419                                                                             |   | 0                                                                                |   | 152,368                               |
| Junior subordinated debentures     | 15,465                                                                           |   | 0                                                                                                        |   | 0                                                                                 |   | 0                                                                                |   | 15,465                                |
| Other liabilities                  | 0                                                                                |   | 0                                                                                                        |   | 12,376                                                                            |   | 0                                                                                |   | 12,376                                |
| Capital                            | 0                                                                                |   | 0                                                                                                        |   | 0                                                                                 |   | 68,908                                                                           |   | 68,908                                |
| Total liabilities & capital    | $  654,295                                                             |   | $ 140,119                                                                                           |   | $    19,257                                                   |   | $  192,770                                                             |   | $ 1,006,441                      |
| Net interest rate                  |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| sensitivity gap                    | $(263,667)                                                                       |   | $ 268,379                                                                                           |   | $  118,618                                                              |   | $(123,330)                                                                       |   |                                  |
| Cumulative interest rate           |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| sensitivity gap                    | $(263,667)                                                                       |   | $     4,712                                                                     |   | $  123,330                                                              |   | $             0 |   |                                  |
| Cumulative interest rate           |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| sensitivity gap divided            |                                                                             |   |                                                                                                     |   |                                                                              |   |                                                                             |   |                                  |
| by total assets                    | (26.2%)                                                                          |   | 0.5%                                                                                                     |   | 12.3%                                                                             |   |                                                                             |   |                                  |

 

 

 

22

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

**BRANCHING, TECHNOLOGY AND CAPITAL PROJECTS**

 

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

 

**CAPITAL****ADEQUACY**

 

The        Corporation is subject to Risk-Based Capital Guidelines adopted by the Federal Reserve        Board for bank holding companies. The Corporation is also subject to similar capital        requirements adopted by the Office of the Comptroller of the Currency. Under these        requirements, the regulatory agencies have set minimum thresholds for Tier I Capital, Total        Capital, and Leverage ratios. At March 31, 2008, both the Corporation’s and the        Bank’s capital exceeded all minimum regulatory requirements, and the Bank was        considered “well capitalized” as defined in the regulations issued pursuant to        the FDIC Improvement Act of 1992.

 

|   | As of March 31,   | As of December 31,   | "Well Capitalized" |
|--------|-----------------------------|--------------------------------|--------------------|

 

|                           | 2008         |   | 2007   |   | 2007   |   | Requirements |
|--------------------------------|--------------|--------|--------|--------|--------|--------|--------------|
| Corporation                    |         |   |   |   |   |   |         |
| Leverage Ratio                 |   8.87% |   | 9.17%  |   | 9.22%  |   | N/A          |
| Tier I Capital Ratio           | 10.35%       |   | 11.00% |   | 10.84% |   | N/A          |
| Total Risk-Based Capital Ratio | 11.39%       |   | 12.19% |   | 11.92% |   | N/A          |
| Bank                           |         |   |   |   |   |   |         |
| Leverage Ratio                 | 8.25%        |   | 8.46%  |   | 8.58%  |   | 5.00%        |
| Tier I Capital Ratio           | 9.64%        |   | 10.10% |   | 10.08% |   | 6.00%        |
| Total Risk-Based Capital Ratio | 10.69%       |   | 11.30% |   | 11.18% |   | 10.00%       |

         

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

         

 

23

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

**ITEM 4.        CONTROLS AND PROCEDURES**

 

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

 

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

 

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

 

**Management’s Report on Disclosure Controls and        Procedures.**As required by Rule 13a-15(b), under the Exchange        Act, Management, including our Principal Officers, conducted an evaluation as of the end of        the period covered by this report, of the effectiveness of the Corporation’s        disclosure controls and procedures. Based on that evaluation, the Principal Officers        concluded that our disclosure controls and procedures were effective, as of March 31, 2008,        at the reasonable assurance level, to ensure that information required to be disclosed by        us in the reports we file or submit under the Exchange Act is recorded, processed and        reported within the time periods specified in the SEC rules and regulations.

 

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

 

 

 

24

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART II - OTHER INFORMATION**

 

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

 

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

 

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

 

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

 

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

         

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

 

|  

                         

Period | (a)

Total Number of Shares (or

Units)

Purchased | (b)

Average

Price Paid

per Share

(or Unit) | (c)

Total Number of Shares (or Units) Purchased as                        Part

of Publicly Announced Plans

or Programs (1) | (d)

Maximum Number (or Approximate Dollar Value) of Shares (or                        Units) that May Yet Be Purchased Under the Plans or Programs (1) |
|------------------------------------------------|----------------------------------------------------|------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------|
| January 1 to January 31, 2008                  | --                                                 | --                                             | --                                                                                                                            | $10,000,000                                                                                                                                             |
| February 1 to February 29, 2008                | --                                                 | --                                             | --                                                                                                                            | $10,000,000                                                                                                                                             |
| March 1 to March 31, 2008                      | --                                                 | --                                             | --                                                                                                                            | $10,000,000                                                                                                                                             |
| Total                                          | --                                                 | --                                             | --                                                                                                                            | $10,000,000                                                                                                                                             |

 

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

 

 

 

 

 

 

 

25

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**PART        II - OTHER INFORMATION - CONTINUED**

 

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

 

None

 

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

 

None

 

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

 

None

 

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

 

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

 

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

         

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

         

10.1 Form of Restricted Stock Awards Agreement used for grants of restricted        stock on February 7, 2008. (CP)*

         

10.2 Executive Incentive Plan amended February 7, 2008 with 2008 Exhibits is        incorporated herein by reference to Exhibit 10(s) to the Corporation’s Annual Report        on Form 10-K for the year ended December 31, 2007. (CP)

 

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

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

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

 

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

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

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

 

 

26

**FIRST        CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**SIGNATURES**

 

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

 

 

**FIRST        CHESTER COUNTY CORPORATION**

 

 

 

| **May 8, 2008** | **__/s/ John A.                        Featherman**______________________ |
|-----------------|---------------------------------------------------------------------------|
|            | **John A. Featherman, III**                                               |
|            | **Chief Executive Officer**                                               |
|            |                                                                      |
|            |                                                                      |
|            |                                                                      |
|            |                                                                      |
| **May 8, 2008** | **__/s/ John E.                        Balzarini______________________**  |
|            | **John E. Balzarini**                                                     |
|            | **Chief Financial Officer**                                               |
|            | **(Principal Financial and Accounting                        Officer)**   |
|            |                                                                      |

 

 

27

**INDEX        TO EXHIBITS**

 

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

 

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

         

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

         

10.1 Form of Restricted Stock Awards Agreement used for grants of restricted        stock on February 7, 2008. (CP)*

         

10.2 Executive Incentive Plan amended February 7, 2008 with 2008 Exhibits is        incorporated herein by reference to Exhibit 10(s) to the Corporation’s Annual Report        on Form 10-K for the year ended December 31, 2007. (CP)

         

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

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

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

 

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

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

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

 

28