Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q/A**

 

**Amendment No. 1**

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

 

**For the quarterly period ended March 31, 2009**

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

 

**For the transition period from                 to                  .**

 

**Commission File No. 0-12870**

 

**FIRST CHESTER COUNTY CORPORATION**

(Exact name of Registrant asspecified 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 telephonenumber, including area code)

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x  No o

 

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

 

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

 

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

 

Indicate by check mark whether the Registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Thenumber of shares outstanding of Common Stock of the Registrant as of May 11,2009 was 6,248,568.

 

 

 

----

Tableof Contents

 

**EXPLANATORY NOTE**

 

FirstChester County Corporation (the “Corporation”) is filing this Amendment No. 1on Form 10-Q/A to its Quarterly Report for the quarter ended March 31,2009 (this “Amendment”) to amend and restate the Corporation’s unauditedconsolidated financial statements as of and for the three months ended March 31,2009, as filed with the Securities and Exchange Commission (the “SEC”) on May 11,2009 (the “Original Filing”).

 

Subsequentto the year ended December 31, 2009, management identified a materialweakness in internal controls related to the Corporation’s process to reviewthe valuation of Mortgage Loans Held for Sale.  Mortgage Loans Held forSale represent mortgage loans originated by the Corporation and held until soldto secondary market investors. Upon the closing of a residential mortgage loanoriginated by the Corporation, the mortgage loan is typically warehoused for aperiod of time and then sold into the secondary market. While in this warehousephase, mortgage loans held for sale are recorded at fair value under the fairvalue option with changes in fair value recognized through earnings.  Anerror was identified in the Corporation’s process to properly identify acertain population of loans held for sale prior to sending the loan details tothe Corporation’s third party valuation firm.  As such, the Corporationerroneously excluded from the population to be fair valued, loans which wereidentified for sale but for which the Corporation was awaiting theconsideration from the counterparty to complete the sales transaction. These particular loans were correctly classified as loans held for sale on theConsolidated Balance Sheet at March 31, 2009; however these loans were notreflected at their fair value in the Consolidated Balance Sheet and the relatedunrealized gains (losses) within the Statement of Operations for the threemonths ended March 31, 2009. This error resulted in an understatement inthe carrying amount of Mortgage Loans Held for Sale at March 31, 2009 aswell as an understatement of net income for the three months ended March 31,2009.  As a result of the material weakness, the Corporation increasedMortgage Loans Held for Sale and net gains from mortgage banking activities$1.2 million at and for the quarter ended March 31, 2009.

 

Asof the date of this Amendment, management is continuing their ongoing effortsto correct, revise and test the processes surrounding the material weaknessdescribed above.  Additional changes willbe implemented as determined necessary.

 

Thedecision to restate the financial statements for the three months ended March 31,2009 was approved by the Corporation’s Board of Directors on March 18,2010.

 

Theinformation in this Amendment has been updated to give effect to therestatement.  The Corporation has not modified nor updated theinformation in the Original Filing, except as necessary to reflect the effectsof the restatement described above.  This Amendment continues tospeak as of the dates described herein, and the Corporation has not updated thedisclosures contained in the Original Filing to reflect any events thatoccurred subsequent to such dates.  Information not affected by therestatement is unchanged and reflects the disclosures made at the time of theOriginal Filing.  Accordingly, this Amendment should be read inconjunction with the Corporation’s subsequent filings with the SEC, asinformation in such filings may update or supersede certain informationcontained in this Amendment.

 

Based on the foregoing, only the following items have been amended:

 

·                  Part I — Financial Information:

·                  Item 1 — FinancialStatements

·                  Item 2 — Management’sDiscussion and Analysis of Financial Condition and Results of Operations

·                  Item 3 — Quantitative andQualitative Disclosures About Market Risk

·                  Item 4 — Controls andProcedures

 

Forthe convenience of the reader, this Form 10-Q/A sets forth theinitial Form 10-Q in its entirety, although the Corporation is onlyamending those portions affected by the restatement described above.

 

Inaddition, as required by Rule 12b-15 under the Securities ExchangeAct of 1934, as amended, new, currently-dated certifications of our principalexecutive officer and principal financial officer are filed herewith.

 

----

Table of Contents

 

**INDEX**

 
| ** **    | ** **             | ** **                                                                                                                   | ** **   | **PAGE**     |
|---------------|------------------------|------------------------------------------------------------------------------------------------------------------------------|--------------|--------------|
| Part I.  | FINANCIAL  INFORMATION |                                                                                                                         | 1            |
|          |                   |                                                                                                                         |         |         |
|          | Item 1 -               | Financial  Statements                                                                                                        |         | 1            |
|          |                   | Consolidated Balance Sheet March 31, 2009  (unaudited and restated) and December 31, 2008                          |         | 1            |
| ** **    | ** **             | ** **                                                                                                                   | ** **   | ** **   |
|          |                   | Consolidated Statements of Income Three-Months Ended  March 31, 2009 (restated) and 2008 (unaudited)                    |         | 2            |
|          |                   |                                                                                                                         |         |         |
|          |                   | Consolidated Statements of Cash Flows Three-Months  Ended March 31, 2009 (restated) and 2008 (unaudited)                |         | 3            |
|          |                   |                                                                                                                         |         |         |
|          |                   | Consolidated Statements of Stockholders’ Equity  Three-Months Ended March 31, 2009 (restated) and 2008 (unaudited) |         | 4            |
|          |                   |                                                                                                                         |         |         |
|          |                   | Notes to Consolidated Financial Statements (unaudited  and restated)                                                         |         | 5            |
|          |                   |                                                                                                                         |         |         |
|          | Item 2 -               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                  |         | 16           |
|          |                   |                                                                                                                         |         |         |
|          | Item 3 -               | Quantitative  and Qualitative Disclosures About Market Risk                                                                  |         | 29           |
|          |                   |                                                                                                                         |         |         |
|          | Item 4 -               | Controls &  Procedures                                                                                              |         | 29           |
|          |                   |                                                                                                                         |         |         |
| Part II. | OTHER INFORMATION      |                                                                                                                         | 31           |
|          |                   |                                                                                                                         |         |         |
|          | Item 1 -               | Legal Proceedings                                                                                                            |         | 31           |
|          |                   |                                                                                                                         |         |         |
|          | Item 1A -              | Risk Factors                                                                                                                 |         | 31           |
|          |                   |                                                                                                                         |         |         |
|          | Item 2 -               | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                 |         | 31           |
|          |                   |                                                                                                                         |         |         |
|          | Item 3 -               | Defaults  Upon Senior Securities                                                                                             |         | 32           |
|          |                   |                                                                                                                         |         |         |
|          | Item 4 -               | Submission  of Matters to a Vote of Security Holders                                                                         |         | 32           |
|          |                   |                                                                                                                         |         |         |
|          | Item 5 -               | Other Information                                                                                                            |         | 32           |
| *** ***  | *** ***           | *** ***                                                                                                                 | *** *** | *** *** |
|          | Item 6 -               | Exhibits                                                                                                                     |         | 32           |
|          |                   |                                                                                                                         |         |         |
|          | Signatures             |                                                                                                                         |         | 33           |
|          |                   |                                                                                                                         |         |
|          | Index  to Exhibits     |                                                                                                                         | 34           |

 

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.  Financial Statements**

 

**CONSOLIDATED BALANCE SHEET**

 
| **(Dollars  in thousands)**                                                                                                                     | ** ** | **March 31,  2009**                       | ** ** | **December 31,  2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                      | ** ** | **(Unaudited — Restated)** | ** ** | ** **             | ** ** |
| ASSETS                                                                                                                                          |       |                                      |       |                   |       |
| Cash and due from banks                                                                                                                         |       | $                                         | 15,020     |                   | $          | 24,939 |   |
| Federal funds sold and other overnight investments                                                                                              |       | 2,501                                     |       | 4,884                  |       |
| Interest bearing deposits                                                                                                                       |       | 37,722                                    |       | 65,327                 |       |
| Total cash and cash equivalents                                                                                                                 |       | 55,243                                    |       | 95,150                 |       |
|                                                                                                                                            |       |                                      |       |                   |       |
| Investment securities available-for-sale, at fair  value                                                                                        |       | 99,779                                    |       | 114,584                |       |
|                                                                                                                                            |       |                                      |       |                   |       |
| Mortgage loans held for sale, at fair value                                                                                                     |       | 187,411                                   |       | 90,940                 |       |
|                                                                                                                                            |       |                                      |       |                   |       |
| Loans and leases                                                                                                                                |       | 940,131                                   |       | 940,083                |       |
| Less:   allowance for possible loan and lease losses                                                                                       |       | (11,263                                   | )          | (10,335                | )          |
| Net loans and leases                                                                                                                            |       | 928,868                                   |       | 929,748                |       |
|                                                                                                                                            |       |                                      |       |                   |       |
| Premises and equipment, net                                                                                                                     |       | 23,664                                    |       | 22,076                 |       |
| Net deferred tax asset                                                                                                                          |       | 8,407                                     |       | 8,585                  |       |
| Due from mortgage investors                                                                                                                     |       | —                                    |       | 9,036                  |       |
| Bank owned life insurance                                                                                                                       |       | 1,411                                     |       | 1,398                  |       |
| Goodwill                                                                                                                                        |       | 7,506                                     |       | 5,906                  |       |
| Other assets                                                                                                                                    |       | 23,958                                    |       | 22,755                 |       |
| Total assets                                                                                                                                    |       | $                                         | 1,336,247  |                   | $          | 1,300,178 |   |
| LIABILITIES                                                                                                                                     |       |                                      |       |                   |       |
| Deposits                                                                                                                                        |       |                                      |       |                   |       |
| Non-interest-bearing                                                                                                                            |       | $                                         | 147,276    |                   | $          | 146,248 |   |
| Interest-bearing (including certificates of  deposit over $100 of $115,073 and $100,018 at March 31, 2009 and December 31,  2008, respectively) |       | 902,047                                   |       | 868,944                |       |
| Total deposits                                                                                                                                  |       | 1,049,323                                 |       | 1,015,192              |       |
| Federal Home Loan Bank advances and other  borrowings                                                                                           |       | 164,998                                   |       | 171,170                |       |
| Subordinated debentures                                                                                                                         |       | 15,465                                    |       | 15,465                 |       |
| Other liabilities                                                                                                                               |       | 18,712                                    |       | 13,034                 |       |
| Total liabilities                                                                                                                               |       | 1,248,498                                 |       | 1,214,861              |       |
|                                                                                                                                            |       |                                      |       |                   |       |
| STOCKHOLDERS’ EQUITY                                                                                                                       |       |                                      |       |                   |       |
| Common stock, par value $1.00; authorized  25,000,000 shares; Outstanding, 6,331,975 at March 31, 2009 and December 31,  2008                   |       | 6,332                                     |       | 6,332                  |       |
| Additional paid-in capital                                                                                                                      |       | 24,596                                    |       | 24,708                 |       |
| Retained earnings                                                                                                                               |       | 60,584                                    |       | 57,899                 |       |
| Accumulated other comprehensive loss                                                                                                            |       | (3,696                                    | )          | (3,292                 | )          |
| Treasury stock, at cost: 83,407 shares and 92,931  shares at March 31, 2009 and December 31, 2008, respectively                                 |       | (1,597                                    | )          | (1,815                 | )          |
| Total First Chester County Corporation  stockholders’ equity                                                                               |       | 86,219                                    |       | 83,832                 |       |
| Non-controlling interest                                                                                                                        |       | 1,530                                     |       | 1,485                  |       |
| Total stockholders’ equity                                                                                                                 |       | 87,749                                    |       | 85,317                 |       |
|                                                                                                                                            |       |                                      |       |                   |       |
| Total liabilities and stockholders’ equity                                                                                                 |       | $                                         | 1,336,247  |                   | $          | 1,300,178 |   |

 

The accompanying notes arean integral part of these statements.

 

1

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF INCOME**

(**UNAUDITED**)

 
| ** **                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------------|------------|
| **(Dollars  in thousands - except per share)**                 | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| ** **                                                     | ** ** | **(Restated)**                    | ** ** | ** ** | ** ** |
| INTEREST INCOME                                                |       |                              |       |   |   |
| Loans and leases, including fees                               |       | $                                 | 13,205     |   | $ | 12,389 |   |
| Mortgage loans held for sale                                   |       | 1,844                             |       | 7 |   |
| Investment securities                                          |       | 1,230                             |       | 1,230 |   |
| Federal funds sold and deposits in banks                       |       | 28                                |       | 451 |   |
| Total interest income                                          |       | 16,307                            |       | 14,077 |   |
| INTEREST EXPENSE                                               |       |                              |       |   |   |
| Deposits                                                       |       | 4,471                             |       | 4,497 |   |
| Subordinated debt                                              |       | 174                               |       | 259 |   |
| Federal Home Loan Bank and other borrowings                    |       | 1,536                             |       | 1,443 |   |
| Total interest expense                                         |       | 6,181                             |       | 6,199 |   |
|                                                           |       |                              |       |   |   |
| Net interest income                                            |       | 10,126                            |       | 7,878 |   |
| Provision for loan and lease losses                            |       | 1,387                             |       | 211 |   |
| Net interest income after provision for loan and  lease losses |       | 8,739                             |       | 7,667 |   |
|                                                           |       |                              |       |   |   |
| NON-INTEREST INCOME                                            |       |                              |       |   |   |
| Wealth management and advisory services                        |       | 918                               |       | 995 |   |
| Service charges on deposit accounts                            |       | 632                               |       | 553 |   |
| Net gains (losses) on sales of investment  securities          |       | (88                               | )          | 262 |   |
| Operating lease rental income                                  |       | 340                               |       | 310 |   |
| Net gains on the sale of fixed assets and  OREO           |       | 46                                |       | 45 |   |
| Loan fees and other                                            |       | 996                               |       | 91 |   |
| Net gain from mortgage banking activities                      |       | 12,007                            |       | 69 |   |
| Bank-owned life insurance                                      |       | 13                                |       | 65 |   |
| Other                                                          |       | 493                               |       | 468 |   |
| Total non-interest income                                      |       | 15,357                            |       | 2,858 |   |
|                                                           |       |                              |       |   |   |
| NON-INTEREST EXPENSE                                           |       |                              |       |   |   |
| Salaries and employee benefits                                 |       | 12,164                            |       | 4,798 |   |
| Occupancy, equipment and data processing                       |       | 2,776                             |       | 1,438 |   |
| Depreciation expense on operating leases                       |       | 280                               |       | 255 |   |
| FDIC deposit insurance                                         |       | 413                               |       | 94 |   |
| Bank shares tax                                                |       | 234                               |       | 192 |   |
| Professional services                                          |       | 1,246                             |       | 424 |   |
| Marketing                                                      |       | 258                               |       | 197 |   |
| Other                                                          |       | 1,711                             |       | 1,050 |   |
| Total non-interest expense                                     |       | 19,082                            |       | 8,448 |   |
| Income before income taxes                                     |       | 5,014                             |       | 2,077 |   |
| INCOME TAXES                                                   |       | 1,526                             |       | 557 |   |
| NET INCOME                                                     |       | $                                 | 3,488      |   | $ | 1,520 |   |
| Less: Net income attributable to the  non-controlling interest |       | (168                              | )          | — |   |
| Net income attributable to First Chester County  Corporation   |       | $                                 | 3,320      |   | $ | 1,520 |   |
|                                                           |       |                              |       |   |   |
| PER SHARE DATA                                                 |       |                              |       |   |   |
| Net income per share (Basic)                                   |       | $                                 | 0.53       |   | $ | 0.29 |   |
| Net income per share (Diluted)                                 |       | $                                 | 0.53       |   | $ | 0.29 |   |
| Dividends declared                                             |       | $                                 | 0.140      |   | $ | 0.140 |   |
|                                                           |       |                              |       |   |   |
| Basic weighted average shares outstanding                      |       | 6,242,252                         |       | 5,176,512 |   |
|                                                           |       |                              |       |   |   |
| Diluted weighted average shares outstanding                    |       | 6,242,252                         |       | 5,203,441 |   |

 

The accompanying notes arean integral part of these statements.

 

2

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(**UNAUDITED**)

 
| ** **                                                                                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(Dollars  in thousands)**                                                                  | ** ** | **2009**                          | ** ** | **2008** | ** ** |
| ** **                                                                                   | ** ** | **(Restated)**                    | ** ** | ** ** | ** ** |
| OPERATING ACTIVITIES                                                                         |       |                              |       |   |   |
| Net income                                                                                   |       | $                                 | 3,488      |   | $ | 1,520 |   |
| Adjustments to reconcile net income to net cash  (used in) provided by operating activities: |       |                              |       |   |   |
| Depreciation                                                                                 |       | 904                               |       | 593 |   |
| Provision for loan and lease losses                                                          |       | 1,387                             |       | 211 |   |
| Amortization of investment security premiums and  accretion of discounts, net                |       | 78                                |       | 65 |   |
| Amortization of deferred loan fees                                                           |       | 28                                |       | (48 | ) |
| (Gains) losses on sales of investment securities,  net                                       |       | 88                                |       | (262 | ) |
| Gains from sales of assets                                                                   |       | —                            |       | (45 | ) |
| Net gain from mortgage banking activities                                                    |       | (12,007                           | )          | (69 | ) |
| Proceeds from the sale of mortgage loans held for  sale                                      |       | 527,417                           |       | 4,707 |   |
| Origination of mortgage loans held for sale                                                  |       | (602,845                          | )          | (5,000 | ) |
| Net cash paid for the settlement of derivative  contracts                                    |       | (981                              | )          | — |   |
| Stock-based compensation expense                                                             |       | 41                                |       | 46 |   |
| (Increase) decrease in other assets                                                          |       | (1,210                            | )          | (3,614 | ) |
| Increase (decrease) in other liabilities                                                     |       | 4,804                             |       | 1,366 |   |
|                                                                                         |       |                              |       |   |   |
| Net cash used in operating activities                                                        |       | $                                 | (78,808    | ) | $ | (530 | ) |
|                                                                                         |       |                              |       |   |   |
| INVESTING ACTIVITIES                                                                         |       |                              |       |   |   |
| Net increase in loans                                                                        |       | (535                              | )          | (6,873 | ) |
| Proceeds from sales of investment securities  available-for-sale                             |       | 11,807                            |       | 11,675 |   |
| Proceeds from maturities of investment securities  available-for-sale                        |       | 2,952                             |       | 6,816 |   |
| Purchases of investment securities  available-for-sale                                       |       | (731                              | )          | (30,841 | ) |
| Purchase of BOLI (Bank Owned Life Insurance)                                                 |       | —                            |       | (10,000 | ) |
| Purchase of premises and equipment                                                           |       | (2,493                            | )          | (1,582 | ) |
| Proceeds from the sale of fixed assets                                                       |       | —                            |       | 48 |   |
|                                                                                         |       |                              |       |   |   |
| Net cash provided by (used in) investing  activities                                         |       | $                                 | 11,000     |   | $ | (30,757 | ) |
|                                                                                         |       |                              |       |   |   |
| FINANCING ACTIVITIES                                                                         |       |                              |       |   |   |
| Change in subsidiary’s shares from non-controlling  interest                            |       | (123                              | )          |   |   |
| Decrease in short term Federal Home Loan Bank and  other short term borrowings               |       | (1,000                            | )          | — |   |
| Increase in long term Federal Home Loan Bank  borrowings                                     |       | 15,000                            |       | 37,000 |   |
| Repayment of long term Federal Home Loan Bank  borrowings                                    |       | (20,172                           | )          | (16 | ) |
| Net increase in deposits                                                                     |       | 34,131                            |       | 52,426 |   |
| Cash dividends paid                                                                          |       | —                            |       | (726 | ) |
| Net increase (decrease) in treasury stock  transactions                                      |       | 65                                |       | (44 | ) |
|                                                                                         |       |                              |       |   |   |
| Net cash provided by financing activities                                                    |       | 27,901                            |       | 88,640 |   |
|                                                                                         |       |                              |       |   |   |
| NET (DECREASE) INCREASE IN CASH AND CASH  EQUIVALENTS                                        |       | (39,907                           | )          | 57,353 |   |
|                                                                                         |       |                              |       |   |   |
| Cash and cash equivalents at beginning of period                                             |       | 95,150                            |       | 53,360 |   |
|                                                                                         |       |                              |       |   |   |
| Cash and cash equivalents at end of period                                                   |       | $                                 | 55,243     |   | $ | 110,713 |   |

 

The accompanying notes are an integral part of these statements.

 

3

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF CHANGESIN STOCKHOLDERS’ EQUITY**

 
| **(Dollars in thousands)**                               | ** ** | **Common  Shares** | ** ** | **Stock  Par Value** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income/(loss)** | ** ** | **Treasury  Stock** | ** ** | **Non-  controlling  Interest** | ** ** | **Total  Stockholders’  Equity** | ** ** | **Comprehensive  Income** | ** ** |
|--------------------------------------------------------------------|------------|--------------------|------------|---------------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------------------------------|------------|---------------------|------------|---------------------------------|------------|---------------------------------------|------------|---------------------------|------------|
|                                                               |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       |                      |       |
| 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 losses 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 |   |   |   |
|                                                               |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       |                      |       |
| Balance  January 1, 2009                                           |       | 6,331,975          |       | $                         | 6,332      |                             | $          | 24,708                 |       | $                                                    | 57,899     |                | $          | (3,292                          | )          | $                                     | (1,815     | )                         | 1,485      |   | $ | 85,317 |   |   |   |
|                                                               |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       |                      |       |
| Cumulative  effect adjustment under FASB No. 156                   |       |               |       |                      |       |                             |       | 240                    |       |                                                 |       |                |       |                            |       | 240                                   |       |                      |       |
| Balance  January 1, 2009, as adjusted                              |       | 6,331,975          |       | 6,332                     |       | 24,708                           |       | 58,139                 |       | (3,292                                               | )          | (1,815              | )          | 1,485                           |       | 85,557                                |       |                      |       |
|                                                               |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       |                      |       |
| Change  in subsidiary shares from non-controlling interest         |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       | (123                            | )          | (123                                  | )          |                      |       |
| Net  income (restated)                                             |       |               |       |                      |       |                             |       | 3,320                  |       |                                                 |       |                |       | 168                             |       | 3,488                                 |       | 3,488                     |       |
| Cash  dividends declared                                           |       |               |       |                      |       |                             |       | (875                   | )          |                                                 |       |                |       |                            |       | (875                                  | )          |                      |       |
| Other  comprehensive income                                        |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       |                      |       |
| Net  unrealized gains on investment securities available-for-sale  |       |               |       |                      |       |                             |       |                   |       | (404                                                 | )          |                |       |                            |       | (404                                  | )          | (404                      | )          |
| Treasury  stock transactions                                       |       |               |       |                      |       | (153                             | )          |                   |       |                                                 |       | 218                 |       |                            |       | 65                                    |       |                      |       |
| Stock  based compensation                                          |       |               |       |                      |       | 41                               |       |                   |       |                                                 |       |                |       |                            |       | 41                                    |       |                      |       |
| Total  comprehensive income (restated)                             |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       | $                         | 3,084      |   |
|                                                               |       |               |       |                      |       |                             |       |                   |       |                                                 |       |                |       |                            |       |                                  |       |                      |       |
| Balance  March 31, 2009 (restated)                                 |       | 6,331,975          |       | $                         | 6,332      |                             | $          | 24,596                 |       | $                                                    | 60,584     |                | $          | (3,696                          | )          | $                                     | (1,597     | )                         | 1,530      |   | $ | 87,749 |   |   |   |

 

The accompanying notes are an integral part of these statements.

 

4

----

Tableof Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(UNAUDITED)**

 

**1.****             ****BASISOF PRESENTATION, AS RESTATED**

 

The foregoing unaudited financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation.  In the opinion ofManagement, all adjustments (consisting only of normal recurring adjustments)necessary for a fair presentation of the financial position and the results ofoperations for the interim period presented have been included.  These interim financial statements should beread in conjunction with the consolidated financial statements and footnotesthereto included in our Annual Report on Form 10-K for the year ended December31, 2008 (our “2008 Annual Report”).

 

The results of operations for the three-month period ended March 31,2009 are not necessarily indicative of the results to be expected for the fullyear.  Information regarding risks anduncertainties that could cause actual results to vary materially from our priorperformance may be found in Part I, Item 1A of our 2008 Annual Report.

 

The consolidated financial statementsinclude the accounts of First Chester County Corporation (the “Corporation”)and First National Bank of Chester County (the “Bank”). All materialintercompany balances and transactions have been eliminated in consolidation.

 

The Corporation completed its acquisition of American Home Bank (“AHB”)on December 31, 2008, and, accordingly, the December 31, 2008 and the March 31,2009 consolidated balance sheet reflects the addition of assets acquired andliabilities assumed in this acquisition. The results of operations presented inthe consolidated income statement for the three months ended March 31, 2009include the results of operations from AHB.

 

As a result of the acquisition of AHB’soperations, the Corporation reports the following new lines in the incomestatement:

 

·                  Loan fees andother consist mainly of fees earned at the inception of a loan as well as feesearned on the servicing of loan portfolios not owned by the Bank. Loan fees andother also includes gains and losses on the Bank’s mortgage servicing rights.

 

·                  Net gain frommortgage banking activities consists of unrealized gains and losses on interestrate lock commitments, loans held for sale, and forward sale commitmentscombined with realized gains and losses on the actual sale of the loan and thesettlement of forward sale commitments.

 

**Restatement of Previously Issued Financial Statements**

 

Duringthe preparation of our consolidated financial statements for the year endedDecember 31, 2009, the Corporation determined that certain mortgage loans heldfor sale were excluded from the mark-to-market process.  This has resulted in a materialunderstatement of net income for the quarterly period ended March 31, 2009.

 

TheCorporation identified this error in its accounting for the fair valueadjustment to its loans held for sale portfolio (primarily the residential loanportfolio), resulting in an adjustment to net income for the three monthsending March 31, 2009.  The Corporationerroneously excluded from the population to be fair valued, certain loans whichwere identified for sale to a third party but for which the Corporation wasawaiting the final approval and agreement from the counterparty to complete thetransaction.  The Corporation’s policy isto continue to record the loans in this portfolio-segment as loans held forsale until the criteria for a sale is met and to record loans held for sale atfair value under the fair value option.

 

Asa result of this error, the Corporation’s Board of Directors, in consultationwith management and its Audit Committee, determined that the financialstatements contained in its Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2009, could no longer be relied upon. Accordingly, we have restatedour unaudited consolidated financial statements as of and for the three monthsended March 31, 2009 to record an adjustment for the correction of thiserror.  As a result of the restatement,the following financial statement line items were adjusted (dollars inthousands, except per share amounts):

 
| ** **                                                        | ** ** | **March 31, 2009** | ** ** |
|-------------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                        | ** ** | **As Reported**    | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| **Statement of Financial  Condition**                             |       |               |       |   |   |   |   |
| Assets                                                            |       |               |       |   |   |   |   |
| Mortgage loans held for sale                                      |       | 186,249            |       | 1,162 |   | 187,411 |   |
| Net deferred tax asset                                            |       | 8,802              |       | (395 | ) | 8,407 |   |
| Total Assets                                                      |       | 1,335,480          |       | 767 |   | 1,336,247 |   |
|                                                              |       |               |       |   |   |   |   |
| Liabilities and Stockholders’ Equity                         |       |               |       |   |   |   |   |
| Retained earnings                                                 |       | 59,817             |       | 767 |   | 60,584 |   |
| Total First Chester County Corporation  Stockholders’ equity |       | 85,452             |       | 767 |   | 86,219 |   |
| Total stockholders’ equity                                   |       | 86,982             |       | 767 |   | 87,749 |   |
| Total liabilities and stockholders’ equity                   |       | 1,335,480          |       | 767 |   | 1,336,247 |   |

 

5

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 
| ** **                                                                                 | ** ** | **Three Months Ended March 31, 2009** | ** ** |
|--------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                 | ** ** | **As Reported**                       | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| **Statement of Income**                                                                    |       |                                  |       |   |   |   |   |
|                                                                                       |       |                                  |       |   |   |   |   |
| Net gains from mortgage banking activities                                                 |       | 10,845                                |       | 1,162 |   | 12,007 |   |
| Total non-interest income                                                                  |       | 14,195                                |       | 1,162 |   | 15,357 |   |
| Income before income taxes and cumulative effect  of change in accounting for income taxes |       | 3,852                                 |       | 1,162 |   | 5,014 |   |
| Income Taxes                                                                               |       | 1,131                                 |       | 395 |   | 1,526 |   |
| Net Income                                                                                 |       | 2,721                                 |       | 767 |   | 3,488 |   |
| Net income attributable to First Chester County  Corporation                               |       | 2,553                                 |       | 767 |   | 3,320 |   |
| Net Income per share (Basic)                                                               |       | 0.41                                  |       | 0.12 |   | 0.53 |   |
| Net Income per share (Diluted)                                                             |       | 0.41                                  |       | 0.12 |   | 0.53 |   |

 
| ** **                                | ** ** | **Three Months Ended March 31, 2009** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|
| ** **                                | ** ** | **As Reported**                       | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| **Statement of Cash Flows**               |       |                                  |       |   |   |   |   |
|                                      |       |                                  |       |   |   |   |   |
| Net Income                                |       | 2,721                                 |       | 767 |   | 3,488 |   |
| Net gain from mortgage banking activities |       | (10,845                               | )          | (1,162 | ) | (12,007 | ) |
| Increase in other assets (DTA)            |       | (1,605                                | )          | 395 |   | (1,210 | ) |

 

**2.****             ****SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

Thefollowing supplements the significant accounting policies described in thefootnotes to the consolidated financial statements in the 2008 Annual Report:

 

Asa result of the acquisition of AHB’s operations, the Corporation reports thefollowing new lines in the income statement:

 

Loanservicing fees and other consist mainly of fees earned at the inception of aloan as well as fees earned on the servicing of loan portfolios not owned bythe Bank. Loan servicing fees and other also includes gains and losses on theBank’s mortgage servicing rights.

 

Netgain from mortgage banking activities consists of unrealized gains and losseson interest rate lock commitments, loans held for sale, and forward salecommitments combined with realized gains and losses on the actual sale of theloan and the settlement of forward sale commitments.

 

6

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**3.****             ****ACCOUNTINGFOR STOCK-BASED COMPENSATION PLANS**

 

At March 31, 2009, the Corporation had one stock based compensationplan, pursuant to which, shares of the Corporation’s common stock could beissued, subject to certain restrictions. The plan, adopted in 2005, allows theCorporation to grant up to 150 thousand shares of restricted stock toemployees. During the three months ended March 31, 2009, the Corporationgranted no shares of restricted stock under this plan. During the three monthsended March 31, 2008, the Corporation granted 34,500 shares valued at $17.80per share at the grant date. One third of these shares vest on each of thefirst three anniversaries of the date of the grant. These restricted stockgrants are also subject to accelerated vesting of all or a portion of theshares upon the occurrence of certain events, as described more fully in ourProxy Statement for the 2009 Annual Meeting of Shareholders. A summary of theCorporation’s unvested restricted shares is as follows:

 

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

 
| ** **                  | ** ** | **Shares** | ** ** | **Grant Date Fair  Value** | ** ** | **Aggregate Intrinsic Value  of Unvested Shares** | ** ** |
|-----------------------------|------------|------------|------------|----------------------------|------------|---------------------------------------------------|------------|
| Unvested at January 1, 2009 |       | 44,075     |       | $                          | 18.74      |                                              |       |   |
| Granted                     |       | —     |       | —                     |       |                                              |       |
| Vested                      |       | 6,400      |       | $                          | 21.05      |                                              |       |   |
| Forfeited                   |       |       |       |                       |       |                                              |       |
| Unvested at March 31, 2009  |       | 37,675     |       | $                          | 20.50      |                                              | $          | 293.1 |   |
|                             |            |            |            |                            |            |                                                   |            |  |  |

 

The Corporation recorded $41 thousand and $46 thousand of restrictedstock expense for the three months ended March 31, 2009 and 2008, respectively.

 

The Corporation’s ability to issue stock options under the Corporation’s1995 Stock Option Plan has expired. Outstanding stock options, however, remainin effect according to their terms. Aggregated information regarding theCorporation’s Stock Option Plan as well as options assumed in connection withthe AHB acquisition as of March 31, 2009 are presented below.

 

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

 
| **Options**                    | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2009 |       | 298,034    |       | $                                       | 15.43      |                                                       | —     |                            | $          | 0 |   |
| Granted                        |       | —     |       | —                                  |       | —                                                     |       | —                          |       |
| Exercised                      |       | —     |       | —                                  |       | —                                                     |       | —                          |       |
| Forfeited                      |       | (880       | )          | 14.79                                   |       | —                                                     |       | —                          |       |
| Expired                        |       | —     |       | —                                  |       | —                                                     |       | —                          |       |
| Outstanding at March 31, 2009  |       | 297,154    |       | $                                       | 15.43      |                                                       | 3.28       |                            | $          | 0 |   |
| Exercisable at March 31, 2009  |       | 297,154    |       | $                                       | 15.43      |                                                       | 3.28       |                            | $          | 0 |   |

 

There were no options granted during the three months ended March 31,2009.  The total intrinsic value (marketvalue on date of exercise less grant price) of options exercised during theyear ended December 31, 2008 was $0.

 

7

----

Table ofContents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**4.****             ****EARNINGSPER SHARE, AS RESTATED**

 

**Three Months ended March 31, 2009**

 
| ** **                                  | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **     | ** ** |
|---------------------------------------------|------------|-----------------|------------|-------------------|------------|----------------|------------|
| ** **                                  | ** ** | **(thousands)** | ** ** | ** **        | ** ** | **Per Share**  | ** ** |
| ** **                                  | ** ** | **(numerator)** | ** ** | **Shares**        | ** ** | **Amount**     | ** ** |
| ** **                                  | ** ** | **(Restated)**  | ** ** | **(denominator)** | ** ** | **(Restated)** | ** ** |
| Basic earnings per share                    |       |            |       |              |       |           |       |
| Net income available to common stockholders |       | $               | 3,320      |              | 6,242,252  |           | $          | 0.53 |   |
| Effect of Dilutive Securities               |       |            |       |              |       |           |       |
| Options to purchase common stock            |       | —          |       | —            |       | —         |       |
| Diluted earnings per share                  |       |            |       |              |       |           |       |
| Net income available to common stockholders |       | $               | 3,320      |              | 6,242,252  |           | $          | 0.53 |   |

 

297,154anti-dilutive weighted average shares have been excluded from this computationbecause the option exercise price was greater than the average market price ofthe common shares.

 

**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            |       | —        |       |
| Diluted earnings per share                  |       |            |       |              |       |          |       |
| Net income available to common stockholders |       | $               | 1,520      |              | 5,203,441  |          | $          | 0.29 |   |

 

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

 

**5.****             ****COMPREHENSIVEINCOME, AS RESTATED**

 

Components of comprehensiveincome are presented in the following chart:

 
| ** **                                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                             | ** ** | **2009********(Restated)**        | ** ** | **2008** | ** ** |
| Unrealized gains (losses) on securities:                               |       |                              |       |   |   |
| Unrealized gains (losses) arising in period                            |       | $                                 | (523       | ) | $ | 10 |   |
| Reclassification adjustment                                            |       | (88                               | )          | 262 |   |
| Net unrealized gains (losses)                                          |       | (611                              | )          | 272 |   |
| Other comprehensive income before taxes                                |       | (611                              | )          | 272 |   |
| Income tax benefit (expense)                                           |       | 207                               |       | (93 | ) |
| Other comprehensive income (loss)                                      |       | (404                              | )          | 179 |   |
| Net income                                                             |       | 3,488                             |       | 1,520 |   |
| Comprehensive income                                                   |       | 3,084                             |       | 1,699 |   |
| Comprehensive income  attributable to non-controlling interest         |       | (168                              | )          | — |   |
| Total comprehensive income attributable to First  Chester County Corp. |       | $                                 | 2,916      |   | $ | 1,699 |   |

 

8

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**6.****             ****CASHFLOW INFORMATION**

 

For purposes of reporting cash flows, cash and cash equivalents includecash on hand, amounts due from banks, and federal funds sold and overnightinvestments.  Generally, federal fundsand overnight investments are purchased and sold for one-day periods.  Cash paid for interest for the three monthperiods ended March 31, 2009 and 2008 was $6.3 million and $7.2 million,respectively.  Cash paid for income taxesfor the three month periods ended March 31, 2009 and 2008  was $50 thousand and $0, respectively.

 

**7.****             ****ACQUISITION**

 

OnDecember 31, 2008, the Corporation completed its acquisition of American HomeBank (“AHB”). This acquisition was intended to help the Bank to furtherdiversify the Bank’s products, services, and sources of income as well asexpand the Bank’s geographic footprint. The AHB merger was accounted for underthe purchase method of accounting in accordance with SFAS No. 141, “BusinessCombinations.” In accordance with SFAS No. 141, certain deal costs andother cash paid are capitalized as part of the total purchase price. Thepurchase price has been allocated to the assets acquired and the liabilitiesassumed based on their estimated fair values at the AHB merger date. Goodwillresulted from the acquisition. During the first quarter of 2009, theCorporation recorded a $1.6 million purchase accounting adjustment related toadditional consideration identified for the acquisition. This amount relates tothe lump sum payments made to certain former executive officers of AHB inconnection with the finalization of the AHB Management Incentive Plan (asdescribed in the Corporation’s Current Report on Form 8-K filed on May 5, 2009containing Item 5.02 disclosure). The full amount of this additionalconsideration was allocated to goodwill. The following shows the prior andcurrent balance of goodwill:

 

(Dollarsin thousands)

 
| ** **                                     | ** ** | **Goodwill  Balance** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
|                                           |       |                  |       |
| December 31, 2008                              |       | $                     | 5,906      |   |
|                                           |       |                  |       |
| Purchase accounting adjustment for acquisition |       | 1,600                 |       |
|                                           |       |                  |       |
| March 31, 2009                                 |       | $                     | 7,506      |   |

 

**8.****             ****SEGMENTREPORTING, AS RESTATED**

 

The Corporation has determined that it has two operating and reportingsegments: Community Banking and Mortgage Banking.

 

The Corporation’s Community Banking segment consists of commercial,commercial construction, retail banking and wealth management. The CommunityBanking segment is managed as a single strategic unit, which generates revenuefrom a variety of products and services provided by the Corporation. Forexample, construction and commercial lending is dependent upon the ability ofthe Corporation to fund itself with retail deposits and other borrowings and tomanage interest rate and credit risk. This situation is also similar forconsumer lending.

 

The Corporation’s Mortgage Banking segment operates under the tradename, “American Home Bank, a division of First National Bank of Chester County,”referred to herein as the “AHB Division”). Its principal activities includeproviding mortgages and associated products to customers and selling most ofthose mortgages into the secondary market on a servicing released basis. TheAHB Division retains the servicing on a portion of the loans that itsells.  The AHB Division also holds someresidential mortgage and construction loans. The AHB Division was formed onDecember 31, 2008 following the acquisition of American Home Bank, NationalAssociation.

 

Reportable segment-specific information and reconciliation toconsolidated financial information is as follows:

 

9

----

Table ofContents

** **

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 
| ** **                  | ** ** | **As of and for the three months ended March 31, 2009** | ** ** |
|-----------------------------|------------|---------------------------------------------------------|------------|
| **(Dollars  in thousands)** | ** ** | **Community Banking  Segment**                          | ** ** | **Mortgage Banking  Segment  (Restated)** | ** ** | **Consolidated  Segment  (Restated)** | ** ** |
| Total assets                |       | $                                                       | 1,087,350  |   | $ | 248,897 |   | $ | 1,336,247 |   |
|                        |       |                                                    |       |   |   |   |   |
| Net interest income         |       | $                                                       | 8,276      |   | $ | 1,850 |   | $ | 10,126 |   |
|                        |       |                                                    |       |   |   |   |   |
| Total non-interest income   |       | $                                                       | 2,453      |   | $ | 12,904 |   | $ | 15,357 |   |
| Total non-interest expense  |       | $                                                       | 8,939      |   | $ | 10,143 |   | $ | 19,082 |   |
|                        |       |                                                    |       |   |   |   |   |
| Net Income                  |       | $                                                       | 719        |   | $ | 2,601 |   | $ | 3,320 |   |

 

 
| ** **                 | ** ** | **As of and for the three months ended March 31, 2008** | ** ** |
|----------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **Community Banking**                                   | ** ** | **Mortgage Banking** | ** ** | **Consolidated** | ** ** |
| **(Dollars in thousands)** | ** ** | **Segment**                                             | ** ** | **Segment** | ** ** | **Segment** | ** ** |
|                       |       |                                                    |       |   |   |   |   |
| Total assets               |       | $                                                       | 1,006,441  |   | $ | — |   | $ | 1,006,441 |   |
|                       |       |                                                    |       |   |   |   |   |
| Net interest income        |       | $                                                       | 7,878      |   | $ | — |   | $ | 7,878 |   |
|                       |       |                                                    |       |   |   |   |   |
| Total non-interest income  |       | $                                                       | 2,858      |   | $ | — |   | $ | 2,858 |   |
| Total non-interest expense |       | $                                                       | 8,448      |   | $ | — |   | $ | 8,448 |   |
|                       |       |                                                    |       |   |   |   |   |
| Net Income                 |       | $                                                       | 1,520      |   | $ | — |   | $ | 1,520 |   |

 

**9.****             ****RECENTACCOUNTING PRONOUNCEMENTS**

 

InApril 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosuresabout Fair Value of Financial Instruments,” (“FSP FAS 107-1”). FSP 107-1expands disclosures for fair value of financial instruments that are within thescope of FASB statement number 107 (“SFAS 107”) and now requires the FAS107fair value disclosures in interim period reports. FSP FAS 107-1 is effectivefor interim reporting periods ending after June 15, 2009. The Corporation hasnot yet determined the impact, if any, that FSP FAS 107-1 will have on ourconsolidated financial statements.

 

InApril 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying TransactionsThat Are Not Orderly,” (“FSP 157-4”). FSP 157-4 provides guidance forestimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when thevolume and level of activity for the asset or liability have significantlydecreased. FSP 157-4 also includes guidance on identifying circumstances thatindicate a transaction is not orderly. FSP 157-4 is effective for interim andannual reporting periods ending after June 15, 2009. The Corporation has notyet determined the impact, if any, that FSP 157-4 will have on our consolidatedfinancial statements.

 

InOctober 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Valueof a Financial Asset When the Market for That Asset is Not Active,” (“FSP FAS157-3”). FSP FAS 157-3 clarifies the application of SFAS 157 in a market thatis not active and provides an example to illustrate key considerations indetermining the fair value of a financial asset when the market for thatfinancial asset is not active.  Weadopted the provisions of FSP FAS 157-3 in September 2008.  FSP FAS157-3 did not have a material impact on our consolidated financial statements.

 

10

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

In June 2008, the FASB posted FASB Staff Position No. EITF 03-6-1,**“DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities,” (“FSP EITF 03-6-1”).  This statementaddressed whether instruments granted in share-based payment transactions areparticipating securities prior to vesting and, therefore, need to be includedin the calculation of earnings per share (EPS) as described in FASB StatementNo. 128,*“*Earnings per Share*.*”* *  FSP EITF 03-6-1 iseffective for financial statements issued for fiscal years beginning afterDecember 15, 2008 with prior period EPS data adjusted retrospectively toconform to its provisions. FSP EITF 03-6-1 did not have a material impact onour consolidated financial statements.

 

In March 2008, the FASBissued Statement of Financial Accounting Standards No. 161,**“Disclosuresabout Derivative Instruments and Hedging Activities,” (“SFAS No. 161”). This statement is an amendment to Statement no. 133 and changes the disclosurerequirements for derivative instruments and hedging activities. No. 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008.  SFASNo. 161 did not have a material impact on our consolidated financialstatements.

 

InFebruary 2008, the FASB issued Staff Position 157-2 (“FSP 157-2”), “EffectiveDate of FASB Statement No. 157.”  FSP 157-2 delays the effective dateof FAS 157 for all nonfinancial assets and nonfinancial liabilities, exceptthose that are recognized or disclosed at fair value on a recurring basis (atleast annually) to fiscal years beginning after November 15, 2008, and interimperiods within those fiscal years. FSP 157-2 did not have a materialimpact on our consolidated financial statements.

 

In December 2007, the FASB issued Statement No. 141(R) (“SFAS 141(R)”),“Business Combinations.”  This Statementreplaces SFAS 141, “Business Combinations.” This Statement retains the fundamental requirements in Statement 141that the acquisition method of accounting (which Statement 141 called the “purchasemethod”) be used for all business combinations and for an acquirer to beidentified for each business combination. This Statement also establishes principles and requirements for how theacquirer: a) recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree; b) recognizes and measures the goodwill acquired inthe business combination or a gain from a bargain purchase and c) determines whatinformation to disclose to enable users of the financial statements to evaluatethe nature and financial effects of the business combination. SFAS 141(R) willapply prospectively to business combinations for which the acquisition date ison or after the first annual reporting period beginning on or after December15, 2008.  While the Corporation has notyet evaluated SFAS 141(R) for the impact, if any, that SFAS 141(R) will have onour consolidated financial statements, we will be required to expense costsrelated to any acquisitions on or after January 1, 2009, rather than capitalizesuch costs as currently required.

 

In December 2007, the FASB issued Statement No. 160 (“SFAS 160”), “NoncontrollingInterests in Consolidated Financial Statements.”  This Statement amends Accounting ResearchBulletin 51 to establish accounting and reporting standards for thenoncontrolling (minority) interest in a subsidiary and for the deconsolidationof a subsidiary.  It clarifies that anoncontrolling interest in a subsidiary is an ownership interest in theconsolidated entity that should be reported as equity in the consolidatedfinancial statements.  SFAS 160 iseffective for fiscal years beginning on or after December 15, 2008. TheCorporation adopted the provisions of SFAS 160 on January 1, 2009 andaccordingly, changed the way in which it reports minority interest in theCorporation’s balance sheet. The Corporation now includes minority interest inthe equity section of the balance sheet.

 

**10.****      ****FAIR MARKET VALUE, AS RESTATED**

 

Statement157 defines fair value as the exchange price that would be received for anasset or paid to transfer a liability (an exit price) in an orderly transactionbetween market participants on the measurement date. Statement 157 alsoestablishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value. FSP FAS 157-3 clarifies the application of SFAS 157 in a marketthat is not active and provides an example to illustrate key considerations indetermining the fair value of a financial asset

 

11

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

whenthe market for that financial asset is not active. We considered therequirements of FSP 157-3 when estimating fair value.

 

FASB Statement No. 159 permits entities to choose to measure manyfinancial instruments and certain other items at fair value at specifiedelection dates. The Corporation elected to account for loans held for saleunder this election option.

 

Statement157 describes three levels of inputs that may be used to measure fair value:

 

Level1: Quoted prices (unadjusted) for identical assets or liabilities in activemarkets that the entity has the ability to access as of the measurement date.

 

Level2: Significant other observable inputs other than Level 1 prices, such asquoted prices for similar assets or liabilities, quoted prices in markets thatare not active, and other inputs that are observable or can be corroborated byobservable market data.

 

Level3: Significant unobservable inputs that reflect a company’s own assumptionsabout the assumptions that market participants would use in pricing an asset orliability.

 

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

 

Securities:Trading securities and investment securities available-for-sale are recorded atfair value on a recurring basis. Fair value measurement is based upon quotedprices, if available. If quoted prices are not available, fair values aremeasured using matrix pricing, which is a mathematical technique used widely inthe industry to value debt securities without relying exclusively on quotedprices for the specific securities but rather by relying on the securities’relationship to other benchmark quoted securities. Level 1 securities includethose traded on nationally recognized securities exchanges, U.S. Treasury andAgency securities, and money market funds. Level 2 securities includemortgage-backed securities issued by government sponsored entities, municipalbonds and corporate debt securities. Securities classified as Level 3 includeasset-backed securities in less liquid markets.

 

Loansheld for sale: The fair value of loans held for sale is based primarily onsecondary-market price quotes. If no such quoted price exists, the fair valueof a loan is determined using quoted prices for comparable instruments. Assuch, the Corporation classifies loans subjected to nonrecurring fair valueadjustments as Level 2.

 

Loansand leases: The Corporation does not record loans at fair value on a recurringbasis. However, from time to time, a loan is considered impaired and anallowance for loan losses is established. Loans for which it is probable thatpayment of interest and principal will not be made in accordance with thecontractual terms of the loan agreement are considered impaired. Once a loan isidentified as individually impaired, management measures impairment inaccordance with SFAS 114, “Accounting by Creditors for Impairment of a Loan,” (“SFAS114”). The fair value of impaired loans is estimated using one of severalmethods, including collateral value, market value of similar debt, enterprisevalue, liquidation value and discounted cash flows. Those impaired loans notrequiring an allowance represent loans for which the fair value of the expectedrepayments or collateral exceed the recorded investments in such loans. AtMarch 31, 2009, substantially all of the total impaired loans were evaluatedbased on the fair value of the collateral. In accordance with SFAS 157,impaired loans where an allowance is established based on the fair value ofcollateral require classification in the fair value hierarchy. When the fairvalue of the collateral is based on an observable market price or a currentappraised value, the Corporation records the impaired loan as nonrecurringLevel 3.

 

OtherReal Estate Owned (“OREO”): OREO is adjusted to fair value upon transfer of theloans to foreclosed assets. Subsequently, OREO is carried at the lower ofcarrying value or fair value. Fair value is based upon independent marketprices, appraised values of the collateral or management’s estimation of thevalue of the collateral. When the fair value of the collateral is based on anobservable market price or a current appraised value, the Corporation recordsthe foreclosed asset as nonrecurring Level 2. When an appraised value is notavailable or management determines the fair

 

12

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

valueof the collateral is further impaired below the appraised value and there is noobservable market price, the Corporation records the foreclosed asset asnonrecurring Level 3.

 

MortgageServicing Rights (“MSRs”): To determine the fair value of MSRs, the Bank usesan independent third party to estimate the present value of estimated futurenet servicing income. This valuation method incorporates an assumption thatmarket participants would use in estimating future net servicing income, whichinclude estimates of the cost to service, the discount rate, custodial earningsrate, an inflation rate, ancillary income, prepayment speeds, and default ratesand losses. The fair value of servicing rights was determined using discountrates ranging from 8.0% to 10.0%, prepayment speeds ranging from 8.1% to 48.18%depending on the stratification of the specific right, and a weighted averagedefault rate of 2.14%.

 

Derivativeinstruments: The fair value of interest rate lock commitments and forward salescommitments are estimated using a process similar to mortgage loans held forsale. Loan commitments and best efforts commitments are assigned a probabilitythat the related loan will be funded and the commitment will be exercised. TheBank relies on historical “pull-through” percentages in establishingprobability.

 

Thetable below presents the balance of assets and liabilities at March 31, 2009,measured at fair value on a recurring basis:

 

 
| **Dollars  in thousands**                | ** ** | **Level 1** | ** ** | **Level 2**    | ** ** | **Level 3** | ** ** | **Total**      | ** ** |
|------------------------------------------|------------|-------------|------------|----------------|------------|-------------|------------|----------------|------------|
| ** **                               | ** ** | ** **  | ** ** | **(Restated)** | ** ** | ** **  | ** ** | **(Restated)** | ** ** |
| Assets                                   |       |        |       |           |       |        |       |           |       |
| Investment securities available for sale |       | $           | 1,206      |           | $          | 98,573      |       | $              | —     |   | $ | 99,779 |   |
| Loans held for sale                      |       | —      |       | 187,411        |       | —      |       | 187,411        |       |
| Mortgage servicing rights                |       | —      |       | —         |       | 421         |       | 421            |       |
| Interest rate lock commitments           |       | —      |       | —         |       | 873         |       | 873            |       |
| Liabilities                              |       |        |       |           |       |        |       |           |       |
| Mandatory forward sales commitments      |       | $           | —     |           | $          | 682         |       | $              | —     |   | $ | 682 |   |

 

Theaggregate unpaid principal balance of mortgage loans held for sale is $183.2million.

 

Thetable below presents the balance of assets and liabilities at March 31, 2009,measured at fair value on a nonrecurring basis:

 

 
| **Dollars  in thousands**   | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|-----------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
|                        |       |        |       |        |       |        |       |      |       |
| Impaired loans & leases |       | $           | —     |        | $          | —      |       | $         | 18,927     |   | $ | 18,927 |   |
|                        |       |        |       |        |       |        |       |      |       |
| OREO                        |       | —      |       | —      |       | 2,142       |       | 2,142     |       |
|                             |            |             |            |             |            |             |            |           |            |  |  |  |  |

 

Thetable below presents the rollforward of assets that are valued usingsignificant unobservable inputs (Level 3) for the quarter ended March 31, 2009:

 

13

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 
| **Dollars  in thousands**             | ** ** | **Mortgage  Servicing  Rights** | ** ** | **Interest Rate  lock  Commitments** | ** ** | **Loans** | ** ** | **OREO** | ** ** |
|---------------------------------------|------------|---------------------------------|------------|--------------------------------------|------------|-----------|------------|----------|------------|
| Beginning balance                     |       | $                               | 239        |                                 | $          | 412       |       | $        | 10,515     |   | $ | 1,872 |   |
| Net transferred into (out of) level 3 |       | 215                             |       | (1,429                               | )          | 9,386     |       | 270      |       |
| Net unrealized gains (losses)         |       | (33                             | )          | 1,890                                |       | (974      | )          |     |       |
| Ending Balance                        |       | $                               | 421        |                                 | $          | 873       |       | $        | 18,927     |   | $ | 2,142 |   |

 

**11.****      ****DERIVATIVEINSTRUMENTS**

 

The Bank, as part of its real estate lending and mortgage bankingactivities, originates fixed-rate 1-4 unit residential loans for sale in thesecondary market.  At the time oforigination, management identifies loans that are expected to be sold in thenear future.  These warehoused loans havebeen classified as mortgage loans held for sale in the consolidated balancesheet.  These loans expose the Bank tovariability in their fair value due to changes in interest rates.  If interest rates increase, the value of theloans decreases.  Conversely, if interestrates decrease, the value of the loans increases.

 

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

 

Loan commitments relate to the origination of mortgage loans that willbe held for sale are accounted for as derivative instruments.  Such commitments, along with any related feesreceived from potential borrowers, are recorded at fair value in derivativeassets or liabilities, with changes in fair value recorded in net revenue fromsales and brokering of loans.

 

To mitigate the effect of this interest rate risk on both the held forsale loans and interest rate lock commitments, the Bank enters into offsettingderivative contracts, primarily forward loan commitments.  The forward loan sales commitments lock inthe price for the sale of specific loans or loans to be funded under specificinterest rate lock commitments or for a generic group of loans with similarcharacteristics.  Mandatory forward salescommitments are agreements to sell a certain notional amount of loans at aspecified future time period at a specified price.  The Bank incurs a penalty for failure tofollow through with the commitment.  Bestefforts forward sales commitments also result in direct or indirect financialpenalties for failure to follow through if the related loans close.  The fair value of forward loan salescommitments that hedge warehouse loans and interest rate lock commitments, aswell as interest rate lock commitments themselves, are summarized as follows atDecember 31, 2008.  The fair values ofall of these items are recorded on the balance sheet within other assets andother liabilities as these items are financial derivatives.

 

The fair value of derivative instruments not designated as hedginginstruments under FASB Statement No. 133 are presented in the following table:

 
| ** **                             | ** ** | **Asset Derivatives**   | ** ** | **Liability Derivatives**  | ** ** |
|----------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
| **(Dollars in  thousands)**       | ** ** | **Balance  Sheet  Location** | ** ** | **Fair  Value**                 | ** ** | **Balance  Sheet  Location** | ** ** | **Fair  Value** | ** ** | **Balance  Sheet  Location** | ** ** | **Fair  Value** | ** ** | **Balance  Sheet  Location** | ** ** | **Fair  Value** | ** ** |
|                                   |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Mandatory forward sales commitments    |       | Other assets                 |       | $                               | —     |   | Other assets |   | $ | — |   | Other Liabilities |   | $ | 682 |   | Other Liabilities |   | $ | 583 |   |
| Best efforts forward sales commitments |       | Other assets                 |       | —                          |       | Other assets |   | — |   | Other Liabilities |   | — |   | Other Liabilities |   | 35 |   |
| Interest rate lock commitments         |       | Other assets                 |       | 873                             |       | Other assets |   | 412 |   | Other Liabilities |   | — |   | Other Liabilities |   | — |   |
|                                        |            |                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

14

----

Tableof Contents

 

**FIRST CHESTER COUNTY CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**12.****      ****SUBSEQUENTEVENTS**

 

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

 

**13.****      ****RECLASSIFICATIONS**

 

Certain2008 numbers have been reclassified to conform with current periodpresentation. These reclassifications have no impact on net income or earningsper share.

 

15

----

Tableof Contents

 

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

 

This discussion is intendedto further your understanding of the consolidated financial condition andresults of operations of First Chester County Corporation and its direct andindirect wholly-owned subsidiaries. It should be read in conjunction with theconsolidated financial statements included in this report.

 

In addition to historicalinformation, this discussion and analysis contains statements relating tofuture results of the Corporation that are considered “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995.  These statements can often beidentified by the use of forward-looking terminology such as “believes,” “expects,”“intends,” “may,” “will,” “should” “or anticipates” or similarterminology.  These statements involverisks and uncertainties and are based on various assumptions.  Although the Corporation believes that itsexpectations are based on reasonable assumptions, investors and prospectiveinvestors are cautioned that such statements are only projections, and that theserisks and uncertainties are all difficult to predict and most are beyond thecontrol of the Corporation’s Management. Information about the primary risks and uncertainties that could causethe Corporation’s actual future results to differ materially from our historicresults or the results described in forward-looking statements made in thisreport or presented elsewhere by Management from time to time are included in Part I, Item1A of our Annual Report on Form 10-K for the year ended December 31,2008 (our “2008 Annual Report”).  Materialchanges to such “risk factors” may be reported in subsequent Quarterly Reportson Form 10-Q in Part II, Item 1A.  There have been no such changes from the riskfactors set forth in our 2008 Annual Report.

 

The Corporation undertakesno obligation to publicly release any revisions to any forward-lookingstatements to reflect events or circumstances after the date of this Report.

 

**CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES**

 

The accounting and reportingpolicies of the Corporation conform with the accounting principles generallyaccepted in the United States of America and general practices within thefinancial services industry.  Thepreparation of the financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the amounts reported in the financialstatements and the accompanying notes. Actual results could differ from thoseestimates. For a discussion of significant accounting policies please refer tothe footnotes to the Corporation’s consolidated financial statements includedin this Report and in our 2008 Annual Report.

 

**GOODWILLIMPAIRMENT**

 

Goodwill was recorded as aresult of the AHB acquisition. Goodwill and other intangible assets must bereviewed at least annually for potential impairment, or more often if events orcircumstances indicate that there may be impairment, in accordance with SFAS No. 142,“Goodwill and Other Intangible Assets and SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets.” Goodwill is tested forimpairment at the reporting unit level and requires that the fair value of eachof our reporting units be compared to the carrying amount of its net assets,including goodwill. An impairment loss is recorded to the extent that thecarrying amount of goodwill exceeds its implied fair value. The Corporationwill utilize general industry practices in evaluating the fair value of itsgoodwill and other intangible assets.

 

**INVESTMENTSECURITIES**

 

In accordance with FASBStatement No. 115, the Corporation evaluates the individual securitiesmaking up the investment portfolio for other than temporary impairment on aquarterly basis. If a security is deemed to be other than temporarily impaired,the impairment is recorded in non-interest income in the period in which it isrecognized. Evaluating whether a security is other than temporarily impairedinvolves a high degree of judgment. Factors considered by management indetermining whether a security is other than temporarily impaired includecurrent and forecasted market conditions for that security as well as ourability and intent to hold the security until recovery.

 

16

----

Tableof Contents

 

**ALLOWANCE FOR LOAN AND LEASE LOSSES**

 

The Corporation considersthat the determination of the allowance for loan and lease losses involves ahigher degree of judgment and complexity than its other significant accountingpolicies.  The balance in the allowancefor loan losses is determined based on Management’s review and evaluation ofthe loan and lease portfolio in relation to past loss experience, the size andcomposition of the portfolio, current economic events and conditions, and otherpertinent factors, including Management’s assumptions as to futuredelinquencies, recoveries and losses. All of these factors may be susceptible to significant change.  To the extent actual outcomes differ fromManagement’s estimates, additional provisions for loan and lease losses may berequired that would adversely impact earnings in future periods.

 

**INCOME TAXES**

 

Under the liability method,deferred tax assets and liabilities are determined based on the differencebetween the financial statement and tax bases of assets and liabilities.  Deferred tax assets are subject to Management’sjudgment based upon available evidence that future realization is more likelythan not.  If Management determines thatthe Corporation may be unable to realize all or part of the net deferred taxassets in the future, a direct charge to income tax expense may be required toreduce the recorded value of the net deferred tax asset to the expectedrealizable amount.

 

**ACQUISITION**

 

Effective December 31,2008, the Corporation completed its acquisition of American Home Bank, NationalAssociation (“AHB”). The mortgage banking business of AHB is now operating as adivision of the Bank under the trade name, “American Home Bank, a Division ofFirst National Bank of Chester County.” AHB’s mortgage-banking activitiesinclude providing mortgages and associated products to customers and sellingmost of those mortgages into the secondary market on a servicing releasedbasis. AHB retains the servicing on a portion of the loans that it sells. Thesourcing of mortgage loans is conducted through a direct, retail deliverychannel comprised of retail loan offices, affiliated business arrangements withbuilders and realtors, and a wholesale lending operation. The wholesaleoperation sources loans through relationships with unrelated mortgage brokers.The acquisition of AHB was intended to help the Bank to further diversify theBank’s products, services, and sources of income as well as expand the Bank’sgeographic footprint.

 

**FINALIZATIONOF THE AHB MANAGEMENT INCENTIVE PLAN**

 

On May 4, 2009, theCorporation finalized the AHB Management Incentive Plan (as described inFootnote 6 to the Financial Statements), which resulted in the treatment foraccounting purposes under GAAP of certain lump sum payments under thefinalized Plan as additional consideration for the AHB shares of certain formerexecutive officers of AHB who were to participate in the Plan.  Under thestructure of the Plan outlined in the Corporation’s Registration Statement on Form S-4,which was not concluded and was subject to finalization, amounts earned underthe AHB MIP may have been considered compensation expense or additionalconsideration.  The Agreement to finalize the AHB MIP providedfor lump sum payments in the amount of $1,600,000 to be paid in May 2009,which are not subject to forfeiture due to employment status or any otherprovision of the employment agreements entered into with the executives inconnection with the merger. The Agreement to finalize the AHB MIP also providedfor participation in the Bank’s Executive Incentive Plan in 2009, which will betreated as compensation expense as earned.

 

**EARNINGS AND DIVIDEND SUMMARY**

 

The Corporation completedits acquisition of American Home Bank on December 31, 2008, and,accordingly, the December 31, 2008 and the March 31, 2009consolidated balance sheets reflect the addition of assets acquired andliabilities assumed in this acquisition. The results of operations presented inthe consolidated income statement for the three months ended March 31,2009 include the results of operations from AHB; however, the consolidatedincome statement for the three months ended March 31, 2008 does notinclude the results of AHB.

 

Net income for the threemonths ended March 31, 2009 was $3.32 million, an increase of $1.8 millionor 118.4% from $1.5 million for the same period in 2008.  Diluted earnings per share for the threemonths ended March 31, 2009 and 2008 were $0.53 and $0.29,respectively.  Basic earnings per sharefor the three months ended March 31, 2009 and 2008

 

17

----

Table of Contents

 

were also $0.53 and $0.29 respectively. Cash dividends declared during the three month period ended March 31,2009 and 2008 were $0.14 and $0.14, respectively.

 

The increase in net incomefor the first quarter of 2009 was largely due to an increase in net interestincome due mainly to the higher average interest-earning assets from theacquisition of AHB. In addition, non-interest income increased significantly,due mainly to the net gains from the mortgage banking activities of the AHBDivision. Offsetting these increases was an increase in non-interest expense,due mainly to the addition of AHB’s operations, combined with an increase inthe provision for loan and lease losses. The increase in the provision wasdriven by the ongoing impact from recessionary economic conditions.

 

**SELECTEDRATIOS**

 
| ** **               | ** ** | **Three Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **March 31,**     | ** ** |
| ** **               | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **               | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| **SELECTED RATIOS**      |       |                   |       |   |   |
| Return on Average Assets |       | 0.78                   | %          | 0.64 | % |
| Return on Average Equity |       | 11.74                  | %          | 8.80 | % |
| Dividend Payout Ratio    |       | 34.23                  | %          | 47.76 | % |
| Book Value Per Share     |       | $                      | 13.92      |   | $ | 13.67 |   |
|                          |            |                        |            |  |  |  |  |

 

**SEGMENT INFORMATION**

 

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

 

The Corporation’s CommunityBanking segment consists of commercial, commercial construction, retail bankingand wealth management. The Community Banking segment is managed as a singlestrategic unit, which generates revenue from a variety of products and servicesprovided by the Corporation. For example, construction and commercial lendingis dependent upon the ability of the Corporation to fund itself with retaildeposits and other borrowings and to manage interest rate and credit risk. Thissituation is also similar for consumer lending.

 

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

 

The tables below summarizethe performance of each of the operating segments:

** **
| ** **                  | ** ** | **As of and for the three months ended March 31, 2009** | ** ** |
|-----------------------------|------------|--------------------------------------------------------------|------------|
| ** **                  | ** ** | **Community Banking**                                        | ** ** | **Mortgage Banking** | ** ** | ** ** | ** ** |
| **(Dollars  in thousands)** | ** ** | **Segment**                                                  | ** ** | **Segment** | ** ** | **Consolidated** | ** ** |
| ** **                  | ** ** | ** **                                                   | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Total assets                |       | $                                                            | 1,087,350  |   | $ | 248,897 |   | $ | 1,336,247 |   |
|                        |       |                                                         |       |   |   |   |   |
| Net interest income         |       | 8,276                                                        |       | 1,850 |   | 10,126 |   |
|                        |       |                                                         |       |   |   |   |   |
| Total non-interest income   |       | 2,453                                                        |       | 12,904 |   | 15,357 |   |
| Total non-interest expense  |       | 8,939                                                        |       | 10,143 |   | 19,082 |   |
|                        |       |                                                         |       |   |   |   |   |
| Net Income                  |       | 719                                                          |       | 2,601 |   | 3,320 |   |
|                             |            |                                                              |            |  |  |  |  |  |  |  |

 

18

----

Table ofContents

 
| ** **                           | ** ** | **As of and for the three months ended March 31, 2008** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                           | ** ** | **Community Banking**                                        | ** ** | **Mortgage Banking** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)** | ** ** | **Segment**                                                  | ** ** | **Segment** | ** ** | **Consolidated** | ** ** |
|                                 |       |                                                         |       |   |   |   |   |
| Total assets                         |       | $                                                            | 1,006,441  |   | $ | — |   | $ | 1,006,441 |   |
|                                 |       |                                                         |       |   |   |   |   |
| Net interest income                  |       | 7,878                                                        |       | — |   | 7,878 |   |
|                                 |       |                                                         |       |   |   |   |   |
| Total non-interest income            |       | 2,858                                                        |       | — |   | 2,858 |   |
| Total non-interest expense           |       | 8,448                                                        |       | — |   | 8,448 |   |
|                                 |       |                                                         |       |   |   |   |   |
| Net Income                           |       | 1,520                                                        |       |   |   | 1,520 |   |
|                                      |            |                                                              |            |  |  |  |  |  |  |  |

 

The results presented in the Net Interest Income, Interest Income, InterestExpense and Provision for Loan and Lease Losses sections present informationfor both the loans held in the Community Banking segment as well as theMortgage Banking segment. Factors driving net interest income and the provisionfor loan and lease losses are similar for the loans held in each of thesesegments. Specific discussion is made below where factors driving the specificcomponents of Non-interest income and expense for the operating segments differfrom the consolidated Corporation.

 

**CONSOLIDATED AVERAGE BALANCE SHEET**

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

**THREE MONTHS ENDED MARCH 31,**

 
| ** **                                                                              | ** ** | **2009**    | ** ** | **2008**     | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------|------------|--------------|------------|
| ** **                                                                              | ** ** | **Average** | ** ** | ** **   | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(Dollars  in thousands)**                                                             | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate%** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate%** | ** ** |
| ASSETS                                                                                  |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Federal funds sold, interest-bearing deposits in  banks and other overnight investments |       | $           | 26,516     |         | $          | 28 |   | 0.43 | % | $ | 49,482 |   | $ | 451 |   | 3.67 | % |
| Investment securities:                                                                  |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Taxable                                                                                 |       | 101,900     |       | 1,152        |       | 4.59 | % | 92,698 |   | 1,116 |   | 4.84 | % |
| Tax-exempt (1)                                                                          |       | 9,606       |       | 114          |       | 4.79 | % | 13,678 |   | 164 |   | 4.81 | % |
| Total investment securities                                                             |       | 111,506     |       | 1,266        |       | 4.61 | % | 106,376 |   | 1,280 |   | 4.84 | % |
|                                                                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Loans held for sale                                                                     |       | 151,157     |       | 1,844        |       | 4.95 | % | 607 |   | 7 |   | 4.64 | % |
|                                                                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Loans and leases: (2)                                                                   |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Taxable                                                                                 |       | 919,111     |       | 12,950       |       | 5.71 | % | 728,464 |   | 12,151 |   | 6.71 | % |
| Tax-exempt (1)                                                                          |       | 20,737      |       | 375          |       | 1.81 | % | 19,572 |   | 348 |   | 7.15 | % |
| Total loans and leases                                                                  |       | 939,848     |       | 13,325       |       | 5.75 | % | 748,036 |   | 12,499 |   | 6.72 | % |
|                                                                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                                           |       | 1,229,027   |       | 16,463       |       | 5.43 | % | 904,501 |   | 14,237 |   | 6.33 | % |
| Non-interest-earning assets                                                             |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses                                                     |       | (10,569     | )          |         |       |   |   | (7,884 | ) |   |   |   |   |
| Cash and due from banks                                                                 |       | 27,952      |       |         |       |   |   | 21,148 |   |   |   |   |   |
| Other assets                                                                            |       | 61,187      |       |         |       |   |   | 35,014 |   |   |   |   |   |
|                                                                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Total assets                                                                            |       | $           | 1,307,597  |         |       |   |   |   | $ | 952,779 |   |   |   |   |   |
|                                                                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                               |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Savings, NOW, and money market deposits                                                 |       | $           | 424,994    |         | $          | 1,205 |   | 1.15 | % | $ | 373,498 |   | $ | 2,035 |   | 2.19 | % |
| Certificates of deposit and other time                                                  |       | 447,521     |       | 3,266        |       | 2.96 | % | 221,127 |   | 2,462 |   | 4.48 | % |
| Total interest-bearing deposits                                                         |       | 872,515     |       | 4,471        |       | 2.08 | % | 594,625 |   | 4,497 |   | 3.04 | % |
| Subordinated debt                                                                       |       | 15,465      |       | 174          |       | 4.55 | % | 15,465 |   | 259 |   | 6.74 | % |
| Federal Home Loan Bank advances and other  borrowings                                   |       | 174,200     |       | 1,536        |       | 3.58 | % | 146,564 |   | 1,443 |   | 3.96 | % |
| Total interest-bearing liabilities                                                      |       | 1,062,180   |       | 6,181        |       | 2.36 | % | 756,654 |   | 6,199 |   | 3.30 | % |
| Non-interest-bearing liabilities:                                                       |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Non-interest-bearing demand deposits                                                    |       | 144,060     |       |         |       |   |   | 116,481 |   |   |   |   |   |
| Other liabilities                                                                       |       | 14,393      |       |         |       |   |   | 10,530 |   |   |   |   |   |
| Total liabilities                                                                       |       | 1,220,633   |       |         |       |   |   | 883,665 |   |   |   |   |   |
| Stockholders’ equity                                                               |       | 86,964      |       |         |       |   |   | 69,114 |   |   |   |   |   |
| Total liabilities and stockholders’ equity                                         |       | $           | 1,307,597  |         |       |   |   |   | $ | 952,779 |   |   |   |   |   |
|                                                                                    |       |        |       |         |       |   |   |   |   |   |   |   |   |
| Net interest income                                                                     |       |        |       | $            | 10,282     |   |   |   |   |   | $ | 8,038 |   |   |   |
| Net yield on interest-earning assets                                                    |       |        |       |         |       | 3.39 | % |   |   |   |   | 3.57 | % |

 

19

----

Tableof Contents

 

----

(1)          The indicated income andannual rate are presented on a taxable equivalent basis using the federalmarginal rate of 34% adjusted for the TEFRA 20% interest expense disallowancefor 2009 and 2008.

(2)                  Non-accruing loans areincluded in the average balance.

 

**NETINTEREST INCOME**

 

Net interest income is the difference between interest income earned oninterest-earning assets and interest expense paid on interest-bearingliabilities. Net interest income on a tax equivalent basis for the three-monthperiod ended March 31, 2009 was $10.3 million, an increase of 27.9 % from $8.0million for the same period in 2008.  Thenet yield on interest-earning assets, on a tax-equivalent basis, was 3.39% forthe three-month period ended March 31, 2009, compared to 3.57% for the sameperiod in 2008, a decrease of 18 basis points (one basis point is equal to1/100 of a percent).

 

The yield earned on interest-earning assets decreased 90 basis pointsto 5.43% in 2009 from 6.33% in 2008.  Theaverage yield paid on interest-bearing liabilities decreased 94 basis points to2.36% in 2009 from 3.30% in 2008.

 

Average interest-earning assets increased approximately $324.5 millionor 35.9% to $1.2 billion for the three-months ended March 31, 2009 from $904.5million in the same period last year. The increase in average interest-earning assets for the three-monthperiod ended March 31, 2009 was the result of a 25.6% or $191.8 millionincrease in average total Loans and leases combined with a 4.8% or $5.1 millionincrease in average investment securities, a 46.4% or $23.0 million decrease inthe average Federal funds sold and interest bearing deposits in banks balance,and a $150.6 million increase in average loans held for sale balances. Theincreases in Loans, Loans held for sale and investment securities wereprimarily due to the acquisition of American Home Bank as of December 31, 2008.Assets acquired at December 31, 2008 through the American Home Bank acquisitionincluded $17.4 million of investments, $89.5 million of loans held for sale and$110.9 million of loans and leases. The decrease in Federal funds sold andinterest bearing deposits in banks was primarily due to growth in Loans held forsale as a result of increased residential mortgage volume in the first quarterof 2009.

 

Average interest-bearing liabilities increased approximately $305.5million or 40.4% to $1.06 billion for the three-months ended March 31, 2009,from $756.7 million in the same period in 2008. The increase in average interest-bearing liabilities for the three-monthperiod was the result of a $277.9 million or 46.7% increase in interest-bearingdeposits, combined with a $27.6 million or 18.9% increase in Federal Home LoanBank (FHLB) advances and other borrowings. The increases in interest bearingdeposits and Federal Home Loan Bank advances and other borrowings wereprimarily due to the acquisition of American Home Bank as of December 31, 2008.Liabilities acquired at December 31, 2008 through the American Home Bankacquisition included $186.7 million of interest bearing deposits and $36.6million of Federal Home Loan Bank advances and other borrowings.

 

**INTERESTINCOME**

 

Interest income on federal funds sold and interest-bearing deposits inbanks for the three-month period ended March 31, 2009 decreased 93.8% to $28thousand when compared to the same period in 2008.  The decrease in interest income on

 

20

----

Table of Contents

 

federalfunds sold and interest-bearing deposits in banks for the three-month period isprimarily the result of a $23.0 million decrease in the average federal fundssold and interest bearing deposits at banks balances combined with a 324 basispoint decrease on the rates earned on these assets as a result of FederalReserve actions to reduce market interest rates.

 

On a tax equivalent basis, interest income on investment securitiesdecreased by 1.0% or $14 thousand to $1.27 million for the three-month periodended March 31, 2009 from $1.28 million for the same period in 2008.  The decrease was the result of a 23 basispoint decrease in the yield earned on investment securities, offset partiallyby a $5.1 million increase in average total investment security balances.

 

Interest income on loans held for sale increased to $1.8 million duringthe first quarter of 2009. This was due to a significant increase in theaverage loans held for sale balance. Average loans held for sale during thefirst quarter of 2009 was $151.2 million as compared to $607 thousand in thefirst quarter of 2008. The increase was due to the American Home Bankacquisition. $89.5 million of loans held for sale were acquired at December 31,2008 through the acquisition. The increase in average balance from December 31,2008 to March 31, 2009 was due to increased volume in the residential mortgageloan originations.

 

Interest income on loans, on a tax equivalent basis, generated by theCorporation’s loan portfolio increased 6.6% or $826 thousand to $13.3 millionfor the three-month period ended March 31, 2009 compared to $12.5 million forthe three months ended March 31, 2008. The increase in interest income for the three-month period ended March 31,2009 is primarily the result of a $191.8 million or 25.6% increase in averageloans outstanding. The increase in average loan balances was primarily due tothe American Home Bank acquisition. $110.9 million of loans were acquired at December31, 2008 through the acquisition. The impact from the increase in average loanbalances was partially offset by a decrease in the tax equivalent yield earnedon average loans outstanding, which decreased by 97 basis points to 5.75% forthe three-month period ended March 31, 2009 from 6.72% for the same period in2008. This rate decrease is the result of Federal Reserve actions to reducemarket interest rates.

 

**INTERESTEXPENSE**

 

Interest expense on deposit accounts decreased by $26 thousand or 0.6%to $4.5 million for the three-month period ended March 31, 2009 from $4.5million for the same period in 2008. This decrease was primarily due to a decrease in the average interestrates paid on interest-bearing deposits. The average rate paid in the firstquarter of 2009 was 2.08%, a 96 basis point decrease from 3.04% in the firstquarter of 2008. This rate decrease was primarily the result of Federal Reserveactions to reduce market interest rates. This impact from rate decreases waspartially offset by increases in average interest-bearing deposit balances.These balances increased $277.9 million to $872.5 million in the first quarterof 2009 from $594.6 million in 2008. The increase in average interest bearingdeposit balances was primarily due to the American Home Bank acquisition.$186.7 million of interest bearing deposit balances were acquired at December 31,2008 through the acquisition. The increase was also due to stronger consumerdemand for traditional interest-bearing deposit products.

 

Interest expense on subordinated debentures decreased $85 thousand to$174 thousand for the three-month period ended March 31, 2009 from $259thousand for the same period in 2008. The decrease for the three-month period ended March 31, 2009 was a directresult of a 219 basis point decrease in the average interest rate paid on thesedebentures. The issuance bears an interest rate of 3 month LIBOR plus 140 basispoints. The rate decrease was due to a decrease in the 3 month LIBOR betweenthe two periods. Average balances between the two periods remained unchanged at$15.5 million.

 

Interest expense on FHLB and other borrowings increased by $93 thousandor 6.4% to $1.5 million for the three-month period ended March 31, 2009 from$1.4 million for the same period in 2008. Average balances of these funding sources increased by 18.9% or $27.6million between the two periods. The increase in average FHLB and otherborrowings was primarily due to the American Home Bank acquisition. $36.6million of FHLB and other borrowings balances were acquired at December 31,2008 through the acquisition. The average rate paid on these borrowings was3.58% in the first quarter of 2009, a decrease of 38 basis points from 3.96%during the same period in 2008. FHLB and other borrowings have been a favorablealternative to deposits to support asset growth.

 

21

----

Table of Contents

 

**PROVISIONFOR LOAN AND LEASE LOSSES**

 

During the three months ended March 31, 2009 and 2008, theCorporation recorded a $1.4 million provision for loan and lease losses ascompared to $211 thousand for the same period in 2008. The increase in theprovision for loan and lease losses was driven mainly by an increase innon-accrual loan balances due to the effects of a recessionary economy. Thepercentage of non-accrual loans to gross loans was 2.21% at March 31, 2009compared to 1.12% at December 31, 2008 and .24% at March 31, 2008.The allowance for loan and lease losses as a percentage of loans at March 31,2009 was 1.20% compared to 1.10% at December 31, 2008 and 1.06% at March 31,2008. Net charge-offs increased to $297 thousand for the first quarter of 2009as compared to $59 thousand in the first quarter of 2008.

 

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

 
| ** **                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)**                                                 | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                                                                 |       |                                             |       |   |   |
| Balance at beginning of period                                                       |       | $                                                | 10,335     |   | $ | 7,817 |   |
|                                                                                 |       |                                             |       |   |   |
| Provision charged to operating expense                                               |       | 1,387                                            |       | 211 |   |
|                                                                                 |       |                                             |       |   |   |
| Recoveries of loans previously charged-off                                           |       | 145                                              |       | 100 |   |
| Loans charged-off                                                                    |       | (442                                             | )          | (159 | ) |
| Net loan (charge-offs) recoveries                                                    |       | (297                                             | )          | (59 | ) |
|                                                                                 |       |                                             |       |   |   |
| Allowance other adjustment (1)                                                       |       | (162                                             | )          | (39 | ) |
| Balance at end of period                                                             |       | $                                                | 11,263     |   | $ | 7,930 |   |
|                                                                                 |       |                                             |       |   |   |
| Period-end loans outstanding                                                         |       | $                                                | 940,131    |   | $ | 750,625 |   |
| Average loans outstanding                                                            |       | $                                                | 939,848    |   | $ | 748,036 |   |
|                                                                                 |       |                                             |       |   |   |
| Allowance for loan and lease losses as a  percentage of period-end loans outstanding |       | 1.20                                             | %          | 1.06 | % |
| Net charge-offs (recoveries) to average loans  Outstanding                           |       | -0.03                                            | %          | 0.01 | % |

 

----

(1)          The “Allowance otheradjustment” represents the reclassification of an allowance for possible losseson unfunded loans and unused lines of credit. These loans and lines of credit, although unfunded, have been committedto by the Bank.

 

Non-performing loans and leases include those on non-accrual status andloans past due 90 days or more and still accruing.  The Corporation’s policy is to write down allnon-performing loans to net realizable value based on updated appraisals.  Non-performing loans are generallycollateralized and are in the process of collection.  Non-accrual loans reduce the Corporation’searnings because interest income is not earned on such assets. The non-accrualloan and lease balance at March 31, 2009 was $20.8 million as compared to$10.5 million at December 31, 2008 and $1.6 million at March 31,2008.

 

OREO represents real estate owned by the Bank following default by theborrowers. OREO is recorded at the lower of the loan carryingvalue or fair market value. Fair market value is based primarily uponindependent market prices, appraised values of the collateral or management’sestimation of the value of the collateral. OREO reduces the Corporation’searnings because interest income is not earned on such assets.

 

22

----

Table of Contents

 

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

 
| ** **                                                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                                                    | ** ** | **2009**           | ** ** | **2008**              | ** ** | **2008** | ** ** |
|                                                                                    |       |               |       |                  |       |   |   |
| Past due over 90 days and still accruing                                                |       | $                  | 46         |                  | $          | 261 |   | $ | 870 |   |
| Non-accrual loans and leases (1)                                                        |       | 20,757             |       | 1,555                 |       | 10,514 |   |
| Total non-performing loans and leases                                                   |       | 20,803             |       | 1,816                 |       | 11,384 |   |
|                                                                                    |       |               |       |                  |       |   |   |
| Other real estate owned                                                                 |       | 2,142              |       | 441                   |       | 1,872 |   |
| Total non-performing assets                                                             |       | $                  | 22,945     |                  | $          | 2,257 |   | $ | 13,256 |   |
|                                                                                    |       |               |       |                  |       |   |   |
| Non-performing loans and leases as a percentage of  total loans and leases              |       | 2.21               | %          | 0.24                  | %          | 1.21 | % |
|                                                                                    |       |               |       |                  |       |   |   |
| Allowance for loan and lease losses as a percentage  of non-performing loans and leases |       | 54.14              | %          | 436.69                | %          | 90.78 | % |
|                                                                                    |       |               |       |                  |       |   |   |
| Non-performing assets as a percentage of total  loans and other real estate owned       |       | 2.44               | %          | 0.30                  | %          | 1.41 | % |
|                                                                                    |       |               |       |                  |       |   |   |
| Allowance for loan and lease losses as a percentage  of non-performing assets           |       | 49.09              | %          | 351.36                | %          | 77.96 | % |

 

----

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

 

Management is not aware of any loans or leases other than thoseincluded in these tables that would be considered potential problem loans andcause Management to have doubts as to the borrower’s ability to comply withloan repayment terms.

 

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

 

FASB 114 “Accounting by Creditors for Impairment of Loans” requires theCorporation to examine commercial and non-residential mortgage loans onnon-accrual status for impairment.  Thebalance of impaired loans was $20.8 million, $10.5 million, and $1.6 million atMarch 31, 2009, December 31, 2008, and March 31, 2008,respectively.  The associated specificreserve for impaired loans was $1.8 million, $856 thousand, and $40 thousand atMarch 31, 2009, December 31, 2008, and March 31, 2008,respectively.

 

For the three-month period ended March 31, 2009, activity in theallowance for impaired loan losses includes a provision of $974 thousand andcharge-offs of $386 thousand.  There wereno recoveries for the three-month period ended March 31, 2009.  Contractual interest amounted to $256 thousandfor the three-months ended March 31, 2009. Total cash collected on impaired loans for the three-month period ended March 31,2009 was $672 thousand all of which was applied to principal.  Loans returned to performing for thethree-months ended March 31, 2009 were $92 thousand.

 

For the three-month period ended March 31, 2008, activity in theallowance for impaired loan losses includes a provision of $18 and charge-offsof $0.  There were no recoveries for thethree-month period ended March 31, 2008. Contractual interest amounted to $25 thousand for the three-months endedMarch 31, 2008.  Total cashcollected 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 thethree-months ended March 31, 2008 was $20 thousand.

 

23

----

Table of Contents

 

The following charts present additional information about impairedloans and lease balances as of March 31, 2009 and December 31, 2008:

 

March 31,2009

 
| ** **                                  | ** ** | ** **   | ** ** | ** **   | ** ** | **Number of** | ** ** | **Specific**    | ** ** |
|---------------------------------------------|------------|--------------|------------|--------------|------------|---------------|------------|-----------------|------------|
| ** **                                  | ** ** | **Loans by** | ** ** | **Impaired** | ** ** | **impaired**  | ** ** | **reserve**     | ** ** |
| **(Dollars  in thousands)**                 | ** ** | **Type**     | ** ** | **by type**  | ** ** | **loans**     | ** ** | **on impaired** | ** ** |
|                                        |       |         |       |         |       |          |       |            |       |
| Commercial loans                            |       | $            | 332,515    |         | $          | 6,057         |       | 22              |       | $ | 248 |   |
| Real estate — commercial               |       | 285,662      |       | 2,239        |       | 2             |       | 253             |       |
| Real estate — commercial construction  |       | 69,051       |       | 4,387        |       | 4             |       | 684             |       |
| Real estate — residential              |       | 83,940       |       | 4,580        |       | 15            |       | 380             |       |
| Real estate — residential construction |       | 39,265       |       | 1,307        |       | 5             |       | 76              |       |
| Consumer loans                              |       | 126,353      |       | 1,909        |       | 33            |       | 189             |       |
| Lease financing receivables                 |       | 3,345        |       | 278          |       | 7             |       | —          |       |
|                                        |       |         |       |         |       |          |       |            |       |
| Totals                                      |       | $            | 940,131    |         | $          | 20,757        |       | 88              |       | $ | 1,830 |   |

 

December 31,2008

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

 

**NON-INTERESTINCOME, AS RESTATED**

 

Total non-interest income increased $12.5 million to $15.4 million forthe three months ended March 31, 2009, compared to $2.9 million for thesame period in 2008. The various components of non-interest income arediscussed below.

 

Wealth Management and Advisory Services revenue decreased $77 thousandor 7.7% to $918 thousand for the three months ended March 31, 2009 from$995 thousand during the same period in 2008. Wealth management and advisory services revenue includes fee income fromboth the Wealth Management division of the Bank and the First NationalFinancial Advisory Services subsidiary of the Bank. In aggregate, wealthmanagement and advisory services revenue consists primarily of fee income fromservices such as trust and portfolio management, estate management, insurance,full-service brokerage, financial planning and mutual fund services. Wealthmanagement and advisory services revenue is based partially on the market valueof assets under management.  The marketvalue of assets under management decreased $94.8 million or 17.0% to $462.6million at March 31, 2009 as compared to $557.4 million at March 31,2008.These balances decreased primarily due to decreases in the market valuesof the underlying securities within the assets under management.

 

24

----

Table of Contents

 

Service charges on deposit accounts increased $79 thousand or 14.3% to$632 thousand for the three-month period ended March 31, 2009 compared to$553 thousand for the same period in 2008. The increase in service charges is primarily due to increases in depositaccount balances.

 

The Corporation recognized a net loss of $88 thousand on sales ofinvestment securities during the three-month period ended March 31, 2009compared with a net gain of $262 thousand during the same period in 2008.  These net gains and losses were taken as aresult of normal portfolio management.

 

The Corporation has operating lease agreements with one customer.  The income on these leases is classified as “RentalIncome”.  Rental Income on operatinglease agreements for the three-month period ended March 31, 2009 was $340thousand, an increase of $30 thousand or 9.7% from $310 thousand during thesame period in 2008.

 

Gains on the sale of fixed assets and OREO was $46 thousand for thethree-months ended March 31, 2009 as compared to gains of $45 thousand forthe same period in 2008. The gains recorded in 2009 and 2008 were theamortization of a deferred gain attributable to a sale-leaseback transactionthat occurred during 2007.

 

Loan servicing fees and other was $996 thousand during the three monthsended March 31, 2009, an increase of $905 thousand from $91 thousandduring the same period in 2008. Loan servicing fees and other primarily relatesto the Mortgage Banking segment and consist mainly of fees earned at theinception of a loan as well as fees earned on the servicing of residential loanportfolios not owned by the Bank. Loan servicing fees and other also includesgains and losses on the Bank’s mortgage servicing rights. The increase in loanservicing fees was due to the addition of the American Home Bank division’smortgage operations.

 

Net gain from mortgage banking activities relates to the MortgageBanking segment and consists of unrealized gains and losses on interest ratelock commitments, loans held for sale, and forward sale commitments combinedwith realized gains and losses on the actual sale of the loan and the settlementof forward sale commitments. The increase in the net gain from mortgage bankingactivities during the first quarter of 2009 was primarily from the addition ofthe American Home Bank division’s residential mortgage operations.

 

The distinguishing activity within the mortgage banking segment is theorigination and sale of residential mortgage and construction loans. Thisactivity drives the net gain on mortgage banking activity line of the incomestatement. For the quarter ended March 31 2009, this line was positivelyimpacted by the actions of the Federal Reserve to reduce market rates.  These actions resulted in mortgage interestrates declining, beginning in December 2008.  The decline in rates was advantageous toconsumers, leading many borrowers to refinance their existing mortgageloan.   The increase in refinanceactivity reduced the negative impact from weak new and existing home salesectors.  The AHB Division originated $602.8million of loans during the period, with refinance activity accounting for 81%,or $489.8 million, of the total.  Loansfor the purchase of new or existing homes totaled $104.5 million, or 17% oftotal originations, while loans to individual borrowers for construction ofsingle-family residences were $8.5 million, or 2% of total originations.

 

Bank-owned life insurance (“BOLI”) income relates to a policy acquiredthrough the American Home Bank acquisition. BOLI involves the purchase of alife insurance policy on a group of employees. The Bank is the owner andbeneficiary of the policy. The BOLI investment is carried on the balance sheetat the cash surrender value of the underlying policies. Income or lossresulting from increases or decreases in the cash surrender value of theproperties is recorded on the income statement.

 

Other non-interest income increased 5.3% or $25 thousand for thethree-month period ended March 31, 2009 due mainly to increases in variousfee income earned from the American Home Bank operations. Other non-interestincome also includes ATM surcharge revenue, STAR/Visa Check Card revenue, safe depositbox income, merchant services income, rental income, lease referral fees andother miscellaneous income.

 

Wealth management and advisory services revenue, service charges ondeposit accounts, Gains and losses on investment securities, Operating leaserental income, Gains on the sale of fixed assets and OREO, BOLI income andnearly all of Other non-interest income are included within the results of thecommunity banking segment. Nearly all of Loan servicing fees and other and allof Net gain from mortgage banking activities are included within the mortgagebanking segment.

 

25

----

Table of Contents

 

**NON-INTERESTEXPENSE**

 

Total non-interest expense increased $10.6 million or 125.9% to $19.1million for the three-month period ended March 31, 2009, compared to $8.4million during the same period in 2008. The various components of non-interest expense are discussed below.

 

Salaries and employee benefits increased 153.5% or $7.4 million to$12.2 million for the three-month period ended March 31, 2009 compared tothe same periods in 2008.  The highersalary and benefits expense was primarily due to the addition of the AmericanHome Bank operations in the first quarter of 2009.

 

Salaries and benefits directly attributable to the Mortgage Bankingsegment totaled $7.4 million for the three months ended March 31,2009.  Of that amount, variablecompensation, that is compensation paid to loan originators accounted for $4.4million, or 60% of the total.  Thisvariable compensation amounts to .73% of total originations, a rate typical inthe mortgage banking industry.  Thisvariable compensation is directly related to the amount of, and type of,mortgage loans originated.

 

Net occupancy, equipment and data processing expense increased $1.3million or 93.0% to $2.8 million for the three-month period ended March 31,2009 when compared to the same periods in 2008. Approximately $1.0 million of this increase was due to the addition ofthe American Home Bank’s operations in the first quarter of 2009. Occupancy,equipment and data processing expense from American Home Bank’s operationsinclude the operations of administrative facilities as well as two branchescombined with IT systems operations. The increase was also due to the openingof the new Jennersville grocery store branch as well as the opening of the newone north high administrative complex in the first quarter of 2009.

 

Depreciation expense on operating leases increased $25 thousand or 9.9%to $280 thousand for the three-month period ended March 31, 2009 whencompared to the same period in 2008. This depreciation expense is the result of operating lease agreementsthe Bank has with one of our customers. The income associated with these operating leases is classified asRental Income, as discussed above.

 

FDIC insurance premiums increased $319 thousand or 339.4% to $413thousand for the three month period ended March 31, 2009 when compared tothe same periods in 2008. In 2008 the FDIC adopted rules that increasedFDIC premiums significantly for assessment periods beginning in the firstquarter of 2009. In 2009, the FDIC adopted rules that further increasedFDIC insurance assessment rates beginning in the second quarter of 2009.  This will cause the Bank’s 2009 FDIC premiumsand assessment expense to increase significantly over 2008. The $94 thousand ofFDIC insurance expense in the first quarter of 2008 was net of a $65 thousandassessment credit granted to the Bank under 2006 legislation.

 

Professional services expense increased $822 thousand or 193.9% to $1.2million for the three-month period ended March 31, 2009 when compared tothe same periods in 2008. Approximately $678 thousand of the increase inprofessional fees is due to increased legal, consulting, audit fees and humanresource expenses from the addition of American Home Bank’s operations. Thebalance of the increase was mainly due to increased legal and consulting feesrelated to the acquisition and integration of American Home Bank.

 

Marketing expense increased $61 thousand or 31.0% from the same periodin 2008. Most of this increase was due to the addition of American Home Bank’soperations.

 

Total other non-interest expense increased $661 thousand or 63.0% to$1.7 million for the three-month period ended March 31, 2009 compared tothe same periods in 2008.  Othernon-interest expense includes loan costs, annual meeting and reports, trustprocessing, postage, directors’ costs, telephone, travel and entertainment andoperating supplies.  Most of the increaseis due to the addition of American Home Bank’s operations.

 

**INCOMETAXES, AS RESTATED**

 

Income tax expense for the three-month period ended March 31, 2009was $1.5 million, compared to $557 thousand for the same period in 2008.  This represents an effective tax rate of 30.4for the three-month period ended March 31, 2009

 

26

----

Table ofContents

 

comparedwith 26.8% for the same periods in 2008. The higher effective tax rates in 2009 as compared with 2008 isprimarily due to a decrease in permanent differences as a relative percentage ofpretax income.

 

**LIQUIDITYMANAGEMENT AND INTEREST RATE SENSITIVITY**

 

The objective of liquidity management is to ensure the availability ofsufficient cash flows to meet all financial commitments and to capitalize onopportunities for business expansion. Liquidity management addresses the Corporation’s ability to meet depositwithdrawals either on demand or at contractual maturity, to repay borrowings asthey mature and to make new loans and investments as opportunities arise.  Liquidity is managed on a daily basisenabling Senior Management to monitor changes in liquidity and to reactaccordingly to fluctuations in market conditions.  The primary sources of liquidity for theCorporation are funding available from growth of our existing deposit base, newdeposits, FHLB, and cash flow from the investment and loan portfolios.  The Corporation considers funds from suchsources to comprise its “core” funding sources because of the historicalstability of such sources of funds. Additional liquidity comes from the Corporation’s non-interest bearingdemand deposit accounts and credit facilities. Other deposit sources include a tiered savings product and certificatesof deposit in excess of $100,000. Details of core deposits, non-interest bearingdemand deposit accounts, and other deposit sources are highlighted in thefollowing table:

 
| ** **                           | ** ** | **For the Three Months Ended** | ** ** | **For the Year Ended**     | ** ** |
|--------------------------------------|------------|--------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **March 31, 2009**        | ** ** | **December 31, 2008** | ** ** |
| **(Dollars in thousands)**           | ** ** | **Average**                    | ** ** | **Effective**              | ** ** | **Average** | ** ** | **Effective** | ** ** |
| **DEPOSIT  TYPE**                    | ** ** | **Balance**                    | ** ** | **Yield**                  | ** ** | **Balance** | ** ** | **Yield** | ** ** |
| NOW Accounts                         |       | $                              | 185,027    |                       | 1.01       | % | $ | 179,512 |   | 1.64 | % |
| Money Market                         |       | 152,665                        |       | 1.47                       | %          | 117,393 |   | 2.46 | % |
| Statement Savings                    |       | 41,485                         |       | 0.60                       | %          | 40,300 |   | 0.70 | % |
| Other Savings                        |       | 1,787                          |       | 1.08                       | %          | 2,802 |   | 1.50 | % |
| Tiered Savings                       |       | 44,030                         |       | 1.18                       | %          | 48,915 |   | 1.30 | % |
| Total NOW Savings, and Money Market  |       | 424,994                        |       | 1.15                       | %          | 388,922 |   | 1.75 | % |
|                                 |       |                           |       |                       |       |   |   |   |   |
| CDs Less than $100,000               |       | 338,082                        |       | 2.96                       | %          | 162,650 |   | 3.73 | % |
| CDs Greater than $100,000            |       | 109,439                        |       | 2.95                       | %          | 74,822 |   | 3.90 | % |
| Total CDs                            |       | 447,521                        |       | 2.96                       | %          | 237,472 |   | 3.78 | % |
|                                 |       |                           |       |                       |       |   |   |   |   |
| Total Interest Bearing Deposits      |       | 872,515                        |       |                       |       | 626,394 |   |   |   |
|                                 |       |                           |       |                       |       |   |   |   |   |
| Non-Interest Bearing Demand Deposits |       | 144,060                        |       |                       |       | 120,941 |   |   |   |
|                                 |       |                           |       |                       |       |   |   |   |   |
| Total Deposits                       |       | $                              | 1,016,574  |                       |       |   | $ | 747,335 |   |   |   |

 

The Bank, as a member of FHLB, maintains several credit facilities. Duringthe first quarter of 2009, average FHLB advances were $174.2 million andconsisted of term advances with a variety of maturities.  The average interest rate on these advanceswas 3.58%.  The Bank currently has amaximum borrowing capacity with FHLB of approximately $320.8 million.  FHLB advances are collateralized by a pledgeon the Bank’s portfolio of unencumbered investment securities, certain mortgageloans, and a lien on the Bank’s FHLB stock.

 

The goal of interest rate sensitivity management is to avoidfluctuating net interest margins, and to enhance consistent growth of netinterest income through periods of changing interest rates.  Such sensitivity is measured as thedifference in the volume of assets and liabilities in the existing portfolio thatare subject to repricing in a future time period.  The Corporation’s net interest ratesensitivity gap within one year is a negative $273.9 million or 20.5% of totalassets at March 31, 2009 compared with a negative $292.9 million or 22.5%of total assets at December 31, 2008. The Corporation’s gap position is one tool used to evaluate interestrate risk and the stability of net interest margins.  Another tool that

 

27

----

Table ofContents

 

managementuses to evaluate interest rate risk is a computer simulation model thatassesses the impact of changes in interest rates on net interest income, netincome under various interest rate forecasts and scenarios.  Management has set acceptable limits of riskwithin its Asset Liability Committee (“ALCO”) policy and monitors the resultsof the simulations against these limits quarterly.  As of the most recent quarter-end, allresults are within policy limits and indicate an acceptable level of interestrate risk. Management monitors interest rate risk as a regular part ofcorporate operations****with theintention of maintaining a stable net interest margin. The following tablepresents our interest sensitivity analysis as of March 31, 2009:

 
| ** **                                                        | ** ** | ** **     | ** ** | **Two**        | ** ** | **Over**       | ** ** | ** **     | ** ** | ** **     | ** ** |
|-------------------------------------------------------------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                                                        | ** ** | **Within**     | ** ** | **through**    | ** ** | **five**       | ** ** | **Non-rate**   | ** ** | ** **     | ** ** |
| ** **                                                        | ** ** | **one year**   | ** ** | **five years** | ** ** | **years**      | ** ** | **sensitive**  | ** ** | **Total**      | ** ** |
| **(Dollars  in thousands)**                                       | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ASSETS                                                            |       |           |       |           |       |           |       |           |       |           |       |
| Federal funds sold and overnight investments                      |       | $              | 2,501      |           | $          | 0              |       | $              | 0          |           | $          | 0 |   | $ | 2,501 |   |
| Investment securities                                             |       | 22,584         |       | 47,236         |       | 29,959         |       | 0              |       | 99,779         |       |
| Interest bearing deposits in banks                                |       | 37,722         |       | 0              |       | 0              |       | 0              |       | 37,722         |       |
| Loans held for sale                                               |       | 187,411        |       | 0              |       | 0              |       | 0              |       | 187,411        |       |
| Net loans and leases                                              |       | 429,014        |       | 406,245        |       | 104,872        |       | (11,263        | )          | 928,868        |       |
| Cash and due from banks                                           |       | 0              |       | 0              |       | 0              |       | 15,020         |       | 15,020         |       |
| Premises and equipment                                            |       | 0              |       | 0              |       | 0              |       | 23,664         |       | 23,664         |       |
| Other assets                                                      |       | 14             |       | 0              |       | 0              |       | 41,268         |       | 41,282         |       |
| Total assets                                                      |       | $              | 679,246    |           | $          | 453,481        |       | $              | 134,831    |           | $          | 68,689 |   | $ | 1,336,247 |   |
|                                                              |       |           |       |           |       |           |       |           |       |           |       |
| LIABILITIES AND CAPITAL                                           |       |           |       |           |       |           |       |           |       |           |       |
| Non-interest bearing deposits                                     |       | $              | 0          |           | $          | 0              |       | $              | 0          |           | $          | 147,276 |   | $ | 147,276 |   |
| Interest bearing deposits                                         |       | 867,765        |       | 27,294         |       | 6,988          |       | 0              |       | 902,047        |       |
| FHLB advances and other borrowings                                |       | 67,794         |       | 93,518         |       | 3,686          |       | 0              |       | 164,998        |       |
| Subordinated debentures                                           |       | 15,465         |       | 0              |       | 0              |       | 0              |       | 15,465         |       |
| Other liabilities                                                 |       | 1,000          |       | 0              |       | 17,712         |       | 0              |       | 18,712         |       |
| Capital                                                           |       | 0              |       | 0              |       | 0              |       | 87,749         |       | 87,749         |       |
| Total liabilities & capital                              |       | $              | 952,024    |           | $          | 120,812        |       | $              | 28,386     |           | $          | 235,025 |   | $ | 1,336,247 |   |
| Net interest rate sensitivity  gap                                |       | $              | (272,778   | )              | $          | 332,669        |       | $              | 106,445    |           | $          | (166,336 | ) |   |   |
| Cumulative interest rate sensitivity  gap                         |       | $              | (272,778   | )              | $          | 59,891         |       | $              | 166,336    |           | $          | 0 |   |   |   |
| Cumulative interest rate sensitivity  gap divided by total assets |       | (20.4          | )%         | 4.5            | %          | 12.4           | %          |           |       |           |       |

 

**BRANCHING,TECHNOLOGY AND CAPITAL PROJECTS**

 

During the first quarter of 2009, the Bank completed renovations on anew office building located at one North High Street in West Chester, PA. Thebuilding, along with and adjacent to our main branch and existing facility atnine North High Street will serve as the company’s corporate headquarters.  During the first quarter of 2009, the Bankalso opened a new grocery store branch in Jennersville, PA. Technologicalimprovements, including enhanced security over customer information, a moreproactive disaster recovery system and an improved infrastructure to supportmore internet banking products are also expected in the future. We arecontinuously looking for appropriate opportunities to expand our branch systemand invest in technology to better serve our customers.

 

**CAPITAL****ADEQUACY**

 

The Corporation is subject to Risk-Based Capital Guidelines adopted bythe Federal Reserve Board for bank holding companies.  The Bank is also subject to similar capitalrequirements adopted by the Office of the Comptroller of the Currency.  Under these requirements, the regulatoryagencies have set minimum thresholds for Tier I Capital, Total Capital, andLeverage ratios.  At March 31, 2009,both the Corporation’s and the Bank’s capital exceeded all minimum regulatory

 

28

----

Table of Contents

 

requirements,and the Bank was considered “well capitalized” as defined in the regulationsissued pursuant to the FDIC Improvement Act of 1992.

 

In April 2009, the Corporation completed the placement of$5,175,000 aggregate liquidation amount of fixed rate trust preferredsecurities (the “Trust Preferred Securities”), through a newly formedsubsidiary, First Chester County Capital Trust IV, a wholly owned Delawarestatutory trust (the “Trust”). In connection with the sale of the TrustPreferred Securities, the Corporation issued $5,330,000 of junior subordinateddeferrable interest debentures (the “Debentures”) to the Trust. The TrustPreferred Securities and the Debentures have a 30 year maturity, and carry afixed rate of interest of 12%. The Corporation has retained the right to redeemthe Trust Preferred Securities at par (plus accrued but unpaid interest) on anyinterest payment date on or after April 28, 2014. The net proceeds of theoffering have been contributed as additional paid in capital to fund growth inthe banking operations of First National Bank of Chester County, theCorporation’s wholly owned subsidiary (the “Bank”).

 
| ** **                     | ** ** | **As of March 31,** | ** ** | ** ** | ** ** | ** **                  | ** ** |
|--------------------------------|------------|--------------------------|------------|------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **2009**                 | ** ** | ** ** | ** ** | **As of December 31,** | ** ** | **“Well Capitalized”** | ** ** |
| ** **                     | ** ** | **(Restated)**           | ** ** | **2008**   | ** ** | **2008**                    | ** ** | **Requirements** | ** ** |
| Corporation                    |       |                     |       |       |       |                        |       |   |   |
| Leverage Ratio                 |       | 7.49                     | %          | 8.87       | %          | 9.87                        | %          | N/A |   |
| Tier I Capital Ratio           |       | 9.36                     | %          | 10.35      | %          | 9.14                        | %          | N/A |   |
| Total Risk-Based Capital Ratio |       | 10.50                    | %          | 11.39      | %          | 10.15                       | %          | N/A |   |
| Bank                           |       |                     |       |       |       |                        |       |   |   |
| Leverage Ratio                 |       | 7.64                     | %          | 8.25       | %          | 9.95                        | %          | 5.00 | % |
| Tier I Capital Ratio           |       | 9.66                     | %          | 9.64       | %          | 9.40                        | %          | 6.00 | % |
| Total Risk-Based Capital Ratio |       | 10.80                    | %          | 10.69      | %          | 10.42                       | %          | 10.00 | % |

 

The Bank is not under any agreement with the regulatory authorities noris 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.

 

**ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

There have been no material changes in the Corporation’s assessment ofits sensitivity to market risk since its presentation in the 2008 AnnualReport. Please refer to Item 7A on pages 39-42 of the Corporation’s 2008Annual Report for more information.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures.**

 

Asof March 31, 2009, the end of the period covered by this Quarterly Reporton Form 10-Q, an evaluation of the effectiveness of our disclosurecontrols and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) wasperformed under the supervision and with the participation of management,including our President and CEO, Chief Operating Officer and our ChiefFinancial Officer. Based on that evaluation and the identification of thematerial weakness in our internal control over financial reporting as describedbelow, management has concluded that our disclosure controls and procedureswere ineffective to ensure that information required to be disclosed by us inthe reports that we file or submit under the Exchange Act is (i) recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and (ii) accumulatedand communicated to management as appropriate to allow timely decisionsregarding required disclosures.

 

**Changes in internal control overfinancial reporting.**

 

Subsequentto the year ended December 31, 2009, management identified a materialweakness in internal controls related to the Corporation’s process to reviewthe valuation of mortgage loans held for sale.  Mortgage loans held forsale represent mortgage loans originated by the Corporation and held until soldto secondary market investors. Upon the closing

 

29

----

Table of Contents

 

of a residential mortgageloan originated by the Corporation, the mortgage loan is typically warehousedfor a period of time and then sold into the secondary market. While in thiswarehouse phase, mortgage loans held for sale are recorded at fair value underthe fair value option with changes in fair value recognized through earnings. An error was identified in the Corporation’s process to properly identifya certain population of loans held for sale prior to sending the loan detailsto the Corporation’s third party valuation firm.  As such, the Corporationerroneously excluded from the population to be fair valued, loans which wereidentified for sale but for which the Corporation was awaiting theconsideration from the counterparty to complete the sales transaction. These particular loans were correctly classified as loans held for sale on theConsolidated Balance Sheet at March 31, 2009; however these loans were notreflected at their fair value in the Consolidated Balance Sheet and the relatedunrealized gains (losses) within the Statement of Operations for the threemonths ended March 31, 2009. This error resulted in an understatement in thecarrying amount of loans held for sale at March 31, 2009, as well as anunderstatement net income for the three months ended March 31, 2009.  As aresult of the material weakness, the Corporation increased loans held for saleand net gains from mortgage banking activities $1.2 million at and for thequarter ended March 31, 2009.

 

**Remediationof Material Weakness**

 

Subsequentto the year ended December 31, 2009, and immediately following management’sidentification of the material weakness surrounding the mark-to-market accountingof Mortgage Loans Held for Sale, management enhanced an existing process thatwill ensure the portfolio of Mortgage Loans Held for Sale is complete prior todelivery to the third party valuation firm.  At each month-end areconciliation is performed to ensure the loans held for sale included in thefile sent to the third party valuation firm reconciles to the Corporation’sinternal subledger.  This internal subledger of loans held for sale isreconciled to the Corporation’s general ledger.  These reconciliations arereviewed by management monthly to ensure timely completion and that reconcilingitems, if any are appropriately addressed.

 

Asof the date of this Amendment, management is continuing their ongoing effortsto correct, revise and test the processes surrounding the material weaknessesdescribed above.  Additional changes willbe implemented as determined necessary.

 

30

----

Table of Contents

 

**PART II - OTHER INFORMATION**

 

**Item 1.****                   ****LegalProceedings**

 

Thereare no material pending legal proceedings, other than ordinary routinelitigation incidental to the business, to which the Corporation, or any of itssubsidiaries, is a party or of which any of their respective property is thesubject. The Corporation and the Bank are not parties to any legal proceedingsunder federal and state environmental laws.

 

**Item 1A.****                ****RiskFactors**

 

Informationregarding risk factors appears in Part 1, Item 1A of our Annual Report on Form10-K for the year ended December 31, 2008. There are no material changes in the risk factors relevant to ouroperations, except as discussed below.

 

**Our disclosure controls and procedures and internal controlover financial reporting were determined not to be effective as ofMarch 31, 2009, as evidenced by a material weakness that existed in ourinternal controls. Our disclosure controls and procedures and internal controlover financial reporting may not be effective in future periods, as a result ofnewly identified material weakness in internal controls.**

 

Effectiveinternal control over financial reporting is necessary for compliance with theSarbanes-Oxley Act of 2002 and appropriate financial reporting. Management isresponsible for establishing and maintaining adequate internal control overfinancial reporting. Internal control over financial reporting is a process,under the supervision of the Corporation’s Chief Executive Officer and ChiefFinancial Officer, designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of our financialstatements for external reporting purposes in accordance with GAAP. Asdisclosed in this Quarterly Report on Form 10-Q, management’s assessmentof our internal control over financial reporting identified a material weaknessas discussed in *Item 4. Controls andProcedures*. A material weakness is a deficiency in internal controlover financial reporting, such that there is a reasonable possibility that amaterial misstatement of the Corporation’s annual or interim financialstatements will not be prevented or detected on a timely basis. See *Item 4. Controls and Procedures*ofthis Form 10-Q for remediation status of the material weakness identified.However, there can be no assurance that additional material weaknesses will notbe identified in the future. We are committed to continuing to improve ourinternal control processes and we will continue to diligently and vigorouslyreview our financial reporting controls and procedures. As we continue toevaluate and improve our internal control over financial reporting, we maydetermine to take additional measures to address internal control deficienciesor determine to modify certain of the remediation measures described herein. Wewill continue to be at an increased risk that our financial statements couldcontain errors that will be undetected, and we will continue to incursignificant expense and management burdens associated with the additional proceduresrequired to prepare our consolidated financial statements.

 

**Item 2.****                   ****UnregisteredSales 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, 2009   |       | —                                                  |       | —                                             |       | —                                                                                                        |       | $                                                                                                                                        | 10,000,000 |   |
| February  1 to February 28, 2009 |       | —                                                  |       | —                                             |       | —                                                                                                        |       | $                                                                                                                                        | 10,000,000 |   |
| March  1 to March 31, 2009       |       | —                                                  |       | —                                             |       | —                                                                                                        |       | $                                                                                                                                        | 10,000,000 |   |
| Total                            |       | —                                                  |       | —                                             |       | —                                                                                                        |       | $                                                                                                                                        | 10,000,000 |   |

 

31

----

Table of Contents

 

----

(1)   The Corporation announced onNovember 16, 2007 a program to repurchase up to $10.0 million of theCorporation’s Common Stock. This program replaced a previous program thatexpired in October 2007.

 

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

 

None

 

**Item 4.****        ****Submission of Matters to a Voteof Security Holders**

 

None

 

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

 

None

 

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

 

Exhibits marked as “(cp)” are management contracts or compensatoryplans, contracts or arrangements in which a director or executive officerparticipates 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 theCorporation’s Quarterly Report on Form 10-Q for the quarter ended March 31,2004.

 

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

 

10.1        Amended and Restated Exhibit B, AnnualIncentive Plan, to Executive Incentive Plan dated May 4, 2009.  (CP) Portions of this exhibit have been redacted and are subject to aconfidential treatment request filed with the Secretary of the Securities andExchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of1934, as amended, is incorporated herein by reference to Exhibit 10.1 to theCorporation’s Quarterly Report on Form 10-Q for the quarter ended March 31,2009.

 

10.2        Amended and Restated Exhibit C, LongTerm Incentive Plan, to Executive Incentive Plan dated May 4, 2009.  (CP) Portions of this exhibit have been redacted and are subject to aconfidential treatment request filed with the Secretary of the Securities andExchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of1934, as amended, , is incorporated herein by reference to Exhibit 10.2 to theCorporation’s Quarterly Report on Form 10-Q for the quarter ended March 31,2009.

 

10.3        Agreement by and among the Corporation,the Bank, James M. Deitch and Anna Ruth Smith dated May 5, 2009 to Finalize theAHB Management Incentive Plan, , is incorporated herein by reference to Exhibit10.3 to the Corporation’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2009. (CP)

 

31.1         Rule 13a-14(a) Certificationof Chief Executive Officer and President*

31.2         Rule 13a-14(a) Certificationof Chief Financial Officer*

 

32.1         Section 906 Certification ofthe Chief Executive Officer and President*

32.2         Section 906 Certification ofthe Chief Financial Officer*

 

----

* Filed herewith

 

32

----

Table of Contents

 

**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 theundersigned thereunto duly authorized on July 26, 2010.

 

 

**FIRST CHESTER COUNTY CORPORATION**

 
|   | /s/  John A. Featherman                          |
|--------|--------------------------------------------------|
|   | John  A. Featherman, III                         |
|   | Chairman,  President and Chief Executive Officer |
|   | (Principal  Executive Officer)                   |
|   |                                             |
|   |                                             |
|   | /s/  Eric A. Segal                               |
|   | Eric  A. Segal                                   |
|   | Interim  Chief Financial Officer                 |
|   | (Principal  Financial and Accounting Officer)    |

 

33

----

Tableof Contents

** **

**INDEXTO EXHIBITS**

 

3(i).         Certificate of Incorporation.  Copy of the Corporation’s Articles ofIncorporation, 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 March31, 2004.

 

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

 

10.1        Amended and Restated Exhibit B, AnnualIncentive Plan, to Executive Incentive Plan dated May 4, 2009.  (CP) Portions of this exhibit have been redacted and are subject to aconfidential treatment request filed with the Secretary of the Securities andExchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of1934, as amended, is incorporated herein by reference to Exhibit 10.1 to theCorporation’s Quarterly Report on Form 10-Q for the quarter ended March 31,2009.

 

10.2        Amended and Restated Exhibit C, Long TermIncentive Plan, to Executive Incentive Plan dated May 4, 2009.  (CP) Portions of this exhibit have been redacted and are subject to aconfidential treatment request filed with the Secretary of the Securities andExchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of1934, as amended, , is incorporated herein by reference to Exhibit 10.2 to theCorporation’s Quarterly Report on Form 10-Q for the quarter ended March 31,2009.

 

10.3        Agreement by and among the Corporation,the Bank, James M. Deitch and Anna Ruth Smith dated May 5, 2009 to Finalize theAHB Management Incentive Plan, , is incorporated herein by reference to Exhibit10.3 to the Corporation’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2009. (CP)

 

31.1         Rule 13a-14(a) Certificationof Chief Executive Officer and President*

31.2         Rule 13a-14(a) Certificationof Chief Financial Officer*

 

32.1         Section 906 Certification ofthe Chief Executive Officer and President*

32.2         Section 906 Certification ofthe Chief Financial Officer*

 

----

* Filed herewith

 

34

----