UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________________



|FORM 10-Q__________________
|---------------------------

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



|For the quarterly period ended September 30, 2008Commission file number: 000-52098__________________
|----------------------------------------------------------------------------------------------------

CHINO COMMERCIAL BANCORP

(Exact name of registrant as specified in its charter)

__________________

California
     
     20-4797048State of incorporation
     
     I.R.S. EmployerIdentification Number14345 Pipeline AvenueChino, California
     
     91710Address of Principal Executive Offices
     
     Zip Code




|(909) 393-8880Registrants telephone number, including area code__________________
|----------------------------------------------------------------------------------

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer ̈Smaller Reporting Companyþ

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

On November 7, 2008, there were 699,798 shares of Chino Commercial Bancorp Common Stock outstanding.

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|TABLE OF CONTENTS                                                                         |  |   
|----------------------------------------------------------------------------------------- |  | --
|                                                                                         
|                                                                                         
|Page                                                                                     
|Part I  Financial Information                                                            |  | 3 
|Item 1. Financial Statements                                                              |  | 3 
|Consolidated Balance Sheets                                                               |  | 3 
|Consolidated Statements of Income                                                         |  | 4 
|Consolidated Statements of Cash Flows                                                     |  | 5 
|Notes to the Consolidated Financial Statements                                            |  | 6 
|                                                                                         
|Item 2. Managements Discussion & Analysis of Financial Condition & Results of Operations |  | 10
|Item 3. Qualitative & Quantitative Disclosures about Market Risk                          |  | 28
|Item 4T. Controls and Procedures                                                          |  | 28
|                                                                                         
|Part II  Other Information                                                               |  | 29
|Item 1  Legal Proceedings                                                                |  | 29
|Item 1A.  Risk Factors                                                                   |  | 29
|Item 2  Unregistered Sale of Equity Securities and Use of Proceeds                       |  | 29
|Item 3  Defaults upon Senior Securities                                                  |  | 29
|Item 4  Submission of Matters to Vote of Security Holders                                |  | 29
|Item 5  Other Information                                                                |  | 29
|Item 6  Exhibits                                                                         |  | 29
|                                                                                         
|                                                                                         
|Signatures                                                                                |  | 31

2

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PART 1  FINANCIAL INFORMATIONItem 1CHINO COMMERCIAL BANCORPCONSOLIDATED BALANCE SHEETSSeptember 30, 2008
     
     
     
     December 31, 2007(unaudited)
     
     
     
     (audited)ASSETS:Cash and due from banks
     
     $
     5,010,809
     
     
     $
     3,487,933Federal funds sold
     
     
     10,500,000
     
     
     
     7,440,000Cash and cash equivalents
     
     
     15,510,809
     
     
     
     10,927,933Interest-bearing deposits in other banks
     
     
     99,000
     
     
     
     99,000Investment securities available for sale
     
     
     5,255,055
     
     
     
     7,339,354Investment securities held to maturity (fair value approximates$3,333,000 at September 30, 2008 and $3,880,000 at December 31, 2007)
     
     
     3,323,939
     
     
     
     3,873,251Total investments
     
     
     8,677,994
     
     
     
     11,311,605LoansConstruction
     
     
     605,229
     
     
     
     2,606,750Real estate
     
     
     36,686,193
     
     
     
     39,726,301Commercial
     
     
     10,209,252
     
     
     
     10,062,969Installment
     
     
     575,426
     
     
     
     790,535Gross loans
     
     
     48,076,100
     
     
     
     53,186,555Unearned fees and discounts
     
     
     (67,841
     )
     
     
     (87,389
     )Loans net of unearned fees and discounts
     
     
     48,008,259
     
     
     
     53,099,166Allowance for loan losses
     
     
     (662,142
     )
     
     
     (725,211
     )Net loans
     
     
     47,346,117
     
     
     
     52,373,955Accrued interest receivable
     
     
     245,564
     
     
     
     326,990Restricted stock
     
     
     673,250
     
     
     
     654,250Fixed assets, net
     
     
     1,982,540
     
     
     
     2,085,203Other real estate
     
     
     685,796
     
     
     
     0Prepaid expenses & other assets
     
     
     2,418,519
     
     
     
     2,268,909Total assets
     
     $
     77,540,589
     
     
     $
     79,948,845LIABILITIES:DepositsNon-interest bearing
     
     $
     34,783,525
     
     
     $
     42,270,696Interest BearingNOW and money market
     
     
     24,663,984
     
     
     
     22,711,556Savings
     
     
     1,104,082
     
     
     
     1,202,965Time deposits less than $100,000
     
     
     2,983,045
     
     
     
     2,054,915Time deposits of $100,000 or greater
     
     
     4,223,904
     
     
     
     2,156,778Total deposits
     
     
     67,758,540
     
     
     
     70,396,910Accrued interest payable
     
     
     56,700
     
     
     
     63,962Accrued expenses & other payables
     
     
     630,218
     
     
     
     509,389Subordinated debentures
     
     
     3,093,000
     
     
     
     3,093,000Total liabilities
     
     
     71,538,458
     
     
     
     74,063,261STOCKHOLDERS' EQUITYCommon stock, authorized 10,000,000 shares with no par value, issuedand outstanding 699,798 shares and 704,278 shares at September 30,2008 and December 31, 2007, respectively.
     
     
     2,539,714
     
     
     
     2,639,462Retained earnings
     
     
     3,488,300
     
     
     
     3,249,982Accumulated other comprehensive loss
     
     
     (25,883
     )
     
     
     (3,860
     )Total equity
     
     
     6,002,131
     
     
     
     5,885,584Total liabilities & stockholders' equity
     
     $
     77,540,589
     
     
     $
     79,948,845The accompanying notes are an integral part of these consolidated financial statements


3

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CHINO COMMERCIAL BANCORPCONSOLIDATED STATEMENTS OF INCOME(unaudited)For the three months ended
     
     
     For the nine months endedSeptember 30
     
     
     September 302008
     
     
     2007
     
     
     2008
     
     
     2007Interest incomeInvestment securities and due from banks
     
     $
     102,966
     
     $
     143,782
     
     $
     341,064
     
     $
     496,815Interest on Federal funds sold
     
     
     35,855
     
     
     120,811
     
     
     66,832
     
     
     380,695Interest and fee income on loans
     
     
     935,448
     
     
     1,010,948
     
     
     2,919,813
     
     
     3,013,734Total interest income
     
     
     1,074,269
     
     
     1,275,541
     
     
     3,327,709
     
     
     3,891,244Interest expenseDeposits
     
     
     182,314
     
     
     201,811
     
     
     547,797
     
     
     528,093Interest on Federal funds purchased
     
     
     0
     
     
     0
     
     
     973
     
     
     0Other borrowings
     
     
     50,963
     
     
     51,263
     
     
     152,888
     
     
     153,787Total interest expense
     
     
     233,277
     
     
     253,074
     
     
     701,658
     
     
     681,880Net interest income
     
     
     840,992
     
     
     1,022,467
     
     
     2,626,051
     
     
     3,209,364Provision for loan losses
     
     
     83,136
     
     
     45,559
     
     
     361,540
     
     
     106,203Net interest income afterprovision for loan losses
     
     
     757,856
     
     
     976,908
     
     
     2,264,511
     
     
     3,103,161Non-interest incomeService charges on deposit accounts
     
     
     223,922
     
     
     223,438
     
     
     708,745
     
     
     595,859Other miscellaneous fee income
     
     
     9,411
     
     
     9,607
     
     
     27,131
     
     
     26,410Dividend income from restricted stock
     
     
     9,978
     
     
     7,639
     
     
     36,461
     
     
     28,152Income from bank owned life insurance
     
     
     16,197
     
     
     15,393
     
     
     46,916
     
     
     46,815Total non-interest income
     
     
     259,508
     
     
     256,077
     
     
     819,253
     
     
     697,236General and administrative expensesSalaries and employee benefits
     
     
     467,413
     
     
     461,870
     
     
     1,444,704
     
     
     1,440,026Occupancy and equipment
     
     
     95,552
     
     
     77,122
     
     
     261,912
     
     
     257,445Data and item processing
     
     
     80,659
     
     
     85,827
     
     
     245,726
     
     
     243,934Advertising and marketing
     
     
     19,889
     
     
     37,837
     
     
     60,504
     
     
     113,208Legal and professional fees
     
     
     49,142
     
     
     53,904
     
     
     144,763
     
     
     162,064Regulatory Assessments
     
     
     22,039
     
     
     22,070
     
     
     63,337
     
     
     69,280Insurance
     
     
     7,898
     
     
     8,141
     
     
     23,894
     
     
     22,686Directors' fees and expenses
     
     
     19,417
     
     
     19,382
     
     
     57,718
     
     
     59,633Other expenses
     
     
     146,753
     
     
     129,638
     
     
     391,501
     
     
     448,584Total general & administrative expenses
     
     
     908,762
     
     
     895,791
     
     
     2,694,059
     
     
     2,816,860Income before income tax expense
     
     
     108,602
     
     
     337,194
     
     
     389,705
     
     
     983,537Income tax expense
     
     
     33,466
     
     
     127,718
     
     
     126,693
     
     
     371,071Net income
     
     $
     75,136
     
     $
     209,476
     
     $
     263,012
     
     $
     612,466Basic earnings per share
     
     $
     0.11
     
     $
     0.29
     
     $
     0.38
     
     $
     0.83Diluted earnings per share
     
     $
     0.10
     
     $
     0.27
     
     $
     0.35
     
     $
     0.77The accompanying notes are an integral part of these consolidated financial statements


4

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CHINO COMMERCIAL BANCORPCONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)Nine Months Ended September 30,2008
     
     
     
     2007Cash Flows from Operating ActivitiesNet income
     
     $
     263,012
     
     
     $
     612,466Adjustments to reconcile net income to net cash providedby operating activities:Provision for loan losses
     
     
     361,540
     
     
     
     97,191Depreciation and amortization
     
     
     127,322
     
     
     
     93,126Net amortization on securities premiums and discounts
     
     
     (2,571
     )
     
     
     (7,553
     )Amortization of deferred loan costs, net
     
     
     26,025
     
     
     
     (32,216
     )Stock-based compensation expense
     
     
     0
     
     
     
     12,222Loss on disposition of equipment
     
     
     740Net changes in:Accrued interest receivable
     
     
     81,426
     
     
     
     65,630Other assets
     
     
     (819,903
     )
     
     
     (166,440
     )Accrued interest payable
     
     
     (7,262
     )
     
     
     (10,962
     )Other liabilities
     
     
     96,135
     
     
     
     94,321Net cash provided by operating activities
     
     
     126,464
     
     
     
     757,785Cash Flows from Investing ActivitiesActivity in available for sale investment securities:Purchases
     
     
     0
     
     
     
     (1,002,377
     )Repayments and calls
     
     
     2,046,115
     
     
     
     4,214,055Activity in held to maturity investment securities:Repayments and calls
     
     
     552,541
     
     
     
     718,411Net change in interest-bearing deposits in other banks
     
     
     0
     
     
     
     0Purchase of stock investments, restricted
     
     
     (19,000
     )
     
     
     (21,150
     )Loan originations and principal collections, net
     
     
     4,640,272
     
     
     
     (1,985,334
     )Purchase of premises and equipment
     
     
     (25,398
     )
     
     
     (928
     )Net cash provided by investing activities
     
     
     7,194,530
     
     
     
     1,922,677Cash Flows from Financing ActivitiesNet decrease in deposits
     
     
     (2,638,370
     )
     
     
     (4,681,597
     )Proceeds from the exercise of stock options
     
     
     0
     
     
     
     48,777Payments for stock repurchases
     
     
     (99,748
     )
     
     
     (2,311,303
     )Net cash used in financing activities
     
     
     (2,738,118
     )
     
     
     (6,944,123
     )Net increase in cash and cash equivalents
     
     
     4,582,876
     
     
     
     (4,263,661
     )Cash and Cash Equivalents at Beginning of Period
     
     
     10,927,933
     
     
     
     17,517,391Cash and Cash Equivalents at End of Period
     
     $
     15,510,809
     
     
     $
     13,253,730Supplemental InformationInterest paid
     
     $
     708,920
     
     
     $
     692,842Income taxes paid
     
     $
     196,000
     
     
     $
     430,000The accompanying notes are an integral part of these consolidated financial statements


5

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CHINO COMMERCIAL BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2008

Note 1  The Business of Chino Commercial Bancorp

Chino Commercial Bancorp (the Company) is a California corporation registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is headquartered in Chino, California. The Company was incorporated in March 2006 and acquired all of the outstanding shares of Chino Commercial Bank, N.A. (the Bank) effective July 1, 2006. The Companys principal subsidiary is the Bank, and the Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries as it may acquire or establish. The Companys principal source of income is dividends from the Bank and cash receipts related to tax benefits, although supplemental sources of income may be explored in the future. The expenditures of the Company, including (but not limited to) the payment of dividends to shareholders, if and when declared by the Board of Directors, the cost of servicing debt, legal fees, audit fees, and shareholder costs will generally be paid from dividends paid to the Company by the Bank.

The Companys only other direct subsidiary is Chino Statutory Trust I, which was formed on October 25, 2006 solely to facilitate the issuance of capital trust pass-through securities. This additional regulatory capital enhances the Companys ability to maintain favorable risk-based capital ratios. Pursuant to the Financial Accounting Standards Board (FASB) Interpretation No. 46,Consolidation of Variable Interest Entities(FIN 46), Chino Statutory Trust I is not reflected on a consolidated basis in the financial statements of the Company.

The Companys Administrative Offices are located at 14345 Pipeline Avenue, Chino, California and the telephone number is (909) 393-8880. References herein to the Company include the Company and its consolidated subsidiary, unless the context indicates otherwise.

The Bank is a national bank which was organized under the laws of the United States in December 1999 and commenced operations on September 1, 2000. The Bank operates two full-service banking offices. The Banks main branch office and administrative offices are located at 14345 Pipeline Avenue, Chino, California. On January 5, 2006 the Bank opened its Ontario branch located at 1551 South Grove Avenue, Ontario, California. As a community-oriented bank, the Bank offers a wide array of commercial and consumer services which would generally be offered by a locally-managed, independently-operated bank.

Note 2  Basis of Presentation

The accompanying unaudited consolidated financial statements for the three and nine months ended September 30, 2008 and 2007 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements. They do not, however, include all of the information and footnotes required by such accounting principles for complete financial statements. In the opinion of management, all adjustments including normal recurring accruals considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole. Certain prior period amounts have been reclassified to conform to current period classification. The interim financial information should be read in conjunction with the Companys Annual Report on Form 10-KSB, as amended, for the year ended December 31, 2007 as filed with the Securities and Exchange Commission (SEC).

Note 3  Recent Accounting Pronouncements:

In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157,Fair Value Measurements,which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but applies under other existing accounting pronouncements that require or permit fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement and, therefore, should be determined based on the assumptions that market participants would use in pricing that asset or liability. SFAS

6

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No. 157 also establishes a fair value hierarchy that distinguishes between market participant assumptions developed based on market data obtained from independent sources and the Companys own assumptions about market participant assumptions based on the best information available. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years with earlier adoption permitted. The adoption of SFAS No. 157 did not have an impact on the Companys consolidated financial statements and results of operations.

In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities  including an amendment of FASB Statement No. 115which is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has decided not to adopt SFAS No. 159.

In September 2006, the Emerging Issues Task Force (EITF) reached a final consensus on Issue No. 06-4 (EITF 06-4), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion  1967. The provisions of EITF 06-4 became effective for the Company on January 1, 2008 and were to be applied as a change in accounting principle either through a cumulative-effect adjustment to retained earnings or other components of equity or net assets in the consolidated statements of financial position as of the beginning of the year of adoption; or through retrospective application to all prior periods. The Company adopted EITF 06-4 and recorded a cumulative-effect adjustment of $24,693 to retained earnings in the first quarter of 2008. Beginning January 1, 2008, a monthly charge to expense of approximately $765 is made to recognize the liability for future benefits.

SFAS No. 141(R) is effective for the Companys 2009 consolidated financial statements. SFAS No. 141(R) requires, among other things, the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. The adoption of this statement is expected to have no effect on the Companys consolidated financial statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, which will be effective for the Companys 2009 financial statements. Its objective is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards for the noncontrolling interest in a subsidiary and for deconsolidation of a subsidiary. The adoption of this statement is not expected to have any effect on the Companys consolidated financial statements.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (an amendment of SFAS No. 133), which provides for enhanced disclosures about how and why an entity uses derivatives and how and where those derivatives and related hedged items are reported in the entitys consolidated financial statements. SFAS No. 161 also requires certain tabular formats for disclosing such information. SFAS No. 161 is effective for the Company in 2009. SFAS No. 161 applies to all entities and all derivative instruments and related hedged items accounted for under SFAS No. 133. Among other things, SFAS No. 161 requires disclosures of an entitys objectives and strategies for using derivatives by primary underlying risk and certain disclosures about the potential future collateral or cash requirements as a result of contingent credit-related features. The Company does not engage in trading or hedging activities, nor does it invest in interest rate derivatives or enter into interest rate swaps. Accordingly, the adoption of SFAS No. 161 is expected to have no impact on its consolidated financial statements.

Note 4  Stock Based Compensation

Under the Companys stock option plan, the Company may grant incentive stock options to officers and employees, and non-qualified stock options to its directors, officers and employees. At September 30, 2008 and 2007, there were 108,405 options available for granting. At September 30, 2008 and 2007, there were 113,433 options outstanding. The Plan provides that the exercise price of these options shall not be less than the market price of the common stock on the date granted. Incentive options begin vesting after one year from date of grant at a rate of 33% per year.

7

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Non-qualified options vest as follows: 25% on the date of the grant, and 25% per year thereafter. All options expire 10 years after the date of grant. Effective January 1, 2006, the Company adopted SFAS No. 123(R),Share-Based Payment,which requires that compensation cost relating to share-based payment transactions be recognized in the consolidated financial statements with measurement based upon the fair value of the equity or liability instruments issued.

The most recent grant of options occurred in 2003. All compensation expense associated with those grants were fully expensed as of December 31, 2006.

Note 5 - Earnings per share (EPS)

Basic EPS excludes dilution and is computed by dividing earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in earnings.

The basic and diluted earnings per share are as follows:

Earnings per share CalculationFor the three months ended September 30,2008
     
     
     
     2007Weighted
     
     
     
     
     
     
     WeightedNet
     
     Average
     
     
     Per Share
     
     
     
     Net
     
     Average
     
     
     Per ShareIncome
     
     Shares
     
     
     Amount
     
     
     
     Income
     
     Shares
     
     
     AmountBasic earnings
     
     $
     75,136
     
     699,798
     
     $
     0.11
     
     
     $
     209,476
     
     712,132
     
     $
     0.29Effect of dilutive shares:assumed exercise ofoutstanding options
     
     
     
     
     50,621
     
     
     (0.01
     )
     
     
     
     
     62,643
     
     
     (0.02
     )Diluted earnings per share
     
     $
     75,136
     
     750,419
     
     $
     0.10
     
     
     $
     209,476
     
     774,775
     
     $
     0.27Earnings per share CalculationFor the nine months ended September 30,2008
     
     
     
     2007Weighted
     
     
     
     
     
     
     WeightedNet
     
     Average
     
     
     Per Share
     
     
     
     Net
     
     Average
     
     
     Per ShareIncome
     
     Shares
     
     
     Amount
     
     
     
     Income
     
     Shares
     
     
     AmountBasic earnings
     
     $
     263,012
     
     700,471
     
     $
     0.38
     
     
     $
     612,466
     
     735,044
     
     $
     0.83Effect of dilutive shares:assumed exercise ofoutstanding options
     
     
     
     
     55,365
     
     
     (0.03
     )
     
     
     
     
     60,401
     
     
     (0.06
     )Diluted earnings per share
     
     $
     263,012
     
     755,836
     
     $
     0.35
     
     
     $
     612,466
     
     795,445
     
     $
     0.77


Note 6 - Off-Balance-Sheet Commitments

The Company is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to grant loans, unadvanced lines of credit, standby letters of credit and commercial letters of credit. Such commitments

8

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involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.

The Companys exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. At September 30, 2008 and December 31, 2007, the Company had $5.9 million and $7.6 million, respectively, of off-balance sheet commitments to extend credit. These commitments represent a credit risk to the Company. All of the Companys outstanding loan commitments are supported by notes payable upon demand by the Company. Included in the total off-balance sheet commitments are unadvanced standby letters of credit. At September 30, 2008 and December 31, 2007, the Company had $128,000 and $140,000, respectively, in unadvanced standby letters of credit.

Commitments to grant loans are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customers creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on managements credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, income-producing commercial properties, residential properties, and properties under construction.

9

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|Item 2MANAGEMENTS DISCUSSION ANDANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS
|-----------------------------------------------------------------------------------------

This discussion focuses primarily on the results of operations of the Company and its consolidated subsidiary on a consolidated basis for the three months and nine months ended September 30, 2008 and 2007, and the financial condition of the Company as of September 30, 2008 and December 31, 2007.

Managements discussion and analysis is written to provide greater insight into the results of operations and the financial condition of the Company and its subsidiary. For a more complete understanding of the Company and its operations, reference should be made to the consolidated financial statements included in this report and in the Company's 2007 Annual Report on Form 10-KSB, as amended.



|Forward Looking Information
|---------------------------

Certain matters discussed in this report contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the Exchange Act), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words anticipate, believe, estimate, may, intend, expect, and similar expressions identify certain of such forward-looking statements. Actual results could differ materially from such forward-looking statements contained herein. Factors that could cause future results to vary from current expectations include, but are not limited to, the following: changes in economic conditions (both generally and more specifically in the markets in which the Company operates); changes in interest rates, deposit flows, loan demand, real estate values and competition; changes in accounting principles, policies or guidelines and in government legislation and regulation (which change from time to time and over which the Company has no control); other factors affecting the Companys operations, markets, products and services; and other risks detailed in this Form 10-Q and in the Companys other reports filed with the SEC pursuant to the SECs rules and regulations. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect managements analysis only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date thereof.



|Critical Accounting Policies
|----------------------------

The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the Companys consolidated financial statements and accompanying notes. Management believes that the judgments, estimates and assumptions used in preparation of the Companys consolidated financial statements are appropriate given the factual circumstances as of September 30, 2008.

Various elements of the Companys accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Companys results of operation. In particular, management has identified one accounting policy that, due to judgments, estimates and assumptions inherent in this policy, and the sensitivity of the Companys consolidated financial statements to those judgments, estimates and assumptions, is critical to an understanding of the Companys consolidated financial statements. This policy relates to the methodology that determines the Companys allowance for loan losses. Management has discussed the development and selection of this critical accounting policy with the Companys Audit Committee of the Board of Directors. Although Management believes the level of the allowance at September 30, 2008 is adequate to absorb losses inherent in the loan portfolio, a further decline in the regional economy may result in increasing losses that cannot reasonably be predicted at this time. For further information regarding the allowance for loan losses and related methodology see Comparison of Financial Condition at September 30, 2008 and December 31, 2007  Allowance for Loan Losses included elsewhere herein.

10

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Overview of the Results of Operations and Financial Condition

Results of Operations Summary

Third quarter 2008 and 2007 comparison

Net income for the quarter ended September 30, 2008 was $75,136 compared with $209,476 for the quarter ended September 30, 2007, a decline of 64.1% . Basic and diluted earnings per share for the third quarter of 2008 were $0.11 and $0.10, respectively, compared to $0.29 and $0.27, respectively, for the third quarter of 2007. The Companys annualized return on average equity was 5.19% and annualized return on average assets was 0.40% for the quarter ended September 30, 2008, compared to a return on average equity of 15.88% and a return on assets of 1.00% for same quarter in 2007. The primary reasons for the change in net income during the third quarter of 2008 are as follows:

|· | The net interest margin declined from 5.42% to 5.02%, due principally to a drop in the interest rates on interest earning assets, an increase in interest bearing deposits to total deposits, and competitive pressures on deposit interest rates. As a result, the ratio of net interest income decreased $181,475 or 17.7% during the three months ended September 30, 2008.              
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|· | The provision for loan losses increased 82.5% to $83,136 during the third quarter of 2008, compared to $45,559 for the three months ended September 30, 2007. The Company increased its loan loss provision due to credit quality concerns stemming from deteriorating economic conditions, increased weakness in the real estate sector, and the increase in charged-off loans (see below).
| 
|· | Salaries and employee benefits remained stable with a slight increase of $5,543 or 1.2% for the third quarter of 2008 compared to the third quarter of 2007.                                                                                                                                                                                                                                
| 
|· | Occupancy and equipment expense increased $18,430 to $95,552 a 23.9% increase for the third quarter of 2008 due to a property tax adjustment received in the third quarter of 2007 that was not repeated in 2008.                                                                                                                                                                           
| 
|· | Advertising and marketing expenses decreased $17,948 to $19,889 for the three months ended September 30, 2008 due to a reduction in marketing campaigns performed during the third quarter of 2008.                                                                                                                                                                                         
| 

For the nine months ended September 30, 2008 and 2007 comparison

Net income for the nine months ended September 30, 2008 was $263,012 compared with $612,466 for the nine months ended September 30, 2007, a decline of 57.1% . Basic and diluted earnings per share for the nine months ended September 30, 2008 were $0.38 and $0.35, respectively, compared to $0.83 and $0.77, respectively, for the same period in 2007. Annualized return on average equity was 6.02% and a return on average assets of 0.47%, compared to a return on average equity of 14.05% and a return on average assets of 0.95% for the same period in 2007. The primary reasons for the change in net income during the nine months ended September 30, 2008 are as follows:

|· | The net interest margin declined from 5.61% to 5.28%, due principally to a drop in the interest rates on interest earning assets, an increase in interest bearing deposits to total deposits, and competitive pressures on deposit interest rates. As a result, the ratio of net interest income decreased $583,313 or 18.2% during the nine months ended September 30, 2008 compared to the same period in 2007.  
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|· | The Provisions for Loan Losses increased $255,337 or 240.4% for the nine months ended September 30, 2008. The Company increased its loan loss provision for the nine months ended September 30, 2008 due to credit quality concerns stemming from deteriorating economic conditions, increased weakness in the real estate sector, and the increase in charged-off loans (see below).                              
| 
|· | Service charge income increased by $112,886 or 18.9% for the nine months ended September 30, 2008, due to an increase in volume subject to analysis charges and returned item charges.                                                                                                                                                                                                                             
| 
|· | For the nine months ended September 30, 2008 salaries and benefits increased slightly by $4,678 or 0.3% as compared with the same period of 2007.                                                                                                                                                                                                                                                                  
| 
|· | Advertising and Marketing expenses decreased $52,704 to $60,504 for the nine months ended September 30, 2008 due to decreased marketing campaigns performed during this period, compared to the same period in 2007.                                                                                                                                                                                               
| 
|· | Legal and professional fees decreased $17,301 to $144,763 for the nine months ended September 30, 2008 due to additional costs incurred in 2007 for the share repurchase plan that were not repeated in 2008.                                                                                                                                                                                                      
| 
|· | Other expenses decreased from $448,584 in the nine months ended September 30, 2007 to $391,501 for the same period of 2008. The major portion of the decrease is attributed to the reserve for off-balance sheet items, which was reduced approximately $37,000 for the nine months ended September 30, 2008. Deposit products and services expense decreased $20,300 as balances in the related accounts declined.
| 

11

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|.Financial Condition Summary
|----------------------------

The Companys total assets were $77.5 million at September 30, 2008, a decline of $2.4 million, or 3.0% as compared to total assets of $79.9 million at December 31, 2007. The most significant changes in the Companys balance sheet during the nine months ended September 30, 2008 are outlined below:

|· | Total assets declined from $79.9 million to $77.5 million or 3.0% between December 31, 2007 and September 30, 2008, resulting from a decrease in loan demand and paydowns and maturities of investment securities, which was partially offset by an increase in Federal funds sold. Federal funds sold increased due to increasing deposit balances during the third quarter of 2008.                                                                                                                                                                            
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|· | Total non-interest bearing deposits decreased from $42.3 million at December 31, 2007 to $34.8 million for reporting period ended September 30, 2008, a 17.7% decrease. Total deposits decreased from $70.4 million at December 31, 2007 to $67.8 million at September 30, 2008, or a 3.7% reduction. Deposit balances declined primarily in the real estate industry related accounts.                                                                                                                                                                          
| 
|· | The Company experienced a decrease in interest-earning assets of $4.7 million or 6.5% to $71.9 million in the nine months ended September 30, 2008. Loan demand and Investment securities decreased $5.1 million and $2.6 million, respectively, in the nine months ended September 30, 2008. No new investment securities have been added in 2008, and the decrease in investment securities was caused by maturities and principal payments from investments in Agency Mortgage-backed securities.                                                             
| 
|· | Interest-bearing liabilities increased $4.8 million or 15.5% to $36.1 million in the nine months ended September 30, 2008 as compared to December 31, 2007. The increase in interest-bearing deposits is the result of the Companys focus on attracting new customers.                                                                                                                                                                                                                                                                                          
| 
|· | Nonperforming assets were $1.1 million or 2.35% of total loans and other real estate owned at September 30, 2008, compared to zero at December 31, 2007. Non performing loans were $461,049 and consisted of one commercial loan secured by real estate with collateral values expected to be sufficient to cover the debt. This nonperforming loan and a partial charge off of a loan transferred to other real estate owned in the amount of $685,796 led Management to increase its allowance for loan losses during the nine months ended September 30, 2008.
| 



|Earnings Performance
|--------------------

The Company earns income from two primary sources: The first is net interest income, which is interest income generated by earning assets less interest expense on interest-bearing liabilities; the second is non-interest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as bank-owned life insurance. The majority of the Companys non-interest expenses are operating costs that relate to providing a full range of banking services to the Banks customers.



|Net Interest Income and Net Interest Margin
|-------------------------------------------

For the third quarter, net interest income declined $181,475, or 17.7% to $840,992 in 2008 from $1,022,467 in 2007. For the nine months ended September 30, 2008, net interest income declined $583,313 or 18.2% to $2.6 million in 2008 from $3.2 million in 2007. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Companys earning assets, deposits, and other interest-bearing liabilities. Occasionally, net interest income is also impacted by the recovery of interest on loans that have been on non-accrual and are either sold or returned to accrual status, or by the reversal of accrued but unpaid interest for loans placed on non-accrual. The Companys net interest income, net interest margin and interest spread are sensitive to general business and economic conditions, including short-term and long-term interest rates, inflation, monetary supply, and the strength of the economy, and the local economics in which the Company conducts business. When net interest income is expressed as a percentage of average earning assets, the results is the net interest margin.

The following tables set forth certain information relating to the Company for the three and nine months ended September 30, 2008 and 2007. The yields and costs are derived by dividing income or expense by the corresponding average balances of assets or liabilities for the periods shown below. Average balances are derived from average daily balances. Yields include fees that are considered adjustments to yields.

12

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|Distribution, Yield and Rate Analysis of Net Interest Income
|------------------------------------------------------------
|(dollars in thousands)                                      
|(unaudited)                                                 
|                                                            
|                                                            
|                                                            
|                                                            
|                                                            
|Assets                                                      
|Interest-earnings assets                                    
|Loans1                                                      
|U.S. government agencies securities                         
|Mortgage-backed securities                                  
|Other securities & Due from banks time                      
|Federal funds sold                                          
|Total interest-earning assets                               
|Non-interest earning assets                                 
|Total assets                                                
|                                                            
|Liabilities and Stockholders' Equity                        
|Interest-bearing liabilities                                
|Money market and NOW deposits                               
|Savings                                                     
|Time deposits < $100,000                                    
|Time deposits equal to or > $100,000                        
|Federal funds purchased                                     
|Subordinated debenture                                      
|Total interest-bearing liabilities                          
|Non-interest bearing deposits                               
|Non-interest bearing liabilities                            
|Stockholders' equity                                        
|Total liabilities & stockholders' equity                    
|                                                            
|Net interest income                                         
|                                                            
|Net interest spread2                                        
|Net interest margin3                                        

1Amortization of loan fees has been included in the calculation of interest income. Loan fees were approximately $22,000 for the three months ended September 30, 2008 as compared to $15,000 for the three months ended September 30, 2007.

2Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

3Represents net interest income as a percentage of average interest-earning assets.

4Average Yield/Rate is based upon actual days based on 365- and 366-day years.

13

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Distribution, Yield and Rate Analysis of Net Interest Income(dollars in thousands)(unaudited)For the nine months ended
     
     
     
     For the nine months endedSeptember 30, 2008
     
     
     
     September 30, 2007Average
     
     
     Income/
     
     Average
     
     
     
     Average
     
     
     Income/
     
     AverageBalance
     
     
     Expense
     
     Yield/Rate4
     
     
     
     Balance
     
     
     Expense
     
     Yield/Rate4AssetsInterest-earnings assetsLoans1
     
     $
     52,583
     
     $
     2,920
     
     7.42
     %
     
     $
     51,289
     
     $
     3,014
     
     7.86
     %U.S. government agencies securities
     
     
     450
     
     
     15
     
     4.42
     %
     
     
     3,171
     
     
     96
     
     4.07
     %Mortgage-backed securities
     
     
     8,065
     
     
     276
     
     4.57
     %
     
     
     9,858
     
     
     309
     
     4.19
     %Other securities & Due from banks time
     
     
     1,483
     
     
     50
     
     4.55
     %
     
     
     2,426
     
     
     91
     
     5.04
     %Federal funds sold
     
     
     3,846
     
     
     67
     
     2.32
     %
     
     
     9,808
     
     
     381
     
     5.19
     %Total interest-earning assets
     
     
     66,427
     
     $
     3,328
     
     6.69
     %
     
     
     76,552
     
     $
     3,891
     
     6.80
     %Non-interest earning assets
     
     
     8,625
     
     
     
     
     
     
     
     
     9,223Total assets
     
     $
     75,052
     
     
     
     
     
     
     
     $
     85,775Liabilities and Stockholders' EquityInterest-bearing liabilitiesMoney market and NOW deposits
     
     $
     23,009
     
     $
     429
     
     2.49
     %
     
     $
     21,797
     
     $
     406
     
     2.49
     %Savings
     
     
     1,185
     
     
     2
     
     0.25
     %
     
     
     1,125
     
     
     2
     
     0.29
     %Time deposits < $100,000
     
     
     2,406
     
     
     54
     
     3.01
     %
     
     
     1,910
     
     
     47
     
     3.26
     %Time deposits equal to or > $100,000
     
     
     2,538
     
     
     63
     
     3.31
     %
     
     
     2,601
     
     
     73
     
     3.74
     %Federal funds purchased
     
     
     40
     
     
     1
     
     3.23
     %
     
     
     0
     
     
     0
     
     0.00
     %Subordinated debenture
     
     
     3,093
     
     
     153
     
     6.60
     %
     
     
     3,093
     
     
     154
     
     6.65
     %Total interest-bearing liabilities
     
     
     32,271
     
     $
     702
     
     2.90
     %
     
     
     30,526
     
     $
     682
     
     2.99
     %Non-interest bearing deposits
     
     
     36,035
     
     
     
     
     
     
     
     
     48,259Non-interest bearing liabilities
     
     
     916
     
     
     
     
     
     
     
     
     1,177Stockholders' equity
     
     
     5,830
     
     
     
     
     
     
     
     
     5,813Total liabilities & stockholders' equity
     
     $
     75,052
     
     
     
     
     
     
     
     $
     85,775Net interest income
     
     
     
     
     $
     2,626
     
     
     
     
     
     
     
     $
     3,209Net interest spread2
     
     
     
     
     
     
     
     3.79
     %
     
     
     
     
     
     
     
     3.81
     %Net interest margin3
     
     
     
     
     
     
     
     5.28
     %
     
     
     
     
     
     
     
     5.61
     %


1Amortization of loan fees has been included in the calculation of interest income. Loan fees were approximately $45,000 for the nine months ended September 30, 2008 as compared to $102,000 for the nine months ended September 30, 2007. Loans are net of deferred fees and related direct costs.

2Represents the average rate earned on interest-earning assets less the average rate paid on interest-bearing liabilities.

3Represents net interest income as a percentage of average interest-earning assets.

4Average Yield/Rate is based upon actual days based on 365- and 366-day years.

Rate/Volume Analysis

The Volume and Rate Variances table below sets forth the dollar difference in interest earned and paid for each major category of interest-earning assets and interest-bearing liabilities for the noted periods, and the amount of such change attributable to changes in average balances (volume) or changes in average interest rates. Volume variances are equal to the increase or decrease in average balance multiplied by prior period rates, and rate variances are equal to the increase or decrease in average rate times prior period average balances. Variances attributable to both rate and volume changes are calculated by multiplying the change in rate by the change in average balance, and are allocated to the rate variance.

14

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Volume & Rate VariancesFor the quarter ended
     
     
     
     For the nine months endedSeptember 30,
     
     
     
     September 30,2008 vs. 2007
     
     
     
     2008 vs. 2007Increase (Decrease) Due to
     
     
     
     Increase (Decrease) Due to($ in thosands)
     
     
     
     ($ in thosands)Volume
     
     
     
     Rate
     
     
     
     Net
     
     
     
     Volume
     
     
     
     Rate
     
     
     
     NetInterest-earnings assetsLoans
     
     ($
     36
     )
     
     ($
     40
     )
     
     ($
     76
     )
     
     $
     74
     
     
     ($
     168
     )
     
     ($
     94
     )Securities of U.S. government agencies
     
     
     (12
     )
     
     
     (12
     )
     
     
     (24
     )
     
     
     (90
     )
     
     
     9
     
     
     
     (81
     )Mortgage-backed securities
     
     
     (20
     )
     
     
     6
     
     
     
     (14
     )
     
     
     (59
     )
     
     
     26
     
     
     
     (33
     )Other securities & Due from banks time
     
     
     (2
     )
     
     
     (1
     )
     
     
     (3
     )
     
     
     (34
     )
     
     
     (7
     )
     
     
     (41
     )Federal funds sold
     
     
     (22
     )
     
     
     (63
     )
     
     
     (85
     )
     
     
     (165
     )
     
     
     (149
     )
     
     
     (314
     )Total interest-earning assets
     
     
     (92
     )
     
     
     (110
     )
     
     
     (202
     )
     
     
     (274
     )
     
     
     (289
     )
     
     
     (563
     )Interest-bearing liabilitiesMoney market & NOW
     
     
     (2
     )
     
     
     (24
     )
     
     
     (26
     )
     
     
     23
     
     
     
     0
     
     
     
     23Savings
     
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     0Time deposits < $100,000
     
     
     7
     
     
     
     (5
     )
     
     
     2
     
     
     
     11
     
     
     
     (4
     )
     
     
     7Time deposits equal to or > $100,000
     
     
     10
     
     
     
     (6
     )
     
     
     4
     
     
     
     (2
     )
     
     
     (8
     )
     
     
     (10
     )Federal funds purchased
     
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     1
     
     
     
     0
     
     
     
     1Subordinated debenture
     
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     0
     
     
     
     (1
     )
     
     
     (1
     )Total interest-bearing liabilities
     
     
     15
     
     
     
     (35
     )
     
     
     (20
     )
     
     
     33
     
     
     
     (13
     )
     
     
     20Change in net interest income
     
     ($
     107
     )
     
     ($
     75
     )
     
     ($
     182
     )
     
     ($
     307
     )
     
     ($
     276
     )
     
     ($
     583
     )


As shown above, the pure volume variance negatively impacted net interest income by $107,000 in the third quarter of 2008 relative to the same period of 2007, while the rate variance negatively impacted net interest income by $75,000 in the same comparative periods.

The Companys net interest income for the third quarter of 2008 was $840,992 compared to $1,022,467 in the third quarter of 2007, a decrease of $181,475, or 17.7% . The net interest margin was 5.02% for the three months ended September 30, 2008 as compared to 5.42% for the same period in 2007 due principally to a drop in the average balance of non-interest bearing demand deposits with migration to interest bearing deposits and competitive market pressures on deposit interest rates.

Average loans decreased $2.0 million or 3.7% for the third quarter of 2008 compared with the same period of 2007. Interest and fee income on loans decreased $75,500. The decrease in average loans resulted in approximately $36,000 decrease in interest income from loans, while the decrease in interest rate resulted in approximately $40,000 decrease in income. The average yield on loans declined from 7.69% for the quarter ended September 30, 2007 to 7.41% for the quarter ended September 30, 2008.

Income from investment securities and due from banks for the quarter ended September 30, 2008 decreased by $40,816 in comparison to the quarter ended September 30, 2007. The primary impact for the decline interest income was due to the decrease in the average balance of investment securities and due from banks of approximately $4.2 million or 31.9% . Average Federal funds sold decreased $2.0 million or 21.7% in the three month period ended September 30, 2008 compared to the three month period ended September 30, 2007. The reduction in the volume of Federal funds sold balances caused a reduction of interest income of approximately $22,000, while the rate decrease caused a further decline in interest income of approximately $63,000 from Federal funds sold for the third quarter of 2008 as compared to the same quarter in 2007. The average yield for Federal funds sold declined from 5.08% for the 3 months ended September 30, 2007 to 1.93% for the same period in 2008.

Average interest bearing liabilities increased $1.6 million in the third quarter of 2008 as compared to the third quarter of 2007. The Company experienced continued migration of existing deposits to higher yielding accounts and higher yielding accounts opened by new customers resulting in increases in money market and time account balances. The increase in average interest bearing deposits resulted in approximately a $15,000 increase in interest expense which was offset by a decrease of approximately $35,000 resulting in decreased rates in the third quarter of 2008 as compared to the third quarter of 2007.

15

---

Pure volume variances negatively impacted net interest income by approximately $307,000 for the nine-month period ended September 30, 2008 relative to the same period of 2007, while the rate variance negatively impacted net interest income by approximately $276,000 in the same comparative periods.

Net interest income for the nine months ended September 30, 2008 was $2,626,051 compared to $3,209,364 in the same period in 2007, a decrease of $583,313, or 18.2% . Interest income decreased $563,535 or 14.5% in the nine month period ended September 30, 2008 compared to the same period of 2007, while interest expense increased $19,778 or 2.9% .

Interest and fee income from loans decreased during the nine months ended September 30, 2008 to $2,919,813, or 3.1% from $3,013,734 for the same period in 2007 due to a decline in average loan balances and rate decreases.Due to the decline in average deposits and the drop in interest rates, Federal funds sold and Investment securities average balances declined as did income from those balances. The most significant decrease was in Federal funds sold, which experienced a negative volume and rate variances of approximately $165,000 and $149,000, respectively, for the nine months ended September 30, 2008 compared to the same period in 2007. Interest income from Federal funds sold decreased to $66,832 for the nine months ended September 30, 2008 from $380,695 for the same period in 2007. The average yield on Federal funds sold was 5.19% for the nine months ended September 30, 2007 compared to 2.32% for the same period in 2008. Interest income from Investment securities and Due from banks time decreased $155,751 or 31.3% to $341,064 for the nine ended September 30, 2008 compared to the same period of 2007.

Interest expense on deposits increased $19,704, or 3.7% to $547,797 for the nine months ended September 30, 2008 compared to the same period of 2007. Average interest bearing deposits to average total deposits increased from 36.2% for the nine months ended September 30, 2007 to 44.7% for the same period in 2008 as new and existing deposits continue to migrate to higher yielding accounts. The Companys net interest margin declined from 5.61% to 5.28%, for the nine months ended September 30, 2008 versus 2007 due principally to a drop in the average balance of non-interest bearing demand deposits and competitive pressures on deposit interest rates. As a result, net interest income decreased $583,313 or 18.2% for the nine months ended September 30, 1008, as compared to the same period of 2007.

Provision for Loan Losses

Provisions to the allowance for loan losses are made monthly if needed, in anticipation of future potential loan losses. The monthly provision is calculated on a predetermined formula to ensure adequacy as the portfolio grows. The formula is composed of various components. Allowance factors are utilized in estimating the adequacy of the allowance for loan losses. The allowance is determined by assigning general reserves on a non-classified loans, and specific allowances for individual classified loans. As higher allowance levels become necessary as a result of this analysis, the allowance for loan losses will be increased through the provision for loan losses. The procedures for monitoring the adequacy of the allowance, and detailed information on the allowance, are included below under Allowance for Loan Losses.

The Company provided $361,540 to the reserve for loan losses during the nine months ended September 30, 2008, a 240.4% increase over the same period during 2007. The Company made this significant provision to the Loan Loss Reserve during the nine months ended September 30, 2008, due to nonperforming loans, net charge-offs of $424,609, and a number of economic events occurring in and around the real estate industry. Nonperforming loans were $461,049 or 0.96% of total loans at September 30, 2008 compared to zero at December 31, 2007. Non performing loans consist of one commercial loan secured by real estate with collateral values sufficient to cover the debts. Though the provision resulted in lower earnings during the nine months ended September 30, 2008, in the long run management believes that these conservative credit practices will benefit the Company on an ongoing basis.

The Company has collected all charged-off loans from prior years, and continues to pursue recovery of the loans charged off during the second and third quarters of this year. The Company has not originated and does not hold sub-prime mortgage loans, or option ARM mortgages.

16

---

Non-Interest Income

Non-interest income was $259,509 for the three months ended September 30, 2008 as compared to $256,077 for the three months ended September 30, 2007, a 1.3% increase. For the nine months ended September 30, 2008, non-interest income increased 17.5% to $819,253 compared to $697,236 for the same period in 2007. Total annualized non-interest income as a percentage of average earning assets increased to 1.6% for the three and nine months ended September 30, 2008, compared to 1.4% and 1.2% for the three and nine months ended September 30, 2007. The increases were due primarily to the additional fee income from service charges on deposit accounts.

Non-Interest Income for the three months
     
     Non-Interest Income for the nine monthsended September 30,
     
     ended September 30,2008
     
     2007
     
     2008
     
     2007Amount
     
     % of Total
     
     Amount
     
     % of Total
     
     Amount
     
     % of Total
     
     Amount
     
     % of Total(Dollars in thousands)
     
     
     
     (Dollars in thousands)Service charges ondeposit accounts
     
     $ 224
     
     86.4%
     
     $ 223
     
     87.2%
     
     $ 709
     
     86.5%
     
     $ 596
     
     85.5%Other miscellaneousfee income
     
     10
     
     3.6%
     
     10
     
     3.8%
     
     27
     
     3.3%
     
     26
     
     3.8%Dividend incomefrom restricted stock
     
     10
     
     3.8%
     
     8
     
     3.0%
     
     36
     
     4.5%
     
     28
     
     4.0%Income from bankowned life insurance
     
     16
     
     6.2%
     
     15
     
     6.0%
     
     47
     
     5.7%
     
     47
     
     6.7%Total non-interestincome
     
     $ 260
     
     100.0%
     
     $ 256
     
     100.0%
     
     $ 819
     
     100.0%
     
     $ 697
     
     100.0%As a percentage ofaverage earning assets
     
     
     
     1.6%
     
     
     
     1.4%
     
     
     
     1.6%
     
     
     
     1.2%


The service charges on deposit accounts, customer fees and miscellaneous income are comprised primarily of fees charged to deposit accounts and depository related services. Fees on deposit accounts consist of periodic service charges and fees that relate to specific actions, such as the return or payment of checks presented against accounts with insufficient funds. Depository related services include fees for money orders and cashiers checks, placing stop payments on checks, check-printing fees, wire transfer fees, fees for safe deposit boxes and fees for returned items or checks that were previously deposited. Service charges on deposit accounts increased $484 or 0.2% to $223,922 for the three months ended September 30, 2008 and increased $112,886 or 18.9% to $708,745 for the nine months period ended September 30, 2008. The increase was primarily attributable to increased analysis charges and returned item charges. The Company periodically reviews service charges to maximize service charge income while still maintaining competitive pricing. Service charge income on deposit accounts increases with the increased number of accounts and to the extent fees are not waived. Therefore, as the number of accounts increases, the nominal service charge income is expected to increase.

Non-Interest Expense

The following table sets forth the non-interest expense for the three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007:

17

---

Non-Interest Expense for the three months
     
     
     
     Non-Interest Expense for the nine monthsended September 30,
     
     
     
     ended September 30,2008
     
     
     
     2007
     
     
     
     2008
     
     
     
     2007Amount
     
     % of Total
     
     
     
     Amount
     
     % of Total
     
     
     
     Amount
     
     
     % of Total
     
     
     
     Amount
     
     % of Total(Dollars in thousands)
     
     
     
     (Dollars in thousands)Salaries and employee benefits
     
     $
     467
     
     51.3
     %
     
     $
     462
     
     51.6
     %
     
     $
     1,445
     
     
     53.5
     %
     
     $
     1,440
     
     51.2
     %Occupancy and equipment
     
     
     96
     
     10.6
     %
     
     
     77
     
     8.6
     %
     
     
     262
     
     
     9.7
     %
     
     
     257
     
     9.1
     %Data and item processing
     
     
     81
     
     8.9
     %
     
     
     86
     
     9.6
     %
     
     
     246
     
     
     9.1
     %
     
     
     244
     
     8.7
     %Deposit products and services
     
     
     54
     
     5.9
     %
     
     
     69
     
     7.7
     %
     
     
     166
     
     
     6.2
     %
     
     
     189
     
     6.7
     %Legal and other professional fees
     
     
     49
     
     5.4
     %
     
     
     54
     
     6.0
     %
     
     
     145
     
     
     5.4
     %
     
     
     162
     
     5.8
     %Regulatory assessments
     
     
     22
     
     2.4
     %
     
     
     22
     
     2.5
     %
     
     
     63
     
     
     2.3
     %
     
     
     69
     
     2.4
     %Advertising and marketing
     
     
     20
     
     2.2
     %
     
     
     38
     
     4.2
     %
     
     
     61
     
     
     2.3
     %
     
     
     113
     
     4.0
     %Directors fees and expenses
     
     
     19
     
     2.1
     %
     
     
     19
     
     2.1
     %
     
     
     58
     
     
     2.2
     %
     
     
     60
     
     2.1
     %Printing and supplies
     
     
     6
     
     0.7
     %
     
     
     16
     
     1.8
     %
     
     
     34
     
     
     1.3
     %
     
     
     48
     
     1.7
     %Telephone
     
     
     6
     
     0.7
     %
     
     
     7
     
     0.8
     %
     
     
     19
     
     
     0.7
     %
     
     
     22
     
     0.8
     %Insurance
     
     
     8
     
     0.9
     %
     
     
     8
     
     0.9
     %
     
     
     24
     
     
     0.9
     %
     
     
     23
     
     0.8
     %Reserve for undisbursed lines ofcredit
     
     
     0
     
     0.0
     %
     
     
     0
     
     0.0
     %
     
     
     (28
     )
     
     -1.0
     %
     
     
     9
     
     0.3
     %Other expenses
     
     
     81
     
     8.9
     %
     
     
     38
     
     4.2
     %
     
     
     199
     
     
     7.4
     %
     
     
     181
     
     6.4
     %Total non-interest expenses
     
     $
     909
     
     100.0
     %
     
     $
     896
     
     100.0
     %
     
     $
     2,694
     
     
     100.0
     %
     
     $
     2,817
     
     100.0
     %Non-interest expense as apercentage of average earningassets
     
     
     
     
     5.5
     %
     
     
     
     
     4.8
     %
     
     
     
     
     
     5.4
     %
     
     
     
     
     4.9
     %Efficiency ratio
     
     
     
     
     89.3
     %
     
     
     
     
     72.7
     %
     
     
     
     
     
     87.4
     %
     
     
     
     
     74.1
     %


Although non-interest expenses decreased, total annualized non-interest expenses as a percentage of average earning assets increased due to the decline in average earning assets. Total annualized non-interest expenses as a percentage of average earning assets increased to 5.5% from 4.8% for the three months ended September 30, 2008 as compared to three months ended September 30, 2007. For the nine months ended September 30, 2008 and 2007, these percentages were 5.4% and 4.9%, respectively. The efficiency ratio increased from 72.7% and 74.1%, respectively, for the three and nine months ended September 30, 2007 to 89.3% and 87.4%, respectively, for the same periods in 2008 due mainly to the decline in net interest income.

Non-interest expenses were $908,762 for the three months ended September 30, 2008 as compared to $895,791 for the three months ended September 30, 2007, a 1.4% increase. Non-interest expenses decreased $122,801 or 4.4% to $2,694,059 for the nine months ended September 30, 2008 compared to the same period in 2007. The largest component of general and administrative expenses was salary and benefits expense of $467,413 for the third quarter and $1,444,704 for the nine months ended September 30, 2008 compared to $461,870 and $1,440,026 for the same periods in 2007, representing 1.2% increase and 0.3% decrease, respectively.

Other components of general and administrative expenses that affected the changes in non interest expense were Advertising and Marketing expenses which decreased by $17,948 or 47.4% in comparison to the quarter ended September 30, 2007, and $52,704, or 46.6% for the nine-month periods due to a reduction in marketing campaigns performed during the nine months ended September 30, 2008 as compared to the same period of 2007. Legal and other professional fees decreased 8.8% and 10.7% or $4,762 and $17,301, respectively, during the three and nine months ended September 30, 2008 compared to the same periods in 2007. Additional legal and professional fees costs were incurred in the first half of 2007 for the purchase of shares from shareholders that did not repeat in 2008. Other expenses decreased $76,419 for the nine-month period ended September 30, 2008 due primarily to reductions in the provision for undisbursed commitments and reduced correspondent bank charges.

Provision for Income Taxes

The tax provision was $33,466 and $126,693 for the third quarter and the nine months ended September 30, 2008, respectively, representing approximately 30.8% and 32.5% of pre-tax income for the third quarter and nine months ended September 30, 2008, respectively. In comparison, the tax provision was $127,718 and $371,071 for the third quarter and the nine months ended September 30, 2007, respectively, representing approximately 38% of pre-tax income for both periods. Of the $389,705 in pre-tax income for the nine months ended September 30, 2008,

18

---

approximately $83,000 was tax-exempt income. The amount of the tax provision is determined by applying the Companys statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income; increases in the cash surrender value of bank-owned life insurance, compensation expense associated with stock options and certain other expenses that are not allowed as tax deductions, and tax credits.

19

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|Financial Condition
|-------------------

Comparison of Financial Condition at September 30, 2008 and December 31, 2007

General

Total assets declined from $79.9 million to $77.5 million or 3.0% between December 31, 2007 and September 30, 2008, resulting from a contraction in deposit balances related to a number of the Companys customers that are engaged in real estate related activities. The Company has experienced deposit contraction as the economic activity of the real estate industry continues to slow, however, the Company is actively seeking to develop alternative and supplemental business relationships with other companies and individuals in an effort to offset the potential reductions and more fully leverage the Companys capital.

Loan Portfolio

During the nine months ended September 30, 2008, the Companys loan portfolio, net of unearned loan fees, decreased by $5.1 million to $48.0 million at September 30, 2008 as compared to $53.1 million at December 31, 2007. The Company experienced declines in construction, real estate secured, and installment loans, while experiencing an increase in commercial loans. The largest loan category at September 30, 2008 was real estate loans, which consist of commercial, and consumer real estate loans excluding construction loans. This constitutes 76.3% of the loan portfolio. In anticipation of further deterioration in economic conditions, though Management believes these credits to be properly underwritten, the Company has elected to take real estate collateral in an abundance of caution on a number of commercial loans. Though the result of this strategy may be to reflect a concentration of assets into real estate secured credits, Management believes the underlying collateral will support overall credit quality and minimize principal risk of the portfolio. The next largest loan concentration at September 30, 2008 was commercial loans, constituting 21.2% of the loan portfolio. The composition of the Companys loan portfolio at September 30, 2008 and December 31, 2007 is set forth below:

September 30, 2008
     
     December 31, 2007Amount
     
     Percentage
     
     Amount
     
     PercentageConstruction
     
     $ 605
     
     1.3%
     
     $ 2,607
     
     4.9%Real estate
     
     36,686
     
     76.3%
     
     39,726
     
     74.7%Commercial
     
     10,209
     
     21.2%
     
     10,063
     
     18.9%Installment
     
     576
     
     1.2%
     
     791
     
     1.5%Gross loans
     
     $ 48,076
     
     100.0%
     
     $ 53,187
     
     100.0%


The weighted average yield on the loan portfolio for the nine months and quarter ended September 30, 2008 was 7.42% and 7.41%, respectively, and the weighted average contractual term of the loan portfolio is approximately six years. Individual loan interest rates may require interest rate changes more frequently than at maturity due to adjustable interest rate terms incorporated into certain loans. At September 30, 2008 approximately 61.3% of loans were variable rate loans tied to adjustable rate indices such as Prime Rate.

Off-Balance Sheet Arrangements

During the ordinary course of business, the Company provides various forms of credit lines to meet the financing needs of its customers. These commitments to provide credit represent an obligation of the Company to its customers, which is not represented in any form within the balance sheets of the Company. At September 30, 2008 and December 31, 2007, the Company had $5.9 million and $7.6 million, respectively, of off-balance sheet commitments to extend credit, which includes unadvanced letters of credit. These commitments are the result of existing unused lines of credit and unfunded loan commitments. These commitments are supported by promissory notes payable upon demand by the Company. These commitments represent a credit risk to the Company. At September 30, 2008 and December 31, 2007, the Company had $128,000 and $140,000, respectively, in unadvanced

20

---

letters of credit. These letters of credit are sometimes unsecured and may not necessarily be drawn upon to the total extent to which the Company is committed.

The effect on the Companys revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used.

Non-performing Assets

Non-performing assets are comprised of loans on non-accrual status, loans 90 days or more past due and still accruing interest, loans restructured where the terms of repayment have been renegotiated resulting in a reduction or deferral of interest or principal, and other real estate owned (OREO). Loans are generally placed on non-accrual status when they become 90 days past due unless Management believes the loan is adequately collateralized and in the process of collection. Loans may be restructured by Management when a borrower has experienced some change in financial status, causing an inability to meet the original repayment terms, and where the Company believes the borrower will eventually overcome those circumstances and repay the loan in full. OREO consists of properties acquired by foreclosure or similar means that Management intends to offer for sale.

Managements classification of a loan as non-accrual is an indication that there is a reasonable doubt as to the full collectibility of principal and/or interest on the loan; at this point, the Company stops recognizing interest income on the loan and may reverse any uncollected interest that had been accrued but unpaid if it is determined uncollectible or the collateral is inadequate to support such accrued interest amount. These loans may or may not be collateralized, but collection efforts are continuously pursued.

The following table presents comparative data for the Companys nonperforming assets:

September 30,
     
     December 31,
     
     September 302008
     
     2007
     
     2007(Dollars in Thousands)NON-ACCRUAL LOANS:1Construction
     
     $ -
     
     $ -
     
     $ -Real estate
     
     0
     
     0
     
     0Commercial
     
     461
     
     0
     
     0Installment
     
     0
     
     0
     
     0TOTAL NON-ACCRUAL LOANS
     
     461
     
     0
     
     0LOANS 90 DAYS OR MOREPAST DUE& STILL ACCRUING:Construction
     
     0
     
     0
     
     0Real estate
     
     0
     
     0
     
     0Commercial
     
     0
     
     0
     
     0Installment
     
     0
     
     0
     
     0TOTAL LOANS 90 DAYS OR MORE PAST DUE & STILL ACCRUING
     
     0
     
     0
     
     0Restructured loans2
     
     0
     
     0
     
     0TOTAL NONPERFORMING LOANS
     
     461
     
     0
     
     0Other real estate owned
     
     686
     
     0
     
     0TOTAL NONPERFORMING ASSETS
     
     $ 1,147
     
     $ -
     
     $ -Nonperforming loans as a percentage of total loans3
     
     0.96%
     
     n/a
     
     n/aNonperforming assets as a percentage of total loans and other real estate owned
     
     2.35%
     
     n/a
     
     n/aAllowance for loan losses to nonperforming loans
     
     143.62%
     
     n/a
     
     n/aAllowance for loan losses
     
     $ 662
     
     $ 725
     
     $ 713


1Additional interest income of approximately $2,500 would have been recorded for the six months ended September 30, 2008 if this loan had been paid or accrued in accordance with their original terms and had been outstanding throughout the applicable perio

2Restructured loans are loans where the terms are renegotiated to provide a reduction or deferral of interest or principal due to deterioration in the financial position of the borrower.

3Total loans are gross loans, which excludes the allowance for loan losses, and net of unearned loan fees.

21

---

At September 30, 2008 and December 31, 2007, the Company had $461,049 in non-accrual loans, no loans 90 days or more past due and still accruing, and no restructured loans. The Company acquired an interest in real estate totaling $685,796 as a result of foreclosure on a construction loan during the third quarter of 2008. The Companys nonperforming assets at September 30, 2008 consisted of one loan on non-accrual status and one other real estate owned. Nonperforming assets at September 30, 2008 totaled $1.1 million, or 2.35% of total loans and foreclosed assets compared to zero at December 31, 2007. Nonperforming loans totaled $461,049, or 0.96% of total loans. The allowance for loan losses to nonperforming loans was 143.62% . Non performing loans at September 30, 2008 consisted of one commercial loan secured by real estate with collateral values expected to be sufficient to cover the debt.

Allowance for Loan Losses

The Company maintains an allowance for loan losses at a level Management considers adequate to cover the inherent risk of loss associated with its loan portfolio under prevailing and anticipated economic conditions. In determining the adequacy of the allowance for loan losses, Management takes into consideration growth trends in the portfolio, examination by financial institution supervisory authorities, prior loan loss experience of the Banks Management, concentrations of credit risk, delinquency trends, general economic conditions, the interest rate environment, and internal and external credit reviews.

The Company formally assesses the adequacy of the allowance on a quarterly basis. This assessment is comprised of: (i) reviewing the adversely classified, delinquent or otherwise problematic loans; (ii) generating an estimate of the loss potential in each loan; (iii) adding a risk factor for industry, economic or other external factors; and (iv) evaluating the present status of each loan and the impact of potential future events.

Because the Company has not experienced significant credit losses, a historical migration analysis of the non-performing assets is not practical. Allowance factors are utilized in the analysis of the allowance for loan losses. Allowance factors ranging from 0.25% to 2.00% are applied to disbursed loans that are unclassified and uncriticized. Allowance factors averaging approximately 0.21% are applied to undisbursed loans. Allowance factors are not applied to loans secured by bank deposits or to loans held for sale, which are recorded at the lower of cost or market.

The process of providing for loan losses involves judgmental discretion, and eventually losses may therefore differ from even the most recent estimates. Due to these limitations, the Company assumes that there are losses inherent in the current loan portfolio but which have not yet been identified. The Bank therefore attempts to maintain the allowance at an amount sufficient to cover such unknown but inherent losses.

The table below summarizes, as of and for the three and nine months ended September 30, 2008 and 2007 and the year ended December 31, 2007, the loan balances at the end of the period and the daily average loan balances during the period; changes in the allowance for loan losses arising from loan charge-offs, recoveries on loans previously charged-off, and additions to the allowance which have been charged against earnings, and certain ratios related to the allowance for loan losses.

22

---

|Allowance for Loan Losses                  
|-------------------------------------------
|                                           
|                                           
|                                           
|                                           
|                                           
|Balances:                                  
|Average total loans                        
|outstanding during period                  
|Total loans outstanding                    
|at end of the period                       
|Allowance for loan losses:                 
|Balance at the beginning of period         
|Provision charged to expense               
|Charge-offs                                
|Construction loans                         
|Commercial loans                           
|Commercial real estate loans               
|Installment loans                          
|Total                                      
|Recovrries                                 
|Construction loans                         
|Commercial loans                           
|Commercial real estate loans               
|Installment loans                          
|Total                                      
|Net loan chage-offs                        
|(recoveries)                               
|Balance                                    
|                                           
|Ratios:                                    
|Net loan charge-offs to average total loans
|Allowance for loan losses to total loans at
|the end of the period                      
|Net loan charge-offs (recoveries) to       
|allowance for loan losses at the end of the
|period                                     
|Net loan charge-offs (recoveries) to       
|Provision for loan losses                  

At September 30, 2008 and December 31, 2007, the allowance for loan losses was $662,142 and $725,211 respectively. The ratios of the allowance for loan losses to total loans at September 30, 2008 and December 31, 2007 were 1.38% and 1.36%, respectively. During the first quarter of 2008, the Company recovered $70,018 from loans charged off in 2007. During the second and third quarters, one unsecured commercial loan was fully charged off and a construction loan was partially charged off for a total of $494,627. The nonperforming loan, coupled with the recent down-grade of certain performing loans, and looking at a number of economic events occurring in and around the real estate industry, led Management to increase its provision for loan losses. All loans charged off in prior years were recovered in full. Management continues to vigorously pursue recoveries for loans charged off in 2008.

While Management believes that the amount of the allowance at September 30, 2008 was adequate, there can be no assurances that future economic or other factors will not adversely affect the Companys borrowers, or that the Companys asset quality may not deteriorate through rapid growth, failure to identify and monitor potential problem loans or for other reasons, thereby causing loan losses to exceed the current allowance.

23

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Investment Portfolio

The Company has not purchased securities during 2008, using funds from maturities and principal payments from securities for investment in the overnight market and in higher-yielding loans to its customers. The primary category of investments in the portfolio at September 30, 2008 was mortgage-backed securities. At September 30, 2008, 47.5% of the mortgage-backed securities were tied to adjustable rate indices such as LIBOR or Constant Maturity Treasury (CMT). Management anticipates purchasing additional investment securities in the future due to the decline in loan demand.

The table below summarizes the carrying value and market value and distribution of the Companys investment securities at September 30, 2008 and December 31, 2007:

September 30, 2008
     
     December 31, 2007Carrying
     
     Fair
     
     Carrying
     
     FairValue
     
     Value
     
     Value
     
     Value($ in thousands)Held to maturity:Municipal
     
     $ 440
     
     $ 437
     
     $ 441
     
     $ 450Mortgage-backed securities
     
     2,710
     
     2,718
     
     3,224
     
     3,212Corporate bonds
     
     174
     
     178
     
     208
     
     218Total held to maturity
     
     3,324
     
     3,333
     
     3,873
     
     3,880Available for sale:Federal agency
     
     0
     
     0
     
     997
     
     997Municipal
     
     696
     
     696
     
     737
     
     737Mortgage-backed
     
     4,559
     
     4,559
     
     5,605
     
     5,605Total available for sale
     
     5,255
     
     5,255
     
     7,339
     
     7,339Total
     
     $ 8,579
     
     $ 8,588
     
     $ 11,212
     
     $ 11,219


There were no material changes since December 31, 2007 in the maturities or repricing of the investment securities.

Deposits

The Company has experienced a reduction in deposit balances, mainly from its customers in the real estate and related industries. Total deposits decreased $2.6 million or 3.7% to $67.8 million at September 30, 2008 from $70.4 million at December 31, 2007 primarily due to the decrease in demand deposit balances, which decreased $7.5 million or 17.7% to $34.8 million at September 30, 2008 from $42.3 million at December 31, 2007, which was partially offset by increases in money market and NOW accounts. Money market demand and NOW deposits increased by $2.0 million to $24.7 million at September 30, 2008 from $22.7 million at December 31, 2007. The ratio of non-interest bearing funds to total deposits was 51.3% at September 30, 2008 and 60.1% at December 31, 2007.

Deposits are the Companys primary source of funds. As the Companys need for lendable funds grows, dependence on deposits increases. The Company is soliciting other industries in its geographical areas to replace the runoff from customers in the real estate industry. Information concerning the average balance and average rates paid on deposits by deposit type for the three and nine months ended September 30, 2008 and 2007 is contained in the Distribution, Yield and Rate Analysis of Net Interest Income tables appearing in a previous section entitled Net Interest Income and Net Interest Margin. At September 30, 2008 and December 31, 2007, the Company had deposits from related parties of $4.2 million, or 6.2% of total deposits and $9.9 million, or 14.0% of total deposits, respectively. Further, at September 30, 2008 and December 31, 2007, deposits from escrow companies represented 15.5% and 20.7% of the Companys total deposits, respectively. There are some escrow company deposits which are also classified as deposits from related parties.

Borrowings

24

---

At September 30, 2008 and December 31, 2007, the Company had no Federal Home Loan Bank (FHLB) advances or overnight borrowings outstanding. On December 21, 2005, the Company entered into a stand by letter of credit with the FHLB for $800,000, which matures and renews annually, as needed. This stand-by letter of credit was issued as collateral for local agency deposits that the Company is maintaining.

Liquidity

Maintenance of adequate liquidity requires that sufficient resources be available at all times to meet the Companys cash flow requirements. Liquidity in a banking institution is required primarily to provide for deposit withdrawals and the credit needs of its customers and to take advantage of investment opportunities as they arise. Liquidity management involves the Companys ability to convert assets into cash or cash equivalents without significant loss, and to raise cash or maintain funds without incurring excessive additional cost. The Company maintains a portion of its funds in cash, deposits in other banks, overnight investments, and securities held for sale. Liquid assets include cash and due from banks, less the federal reserve requirement; Federal funds sold; interest-bearing deposits in financial institutions, and unpledged investment securities available for sale. At September 30, 2008, the Companys liquid assets totaled approximately $20.9 million and its liquidity level, measured as the percentage of liquid assets to total assets, was 26.9% . At December 31, 2007, the Companys liquid assets totaled approximately $18.4 million and its liquidity level, measured as the percentage of liquid assets to total assets, was 23.0% .The Company's assets and liabilities are managed to achieve a liquidity and dependency ratio of at least eight percent (8.0%) positive.Management anticipates that liquid assets and the liquidity level will decline as the Company becomes more leveraged in the future.

Although the Companys primary sources of liquidity include liquid assets and a stable deposit base, the Company has Fed funds lines of credit of $4 million each with both Union Bank of California and Pacific Coast Bankers Bank. In addition, as a member of the FHLB, the Bank may borrow funds collateralized by the Banks securities or qualified loans up to 25% of its total asset base, or $19.4 million at September 30, 2008.

Capital Resources

Total stockholders equity was $6.0 million at September 30, 2008 and $5.9 million at December 31, 2007. There was an overall increase of $116,547. Stock repurchases under the Companys stock repurchase program during the nine months ended September 30, 2008 (all of which occurred during the first quarter) totaled $99,748 for 4,480 shares. Net income increased retained earnings by $263,012. A cumulative-effect adjustment to retained earnings for prior period postretirement benefits reduced equity by $24,693. The change in the unrealized loss on securities available for sale decreased equity by $22,024 during the nine months ended September 30, 2008.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can trigger mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a material effect on the Banks financial statements and operations. Under capital adequacy guidelines and regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Banks assets, liabilities, and certain off-balance sheet items as calculated under regulatory accepted accounting practices. The Banks capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain the following minimum ratios: Total risk-based capital ratio of at least 8%, Tier 1 Risk-based capital ratio of at least 4%, and a leverage ratio of at least 4%. Total capital is classified into two components: Tier 1 (common shareholders equity, qualifying perpetual preferred stock to certain limits, minority interests in equity accounts of consolidated subsidiary and trust preferred securities to certain limits, less goodwill and other intangibles) and Tier 2 (supplementary capital including allowance for possible credit losses to certain limits, certain preferred stock, eligible subordinated debt, and other qualifying instruments).

The Bank had Total Risk-Based and Tier 1 Risk-Based capital ratios of 16.93% and 15.75%, respectively at September 30, 2008, as compared to 15.31% and 14.07%, respectively at December 31, 2007. At September 30, 2008 and December 31, 2007, the Banks Leverage Capital Ratios were 11.91% and 10.84%, respectively. As of September 30, 2008 and December 31, 2007, the Bank was well-capitalized. To be categorized as well-

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capitalized the Bank must maintain Total Risk-Based, Tier 1 Risk-Based, and Tier 1 Leverage Ratios of at least 10%, 6% and 5%, respectively.

Under the Federal Reserve Boards guidelines, Chino Commercial Bancorp is a small bank holding company, and thus qualifies for an exemption from the consolidated risk-based and leverage capital adequacy guidelines applicable to bank holding companies with assets of $500 million or more. However, while not required to do so under the Federal Reserve Boards capital adequacy guidelines, the Company still maintains levels of capital on a consolidated basis which qualify it as well capitalized. As of September 30, 2008, the Companys Total Risk-Based and Tier 1 Risk-Based Capital ratios were 17.14% and 14.06%, respectively, and its Leverage Capital ratio was 10.64% .

As noted previously, the Companys subordinated note represents $3.1 million borrowings from its unconsolidated trust subsidiary. This subordinated note currently qualifies for inclusion as Tier 1 capital for regulatory purposes to the extent that they do not exceed 25% of total Tier 1 capital. On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued inclusion of trust-preferred securities (and/or related subordinated debentures) in the Tier 1 capital of bank holding companies. Generally, the amount of junior subordinated debentures in excess of the 25% Tier 1 limitation is included in Tier 2 capital. Of the Companys $8.0 million of Tier 1 capital at September 30, 2008, $2.0 million consisted of Trust Preferred Securities. The remaining $1.1 million of Trust Preferred Securities is included in Tier 2 capital.

The following table sets forth the Companys and the Banks regulatory capital ratios as of the dates indicated:

Risk Based Ratios(unaudited)September 30,
     
     December 31,
     
     Minimum Requirement2008
     
     2007
     
     to be Well CapitalizedChino Commercial BancorpTotal capital to total risk-weighted assets
     
     17.14%
     
     15.75%
     
     10.00%Tier 1 capital to total risk-weighted assets
     
     14.06%
     
     12.66%
     
     6.00%Tier 1 leverage ratio
     
     10.64%
     
     9.74%
     
     5.00%Chino Commercial BankTotal capital to total risk-weighted assets
     
     16.93%
     
     15.31%
     
     10.00%Tier 1 capital to total risk-weighted assets
     
     15.75%
     
     14.07%
     
     6.00%Tier 1 leverage ratio
     
     11.91%
     
     10.84%
     
     5.00%


Presently, there are no outstanding commitments that would necessitate the use of material amounts of the Companys capital.

Interest Rate Risk Management

The principal objective of interest rate risk management (often referred to as asset/liability management) is to manage the financial components of the Companys balance sheet so as to optimize the risk/reward equation for earnings and capital in relation to changing interest rates. In order to identify areas of potential exposure to rate changes, the Company calculates its repricing gap on a quarterly basis. It also performs an earnings simulation analysis and market value of portfolio equity calculation on a quarterly basis to identify more dynamic interest rate exposures than those apparent in standard repricing gap analysis.

The Company manages the balance between rate-sensitive assets and rate-sensitive liabilities being repriced in any given period with the objective of stabilizing net interest income during periods of fluctuating interest rates. Rate-sensitive assets either contain a provision to adjust the interest rate periodically or mature within one year. Those assets include certain loans, certain investment securities and federal funds sold. Rate-sensitive liabilities allow for periodic interest rate changes and include time certificates, certain savings and interest-bearing demand deposits. The difference between the aggregate amount of assets and liabilities that are repricing at various time frames is called the interest rate sensitivity gap. Generally, if repricing assets exceed repricing liabilities in any given time period the Company would be deemed to be asset-sensitive for that period, and if repricing liabilities exceed repricing assets in any given period the Company would be deemed to be liability-sensitive for that period. The

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Company seeks to maintain a balanced position over the period of one year in which it has no significant asset or liability sensitivity, to ensure net interest margin stability in times of volatile interest rates. This is accomplished by maintaining a significant level of loans and deposits available for repricing within one year.

The Company is generally asset sensitive, meaning that net interest income tends to rise as interest rates rise and decline as interest rates fall. At September 30, 2008, approximately 61.3% of loans have terms that incorporate variable interest rates. Most variable rate loans are indexed to the Banks prime rate and changes occur as the prime rate changes. Approximately 15.7% of all fixed rate loans at September 30, 2008 mature within twelve months.

Regarding the investment portfolio, a preponderance of the portfolio consists of fixed rate products with typical average lives of between three and five years. The mortgage-backed security portfolio receives monthly principal repayments which has the effect of reducing the securities average lives as principal repayments levels may exceed expected levels. Additionally, agency securities contain options by the agency to call the security, which would cause repayment prior to scheduled maturity.

Liability costs are generally based upon, but not limited to, U.S. Treasury interest rates and movements and rates paid by local competitors for similar products.

The change in net interest income may not always follow the general expectations of an asset-sensitive or liability-sensitive balance sheet during periods of changing interest rates. This possibility results from interest rates earned or paid changing by differing increments and at different time intervals for each type of interest-sensitive asset and liability. The interest rate gaps reported arise when assets are funded with liabilities having different repricing intervals. Since these gaps are actively managed and change daily as adjustments are made in interest rate views and market outlook, positions at the end of any period may not reflect the Banks interest rate sensitivity in subsequent periods. The Company attempts to balance longer-term economic views against prospects for short-term interest rate changes in all repricing intervals.

The Company uses Risk Monitor software for asset/liability management in order to simulate the effects of potential interest rate changes on the Companys net interest margin. These simulations provide static information on the projected fair market value of the Companys financial instruments under differing interest rate assumptions. The simulation program utilizes specific loan and deposit maturities, embedded options, rates and re-pricing characteristics to determine the effects of a given interest rate change on the Companys interest income and interest expense. Rate scenarios consisting of key rate and yield curve projections are run against the Companys investment, loan, deposit and borrowed funds portfolios. The rate projections can be shocked (an immediate and sustained change in rates, up or down). The Company typically uses standard interest rate scenarios in conducting the simulation of upward and downward shocks of 100 and 200 basis points (bp). As of September 30, 2008, the Company had the following estimated net interest income sensitivity profile:



|Immediate Change in Rate
|------------------------

-200 bp
     
     -100 bp
     
     +100 bp
     
     +200 bpChange in Net interest income (in $000s)
     
     $ (219)
     
     $ (100)
     
     $ 71
     
     $ 137% Change
     
     -6.53%
     
     -2.98%
     
     2.12%
     
     4.08%


Risk Management

Various types of risk are inherent in the business of banking. Federal regulators have adopted examination guidelines that scrutinize not only the Companys level of risk, but also its ability to manage and control that risk. Regulators evaluate risks that affect capital, liquidity, and compliance to determine their potential effect on the safety and soundness of the Company. Certain risks may be covered by insurance coverage, but management must establish a risk management approach that addresses all areas of risk.

The Company has in place acceptable limits for each of the risks identified by the regulatory environment. The Company has defined the types of risk, and has mechanisms in place to manage, monitor and report these risks. Specifically, the Company focuses on various risk categories within each area of the Company. Those categories include: credit risk, interest rate risk, liquidity risk, market/strategic risk, transaction risk, and compliance risk.

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Item 3.

QUALITATIVE & QUANTITATIVE DISCLOSURES ABOUT MARKET RISK



|Not applicable.
|---------------



|Item 4T.CONTROLS AND PROCEDURES
|-------------------------------

Evaluation of Disclosure Controls and Procedures

The Companys Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company's disclosure controls and procedures as defined in Exchange Act Rules 13a-15(e) promulgated under the Exchange Act as of the end of the period covered by this report (the "Evaluation Date") have concluded that as of the Evaluation Date, the Companys disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the Company, particularly during the period in which this report was being prepared. Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls

There were no significant changes in the Company's internal controls over financial reporting or in other factors in the third quarter of 2008 that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial reporting.

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PART II

Item1: Legal ProceedingsNone

Item 1A: Risk FactorsNot applicable

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

Stock Repurchases

On October 19, 2006, the Board of Directors approved a stock repurchase program pursuant to which the Company may purchase up to $3.0 million in its common stock in open market transactions or in privately negotiated transactions. The repurchase program was initially approved for a period of up to 12 months and has been extended to October 31, 2008. As anticipated and announced at the inception of the plan, certain non-employee directors have sold a significant amount of the Companys stock in the repurchase program. The Board of Directors also authorized an additional $100,000 for stock repurchase under the Companys stock repurchase plan since it was originally approved.

Since the commencement of the Stock Repurchase Program and through September 30, 2008 the Company has acquired and retired 141,601 of its shares at a weighted average price of $21.90 per share. The Repurchase Program is designed to improve the Company's return on equity and earnings per share, and to provide an additional outlet for shareholders interested in selling their shares. Repurchases pursuant to the program are made at the prevailing market prices from time to time in open market transactions or in privately negotiated transactions. The timing of the purchases and the number of shares to be repurchased at any given time will depend on market conditions and SEC regulations.

There was no common stock repurchased under the Plan during the third quarter of 2008.

Item 3: Default of Senior Securities- None

Item 4: Submission of Matters to Vote of Security Holders- None

Item 5: Other Information- None

Item 6: Exhibits

3.1
     Articles of Incorporation of Chino Commercial Bancorp (1)3.2
     Bylaws of Chino Commercial Bancorp (1)10.1
     2000 Stock Option Plan (1)10.2
     Chino Commercial Bank, N.A. Salary Continuation Plan (1)10.3
     Salary Continuation and Split Dollar Agreements for Dann H. Bowman (1)10.4
     Employment Agreement for Dann H. Bowman (2)10.5
     Salary Continuation and Split Dollar Agreements for Roger Caberto (1)10.6
     Item Processing Agreement between the Bank and InterCept Group (1)10.7
     Data Processing Agreement between the Bank and InterCept Group (1)10.8
     Lease between Chino Commercial Bank, N.A. and Majestic Realty Co., as amended (3)10.9
     Indenture dated as of October 27, 2006 between U.S. Bank National Association, as Trustee, and Chino Commercial Bancorp, as Issuer (3)10.10
     Amended and Restated Declaration of Trust of Chino Statutory Trust I, dated as of October 27, 2006 (3)10.11
     Guarantee Agreement between Chino Commercial Bancorp and U.S. Bank National Association dated as of October 27, 2006 (3)11
     Statement Regarding Computation of Net Income Per Share (4)31.1
     Certification of Chief Executive Officer (Section 302 Certification)31.2
     Certification of Chief Financial Officer (Section 302 Certification)


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32 Certification of Periodic Financial Report (Section 906 Certification)

(1)
     Incorporated by reference to the exhibit of the same number to the Companys Registration Statement on Form S-8 as filed with the Securities and Exchange Commission on July 5, 2006.(2)
     Incorporated by reference to exhibit 10.1 to the Companys Form 8-K Current Report filed with the Securities and Exchange Commission on November 13, 2006.(3)
     Incorporated by reference to the exhibit of the same number to the Companys Quarterly Report on Form 10-QSB for the quarterly period ended September 30, 2006.(4)
     The information required by this exhibit is incorporated from Note 3 of the Companys Financial Statements included herein.


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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

|Dated: November 7, 2008 |  | CHINO COMMERCIAL BACORP                          
|----------------------- |  | -------------------------------------------------
|                       
|                       
|                        |  | By:/s/ Dann H. Bowman___________                 
|                        |  | Dann H. Bowman                                   
|                        |  | President and Chief Executive Officer            
|                       
|                       
|                        |  | By:/s/ Sandra F. Pender                          
|                        |  | Sandra F. Pender                                 
|                        |  | Senior Vice President and Chief Financial Officer

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