Table ofContents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

**(MarkOne)**

 

| **x**                                                  | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                     |
| **For the quarterly period ended June 30,  2010** |
|                                                   |
| **OR**                                                 |
|                                                   |                                                                                                     |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                 to                 .**

 

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

 

**FIRST CHESTER COUNTY CORPORATION**

(Exact name of Registrant asspecified in its charter)

 

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

 

**9 North High Street**

**West Chester, Pennsylvania 19380**

(Address of principalexecutive 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 August 10,2010 was 6,318,611.

 

 

 

----

Table ofContents

 

**INDEX**

 
| ** **    | ** **            | ** **                                                                                                             | **Page**     |
|---------------|-----------------------|------------------------------------------------------------------------------------------------------------------------|--------------|
| Part I.  | FINANCIAL INFORMATION |                                                                                                                   |
|          |                  |                                                                                                                   |         |
|          | Item 1 -              | Financial Statements                                                                                                   |         |
|          |                  |                                                                                                                   |         |
|          |                  | Consolidated Balance  Sheets June 30, 2010 (unaudited) and December 31, 2009                                 | 2            |
|          |                  |                                                                                                                   |         |
|          |                  | Consolidated  Statements of Operations Three and Six Months Ended June 30, 2010  (unaudited) and 2009 (unaudited) | 3            |
|          |                  |                                                                                                                   |         |
|          |                  | Consolidated  Statements of Cash Flows Six Months Ended June 30, 2010 (unaudited) and  2009 (unaudited)           | 4            |
|          |                  |                                                                                                                   |         |
|          |                  | Consolidated  Statements of Equity Six Months Ended June 30, 2010 (unaudited) and  2009 (unaudited)          | 5            |
|          |                  |                                                                                                                   |         |
|          |                  | Notes  to Consolidated Financial Statements (unaudited)                                                                | 6            |
|          |                  |                                                                                                                   |         |
|          | Item 2 -              | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            | 28           |
|          |                  |                                                                                                                   |         |
|          | Item  3 -             | Quantitative  and Qualitative Disclosures About Market Risk                                                            | 41           |
|          |                  |                                                                                                                   |         |
|          | Item 4 -              | Controls &  Procedures                                                                                        | 41           |
|          |                  |                                                                                                                   |         |
| Part II. | OTHER INFORMATION     |                                                                                                                   |
|          |                  |                                                                                                                   |         |
|          | Item 1 -              | Legal  Proceedings                                                                                                     | 44           |
|          |                  |                                                                                                                   |         |
|          | Item 1A -             | Risk Factors                                                                                                           | 44           |
|          |                  |                                                                                                                   |         |
|          | Item  2 -             | Unregistered  Sales of Equity Securities and Use of Proceeds                                                           | 44           |
|          |                  |                                                                                                                   |         |
|          | Item  3 -             | Defaults  Upon Senior Securities                                                                                       | 44           |
|          |                  |                                                                                                                   |         |
|          | Item 4 -              | [Removed  and Reserved]                                                                                                | 44           |
|          |                  |                                                                                                                   |         |
|          | Item 5 -              | Other Information                                                                                                      | 44           |
| *** ***  | *** ***          | *** ***                                                                                                           | *** *** |
|          | Item 6 -              | Exhibits                                                                                                               | 45           |
| *** ***  | *** ***          | *** ***                                                                                                           | *** *** |
|          | Signatures            |                                                                                                                   | 46           |
|          |                  |                                                                                                                   |         |
|          | Exhibits              |                                                                                                                   |         |

 

----

Tableof Contents

 

**FORWARD-LOOKING STATEMENTS**

 

This Quarterly Report onForm 10-Q contains “forward-looking statements.”  These forward-looking statements are made ingood faith pursuant to the “safe harbor” provisions of the Private SecuritiesLitigation Reform Act of 1995.  The words“may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,”“intend,” “plan” and similar expressions are intended to identifyforward-looking statements. References to “we,” “our” and the “Corporation”refer to First Chester County Corporation, together in each case with ourconsolidated subsidiaries unless the context suggests otherwise.

 

The forward-looking statements contained in this Quarterly Report onForm 10-Q are based on current expectations, estimates, forecasts andprojections about the industry in which we operate and management’s beliefs andassumptions. These statements are not guarantees of future performance andinvolve risks, uncertainties and assumptions that are difficult to predict.Therefore, actual outcomes and results may differ materially from what isexpressed or forecasted in such forward-looking statements, including as aresult of risks discussed in “Part I, Item 1A. Risk Factors” in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2009, in this Quarterly Report on Form 10-Q, and in subsequent filingswith the Securities and Exchange Commission (“SEC”).

 

i

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**PART I. FINANCIALINFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(Dollars  in thousands)**                                                                                                                                       | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                        | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| ASSETS                                                                                                                                                            |       |              |       |                  |       |
| Cash and due from banks                                                                                                                                           |       | $                 | 19,306     |                  | $          | 20,853 |   |
| Federal funds sold and other overnight investments                                                                                                                |       | 806               |       | 1,721                 |       |
| Interest bearing deposits                                                                                                                                         |       | 23,638            |       | 124,107               |       |
| Total cash and cash equivalents                                                                                                                                   |       | 43,750            |       | 146,681               |       |
|                                                                                                                                                              |       |              |       |                  |       |
| Investment securities available-for-sale, at fair  value                                                                                                          |       | 62,801            |       | 82,698                |       |
|                                                                                                                                                              |       |              |       |                  |       |
| Loans and leases                                                                                                                                                  |       | 867,478           |       | 901,889               |       |
| Less: allowance for loan and lease losses                                                                                                                         |       | (21,534           | )          | (23,217               | )          |
| Net loans and leases                                                                                                                                              |       | 845,944           |       | 878,672               |       |
|                                                                                                                                                              |       |              |       |                  |       |
| Premises and equipment, net                                                                                                                                       |       | 19,389            |       | 20,513                |       |
| Deferred tax asset, net                                                                                                                                           |       | 357               |       | 2,593                 |       |
| Bank owned life insurance                                                                                                                                         |       | 1,510             |       | 1,474                 |       |
| Other real estate owned                                                                                                                                           |       | 1,414             |       | 3,692                 |       |
| Other assets                                                                                                                                                      |       | 19,915            |       | 32,560                |       |
| Discontinued assets (see Note 6):                                                                                                                                 |       |              |       |                  |       |
| Mortgage loans and related derivative instruments                                                                                                                 |       | 169,126           |       | 205,150               |       |
| Other discontinued assets held for sale                                                                                                                           |       | 3,664             |       | 3,203                 |       |
| Total assets                                                                                                                                                      |       | $                 | 1,167,870  |                  | $          | 1,377,236 |   |
| LIABILITIES                                                                                                                                                       |       |              |       |                  |       |
| Deposits                                                                                                                                                          |       |              |       |                  |       |
| Non-interest-bearing                                                                                                                                              |       | $                 | 161,760    |                  | $          | 155,647 |   |
| Interest-bearing (including certificates of  deposit over $100 thousand of $178,679 and $250,757 at June 30, 2010 and  December 31, 2009, respectively) |       | 830,207           |       | 954,653               |       |
| Total deposits                                                                                                                                                    |       | 991,967           |       | 1,110,300             |       |
| Federal Home Loan Bank advances and other  borrowings                                                                                                             |       | 83,302            |       | 172,897               |       |
| Subordinated debentures                                                                                                                                           |       | 20,795            |       | 20,795                |       |
| Other liabilities                                                                                                                                                 |       | 12,176            |       | 13,097                |       |
| Discontinued liabilities (see Note 6)                                                                                                                             |       | 4,078             |       | 3,245                 |       |
| Total liabilities                                                                                                                                                 |       | $                 | 1,112,318  |                  | $          | 1,320,334 |   |
|                                                                                                                                                              |       |              |       |                  |       |
| EQUITY                                                                                                                                                            |       |              |       |                  |       |
| Common stock, par value $1.00; authorized  25,000,000 shares; outstanding, 6,354,475 at June 30, 2010 and  December 31, 2009                       |       | $                 | 6,354      |                  | $          | 6,354 |   |
| Additional paid-in capital                                                                                                                                        |       | 23,772            |       | 23,678                |       |
| Retained earnings                                                                                                                                                 |       | 24,122            |       | 25,753                |       |
| Accumulated other comprehensive income (loss)                                                                                                                     |       | 177               |       | (499                  | )          |
| Treasury stock, at cost: 35,374 shares and 13,702  shares at June 30, 2010 and December 31, 2009, respectively                                          |       | (443              | )          | (209                  | )          |
| Total First Chester County Corporation  stockholders’ equity                                                                                                 |       | 53,982            |       | 55,077                |       |
| Non-controlling interests                                                                                                                                         |       | 1,570             |       | 1,825                 |       |
| Total equity                                                                                                                                                      |       | $                 | 55,552     |                  | $          | 56,902 |   |
|                                                                                                                                                              |       |              |       |                  |       |
| Total liabilities and equity                                                                                                                                      |       | $                 | 1,167,870  |                  | $          | 1,377,236 |   |

 

The accompanying notes arean integral part of these statements.

 

2

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(**UNAUDITED**)

 
| ** **                                                                                                                                                                                                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                                                                     | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| **(Dollars  in thousands - except per share)**                                                                                                                                                                                 | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                                                                                                                                                                     | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| INTEREST INCOME                                                                                                                                                                                                                |       |                   |       |                 |       |   |   |   |   |
| Loans and leases, including fees                                                                                                                                                                                               |       | $                      | 12,071     |                 | $          | 13,367 |   | $ | 24,442 |   | $ | 26,576 |   |
| Investment securities                                                                                                                                                                                                          |       | 463                    |       | 996                  |       | 894 |   | 2,227 |   |
| Federal funds sold and deposits in banks                                                                                                                                                                                       |       | 72                     |       | 13                   |       | 191 |   | 35 |   |
| Total interest income                                                                                                                                                                                                          |       | 12,606                 |       | 14,376               |       | 25,527 |   | 28,838 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| INTEREST EXPENSE                                                                                                                                                                                                               |       |                   |       |                 |       |   |   |   |   |
| Deposits                                                                                                                                                                                                                       |       | 2,576                  |       | 3,105                |       | 5,518 |   | 6,973 |   |
| Subordinated debt                                                                                                                                                                                                              |       | 276                    |       | 252                  |       | 547 |   | 426 |   |
| Federal Home Loan Bank and other borrowings                                                                                                                                                                                    |       | 992                    |       | 1,514                |       | 2,426 |   | 2,973 |   |
| Total interest expense                                                                                                                                                                                                         |       | 3,844                  |       | 4,871                |       | 8,491 |   | 10,372 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| Net interest income                                                                                                                                                                                                            |       | 8,762                  |       | 9,505                |       | 17,036 |   | 18,466 |   |
| Provision for loan and lease losses                                                                                                                                                                                            |       | 132                    |       | 5,084                |       | 398 |   | 6,471 |   |
| Net interest income after provision for loan and  lease losses                                                                                                                                                                 |       | 8,630                  |       | 4,421                |       | 16,638 |   | 11,995 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| NON-INTEREST INCOME                                                                                                                                                                                                            |       |                   |       |                 |       |   |   |   |   |
| Wealth management and advisory services                                                                                                                                                                                        |       | 1,100                  |       | 1,048                |       | 1,989 |   | 1,966 |   |
| Service charges on deposit accounts                                                                                                                                                                                            |       | 579                    |       | 659                  |       | 1,165 |   | 1,291 |   |
| Gains on sales and calls of investment securities,  net                                                                                                                                                                        |       | 1                      |       | 89                   |       | 1 |   | 1 |   |
| Operating lease rental income                                                                                                                                                                                                  |       | 247                    |       | 345                  |       | 504 |   | 685 |   |
| Net (loss) gains on the sale of fixed assets and  OREO                                                                                                                                                                         |       | (27                    | )          | 72                   |       | (75 | ) | 117 |   |
| Write down of other real estate owned                                                                                                                                                                                          |       | —                 |       | —               |       | (1,333 | ) | — |   |
| Bank owned life insurance                                                                                                                                                                                                      |       | 18                     |       | 13                   |       | 36 |   | 26 |   |
| Other                                                                                                                                                                                                                          |       | 561                    |       | 496                  |       | 1,205 |   | 1,081 |   |
| Total non-interest income                                                                                                                                                                                                      |       | 2,479                  |       | 2,722                |       | 3,492 |   | 5,167 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| NON-INTEREST EXPENSE                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| Salaries and employee benefits                                                                                                                                                                                                 |       | 3,528                  |       | 4,894                |       | 7,110 |   | 10,127 |   |
| Occupancy, equipment and data processing                                                                                                                                                                                       |       | 1,677                  |       | 1,823                |       | 3,429 |   | 3,599 |   |
| Depreciation expense on operating leases                                                                                                                                                                                       |       | 199                    |       | 290                  |       | 407 |   | 570 |   |
| FDIC deposit insurance                                                                                                                                                                                                         |       | 670                    |       | 1,062                |       | 1,340 |   | 1,475 |   |
| Bank shares tax                                                                                                                                                                                                                |       | 239                    |       | 232                  |       | 478 |   | 467 |   |
| Professional services                                                                                                                                                                                                          |       | 2,695                  |       | 832                  |       | 4,510 |   | 1,408 |   |
| Marketing                                                                                                                                                                                                                      |       | 151                    |       | 446                  |       | 376 |   | 620 |   |
| Other real estate expense                                                                                                                                                                                                      |       | 1                      |       | 10                   |       | 61 |   | 15 |   |
| Communications expense                                                                                                                                                                                                         |       | 150                    |       | 240                  |       | 340 |   | 452 |   |
| Other                                                                                                                                                                                                                          |       | 1,425                  |       | 1,005                |       | 2,308 |   | 1,920 |   |
| Total non-interest expense                                                                                                                                                                                                     |       | 10,735                 |       | 10,834               |       | 20,359 |   | 20,653 |   |
| Income (loss) from continuing operations before  income taxes                                                                                                                                                                  |       | 374                    |       | (3,691               | )          | (229 | ) | (3,491 | ) |
| INCOME TAXES                                                                                                                                                                                                                   |       | —                 |       | (780                 | )          | — |   | (787 | ) |
| NET INCOME (LOSS) FROM CONTINUING OPERATIONS                                                                                                                                                                                   |       | 374                    |       | (2,911               | )          | (229 | ) | (2,704 | ) |
| DISCONTINUED OPERATIONS:                                                                                                                                                                                                       |       |                   |       |                 |       |   |   |   |   |
| Income (loss) from discontinued operations, net of  taxes of $0 for the three and six months ended June 30, 2010 and $524  thousand and $2.0 million for the three and six months ended June 30,  2009, respectively |       | 449                    |       | 3,482                |       | (549 | ) | 6,833 |   |
| Less: Net income attributable to non-controlling  interests                                                                                                                                                                    |       | 654                    |       | 633                  |       | 853 |   | 870 |   |
| Net (loss) income attributable to discontinued  operations                                                                                                                                                                     |       | $                      | (205       | )                    | $          | 2,849 |   | $ | (1,402 | ) | $ | 5,963 |   |
| NET INCOME (LOSS) INCOME ATTRIBUTABLE TO FIRST  CHESTER COUNTY CORPORATION                                                                                                                                                     |       | $                      | 169        |                 | $          | (62 | ) | $ | (1,631 | ) | $ | 3,259 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| PER SHARE DATA                                                                                                                                                                                                                 |       |                   |       |                 |       |   |   |   |   |
| Net income (loss) per share from continuing  operations (Basic)                                                                                                                                                                |       | $                      | 0.06       |                 | $          | (0.46 | ) | $ | (0.04 | ) | $ | (0.43 | ) |
| Net income (loss) per share from continuing  operations (Diluted)                                                                                                                                                              |       | $                      | 0.06       |                 | $          | (0.46 | ) | $ | (0.04 | ) | $ | (0.43 | ) |
| Net (loss) income per share from discontinued  operations (Basic)                                                                                                                                                              |       | $                      | (0.03      | )                    | $          | 0.45 |   | $ | (0.22 | ) | $ | 0.95 |   |
| Net (loss) income per share from discontinued  operations (Diluted)                                                                                                                                                            |       | $                      | (0.03      | )                    | $          | 0.45 |   | $ | (0.22 | ) | $ | 0.95 |   |
| Net income (loss) per share attributable to First  Chester County Corporation (Basic)                                                                                                                                          |       | $                      | 0.03       |                 | $          | (0.01 | ) | $ | (0.26 | ) | $ | 0.52 |   |
| Net income (loss) per share attributable to First  Chester County Corporation (Diluted)                                                                                                                                        |       | $                      | 0.03       |                 | $          | (0.01 | ) | $ | (0.26 | ) | $ | 0.52 |   |
| Dividends declared                                                                                                                                                                                                             |       | $                      | —     |                 | $          | 0.14 |   | $ | — |   | $ | 0.28 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| Basic weighted average shares outstanding                                                                                                                                                                                      |       | 6,320,546              |       | 6,268,195            |       | 6,328,446 |   | 6,255,295 |   |
|                                                                                                                                                                                                                           |       |                   |       |                 |       |   |   |   |   |
| Diluted weighted average shares outstanding                                                                                                                                                                                    |       | 6,320,546              |       | 6,268,195            |       | 6,328,446 |   | 6,255,295 |   |

 

The accompanying notes arean integral part of these statements.

 

3

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(**UNAUDITED**)

** **
| ** **                                                                                          | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                          | ** ** | **June 30,**    | ** ** |
| **(Dollars  in thousands)**                                                                         | ** ** | **2010**             | ** ** | **2009** | ** ** |
| OPERATING ACTIVITIES                                                                                |       |                 |       |   |   |
| Net (loss) income attributable to First Chester  County Corporation                                 |       | $                    | (1,631     | ) | $ | 3,259 |   |
| Net income attributable to non-controlling  interests                                               |       | 853                  |       | 870 |   |
| Net (loss) income including non-controlling  interests                                              |       | $                    | (778       | ) | $ | 4,129 |   |
| Adjustments to reconcile net (loss) income to net  cash provided by (used in) operating activities: |       |                 |       |   |   |
| Depreciation                                                                                        |       | 1,536                |       | 1,835 |   |
| Provision for loan and lease losses                                                                 |       | 398                  |       | 6,471 |   |
| Amortization of investment security premiums and  accretion of discounts, net                       |       | 234                  |       | 182 |   |
| Amortization of deferred loan fees                                                                  |       | (1,050               | )          | (1,099 | ) |
| Gains on sales and calls of investment securities  available for sale, net                          |       | (1                   | )          | (1 | ) |
| Net gains (losses) from sales of fixed assets and  OREO                                             |       | 75                   |       | (117 | ) |
| Write down of other real estate owned                                                               |       | 1,333                |       | — |   |
| Net gain from mortgage banking activities                                                           |       | (22,988              | )          | (25,439 | ) |
| Proceeds from the sale of mortgage loans held for  sale                                             |       | 553,157              |       | 1,218,374 |   |
| Origination of mortgage loans held for sale                                                         |       | (494,230             | )          | (1,435,744 | ) |
| Net cash paid for the settlement of derivative  contracts                                           |       | (516                 | )          | (1,005 | ) |
| Stock-based compensation expense                                                                    |       | 64                   |       | 100 |   |
| Decrease (increase) in deferred tax asset                                                           |       | 1,887                |       | (29 | ) |
| Decrease (increase) in other assets                                                                 |       | 10,527               |       | (7,116 | ) |
| Increase in other liabilities                                                                       |       | 765                  |       | 6,632 |   |
|                                                                                                |       |                 |       |   |   |
| Net cash provided by (used in) operating  activities                                                |       | 50,413               |       | (232,827 | ) |
|                                                                                                |       |                 |       |   |   |
| INVESTING ACTIVITIES                                                                                |       |                 |       |   |   |
| Net decrease (increase) in loans                                                                    |       | 33,380               |       | (8,010 | ) |
| Proceeds from sales of investment securities  available-for-sale                                    |       | —               |       | 30,333 |   |
| Proceeds from maturities, prepayments and calls of  investment securities available-for-sale        |       | 21,403               |       | 6,867 |   |
| Purchases of investment securities  available-for-sale                                              |       | (713                 | )          | (5,786 | ) |
| Proceeds from the sale of OREO                                                                      |       | 2,191                |       | 1,475 |   |
| Purchase of premises and equipment                                                                  |       | (502                 | )          | (3,281 | ) |
| Proceeds from the sale of premises and equipment                                                    |       | 137                  |       | — |   |
|                                                                                                |       |                 |       |   |   |
| Net cash provided by investing activities                                                           |       | 55,896               |       | 21,598 |   |
|                                                                                                |       |                 |       |   |   |
| FINANCING ACTIVITIES                                                                                |       |                 |       |   |   |
| Change in subsidiary’s shares from non-controlling  interest                                   |       | (1,108               | )          | (552 | ) |
| Increase in short term Federal Home Loan Bank and  other short term borrowings                      |       | 10,000               |       | 145,000 |   |
| Increase in long term Federal Home Loan Bank and  other borrowings                                  |       | —               |       | 48,300 |   |
| Repayment of long term Federal Home Loan Bank and  other borrowings                                 |       | (99,595              | )          | (59,097 | ) |
| Proceeds from issuance of subordinated debentures                                                   |       | —               |       | 5,330 |   |
| Net (decrease) increase in deposits                                                                 |       | (118,333             | )          | 241 |   |
| Cash dividends paid                                                                                 |       | —               |       | (874 | ) |
| Net treasury stock transactions                                                                     |       | (204                 | )          | 90 |   |
|                                                                                                |       |                 |       |   |   |
| Net cash (used in) provided by financing  activities                                                |       | (209,240             | )          | 138,438 |   |
|                                                                                                |       |                 |       |   |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                                           |       | (102,931             | )          | (72,791 | ) |
|                                                                                                |       |                 |       |   |   |
| Cash and cash equivalents at beginning of period                                                    |       | 146,681              |       | 95,150 |   |
|                                                                                                |       |                 |       |   |   |
| Cash and cash equivalents at end of period                                                          |       | $                    | 43,750     |   | $ | 22,359 |   |
|                                                                                                |       |                 |       |   |   |
| Supplementary cash flow information:                                                                |       |                 |       |   |   |
| Interest paid                                                                                       |       | $                    | 9,643      |   | $ | 6,300 |   |
| Income taxes paid                                                                                   |       | $                    | —     |   | $ | 50 |   |
| Loans transferred to real estate owned                                                              |       | $                    | 1,137      |   | $ | 1,117 |   |

 

The accompanying notes are an integral part of these statements.

 

4

----

Tableof Contents

 

**FIRST CHESTER COUNTYCORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF CHANGES IN EQUITY**

(**UNAUDITED**)

 
| ** **                                                             | ** ** | **Common Stock** | ** ** | **Additional  Paid -in** | ** ** | **Retained** | ** ** | **Accumulated   Other   Comprehensive** | ** ** | **Treasury**      | ** ** | **Non-  Controlling** | ** ** | **Total**    | ** ** | **Comprehensive** | ** ** |
|------------------------------------------------------------------------|------------|------------------|------------|--------------------------|------------|--------------|------------|-----------------------------------------|------------|-------------------|------------|-----------------------|------------|--------------|------------|-------------------|------------|
| **(Dollars  in thousands)**                                            | ** ** | **Shares**       | ** ** | **Par Value**            | ** ** | **Capital**  | ** ** | **Earnings**                            | ** ** | **Income (loss)** | ** ** | **Stock**             | ** ** | **Interest** | ** ** | **Equity**        | ** ** | **Income** | ** ** |
|                                                                   |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       |   |   |
| 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 ASC 860-50                     |       | —           |       | —                   |       | —       |       | 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             |       | —           |       | —                   |       | —       |       | —                                  |       | —            |       | —                |       | (552         | )          | (552              | )          |   |   |
| Net income                                                             |       | —           |       | —                   |       | —       |       | 3,259                                   |       | —            |       | —                |       | 870          |       | 4,129             |       | $ | 4,129 |   |
| Cash dividends declared                                                |       | —           |       | —                   |       | —       |       | (1,749                                  | )          | —            |       | —                |       | —       |       | (1,749            | )          |   |   |
| Other comprehensive income                                             |       | —           |       | —                   |       | —       |       | —                                  |       | —            |       | —                |       | —       |       | —            |       |   |   |
| Net unrealized gains on investment securities  available-for-sale |       | —           |       | —                   |       | —       |       | —                                  |       | 888               |       | —                |       | —       |       | 888               |       | 888 |   |
| Treasury stock transactions                                            |       | —           |       | —                   |       | (1,316       | )          | —                                  |       | —            |       | 1,406                 |       | —       |       | 90                |       |   |   |
| Stock based compensation                                               |       | —           |       | —                   |       | 100          |       | —                                  |       | —            |       | —                |       | —       |       | 100               |       |   |   |
| Total comprehensive income                                             |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       | $ | 5,017 |   |
|                                                                   |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       |   |   |
| Balance June 30, 2009                                             |       | 6,331,975        |       | $                        | 6,332      |         | $          | 23,492                                  |       | $                 | 59,649     |                  | $          | (2,404       | )          | $                 | (409       | ) | $ | 1,803 |   | $ | 88,463 |   |   |   |
|                                                                   |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       |   |   |
| Balance January 1, 2010                                           |       | 6,354,475        |       | $                        | 6,354      |         | $          | 23,678                                  |       | $                 | 25,753     |                  | $          | (499         | )          | $                 | (209       | ) | $ | 1,825 |   | $ | 56,902 |   |   |   |
|                                                                   |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       |   |   |
| Change in subsidiary shares from non-controlling  interest             |       | —           |       | —                   |       | —       |       | —                                  |       | —            |       | —                |       | (1,108       | )          | (1,108            | )          |   |   |
| Net (loss) income                                                      |       | —           |       | —                   |       | —       |       | (1,631                                  | )          | —            |       | —                |       | 853          |       | (778              | )          | $ | (778 | ) |
| Other comprehensive income                                             |       | —           |       | —                   |       | —       |       | —                                  |       | —            |       | —                |       | —       |       | —            |       |   |   |
| Net unrealized gains on investment securities  Available-for-sale |       | —           |       | —                   |       | —       |       | —                                  |       | 676               |       | —                |       | —       |       | 676               |       | 676 |   |
| Treasury stock transactions                                            |       | —           |       | —                   |       | 30           |       | —                                  |       | —            |       | (234                  | )          | —       |       | (204              | )          |   |   |
| Share based compensation                                               |       | —           |       | —                   |       | 64           |       | —                                  |       | —            |       | —                |       | —       |       | 64                |       |   |   |
| Total comprehensive loss                                               |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       | $ | (102 | ) |
|                                                                   |       |             |       |                     |       |         |       |                                    |       |              |       |                  |       |         |       |              |       |   |   |
| Balance June 30, 2010                                             |       | 6,354,475        |       | $                        | 6,354      |         | $          | 23,772                                  |       | $                 | 24,122     |                  | $          | 177          |       | $                 | (443       | ) | $ | 1,570 |   | $ | 55,552 |   |   |   |

 

The accompanying notes are an integral part of these statements.

 

5

----

Tableof Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**1.****           ****Summaryof Significant Accounting Policies**

 

**Basis of presentation**

 

Theforegoing unaudited financial statements have been prepared in accordance withaccounting principles generally accepted in the United States (“GAAP”) forinterim financial information.  Thepreparation of the financial statements in conformity with GAAP requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and the accompanying notes.  Certain prior period amounts have beenreclassified to conform to current year presentation, which includesreclassifications for discontinued operations (see Note 6 for discontinuedoperations disclosure and Note 12 for earnings (loss) per share).  Actual results could differ from thoseestimates.

 

Inthe opinion of management, all adjustments (consisting only of normal recurringadjustments) necessary for a fair presentation of the financial position andthe results of operations for the interim periods presented have beenincluded.  The results of operations forthe three and six month periods ended June 30, 2010 are not necessarilyindicative of the results to be expected for the full year.  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 endedDecember 31, 2009 (our “2009 Annual Report”).

 

Priorto January 1, 2010, our business was conducted through two primarysegments, community banking and mortgage banking.  During the firstquarter 2010, we announced the potential sale of our American Home Bank (“AHB”)mortgage banking segment.  Accordingly,the mortgage banking operations related to this segment have been reclassified,and are now presented as discontinued operations in the consolidated statementsof operations.  Certain assets and liabilities of this former segment arepresented as discontinued assets held for sale. The statements of cash flows are presented on a consolidated basis,including both continuing and discontinued operations.  The notes to the consolidated financialstatements have been adjusted to exclude discontinued operations unlessotherwise noted.  Footnote segment disclosures are not provided.  Refer to Note 6 of the accompanyingconsolidated financial statements for information related to discontinuedoperations.

 

The consolidated financial statements include theaccounts of First Chester County Corporation (“First Chester” or the “Corporation”)  and First National Bank of Chester County(the “Bank”).  All material intercompanybalances and transactions have been eliminated in consolidation.

 

**2.****             ****GoingConcern**

 

TheCorporation’s financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the discharge of liabilitiesin the normal course of business for the foreseeable future. However, due tothe Corporation’s financial results, the substantial uncertainty throughout theU.S. banking industry and other matters discussed in this report, a substantialdoubt exists regarding our ability to continue as a going concern. Ourfinancial statements do not include any adjustments that might be necessary ifwe are unable to continue as a going concern.

 

Asfurther described in Note 5, on October 16, 2009, the Bank entered into aMemorandum of Understanding (“MOU”) with the Office of the Comptroller of theCurrency (“OCC”). The OCC also mandated higher individual minimum capitalratios (“IMCRs”), which the Bank was required to achieve by December 31,2009. Continued operations may depend on the Corporation’s ability to complywith the terms of the MOU, the IMCRs and the closing of the pending merger withTower Bancorp, Inc. (“Tower”). For the year ended December 31, 2009,the Corporation incurred a net loss from operations, primarily from the higherprovisions for loan losses due to increased levels of non-performing assets,the write-off of goodwill and the establishment of a valuation allowance on thedeferred tax assets. Our efforts to raise capital to comply with the IMCRsprior to the deadline ultimately resulted in the planned merger with Tower, asdescribed in Note 3 below, which was announced on December 28, 2009. Inaddition, in efforts to conserve capital, we elected to reduce and subsequentlysuspend our cash dividends on our common stock beginning with the third quarterof 2009. However, despite the above efforts, as of March 31, 2010 and December 31,2009, the Bank was below certain IMCR thresholds.  The Corporation is in compliance with theIMCRs as of June 30, 2010, as further discussed in Note 5.

 

6

----

Table ofContents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Managementand the board of directors are committed to the planned merger with Tower.However, if the announced merger were not to occur, then Management would seekto recapitalize the Bank by finding another merger partner or by raisingadditional capital in the public or private markets. The Corporation iscompleting a regular planning cycle for 2011, which includes, among otherthings, updating the Corporation’s strategic business plan and creatingdetailed operating and marketing plans for the Bank as an independent company.

 

**3.****           ****PendingMerger**

 

OnDecember 27, 2009, the Corporation entered into a definitive mergeragreement, as amended on March 4, 2010 (the “Merger Agreement”), withTower, the holding company for Graystone Tower Bank (“Graystone”), pursuant towhich First Chester will merge with and into Tower (the “Merger”), with Towerbeing the surviving corporation. The Merger Agreement also provides that uponconsummation of the merger, the Bank will merge with and into Graystone, withGraystone as the surviving institution (the “Bank Merger”). The MergerAgreement additionally provides for the potential sale of the AHB segment at orprior to the consummation of the Merger. At the effective time of the Merger,the board of directors of Tower will be increased by three (3) directorsand three (3) of the current directors of First Chester selected by theboard of directors of First Chester, with the approval of Tower’s board ofdirectors, will be added to the board of directors of Tower, to serve as suchfor no less than three years.

 

Underthe terms of the Merger Agreement, shareholders of First Chester will receive0.453 shares of Tower common stock for each share of First Chester common stockthey own. The Merger Agreement establishes loan delinquency thresholds andprovides for an increase or reduction in the consideration paid by Tower toFirst Chester shareholders in the event of specified increases or decreases inFirst Chester’s loan delinquencies prior to closing.

 

Directorsand executive officers of First Chester have entered into Voting Agreementswith Tower, pursuant to which they have agreed, among other things, to vote allshares of common stock of First Chester owned by them in favor of the approvalof the Merger at the special shareholder’s meeting to vote upon the Merger.

 

Consummationof the Merger is subject to certain terms and conditions, including, but notlimited to, receipt of various regulatory approvals and approval by both Tower’sand First Chester’s shareholders and First Chester’s loan delinquencies notexceeding $90 million in the aggregate. As of June 30, 2010, allregulatory approvals have been received from the bank regulators. However,certain of these approvals contain expiration dates such that extensions mayneed to be obtained if the merger is not closed prior to the end of the thirdquarter of 2010.

 

**4.****           ****RecentAccounting Pronouncements**

 

InJuly 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-20,Receivables (Topic 310): Disclosures about the Credit Quality of FinancingReceivables and the Allowance for Credit Losses. The update requires companiesto provide more information in their disclosures about the credit quality oftheir financing receivables and the credit reserves held against them. Theamendments that require disclosures as of the end of a reporting period areeffective for the periods ending on or after December 15, 2010. ASU No. 2010-20will enhance the disclosure requirements for financing receivables and creditlosses, but will not impact the Corporation’s financial position, results ofoperations or cash flows.

 

In February 2010, the FASB issuedASU 2010-09, Subsequent Events (Topic 855): Amendments to CertainRecognition and Disclosure Requirements.  This guidance removes therequirement for a SEC filer to disclose a date through which subsequent eventshave been evaluated in both issued and revised financial statements. Revisedfinancial statements include financial statements revised as a result of eithercorrection of an error or retrospective application of GAAP.  ASU 2010-09is intended to remove potential conflicts with the SEC’s literature and all ofthe amendments are effective upon issuance, except for the use of theissued date for conduit debt obligors. The Corporation adopted the guidance for the interim period ending June 30,2010 with no impact on the Corporation’s financial condition or results ofoperations.

 

InJanuary 2010, the FASB issued ASU 2010-06, Fair Value Measurements andDisclosures (Topic 820): Improving Disclosures about Fair ValueMeasurements.  This guidance requires: (1) disclosure of thesignificant amount transferred in and out of Level 1 and Level 2 fair valuemeasurements and the reasons for the 

 

7

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

transfers;and (2) separate presentation of purchases, sales, issuances andsettlements in the reconciliation for fair value measurements using significantunobservable inputs (Level 3).  Inaddition, ASU 2010-06 clarifies the requirements of the following existingdisclosures set forth in FASB Accounting Standards Codifications (ASC) 820, “FairValue Measurements and Disclosures”: (1) For purposes of reporting fairvalue measurement for each class of assets and liabilities, a reporting entityneeds to use judgment in determining the appropriate classes of assets andliabilities; and (2) a reporting entity should provide disclosures aboutthe valuation techniques and inputs used to measure fair value for bothrecurring and nonrecurring fair value measurements. This guidance is effectivefor interim and annual reporting periods beginning January 1, 2010, exceptfor the disclosures about purchases, sales, issuances, and settlements in theroll forward of activity in Level 3 fair value measurements, which areeffective for fiscal years beginning January 1, 2011, and for interimperiods within those fiscal years. The Corporation adopted the guidance on January 1,2010, and the guidance did not have an impact on the Corporation’s financialcondition or results of operations.

 

In June 2009, the FASB updated ASC 860, “Transfersand Servicing,” to eliminate the concept of a qualifying special-purpose entity(“QSPE”), modify the criteria for applying sale accounting to transfers offinancial assets or portions of financial assets, differentiate between theinitial measurement of an interest held in connection with the transfer of anentire financial asset recognized as a sale and participating interestsrecognized as a sale and remove the provision allowing classification ofinterests received in a guaranteed mortgage securitization transaction thatdoes not qualify as a sale as available-for-sale or trading securities. Theupdates to ASC 860 clarify (i) that an entity must consider allarrangements or agreements made contemporaneously or in contemplation of atransfer, (ii) the isolation analysis related to the transferor and itsconsolidated subsidiaries and (iii) the principle of effective controlover the transferred financial asset. The updates to ASC 860 also enhancefinancial statement disclosures. The updates to ASC 860 are effective forfiscal years beginning after November 15, 2009 with earlier applicationprohibited. Revised recognition and measurement provisions are to be applied totransfers occurring on or after the effective date and the disclosureprovisions are to be applied to transfers that occurred both before and afterthe effective date. The guidance was effective for January 1, 2010 and didnot have an impact on the Corporation’s financial condition or results ofoperations.

 

In June 2009, the FASB updated ASC 810, “Consolidation,”to modify certain characteristics that identify a variable interest entity (“VIE”),revise the criteria for determining the primary beneficiary of a VIE, add anadditional reconsideration event to determining whether an entity is a VIE,eliminating troubled debt restructurings as an excluded reconsideration eventand enhance disclosures regarding involvement with a VIE. Additionally, withthe elimination of the concept of QSPEs in the updates to ASC 860, entitiespreviously considered QSPEs are now within the scope of ASC 810. Entitiesrequired to consolidate or deconsolidate a VIE will recognize a cumulativeeffect in retained earnings for any difference in the carrying amount of theinterest recognized. The updates to ASC 810 are effective for fiscal yearsbeginning after November 15, 2009 with earlier application prohibited. Theguidance was effective for January 1, 2010 and did not have an impact onthe Corporation’s financial condition or results of operations.

 

**5.****             ****RegulatoryMatters**

 

*Supervisory Actions*

 

TheBank is subject to various regulatory capital requirements administered by thefederal banking agencies. Failure to meet minimum capital requirements canprompt certain mandatory, and possibly additional discretionary, actions byregulators that, if undertaken, could have a direct material effect on theCorporation’s financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance-sheet items as calculated under regulatoryaccounting practices. The Bank’s capital amounts and classification are alsosubject to qualitative judgments by the regulators involving factors such asthe risk weights assigned to assets and what items may be counted as capital.Regulators also have broad discretion to require any institution to maintainhigher capital levels than otherwise required by statute or regulation, eveninstitutions that are considered “well-capitalized” under applicableregulations.

 

OnOctober 16, 2009, the Board of Directors of the Bank entered into an MOUwith the OCC. An MOU with regulatory authorities is an informal action that isnot published or publicly available and that is used when 

 

8

----

Table ofContents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

circumstanceswarrant a milder form of action than a formal supervisory action, such as aformal written agreement or order. Under the MOU, the Bank has agreed toaddress, among other things, the following matters:

 

·                  Develop a comprehensive three-year capitalplan;

 

·                  Take action to protect criticized assets andadopt and implement a program to eliminate the basis of criticism of suchassets;

 

·                  Establish an effective program that providesfor early problem loan identification and a formal plan to proactively managethose assets;

 

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

 

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

 

TheBoard of Directors and Management have initiated corrective actions to complywith the provisions of the MOU.

 

Additionally,in November 2009, the Bank was advised that the OCC established IMCRs forthe Bank higher than the capital ratios generally applicable to banks undercurrent regulations. In the case of the Bank, the OCC established IMCRsrequiring a Tier 1 leverage ratio of at least eight percent (8%), a Tier 1risk-based capital ratio of at least ten percent (10%) and a total risk-basedcapital ratio of at least twelve percent (12%) which the Bank was required toachieve by December 31, 2009. The Corporation’s efforts to raise capitalprior to the deadline ultimately resulted in the planned merger with TowerBancorp, which was announced on December 28, 2009.  During the fourth quarter of 2009, theCorporation also received notice from the Federal Reserve, its primary regulator,that the Federal Reserve must approve any dividends to be paid in advance ofthe declaration or payment of the dividend.

 

Forthe purpose of satisfying the IMCRs, during December 2009, the Corporationentered into an amendment to our existing loan agreement with Graystone torecapitalize the Bank. As of December 31, 2009, the Corporation borrowedthe full $26.0 million available under the credit facility which wascontributed to the Bank as Tier 1 capital. Additionally, Graystone purchased$52.5 million in first lien residential real estate and commercial loanparticipations at a 1.5% discount.

 

Asset forth in the tables below, as of June 30, 2010, the Bank met the IMCRthresholds for all capital ratios, but as of December 31, 2009, the Bank wasbelow the IMCR thresholds for Tier 1 leverage and total risk-based capital.

 
| ** **                     | ** ** | ** ** | ** ** | ** **            | ** ** | ** **         | ** ** | ** **             | ** ** | **To Be Well**        | ** ** |
|--------------------------------|------------|------------|------------|-----------------------|------------|--------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | ** ** | ** ** | ** **            | ** ** | ** **         | ** ** | ** **             | ** ** | **Capitalized Under** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**    | ** ** | **Individual Minimum** | ** ** |
| ** **                     | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Capital Ratios** | ** ** |
| **(Dollars  in thousands)**    | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**         | ** ** | **Ratio**              | ** ** | **Amount**            | ** ** | **Ratio** | ** ** |
| As of June 30, 2010:      |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Leverage Ratio                 |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Corporation                    |       | 73,765     |       | 6.03                  | %          | 48,916             |       | >4.00               | %          | N/A                   |       | N/A |   |
| Bank                           |       | 102,574    |       | 8.40                  | %          | 48,833             |       | >4.00               | %          | 97,665                |       | >8.00 | % |
|                           |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Tier I Capital Ratio           |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Corporation                    |       | 73,765     |       | 8.09                  | %          | 36,469             |       | >4.00               | %          | N/A                   |       | N/A |   |
| Bank                           |       | 102,574    |       | 11.27                 | %          | 36,395             |       | >4.00               | %          | 90,986                |       | >10.00 | % |
|                           |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Total Risk Based Capital Ratio |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Corporation                    |       | 87,635     |       | 9.61                  | %          | 72,938             |       | >8.00               | %          | N/A                   |       | N/A |   |
| Bank                           |       | 114,106    |       | 12.54                 | %          | 72,789             |       | >8.00               | %          | 109,184               |       | >12.00 | % |

 

9

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 
| ** **                     | ** ** | ** ** | ** ** | ** **            | ** ** | ** **         | ** ** | ** **             | ** ** | **To Be Well**        | ** ** |
|--------------------------------|------------|------------|------------|-----------------------|------------|--------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | ** ** | ** ** | ** **            | ** ** | ** **         | ** ** | ** **             | ** ** | **Capitalized Under** | ** ** |
| ** **                     | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**    | ** ** | **Individual Minimum** | ** ** |
| ** **                     | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Capital Ratios** | ** ** |
| **(Dollars  in thousands)**    | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**         | ** ** | **Ratio**              | ** ** | **Amount**            | ** ** | **Ratio** | ** ** |
| As of December 31, 2009:  |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Leverage Ratio                 |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Corporation                    |       | 76,459     |       | 5.71                  | %          | 53,522             |       | >4.00               | %          | N/A                   |       | N/A |   |
| Bank                           |       | 102,617    |       | 7.68                  | %          | 53,472             |       | >4.00               | %          | 106,943               |       | >8.00 | % |
|                           |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Tier I Capital Ratio           |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Corporation                    |       | 76,459     |       | 7.79                  | %          | 39,262             |       | >4.00               | %          | N/A                   |       | N/A |   |
| Bank                           |       | 102,617    |       | 10.47                 | %          | 39,203             |       | >4.00               | %          | 98,008                |       | >10.00 | % |
|                           |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Total Risk Based Capital Ratio |       |       |       |                  |       |               |       |                   |       |                  |       |   |   |
| Corporation                    |       | 89,936     |       | 9.16                  | %          | 78,525             |       | >8.00               | %          | N/A                   |       | N/A |   |
| Bank                           |       | 115,035    |       | 11.74                 | %          | 78,407             |       | >8.00               | %          | 117,610               |       | >12.00 | % |

 

Dividend Restrictions

 

TheBank, as a national bank, is required by federal law to obtain the approval ofthe OCC for the payment of dividends if the total of all dividends declared bythe Board of Directors of the Bank in any calendar year will exceed the totalof the Bank’s net income for that year and the retained net income for thepreceding two years, less any required transfers to surplus or a fund for theretirement of any preferred stock, subject to the further limitations that anational bank can pay dividends only to the extent that the payment of suchdividends would not cause the Bank to become “undercapitalized” (as definedunder federal law).  There were nodividends declared or payable by the Bank as of June 30, 2010.

 

Duringthe fourth quarter of 2009, the Corporation received notice from the FederalReserve Board that the Federal Reserve must approve any dividends to be paid bythe Corporation in advance of the declaration or payment of the dividend.  The Corporation announced during the firstquarter 2010 that it will not be paying any dividends prior to the completionof the proposed merger. There were no dividends declared or payable by theCorporation as of June 30, 2010.

 

**6.****           ****DiscontinuedAssets Held for Sale and Discontinued Operations**

 

OnMarch 4, 2010, the Corporation and Tower, entered into an amendment to theMerger Agreement, which provides for the merger of the Bank with and intoGraystone, with Graystone as the surviving institution. Graystone and the Bankentered into a Bank Plan of Merger on March 4, 2010. The amendmentadditionally provides for the potential sale of the AHB division at or prior tothe consummation of the Merger.  TheCorporation has engaged a financial advisor to assist in the sale of the AHBdivision.

 

Theresults of operations of a component of an entity that has either been disposedof, or is classified as held for sale, shall be reported in discontinuedoperations if both the operations and cash flows of the component have been, orwill be, eliminated from ongoing operations of the entity as a result of thedisposal transaction and the entity will not have any significant continuinginvolvement in the operations of the component after the disposal transaction.

 

Indetermining whether the Corporation met the conditions for a qualified plan ofsale, management considered the relevant accounting guidance and concluded thatthe “held for sale” conditions were met during the first quarter 2010.Management determined that the Corporation will exit significant mortgagebanking activities after the sale of AHB and, as such, certain assets andliabilities of the Corporation’s mortgage banking operations will be presentedas discontinued assets held for sale and the results of operations directlyrelated to mortgage banking activity will be presented as discontinuedoperations for the quarter ended March 31, 2010, and for all futureperiods.

 

10

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Loans held for sale and related derivative instruments are shown as aseparate disposal group separate from other AHB assets.  Based on discussions with interested thirdparties to date, management anticipates that these assets, althoughdiscontinued from the Corporation’s future business model most likely will notbe sold in the transaction as described above. These assets although directly related to the mortgage banking segment’soperations are to be sold by the Corporation in the normal course of businessshortly after the close of a potential sale transaction.  The Corporation does not expect to originatesignificant loans held for sale after the completion of the sale of itsmortgage banking operations.

 

Theremaining assets, disposal group 2, will likely be sold as indicated in theamended Merger Agreement noted above. The carrying value of these assets arerequired to be at the lower of their carrying value or fair market value lesscosts to sell, and depreciation and amortization expense associated with assetsheld-for-sale ceases.

 
| ** **                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Disposal Group 1                         |       |              |       |                  |       |
| Loans held for sale, at fair value       |       | $                 | 166,818    |                  | $          | 202,757 |   |
| Derivative instruments, at fair value    |       | 2,308             |       | 2,393                 |       |
| Total assets                             |       | $                 | 169,126    |                  | $          | 205,150 |   |
|                                     |       |              |       |                  |       |
| Fair value of derivative instruments     |       | $                 | 331        |                  | $          | — |   |
| Total liabilities                        |       | $                 | 331        |                  | $          | — |   |
|                                     |       |              |       |                  |       |
| Disposal Group 2                         |       |              |       |                  |       |
| Premises and equipment                   |       | $                 | 2,007      |                  | $          | 1,956 |   |
| Other miscellaneous assets               |       | 1,657             |       | 1,247                 |       |
| Total assets                             |       | $                 | 3,664      |                  | $          | 3,203 |   |
|                                     |       |              |       |                  |       |
| Accounts payable and accrued liabilities |       | $                 | 3,747      |                  | $          | 3,245 |   |
| Total liabilities                        |       | $                 | 3,747      |                  | $          | 3,245 |   |

 

Resultsof operations for discontinued operations for the three and six months ended June 30,2010 and 2009 are presented below.

 
| ** **                                                 | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                 | ** ** | **June 30,**      | ** ** |
| ** **                                                 | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Interest income (1)                                        |       | $                      | 1,491      |   | $ | 3,099 |   |
| Interest expense (2)                                       |       | 380                    |       | 881 |   |
| Net interest income                                        |       | 1,111                  |       | 2,218 |   |
| Non-interest income                                        |       | 13,280                 |       | 15,280 |   |
| Non-interest expense                                       |       | 13,942                 |       | 13,492 |   |
| Income before income taxes                                 |       | 449                    |       | 4,006 |   |
| Income taxes                                               |       | —                 |       | 524 |   |
| Net income prior to non-controlling interest               |       | $                      | 449        |   | $ | 3,482 |   |
| Less: Net income attributable to non-controlling  interest |       | $                      | 654        |   | $ | 633 |   |
| (Loss) income from discontinued operations, net of  taxes  |       | $                      | (205       | ) | $ | 2,849 |   |

 

11

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 
| ** **                                                 | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                 | ** ** | **June 30,**    | ** ** |
| ** **                                                 | ** ** | **2010**             | ** ** | **2009** | ** ** |
| Interest income (1)                                        |       | $                    | 2,686      |   | $ | 4,944 |   |
| Interest expense (2)                                       |       | 728                  |       | 1,561 |   |
| Net interest income                                        |       | 1,958                |       | 3,383 |   |
| Non-interest income                                        |       | 23,473               |       | 28,242 |   |
| Non-interest expense (3)                                   |       | 25,980               |       | 22,804 |   |
| (Loss) income before income taxes                          |       | (549                 | )          | 8,821 |   |
| Income taxes                                               |       | —               |       | 1,988 |   |
| Net (loss) income prior to non-controlling  interest       |       | $                    | (549       | ) | $ | 6,833 |   |
| Less: Net income attributable to non-controlling  interest |       | $                    | 853        |   | $ | 870 |   |
| (Loss) income from discontinued operations, net of  taxes  |       | $                    | (1,402     | ) | $ | 5,963 |   |

 

----

(1)          Interest income excludesinterest income earned on the Corporation’s residential and construction loansheld for investment that was previously disclosed as part of the results ofoperations of the mortgage banking segment. Management anticipates that these held for investment portfolios willremain as part of the Corporation’s continuing community banking operationsafter the sale of the mortgage banking business.

 

(2)          Interest expense of themortgage banking segment is based on management’s internal methodology ofallocating consolidated interest expense of the Corporation’s existing fundingsources to the mortgage banking segment’s assets directly related todiscontinued loans held for sale and certain discontinued non-interest earningassets held for sale.  This allocationmethodology is consistent with management’s previous segment reportingpolicies, however, it excludes any funding costs attributable to the Corporation’sresidential and construction loans held for investment that were previouslydisclosed as part of the results of operations of the mortgage bankingsegment.  Imputed interest expense of themortgage banking segment is shown as part of the consolidated statement ofoperations as deposit and Federal Home Loan Bank (“FHLB”) advances and otherborrowings interest expense.  To properlyreport the net loss (income) from discontinued operations, interest expensefrom deposits of $347 thousand and $665 thousand and interest expense from FHLBadvances and other borrowings of $33 thousand and $63 thousand for the threeand six month periods ending June 30, 2010, respectively, was reclassifiedfrom the Corporation’s continuing operations on the consolidated statements ofoperations to interest expense from discontinued operations.  Interest expense from deposits of $778thousand and $1.4 million and interest expense from FHLB advances and otherborrowings of $103 thousand and $180 thousand for the three and six monthperiods ending June 30, 2009, respectively, was reclassified from theCorporation’s continuing operations on the consolidated statements ofoperations to interest expense from discontinued operations.

 

(3)          Non-interest expenseincludes a $500 thousand charge recorded in the first quarter 2010 resultingfrom anticipated investment banking, legal and audit fees directly related tothe potential sale of AHB.

 

**7.****           ****InvestmentSecurities**

 

The Corporation’s investmentportfolio consists of the following categories of securities:

 

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

 

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

 

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

 

12

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Mac pass-through securities or the underlying FNMA and Freddie Macsecurities backing the CMOs are guaranteed by the respective US Governmentagency.

 

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

 

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

 

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

 

·                  Corporate DebtSecurities — Consists of corporate debt securities.

 

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

 

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

 

The amortized cost, grossunrealized gains and losses, and fair market value of the Corporation’savailable-for-sale securities at June 30, 2010 and December 31, 2009are summarized as follows:

 

June 30,2010

 
| ** **                                        | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| **(Dollars  in thousands)**                       | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
|                                              |       |          |       |           |       |           |       |       |       |
| US Treasury                                       |       | $             | 5,002      |           | $          | 16             |       | $          | —     |   | $ | 5,018 |   |
| US Government agency notes                        |       | 2,005         |       | 1              |       | —         |       | 2,006      |       |
| US Government agency mortgage-backed securities   |       | 31,076        |       | 1,197          |       | (20            | )          | 32,253     |       |
| Collateralized mortgage obligations - Residential |       | 1,113         |       | 4              |       | (106           | )          | 1,011      |       |
| Collateralized mortgage obligations - Commercial  |       | 1,003         |       | —         |       | (87            | )          | 916        |       |
| State and municipal                               |       | 3,270         |       | 49             |       | —         |       | 3,319      |       |
| Corporate debt securities                         |       | 7,048         |       | —         |       | (826           | )          | 6,222      |       |
| Bank equity securities                            |       | 525           |       | 59             |       | (19            | )          | 565        |       |
| Other equity securities                           |       | 11,491        |       | —         |       | —         |       | 11,491     |       |
| Totals                                            |       | $             | 62,533     |           | $          | 1,326          |       | $          | (1,058     | ) | $ | 62,801 |   |

 

December 31,2009

 
| ** **                                        | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|------------|------------|
| ** **                                        | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**   | ** ** |
| **(Dollars  in thousands)**                       | ** ** | **Cost**      | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Value**  | ** ** |
|                                              |       |          |       |           |       |           |       |       |       |
| US Treasury                                       |       | $             | 20,003     |           | $          | 13             |       | $          | —     |   | $ | 20,016 |   |
| US Government agency notes                        |       | 2,040         |       | 7              |       | —         |       | 2,047      |       |
| US Government agency mortgage-backed securities   |       | 36,193        |       | 902            |       | (100           | )          | 36,995     |       |
| Collateralized mortgage obligations - Residential |       | 1,249         |       | —         |       | (251           | )          | 998        |       |
| Collateralized mortgage obligations - Commercial  |       | 1,004         |       | —         |       | (196           | )          | 808        |       |
| State and municipal                               |       | 4,542         |       | 52             |       | —         |       | 4,594      |       |
| Corporate debt securities                         |       | 7,056         |       | —         |       | (1,191         | )          | 5,865      |       |
| Bank equity securities                            |       | 525           |       | 50             |       | (42            | )          | 533        |       |
| Other equity securities                           |       | 10,842        |       | —         |       | —         |       | 10,842     |       |
|                                              |       | $             | 83,454     |           | $          | 1,024          |       | $          | (1,780     | ) | $ | 82,698 |   |

 

The amortized cost and estimated fair value of debt securitiesclassified as available-for-sale at June 30, 2010, by contractual maturity,are shown in the following table. Expected maturities will differ from contractual 

 

13

----

Table ofContents

** **

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

maturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.

 
| ** **                              | ** ** | **Amortized** | ** ** | **Fair**  | ** ** |
|-----------------------------------------|------------|---------------|------------|-----------|------------|
| **(Dollars  in thousands)**             | ** ** | **Cost**      | ** ** | **Value** | ** ** |
| Due in one year or less                 |       | $             | 5,949      |      | $          | 5,980 |   |
| Due after one year through five years   |       | 9,887         |       | 9,436     |       |
| Due after five years through ten years  |       | 500           |       | 506       |       |
| Due after ten years                     |       | 989           |       | 643       |       |
|                                    |       | 17,325        |       | 16,565    |       |
| Mortgage-backed securities and CMOs     |       | 33,192        |       | 34,180    |       |
| Bank equity and other equity securities |       | 12,016        |       | 12,056    |       |
|                                    |       | $             | 62,533     |      | $          | 62,801 |   |

 

Duringthe six months ended June 30, 2010, there were no sales of investmentsecurities available for sale. Proceeds from the sale of investment securitiesavailable for sale for the three months ended June 30, 2009 were $18.5million.  Gross gains from the sale ofinvestment securities for the three months ended June 30, 2009 were $89thousand.  The principal amount ofinvestment securities pledged to secure public deposits and for other purposesrequired or permitted by law were $50.8 million at June 30, 2010 and $71.4million at December 31, 2009. Other than US government agency mortgageback securities, there were no securities held from a single issuer thatrepresented more than 10% of stockholders’ equity.

 

The table below indicatesthe length of time individual securities have been in a continuous unrealizedloss position at June 30, 2010.

 
| ** **                                             | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**      | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|----------------|------------|
| **(Dollars  in thousands)**                            | ** ** | **Number**              | ** ** | ** **              | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Description  of**                                    | ** ** | **of**                  | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Securities**                                         | ** ** | **Securities**          | ** ** | **Value**               | ** ** | **Losses**     | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| US Government agency mortgage-backed securities        |       | 2                       |       | $                       | 3,465      |           | $          | (20 | ) | $ | — |   | $ | — |   | $ | 3,465 |   | $ | (20 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Collateralized mortgage obligations — Residential |       | 1                       |       | —                  |       | —         |       | 569 |   | (106 | ) | 569 |   | (106 | ) |
| Collateralized mortgage obligations — Commercial  |       | 1                       |       | —                  |       | —         |       | 1,003 |   | (87 | ) | 1,003 |   | (87 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Corporate debt securities                              |       | 6                       |       | 987                     |       | (13            | )          | 5,235 |   | (813 | ) | 6,222 |   | (826 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Bank equity securities                                 |       | 2                       |       | —                  |       | —         |       | 235 |   | (19 | ) | 235 |   | (19 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Total temporarily impaired investment securities       |       | 12                      |       | $                       | 4,452      |           | $          | (33 | ) | $ | 7,042 |   | $ | (1,025 | ) | $ | 11,494 |   | $ | (1,058 | ) |

 

The table below indicates the length of time individual securities havebeen in a continuous unrealized loss position at December 31, 2009.

 

14

----

Tableof Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 
| ** **                                             | ** ** | **Less than 12 months** | ** ** | **12 months or longer** | ** ** | **Total**      | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|----------------|------------|
| **(Dollars  in thousands)**                            | ** ** | **Number**              | ** ** | ** **              | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Description  of**                                    | ** ** | **of**                  | ** ** | **Fair**                | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Securities**                                         | ** ** | **Securities**          | ** ** | **Value**               | ** ** | **Losses**     | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
| US Government agency mortgage-backed securities        |       | 5                       |       | $                       | 9,386      |           | $          | (100 | ) | $ | — |   | $ | — |   | $ | 9,386 |   | $ | (100 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Collateralized mortgage obligations — Residential |       | 3                       |       | 292                     |       | —         |       | 700 |   | (251 | ) | 992 |   | (251 | ) |
| Collateralized mortgage obligations — Commercial  |       | 1                       |       | —                  |       | —         |       | 808 |   | (196 | ) | 808 |   | (196 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Corporate debt securities                              |       | 6                       |       | —                  |       | —         |       | 5,865 |   | (1,191 | ) | 5,865 |   | (1,191 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Bank equity securities                                 |       | 2                       |       | —                  |       | —         |       | 213 |   | (42 | ) | 213 |   | (42 | ) |
|                                                   |       |                    |       |                    |       |           |       |   |   |   |   |   |   |   |   |
| Total temporarily impaired  investment securities |       | 17                      |       | $                       | 9,678      |           | $          | (100 | ) | $ | 7,586 |   | $ | (1,680 | ) | $ | 17,264 |   | $ | (1,780 | ) |

 

**Other than Temporary Impairment**

 

Inaccordance with ASC 320-10, “Investments — Debt and Equity Securities,” theCorporation evaluates its securities portfolio for other-than-temporaryimpairment (“OTTI”) throughout the year. Each investment, that has a fair valueless than the book value is reviewed on a quarterly basis by management.Management considers at a minimum the following factors that, both individuallyor in combination, could indicate that the decline is other-than-temporary: (a) theCorporation has the intent to sell the security; (b) it is more likelythan not that it will be required to sell the security before recovery; and (c) theCorporation does not expect to recover the entire amortized cost basis of thesecurity.  Among the factors that are considered in determiningintent is a review of capital adequacy, interest rate risk profile andliquidity at the Corporation. An impairment charge is recorded againstindividual securities if the review described above concludes that the declinein value is other-than-temporary. There were no impairments recorded during thesix months ended June 30, 2010 and 2009 on available for sale securities.

 

Specificconclusions for each category of securities with an unrealized loss positionand where management believed an other than temporary impairment analysis waswarranted are summarized below:

 

*CMO — Residential andCommercial*

 

There are a total of twoprivate label CMO securities that had unrealized loss positions at June 30,2010. One of the securities had a AA- rating from S&P, and the other had aB- rating from S&P. All contractual cash flows have been received on thesesecurities. All of these issuances have subordinated tranches supportingprincipal. In addition, we conducted due diligence of publicly availableinformation regarding these securities and no material information came to ourattention that would indicate an inability to recover our basis in thesesecurities. We reviewed and considered information about the underlyingcollateral as well information provided by our professional investmentadvisors. This information indicated likelihood that subordinate tranches ofthe CMO provide sufficient protection to the Bank’s senior tranches such thatmanagement can conclude that the probability of suffering a principal loss isunlikely. Because the Company does not intend to sell these securities and itis more likely than not that the Company will not be required to sell thesecurities before recovery of its amortized cost basis, which may be maturity,it does not consider these investments to be other-than-temporarilyimpaired at June 30, 2010.

 

*Corporate Debt Securities*

 

There are a total of sixsecurities in this category that had unrealized loss positions at June 30,2010. All of these securities are obligations of well-known, establishedcompanies or subsidiaries thereof. All contractual cash flows have beenreceived on these securities. Depreciation on three of the securities accountedfor 91% of the total depreciation in this category. For these three securitiesmanagement reviewed rating agency information 

 

15

----

Table ofContents

** **

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

and noted that all threesecurities had below investment grade ratings. Current news and filings as well as the length and duration of thedepreciation was also reviewed and management concluded that there was noinformation that would indicate a going concern or other issue that wouldimpair our ability to recover our cost basis. Management performed additionalanalysis, which included reviewing analysis from our third party investmentadvisor as well as current news and filings. The conclusion drawn from thisinformation was that there was no information that indicated a going concern orother issue that would impair our ability to recover our cost basis. Becausethe Corporation does not intend to sell these securities and it is not morelikely than not that the Corporation will be required to sell the securitiesbefore recovery of its amortized cost basis, it does not consider theseinvestments to be other-than-temporarily impaired at June 30, 2010.

 

**8.****           ****Loansand Leases**

 

Thefollowing charts present information about major loan classifications as wellas impaired loans and lease balances as of June 30, 2010 andDecember 31, 2009:

 

June 30, 2010

 
| ** **                                  | ** ** | ** **  | ** ** | ** **   | ** ** | ** **    | ** ** | **Specific**    | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|---------------|------------|-----------------|------------|
| ** **                                  | ** ** | ** **  | ** ** | **Impaired** | ** ** | **Number of** | ** ** | **Allowance**   | ** ** |
| ** **                                  | ** ** | **Loan**    | ** ** | **Loan**     | ** ** | **Impaired**  | ** ** | **on Impaired** | ** ** |
| **(Dollars  in thousands)**                 | ** ** | **Balance** | ** ** | **Balance**  | ** ** | **Loans**     | ** ** | **Loans**       | ** ** |
|                                        |       |        |       |         |       |          |       |            |       |
| Commercial loans                            |       | $           | 312,533    |         | $          | 18,215        |       | 54              |       | $ | 2,615 |   |
| Real estate — commercial               |       | 258,350     |       | 19,198       |       | 15            |       | 2,203           |       |
| Real estate — commercial construction  |       | 56,629      |       | 13,242       |       | 12            |       | 286             |       |
| Real estate — residential              |       | 93,715      |       | 2,524        |       | 9             |       | 826             |       |
| Real estate — residential construction |       | 31,695      |       | 844          |       | 2             |       | 348             |       |
| Consumer loans                              |       | 113,531     |       | 1,517        |       | 37            |       | 262             |       |
| Lease financing receivables                 |       | 1,025       |       | 89           |       | 3             |       | 89              |       |
|                                        |       |        |       |         |       |          |       |            |       |
| Totals                                      |       | $           | 867,478    |         | $          | 55,629        |       | 132             |       | $ | 6,629 |   |

 

Unearned income included in the carrying amount of the loan balancesabove was $772 thousand at June 30, 2010. The amount of deposit account overdrafts classified as loans abovetotaled $146 thousand at June 30, 2010.

 

The non-accrual loan and lease balance was $37.0 million at June 30,2010. The approximate gross interest income that would have been recorded forthe three and six months ending June 30, 2010 if the $37.0 million innon-accrual loans had been current in accordance with their original terms was$533 thousand and $859 thousand, respectively. The actual amount of interestincome included in net income as of the three and six months ended June 30,2010 on these loans was $2 and $35 thousand, respectively  resulting from interest earned prior to theloans being placed on non-accrual status.

 

December 31, 2009

 
| ** **                                  | ** ** | ** **  | ** ** | ** **   | ** ** | ** **    | ** ** | **Specific**    | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|---------------|------------|-----------------|------------|
| ** **                                  | ** ** | ** **  | ** ** | **Impaired** | ** ** | **Number of** | ** ** | **Allowance**   | ** ** |
| ** **                                  | ** ** | **Loan**    | ** ** | **Loan**     | ** ** | **Impaired**  | ** ** | **on Impaired** | ** ** |
| **(Dollars  in thousands)**                 | ** ** | **Balance** | ** ** | **Balance**  | ** ** | **Loans**     | ** ** | **Loans**       | ** ** |
|                                        |       |        |       |         |       |          |       |            |       |
| Commercial loans                            |       | $           | 334,286    |         | $          | 13,269        |       | 35              |       | $ | 1,029 |   |
| Real estate — commercial               |       | 261,643     |       | 12,071       |       | 11            |       | 3,637           |       |
| Real estate — commercial construction  |       | 66,204      |       | 8,786        |       | 8             |       | 135             |       |
| Real estate — residential              |       | 88,024      |       | 2,601        |       | 7             |       | 644             |       |
| Real estate — residential construction |       | 29,387      |       | 2,137        |       | 7             |       | 874             |       |
| Consumer loans                              |       | 120,767     |       | 2,596        |       | 42            |       | 1,148           |       |
| Lease financing receivables                 |       | 1,578       |       | 167          |       | 8             |       | 55              |       |
|                                        |       |        |       |         |       |          |       |            |       |
| Totals                                      |       | $           | 901,889    |         | $          | 41,627        |       | 118             |       | $ | 7,522 |   |

 

16

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Unearned income included in the carrying amount of the loan balancesabove was $746 thousand at December 31, 2009.  The amount of deposit account overdraftsclassified as loans above totaled $220 thousand at December 31, 2009.

 

The non-accrual loan and lease balance was $27.6 million at December 31,2009. The approximate gross interest income that would have been recorded forthe twelve months ending December 31, 2009 if the $27.6 million innon-accrual loans had been current in accordance with their original terms was$1.8 million. The actual amount of interest income included in net income as ofDecember 31, 2009 on these loans was $960 thousand resulting from interestearned prior to the loans being placed on non-accrual status.

 

The following chart presentschanges in the allowance for loan and lease losses for the three and six monthsended June 30, 2010 and 2009:

 
| ** **                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **June 30,**      | ** ** |
| **(Dollars  in thousands)**             | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Balance at beginning of period          |       | $                      | 22,464     |   | $ | 11,263 |   |
| Provision charged to operating expenses |       | 132                    |       | 5,084 |   |
| Recoveries                              |       | 141                    |       | 104 |   |
| Loans charged-off                       |       | (1,303                 | )          | (924 | ) |
| Allowance adjustment — Other       |       | 100                    |       | 1 |   |
| Balance at end of Period                |       | $                      | 21,534     |   | $ | 15,528 |   |

 
| ** **                              | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------|------------|
| ** **                              | ** ** | **June 30,**    | ** ** |
| **(Dollars  in thousands)**             | ** ** | **2010**             | ** ** | **2009** | ** ** |
| Balance at beginning of period          |       | $                    | 23,217     |   | $ | 10,335 |   |
| Provision charged to operating expenses |       | 398                  |       | 6,471 |   |
| Recoveries                              |       | 278                  |       | 249 |   |
| Loans charged-off                       |       | (2,529               | )          | (1,366 | ) |
| Allowance adjustment — Other       |       | 170                  |       | (161 | ) |
| Balance at end of Period                |       | $                    | 21,534     |   | $ | 15,528 |   |

 

**9.****            ****IncomeTaxes**

 

The Corporation has not recorded an income tax benefit for its netoperating loss for the six month period ended June 30, 2010. At June 30,2010 the valuation allowance against the Corporation’s deferred tax assetincreased to $8.4 million from $7.5 million at December 31, 2009. The valuationallowance is recorded against a portion of the Corporation’s deferred taxassets after concluding that it was more likely than not that a portion of thedeferred tax asset would not be realized. In evaluating the ability to recoverour deferred tax assets, Management considers all available positive andnegative evidence regarding the ultimate realizability of our deferred taxassets including past operating results and our forecast of future taxableincome. In addition, general uncertainty surrounding the future economic andbusiness conditions have increased the likelihood of volatility in our futureearnings. The Corporation has concluded and recorded a valuation allowanceagainst its deferred tax asset, except for amounts available for carry back claims.

 

17

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**10.****    ****OtherReal Estate Owned**

 

Otherreal estate owned (“OREO”) represents property owned by the Bank followingdefault by the borrowers. OREO property acquired through foreclosure isinitially transferred at fair value based on an appraised value less estimatedcost to dispose. Adjustments are subsequently made to mark the property belowthis amount if circumstances warrant. Losses arising from foreclosure transactions are charged against theallowance for loan losses. Costs to maintain real estate owned and anysubsequent gains or losses are included in the Corporation’s results ofoperations. In June 2010, the Corporation sold eight other realestate owned properties to one buyer.  Acharge of $1.3 million was recorded during the first quarter 2010 to reduce thecarrying amount of these assets to an amount that reflects the realizable valueof these properties based on the actual sales price.

 

The following table summarizes properties held as OREO as of June 30,2010 and December 31, 2009:

 
| **(Dollars in thousands)** | ** ** | **June 30,  2010** | ** ** | **Number  of  properties** | ** ** | **December 31,  2009** | ** ** | **Number  of  properties** | ** ** |
|----------------------------|------------|-------------------------|------------|----------------------------|------------|-----------------------------|------------|----------------------------|------------|
| Land                       |       | $                       | 389        |                       | 4          |                        | $          | 49                         |       | 1 |   |
| Residential  1-4 family    |       | 1,025                   |       | 6                          |       | 3,643                       |       | 15                         |       |
| Total                      |       | $                       | 1,414      |                       | 10         |                        | $          | 3,692                      |       | 16 |   |

 

**11.****    ****Other Assets**

 

During thefirst quarter of 2010, the Corporation received cash proceeds in full paymentof an $8.7 million receivable recorded in other assets during the year ended December 31,2009, which related to a former BOLI policy which the Bank had surrendered in2008.  The Corporation also received anincome tax refund of $3.1 million during the second quarter of 2010 which wasrecorded as a receivable in other assets at December 31, 2009.

 

**12.****    ****Borrowings**

 

At June 30,2010, the Bank had borrowings totaling $83.3 million compared to $172.9 millionat December 31, 2009. During the first half of 2010 borrowings from theFHLB decreased $89.3 million to $54.5 million as compared to December 31,2009. Scheduled maturities of $42.5 million and prepayments of $56.7 millionnet of advances of $10.0 million during the six months ended June 30, 2010totaled $89.2 million. The remaining decrease was due to amortization.

 

TheCorporation deferred its regularly scheduled interest payments on itsoutstanding junior subordinated notes relating to its $20.8 million of trustpreferred securities beginning with the regularly scheduled quarterly interestpayments that would otherwise have been made in September 2010.  Theterms of the junior subordinated notes and the related trust indentures allowthe Corporation to defer such payments of interest for up to 20 consecutivequarterly periods without default.  During the deferral period, therespective trusts will suspend the declaration and payment of dividends on thetrust preferred securities. During the deferral period, the Corporation maynot, among other things and with limited exceptions, pay cash dividends on orrepurchase its common stock nor make any payment on outstanding debtobligations that rank equally with or junior to the junior subordinated notes.

 

18

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**13.****    ****Earnings (Loss) per Share**

 

**Three Months ended June 30,2010**

 
| ** **                                                                      | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                                                      | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                                                      | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic income from continuing operations per share                               |       |            |       |              |       |          |       |
| Net income from continuing operations                                           |       | $               | 374        |              | 6,320,546  |          | $          | 0.06 |   |
| Effect of dilutive securities                                                   |       |            |       |              |       |          |       |
| Options to purchase common stock                                                |       | —          |       | —            |       | —        |       |
| Diluted net income from continuing operations  available to common stockholders |       | $               | 374        |              | 6,320,546  |          | $          | 0.06 |   |
|                                                                            |       |            |       |              |       |          |       |
| Basic loss from discontinued operations per share                               |       |            |       |              |       |          |       |
| Net loss from discontinued operations                                           |       | $               | (205       | )                 | 6,320,546  |          | $          | (0.03 | ) |
| Effect of dilutive securities                                                   |       |            |       |              |       |          |       |
| Options to purchase common stock                                                |       | —          |       | —            |       | —        |       |
| Diluted net loss from discontinued operations  available to common stockholders |       | $               | (205       | )                 | 6,320,546  |          | $          | (0.03 | ) |
|                                                                            |       |            |       |              |       |          |       |
| Basic income available to common stockholders per  share                        |       |            |       |              |       |          |       |
| Net income available to common stockholders                                     |       | $               | 169        |              | 6,320,546  |          | $          | 0.03 |   |
| Effect of dilutive securities                                                   |       |            |       |              |       |          |       |
| Options to purchase common stock                                                |       | —          |       | —            |       | —        |       |
| Diluted net income available to common  stockholders                            |       | $               | 169        |              | 6,320,546  |          | $          | 0.03 |   |

 

----

(1)          226,720 anti-dilutiveweighted average shares have been excluded from this computation because theoption exercise price was greater than the average market price of the commonshares.

 

**Three Months ended June 30, 2009**

 
| ** **                                                                        | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                                                        | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                                                        | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic loss from continuing operations per share                                   |       |            |       |              |       |          |       |
| Net loss from continuing operations                                               |       | $               | (2,911     | )                 | 6,268,195  |          | $          | (0.46 | ) |
| Effect of dilutive securities                                                     |       |            |       |              |       |          |       |
| Options to purchase common stock                                                  |       | —          |       | —            |       | —        |       |
| Diluted net loss from continuing operations  available to common stockholders     |       | $               | (2,911     | )                 | 6,268,195  |          | $          | (0.46 | ) |
|                                                                              |       |            |       |              |       |          |       |
| Basic income from discontinued operations per  share                              |       |            |       |              |       |          |       |
| Net income from discontinued operations                                           |       | $               | 2,849      |              | 6,268,195  |          | $          | 0.45 |   |
| Effect of dilutive securities                                                     |       |            |       |              |       |          |       |
| Options to purchase common stock                                                  |       | —          |       | —            |       | —        |       |
| Diluted net income from discontinued operations  available to common stockholders |       | $               | 2,849      |              | 6,268,195  |          | $          | 0.45 |   |
|                                                                              |       |            |       |              |       |          |       |
| Basic loss available to common stockholders per  share                            |       |            |       |              |       |          |       |
| Net loss available to common stockholders                                         |       | $               | (62        | )                 | 6,268,195  |          | $          | (0.01 | ) |
| Effect of dilutive securities                                                     |       |            |       |              |       |          |       |
| Options to purchase common stock                                                  |       | —          |       | —            |       | —        |       |
| Diluted net loss available to common stockholders                                 |       | $               | (62        | )                 | 6,268,195  |          | $          | (0.01 | ) |

 

----

(1)          289,047 anti-dilutiveweighted average shares have been excluded from this computation because theoption exercise price was greater than the average market price of the commonshares.

 

19

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**Six Months ended June 30,2010**

 
| ** **                                                                      | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                                                      | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                                                      | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic loss from continuing operations per share                                 |       |            |       |              |       |          |       |
| Net loss from continuing operations                                             |       | $               | (229       | )                 | 6,328,446  |          | $          | (0.04 | ) |
| Effect of dilutive securities                                                   |       |            |       |              |       |          |       |
| Options to purchase common stock                                                |       | —          |       | —            |       | —        |       |
| Diluted net loss from continuing operations  available to common stockholders   |       | $               | (229       | )                 | 6,328,446  |          | $          | (0.04 | ) |
|                                                                            |       |            |       |              |       |          |       |
| Basic loss from discontinued operations per share                               |       |            |       |              |       |          |       |
| Net loss from discontinued operations                                           |       | $               | (1,402     | )                 | 6,328,446  |          | $          | (0.22 | ) |
| Effect of dilutive securities                                                   |       |            |       |              |       |          |       |
| Options to purchase common stock                                                |       | —          |       | —            |       | —        |       |
| Diluted net loss from discontinued operations  available to common stockholders |       | $               | (1,402     | )                 | 6,328,446  |          | $          | (0.22 | ) |
|                                                                            |       |            |       |              |       |          |       |
| Basic loss available to common stockholders per  share                          |       |            |       |              |       |          |       |
| Diluted net loss available to common stockholders                               |       | $               | (1,631     | )                 | 6,328,446  |          | $          | (0.26 | ) |
| Effect of dilutive securities                                                   |       |            |       |              |       |          |       |
| Options to purchase common stock                                                |       | —          |       | —            |       | —        |       |
| Diluted net loss available to common stockholders                               |       | $               | (1,631     | )                 | 6,328,446  |          | $          | (0.26 | ) |

 

----

(1) 226,720anti-dilutive weighted average shares have been excluded from this computationbecause the option exercise price was greater than the average market price ofthe common shares.

 

**Six Months ended June 30,2009**

 
| ** **                                                                        | ** ** | **Income**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------|------------|-------------------|------------|---------------|------------|
| ** **                                                                        | ** ** | **(thousands)** | ** ** | **Shares (1)**    | ** ** | **Per Share** | ** ** |
| ** **                                                                        | ** ** | **(numerator)** | ** ** | **(denominator)** | ** ** | **Amount**    | ** ** |
| Basic loss from continuing operations per share                                   |       |            |       |              |       |          |       |
| Net income from continuing operations                                             |       | $               | (2,704     | )                 | 6,255,295  |          | $          | (0.43 | ) |
| Effect of dilutive securities                                                     |       |            |       |              |       |          |       |
| Options to purchase common stock                                                  |       | —          |       | —            |       | —        |       |
| Diluted net loss from continuing operations  available to common stockholders     |       | $               | (2,704     | )                 | 6,255,295  |          | $          | (0.43 | ) |
|                                                                              |       |            |       |              |       |          |       |
| Basic income from discontinued operations per share                               |       |            |       |              |       |          |       |
| Net income from discontinued operations                                           |       | $               | 5,963      |              | 6,255,295  |          | $          | 0.95 |   |
| Effect of dilutive securities                                                     |       |            |       |              |       |          |       |
| Options to purchase common stock                                                  |       | —          |       | —            |       | —        |       |
| Diluted net income from discontinued operations  available to common stockholders |       | $               | 5,963      |              | 6,255,295  |          | $          | 0.95 |   |
|                                                                              |       |            |       |              |       |          |       |
| Basic income available to common stockholders per  share                          |       |            |       |              |       |          |       |
| Net income available to common stockholders                                       |       | $               | 3,259      |              | 6,255,295  |          | $          | 0.52 |   |
| Effect of dilutive securities                                                     |       |            |       |              |       |          |       |
| Options to purchase common stock                                                  |       | —          |       | —            |       | —        |       |
| Diluted net income available to common  stockholders                              |       | $               | 3,259      |              | 6,255,295  |          | $          | 0.52 |   |

 

----

(1) 289,047anti-dilutive weighted average shares have been excluded from this computationbecause the option exercise price was greater than the average market price ofthe common shares.

 

20

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

**14.****    ****Comprehensive Income**

 

Components of comprehensive income are presented in the followingcharts:

 
| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **June 30,**      | ** ** |
| **Dollars in thousands**                                              | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Unrealized gains on securities:                                       |       |                   |       |   |   |
| Unrealized gains arising in period                                    |       | $                      | 225        |   | $ | 1,869 |   |
| Reclassification adjustment                                           |       | 1                      |       | 89 |   |
| Net unrealized gains                                                  |       | 226                    |       | 1,958 |   |
| Other comprehensive income before taxes                               |       | 226                    |       | 1,958 |   |
| Income tax expense                                                    |       | (77                    | )          | (666 | ) |
| Other comprehensive income                                            |       | 149                    |       | 1,292 |   |
| Net income including non-controlling interests                        |       | 823                    |       | 571 |   |
| Comprehensive income                                                  |       | 972                    |       | 1,863 |   |
| Less comprehensive income attributable to non-  controlling interests |       | 654                    |       | 633 |   |
| Comprehensive income for First Chester County  Corporation            |       | $                      | 318        |   | $ | 1,230 |   |

 
| ** **                                                            | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                            | ** ** | **June 30,**    | ** ** |
| **Dollars in thousands**                                              | ** ** | **2010**             | ** ** | **2009** | ** ** |
| Unrealized gains on securities:                                       |       |                 |       |   |   |
| Unrealized gains arising in period                                    |       | $                    | 1,023      |   | $ | 1,345 |   |
| Reclassification adjustment                                           |       | 1                    |       | 1 |   |
| Net unrealized gains                                                  |       | 1,024                |       | 1,346 |   |
| Other comprehensive income before taxes                               |       | 1,024                |       | 1,346 |   |
| Income tax expense                                                    |       | (348                 | )          | (458 | ) |
| Other comprehensive income                                            |       | 676                  |       | 888 |   |
| Net (loss) income including non-controlling  interests                |       | (778                 | )          | 4,129 |   |
| Comprehensive (loss) income                                           |       | (102                 | )          | 5,017 |   |
| Less comprehensive income attributable to non-  controlling interests |       | 853                  |       | 870 |   |
| Comprehensive (loss) income for First Chester  County Corporation     |       | $                    | (955       | ) | $ | 4,147 |   |

 

**15.****    ****Fair Value Measurement and FairValue of Financial Instruments**

 

ASC820-10 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. ASC 820-10 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. ASC 820-10 clarifies proper fair value determination in a marketthat is 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. The Corporation considered the requirements ofASC 820-10 when estimating fair value.

 

ASC825-10 — Financial Instruments 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.

 

ASC820-10 describes three levels of inputs that may be used to measure fair value:

 

·                  Level 1: Quoted prices(unadjusted) for identical assets or liabilities in active markets that theentity 

 

21

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

has the ability to access asof the measurement date.

 

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

 

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

 

*Assets and Liabilities Measuredat Fair Value on a Recurring Basis*

 

Adescription of the valuation methodologies used for financial instrumentsmeasured at fair value on a recurring basis, as well as the classification ofthe instruments pursuant to the valuation hierarchy, are as follows:

 

Securities: Investmentsecurities available-for-sale are recorded at fair value on a recurring basis.Fair value measurement is based upon quoted prices, if available. If quotedprices are not available, fair values are measured using matrix pricing, whichis a mathematical technique used widely in the industry to value debtsecurities without relying exclusively on quoted prices for the specificsecurities but rather by relying on the securities’ relationship to otherbenchmark quoted securities.

 

Level1 Valuation Techniques and Inputs for Investment Securities

 

TheCorporation reports U.S. Treasury and certain Bank equity securities at fairvalue utilizing Level 1 inputs. These securities are priced using observablequotations for the indicated security.

 

Level2 Valuation Techniques and Inputs for Investment Securities

 

Themajority of the Corporation’s investment securities are reported at fair valueutilizing Level 2 inputs. The valuations for U.S. Government agency securities,U.S. Government agency mortgage backed securities, residential and commercialCMO’s, and corporate debt securities are obtained through independent,third-party pricing services. Prices obtained through these sources includemarket derived quotations and matrix pricing and may include both observableand unobservable inputs. Fair market values take into consideration data suchas dealer quotes, new issue pricing, trade prices for similar issues,prepayment estimates, cash flows, market credit spreads and other factors.

 

Thevaluations for state and municipal obligations are obtained throughindependent, third-party pricing services as well.  Valuations for these securities are performedusing information on identical or similar securities provided by market makers,broker/dealers and buy-side firms, new issue sales and bid-wanted lists. Theindividual securities are then priced based on mapping the characteristics ofthe security such as obligation type (General Obligation, Revenue, etc.),maturity, state discount and premiums, call features, taxability and otherconsiderations.

 

Level3 Valuation Techniques and Inputs for Investment Securities

 

Otherequity securities are primarily comprised of Federal Home Loan Corporation (“FHLB”)and Federal Reserve Board (“FRB”) stock. The Corporation is required to purchase and hold stock in the FHLB andFRB to satisfy membership and borrowing requirements. This stock is restrictedin that it can only be sold to the FHLB, FRB or to another member institution,and all sales must be at par. As a result of these restrictions, these equitysecurities are unlike other investment securities insofar as there is notrading market and the transfer price is determined by membership rules andnot by market participants.  Accordingly,the Corporation’s valuation for these securities is estimated at its par value.

 

MortgageServicing Rights (“MSRs”): To determine the fair value of MSRs, theBank uses an independent third party to estimate the present value of estimatedfuture net servicing income. This valuation method incorporates an assumptionthat market participants would use in estimating future net servicing income,which include 

 

22

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

estimatesof the cost to service, the discount rate, custodial earnings rate, aninflation rate, ancillary income, prepayment speeds, and default rates andlosses. The fair value of servicing rights was determined using discount ratesranging from 8.0% to 12.5%, prepayment speeds ranging from 6.7% to 50.8%depending on the stratification of the specific right, and a weighted averagedefault rate of 0.9%. The Corporation records the MSR as a recurring Level 3.

 

TheCorporation had no transfers in or out of Level 1 and Level 2 during the sixmonth period ended June 30, 2010.

 

Thetable below presents the balance of assets and liabilities from continuingoperations at June 30, 2010 and December 31, 2009, measured at fairvalue on a recurring basis:

 
| **(Dollars  in thousands)**                       | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** |
|---------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|
| **June 30,  2010**                           | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
| Assets                                            |       |        |       |        |       |        |       |       |       |
| Investment securities available for sale:         |       |        |       |        |       |        |       |       |       |
| U.S. Treasury                                     |       | $           | 5,018      |        | $          | —      |       | $          | —     |   | $ | 5,018 |   |
| U.S. Government agency                            |       | —      |       | 2,006       |       | —      |       | 2,006      |       |
| U.S. Government agency mortgage-backed securities |       | —      |       | 32,253      |       | —      |       | 32,253     |       |
| CMO — Residential                            |       | —      |       | 1,011       |       | —      |       | 1,011      |       |
| CMO — Commercial                             |       | —      |       | 916         |       | —      |       | 916        |       |
| State and municipal                               |       | —      |       | 3,319       |       | —      |       | 3,319      |       |
| Corporate debt securities                         |       | —      |       | 6,222       |       | —      |       | 6,222      |       |
| Bank equity securities                            |       | 3           |       | 562         |       | —      |       | 565        |       |
| Other equity securities                           |       | —      |       | —      |       | 11,491      |       | 11,491     |       |
| Mortgage servicing rights                         |       | —      |       | —      |       | 534         |       | 534        |       |
|                                                   |            |             |            |             |            |             |            |            |            |  |  |  |  |

 
| **December 31,  2009**                       | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
| Assets                                            |       |        |       |        |       |        |       |      |       |
| Investment securities available for sale:         |       |        |       |        |       |        |       |      |       |
| U.S. Treasury                                     |       | $           | 20,016     |        | $          | —      |       | $         | —     |   | $ | 20,016 |   |
| U.S. Government agency                            |       | —      |       | $           | 2,047      |        | —     |      | 2,047      |   |
| U.S. Government agency mortgage-backed securities |       | —      |       | 36,995      |       | —      |       | 36,995    |       |
| CMO — Residential                            |       | —      |       | 998         |       | —      |       | 998       |       |
| CMO — Commercial                             |       | —      |       | 808         |       | —      |       | 808       |       |
| State and municipal                               |       | —      |       | 4,594       |       | —      |       | 4,594     |       |
| Corporate debt securities                         |       | —      |       | 5,865       |       | —      |       | 5,865     |       |
| Bank equity securities                            |       | 3           |       | 530         |       | —      |       | 533       |       |
| Other equity securities                           |       | —      |       | —      |       | 10,842      |       | 10,842    |       |
| Mortgage servicing rights                         |       | —      |       | —      |       | 575         |       | 575       |       |
|                                                   |            |             |            |             |            |             |            |           |            |  |  |  |  |

 

*Assets Measured at Fair Value on a Nonrecurring Basis*

 

23

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

Adescription of the valuation methodologies and classification levels used forfinancial instruments measured at fair value on a nonrecurring basis are listedas follows. These listed instruments are subject to fair value adjustments(impairment) as they are valued at the lower of cost or market.

 

Loans and leases:  The Corporation does not record loans at fairvalue on a recurring basis. However, from time to time, a loan is consideredimpaired and an allowance for loan losses is established. Loans for which it isprobable that payment of interest and principal will not be made in accordancewith the contractual terms of the loan agreement are considered impaired. Oncea loan is identified as individually impaired, Management measures impairmentin accordance with ASC 310. The fair value of impaired loans is estimated usingone of several methods, including collateral value, market value of similar debt,enterprise value, liquidation value and discounted cash flows. Those impairedloans not requiring an allowance represent loans for which the fair value ofthe expected repayments or collateral exceed the recorded investments in suchloans. At June 30, 2010 substantially all of the impaired loans wereevaluated based on the fair value of the collateral less costs to sell. Inaccordance with ASC 820-10 impaired loans where an allowance is establishedbased on the fair value of collateral require classification in the fair valuehierarchy. When the fair value of the collateral is based on an observablemarket price or a current appraised value, the Corporation records the impairedloan as nonrecurring Level 3.  TheBank’s policies require loan officers to regularly review accounts. Consistentwith OCC guidance appraisals are updated as warranted based on specific factsand circumstances. Appraisals are also updated whenever a loan becomescriticized or classified.

 

OREO: OREO isadjusted to fair value upon transfer of the loans to foreclosed assets.Subsequently, OREO is carried at the lower of carrying value or fair value.Fair value is based upon independent market prices, appraised values of thecollateral or Management’s estimation of the value of the collateral. TheCorporation records the foreclosed asset as nonrecurring Level 3.

 

Thetable below presents the balance of assets and liabilities from continuingoperations at June 30, 2010 and December 31, 2009, measured at fairvalue on a nonrecurring basis:

 
| **(Dollars  in thousands)**      | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** |
|----------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|
| **June 30,  2010**          | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
|                             |       |        |       |        |       |        |       |       |       |
| Impaired loans & leases |       | $           | —     |        | $          | —      |       | $          | 49,000     |   | $ | 49,000 |   |
| OREO                             |       | —      |       | —      |       | 1,414       |       | 1,414      |       |
|                                  |            |             |            |             |            |             |            |            |            |  |  |  |  |

 
| **(Dollars  in thousands)**      | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** |
|----------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|
| **December 31,  2009**      | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total**  | ** ** |
|                             |       |        |       |        |       |        |       |       |       |
| Impaired loans & leases |       | $           | —     |        | $          | —      |       | $          | 34,105     |   | $ | 34,105 |   |
| OREO                             |       | —      |       | —      |       | 3,692       |       | 3,692      |       |
|                                  |            |             |            |             |            |             |            |            |            |  |  |  |  |

 

24

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

*Disclosures about financial instruments*

 

Thetable below presents the rollforward of assets from continuing operations thatare valued using significant unobservable inputs (Level 3) for the six monthsended June 30, 2010:

 
| **(Dollars  in thousands)**          | ** ** | **Mortgage  Servicing Rights** | ** ** | **Investments** | ** ** |
|--------------------------------------|------------|--------------------------------|------------|-----------------|------------|
| Beginning balance                    |       | $                              | 575        |            | $          | 10,842 |   |
| Total gains realized/unrealized:     |       |                           |       |            |       |
| Included in earnings                 |       | (41                            | )          | —          |       |
| Included in other comprehensive loss |       | —                         |       | —          |       |
| Purchases                            |       | —                         |       | 713             |       |
| Maturities/amortizations             |       | —                         |       | (64             | )          |
| Prepayments                          |       | —                         |       | —          |       |
| Calls                                |       | —                         |       | —          |       |
| Transfers into Level 3               |       | —                         |       | —          |       |
| Ending Balance                       |       | $                              | 534        |            | $          | 11,491 |   |

 

The estimated fair values and carrying amounts of the assets and liabilitiesfrom continuing operations are summarized as follows:

 
| ** **                                                      | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                                      | ** ** | **Estimated**          | ** ** | **Carrying**               | ** ** | **Estimated** | ** ** | **Carrying** | ** ** |
| **(Dollars  in thousands)**                                     | ** ** | **Fair Value**         | ** ** | **Amount**                 | ** ** | **Fair Value** | ** ** | **Amount** | ** ** |
| Financial Assets                                                |       |                   |       |                       |       |   |   |   |   |
| Cash and cash equivalents                                       |       | $                      | 43,750     |                       | $          | 43,750 |   | $ | 146,681 |   | $ | 146,681 |   |
| Investment securities available-for-sale                        |       | 62,801                 |       | 62,801                     |       | 82,698 |   | 82,698 |   |
| Gross loans and leases                                          |       | 830,310                |       | 867,478                    |       | 866,754 |   | 901,889 |   |
| Mortgage servicing rights                                       |       | 534                    |       | 534                        |       | 575 |   | 575 |   |
|                                                            |       |                   |       |                       |       |   |   |   |   |
| Financial Liabilities                                           |       |                   |       |                       |       |   |   |   |   |
| Deposits with no stated maturities                              |       | 555,407                |       | 555,407                    |       | 594,278 |   | 594,278 |   |
| Deposits with stated maturities                                 |       | 440,671                |       | 436,560                    |       | 518,642 |   | 516,022 |   |
| FHLB and other borrowings                                       |       | 85,455                 |       | 83,302                     |       | 175,904 |   | 172,897 |   |
| Subordinated debentures                                         |       | 14,870                 |       | 20,795                     |       | 12,410 |   | 20,795 |   |
|                                                            |       |                   |       |                       |       |   |   |   |   |
| Off-Balance-Sheet                                               |       |                   |       |                       |       |   |   |   |   |
| Commitments to extend credit and outstanding  letters of credit |       | 132,359                |       | 132,359                    |       | 205,468 |   | 205,468 |   |
|                                                                 |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

**16.****    ****Accounting for Stock-BasedCompensation Plans**

 

At June 30, 2010, 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 150,000 shares of restricted stock to employees.During the six months ended June 30, 2010 the Corporation granted noshares of restricted stock under this plan. These restricted stock grants aresubject to accelerated vesting of all or a portion of the shares upon theoccurrence of certain events.  A summaryof the Corporation’s unvested restricted shares is as follows:

 

25

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

 
| **(Dollars  in thousands, except shares,  and per share data)** | ** ** | **Shares** | ** ** | **Grant Date Fair  Value** | ** ** | **Aggregate Intrinsic  Value  of Unvested Shares** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------------------------------|------------|
| Unvested at January 1, 2010                                |       | 54,474     |       | $                          | 10.57      |                                               | $          | 503 |   |
| Granted                                                         |       | —     |       | $                          |       |                                               |       |   |
| Vested                                                          |       | (2,199     | )          | $                          | 21.05      |                                               |       |   |
| Forfeited                                                       |       | (1,400     | )          | $                          | 11.35      |                                               |       |   |
| Unvested at June 30, 2010                                  |       | 50,875     |       | $                          | 10.09      |                                               | $          | 440 |   |

 

The Corporation recorded approximately $29 thousand and $64 thousandand $41 thousand and $100 thousand of restricted stock expense for the threeand six months ended June 30, 2010 and 2009, respectively.

 

The Corporation’s ability to issue stock options under the Corporation’s1995 Stock Option Plan has expired. However, outstanding stock options remainin effect according to their terms. Aggregated information regarding theCorporation’s 1995 Stock Option Plan and the options assumed in the AHBacquisition as of June 30, 2010 is presented below.

 
| **(Dollars  in thousands, except shares,  per share and years data)  Options** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Weighted-Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at January 1, 2010                                            |       | 230,900    |       | $                                       | 15.79      |                                                       | 3.32       |                            | $          | — |   |
| Granted                                                                        |       | —     |       |                                    |       |                                                       |       |                            |       |
| Exercised                                                                      |       | —     |       |                                    |       |                                                       |       |                            |       |
| Forfeited                                                                      |       | (4,180     | )          | 15.86                                   |       |                                                       |       |                            |       |
| Expired                                                                        |       | —     |       | $                                       | —     |                                                       |       |                            |       |   |
| Outstanding at June 30, 2010                                              |       | 226,720    |       | $                                       | 15.75      |                                                       | 2.80       |                            | $          | — |   |
| Exercisable at June 30, 2010                                              |       | 226,720    |       | $                                       | 15.75      |                                                       | 2.80       |                            | $          | — |   |

 

There were no options granted during the six months ended June 30,2010.  There was no intrinsic value (marketvalue on date of exercise less grant price) of options at June 30, 2010 asall options had an exercise price that was higher than the June 30, 2010market price.

 

**17.****    ****Commitment and Contingencies**

 

**Reserve for Unfunded Commitments**

 

TheCorporation maintains a reserve for unfunded loan commitments and letters ofcredit which is reported in other liabilities in the Unaudited ConsolidatedStatements of Financial Condition consistent with ASC 825-10. As of the balancesheet date, the Corporation records estimated losses inherent with unfundedloan commitments in accordance with ASC 450-20, and estimated futureobligations under letters of credit in accordance with ASC 460-10. Themethodology used to determine the adequacy of this reserve is integrated in theCorporation’s process for establishing the allowance for loan losses andconsiders the probability of future losses and obligations that may be incurredunder these off-balance sheet agreements.  The reserve for unfundedloan commitments and letters of credit as of June 30, 2010 andDecember 31, 2009 was approximately $499 thousand and $669 thousand,respectively. Management believes this reserve level is sufficient to absorbestimated probable losses related to these commitments.

 

**Loan Recourse**

 

TheCorporation sells its residential mortgage loans on a non-recourse basis. TheCorporation also provides representations and warranties to purchasers andinsurers of the loans sold. In the event of a breach of these representationsand warranties, the Corporation may be required to repurchase a mortgage loanor indemnify the purchaser, and any subsequent loss on the mortgage loan may beborne by the Corporation. If there is no breach of a representation andwarranty provision, the Corporation has no obligation to repurchase the loan orindemnify the investor against loss. The unpaid principal balance of the loanssold by the Corporation represents the maximum potential exposure related torepresentations and warranty provisions; however, the Corporation cannot estimateits maximum exposure because it does not service all of the loans for which ithas provided a 

 

26

----

Table of Contents

 

**FIRST CHESTER COUNTY CORPORATIONAND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(UNAUDITED)**

 

representationor warranty. As of June 30, 2010 and December 31, 2009, theCorporation had a liability of $733 thousand and $688 thousand, respectively,included in Liabilities related to assets held for sale on the ConsolidatedBalance Sheet, for probable losses related to the Corporation’s recourseexposure.  This liability is part of ourdiscontinued mortgage banking operations, however it is anticipated that theCorporation will retain this liability after the anticipated sale of themortgage banking division.

 

27

----

Tableof Contents

 

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

 

Thisdiscussion is intended to further your understanding of the consolidatedfinancial condition and results of operations of the Corporation and its directand indirect subsidiaries. It should be read in conjunction with theconsolidated financial statements included in this report.

 

**OVERVIEW**

 

TheCorporation reported a net income from continuing operations of $374 thousandand net loss from continuing operations of $229 thousand for the three and sixmonths ended June 30, 2010, as compared to a net loss from continuingoperations of $2.9 million and $2.7 million for the three and six months ended June 30,2009.

 

Thefollowing is an overview of key factors affecting our June 30, 2010results from continuing operations:

 

·                  Net interest income from continuingoperations decreased $743 thousand to $8.8 million for the three-month periodended June 30, 2010, and decreased $1.4 million to $17.0 million for thesix month period ended June 30, 2010 as compared to the same period in2009.

 

·                  Professional fees increased $1.9 million and$3.1 million to $2.7 million and $4.5 million for the three and six monthsending June 30, 2010, respectively.

 

·                  Salaries and employee benefits decreased $1.4million and $3.0 million to $3.5 million and $7.1 million for the three and sixmonths ending June 30, 2010, respectively.

 

·                  The provision for loan and lease lossesdecreased $5.0 million and $6.1 million to $132 thousand and $398 thousand forthe three and six months ended June 30, 2010, respectively.

 

·                  During the first quarter ended March 31,2010, the Corporation recorded a write-down on OREO of $1.3 million.  There were no such write-downs during the sixmonths ended June 30, 2009.

 

During first quarter 2010, we announced thepotential sale of the AHB mortgage banking segment. Accordingly, assets relatedto mortgage banking operations have been reclassified to discontinued assetsheld for sale and the mortgage banking operations related to this segment havebeen reclassified, and are now reflected as discontinued operations. Refer toNote 6 of the accompanying consolidated financial statements for informationrelated to discontinued operations.

 

**CRITICAL ACCOUNTING POLICIES,JUDGMENTS AND ESTIMATES**

 

Our accounting and reporting policies conform withGAAP and the general practices within the financial services industry. Thepreparation of financial statements in conformity with GAAP requires Managementto make estimates and assumptions that affect the amounts reported in thefinancial statements and the accompanying notes. Actual results could differfrom those estimates.

 

Critical accounting estimates are necessary in theapplication of certain accounting policies and procedures, and are particularlysusceptible to significant change. Critical accounting policies are defined asthose that are reflective of significant judgments and uncertainties, and couldpotentially result in materially different results under different assumptionsand conditions. In addition to the information contained in Note 4 of theaccompanying consolidated financial statements and Note C of the consolidatedfinancial statements included in our 2009 Annual Report, management believesthat the most critical accounting policies, which involve the most complex orsubjective decisions or assessments, are as follows:

 

**Discontinued Operations**

 

In accordance with ASC 360-10-45, “Property, Plantand Equipment — Overall — Other Presentation Matters,” we classify the assetsand liabilities of a business as held-for-sale when management approves andcommits to a formal plan of sale and it is probable that the sale will becompleted. The carrying value of the net assets of the business held-for-saleare then recorded at the lower of their carrying value or fair market value,less costs to sell, and we cease to record depreciation and amortizationexpense associated with assets held-for-sale.

 

28

----

Tableof Contents

 

In accordance with ASC 205-20-45, “Presentation ofFinancial Statements — Discontinued Operations — Other Presentation Matters,”the results of operations of a component of an entity that has either beendisposed of, or is classified as held for sale, shall be reported indiscontinued operations if both the operations and cash flows of the componenthave been, or will be, eliminated from ongoing operations of the entity as aresult of the disposal transaction and the entity will not have any significantcontinuing involvement in the operations of the component after the disposaltransaction.

 

**OTHER ASSETS**

 

Other assetsdecreased $12.6 million during the first half of 2010 to $19.9 million at June 30,2010.  In 2010, the Corporation receivedcash proceeds in full payment an $8.7 million receivable recorded in otherassets during the year ended December 31, 2009, which related to a formerBOLI policy which the Bank had surrendered in 2008.  The Corporation also received an income taxrefund of $3.1 million during the second quarter 2010 which was recorded as areceivable in other assets at December 31, 2009.

 

**NET INTEREST INCOME**

 

Net interest incomeis the difference between interest income earned on interest-earning assets andinterest expense paid on interest bearing liabilities. The followingtables provides detail regarding the Corporation’s average balances withcorresponding interest income (on a tax-equivalent basis) and interest expenseas well as yield and cost information for the periods presented. Management’s discussion and analysis of netinterest income, interest income, and interest expense is based on aggregatedamounts of continuing and discontinued operations.

 
| ** **                                                                              | ** ** | **Three Months ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                              | ** ** | **2010**                             | ** ** | **2009** | ** ** |
| ** **                                                                              | ** ** | **Average**                          | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(Dollars  in thousands)**                                                             | ** ** | **Balance**                          | ** ** | **Interest** | ** ** | **Rate%** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate%** | ** ** |
| ASSETS                                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold, interest-bearing deposits in  banks and other overnight investments |       | $                                    | 112,988    |   | $ | 71 |   | 0.25 | % | $ | 16,019 |   | 17 |   | 0.41 | % |
| Investment securities:                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                 |       | 60,760                               |       | 433 |   | 2.86 | % | 87,642 |   | 934 |   | 4.28 | % |
| Tax-exempt (1)                                                                          |       | 3,338                                |       | 44 |   | 5.32 | % | 7,544 |   | 91 |   | 4.82 | % |
| Total investment securities                                                             |       | 64,098                               |       | 477 |   | 2.99 | % | 95,186 |   | 1,025 |   | 4.32 | % |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                                                     |       | 136,924                              |       | 1,491 |   | 4.37 | % | 267,299 |   | 3,095 |   | 4.64 | % |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases: (2)                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                 |       | 861,085                              |       | 11,932 |   | 5.56 | % | 924,294 |   | 13,112 |   | 5.69 | % |
| Tax-exempt (1)                                                                          |       | 14,602                               |       | 207 |   | 5.68 | % | 20,532 |   | 377 |   | 7.36 | % |
| Total loans and leases                                                                  |       | 875,687                              |       | 12,139 |   | 5.56 | % | 944,826 |   | 13,489 |   | 5.73 | % |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                                           |       | 1,189,697                            |       | 14,178 |   | 4.78 | % | 1,323,330 |   | 17,626 |   | 5.34 | % |
| Non-interest-earning assets                                                             |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses                                                     |       | (23,113                              | )          |   |   |   |   | (11,236 | ) |   |   |   |   |
| Cash and due from banks                                                                 |       | 17,437                               |       |   |   |   |   | 10,848 |   |   |   |   |   |
| Other assets                                                                            |       | 38,893                               |       |   |   |   |   | 47,004 |   |   |   |   |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                                            |       | $                                    | 1,222,914  |   |   |   |   |   | $ | 1,369,946 |   |   |   |   |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND EQUITY                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW, and money market Deposits                                                 |       | $                                    | 423,179    |   | $ | 648 |   | 0.61 | % | $ | 437,316 |   | 1,040 |   | 0.95 | % |
| Certificates of deposit and other time                                                  |       | 472,790                              |       | 2,275 |   | 1.93 | % | 429,948 |   | 2,843 |   | 2.65 | % |
| Total interest-bearing deposits                                                         |       | 895,969                              |       | 2,923 |   | 1.31 | % | 867,264 |   | 3,883 |   | 1.80 | % |
| Subordinated debt                                                                       |       | 20,795                               |       | 276 |   | 5.32 | % | 19,436 |   | 252 |   | 5.20 | % |
| Federal Home Loan Bank advances and other borrowings                                    |       | 86,899                               |       | 1,025 |   | 4.73 | % | 228,188 |   | 1,617 |   | 2.84 | % |
| Total interest-bearing liabilities                                                      |       | 1,003,663                            |       | 4,224 |   | 1.69 | % | 1,114,888 |   | 5,752 |   | 2.07 | % |
| Non-interest-bearing liabilities:                                                       |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing demand deposits                                                    |       | 149,987                              |       |   |   |   |   | 149,078 |   |   |   |   |   |
| Other liabilities                                                                       |       | 14,271                               |       |   |   |   |   | 16,925 |   |   |   |   |   |
| Total liabilities                                                                       |       | 1,167,921                            |       |   |   |   |   | 1,280,891 |   |   |   |   |   |
| Equity                                                                                  |       | 54,993                               |       |   |   |   |   | 89,055 |   |   |   |   |   |
| Total liabilities and equity                                                            |       | $                                    | 1,222,914  |   |   |   |   |   | $ | 1,369,946 |   |   |   |   |   |
|                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income (tax equivalent) / margin on earning  assets                        |       |                                 |       | $ | 9,954 |   | 3.36 | % |   |   | 11,874 |   | 3.60 | % |
| Less net interest income from discontinued  operations (3)                              |       |                                 |       | 1,111 |   |   |   |   |   | 2,218 |   |   |   |
| Less tax equivalent adjustment                                                          |       |                                 |       | 81 |   |   |   |   |   | 151 |   |   |   |
| Net interest income from continuing operations                                          |       |                                 |       | 8,762 |   |   |   |   |   | 9,505 |   |   |   |

 

29

----

Tableof Contents

 
| ** **                                                                              | ** ** | **Six Months ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                              | ** ** | **June 30,**    | ** ** |
| ** **                                                                              | ** ** | **2010**             | ** ** | **2009** | ** ** |
| ** **                                                                              | ** ** | **Average**          | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(Dollars  in thousands)**                                                             | ** ** | **Balance**          | ** ** | **Interest** | ** ** | **Rate%** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate%** | ** ** |
| ASSETS                                                                                  |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold, interest-bearing deposits in  banks and other overnight investments |       | $                    | 147,619    |   | 192 |   | 0.26 | % | $ | 21,238 |   | 44 |   | 0.42 | % |
| Investment securities:                                                                  |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                 |       | 62,509               |       | 828 |   | 2.67 | % | 94,732 |   | 2,087 |   | 4.44 | % |
| Tax-exempt (1)                                                                          |       | 3,705                |       | 96 |   | 5.21 | % | 8,569 |   | 204 |   | 4.81 | % |
| Total investment securities                                                             |       | 66,214               |       | 924 |   | 2.81 | % | 103,301 |   | 2,291 |   | 4.47 | % |
|                                                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans held for sale                                                                     |       | 126,499              |       | 2,685 |   | 4.28 | % | 209,291 |   | 4,939 |   | 4.76 | % |
|                                                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases: (2)                                                                   |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                                                                                 |       | 867,319              |       | 24,152 |   | 5.62 | % | 921,975 |   | 26,062 |   | 5.70 | % |
| Tax-exempt (1)                                                                          |       | 14,714               |       | 429 |   | 5.89 | % | 20,633 |   | 754 |   | 7.36 | % |
| Total loans and leases                                                                  |       | 882,033              |       | 24,581 |   | 5.62 | % | 942,608 |   | 26,816 |   | 5.74 | % |
|                                                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                                                           |       | 1,222,365            |       | 28,382 |   | 4.68 | % | 1,276,438 |   | 34,090 |   | 5.39 | % |
| Non-interest-earning assets                                                             |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan and lease losses                                                     |       | (23,560              | )          |   |   |   |   | (10,904 | ) |   |   |   |   |
| Cash and due from banks                                                                 |       | 18,906               |       |   |   |   |   | 19,353 |   |   |   |   |   |
| Other assets                                                                            |       | 48,629               |       |   |   |   |   | 54,057 |   |   |   |   |   |
|                                                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                                                            |       | $                    | 1,266,340  |   |   |   |   |   | $ | 1,338,944 |   |   |   |   |   |
|                                                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND EQUITY                                                                  |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW, and money market Deposits                                                 |       | $                    | 426,905    |   | 1,372 |   | 0.65 | % | $ | 431,189 |   | 2,246 |   | 1.05 | % |
| Certificates of deposit and other time                                                  |       | 482,165              |       | 4,812 |   | 2.01 | % | 438,686 |   | 6,108 |   | 2.81 | % |
| Total interest-bearing deposits                                                         |       | 909,070              |       | 6,184 |   | 1.37 | % | 869,875 |   | 8,354 |   | 1.94 | % |
| Subordinated debt                                                                       |       | 20,795               |       | 547 |   | 5.30 | % | 17,461 |   | 426 |   | 4.92 | % |
| Federal Home Loan Bank advances and other  borrowings                                   |       | 115,876              |       | 2,488 |   | 4.33 | % | 201,343 |   | 3,153 |   | 3.16 | % |
| Total interest-bearing liabilities                                                      |       | 1,045,741            |       | 9,219 |   | 1.78 | % | 1,088,679 |   | 11,933 |   | 2.21 | % |
| Non-interest-bearing liabilities:                                                       |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing demand deposits                                                    |       | 150,356              |       |   |   |   |   | 146,583 |   |   |   |   |   |
| Other liabilities                                                                       |       | 14,637               |       |   |   |   |   | 15,667 |   |   |   |   |   |
| Total liabilities                                                                       |       | 1,210,734            |       |   |   |   |   | 1,250,929 |   |   |   |   |   |
| Equity                                                                                  |       | 55,606               |       |   |   |   |   | 88,015 |   |   |   |   |   |
| Total liabilities and equity                                                            |       | $                    | 1,266,340  |   |   |   |   |   | $ | 1,338,944 |   |   |   |   |   |
|                                                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Net interest income (tax equivalent) / margin on  earning assets                        |       |                 |       | $ | 19,163 |   | 3.16 | % |   |   | $ | 22,157 |   | 3.50 | % |
| Net yield on interest-earning assets                                                    |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Less net interest income from discontinued  operations (3)                              |       |                 |       | 1,958 |   |   |   |   |   | 3,383 |   |   |   |
| Less tax equivalent adjustment                                                          |       |                 |       | 169 |   |   |   |   |   | 308 |   |   |   |
| Net interest income from continuing operations                                          |       |                 |       | 17,036 |   |   |   |   |   | 18,466 |   |   |   |
|                                                                                         |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

30

----

Table ofContents

 

----

(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 all periods presented.

 

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

 

(3)           Net interest income of the mortgage banking segmentincludes income from loans held for sale and imputed interest expensecalculated using the Corporation’s internal matched funds transfer pricingmethodology. 

 

Net interest income on a tax equivalent basis for the three monthperiod ended June 30, 2010 was $10.0 million, a decrease of 16.2% from$11.9 million for the same period in 2009. Net interest income on a tax equivalent basis for the six month periodended June 30, 2010 was $19.2 million, a decrease of 13.5% from $22.2million for the same period in 2009.  Thenet yield on interest-earning assets, on a tax-equivalent basis, was 3.36% forthe three month period ended June 30, 2010, compared to 3.60% for the sameperiod in 2009, an decrease of 24 basis points (one basis point is equal to1/100 of a percent).  For the six monthperiod ended June 30, 2010, the net yield on interest earning assetsdecreased 34 basis points to 3.16% from 3.50% during the same period in 2009.

 

The yield earned on average interest-earning assets was 4.78% for thethree month period ended June 30, 2010, compared to 5.34% for the sameperiod in 2009, a decrease of 56 basis points. For the six month period endedJune 30, 2010, the yield earned on interest earning assets decreased 71basis points to 4.68% from 5.39% during the same period in 2009.

 

Average interest-earning assets decreased approximately $133.6 millionor 10.1% to $1.190 billion for the three months ended June 30, 2010 from$1.323 billion in the same period last year. The decrease in average interest-earning assets for the three monthperiod ended June 30, 2010 was the result of a $130.4 million decrease inloans held for sale, a $69.1 million decrease in average total loans andleases, and a decrease of $31.1 million in investments securities available forsale. These decreases were partially offset by a $97.0 million increase inaverage Federal funds sold and interest bearing deposits in banks balance.

 

Average interest-earning assets decreased approximately $54.1 millionor 4.2% to $1.222 billion for the six months ended June 30, 2010 from$1.276 billion in the same period last year. The decrease in average interest-earning assets for the six month periodended June 30, 2010 was the result of a $82.8 million decrease in loansheld for sale, a $60.6 million decrease in average total loans and leases, anda decrease of $37.1 million in investments securities available for sale. Thesedecreases were partially offset by a $126.4 million increase in average Federalfunds sold and interest bearing deposits in banks balance.

 

Averageinterest-bearing liabilities decreased approximately $111.2 million or 10.0% to$1.004 billion for the three months ended June 30, 2010, from $1.115billion in the same period in 2009.  Thedecrease in average interest-bearing liabilities for the three month period wasthe result of a $141.3 million decrease FHLB advances and other borrowings,offset by an increase of $28.7 million in interest bearing deposits.

 

Averageinterest-bearing liabilities decreased approximately $42.9 million or 3.9% to$1.046 billion for the six months ended June 30, 2010, from $1.089 billionin the same period in 2009.  The decreasein average interest-

 

31

----

Table ofContents

 

bearingliabilities for the six month period was the result of an $85.5 milliondecrease FHLB advances and other borrowings, offset by an increase of $39.2million in interest bearing deposits.

 

**INTERESTINCOME**

 

Interestincome on a tax-equivalent basis decreased $3.4 million to $14.2 million forthe three months ended June 30, 2010 from the same period in 2009.  For the six month period ended June 30,2010, interest income on a tax-equivalent basis decreased $5.7 million to $28.4million.

 

Ona tax equivalent basis, interest income on investment securities decreased by53.5% or $548 thousand to $477 thousand for the three month period endedJune 30, 2010 compared to the same period in 2009.  For the six month period ended June 30, 2010,interest income on investment securities decreased 59.7% or approximately $1.4million to $924 thousand when compared to the same period in 2009.  The decrease reflects sales, amortizations,maturities, and called securities net of purchases over the yearended 2009 and the first half of 2010.  Except for the required purchaseof $0.7 million of Federal Reserve Bank stock in the first quarter of 2010, noinvestment securities have been purchased or sold during the firstsix months of 2010.  During the fourthquarter 2009, $52.8 million of securities were sold and $41.2 million ofsecurities were purchased.  These actions were taken primarily to reducethe level risk weighted assets to assist the Bank in satisfying the IMCRs andshorten the duration of the investment portfolio to help mitigate the risk ofrising interest rates.  Matured and called securities as well as principalpayments on mortgage-backed securities totaled $21.5 million during the firstsix months of 2010.

 

Interestincome on loans held for sale decreased $1.6 million to $1.5 million during thethree month period ended June 30, 2010. For the six month period ended June 30, 2010, interest income onloans held for sale decreased $2.3 million to $2.7 million.  These decreases were due to a significantdecrease in the average loans held for sale balance.  Average loans held for sale for the three andsix months periods ended June 30, 2010 were $136.9 million and $126.5million as compared to approximately $267.3 million and $209.3 million for thesame periods in 2009.

 

Interestincome on loans, on a tax equivalent basis, generated by the Corporation’s loanportfolio decreased 10.0% or $1.4 million to $12.1 million for the three monthperiod ended June 30, 2010 compared to $13.5 million for the three monthsended June 30, 2009.  For the sixmonth period ended June 30, 2010, interest income on loans, on a taxequivalent basis decreased 8.3% or $2.2 million when compared to the sameperiod in 2009.  These decreases ininterest income for the three and six month periods ended June 30, 2010were primarily due to a $69.1 million or 7.3% decrease in average loansoutstanding for the three month period and a $60.6 million or 6.4% decrease inaverage loans outstanding for the six month period as compared to the sameperiods in 2009. These decreases in average loan balances were primarily due a$52.5 million loan sale to Tower in the fourth quarter 2009, lack of organicloan growth as well as significant fourth quarter 2009 charge-offs. In additionto the impact from the decrease in average loan balances, there was also adecrease in the tax equivalent yield earned on average loans outstanding, whichdecreased by 17 and 12 basis points to 5.56% and 5.62% for the three and sixmonth periods ended June 30, 2010 from 5.73% and 5.74% for the sameperiods in 2009.

 

**INTERESTEXPENSE**

 

Interestexpense on deposit accounts decreased by approximately $960 thousand or 24.7%to $2.9 million for the three month period ended June 30, 2010 from $3.9million for the same period in 2009. Interest expense on deposit accounts decreased approximately $2.2million or 26.0% to $6.2 million for the six months ended June 30, 2010compared to the same period in 2009.  Thedecreases for the three and six month periods were primarily due to a decreasein the average interest rates paid on interest-bearing deposits. The averagerate paid for the three month period in 2010 was 1.31%, a 49 basis pointdecrease from 1.80% in 2009. The average rate paid for the six month period in2010 was 1.37%, a 57 basis point decrease from 1.94% in 2009. The impact fromrate decreases was partially offset by increases in average interest-bearingdeposit balances. These balances increased $28.7 million for the three monthperiod to $896.0 million in 2010 from $867.3 million in 2009. These balancesincreased $39.2 million for the six month period to $909.1 million in 2010 from$869.9 million in 2009.  The increase inaverage interest bearing deposit balances was primarily due to a fourth quarter2009 CD promotion which was undertaken to increase liquidity andlengthen the maturities of liabilities supporting earning assets tohelp mitigate the risk of rising interest rates.

 

Interestexpense on FHLB and other borrowings decreased $592 thousand or 36.6% to $1.0million for the three month period ended June 30, 2010 from the sameperiod in 2009. Interest expense on FHLB and other borrowings for the sixmonths ended June 30, 2010 decreased approximately $665 thousand or 21.1%to $2.5million from $3.2 million in 2009. These decreases in interest expensewere primarily due to decreases in the average balances of these fundingsources in 2010 as compared to 2009. The average balance of FHLB and otherborrowings for the three 

 

32

----

Table ofContents

 

monthsended June 30, 2010 decreased by 61.9% or $141.3 million between the twoperiods. Average balances of these funding sources for the six month perioddecreased 42.4% or $85.5 million between the two periods.  During the first six months of2009 other borrowings were increased to fund the growth of themortgages held for sale portfolio as mortgage refinancing demand washigh.  The mortgages held for sale portfolio declined through thesecond half of 2009 and the other borrowingbalances were reduced.  With the increase in time depositsin the fourth quarter 2009, due to promotional efforts, and the furtherreduction in the mortgages held for sale portfolio in 2010, $42.5 millionin FHLB advances that matured during the first quarter of 2010 werenot replaced.  Further, in the second quarter of 2010, $56.7 million ofFHLB advances were prepaid to reduce the size of the balancesheet and help improve the Bank’s Tier 1 Leverage capitalratio.  Partly offsetting these decreases was a $26.0 million loan fromTower Bancorp in the fourth quarter 2009.

 

**ASSETQUALITY AND ALLOWANCE FOR LOAN AND LEASE LOSSES**

 

*Allowanceand provision for loan and lease losses*

 

Managementbelieves that the allowance for loan and lease losses is adequate.  The determination for this allowance requiressignificant judgment, and estimates of probable losses in the loan and leaseportfolio can vary significantly from the amounts actuallyobserved.  While management uses available information to recognizeprobable losses, future additions to the allowance may be necessary based onchanges in the credits comprising the portfolio and changes in the financialcondition of borrowers. In addition, regulatory agencies, as an integral partof their examination process, and independent consultants engaged by theCorporation, periodically review the loan and lease portfolio and theallowance.  Such reviews may result in adjustments to the provisionbased upon their analysis of the information available at the time of eachexamination. During 2010, there were no major changes in estimation methodsthat affected the allowance methodology from the prior year.

 

TheCorporation makes provisions for loan and lease losses in amounts necessary tomaintain the allowance at an appropriate level, as established by use of theallowance methodology and by management review and judgment. The allowancefor loans and lease losses decreased $1.7 million to $21.5 million at June 30,2010, as compared to December 31, 2009. The allowance for loan and lease losses as a percentage ofnon-performing loans decreased to 38.71%, as compared to 55.07% at December 31,2009 as total non-performing loans increased $13.5 million during the firsthalf of 2010.  During the three and sixmonth periods ended June 30, 2010, we recorded a $132 thousand and $398thousand provision for loan and lease losses as compared to $5.1 million and$6.5 million for the same periods in 2009.

 

Thedecrease in the June 30, 2010 required allowance for loan losses, ascompared to December 31, 2009, can be attributed to the following factors:

 

·      The Corporation’s total loan and leasebalances decreased $34.4 million at June 30, 2010 as compared to December 31,2009.  The decrease in loan balance isprimarily due to $2.3 million in net charge-offs and loans which have paid offduring the six months ended June 30, 2010. This decrease had a direct effect in reducing the amount of requiredallowance for loan and lease as of June 30, 2010. However, several othervariables also contribute to the amount of required reserves as describedbelow.

 

·      When loan losses are confirmed, theCorporation reduces the allowance for loan and lease losses through the recordingof a charge-off.  For the six monthsended June 30, 2010, the Corporation recorded $2.5 million in grosscharge-offs.  Several of thesecharge-offs were related to loans that were impaired at December 31,2009.  These loans had approximately $1.8million of allocated specific reserves at December 31, 2009.  These specific reserves were created throughcharges to the provision for loan and lease losses during 2009. These chargeoffs increased the reserve factors within the allowance calculation however, theseincreases were more than offset by the reduction in specific reserves.

 

·      In July 2010, a $2.3 million impairedcommercial real estate loan paid off in full. This loan had an allocated specific reserve of approximately $1.0million at December 31, 2009. Because the borrower had a contract for re-financing with another lender,management determined that this specific reserve was no longer needed in thecalculation of the June 30, 2010 required allowance for loan and leaselosses, however the $2.3 million loan balance continued to be classified as animpaired loan until payment was received in July 2010.

 

·      Several commercial real estate loansmigrated from the Corporation’s internal substandard pool classification to animpaired loan classification during the first six months of 2010.  The required reserve for substandard loans isevaluated based on the historical loss experience, adjusted for currentconditions, for similar pools of loans. If an individually analyzed loan isdetermined to be impaired, reserves are specifically allocated in accordancewith applicable accounting guidance, and not as part of a pool.  In some cases, management’s review of theseloans resulted in a nominal specific reserve based on supporting evidence thatthere was sufficient collateral to support the loan balance.  For several of these newly impaired loans atJune 30, 2010 specific reserves were often less than the December 31,2009 reserves calculated based on the substandard pool classification.

 

*Netcharge-offs*

 

Netcharge-offs for the three and six month periods ended June 30, 2010 were$1.2 million and $2.3 million, respectively, compared to $820 thousand and $1.1million of net charge-offs during the same periods in 2009. The increasein charge-offs reflects the deterioration of economic conditions and resultingfailure of businesses, devaluation of collateral values and negative impact onconsumers’ ability to service debt.  A significant portion of loanscharged-off in the three and six months ended June 30, 2010 related toloans that had been evaluated and deemed impaired at December 31,2009.  Specific reserves allocated toloans charged-off during the six months ended June 30, 2010 wereapproximately $1.8 million at December 31, 2009.

 

33

----

Tableof Contents

 

Thefollowing chart presents an analysis of the Allowance for Loan and LeaseLosses:

 
| ** **                                                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **Dollars  in thousands**                                                            | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                                           | ** ** | ** **                            | ** ** | ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of period                                                       |       | $                                     | 22,464     |                                | $          | 11,263 |   | $ | 23,217 |   | $ | 10,335 |   |
|                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Provision charged to operating expense                                               |       | 132                                   |       | 5,084                               |       | 398 |   | 6,471 |   |
|                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Recoveries of loans previously charged-off                                           |       | 141                                   |       | 104                                 |       | 278 |   | 249 |   |
| Loans charged-off                                                                    |       | (1,303                                | )          | (924                                | )          | (2,529 | ) | (1,366 | ) |
| Net loan charge-offs                                                                 |       | (1,162                                | )          | (820                                | )          | (2,251 | ) | (1,117 | ) |
|                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Allowance other adjustment (1)                                                       |       | 100                                   |       | 1                                   |       | 170 |   | (161 | ) |
|                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Balance at end of period                                                             |       | $                                     | 21,534     |                                | $          | 15,528 |   | $ | 21,534 |   | $ | 15,528 |   |
|                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Period-end loans outstanding                                                         |       | $                                     | 867,478    |                                | $          | 947,914 |   | $ | 867,478 |   | $ | 947,914 |   |
| Average loans outstanding                                                            |       | $                                     | 875,687    |                                | $          | 944,826 |   | $ | 882,033 |   | $ | 942,608 |   |
|                                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Allowance for loan and lease losses as a  percentage of period-end loans outstanding |       | 2.48                                  | %          | 1.64                                | %          | 2.48 | % | 1.64 | % |
| Net charge-offs to average loans outstanding                                         |       | 0.13                                  | %          | 0.09                                | %          | 0.26 | % | 0.12 | % |

----

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

 

*Non-performing assets*

 

Non-performingassets include those loans on non-accrual status, loans past due 90 days ormore and still accruing, troubled debt restructurings and other loans deemedimpaired and other real estate owned.  Non-performing loans are generallycollateralized and are in the process of collection.  The percentage ofnon-performing loans to gross loans was 6.41% at June 30, 2010, comparedto 4.67% at December 31, 2009.  Thenon-accrual loan and lease balance at June 30, 2010 was $37.0 million,compared to $27.6 million at December 31, 2009.

 

*Non-accrualloan and leases*

 

Loans are generally placedon non-accrual when the loan becomes 90 days delinquent at which time allaccrued but unpaid interest is reversed. Interest income is no longer accrued on such assets and any futurepayments are applied as a reduction in the principal balance of the loan. Allnon-accrual loans are considered impaired assets and are evaluated individuallyfor required specific reserves.  Theapproximate gross interest income that would have been recorded for the threeand six months ending June 30, 2010 if the $37.0 million in non-accrualloans had been current in accordance with their original terms wasapproximately $533 thousand and $859 thousand, respectively. The actual amountof interest income included in net income for the three and six months ending June 30,2010 on these loans was $2 thousand and $35 thousand, respectively relating tointerest received prior to loans being placed on non accrual status.

 

*Restructuredand other impaired loans*

 

Through negotiations with aborrower, we may restructure a loan prior to the completion of its contractualterm. Modification of a loan’s terms constitutes a troubled debt restructuring(“TDR”) if we for economic or legal reasons related to the borrower’s financialdifficulties grant a concession that we would not otherwise consider. Not allmodifications of loan terms automatically result in a TDR. At June 30,2010, we had $18.6 million in restructured and other impaired loans of which$6.7 million are considered by management to be TDRs. At June 30, 2010,these TDRs continue to perform under their re-negotiated terms and remain onaccrual status. At June 30, 2010, $5.5 million in TDRs were attributableto various loans to one commercial real estate borrower.

 

The remaining $11.9 millionis comprised of loans which Management has reviewed individually and believesthe borrower’s financial performance and/or a shortfall in the value ofcollateral securing the loan provide enough evidence to deem the loan impaired.These other impaired loans were performing under their original contractualterms as of June 30, 2010.

 

*PotentialProblem Loans*

 

As a recurring part of itsportfolio management program, we identified approximately $42.2 million inpotential problem loans at June 30, 2010, compared to $54.1 million atDecember 31, 2009. Potential problem loans are loans that are currentlyperforming, but where the borrower’s operating performance or other relevantfactors could result in potential credit problems, and are typically classifiedby our loan rating system as “substandard.” At June 30, 2010, potential problemloans primarily consisted of commercial loans and commercial real estate. Therecan be no assurance that additional loans will not become nonperforming,require restructuring, or require increased provision for loan losses.

 

34

----

Table of Contents

 

*Otherreal estate owned*

 

OREOrepresents property owned by us following default by the borrowers. OREOproperty acquired through foreclosure is initially transferred at fair valuebased on an appraised value less estimated cost to dispose. Adjustments aresubsequently made to mark the property below this amount if circumstanceswarrant.  Losses arising from foreclosure transactions are charged againstthe allowance for loan losses. Costs to maintain real estate owned and anysubsequent gains or losses are included in our consolidated statements of operations. Thetotal OREO balance at June 30, 2010 was $1.4 million, as compared to $3.7million at December 31, 2009, and was comprised primarily of 1-4 familyresidential properties.  In June 2010,the Corporation sold eight other real estate owned properties to onebuyer.  A charge of $1.3 million wasrecorded during the first quarter 2010 to reduce the carrying amount of theseassets to an amount that reflects the realizable value of these propertiesbased on the actual sales price.

 

Thefollowing chart presents detailed information regarding non-performing loansand leases and OREO:

 
| ** **                                                                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                                                         | ** ** | **2010**          | ** ** | **2009**              | ** ** | **2009** | ** ** |
| ** **                                                                                   | ** ** | ** **        | ** ** | ** **            | ** ** | ** ** | ** ** |
| Past due over 90 days and  still accruing                                                    |       | $                 | —     |                  | $          | 686 |   | $ | 530 |   |
| Non-accrual loans and  leases (1)                                                            |       | 36,985            |       | 19,111                |       | 27,581 |   |
| Restructured and other  impaired loans                                                       |       | 18,644            |       | 7,015                 |       | 14,046 |   |
| Total non-performing loans  and leases                                                       |       | 55,629            |       | 26,812                |       | 42,157 |   |
|                                                                                         |       |              |       |                  |       |   |   |
| Other real estate owned                                                                      |       | 1,414             |       | 1,592                 |       | 3,692 |   |
| Total non-performing  assets                                                                 |       | $                 | 57,043     |                  | $          | 28,404 |   | $ | 45,849 |   |
|                                                                                         |       |              |       |                  |       |   |   |
| Non-performing loans and  leases as a percentage of total loans and leases                   |       | 6.41              | %          | 2.83                  | %          | 4.67 | % |
|                                                                                         |       |              |       |                  |       |   |   |
| Allowance for loan and  lease losses as a percentage of non-performing loans and leases |       | 38.71             | %          | 57.91                 | %          | 55.07 | % |
|                                                                                         |       |              |       |                  |       |   |   |
| Non-performing assets as a  percentage of total loans and other real estate owned       |       | 6.57              | %          | 2.99                  | %          | 5.06 | % |
|                                                                                         |       |              |       |                  |       |   |   |
| Allowance for loan and  lease losses as a percentage of non-performing assets           |       | 37.75             | %          | 54.67                 | %          | 50.64 | % |

 

----

(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.

 

Weidentify a loan as impaired when it is probable that interest and/or principalwill not be collected according to the contractual terms of the loan agreement.ASC 310-10-35, “Receivables,” requires us to individually examine loans whereit is probable that we will be unable to collect all contractual interest andprincipal payments according to the contractual terms of the loan agreement andassess for impairment. The average recorded investment in the June 30,2010 and December 31, 2009 impaired loans was $56.8 million and $25.2million, respectively.  For the three andsix months ending June 30, 2010, interest income recognized during thetime within the period that the loans were impaired was $240 thousand and $469thousand, respectively.

 

Thefollowing charts present additional information about impaired loans and leasebalances as of June 30, 2010 and December 31, 2009:

 

June 30, 2010

 
| ** **                                  | ** ** | ** **  | ** ** | ** **   | ** ** | ** **    | ** ** | **Specific**    | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|---------------|------------|-----------------|------------|
| ** **                                  | ** ** | ** **  | ** ** | **Impaired** | ** ** | **Number of** | ** ** | **Allowance**   | ** ** |
| ** **                                  | ** ** | **Loan**    | ** ** | **Loan**     | ** ** | **Impaired**  | ** ** | **on Impaired** | ** ** |
| **(Dollars  in thousands)**                 | ** ** | **Balance** | ** ** | **Balance**  | ** ** | **Loans**     | ** ** | **Loans**       | ** ** |
|                                        |       |        |       |         |       |          |       |            |       |
| Commercial loans                            |       | $           | 312,533    |         | $          | 18,215        |       | 54              |       | $ | 2,615 |   |
| Real estate — commercial               |       | 258,350     |       | 19,198       |       | 15            |       | 2,203           |       |
| Real estate — commercial construction  |       | 56,629      |       | 13,242       |       | 12            |       | 286             |       |
| Real estate — residential              |       | 93,715      |       | 2,524        |       | 9             |       | 826             |       |
| Real estate — residential construction |       | 31,695      |       | 844          |       | 2             |       | 348             |       |
| Consumer loans                              |       | 113,531     |       | 1,517        |       | 37            |       | 262             |       |
| Lease financing receivables                 |       | 1,025       |       | 89           |       | 3             |       | 89              |       |
|                                        |       |        |       |         |       |          |       |            |       |
| Totals                                      |       | $           | 867,478    |         | $          | 55,629        |       | 132             |       | $ | 6,629 |   |

 

35

----

Tableof Contents

 

December 31, 2009

 
| ** **                                  | ** ** | ** **  | ** ** | ** **   | ** ** | ** **    | ** ** | **Specific**    | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|---------------|------------|-----------------|------------|
| ** **                                  | ** ** | ** **  | ** ** | **Impaired** | ** ** | **Number of** | ** ** | **Allowance**   | ** ** |
| ** **                                  | ** ** | **Loan**    | ** ** | **Loan**     | ** ** | **Impaired**  | ** ** | **on Impaired** | ** ** |
| **(Dollars  in thousands)**                 | ** ** | **Balance** | ** ** | **Balance**  | ** ** | **Loans**     | ** ** | **Loans**       | ** ** |
|                                        |       |        |       |         |       |          |       |            |       |
| Commercial loans                            |       | $           | 334,286    |         | $          | 13,269        |       | 35              |       | $ | 1,029 |   |
| Real estate — commercial               |       | 261,643     |       | 12,071       |       | 11            |       | 3,637           |       |
| Real estate — commercial construction  |       | 66,204      |       | 8,786        |       | 8             |       | 135             |       |
| Real estate — residential              |       | 88,024      |       | 2,601        |       | 7             |       | 644             |       |
| Real estate — residential construction |       | 29,387      |       | 2,137        |       | 7             |       | 874             |       |
| Consumer loans                              |       | 120,767     |       | 2,596        |       | 42            |       | 1,148           |       |
| Lease financing receivables                 |       | 1,578       |       | 167          |       | 8             |       | 55              |       |
|                                        |       |        |       |         |       |          |       |            |       |
| Totals                                      |       | $           | 901,889    |         | $          | 41,627        |       | 118             |       | $ | 7,522 |   |

 

**NON-INTERESTINCOME**

 

Totalnon-interest income from continuing operations decreased $243 thousand to $2.5million for the three months ended June 30, 2010, compared to $2.7 millionfor the same period in 2009.  Totalnon-interest income from continuing operations decreased $1.7 million to $3.5million for the six months ended June 30, 2010, compared to $5.2 millionfor the same period in 2009.

 

InJune 2010, the Corporation sold eight other real estate owned propertiesto one buyer.  A charge of $1.3 millionwas recorded during the first quarter 2010 to reduce the carrying amount ofthese assets to an amount that reflects the realizable value of theseproperties based on the actual sales price.

 

**NON-INTERESTEXPENSE**

 

Totalnon-interest expense decreased $99 thousand to $10.7 million for thethree-month period ended June 30, 2010, compared to $10.8 million duringthe same period in 2009.  Totalnon-interest expense decreased $295 thousand to $20.4 million for the sixmonths ended June 30, 2010, from $20.7 million during the same period in2009.

 

Salariesand employee benefits decreased $1.4 million to $3.5 million for the threemonth period ended June 30, 2010 compared to the same period in 2009.Salaries and employee benefits decreased $3.0 million to $7.1 million for thesix month period ended June 30, 2010 compared to the same period in 2009.The primary driver of this reduction was the fourth quarter 2009 reduction inforce.

 

FDICinsurance expense decreased $392 thousand to $670 thousand for the three monthperiod ended June 30, 2010 compared to the same period in 2009. FDICinsurance expense decreased $135 thousand to $1.3 million for the six monthperiod ended June 30, 2010 compared to the same period in 2009. Theprimary driver of this reduction was due to the one time special FDIC paymentthat the corporation paid in the second quarter of 2009 of approximately $673thousand.

 

Marketingexpense decreased $295 thousand to $151 thousand for the three month periodended June 30, 2010 compared to the same period in 2009. Marketing expensedecreased $244 thousand to $376 thousand for the six

 

36

----

Table ofContents

 

monthperiod ended June 30, 2010 compared to the same period in 2009. Theprimary driver of this reduction was due to several special deposit campaignsthat the corporation had during 2009.

 

Offsettingthese decreases, professional services expense increased $1.9 million to $2.7million for the three month period ended June 30, 2010 from $832 thousandfor the same period in 2009. Professional services expense increased $3.1 million to $4.5 million forthe six month period ended June 30, 2010 from $1.4 million for the sameperiod in 2009.  The increases wereprimarily due to the increased legal, audit and consulting fees related to themerger with Tower Bank and the restatement of 2009 SEC filings.

 

Othernon-interest expense increased $420 thousand to $1.4 million for the threemonth period ended June 30, 2010 from $1.0 million for the same period in2009.  Other non-interest expenseincreased $387 thousand to $2.3 million for the six month period endedJune 30, 2010 from $1.9 million for the same period in 2009.  The increases were primarily due topre-payment penalties that the corporation paid in conjunction with the earlypayoff of certain Federal Home Loan Bank borrowings in 2009.

 

I**NCOME TAXES**

 

The Corporation has notrecorded an income tax benefit for its net operating loss for the six monthperiod ended June 30, 2010. At June 30, 2010 the valuation allowanceagainst the Corporation’s deferred tax asset increased to $8.4 million from$7.5 million at December 31. 2009. The valuation allowance is recordedagainst a portion of the Corporation’s deferred tax assets after concludingthat it was more likely than not that a portion of the deferred tax asset wouldnot be realized. In evaluating the ability to recover our deferred tax assets,Management considers all available positive and negative evidence regarding theultimate realizability of our deferred tax assets including past operatingresults and our forecast of future taxable income. In addition, generaluncertainty surrounding the future economic and business conditions haveincreased the likelihood of volatility in our future earnings. The Corporationhas concluded and recorded a valuation allowance against its deferred taxasset, except for amounts available for carry back claims.

 

**LIQUIDITYMANAGEMENT AND INTEREST RATE SENSITIVITY**

 

**LiquidityManagement**

 

Theobjective of liquidity management is to ensure the availability of sufficientcash flows to meet all financial commitments. 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 management to monitor changes in liquidity and to react accordingly tofluctuations in market conditions.  Theprimary sources of liquidity for the Corporation are funding available from thegrowth of the existing deposit base, new deposits and cash flow from theinvestment and loan portfolios.  TheCorporation considers funds from such sources to comprise its “core” fundingsources because of the historical stability of such sources of funds.  Additional liquidity comes from theCorporation’s credit facilities.  Otherdeposit sources include a tiered savings product and certificates of deposit inexcess of $100,000. Details of core deposits, non-interest bearing demanddeposit accounts, and other deposit sources are highlighted in the followingtable and include aggregated amounts from both continuing and discontinuedoperations:

 

37

----

Table of Contents

 
| ** **                          | ** ** | **For the Six Months Ended  June 30, 2010** | ** ** | **For the Year Ended  December 31, 2009** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                          | ** ** | **Average**                                      | ** ** | **Effective**                                  | ** ** | **Average** | ** ** | **Effective** | ** ** |
| **(Dollars  in thousands)**         | ** ** | **Balance**                                      | ** ** | **Yield**                                      | ** ** | **Balance** | ** ** | **Yield** | ** ** |
| **DEPOSIT TYPE**                    |       |                                             |       |                                           |       |   |   |   |   |
| NOW Accounts                        |       | $                                                | 224,700    |                                           | 0.42       | % | $ | 193,760 |   | 0.78 | % |
| Money Market                        |       | 112,024                                          |       | 1.07                                           | %          | 158,668 |   | 1.17 | % |
| Statement Savings                   |       | 38,949                                           |       | 0.43                                           | %          | 40,198 |   | 0.55 | % |
| Other Savings                       |       | 2,215                                            |       | 0.88                                           | %          | 1,946 |   | 0.96 | % |
| Tiered Savings                      |       | 49,017                                           |       | 0.89                                           | %          | 46,650 |   | 1.05 | % |
| Total NOW Savings, and Money Market |       | 426,905                                          |       | 0.65                                           | %          | 441,222 |   | 0.93 | % |
|                                |       |                                             |       |                                           |       |   |   |   |   |
| CDs Less than $100,000              |       | 274,743                                          |       | 1.99                                           | %          | 276,274 |   | 2.55 | % |
| CDs Greater than $100,000           |       | 207,422                                          |       | 2.05                                           | %          | 152,891 |   | 2.66 | % |
| Total CDs                           |       | 482,165                                          |       | 2.01                                           | %          | 429,165 |   | 2.59 | % |
|                                |       |                                             |       |                                           |       |   |   |   |   |
| Total Interest Bearing Deposits     |       | 909,070                                          |       | 1.37                                           | %          | 870,387 |   | 1.75 | % |
|                                |       |                                             |       |                                           |       |   |   |   |   |
| Non-Interest Bearing                |       |                                             |       |                                           |       |   |   |   |   |
| Demand Deposits                     |       | 150,356                                          |       | —                                         |       | 149,967 |   | — |   |
|                                |       |                                             |       |                                           |       |   |   |   |   |
| Total Deposits                      |       | $                                                | 1,059,426  |                                           |       |   | $ | 1,020,354 |   |   |   |

 

TheBank maintains several credit facilities with the FHLB as well as the FederalReserve and other banking institutions. During the second quarter of 2010, average FHLB advances were $58.5million and consisted of term advances with a variety of maturities.  The average interest rate on these advanceswas 3.84%.  The bank currently has amaximum borrowing capacity with FHLB of $60.0 million.  FHLB advances are collateralized by a pledgeon the Bank’s portfolio of certain mortgage loans and a lien on the Bank’s FHLBstock.  In addition, the Bank has backupline of credit available from other financial institutions, as well as theFederal Reserve, totaling approximately $186.9 million.  Federal Reserve borrowings are collateralizedby a pledge on certain commercial and commercial real estate loans and a lienon the banks Federal Reserve stock.

 

Aspart of its holding company cash management strategy, the Corporation deferredits regularly scheduled interest payments on its outstanding juniorsubordinated notes relating to its $20.9 million of trust preferred securitiesbeginning with the regularly scheduled quarterly interest payments that wouldotherwise have been made in September 2010.  The terms of the juniorsubordinated notes and the related trust indentures allow the Corporation todefer such payments of interest for up to 20 consecutive quarterly periodswithout default.  During the deferral period, the respective trusts willsuspend the declaration and payment of dividends on the trust preferredsecurities. During the deferral period, the Corporation may not, among otherthings and with limited exceptions, pay cash dividends on or repurchase itscommon stock nor make any payment on outstanding debt obligations that rankequally with or junior to the junior subordinated notes. We expect our deferralof interest on the junior subordinated notes will preserve approximately $270thousand per quarter based upon the interest payments completed during thefirst and second quarters of 2010.

 

**InterestRate Sensitivity**

 

The goal of interest ratesensitivity management is to avoid fluctuating net interest margins, and toenhance consistent growth of net interest income through periods of changinginterest rates.  Such sensitivity ismeasured as the difference in the volume of assets and liabilities in theexisting portfolio that are subject to repricing in a future time period.  The Corporation’s net interest ratesensitivity gap within one year including assets and liabilities ofdiscontinued operations is a negative $175.2 million or 15.0% of total assetsat June 30, 2010.  The Corporation’sgap position is one tool used to evaluate interest rate risk and the stabilityof net interest margins.  Another toolthat management uses to evaluate interest rate risk is a computer simulationmodel that assesses the impact of changes in interest rates on net interestincome 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, resultsare within policy limits and indicate an acceptable level of interest raterisk, except rate simulations quantifying the impact of an interest rate declinesof 100 basis points or more. Given the historically low interest rate levelsthe Bank is currently operating in, Management believes it is unlikely interestrates would decline 100 basis points or more in the future. Management 

 

38

----

Table of Contents

 

monitors interest rate riskas a regular part of corporate operations****with theintention of maintaining a stable net interest margin. The following tablepresents our interest rate sensitivity analysis as of June 30, 2010 andincludes aggregated amounts from both continuing and discontinued operations:

 
| ** **                                                        | ** ** | ** **       | ** ** | **Two**            | ** ** | **Over**      | ** ** | ** **        | ** ** | ** **    | ** ** |
|-------------------------------------------------------------------|------------|------------------|------------|--------------------|------------|---------------|------------|-------------------|------------|---------------|------------|
| ** **                                                        | ** ** | **Within**       | ** ** | **through**        | ** ** | **five**      | ** ** | **Non-rate**      | ** ** | ** **    | ** ** |
| **(Dollars  in thousands)**                                       | ** ** | **one year (1)** | ** ** | **five years (1)** | ** ** | **Years (1)** | ** ** | **Sensitive (1)** | ** ** | **Total (1)** | ** ** |
| ASSETS                                                            |       |             |       |               |       |          |       |              |       |          |       |
| Federal funds sold and overnight investments                      |       | $                | 806        |               | $          | —        |       | $                 | —     |          | $          | — |   | $ | 806 |   |
| Investment securities                                             |       | 28,407           |       | 13,578             |       | 20,816        |       | —            |       | 62,801        |       |
| Interest bearing deposits in banks                                |       | 23,638           |       | —             |       | —        |       | —            |       | 23,638        |       |
| Loans held for sale                                               |       | 166,818          |       | —             |       | —        |       | —            |       | 166,818       |       |
| Net loans and leases                                              |       | 343,115          |       | 359,188            |       | 165,175       |       | (21,534           | )          | 845,944       |       |
| Cash and due from banks                                           |       | —           |       | —             |       | —        |       | 19,306            |       | 19,306        |       |
| Premises and equipment                                            |       | —           |       | —             |       | —        |       | 21,396            |       | 21,396        |       |
| Other assets                                                      |       | —           |       | —             |       | —        |       | 27,161            |       | 27,161        |       |
| Total assets                                                      |       | $                | 562,784    |               | $          | 372,766       |       | $                 | 185,991    |          | $          | 46,329 |   | $ | 1,167,870 |   |
|                                                              |       |             |       |               |       |          |       |              |       |          |       |
| LIABILITIES AND CAPITAL                                           |       |             |       |               |       |          |       |              |       |          |       |
| Non-interest bearing deposits                                     |       | $                | —     |               | $          | —        |       | $                 | —     |          | $          | 161,760 |   | $ | 161,760 |   |
| Interest bearing deposits                                         |       | 661,947          |       | 165,007            |       | 3,253         |       | —            |       | 830,207       |       |
| FHLB advances and other Borrowings                                |       | 60,543           |       | 20,297             |       | 2,462         |       | —            |       | 83,302        |       |
| Subordinated debentures                                           |       | 15,465           |       | —             |       | 5,330         |       | —            |       | 20,795        |       |
| Other liabilities                                                 |       | —           |       | —             |       | —        |       | 16,254            |       | 16,254        |       |
| Capital                                                           |       | —           |       | —             |       | —        |       | 55,552            |       | 55,552        |       |
| Total liabilities & capital                              |       | $                | 737,955    |               | $          | 185,304       |       | $                 | 11,045     |          | $          | 233,566 |   | $ | 1,167,870 |   |
| Net interest rate sensitivity gap                                 |       | $                | (175,171   | )                  | $          | 187,462       |       | $                 | 174,946    |          | $          | (187,237 | ) |   |   |
| Cumulative interest rate sensitivity gap                          |       | $                | (175,171   | )                  | $          | 12,291        |       | $                 | 187,237    |          | $          | — |   |   |   |
| Cumulative interest rate sensitivity gap divided  by total assets |       | (15.0            | )%         | 1.1                | %          | 16.0          | %          |              |       |          |       |

 

----

(1)          Amounts above are shownconsolidated and do not exclude the balances related to the mortgage bankingdivision’s discontinued operations. Presentation with the exclusion of these balance sheet amounts wasdeemed not meaningful by management.

 

The nature of our current operations is such thatwe are not subject to foreign currency exchange or commodity price risk.However, the Bank is subject to interest rate risk with respect to its mortgagebanking division. When the Bank contractually commits with a customer to aninterest rate on a residential mortgage loan that it intends to sell, the Bankmay be at risk that the value of the loan, when ultimately sold, will be lessthan par. To hedge this risk, the Bank enters into a derivative contract,primarily consisting of forward loan sale commitments. Additionally, ourliquidity planning takes into account current risks in our mortgage bankingoperations. We sell residential mortgage loans to various secondary marketinvestors under several agreements. In the event we breach certain requirementswithin these agreements, the investors have the ability to suspend or terminatethe agreements. A suspension or termination could expose us to interest rateand liquidity risk, and also limit our ability to manage our balance sheet sizeand maintain compliance with regulatory capital guidelines. Prior to filingthis report, we were in default under these agreements due to our failure tofile our audited financial statements within the specified timeframe and ourfailure to satisfy the IMCRs.  We willcontinue to be in default under certain agreements due to the inclusion of a “goingconcern” explanatory paragraph in the auditors’ report regarding theconsolidated financial statements. To date, two of the investors under theseagreements have terminated their agreements with us. Additionally, otherinvestors, to whom we sell nearly 88% of our loan production, have verballyindicated that although we are in breach of the above mentioned requirements,they will forebear the defaults for an unspecified period of time.

 

**CAPITAL****ADEQUACY**

 

Weare subject to Risk-Based Capital Guidelines adopted by the Federal Reserve forbank holding companies. The Bank is also subject to similar capitalrequirements adopted by the OCC. Under these requirements, the regulatoryagencies have set minimum capital ratio thresholds. To be considered “wellcapitalized” banks must generally maintain a Tier I leverage ratio of at least5%, a Tier 1 risk-based capital ratio of at least 6% and a total risked-based

 

39

----

Table ofContents

 

capitalratio of at least 10%. During the fourth quarter of 2009, the OCC advisedmanagement that they had established new higher capital ratio requirements onthe Bank (individual minimum capital ratios, or IMCRs) thereby requiring theBank to maintain its Tier 1 leverage ratio at not less than 8%, its Tier 1risk-based capital ratio at not less than 10% and its total risk-based capitalratio at not less than 12%. The Bank was required to achieve these new higherlevels by December 31, 2009.

 

Ourefforts to raise capital before the OCC’s deadline consummated in thedefinitive merger agreement with Tower Bancorp. As part of the mergeragreement, Graystone Tower Bank increased our loan from $4 million, which wasentered into on November 20, 2009, to up to a maximum of $26 million. Weused the increased proceeds to make a capital contribution to the Bank ineffort to satisfy the capital requirements established by the OCC. The loan, asmodified, is a non-revolving one year term loan bearing interest at the rate of6% per annum, and is secured by a pledge of all of the common stock of theBank. Additionally, under the definitive merger agreement, Graystone purchased$52.5 million in first lien residential real estate and commercial loanparticipations at a 1.5% discount in effort to assist the Bank in satisfyingthe IMCRs.

 

Asset forth in the table below, as of June 30, 2010, the Bank met the IMCRthresholds for all capital ratios, but as of December 31, 2009 the Bankwas below the IMCR thresholds for Tier 1 leverage and total risk-based capital.  The Corporation’s and Bank’s risk-basedcapital ratios, shown below, have been computed in accordance with regulatoryaccounting policies.

 
| ** **                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Current Requirements to remain “Well  Capitalized”** | ** ** |
|--------------------------------|------------|-------------------|------------|-----------------------|------------|------------------------------------------------------------------|------------|
| ** **                     | ** ** | **2010**          | ** ** | **2009**              | ** ** | **Requirements (*)**                                             | ** ** |
| Corporation                    |       |              |       |                  |       |                                                             |       |
| Leverage Ratio                 |       | 6.03              | %          | 5.71                  | %          | N/A                                                              |       |
| Tier I Capital Ratio           |       | 8.09              | %          | 7.79                  | %          | N/A                                                              |       |
| Total Risk-Based Capital Ratio |       | 9.61              | %          | 9.16                  | %          | N/A                                                              |       |
| Bank                           |       |              |       |                  |       |                                                             |       |
| Leverage Ratio                 |       | 8.40              | %          | 7.68                  | %          | 8.00                                                             | %          |
| Tier I Capital Ratio           |       | 11.27             | %          | 10.47                 | %          | 10.00                                                            | %          |
| Total Risk-Based Capital Ratio |       | 12.54             | %          | 11.74                 | %          | 12.00                                                            | %          |

 

----

(*)           Ratios imposed by the OCC under the IMCRs.

 

**REGULATORYMATTERS**

 

OnOctober 16, 2009, the Board of Directors of the Bank entered into an MOUwith the OCC.  An MOU with regulatory authorities is an informalaction that is not published or publicly available and that is used whencircumstances warrant a milder form of action than a formal supervisory action,such as a formal written agreement or order. Among other things, under the MOU,the Bank has agreed to address the following matters:

 

·                  Develop a comprehensive three-year capitalplan;

 

·                  Take action to protect criticized assets andadopt and implement a program to eliminate the basis of criticism of suchassets;

 

·                  Establish an effective program that providesfor early problem loan identification and a formal plan to proactively managethose assets;

 

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

 

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

 

TheBoard of Directors and management have already initiated corrective actions tocomply with the provisions of the MOU.

 

40

----

Tableof Contents

 

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

 

Therehave been no material changes in the Corporation’s assessment of itssensitivity to market risk since its presentation in the 2009 Annual Report.Please refer to Item 7A of the Corporation’s 2009 Annual Report for moreinformation.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures**

 

Asof June 30, 2010, 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) and15(d)-5(e) promulgated under the Securities Exchange Act of 1934, as amended(the “Exchange Act”)) was performed under the supervision and with theparticipation of management, including our President and CEO, Chief OperatingOfficer and our Chief Financial Officer. Based on that evaluation and theidentification of the material weakness in our internal control over financialreporting as described below, management has concluded that our disclosurecontrols and procedures were not effective to ensure that information requiredto be disclosed by us in the reports that we file or submit under the ExchangeAct is (i) recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s rules andforms, and (ii) accumulated and communicated to management as appropriateto allow timely decisions regarding required disclosures.

 

**Changesin Internal Control over Financial Reporting**

 

Asreported in our 2009 Annual Report, Management conducted a thorough andmethodical evaluation and testing of our internal controls over financialreporting as of December 31, 2009, which resulted in the identification ofthree material control weaknesses. Management continues their ongoing efforts to correct and revise theexisting processes surrounding these material weaknesses and additional changeswill be implemented as determined necessary.

 

*Allowance for Loan and Lease Losses*

 

Duringthe third quarter of 2009, management identified a material weakness in ourinternal controls related to the design and implementation of policies topromptly identify problem loans and to quantify the elements of risk in problemloans. The Bank’s policies and procedures were not systematically applied,which caused a failure in the identification of problem loans on a timely basisand a failure to accurately estimate the risk in the portfolio; this in turncaused a failure to accurately determine the appropriate allowance for loan andlease losses (“ALLL”). We also discovered a monitoring weakness thatcontributed to the characterization of the status of certain loans to beclassified as fully performing, when in fact these loans were not. Managementconcluded that the ALLL and the provision for loan and lease losses as of andfor the three and six months ended June 30, 2009 should be increased by$3.5 million. As a result of the June 30, 2009 ALLL shortfall of $3.5million, amounts originally recorded as provision for loan and lease losses forthe three months ended September 30, 2009 were restated to the three monthperiod ended June 30, 2009. This restatement created a materialmisstatement in the consolidated statements of operations for the three monthsended September 30, 2009, as well as related footnote disclosures. Duringthe fourth quarter of 2009 and subsequent to year-end, we began taking thesteps described below to remediate the material weakness surrounding the ALLLas disclosed in our Amendment No. 1 to Form 10-Q/A for the periodsended June 30, 2009 and September 30, 2009.

 

*Mark-to-Market Accounting of Mortgage Loans Held for Sale*

 

Subsequent to year-end,management identified a material weakness in internal controls related to ourprocess to review the valuation of mortgage loans held for sale. Mortgage loansheld for sale represent mortgage loans originated by us and held until sold tosecondary market investors. Upon the closing of a residential mortgage loanoriginated by us, the mortgage loan is typically warehoused for a period oftime and then sold into the secondary market. While in this warehouse phase,mortgage loans held for sale are recorded at fair value under the fair valueoption with changes in fair value recognized through earnings. An error wasidentified in our process to properly identify a certain population of loansheld for sale prior to sending the loan details to our third party valuationfirm. As such, we erroneously excluded from the population to be fair valued,loans which were identified for sale but for which we were awaiting theconsideration from the counterparty to complete the sales transaction. Theseparticular loans were correctly classified as loans held for sale on theconsolidated balance sheet; however, the unrealized gain associated with theseloans was not reflected in the consolidated balance sheet and the statement ofoperations. This

 

41

----

Table of Contents

 

error resulted in anunderstatement in the carrying amount of loans held for sale for the quartersended March 31, June 30 and September 30, 2009, as well as anunderstatement of net income for each quarter. As a result of this materialweakness, the Bank increased net gains from mortgage banking by $1.2 million,$14 thousand and $2.7 million for the quarters ended March 31, June 30,and September 30, 2009, respectively. Additionally, in April 2010,management discovered another process error relating to the accounting for themark-to-market of mortgage loans held for sale, which produced an additionalincrease in net gains from mortgage banking of $215 thousand as of December 31,2009, which wascorrectly reflected in our financial statements for the year ended December 31,2009. Accordingly, management concluded that these deficiencies constitute amaterial weakness in internal controls related to our process to review thevaluation of mortgage loans held for sale.

 

*Subsequent Events*

 

In May 2010, managementdiscovered an error related to our process of reviewing, accounting for and thereporting of subsequent events, which resulted in the improper application ofGAAP. Specifically, $6.7 million of the provision for loan and lease losses,which was recorded subsequent to December 31, 2009, should have beenrecorded as of December 31, 2009. This error was correctly reflected in our financialstatements for the year ended December 31, 2009.

 

***Remediation of Material Weaknesses***

 

*Allowance for Loan and Lease Losses*

 

Duringthe fourth quarter 2009 and subsequent to year-end, management began takingsteps to remediate the material weakness surrounding the Allowance for Loan andLease Losses. The following steps have been completed as of the time of thisfiling:

 

·                  hired aseasoned Credit Administration and Credit Policy Officer to oversee, manage andtrain lending personnel

 

·                  engaged anindependent third party to perform the quarterly loan review process, whichincludes 100% coverage of criticized and classified assets;

 

·                  approved andimplemented separation of lending and credit administration functions toincrease internal controls and improve segregation of duties;

 

·                  conducted riskrecognition training to improve criticized asset management and to ensureproper evaluation of ongoing credit ratings;

 

·                  improvedprocesses for identifying impaired loans and the determination of the amount ofimpairment in accordance with OCC guidelines;

 

·                  approved andimplemented change of lending authorities to ensure better oversight of lendersand to increase oversight on criticized assets;

 

·                  approved andimplemented Board of Director approval for all new credit advances forcriticized assets of $1,000,000 or greater;

 

·                  transferredresponsibilities for management and oversight of the Loan Quality Committee,Loan Committee, Delinquency Committee and Classified Asset Committee to aseparate Credit Administration and Credit Policy Officer; and

 

·                  the Loan ReviewCommittee shall continue to review the Loan Quality Status Reports on aquarterly basis.

 

Managementcontinues to review existing policies, procedures and practices for compliancewith risk rating, accountability and timeliness regarding creditadministration, risk recognition, credit management and credit assessment.

 

*Mark-to-Market Accounting of Mortgage Loans Held for Sale*

 

Subsequentto December 31, 2009, and immediately following management’sidentification of the material weakness surrounding the mark-to-marketaccounting of Mortgage Loans Held for Sale, management enhanced an existingprocess that will ensure the portfolio of Mortgage Loans Held for Sale iscomplete prior to delivery to the third party valuation firm. At each month-enda reconciliation is performed to ensure the loans held for sale included

 

42

----

Table of Contents

 

inthe file sent to the third party valuation firm reconciles to our internalsubledger. This internal subledger of loans held for sale is reconciled to ourgeneral ledger. These reconciliations are reviewed by management monthly toensure timely completion and that reconciling items, if any, are appropriatelyaddressed.

 

*Subsequent Events*

 

Managementhas created and implemented procedures to review and evaluate events occurringafter the end of each quarter, but prior to issuing financial statements, todetermine if there is any impact on the quarterly or annual financialstatements. As of the date of this report, management is continuing theirongoing efforts to correct, revise and test the processes surrounding thematerial weaknesses described above. Additional changes will be implemented asdetermined necessary.

 

43

----

Table of Contents

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.  LEGAL PROCEEDINGS.**

 

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.

 

**ITEM 1A.  RISK FACTORS.**

 

Fora summary of risk factors relevant to our operations, see Part 1, Item1A, “Risk Factors” in our 2009 Annual Report. There have been no material changes in the risk factors relevant to ouroperations, except as discussed below:

 

**Compliancewith the recently enacted Dodd-Frank Reform Act may increase our costs ofoperations and adversely impact our earnings.**

 

On July 21,2010, President Obama signed the Dodd-Frank Wall Street Reform and ConsumerProtection Act (the “Dodd-Frank Act”) into law.  The Dodd-Frank Actrepresents a significant overhaul of many aspects of the regulation of thefinancial-services industry.  Among other things, the Dodd-Frank Actcreates a new federal financial consumer protection agency, tightens capitalstandards, imposes clearing and margining requirements on many derivativesactivities, and generally increases oversight and regulation of financialinstitutions and financial activities.  In addition to theself-implementing provisions of the statute, the Dodd-Frank Act calls for manyadministrative rulemakings by various federal agencies to implement variousparts of the legislation.  It isimpossible to predict when any final rules would be issued through anysuch rulemakings, and what the content of such rules will be.  Thefinancial reform legislation and any implementing rules that areultimately issued could have adverse implications on the financial industry,the competitive environment, and our business. We will have to apply resourcesto ensure that we are in compliance with all applicable provisions of theDodd-Frank Act and any implementing rules, which may increase our costs ofoperations and adversely impact our earnings.

 

**ITEM 2.  UNREGISTERED SALES OFEQUITY SECURITIES AND USE OF PROCEEDS.**

 

The following table providesthe total repurchases made by the Company during the three months ended June 30,2010:

 
| **Period**                     | ** ** | **Total  Number of  Shares (or  Units)  Purchased  (a) (1)** | ** ** | **Average  Price Paid  per Share  (or Unit)  (b) (1)** | ** ** | **Total Number of  Shares (or Units)  Purchased as Part  of Publicly Announced  Plans  or Programs  (c)** | ** ** | **Maximum Number (or  Approximate Dollar Value) of  Shares (or Units) that May Yet  Be Purchased Under the Plans  or Programs  (d)** | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1  to April 30 |       | 4,161                                                                       |       | $                                                                          | 9.93       |                                                                                                                                                   | —     |                                                                                                                                                                                                            | —     |   |
| May 1  to May 31     |       | —                                                                      |       | $                                                                          | —     |                                                                                                                                                   | —     |                                                                                                                                                                                                            | —     |   |
| June 1  to June 30   |       | 323                                                                         |       | $                                                                          | 7.65       |                                                                                                                                                   | —     |                                                                                                                                                                                                            | —     |   |
| Total                          |       | 4,484                                                                       |       | $                                                                          | 9.77       |                                                                                                                                                   | —     |                                                                                                                                                                                                            | —     |   |

 

----

(1)             Pursuant to the trust agreement between theCorporation and the trustee, these shares were repurchased from our 401(k) Plan.The purchase price was the average between the bid and the ask on therepurchase date.

 

**ITEM 3.  DEFAULTS UPON SENIORSECURITIES.**

 

None.

 

**ITEM 4.  [REMOVED AND RESERVED.]**

 

**ITEM 5.  OTHER INFORMATION.**

 

None.

 

44

----

Table of Contents

 

**ITEM 6.  EXHIBITS.**

 

Theexhibits required to be filed as part of this Quarterly Report on Form 10-Qare listed in the Exhibit Index attached hereto and are incorporatedherein by reference.

 

45

----

Table of Contents

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized on August 18, 2010.

 

**FIRSTCHESTER COUNTY CORPORATION**

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

 

46

----

Table of Contents

 

**INDEXTO EXHIBITS**

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

 

----

*Filed herewith.

 

47

----