Tableof Contents

 

 

 

##### **UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

###### **Washington, D.C. 20549**

###### ** **

##### **FORM 10-K**

#### ** **

**(MarkOne):**

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

 

**For thefiscal year ended:  December 31,2008**

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

 

**For thetransition period from:                       to**

 

**CommissionFile Number:  000-18464**

 

##### **EMCLAIRE FINANCIAL CORP.**

(Exact name of registrant as specified in its charter)

 

| **Pennsylvania**                                                | ** ** | **25-1606091**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **612  Main Street, Emlenton, PA**                              | ** ** | **16373**                             |
| (Address of  principal executive office)                        |       | (Zip Code)                            |

 

Registrant’s telephonenumber: ** (724)867-2311**

 

| Securities registered  pursuant to Section 12(b) of the Act: |   | **None.** |   | **OTC  Electronic Bulletin Board (OTCBB)** |
|------------------------------------------------------------------------|--------|-----------|--------|--------------------------------------------|
|                                                                   |   |      |   | Name of exchange  on which registered      |

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

# **Common Stock, par value $1.25 per share**

 (Title ofClass)

 

 Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.

YES o  NO x.

 

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.

YES o  NO x.

 

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

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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

 
| Large accelerated filer o |   | Accelerated filer o |   | Non-accelerated filer o |   | Smaller reporting company x |
|---------------------------|--------|---------------------|--------|-------------------------|--------|-----------------------------|

 

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

 

As of June 30,2008, the aggregate value of the 1,267,835 shares of Common Stock of theRegistrant issued and outstanding on such date, which excludes 152,410 sharesheld by the directors and officers of the Registrant as a group, wasapproximately $28.7 million.  This figureis based on the last sales price of $25.75 per share of the Registrant’s CommonStock on June 30, 2008.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of the ProxyStatement for the 2009 Annual Meeting of Stockholders are incorporated byreference in Part III of this Form 10-K.

 

 

 

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Tableof Contents

 

**EMCLAIREFINANCIAL CORP.**

 

**TABLE OFCONTENTS**

 
| **PART I**                    |
|------------------------------------|
|                               |   |   |   |
| Item 1.                            | Business |   | K-3 |
|                               |   |   |   |
| Item 1A.                           | Risk Factors |   | K-18 |
|                               |   |   |   |
| Item 1B.                           | Unresolved  Staff Comments |   | K-19 |
|                               |   |   |   |
| Item 2.                            | Properties |   | K-20 |
|                               |   |   |   |
| Item 3.                            | Legal Proceedings |   | K-20 |
|                               |   |   |   |
| Item 4.                            | Submission  of Matters to a Vote of Security Holders |   | K-20 |
|                               |   |   |   |
| **PART II**                   |
|                               |   |   |   |
| Item 5.                            | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities |   | K-20 |
|                               |   |   |   |
| Item 6.                            | Selected Financial  Data |   | K-21 |
|                               |   |   |   |
| Item 7.                            | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   | K-21 |
|                               |   |   |   |
| Item 7A.                           | Quantitative  and Qualitative Disclosures about Market Risk |   | K-32 |
|                               |   |   |   |
| Item 8.                            | Financial  Statements and Supplementary Data |   | K-32 |
|                               |   |   |   |
| Item 9.                            | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure |   | K-32 |
|                               |   |   |   |
| Item 9A(T).                        | Controls and  Procedures |   | K-32 |
|                               |   |   |   |
| Item 9B.                           | Other Information |   | K-33 |
|                               |   |   |   |
| **PART III**                  |
|                               |   |   |   |
| Item 10.                           | Directors,  Executive Officers and Corporate Governance |   | K-33 |
|                               |   |   |   |
| Item 11.                           | Executive  Compensation |   | K-33 |
|                               |   |   |   |
| Item 12.                           | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters |   | K-33 |
|                               |   |   |   |
| Item 13.                           | Certain  Relationships and Related Transactions, and Director Independence |   | K-34 |
|                               |   |   |   |
| Item 14.                           | Principal  Accountant Fees and Services |   | K-34 |
|                               |   |   |   |
| **PART IV**                   |
|                               |   |   |   |
| Item 15.                           | Exhibits and  Financial Statement Schedules |   | K-34 |
|                               |   |   |   |
| **SIGNATURES  AND CERTIFICATIONS** |

 

K-2

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*Discussions of certain matters inthis Form 10-K and other related year end documents may constituteforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended (the Exchange Act), and as such, may involverisks and uncertainties.  Forward-lookingstatements, which are based on certain assumptions and describe future plans,strategies, and expectations, are generally identifiable by the use of words orphrases such as “believe”, “plan”, “expect”, “intend”, “anticipate”, “estimate”,“project”, “forecast”, “may increase”, “may fluctuate”, “may improve” andsimilar expressions of future or conditional verbs such as “will”, “should”, “would”,and “could”.  These forward-lookingstatements relate to, among other things, expectations of the businessenvironment in which the Corporation operates, projections of futureperformance, potential future credit experience, perceived opportunities in themarket and statements regarding the Corporation’s mission and vision.  The Corporation’s actual results, performanceand achievements may differ materially from the results, performance, andachievements expressed or implied in such forward-looking statements due to awide range of factors.  These factorsinclude, but are not limited to, changes in interest rates, general economicconditions, the local economy, the demand for the Corporation’s products andservices, accounting principles or guidelines, legislative and regulatorychanges, monetary and fiscal policies of the U.S. Government, U.S. Treasury,and Federal Reserve, real estate markets, competition in the financial servicesindustry, attracting and retaining key personnel, performance of new employees,regulatory actions, changes in and utilization of new technologies and otherrisks detailed in the Corporation’s reports filed with the Securities andExchange Commission (SEC) from time to time. These factors should be considered in evaluating the forward-lookingstatements, and undue reliance should not be placed on such statements.  The Corporation does not undertake, andspecifically disclaims any obligation, to update any forward-looking statementsto reflect occurrences or unanticipated events or circumstances after the dateof such statements.*

 

**PART I**

 

**Item 1. Business**

 

**General**

 

Emclaire Financial Corp.(the Corporation) is a Pennsylvania corporation and financial holding companythat provides a full range of retail and commercial financial products andservices to customers in western Pennsylvania through its wholly ownedsubsidiary bank, the Farmers National Bank of Emlenton (the Bank).  The Corporation also provides real estatesettlement services to Bank and other customers through its subsidiary,Emclaire Settlement Services, LLC (the Title Company).  In addition, the Bank provides investmentadvisory services through its Farmers National Financial Services division.

 

The Bank was organized in1900 as a national banking association and is a financial intermediary whoseprincipal business consists of attracting deposits from the general public andinvesting such funds in real estate loans secured by liens on residential andcommercial property, consumer loans, commercial business loans, marketablesecurities and interest-earning deposits. The Bank operates through a network of twelve retail branch offices inVenango, Butler, Clarion, Clearfield, Elk, Jefferson and Mercer counties,Pennsylvania.  The Corporation and theBank are headquartered in Emlenton, Pennsylvania.

 

The Bank is subject toexamination and comprehensive regulation by the Office of the Comptroller of theCurrency (OCC), which is the Bank’s chartering authority, and the FederalDeposit Insurance Corporation (FDIC), which insures customer deposits held bythe Bank to the full extent provided by law. The Bank is a member of the Federal Reserve Bank of Cleveland (FRB) andthe Federal Home Loan Bank of Pittsburgh (FHLB).  The Corporation is a registered financialholding company pursuant to the Bank Holding Company Act of 1956 (BHCA), asamended.

 

The Corporation completedthe acquisition of Elk County Savings and Loan Association (ECSLA) and themerger conversion of ECSLA with and into the Bank as of October 17,2008.  Associated with the mergerconversion, the Corporation also conducted a common stock offering to eligibledepositors and borrowers of ECSLA and the general public.  The merger conversion and the offeringgenerated $4.5 million in additional equity for the Corporation.

 

K-3

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OnDecember 23, 2008 the Corporation issued to the U.S. Department of theTreasury (U.S. Treasury), in exchange for aggregate consideration of $7.5million, 7,500 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A,with a liquidation preference of $1,000, and a ten year warrant to purchase upto 50,836 shares of the Corporation’s common stock at an exercise price of$22.13 per share.  The preferredsecurities pay cumulative dividends of 5% a year for the first five years and9% a year thereafter.

 

At December 31,2008, the Corporation had $375.7 million in total assets, $36.1 million instockholders’ equity, $264.8 million in loans and $286.6 million in deposits.

 

**LendingActivities**

 

***General****.*  The principallending activities of the Bank are the origination of residential mortgage,commercial mortgage, commercial business and consumer loans. Significantly allof the Bank’s loans are secured by property in the Bank’s primary market area.

 

***One-to-FourFamily Mortgage Loans****.*  The Bank offers first mortgage loans securedby one-to-four family residences located in the Bank’s primary lendingarea.  Typically such residences aresingle-family owner occupied units.  TheBank is an approved, qualified lender for the Federal Home Loan MortgageCorporation (FHLMC).  As a result, theBank may sell loans to and service loans for the FHLMC in market conditions andcircumstances where this is advantageous in managing interest rate risk.

 

***HomeEquity Loans****.*  The Bank originates home equity loans securedby single-family residences.  These loansmay be either a single advance fixed-rate loan with a term of up to 20 years,or a variable rate revolving line of credit. These loans are made only on owner-occupied single-family residences.

 

***CommercialBusiness and Commercial Real Estate Loans****.*  Commercial lendingconstitutes a significant portion of the Bank’s lending activities.  Commercial business and commercial realestate loans amounted to 47.3% of the total loan portfolio at December 31,2008.  Commercial real estate loansgenerally consist of loans granted for commercial purposes secured bycommercial or other nonresidential real estate. Commercial loans consist of secured and unsecured loans for such itemsas capital assets, inventory, operations and other commercial purposes.

 

***ConsumerLoans****.*  Consumer loans generally consist offixed-rate term loans for automobile purchases, home improvements not securedby real estate, capital and other personal expenditures.  The Bank also offers unsecured revolvingpersonal lines of credit and overdraft protection.

 

***Loans******to One Borrower****.*  National banks aresubject to limits on the amount of credit that they can extend to oneborrower.  Under current law, loans toone borrower are limited to an amount equal to 15% of unimpaired capital andsurplus on an unsecured basis, and an additional amount equal to 10% ofunimpaired capital and surplus if the loan is secured by readily marketablecollateral.  At December 31, 2008,the Bank’s loans to one borrower limit based upon 15% of unimpaired capital was$5.4 million.  At December 31, 2008, the Bank had no single lending relationshipexceeding this limit.

 

K-4

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***Loan Portfolio****. *Thefollowing table sets forth the composition and percentage of the Corporation’sloans receivable in dollar amounts and in percentages of the portfolio as of December 31:

 
| ** **                                       | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                       | ** ** | **Dollar** | ** ** | ** ** | ** ** | **Dollar** | ** ** | ** ** | ** ** | **Dollar** | ** ** | ** ** | ** ** | **Dollar** | ** ** | ** ** | ** ** | **Dollar** | ** ** | ** ** | ** ** |
| **(Dollar amounts in thousands)** | ** ** | **Amount** | ** ** | **%**      | ** ** | **Amount** | ** ** | **%**      | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Mortgage loans on  real estate:                  |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Residential first  mortgages                     |       | $          | 74,130     |       | 27.7       | %          | $          | 65,706     |       | 28.3       | %          | $ | 64,662 |   | 30.0 | % | $ | 66,011 |   | 34.0 | % | $ | 69,310 |   | 38.2 | % |
| Home equity loans  and lines of credit           |       | 57,454     |       | 21.5       | %          | 49,426     |       | 21.3       | %          | 47,330     |       | 22.0 | % | 39,933 |   | 20.5 | % | 31,548 |   | 17.4 | % |
| Commercial                                       |       | 85,689     |       | 32.1       | %          | 71,599     |       | 30.9       | %          | 61,128     |       | 28.4 | % | 52,990 |   | 27.3 | % | 48,539 |   | 26.8 | % |
|                                             |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total real estate  loans                         |       | 217,273    |       | 81.3       | %          | 186,731    |       | 80.5       | %          | 173,120    |       | 80.4 | % | 158,934 |   | 81.8 | % | 149,397 |   | 82.4 | % |
|                                             |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Other loans:                                     |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Commercial  business                             |       | 40,787     |       | 15.2       | %          | 35,566     |       | 15.3       | %          | 34,588     |       | 16.0 | % | 27,732 |   | 14.2 | % | 23,898 |   | 13.2 | % |
| Consumer                                         |       | 9,429      |       | 3.5        | %          | 9,679      |       | 4.2        | %          | 7,671      |       | 3.6 | % | 7,729 |   | 4.0 | % | 8,090 |   | 4.4 | % |
|                                             |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total other loans                                |       | 50,216     |       | 18.7       | %          | 45,245     |       | 19.5       | %          | 42,259     |       | 19.6 | % | 35,461 |   | 18.2 | % | 31,988 |   | 17.6 | % |
|                                             |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total loans  receivable                          |       | 267,489    |       | 100.0      | %          | 231,976    |       | 100.0      | %          | 215,379    |       | 100.0 | % | 194,395 |   | 100.0 | % | 181,385 |   | 100.0 | % |
| Less:                                            |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for  loan losses                       |       | 2,651      |       |       |       | 2,157      |       |       |       | 2,035      |       |   |   | 1,869 |   |   |   | 1,810 |   |   |   |
|                                             |       |       |       |       |       |       |       |       |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Net loans  receivable                            |       | $          | 264,838    |       |       |       | $          | 229,819    |       |       |       | $ | 213,344 |   |   |   | $ | 192,526 |   |   |   | $ | 179,575 |   |   |   |

 

The following table setsforth the scheduled contractual principal repayments or interest repricing ofloans in the Corporation’s portfolio as of December 31, 2008.  Demand loans having no stated schedule ofrepayment and no stated maturity are reported as due within one year.

 
| ** **                                       | ** ** | **Due in one**   | ** ** | **Due from one**  | ** ** | **Due from five** | ** ** | **Due after** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|-----------------------------|------------|--------------------|------------|------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **year or less** | ** ** | **to five years** | ** ** | **to ten years**  | ** ** | **ten years** | ** ** | **Total**  | ** ** |
| Residential  mortgages                           |       | $                          | 1,518      |                        | $          | 4,938                       |       | $                  | 14,162     |       | $          | 53,512 |   | $ | 74,130 |   |
| Home equity  loans and lines of credit           |       | 130                        |       | 6,040                       |       | 22,446                      |       | 28,838             |       | 57,454     |       |
| Commercial  mortgages                            |       | 3,821                      |       | 3,599                       |       | 13,664                      |       | 64,605             |       | 85,689     |       |
| Commercial  business                             |       | 4,085                      |       | 11,438                      |       | 6,552                       |       | 18,712             |       | 40,787     |       |
| Consumer                                         |       | 362                        |       | 7,759                       |       | 913                         |       | 395                |       | 9,429      |       |
|                                             |       | $                          | 9,916      |                        | $          | 33,774                      |       | $                  | 57,737     |       | $          | 166,062 |   | $ | 267,489 |   |

 

The following table setsforth the dollar amount of the Corporation’s fixed and adjustable rate loanswith maturities greater than one year as of December 31, 2008:

 
| ** **                                       | ** ** | **Fixed** | ** ** | **Adjustable** | ** ** |
|--------------------------------------------------|------------|-----------|------------|----------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **rates** | ** ** | **rates**      | ** ** |
|                                             |       |      |       |           |       |
| Residential  mortgage                            |       | $         | 51,745     |           | $          | 20,867 |   |
| Home equity  loans and lines of credit           |       | 53,358    |       | 3,966          |       |
| Commercial  mortgage                             |       | 35,117    |       | 46,751         |       |
| Commercial  business                             |       | 33,250    |       | 3,452          |       |
| Consumer                                         |       | 9,067     |       | —         |       |
|                                             |       | $         | 182,537    |           | $          | 75,036 |   |

 

Contractual maturities ofloans do not reflect the actual term of the Corporation’s loan portfolio.  The average life of mortgage loans issubstantially less than their contractual terms because of loan prepayments andenforcement of due-on-sale clauses, which give the Corporation the right todeclare a loan immediately payable in the event, among other things, that theborrower sells the real property subject to the mortgage.  Scheduled principal amortization also reducesthe average life of the loan portfolio. The average life of mortgage loans tends to increase when current marketmortgage rates substantially exceed rates on existing mortgages and conversely,decrease when rates on existing mortgages substantially exceed current marketinterest rates.

 

K-5

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**Delinquencies and ClassifiedAssets**

 

***Delinquent Loans and Real Estate Acquired ThroughForeclosure (REO)****. *Typically,a loan is considered past due and a late charge is assessed when the borrowerhas not made a payment within fifteen days from the payment due date.  When a borrower fails to make a requiredpayment on a loan, the Corporation attempts to cure the deficiency bycontacting the borrower.  The initialcontact with the borrower is made shortly after the seventeenth day followingthe due date for which a payment was not received.  In most cases, delinquencies are curedpromptly.

 

If the delinquencyexceeds 60 days, the Corporation works with the borrower to set up asatisfactory repayment schedule. Typically loans are considered non-accruing upon reaching 90 daysdelinquent, although the Corporation may be receiving partial payments ofinterest and partial repayments of principal on such loans.  When a loan is placed in non-accrual status,previously accrued but unpaid interest is deducted from interest income.  The Corporation institutes foreclosure actionon secured loans only if all other remedies have been exhausted.  If an action to foreclose is instituted andthe loan is not reinstated or paid in full, the property is sold at a judicialor trustee’s sale at which the Corporation may be the buyer.

 

Real estate propertiesacquired through, or in lieu of, foreclosure are to be sold and are initiallyrecorded at fair value at the date of foreclosure establishing a new costbasis.  After foreclosure, managementperiodically performs valuations and the real estate is carried at the lower ofcarrying amount or fair value less cost to sell.  Revenue and expenses from operations andchanges in the valuation allowance are included in loss on foreclosed realestate.  The Corporation generallyattempts to sell its REO properties as soon as practical upon receipt of cleartitle.  The original lender typicallyhandles disposition of those REO properties resulting from loans purchased inthe secondary market.

 

As of December 31,2008, the Corporation’s non-performing assets, which include non-accrual loans,loans delinquent due to maturity, troubled debt restructuring, repossessionsand REO, amounted to $1.1 million or 0.28% of the Corporation’s totalassets.  Interest income of $78,000 wouldhave been recorded in 2008 if these loans had been current and were outstandingduring the entire period.  Interest of$43,000 on these loans was included in income during 2008.

 

***Classified Assets****.*  Regulations applicable to insuredinstitutions require the classification of problem assets as “substandard,” “doubtful,”or “loss” depending upon the existence of certain characteristics as discussedbelow.  A category designated “specialmention” must also be maintained for assets currently not requiring the aboveclassifications but having potential weakness or risk characteristics thatcould result in future problems.  Anasset is classified as substandard if not adequately protected by the currentnet worth and paying capacity of the obligor or of the collateral pledged, ifany.  A substandard asset ischaracterized by the distinct possibility that the Corporation will sustainsome loss if the deficiencies are not corrected.  Assets classified as doubtful have all theweaknesses inherent in those classified as substandard.  In addition, these weaknesses make collectionor liquidation in full, on the basis of currently existing facts, conditionsand values, highly questionable or improbable. Assets classified as loss are considered uncollectible and of suchlittle value that their continuance as assets is not warranted.

 

The Corporation’sclassification of assets policy requires the establishment of valuationallowances for loan losses in an amount deemed prudent by management.  Valuation allowances represent lossallowances that have been established to recognize the inherent risk associatedwith lending activities.  When theCorporation classifies a problem asset as a loss, the portion of the assetdeemed uncollectible is charged off immediately.

 

The Corporation regularlyreviews the problem loans and other assets in its portfolio to determinewhether any require classification in accordance with the Corporation’s policyand applicable regulations.  As of December 31,2008, the Corporation’s classified and criticized assets amounted to $9.6million, with $6.5 million classified as substandard and $3.1 millionidentified as special mention.

 

K-6

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The following table sets forth information regarding theCorporation’s non-performing assets as of December 31:

 
| **(Dollar amounts in thousands)**                   | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Non-performing  loans                                              |       | $        | 1,011      |     | $          | 952      |       | $        | 1,841      |     | $          | 1,452 |   | $ | 840 |   |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Total as a  percentage of gross loans                              |       | 0.38     | %          | 0.41     | %          | 0.85     | %          | 0.74     | %          | 0.46     | %          |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Repossessions                                                      |       | —   |       | —   |       | —   |       | —   |       | 2        |       |
| Real estate  acquired through foreclosure                          |       | 50       |       | 129      |       | 98       |       | 106      |       | 69       |       |
| Total as a  percentage of total assets                             |       | 0.01     | %          | 0.04     | %          | 0.03     | %          | 0.04     | %          | 0.03     | %          |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Total  non-performing assets                                       |       | $        | 1,061      |     | $          | 1,081    |       | $        | 1,939      |     | $          | 1,558 |   | $ | 911 |   |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Total  non-performing assets as a percentage of total assets       |       | 0.28     | %          | 0.35     | %          | 0.65     | %          | 0.57     | %          | 0.33     | %          |
|                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Allowance for  loan losses as a percentage of non-performing loans |       | 262.22   | %          | 226.58   | %          | 110.54   | %          | 128.72   | %          | 215.48   | %          |

 

***Allowance for Loan Losses****.*  Management establishes allowances forestimated losses on loans based upon its evaluation of the pertinent factorsunderlying the types and quality of loans; historical loss experience based onvolume and types of loans; trend in portfolio volume and composition; level andtrend on non-performing assets; detailed analysis of individual loans for whichfull collectibility may not be assured; determination of the existence andrealizable value of the collateral and guarantees securing such loans and thecurrent economic conditions affecting the collectibility of loans in theportfolio.  The Corporation analyzes itsloan portfolio at least quarterly for valuation purposes and to determine theadequacy of its allowance for losses. Based upon the factors discussed above, management believes that theCorporation’s allowance for losses as of December 31, 2008 of $2.7 millionwas adequate to cover probable losses inherent in the portfolio.

 

The following table setsforth an analysis of the allowance for losses on loans receivable for the yearsended December 31:

 
| **(Dollar amounts in thousands)**       | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Balance at  beginning of period                        |       | $        | 2,157      |     | $          | 2,035    |       | $        | 1,869      |     | $          | 1,810 |   | $ | 1,777 |   |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Provision for  loan losses                             |       | 500      |       | 256      |       | 358      |       | 205      |       | 290      |       |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Allowance for  loan losses of ECSLA                    |       | 206      |       | —   |       | —   |       | —   |       | —   |       |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Charge-offs:                                           |       |     |       |     |       |     |       |     |       |     |       |
| Mortgage loans                                         |       | (92      | )          | (82      | )          | (154     | )          | (46      | )          | (165     | )          |
| Commercial  business loans                             |       | —   |       | (22      | )          | (18      | )          | (60      | )          | (36      | )          |
| Consumer loans                                         |       | (160     | )          | (60      | )          | (49      | )          | (91      | )          | (117     | )          |
|                                                   |       | (252     | )          | (164     | )          | (221     | )          | (197     | )          | (318     | )          |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Recoveries:                                            |       |     |       |     |       |     |       |     |       |     |       |
| Mortgage loans                                         |       | —   |       | 1        |       | —   |       | —   |       | 17       |       |
| Commercial  business loans                             |       | 15       |       | 16       |       | 19       |       | 18       |       | 19       |       |
| Consumer loans                                         |       | 25       |       | 13       |       | 10       |       | 33       |       | 25       |       |
|                                                   |       | 40       |       | 30       |       | 29       |       | 51       |       | 61       |       |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Net charge-offs                                        |       | (212     | )          | (134     | )          | (192     | )          | (146     | )          | (257     | )          |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Balance at end  of period                              |       | $        | 2,651      |     | $          | 2,157    |       | $        | 2,035      |     | $          | 1,869 |   | $ | 1,810 |   |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Ratio of net  charge-offs to average loans outstanding |       | 0.08     | %          | 0.06     | %          | 0.09     | %          | 0.08     | %          | 0.14     | %          |
|                                                   |       |     |       |     |       |     |       |     |       |     |       |
| Ratio of  allowance to total loans at end of period    |       | 0.99     | %          | 0.93     | %          | 0.94     | %          | 0.96     | %          | 1.00     | %          |

 

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The following tableprovides a breakdown of the allowance for loan losses by major loan categoryfor the years ended December 31:

 

*(Dollar amounts in thousands)*

 
|                                    |   | **2008**   |   | **2007**                    |   | **2006**   |   | **2005**                    |   | **2004**   |   |
|-----------------------------------------|--------|------------|--------|-----------------------------|--------|------------|--------|-----------------------------|--------|------------|--------|
|                                    |   |       |   | **Percent of**         |   |       |   | **Percent of**         |   |       |   | **Percent of** |   |   |   | **Percent of** |   |   |   | **Percent of** |   |
|                                    |   |       |   | **loans in each** |   |       |   | **loans in each** |   |       |   | **loans in each** |   |   |   | **loans in each** |   |   |   | **loans in each** |   |
|                                    |   | **Dollar** |   | **category to**        |   | **Dollar** |   | **category to**        |   | **Dollar** |   | **category to** |   | **Dollar** |   | **category to** |   | **Dollar** |   | **category to** |   |
| **Loan Categories:**               |   | **Amount** |   | **total loans**        |   | **Amount** |   | **total loans**        |   | **Amount** |   | **total loans** |   | **Amount** |   | **total loans** |   | **Amount** |   | **total loans** |   |
| Commercial,  financial and agricultural |   | $          | 431    |                        | 16.3   | %          | $      | 387                         |   | 17.9       | %      | $ | 532 |   | 26.1 | % | $ | 554 |   | 29.6 | % | $ | 503 |   | 27.8 | % |
| Commercial  mortgages                   |   | 1,369      |   | 51.6                        | %      | 1,068      |   | 49.5                        | %      | 820        |   | 40.3 | % | 841 |   | 45.0 | % | 1,137 |   | 62.8 | % |
| Residential  mortgages                  |   | 363        |   | 13.7                        | %      | 309        |   | 14.3                        | %      | 239        |   | 11.7 | % | 211 |   | 11.3 | % | 10 |   | 0.6 | % |
| Home equity loans                       |   | 467        |   | 17.6                        | %      | 368        |   | 17.1                        | %      | 339        |   | 16.7 | % | 150 |   | 8.0 | % | 39 |   | 2.2 | % |
| Consumer loans                          |   | 73         |   | 2.8                         | %      | 79         |   | 3.7                         | %      | 83         |   | 4.1 | % | 106 |   | 5.7 | % | 121 |   | 6.7 | % |
| Unallocated                             |   | (52        | )      | -2.0                        | %      | (54        | )      | -2.5                        | %      | 22         |   | 1.1 | % | 7 |   | 0.4 | % | — |   | 0.0 | % |
|                                    |   |       |   |                        |   |       |   |                        |   |       |   |   |   |   |   |   |   |   |   |   |   |
|                                    |   | $          | 2,651  |                        | 100    | %          | $      | 2,157                       |   | 100        | %      | $ | 2,035 |   | 100 | % | $ | 1,869 |   | 100 | % | $ | 1,810 |   | 100 | % |

 

**InvestmentActivities**

 

***General****.*  The Corporationmaintains an investment portfolio of securities such as U.S. governmentagencies, mortgage-backed securities, municipal and corporate securities andequity securities.

 

Investment decisions aremade within policy guidelines established by the Board of Directors.  This policy is aimed at maintaining adiversified investment portfolio, which complements the overall asset/liabilityand liquidity objectives of the Bank, while limiting the related credit risk toan acceptable level.

 

The following table setsforth certain information regarding the fair value, weighted average yields andcontractual maturities of the Corporation’s securities as of December 31,2008:

 
| ** **                                       | ** ** | **Due in 1**     | ** ** | **Due from 1** | ** ** | **Due from 3** | ** ** | **Due from 5**  | ** ** | **Due after** | ** ** | **No scheduled** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|--------------------------|------------|---------------------------|------------|--------------------|------------|-----------------------|------------|------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **year or less** | ** ** | **to 3 years** | ** ** | **to 5 years** | ** ** | **to 10 years** | ** ** | **10 years**  | ** ** | **maturity**          | ** ** | **Total**  | ** ** |
|                                             |       |                       |       |                     |       |                     |       |                      |       |               |       |                  |       |       |       |
| U.S. Government  securities                      |       | $                          | 1,027      |                     | $          | 2,506                    |       | $                         | 4,012      |               | $          | 8,549                 |       | $          | 3,983      |   | $ | — |   | $ | 20,077 |   |
| Mortgage-backed  securities                      |       | —                     |       | 247                      |       | 408                      |       | 2,721                     |       | 27,004             |       | —                |       | 30,380     |       |
| Municipal  securities                            |       | —                     |       | —                   |       | 100                      |       | 4,097                     |       | 9,611              |       | —                |       | 13,808     |       |
| Corporate  securities                            |       | 3,984                      |       | —                   |       | —                   |       | —                    |       | —             |       | —                |       | 3,984      |       |
| Equity  securities                               |       | —                     |       | —                   |       | —                   |       | —                    |       | —             |       | 3,194                 |       | 3,194      |       |
|                                             |       |                       |       |                     |       |                     |       |                      |       |               |       |                  |       |       |       |
| Estimated fair  value                            |       | $                          | 5,011      |                     | $          | 2,753                    |       | $                         | 4,520      |               | $          | 15,367                |       | $          | 40,598     |   | $ | 3,194 |   | $ | 71,443 |   |
|                                             |       |                       |       |                     |       |                     |       |                      |       |               |       |                  |       |       |       |
| Weighted average  yield (1)                      |       | 5.49                       | %          | 4.09                     | %          | 4.68                     | %          | 5.05                      | %          | 4.35               | %          | 4.29                  | %          | 4.59       | %          |

 

----

(1) Weighted averageyield is calculated based upon amortized cost.

 

The following table setsforth the fair value of the Corporation’s investment securities as of December 31:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |     |       |
| U.S. Government  agencies                        |       | $        | 20,077     |     | $          | 29,334   |       | $ | 30,748 |   |
| Mortgage-backed  securities                      |       | 30,380   |       | 1,884    |       | 2,339    |       |
| Municipal  securities                            |       | 13,808   |       | 14,251   |       | 15,262   |       |
| Corporate  securities                            |       | 3,984    |       | 2,939    |       | —   |       |
| Equity  securities                               |       | 3,194    |       | 3,511    |       | 3,425    |       |
|                                             |       | $        | 71,443     |     | $          | 51,919   |       | $ | 51,774 |   |

 

For additionalinformation regarding the Corporation’s investment portfolio see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” initem 7 and “Notes to Consolidated Financial Statements” beginning on page F-7.

 

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**Sourcesof Funds**

 

***General****.*  Deposits are theprimary source of the Bank’s funds for lending and investing activities.Secondary sources of funds are derived from loan repayments,  investment maturities and borrowedfunds.  Loan repayments can be considereda relatively stable funding source, while deposit activity is greatlyinfluenced by interest rates and general market conditions.  The Bank also has access to funds through othervarious sources.  For a description ofthe Bank’s sources of funds, see “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in item 7.

 

***Deposits****.*  The Bank offers awide variety of retail deposit account products to both consumer and commercialdeposit customers, including time deposits, non-interest bearing and interestbearing demand deposit accounts, savings deposits and money market accounts.

 

Deposit products arepromoted in periodic newspaper and radio advertisements, along with noticesprovided in customer account statements. The Bank’s marketing strategy is based on its reputation as a communitybank that provides quality products and personal customer service.

 

The Bank pays interestrates on its interest bearing deposit products that are competitive with ratesoffered by other financial institutions in its market area.  Management reviews interest rates on depositsweekly and considers a number of factors, including: (1) the Bank’sinternal cost of funds; (2) rates offered by competing financialinstitutions; (3) investing and lending opportunities; and (4) theBank’s liquidity position.

 

The following table setsforth maturities of the Corporation’s certificates of deposit of $100,000 ormore at December 31, 2008 by time remaining to maturity:

 

| **(Dollar amounts in thousands)** | ** ** | **Amount** | ** ** |
|--------------------------------------------------|------------|------------|------------|
|                                             |       |       |       |   |
| Less than three  months                          |       | $          | 2,663      |   |
| Over three  months to six months                 |       | 11,480     |       |
| Over six months  to twelve months                |       | 4,681      |       |
| Over twelve  months                              |       | 19,945     |       |
|                                             |       |       |       |
|                                             |       | $          | 38,769     |   |

 

***Borrowings****.*  Borrowings may beused to compensate for reductions in deposit inflows or net deposit outflows,or to support lending and investment activities.  These borrowings include FHLB advances,federal funds, repurchase agreements, advances from the Federal ReserveDiscount Window and lines of credit at the bank and holding company with othercorrespondent banks.

 

| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                             |       |                  |       |   |   |   |   |
| Ending balance                                   |       | $                     | 48,188     |   | $ | 40,400 |   |
| Average balance                                  |       | 45,096                |       | 32,441 |   |
| Maximum balance                                  |       | 54,683                |       | 40,400 |   |
| Weighted average  rate                           |       | 3.89                  | %          | 4.46 | % |

 

For additionalinformation regarding the Corporation’s deposit base and borrowed funds, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” initem 7 and “Notes to Consolidated Financial Statements” beginning on page F-7.

 

**Subsidiary Activity**

 

The Corporation has twowholly owned subsidiaries, the Bank, a national association and the TitleCompany.  As of December 31, 2008,the Bank and the Title Company had no subsidiaries.

 

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**Personnel**

 

At December 31,2008, the Bank had 104 full time equivalent employees.  There is no collective bargaining agreementbetween the Bank and its employees, and the Bank believes its relationship withits employees to be satisfactory.

 

**Competition**

 

The Bank competes forloans, deposits and customers with other commercial banks, savings and loanassociations, securities and brokerage companies, mortgage companies, insurancecompanies, finance companies, money market funds, credit unions and othernonbank financial service providers.

 

**Supervisionand Regulation**

 

***General****. *Bankholding companies and banks are extensively regulated under both federal andstate law.  Set forth below is a summarydescription of certain provisions of certain laws that relate to the regulationof the Corporation and the Bank.  Thedescription does not purport to be complete and is qualified in its entirety byreference to the applicable laws and regulations.

 

***The Corporation***.  The Corporation isa registered bank holding company, and subject to regulation and examination bythe FRB under the BHCA of 1956, as amended. The Corporation is required to file with the FRB periodic****reports and such additional information as the FRB mayrequire.  Recent changes to the BankHolding Company rating system emphasizes risk management and evaluation of thepotential impact of non-depository entities on safety and soundness.

 

The FRB may require the Corporation to terminate anactivity or terminate control of or liquidate or divest certain subsidiaries,affiliates or investments when the FRB believes the activity or the control ofthe subsidiary or affiliate constitutes a significant risk to the financialsafety, soundness or stability of any of its banking subsidiaries.  The FRB also has the authority to regulateprovisions of certain bank holding company debt, including the authority toimpose interest ceilings and reserve requirements on such debt.  Under certain circumstances, the Corporationmust file written notice and obtain FRB approval prior to purchasing orredeeming its equity securities.

 

Further, the Corporation is required by the FRB to maintaincertain levels of capital.  See “CapitalStandards.”

 

The Corporation is required to obtain prior FRB approvalfor the acquisition of more than 5% of the outstanding shares of any class ofvoting securities or substantially all of the assets of any bank or bankholding company.  Prior FRB approval isalso required for the merger or consolidation of the Corporation and anotherbank holding company.

 

The Corporation is prohibited by the BHCA, except incertain statutorily prescribed instances, from acquiring direct or indirectownership or control of more than 5% of the outstanding voting shares of anycompany that is not a bank or bank holding company and from engaging directlyor indirectly in activities other than those of banking, managing orcontrolling banks, or furnishing services to its subsidiaries.  However, subject to the prior FRB approval,the Corporation may engage in any, or acquire shares of companies engaged in, activitiesthat the FRB deems to be so closely related to banking or managing orcontrolling banks as to be a proper incident thereto.

 

Under FRB regulations, the Corporation is required to serveas a source of financial and managerial strength to the Corporation’ssubsidiary bank and may not conduct operations in an unsafe or unsoundmanner.  In addition, it is the FRB’spolicy that a bank holding company should stand ready to use availableresources to provide adequate capital funds to its subsidiary banks duringperiods of financial stress or adversity and should maintain the financialflexibility and capital-raising capacity to obtain additional resources forassisting its subsidiary banks.  A bankholding company’s failure to meet its obligations to serve as a source ofstrength to its subsidiary banks will generally be considered by the FRB to bean unsafe and unsound banking practice or a violation of FRB regulations orboth.

 

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The Corporation is also a bank holding company within themeaning of the Pennsylvania Banking Code. As such, the Corporation and its subsidiaries are subject to examinationby, and may be required to file reports with, the Pennsylvania Department ofBanking.

 

The Corporation’s securities are registered with the SECunder the Exchange Act.  As such, theCorporation is subject to the information, proxy solicitation, insider trading,corporate governance, and other requirements and restrictions of the ExchangeAct.  The public may obtain all forms andinformation filed with the SEC through their website http://www.sec.gov.

 

***The Bank****.*  As a nationalbanking association, the Bank is subject to primary supervision, examinationand regulation by the OCC.  TheCorporation is also subject to regulations of the FDIC as administrator of theDeposit Insurance Fund (DIF) and the FRB. If, as a result of an examination of the Bank, the OCC should determinethat the financial condition, capital resources, asset quality, earningsprospects, management, liquidity or other aspects of the Corporation’soperations are unsatisfactory or that the Bank is violating or has violated anylaw or regulation, various remedies are available to the OCC.  Such remedies include the power to enjoin “unsafeor unsound practices,” to require affirmative action to correct any conditionsresulting from any violation or practice, to issue an administrative order thatcan be judicially enforced, to direct an increase in capital, to restrict theBank’s growth, to assess civil monetary penalties, and to remove officers anddirectors.  The FDIC has similarenforcement authority, in addition to its authority to terminate the Bank’sdeposit insurance in the absence of action by the OCC and upon a finding thatthe Bank is operating in an unsafe or unsound condition, is engaging in unsafeor unsound activities, or that the Corporation’s conduct poses a risk to thedeposit insurance fund or may prejudice the interest of its depositors.

 

A national bank may have a financial subsidiary engaged inany activity authorized for national banks directly or certain permissibleactivities.  Generally, a financialsubsidiary is permitted to engage in activities that are “financial in nature”or incidental thereto, even though they are not permissible for the nationalbank itself. The definition of “financial in nature” includes, among otheritems, underwriting, dealing in or making a market in securities, including,for example, distributing shares of mutual funds. The subsidiary may not,however, engage as principal in underwriting insurance, issue annuities orengage in real estate development or investment or merchant banking.

 

***The Sarbanes-Oxley Act of 2002***.  TheSarbanes-Oxley Act of 2002 addresses accounting oversight and corporategovernance matters, including:

 
| · | The  prohibition of accounting firms from providing various types of consulting  services to public clients and requiring accounting firms to rotate partners  among public client assignments every five years; |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | Increased  penalties for financial crimes and forfeiture of executive bonuses in certain  circumstances;                                                                                                         |
| · | Required  executive certification of financial presentations;                                                                                                                                                    |
| · | Increased  requirements for board audit committees and their members;                                                                                                                                            |
| · | Enhanced  disclosure of controls and procedures and internal control over financial  reporting;                                                                                                                  |
| · | Enhanced  controls on, and reporting of, insider trading; and                                                                                                                                                    |
| · | Statutory separations between  investment bankers and analysts.                                                                                                                                                  |

 

Thenew legislation and its implementing regulations have resulted in increasedcosts of compliance, including certain outside professional costs.  To date these costs have not had a materialimpact on the Corporation’s operations.

 

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***USA PATRIOT Act of 2001***.  The USAPATRIOT Act of 2001 and its implementing regulations significantly expanded theanti-money laundering and financial transparency laws.  Under the USA PATRIOT Act, financialinstitutions are subject to prohibitions regarding specified financialtransactions and account relationships, as well as enhanced due diligence and “knowyour customer” standards in their dealings with foreign financial institutionsand foreign customers. For example, the enhanced due diligence policies,procedures and controls generally require financial institutions to takereasonable steps:

 
| · | To  conduct enhanced scrutiny of account relationships to guard against money  laundering and report any suspicious transaction,                                                                               |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | To  ascertain the identity of the nominal and beneficial owners of, and the  source of funds deposited into, each account as needed to guard against money  laundering and report any suspicious transactions, |
| · | To  ascertain for any foreign bank, the shares of which are not publicly traded,  the identity of the owners of the foreign bank, and the nature and extent of  the ownership interest of each such owner, and |
| · | To ascertain whether any foreign  bank provides correspondent accounts to other foreign banks and, if so, the  identity of those foreign banks and related due diligence information.                          |

 

Underthe USA PATRIOT Act, financial institutions are required to establish andmaintain anti-money laundering programs which include:

 
| · | The  establishment of a customer identification program,         |
|--------|------------------------------------------------------------------|
| · | The  development of internal policies, procedures, and controls, |
| · | The  designation of a compliance officer,                        |
| · | An  ongoing employee training program, and                       |
| · | An independent audit function to  test the programs.             |

 

The Bank has implemented comprehensive policies andprocedures to address the requirements of the USA PATRIOT Act.

 

***Privacy.***  Federal banking rules limitthe ability of banks and other financial institutions to disclose non-publicinformation about consumers to nonaffiliated third parties. Pursuant to theserules, financial institutions must provide:

 
| · | Initial  notices to customers about their privacy policies, describing the conditions  under which they may disclose nonpublic personal information to nonaffiliated  third parties and affiliates; |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| · | Annual  notices of their privacy policies to current customers; and                                                                                                                                 |
| · | A reasonable method for customers  to “opt out” of disclosures to nonaffiliated third parties.                                                                                            |

 

Theseprivacy provisions affect how consumer information is transmitted throughdiversified financial companies and conveyed to outside vendors.  The Corporation’s privacy policies have beenimplemented in accordance with the law.

 

***Dividends and Other Transfers of Funds***.  Dividends from theBank constitute the principal source of income to the Corporation.  The Corporation is a legal entity separateand distinct from the Bank. The Bank is subject to various statutory andregulatory restrictions on its ability to pay dividends to theCorporation.  In addition, the Bank’sregulators have the authority to prohibit the Bank from paying dividends,depending upon the Bank’s financial condition, if such payment is deemed toconstitute an unsafe or unsound practice.

 

The Corporation entered into a Securities PurchaseAgreement (the Agreement) on December 23, 2008 with the U.S. Treasury inassociation with its participation in the Capital Purchase Program (CPP) of theEmergency Economic Stabilization Act of 2008 (EESA). Under the Agreement, theCorporation may not increase its dividend for three years unless the preferredshares purchase by the U.S. Treasury have been redeemed in whole or transferredto a third party which is not an affiliate of the Corporation.  For additional information regarding the CPPsee “Notes to Consolidated Financial Statements” beginning on page F-7.

 

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***Transactions with Affiliates****.*  The Bank is subjectto certain restrictions imposed by federal law on any extensions of credit to,or the issuance of a guarantee or letter of credit on behalf of, anyaffiliates, the purchase of, or investments in, stock or other securitiesthereof, the taking of such securities as collateral for loans, and thepurchase of assets of any affiliates. Such restrictions prevent any affiliatesfrom borrowing from the Bank unless the loans are secured by marketableobligations of designated amounts. Further, such secured loans and investmentsby the Bank to or in any affiliate are limited, individually, to 10% of theBank’s capital and surplus (as defined by federal regulations), and suchsecured loans and investments are limited, in the aggregate, to 20% of the Bank’scapital and surplus.  Some of theentities included in the definition of an affiliate are parent companies,sister banks, sponsored and advised companies, investment companies whereby theBank or its affiliate serves as investment advisor, and financial subsidiariesof the bank.  Additional restrictions ontransactions with affiliates may be imposed on****theBank under the prompt corrective action provisions of federal law. See “PromptCorrective Action and Other Enforcement Mechanisms.”

 

***Loans to One Borrower Limitations****.*  With certain limited exceptions, the maximumamount that a national bank may lend to any borrower (including certain relatedentities of the borrower) at one time may not exceed 15% of the unimpairedcapital and surplus of the institution, plus an additional 10% of unimpairedcapital and surplus for loans fully secured by readily marketablecollateral.  At December 31, 2008,the Bank’s loans-to-one-borrower limit was $5.4 million based upon the 15% ofunimpaired capital and surplus measurement. At December 31, 2008, the bank had no single lending relationshipexceeding this limit.

 

***Capital Standards***.  The federal banking agencies have adopted risk-basedminimum capital guidelines intended to provide a measure of capital thatreflects the degree of risk associated with a banking organization’s operationsfor both transactions reported on the balance sheet as assets and transactionswhich are recorded as off-balance sheet items. Under these guidelines, nominal dollar amounts of assets and creditequivalent amounts of off-balance sheet items are multiplied by one of severalrisk adjustment percentages, which range from 0% for assets with low creditrisk, such as federal banking agencies, to 100% for assets with relatively highcredit risk.

** **

**The risk-based capital ratio is determined by classifyingassets and certain off-balance sheet financial instruments into weightedcategories, with higher levels of capital being required for those categoriesperceived as representing greater risk. Under the capital guidelines, a bankingorganization’s total capital is divided into tiers. “Tier I capital” consistsof (1) common equity, (2) qualifying noncumulative perpetualpreferred stock, (3) a limited amount of qualifying cumulative perpetualpreferred stock and (4) minority interests in the equity accounts ofconsolidated subsidiaries (including trust-preferred securities), less goodwilland certain other intangible assets. Not more than 25% of qualifying Tier Icapital may consist of trust-preferred securities. “Tier II capital” consistsof hybrid capital instruments, perpetual debt, mandatory convertible debtsecurities, a limited amount of subordinated debt, preferred stock that doesnot qualify as Tier I capital, a limited amount of the allowance for loan andlease losses and a limited amount of unrealized holding gains on equitysecurities. “Tier III capital” consists of qualifying unsecured subordinateddebt. The sum of Tier II and Tier III capital may not exceed the amount of TierI capital.**

** **

**The guidelines require a minimum ratio of qualifying totalcapital to risk-adjusted assets of 8% and a minimum ratio of Tier 1 capital torisk-adjusted**assets of 4%.  Inaddition to the risk-based guidelines, federal banking regulators requirebanking organizations to maintain a minimum amount of Tier 1 capital to totalassets, referred to as the leverage ratio. For a banking organization rated in the highest of the five categoriesused by regulators to rate banking organizations, the minimum leverage ratio ofTier 1 capital to total assets must be 3%. In addition to these uniform risk-based capital guidelines and leverageratios that apply across the industry, the regulators have the discretion toset individual minimum capital requirements for specific institutions at ratessignificantly above the minimum guidelines and ratios.

** **

In addition, federal banking regulators may set capitalrequirements higher than the minimums described above for financial institutionswhose circumstances warrant it. For example, a financial institutionexperiencing or anticipating significant growth may be expected to maintaincapital positions substantially above the minimum supervisory levels withoutsignificant reliance on intangible assets.

 

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***Prompt Corrective Action and OtherEnforcement Mechanisms***.  Federal banking agencies possess broad powersto take corrective and other supervisory action to resolve the problems ofinsured depository institutions, including but not limited to thoseinstitutions that fall below one or more prescribed minimum capital ratios.  Each federal banking agency has promulgatedregulations defining the following five categories in which an insureddepository institution will be placed, based on its capital ratios: wellcapitalized, adequately capitalized, undercapitalized, significantlyundercapitalized, and critically undercapitalized.  At December 31, 2008, the Bank exceededthe required ratios for classification as “well capitalized.”

 

An institution that, based upon its capital levels, isclassified as well capitalized, adequately capitalized, or undercapitalized maybe treated as though it were in the next lower capital category if theappropriate federal banking agency, after notice and opportunity for hearing,determines that an unsafe or unsound condition or an unsafe or unsound practicewarrants such treatment.  At eachsuccessive lower capital category, an insured depository institution is subjectto more restrictions.  The federalbanking agencies, however, may not treat a significantly undercapitalizedinstitution as critically undercapitalized unless its capital ratio actuallywarrants such treatment.

 

In addition to measures taken under the prompt correctiveaction provisions, commercial banking organizations may be subject to potentialenforcement actions by the federal regulators for unsafe or unsound practicesin conducting their businesses or for violations of any law, rule, regulation,or any condition imposed in writing by the agency or any written agreement withthe agency.  Finally, pursuant to aninteragency agreement, the FDIC can examine any institution that has asubstandard regulatory examination score or is considered undercapitalized —without the express permission of the institution’s primary regulator.

 

***Safety and SoundnessStandards***.  The federal banking agencies have adoptedguidelines designed to assist the federal banking agencies in identifying andaddressing potential safety and soundness concerns before capital becomesimpaired. The guidelines set forth operational and managerial standardsrelating to: (i) internal controls, information systems and internal auditsystems, (ii) loan documentation, (iii) credit underwriting, (iv) assetgrowth, (v) earnings, and (vi) compensation, fees and benefits. Inaddition, the federal banking agencies have also adopted safety and soundnessguidelines with respect to asset quality and earnings standards. Theseguidelines provide six standards for establishing and maintaining a system toidentify problem assets and prevent those assets from deteriorating. Underthese standards, an insured depository institution should: (i) conductperiodic asset quality reviews to identify problem assets, (ii) estimatethe inherent losses in problem assets and establish reserves that aresufficient to absorb estimated losses, (iii) compare problem asset totalsto capital, (iv) take appropriate corrective action to resolve problemassets, (v) consider the size and potential risks of material assetconcentrations, and (vi) provide periodic asset quality reports withadequate information for management and the board of directors to assess thelevel of asset risk. These guidelines also set forth standards for evaluatingand monitoring earnings and for ensuring that earnings are sufficient for themaintenance of adequate capital and reserves.

 

***Insurance of Accounts****. *The deposits of the Bank are insured to the maximumextent permitted by the DIF and are backed by the full faith and credit of theU.S. Government.  As insurer, the FDIC isauthorized to conduct examinations of, and to require reporting by, insuredinstitutions.  It also may prohibit anyinsured institution from engaging in any activity determined by regulation ororder to pose a serious threat to the FDIC.

 

The deposits of the Bank have historically been insured bythe FDIC up to $100,000 per insured depositor, except certain types ofretirement accounts, which are insured up to $250,000 per insureddepositor.  On October 3, 2008, themaximum amount insured under FDIC deposit insurance was temporarily increasedfrom $100,000 to $250,000 per insured depositor through December 31,2009.  This increase was part of the EESAof 2008.  Additionally, the Bank haselected to participate in the FDIC’s Temporary Liquidity Guarantee Program(TLGP).  Under the TLGP, all noninterestbearing deposit transaction accounts, lawyers’ trust accounts and NOW accountsthat pay interest rates equal to or less than 50 basis points and public fundsheld in noninterest bearing accounts with balances over $250,000 will also befully insured through December 31, 2009 at an additional cost to the Bankof 10 basis points per dollar over $250,000 on a per account basis.  After December 31, 2009, the standardinsurance limit will return to $100,000 for all deposit categories exceptretirement accounts, which will continue to be insured up to $250,000 perinsured depositor.

 

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Each FDIC insured institution is assigned to one of threecapital groups which are based solely on the level of an institution’s capital—“well capitalized,” “adequately capitalized,” and “undercapitalized.”  These capital levels are defined in the samemanner as under the prompt corrective action system discussed above.  These three groups are then divided intothree subgroups which reflect varying levels of supervisory concern, from thosewhich are considered to be healthy to those which are considered to be ofsubstantial supervisory concern.  In 2007and 2008, the annual insurance premiums on bank deposits insured by the DIFvaried between $.05 and $.43 per $100 of deposits.

 

In addition, all institutions with deposits insured by theFDIC are required to pay assessments to fund interest payments on bonds issuedby the Financing Corporation, a mixed-ownership government corporationestablished to recapitalize the predecessor to the DIF.  The annual assessment rate set for the fourthquarter of 2008 was 27.5 basis points of insured deposits and is adjustedquarterly.  These assessments willcontinue until the Financing Corporation bonds mature in 2019.

 

The FDIC may terminate the deposit insurance of any insureddepository institution, including the Bank, if it determines after a hearingthat the institution has engaged or is engaging in unsafe or unsound practices,is in an unsafe or unsound condition to continue operations, or has violatedany applicable law, regulation, order or any condition imposed by an agreementwith the FDIC.  It also may suspenddeposit insurance temporarily during the hearing process for the permanent terminationof insurance, if the institution has no tangible capital.  If insurance of accounts is terminated, theaccounts at the institution at the time of the termination, less subsequentwithdrawals, shall continue to be insured for a period of six months to twoyears, as determined by the FDIC. Management is aware of no existing circumstances which would result intermination of the Bank’s deposit insurance.

 

On December 16, 2008, the FDIC approved the final rule toraise the risk-based deposit insurance assessment rates uniformly by seven basispoints for the first quarter of 2009 assessment period beginning on January 1,2009.  On February 26, 2009, theFDIC approved the final rule to raise the assessment rates for theassessment period beginning on April 1, 2009, and subsequent assessmentperiods.  The new assessment scheme willdifferentiate between risk profiles and will require riskier institutions topay higher assessment rates based on classification into one of four riskcategories.  Institutions that are ratedin the category with the lowest risk will see their initial base rates increaseto between 12 and 16 basis points.

 

On February 26, 2009, the FDIC adopted an interimrule, with request for comment, to impose a one-time 20 basis point emergencyassessment effective on June 30, 2009 and to be collected on September 30,2009.  Based on our most recent FDICdeposit insurance assessment base, the emergency special assessment of 20 basispoints, if implemented, would increase our FDIC deposit insurance premiums byapproximately $565,000 in 2009.  The FDIChas indicated in recent press reports that it may consider reducing theemergency special assessment by half to 10 basis points if, among otherfactors, Congress enacts legislation to expand the FDIC’s line of credit withthe Department of Treasury to $100 billion.

 

On February 26, 2009, the FDIC adopted another interimrule, with request for comment, to have the option to impose a further specialassessment of up to 10 basis points on an institution’s assessment base on thelast day of any calendar quarter after June 30, 2009 to be collected atthe same time the risk-based assessment are collected.  The assessment will be imposed if the FDICdetermines the DIF reserve ratio will fall to a level that would adverselyaffect public confidence or to a level close to zero or negative, among otherfactors.  The ultimate goal of theincrease in assessment rates and the proposed special assessments is to restorethe DIF ratio to a minimum of 1.15% within the next seven years.  However, the interim rules are subjectto change and may or may not be enacted.

 

Given the enacted and proposed increases in assessments forinsured financial institutions in 2009, the Corporation anticipated that FDICassessments on deposits will have a significantly greater impact on operatingexpenses in 2009 compared to 2008 and could materially affect our reportedearnings, liquidity and capital.

 

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** **

***Interstate Banking and Branching***.  Banks have the ability, subject to certain Staterestrictions, to acquire, by acquisition or merger, branches outside its homestate.  The establishment of newinterstate branches is also possible in those states with laws that expresslypermit it.  Interstate branches aresubject to certain laws of the states in which they are located.  Competition may increase further as banksbranch across state lines and enter new markets.

** **

***Consumer Protection Laws and Regulations***. The bank regulatory agencies are focusing greater attention oncompliance with consumer protection laws and their implementing regulations.Examination and enforcement have become more intense in nature, and insuredinstitutions have been advised to monitor carefully compliance with such lawsand regulations. The Bank is subject to many federal consumer protectionstatutes and regulations, some of which are discussed below.

 

TheCommunity Reinvestment Act (CRA) is intended to encourage insured depositoryinstitutions, while operating safely and soundly, to help meet the credit needsof their communities. The CRA specifically directs the federal regulatoryagencies, in examining insured depository institutions, to assess a bank’s recordof helping meet the credit needs of its entire community, including low- andmoderate-income neighborhoods, consistent with safe and sound bankingpractices. The CRA further requires the agencies to take a financialinstitution’s record of meeting its community credit needs into account whenevaluating applications for, among other things, domestic branches, mergers oracquisitions, or holding company formations. The agencies use the CRAassessment factors in order to provide a rating to the financial institution.The ratings range from a high of “outstanding” to a low of “substantialnoncompliance.” In its last examination for CRA compliance, as of April 21,2008, the Bank was rated “satisfactory.”

 

On September 1,2005, the federal banking agencies amended the CRA regulations to:

 

·                 Establishthe definition of “Intermediate Small Bank” as an institution with total assetsof $250 million to $1 billion, without regard to any holding company; and

·                 Takeinto account abusive lending practices by a bank or its affiliates indetermining a bank’s CRA rating.

 

TheFair Credit Reporting Act (FCRA), as amended by the Fair and Accurate CreditTransactions Act of 2003 (FACTA), requires financial firms to help deteridentity theft, including developing appropriate fraud response programs, andgive consumers more control of their credit data.  It also reauthorizes a federal ban on statelaws that interfere with corporate credit granting and marketingpractices.  In connection with the FACTA,financial institution regulatory agencies proposed rules that wouldprohibit an institution from using certain information about a consumer itreceived from an affiliate to make a solicitation to the consumer, unless theconsumer has been notified and given a chance to opt out of such solicitations.  A consumer’s election to opt out would beapplicable for at least five years.

 

TheFederal Trade Commission (FTC), the federal bank regulatory agencies and theNational Credit Union Administration (NCUA) have issued regulations (the RedFlag Rules) requiring financial institutions and creditors to develop andimplement written identity theft prevention programs as part of the FACTA.  The programs must be in place by May 1,2009 and must provide for the identification, detection and response topatterns, practices or specific activities — known as red flags — that couldindicate identity theft.  These red flagsmay include unusual account activity, fraud alerts on a consumer report orattempted use of suspicious account application documents.  The program must also describe appropriateresponses that would prevent and mitigate the crime and detail a plan to updatethe program.  The program must be managedby the Board of Directors or senior employees of the institution or creditor,include appropriate staff training and provide oversight of any serviceproviders.

 

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TheCheck Clearing for the 21st Century Act (Check 21) facilitates check truncationand electronic check exchange by authorizing a new negotiable instrument calleda “substitute check,” which is the legal equivalent of an original check.  Check 21, effective October 28, 2004,does not require banks to create substitute checks or accept checkselectronically; however, it does require banks to accept a legally equivalentsubstitute check in place of an original.

 

TheEqual Credit Opportunity Act (ECOA) generally prohibits discrimination in anycredit transaction, whether for consumer or business purposes, on the basis ofrace, color, religion, national origin, sex, marital status, age (except inlimited circumstances), receipt of income from public assistance programs, orgood faith exercise of any rights under the Consumer Credit Protection Act.

 

TheTruth in Lending Act (TILA) is designed to ensure that credit terms aredisclosed in a meaningful way so that consumers may compare credit terms morereadily and knowledgeably. As a result of the TILA, all creditors must use thesame credit terminology to express rates and payments, including the annualpercentage rate, the finance charge, the amount financed, the total of paymentsand the payment schedule, among other things.

 

TheFair Housing Act (FHA) regulates many practices, including making it unlawfulfor any lender to discriminate in its housing-related lending activitiesagainst any person because of race, color, religion, national origin, sex,handicap or familial status. A number of lending practices have been found bythe courts to be, or may be considered, illegal under the FHA, including somethat are not specifically mentioned in the FHA itself.

 

TheHome Mortgage Disclosure Act (HMDA) grew out of public concern over creditshortages in certain urban neighborhoods and provides public information thatwill help show whether financial institutions are serving the housing creditneeds of the neighborhoods and communities in which they are located. The HMDAalso includes a “fair lending” aspect that requires the collection anddisclosure of data about applicant and borrower characteristics as a way ofidentifying possible discriminatory lending patterns and enforcinganti-discrimination statutes.

 

Theterm “predatory lending,” much like the terms “safety and soundness” and “unfairand deceptive practices,” is far-reaching and covers a potentially broad rangeof behavior. As such, it does not lend itself to a concise or a comprehensivedefinition. But typically predatory lending involves at least one, and perhapsall three, of the following elements:

 

·                  Makingunaffordable loans based on the assets of the borrower rather than on theborrower’s ability to repay an obligation (“asset-based lending”)

·                  Inducinga borrower to refinance a loan repeatedly in order to charge high points andfees each time the loan is refinanced (“loan flipping”)

·                  Engagingin fraud or deception to conceal the true nature of the loan obligation from anunsuspecting or unsophisticated borrower.

 

FRBregulations aimed at curbing such lending significantly widen the pool ofhigh-cost home-secured loans covered by the Home Ownership and EquityProtection Act of 1994, a federal law that requires extra disclosures andconsumer protections to borrowers. Lenders that violate the rules face cancellation of loans andpenalties equal to the finance charges paid.

 

EffectiveApril 8, 2005, OCC guidelines require national banks and their operatingsubsidiaries to comply with certain standards when making or purchasing loansto avoid predatory or abusive residential mortgage lending practices.  Failure to comply with the guidelines couldbe deemed an unsafe and unsound or unfair or deceptive practice, subjecting thebank to supervisory enforcement actions.

 

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Finally,the Real Estate Settlement Procedures Act (RESPA) requires lenders to provideborrowers with disclosures regarding the nature and cost of real estatesettlements. Also, RESPA prohibits certain abusive practices, such askickbacks, and places limitations on the amount of escrow accounts. Penaltiesunder the above laws may include fines, reimbursements and other penalties. Dueto heightened regulatory concern related to compliance with the CRA, FACTA,TILA, FHA, ECOA, HMDA and RESPA generally, the Bank may incur additionalcompliance costs or be required to expend additional funds for investments inits local community.

 

***Federal Home Loan Bank System*****.**  The Bank is a member of the FHLB.  Among other benefits, each FHLB serves as areserve or central bank for its members within its assigned region. Each FHLBis financed primarily from the sale of consolidated obligations of the FHLBsystem. Each FHLB makes available loans or advances to its members incompliance with the policies and procedures established by the Board ofDirectors of the individual FHLB. As an FHLB member, the Bank is required toown a certain amount of capital stock in the FHLB.  At December 31, 2008, the Bank was incompliance with the stock requirements.

 

***Federal Reserve System*****. **The FRB requires all depositoryinstitutions to maintain noninterest bearing reserves at specified levelsagainst their transaction accounts (primarily checking) and non-personal timedeposits.  At December 31, 2008, theBank was in compliance with these requirements.

 

**Item 1A.  Risk Factors**

 

*Inanalyzing whether to make or to continue an investment in our securities,investors should consider, among other factors, the following risk factors.*

 

**Thecurrent economic environment poses significant challenges for the Corporationand could adversely affect its financial condition and results of operations.**

 

TheCorporation is operating in a challenging and uncertain economic environment,including generally uncertain national and local conditions.  Financial institutions continue to beaffected by sharp declines in the real estate market and constrained financialmarkets.  Dramatic declines in thehousing market over the past year, with falling home prices and increasingforeclosures and unemployment, have resulted in significant write-downs ofasset values by financial institutions. Continued declines in real estate values, home sales volumes, andfinancial stress on borrowers as a result of the uncertain economic environmentcould have an adverse effect on the Bank’s borrowers or their customers, whichcould adversely affect the Corporation’s financial condition and results ofoperations.  A worsening of theseconditions would likely exacerbate the adverse effects on the Corporation andothers in the financial services industry. For example, further deterioration in local economic conditions in theCorporation’s markets could drive losses beyond that which is provided for inits allowance for loan losses.  TheCorporation may also face the following risks in connection with these events:

 

·                  Economicconditions that negatively affect housing prices and the job market haveresulted, and may continue to result, in a deterioration in credit quality ofthe Bank’s loan portfolio, and such deterioration in credit quality has had,and could continue to have, a negative impact on the Corporation’s business.

·                  Marketdevelopments may affect consumer confidence levels and may cause adversechanges in payment patterns, causing increases in delinquencies and defaultrates on loans and other credit facilities.

·                  Theprocesses the Corporation uses to estimate the allowance for loan losses may nolonger be reliable because they rely on complex judgments, including forecastsof economic conditions, which may no longer be capable of accurate estimation.

·                  TheBank’s ability to assess the creditworthiness of its customers may be impairedif the processes and approaches it uses to select, manage, and underwrite itscustomers become less predictive of future charge-offs.

·                  TheCorporation expects to face increased regulation of its industry, andcompliance with such regulation may increase its costs, limit its ability topursue business opportunities, and increase compliance challenges.

 

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Asthese conditions or similar ones continue to exist or worsen, the Corporationcould experience continuing or increased adverse effects on its financialcondition and results of operations.

 

**TheCorporation’s business is subject to various lending and other economic risksthat could adversely impact the Corporation’s financial condition and resultsof operations.**

 

Changein economic conditions, particularly an economic slowdown, could hurt theCorporation’s business.  The Corporation’sbusiness is directly affected by political and market conditions, broad trendsin industry and finance, legislative and regulatory changes, and changes ingovernmental monetary and fiscal policies and inflation, all of which arebeyond the Corporation’s control.  Adeterioration in economic conditions, in particular an economic slowdown withinthe Corporation’s geographic region, could result in the followingconsequences, any of which could have a material adverse effect on theCorporation’s business:

 

·                  loandelinquencies may increase;

·                  problemassets and foreclosures may increase;

·                  demandfor the Corporation’s products and services may decline; and

·                  collateralfor loans made by the Bank many decline in value, in turn reducing a client’sborrowing power, and reducing the value of assets and collateral associatedwith the Corporation’s loans held for investment.

 

**Thedeclining real estate market could impact the Corporation’s business.**

 

TheBank’s business activities and credit exposures are concentrated in WesternPennsylvania and the surrounding region. A continued downturn in this regional real estate market could hurt theCorporation’s business because of the geographic concentration within thisregional area.  If there is a significantdecline in real estate values, the collateral for the Bank’s loans will provideless security.  As a result, the Bank’sability to recover on defaulted loans by selling the underlying real estatewould be diminished, and we would be more likely to suffer losses on defaultedloans.

 

**The building of market sharethrough our branching strategy could cause our expenses to increase faster thanrevenues.**

 

Weopened one new branch office during calendar year 2008.  There are considerable costs involved inopening offices and new offices generally require a period of time to generatesufficient revenues to offset their costs, especially in areas in which we donot have an established presence. Accordingly, any new office can be expected to negatively impact ourearnings for some period of time until the office reaches certain economies ofscale.  We have no assurance our newoffice will be successful even after it has been established.

 

**If external funds are not available, this could adverselyimpact our growth and future prospects.**

 

We primarily rely on depositsand FHLB advances to fund our operations. Although we have historically been able to replace maturing deposits ifdesired, no assurance can be given that we will be able to replace such fundsin the future if our financial condition or market conditions were tochange.  Although we consider the sourcesof existing funds adequate for our current liquidity needs, we may seekbrokered deposits or debt in the future to achieve our long-term businessobjectives.  There can be no assuranceadditional funds, if sought, would be available to us or, if available, wouldbe on favorable terms.  If additionalfinancing sources are unavailable or are not available on reasonable terms, ourgrowth and future prospects could be adversely affected.

 

**Item 1B.  Unresolved Staff Comments**

 

None.

 

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**Item 2.  Properties**

 

The Corporation owns noreal property but utilizes the main office of the Bank.  The Corporation’s and the Bank’s executiveoffices are located at 612 Main Street, Emlenton, Pennsylvania.  The Corporation pays no rent or other form ofconsideration for the use of this facility.

 

TheCorporation owns and leases numerous other premises for use in conductingbusiness activities.  The Corporationconsiders these facilities owned or occupied under lease to be adequate.  For additional information regarding theCorporation’s properties, see “Notes to Consolidated Financial Statements”,Note 7, Premises and Equipment.

 

**Item  3. Legal Proceedings**

 

Neither the Bank nor theCorporation is involved in any material legal proceedings.  The Bank, from time to time, is party tolitigation that arises in the ordinary course of business, such as claims toenforce liens, claims involving the origination and servicing of loans, andother issues related to the business of the Bank. In the opinion of management,the resolution of any such issues would not have a material adverse impact onthe financial position, results of operation, or liquidity of the Bank or theCorporation.

 

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

 

No matters were submittedto stockholders for a vote during the quarter ended December 31, 2008.

 

**PART II**

 

**Item  5. Market for the Registrant’s Common Equity, Related Stockholder Mattersand Issuer Purchases of Equity Securities**

 

**Market, Holder and DividendInformation**

 

Emclaire Financial Corp. commonstock is traded on the Over the Counter Bulletin Board (OTCBB) under the symbol“EMCF”.  The listed market makers for theCorporation’s common stock include:

** **
| **Ferris, Baker Watts, Inc.** | ** ** | **Boenning and Scattergood**    | ** ** | **Parker/Hunter**                   |
|------------------------------------|------------|---------------------------------|------------|-------------------------------------|
| 100  Light Street, 8th Floor       |       | 4  Tower Bridge, Suite 300 |       | 600  Grant Street - Suite 3100 |
| Baltimore,  MD 21202               |       | 200  Bar Harbor Drive           |       | Pittsburgh,  PA 15219               |
| Telephone:  (800) 436-2000         |       | West  Conshonhocken, PA 19428   |       | Telephone:  (800) 441-1514          |
|                               |       | Telephone:  (800) 883-1212      |       |                                |

 

The bid and ask price ofthe Corporation’s common stock were $22.10 and $23.50, respectively, as of February 9,2009.  The Corporation traditionally haspaid regular quarterly cash dividends. As a result of the Corporation’s participation in the U.S. Treasury’sCPP, the Corporation may not pay a dividend in excess of $0.32 per share untilthe earlier of December 23, 2011 and the date the preferred shares havebeen redeemed in whole or transferred to a non-affiliated third party.

 

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The following table setsforth the high and low sale market prices of the Corporation’s common stock aswell as cash dividends paid for the quarterly periods presented:

 
| ** **     | ** ** | **Market Price** | ** ** | **Cash** | ** ** |
|----------------|------------|-----------------------|------------|----------|------------|
| ** **     | ** ** | **High**              | ** ** | **Low**  | ** ** | **Close** | ** ** | **Dividend** | ** ** |
| ** **     |       |                  |       |     |       |   |   |   |   |
| **2008:**      |       |                  |       |     |       |   |   |   |   |
| Fourth quarter |       | $                     | 24.50      |     | $          | 20.05 |   | $ | 23.50 |   | $ | 0.34 |   |
| Third quarter  |       | 26.50                 |       | 21.00    |       | 24.00 |   | 0.32 |   |
| Second quarter |       | 28.00                 |       | 24.60    |       | 25.75 |   | 0.32 |   |
| First quarter  |       | 28.35                 |       | 24.55    |       | 26.50 |   | 0.32 |   |
|           |       |                  |       |     |       |   |   |   |   |
| **2007:**      |       |                  |       |     |       |   |   |   |   |
| Fourth quarter |       | $                     | 28.25      |     | $          | 25.20 |   | $ | 25.75 |   | $ | 0.67 |   |
| Third quarter  |       | 27.75                 |       | 25.00    |       | 25.60 |   | 0.29 |   |
| Second quarter |       | 27.00                 |       | 23.50    |       | 25.25 |   | 0.29 |   |
| First quarter  |       | 31.00                 |       | 26.75    |       | 27.25 |   | 0.29 |   |

 

Inlight of current and projected economic conditions, the Board of Directors hasdetermined to reduce the Corporation’s quarterly cash dividend from the currentrate of $0.32 per share to $0.14 per share effective for the second quarter of2009.  Future dividends will bedetermined by the Board of Directors after giving consideration to theCorporation’s financial condition, results of operations, tax status, industrystandards, economic conditions, regulatory requirements and other factors.

 

As of December 31,2008, there were approximately 730 stockholders of record and 1,431,404 sharesof common stock entitled to vote, receive dividends and considered outstandingfor financial reporting purposes.  Thenumber of stockholders of record does not include the number of persons orentities who hold their stock in nominee or “street” name.

 

Common stockholders mayhave Corporation dividends reinvested to purchase additional shares.  Participants may also make optional cashpurchases of common stock through this plan and pay no brokerage commissions orfees.  To obtain a plan document andauthorization card call 800-757-5755.

 

**Purchases of Equity Securities**

 

The Corporation did not repurchase any of its equitysecurities in the year ended December 31, 2008.

 

**Item6.  Selected Financial Data**

 

Not applicable as theCorporation is a smaller reporting company.

 

**Item7.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

The followingdiscussion and analysis represents a review of Emclaire Financial Corp.’sconsolidated financial condition and results of operations.  This review should be read in conjunctionwith the consolidated financial statements beginning on page F-3.

 

**Overview**

 

The Corporationreported a decrease in net income of $267,000 or 9.9% for 2008 as consolidatednet income amounted to $2.4 million or $1.87 per common share for 2008,compared to net income of $2.7 million or $2.13 per common share for 2007.  The decrease resulted from the following:

 

·                  Net interest income increased primarily due to an increase in interestearned on loans resulting from the Bank’s loan growth during the year.

 

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·                  The provision for loan losses increased related to theaforementioned loan growth experienced during the year.

·                  Noninterest income decreased primarily due to other than temporaryimpairment charges recorded during 2008 on two marketable equity investmentsecurities.  Conversely, during 2007, theCorporation realized security gains primarily from the sale of a community bankstock investment as a result of that bank’s merger with a larger financialinstitution.

·                  Noninterest expense increased due to severance charges recorded relatedto the retirement of the Corporation’s former Chairman, President and ChiefExecutive Officer, contract termination fees recorded in connection with anautomated teller machine (ATM) processing conversion planned for 2009 and costsrelated to the additional of a branch banking office in Grove City,Pennsylvania.

·                  The provision for income taxes decreased as a result of decreasedpre-tax income.

·                  The Corporation realized extraordinary income relatedto the completion of a merger conversion with ECSLA in Ridgway, Pennsylvania.

 

During the yearended December 31, 2008, the Corporation experienced asset growth of 20.5%as total assets increased $63.9 million to $375.7 million at year end from$311.7 million at December 31, 2007. This asset growth was driven by total loan portfolio growth of $35.0million or 15.2%, security portfolio growth of $19.5 million or 37.6% and anincrease in cash and equivalents of $6.1 million or 58.1%.  This asset growth was funded by an increasein customer deposits of $42.4 million or 17.4% and an increase in borrowedfunds of $7.8 million or 19.3%.

 

**Changesin Financial Condition**

 

Total assetsincreased $63.9 million or 20.5% to $375.7 million at December 31, 2008from $311.7 million at December 31, 2007. This increase was due to increases in loans receivable, securitiesavailable for sale and cash and equivalents of $35.0 million, $19.5 million and$6.1 million, respectively.

 

The increase inthe Corporation’s total assets was primarily funded by increases in totalliabilities of $52.5 million or 18.3% and total stockholders’ equity of $11.4million or 46.2%.  The increase in totalliabilities was primarily due to an increase in total deposits of $42.4 millionor 17.4% and an increase in borrowed funds of $7.8 million or 19.3%.  The increase in stockholders’ equity wasprimarily due to a purchase of preferred stock by the U.S. Treasury inconnection with the CPP and the issuance of common stock related to theCorporation’s public stock offering in connection with the ECSLA mergerconversion.

 

**Cash andcash equivalent**s.  These accounts increased a combined $6.1million or 58.1% to $16.6 million at December 31, 2008 from $10.5 millionat December 31, 2007.  Theseaccounts are typically increased by net operating results, deposits bycustomers into savings and checking accounts, loan and security repayments andproceeds from borrowed funds.  Decreasesresult from customer deposit withdrawals, new loan originations or other loanfundings, security purchases, repayments of borrowed funds and cash dividends tostockholders.  The increased balance isprimarily due to the Bank’s investment in certificates of deposits with otherfinancial institutions.

 

**Securities.** Securities increased $19.5 million or 37.6% to $71.4 million at December 31,2008 from $51.9 million at December 31, 2007.  This increase was primarily related to thepurchase of mortgage-backed securities, partially offset by a decrease in U.S.Government agency securities as a result of such securities being calledthroughout the year.  The mortgage-backedsecurities were funded with short-term borrowings to obtain a favorableinterest rate spread.

 

**Loansreceivable.**  Net loans receivable increased $35.0 millionor 15.2% to $264.8 million at December 31, 2008 from $229.8 million at December 31,2007, as a result of loan production of $75.1 million during 2008 partiallyoffset by normal amortization and payoffs. This increase was primarily attributed to growth in the Corporation’scommercial and residential mortgage loan portfolios.  Commercial real estate loans increased $14.1million or 19.7% and residential first mortgage loans increased $8.4 million or12.8% as $7.0 million was added in association with the ECSLA acquisition.  Also contributing to loan portfolio growthwere increases in home equity and commercial business loans of $8.0 million and$5.2 million, respectively.

 

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**Non-performingassets.**  Non-performing assets include non-accrualloans, loans 90 days past due and still accruing, REO.  Non-performing assets were $1.1 million or0.28% of total assets at December 31, 2008 compared to $1.1 million or0.35% of total assets at December 31, 2007.  Non-performing assets consisted ofnon-performing loans and REO of $1.0 million and $50,000, respectively, at December 31,2008 and $1.0 million and $129,000, respectively, at December 31,2007.  At December 31, 2008,non-performing assets consisted primarily of commercial and residentialmortgage loans.

 

**Federalbank stocks.**  Federal bank stocks were comprised of FHLBstock and FRB stock of $3.5 million and $333,000, respectively, at December 31,2008.  These stocks are purchased andredeemed at par as directed by the federal banks and levels maintained arebased primarily on borrowing and other correspondent relationships between theCorporation and the banks.  The increasein federal bank stocks can be attributed to increased short-term borrowingswith the FHLB.  In December 2008,the FHLB notified member banks that it was suspending dividend payments and therepurchase of capital stock.  Managementevaluated the FHLB stock for impairment and determined that no impairmentcharge was necessary as of December 31, 2008.

 

**Bank-ownedlife insurance (BOLI).**  The Corporation maintainssingle premium life insurance policies on twenty current and former officersand employees of the Bank.  In additionto providing life insurance coverage, whereby the Bank as well as the officersand employees receive life insurance benefits, the appreciation of the cashsurrender value of the BOLI will serve to offset and finance existing andfuture employee benefit costs.  Increasesin this account during 2008 wereassociated with an increase in the cash surrender value of the policies,partially offset by certain administrative expenses.

 

**Premisesand equipment.**  Premises and equipment increased $705,000 or8.9% to $8.6 million at December 31, 2008 from $7.9 million at December 31,2007.  The overall increase in premisesand equipment during the year was due to capital expenditures of $1.4 million,partially offset by normal depreciation and amortization of $737,000.  Major capital expenditures during the yearconsisted of improvements made at the full service banking office in GroveCity, Pennsylvania that was purchased in December of 2006 and openedduring 2008.  In addition, constructionbegan on a new facility to replace the current office in East Brady,Pennsylvania.  This facility is expectedto open during the first quarter of 2009. Also, the Corporation made a significant investment in technology withan upgrade to its mainframe equipment and related system software.

 

**Deposits. **Total deposits increased$42.4 million or 17.4% to $286.6 million at December 31, 2008 from $244.3million at December 31, 2007. Noninterest bearing deposits increased $9.2 million or 19.6% during theyear and interest bearing deposits increased by $33.1 million or 16.8%.  Contributing to this increase was $6.5million in deposits obtained at the new Grove City, Pennsylvania office and$6.2 million of deposits added in connection with the ECSLA acquisition.  Deposit growth in the remaining elevenoffices totaled $29.7 million.

 

**Borrowed funds.**  Borrowed funds increased $7.8 million or19.3% to $48.2 million at December 31, 2008 from $40.4 million at December 31,2007.  This increase was related to thefunding of certain mortgage-backed investment securities.

 

**Stockholders’ equity.**  Stockholders’ equity increased $11.4 millionor 46.2% to $36.1 million at December 31, 2008 from $24.7 million at December 31,2007.  This increase was primarily theresult of the U.S. Treasury’s purchase of $7.5 million of preferred stockrelated to the CPP.  Also during theyear, the Corporation completed a public stock offering related to the ECSLAmerger in which 163,569 shares of Emclaire common stock were issued at a priceof $21.15, resulting in proceeds of $3.5 million, net of discount on commonstock of $293,000.

 

# **Changesin Results of Operations**

#  

The Corporation reportednet income of $2.4 million and $2.7 million in 2008 and 2007,respectively.  The following “AverageBalance Sheet and Yield/Rate Analysis” and “Analysis of Changes in Net InterestIncome” tables should be utilized in conjunction with the discussion of the netinterest income and interest expense components of net income.

 

K-23

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Table of Contents

 

**Average Balance Sheet andYield/Rate Analysis.** The following table sets forth, for the periods indicated, information concerningthe total dollar amounts of interest income from interest-earning assets andthe resulting average yields, the total dollar amounts of interest expense oninterest-bearing liabilities and the resulting average costs, net interestincome, interest rate spread and the net interest margin earned on averageinterest-earning assets.  For purposes ofthis table, average loan balances include non-accrual loans and exclude theallowance for loan losses and interest income includes accretion of net deferredloan fees.  Interest and yields ontax-exempt loans and securities (tax-exempt for federal income tax purposes)are shown on a fully tax equivalent basis. The information is based on average daily balances during the periodspresented.

 
| ** **                                                                                                                          | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                          | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| **(Dollar amounts in thousands)**                                                                                    | ** ** | **Average  Balance**                       | ** ** | **Interest** | ** ** | **Yield /  Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Yield /  Rate** | ** ** |
| ** **                                                                                                                          |
| ** **                                                                                                                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-earning  assets:**                                                                                                       |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Loans, taxable                                                                                                                      |       | $                                          | 240,714    |   | $ | 15,906 |   | 6.61 | % | $ | 215,771 |   | $ | 15,006 |   | 6.95 | % |
| Loans,  tax-exempt                                                                                                                  |       | 5,954                                      |       | 370 |   | 6.21 | % | 6,286 |   | 407 |   | 6.47 | % |
| *Total  loans receivable*                                                                                                           |       | 246,668                                    |       | 16,276 |   | 6.60 | % | 222,057 |   | 15,413 |   | 6.94 | % |
|                                                                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Securities,  taxable                                                                                                                |       | 44,447                                     |       | 1,992 |   | 4.48 | % | 36,882 |   | 1,571 |   | 4.26 | % |
| Securities,  tax-exempt                                                                                                             |       | 14,031                                     |       | 921 |   | 6.56 | % | 14,750 |   | 996 |   | 6.75 | % |
| *Total  securities*                                                                                                                 |       | 58,478                                     |       | 2,913 |   | 4.98 | % | 51,632 |   | 2,567 |   | 4.97 | % |
|                                                                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  deposits with banks                                                                                               |       | 7,515                                      |       | 201 |   | 2.67 | % | 3,209 |   | 166 |   | 5.17 | % |
| Federal bank  stocks                                                                                                                |       | 2,868                                      |       | 102 |   | 3.56 | % | 2,315 |   | 144 |   | 6.22 | % |
| *Total  interest-earning cash equivalents*                                                                                          |       | 10,383                                     |       | 303 |   | 2.92 | % | 5,524 |   | 310 |   | 5.61 | % |
| ** **                                                                                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  interest-earning assets**                                                                                                  | ** ** | **315,529**                                | ** ** | **19,492** | ** ** | **6.18** | **%** | **279,213** | ** ** | **18,290** | ** ** | **6.55** | **%** |
| Cash and due  from banks                                                                                                            |       | 5,512                                      |       |   |   |   |   | 5,952 |   |   |   |   |   |
| Other  noninterest-earning assets                                                                                                   |       | 14,928                                     |       |   |   |   |   | 14,649 |   |   |   |   |   |
|                                                                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Assets                                                                                                                        |       | $                                          | 335,969    |   |   |   |   |   | $ | 299,814 |   |   |   |   |   |
| ** **                                                                                                                          |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing  liabilities:**                                                                                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  demand deposits                                                                                                   |       | $                                          | 92,208     |   | 1,332 |   | 1.44 | % | $ | 73,364 |   | 956 |   | 1.30 | % |
| Time deposits                                                                                                                       |       | 121,275                                    |       | 5,083 |   | 4.19 | % | 121,889 |   | 5,484 |   | 4.50 | % |
| *Total  interest-bearing deposits*                                                                                                  |       | 213,483                                    |       | 6,415 |   | 3.00 | % | 195,253 |   | 6,440 |   | 3.30 | % |
|                                                                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Borrowed funds,  short-term                                                                                                         |       | 10,096                                     |       | 182 |   | 1.80 | % | 1,208 |   | 33 |   | 2.73 | % |
| Borrowed funds,  long-term                                                                                                          |       | 35,000                                     |       | 1,571 |   | 4.49 | % | 31,233 |   | 1,413 |   | 4.52 | % |
| *Total  borrowed funds*                                                                                                             |       | 45,096                                     |       | 1,753 |   | 3.89 | % | 32,441 |   | 1,446 |   | 4.46 | % |
| ** **                                                                                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Total  interest-bearing liabilities**                                                                                             | ** ** | **258,579**                                | ** ** | **8,168** | ** ** | **3.16** | **%** | **227,694** | ** ** | **7,886** | ** ** | **3.46** | **%** |
| ** **                                                                                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Noninterest-bearing  demand deposits                                                                                                |       | 48,696                                     |       | — |   | — |   | 45,086 |   | — |   | — |   |
| ** **                                                                                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Funding  and cost of funds**                                                                                                      | ** ** | **307,275**                                | ** ** | **8,168** | ** ** | **2.66** | **%** | **272,780** | ** ** | **7,886** | ** ** | **2.89** | **%** |
| ** **                                                                                                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Other  noninterest-bearing liabilities                                                                                              |       | 2,762                                      |       |   |   |   |   | 2,810 |   |   |   |   |   |
| Total  Liabilities                                                                                                                  |       | 310,037                                    |       |   |   |   |   | 275,590 |   |   |   |   |   |
|                                                                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Stockholders’  Equity                                                                                                          |       | 25,932                                     |       |   |   |   |   | 24,224 |   |   |   |   |   |
|                                                                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Total  Liabilities and Stockholders’ Equity                                                                                    |       | $                                          | 335,969    |   |   |   |   |   | $ | 299,814 |   |   |   |   |   |
| ** **                                                                                                                          |       |                                       | ** ** | ** ** |   |   |   |   | ** ** | ** ** |   |   |   |
| **Net  interest income**                                                                                                            |       |                                       | ** ** | **$** | **11,324** |   |   |   |   | ** ** | **$** | **10,404** |   |   |   |
| ** **                                                                                                                          |       |                                       |       |   |   | ** ** | ** ** |   |   |   |   | ** ** | ** ** |
| **Interest  rate spread**(difference between****weighted  average rate on interest-earning assets and interest-bearing liabilities) |       |                                       |       |   |   | **3.02** | **%** |   |   |   |   | **3.09** | **%** |
| ** **                                                                                                                          |       |                                       |       |   |   | ** ** | ** ** |   |   |   |   | ** ** | ** ** |
| **Net  interest margin**(net interest income as a percentage of  average interest-earning assets)                                   |       |                                       |       |   |   | **3.59** | **%** |   |   |   |   | **3.73** | **%** |

 

K-24

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Table of Contents

 

**Analysis of Changes in NetInterest Income.**  Thefollowing table analyzes the changes in interest income and interest expense interms of: (1) changes in volume of interest-earning assets andinterest-bearing liabilities and (2) changes in yields and rates.  The table reflects the extent to which changesin the Corporation’s interest income and interest expense are attributable tochanges in rate (change in rate multiplied by prior year volume), changes involume (changes in volume multiplied by prior year rate) and changesattributable to the combined impact of volume/rate (change in rate multipliedby change in volume).  The changesattributable to the combined impact of volume/rate are allocated on aconsistent basis between the volume and rate variances.  Changes in interest income on loans andsecurities reflect the changes in interest income on a fully tax equivalentbasis.

 
| ** **                                       | ** ** | **2008 versus 2007**                | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **Increase (decrease) due to** | ** ** |
| **(Dollar amounts in thousands)** | ** ** | **Volume**                                    | ** ** | **Rate** | ** ** | **Total** | ** ** |
| **Interest  income:**                            |       |                                          |       |   |   |   |   |
| Loans                                            |       | $                                             | 1,650      |   | $ | (787 | ) | $ | 863 |   |
| Securities                                       |       | 341                                           |       | 5 |   | 346 |   |
| Interest-earning  deposits with banks            |       | 144                                           |       | (109 | ) | 35 |   |
| Federal bank  stocks                             |       | 29                                            |       | (71 | ) | (42 | ) |
|                                             |       |                                          |       |   |   |   |   |
| Total  interest-earning assets                   |       | 2,164                                         |       | (962 | ) | 1,202 |   |
| ** **                                       |       |                                          |       |   |   |   |   |
| **Interest  expense:**                           |       |                                          |       |   |   |   |   |
| Deposits                                         |       | 574                                           |       | (599 | ) | (25 | ) |
| Borrowed funds                                   |       | 510                                           |       | (203 | ) | 307 |   |
|                                             |       |                                          |       |   |   |   |   |
| Total  interest-bearing liabilities              |       | 1,084                                         |       | (802 | ) | 282 |   |
|                                             |       |                                          |       |   |   |   |   |
| **Net  interest income**                         |       | $                                             | 1,080      |   | $ | (160 | ) | $ | 920 |   |

 

## ***2008 Results Compared to 2007Results***

## ** **

The Corporation reported net income of $2.4 millionand $2.7 million for 2008 and 2007, respectively.  The $267,000 or 9.9% decrease in net incomewas attributed to increases in noninterest expense and the provision for loanlosses of $1.9 million and $244,000, respectively, and a decrease innoninterest income of $456,000, partially offset by an increase in net interestincome of $956,000 and a decrease in the provision for income taxes of$439,000.  In addition, extraordinaryincome of $906,000 was recorded in 2008 associated with the ECSLA acquisition.

 

**Netinterest income.**  Theprimary source of the Corporation’s revenue is net interest income.  Net interest income is the difference betweeninterest income on earning assets such as loans and securities, and interestexpense on liabilities, such as deposits and borrowed funds, used to fund theearning assets.  Net interest income isimpacted by the volume and composition of interest-earning assets andinterest-bearing liabilities, and changes in the level of interest rates.  Tax equivalent net interest income increased$920,000 to $11.3 million for 2008, compared to $10.4 million for 2007.  This increase in net interest income can beattributed to an increase in tax equivalent interest income of $1.2 millionpartially offset by an increase in interest expense of $282,000.

 

**Interestincome.**  Tax equivalentinterest income increased $1.2 million or 6.6% to $19.5 million for 2008,compared to $18.3 million for 2007.  Thisincrease can be attributed to increases in interest earned on loans, securitiesand interest-earning deposits of $863,000, $346,000, and $35,000, partiallyoffset by a decrease in dividends on federal bank stocks of $42,000.

 

K-25

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Tableof Contents

 

Taxequivalent interest earned on loans receivable increased $863,000 or 5.6% to$16.3 million for 2008, compared to $15.4 million for 2007.  During that time, average loans increased$24.6 million or 11.1%, generating $1.7 million of additional loan interestincome.  The increase in average loansoutstanding can be attributed to $75.1 million of loan production in 2008, theaddition of loans from the ECSLA acquisition, and the impact in 2008 of loangrowth in late 2007.  Offsetting thisfavorable asset growth, the yield on loans decreased 34 basis points to 6.60%for 2008, versus 6.94% for 2007 as a result of declines in market interestrates throughout 2008 causing a $787,000 decrease in interest income.

 

Tax equivalentinterest earned on securities increased $346,000 or 13.5% to $2.9 million for2008, compared to $2.6 million for 2007. During this time, average securities increased $6.8 million or 13.3%accounting for $341,000 in additional security interest income.  This increase was primarily related to thepurchase of mortgage-backed securities during the year.  The average yield on securities remainedstable at 4.98% for 2008 versus 4.97% for 2007.

 

Interest earned oninterest-earning deposit accounts increased $35,000 to $201,000 for 2008,compared to $166,000 for 2007.  Averageinterest-earning deposits increased $4.3 million or 134.2% primarily related tocertificates of deposits held with other financial institutions. This increasegenerated $144,000 of additional interest income.  Partially offsetting the favorable volumevariance, the average yield decreased 250 basis points due to declining marketinterest rates resulting in a $109,000 decrease in interest income.  Interest earned on federal bank stocksdecreased $42,000 to $102,000 for 2008, compared to $144,000 for 2007 as aresult of lower yields despite higher volume.

 

**Interestexpense.**  Interestexpense increased $282,000 or 3.6% to $8.2 million for 2008, compared to $7.9million for 2007.  This increase can beattributed to an increase in interest incurred on borrowed funds of $307,000,partially offset by a decrease in interest incurred on interest-bearingdeposits of $25,000.

 

Interest expense onborrowed funds increased $307,000 to $1.8 million for 2008, compared to $1.5million for 2007 as a result of the addition of $5.0 million of FHLB long-termborrowings placed in the fourth quarter of 2007 to fund loan growth and anincrease in average FHLB short-term borrowings to $10.1 million during 2008from $1.2 million in 2007.  The increasein average short-term borrowed funds was due to borrowings utilized primarilyto fund the purchase of certain mortgage-backed investment securities.

 

Deposit interest expensedecreased $25,000 and totaled $6.4 million for 2008 and 2007.  This decrease was primarily due to a decreasein the cost of interest-bearing deposits of 30 basis points to 3.00% for 2008compared to 3.30% for 2007 decreasing interest expense by $599,000.  Partially offsetting the favorable yieldvariance, the average volume of deposits increased by $18.2 million or 9.3%contributing an additional $574,000 in interest expense.

 

**Provision for loan losses.**  The Corporation records provisions for loanlosses to maintain a level of total allowance for loan losses that managementbelieves, to the best of its knowledge, covers all known and inherent lossesthat are both probable and reasonably estimable at each reporting date.Management considers historical loss experience, the present and prospectivefinancial condition of borrowers, current conditions (particularly as theyrelate to markets where the Corporation originates loans), the status ofnon-performing assets, the estimated underlying value of the collateral andother factors related to the collectability of the loan portfolio.

 

The provision for loanlosses increased $244,000 or 95.3% to $500,000 for 2008, compared to $256,000for 2007. The Corporation’s allowance for loan losses amounted to $2.7 millionor 0.99% of the Corporation’s total loan portfolio at December 31, 2008,compared to $2.2 million or 0.93% at December 31, 2007.  The allowance for loan losses as a percentageof non-performing loans at December 31, 2008 and 2007 was 262.2% and226.6%, respectively.  The increase inthe provision for loan losses was primarily due to the aforementioned growth inthe Corporation’s loan portfolio.

 

K-26

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**Noninterestincome.**  Noninterestincome includes revenue that is not related to interest rates, but rather toservices rendered and activities conducted in the financial services industry,including fees on depository accounts, general transaction and service fees,commissions on financial services, security and loan gains and losses, andearnings on BOLI.  Noninterest incomedecreased $456,000 or 15.5% to $2.5 million for 2008 compared to $2.9 millionfor 2007.  This decrease was primarilyrelated to impairment charges recorded on two marketable equity securitiesduring 2008 totaling $391,000.  Theimpairment of these financial industry securities were considered to be otherthan temporary due to developments in the financial conditions and near-termprospects of the issuers, a downturn in economic conditions of the industry anddeteriorating book values of the securities. Conversely, during 2007, the Corporation realized $166,000 in gainsprimarily from the sale of a community bank stock investment as a result ofthat bank’s merger with a larger financial institution.

 

Partiallyoffsetting this decrease in noninterest income, fee and service charges andother noninterest income increased $89,000 and $71,000, respectively.  Theses increases were the result of increasedoverdraft fee income and gains realized during 2008 associated with the sale offoreclosed properties.

 

**Noninterestexpense.**  Noninterestexpense increased $1.9 million or 20.4% to $11.0 million for 2008, compared to$9.2 million for 2007.  This increase innoninterest expense was comprised of increases in compensation and employeebenefits, premises and equipment and other expenses of $1.3 million, $125,000and $486,000, respectively.

 

The largest component ofnoninterest expense, compensation and employee benefits, increased $1.3 millionor 24.7%.  This increase was primarilythe result of severance charges totaling $590,000 recorded in 2008, principallyassociated with the retirement of the Corporation’s former Chairman of theBoard, President and Chief Executive Officer in December 2008.  Also contributing to the increase incompensation and benefits expense were customary salary and wage increases andthe addition of staff related to the new Grove City, Pennsylvania office whichopened in April 2008.

 

Premises and equipmentexpense increased $125,000 or 7.9%, related to operating costs associated withthe new Grove City office and a write-down of the Bank’s East Brady,Pennsylvania building as the current office has not been sold and the newfacility will be ready for occupancy in early 2009.

 

Other expense increased $486,000 or 19.6%primarily due to an increase in other operating expenses of $361,000. Theincrease in other operating expenses was primarily the result of contracttermination fees of $360,000 recognized in connection with an ATM processingconversion planned for 2009.  Management’sstrategic decision to change the Bank’s ATM processor was made in an effort toimprove customer service, increase operational efficiency and provide futurecost savings.

 

Other expense includes FDIC insurance expense,which totaled $82,000 and $28,000 for the years ended December 31, 2008and 2007, respectively.  Due to theassessment credits that partially offset FDIC premium expense in 2008 and 2007as well as deposit insurance premium increases projected for 2009 and possibleemergency assessments, FDIC insurance expense will be significantly higher in2009.

 

The provision for income taxesdecreased $439,000 or 55.2% to $356,000 for 2008, compared to $795,000 for 2007due to a decrease in pre-tax earnings of $1.6 million and a decrease in theCorporation’s effective tax rate to 18.9 % for 2008 from 22.8% for 2007.

 

**Extraordinary item.**  The Corporation recognized $906,000 ofextraordinary income during 2008 related to the acquisition of ECSLA.  The extraordinary income, also defined asnegative goodwill, was the result of the sum of the fair values of the assetsacquired less the liabilities assumed exceeding the acquisition cost.

 

K-27

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Tableof Contents

 

**Market Risk Management**

 

Market risk for theCorporation consists primarily of interest rate risk exposure and liquidity risk.  The Corporation is not subject to currencyexchange risk or commodity price risk, and has no trading portfolio, andtherefore, is not subject to any trading risk. In addition, the Corporation does not participate in hedgingtransactions such as interest rate swaps and caps.  Changes in interest rates will impact bothincome and expense recorded and also the market value of long-terminterest-earning assets.

 

The primary objective ofthe Corporation’s asset liability management function is to maximize theCorporation’s net interest income while simultaneously maintaining anacceptable level of interest rate risk given the Corporation’s operatingenvironment, capital and liquidity requirements, balance sheet mix, performanceobjectives and overall business focus. One of the primary measures of the exposure of the Corporation’searnings to interest rate risk is the timing difference between the repricingor maturity of interest-earning assets and the repricing or maturity of itsinterest-bearing liabilities.

 

TheCorporation’s Board of Directors has established a Finance Committee,consisting of four outside directors, the President and Chief Executive Officer(CEO) and the Principal Accounting Officer (PAO), to monitor market risk,including primarily interest rate risk. This committee, which meets at least quarterly, generally establishesand monitors the investment, interest rate risk and asset liability managementpolicies established by the Corporation.

 

In order to minimize the potential for adverse affectsof material and prolonged changes in interest rates on the Corporation’sresults of operations, the Corporation’s management has implemented andcontinues to monitor asset liability management policies to better match thematurities and repricing terms of the Corporation’s interest-earning assets andinterest-bearing liabilities.  Suchpolicies have consisted primarily of (i) originating adjustable-rate mortgage loans; (ii) originatingshort-term secured commercial loans with the rate on the loan tied to the primerate or reset features in which the rate changes at determined intervals; (iii) emphasizinginvestment in shorter-term (15 years or less) investment securities; (iv) sellinglonger-term (30-year) fixed-rate residential mortgage loans in the secondarymarket; (v) maintaining a high level of liquid assets (includingsecurities classified as available for sale) that can be readily reinvested inhigher yielding investments should interest rates rise; (vi) emphasizingthe retention of lower-costing savings accounts and other core deposits; and (vii) lengtheningliabilities and locking in lower borrowing rates with longer terms wheneverpossible.

 

**Interest Rate Sensitivity GapAnalysis**

 

Theimplementation of asset and liability initiatives and strategies and compliancewith related policies, combined with other external factors such as demand forthe Corporation’s products and economic and interest rate environments ingeneral, has resulted in the Corporation maintaining a one-year cumulativeinterest rate sensitivity gap ranging between a positive and negative 20% oftotal assets.  The one-year interest ratesensitivity gap is identified as the difference between the Corporation’sinterest-earning assets that are scheduled to mature or reprice within one yearand its interest-bearing liabilities that are scheduled to mature or repricewithin one year.

 

Theinterest rate sensitivity gap is defined as the difference between the amountof interest-earning assets maturing or repricing within a specific time periodand the amount of interest-bearing liabilities maturing or repricing withinthat time period.  A gap is consideredpositive when the amount of interest rate-sensitive assets exceeds the amountof interest rate-sensitive liabilities, and is considered negative when theamount of interest rate-sensitive liabilities exceeds the amount of interestrate-sensitive assets.  Generally, duringa period of rising interest rates, a negative gap would adversely affect netinterest income while a positive gap would result in an increase in netinterest income.  Conversely, during aperiod of falling interest rates, a negative gap would result in an increase innet interest income and a positive gap would adversely affect net interestincome.  The closer to zero, or moreneutral, that gap is maintained, generally, the lesser the impact of marketinterest rate changes on net interest income.

 

K-28

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Basedon certain assumptions provided by a federal regulatory agency, whichmanagement believes most accurately represents the sensitivity of theCorporation’s assets and liabilities to interest rate changes, at December 31,2008, the Corporation’s interest-earning assets maturing or repricing withinone year totaled $140.3 million while the Corporation’s interest-bearingliabilities maturing or repricing within one-year totaled $114.1 million,providing an excess of interest-bearing assets over interest-earningliabilities of $26.1 million or 7.0% of total assets.  At December 31, 2008, the percentage ofthe Corporation’s assets to liabilities maturing or repricing within one yearwas 122.9%.

 

Thefollowing table presents the amounts of interest-earning assets andinterest-bearing liabilities outstanding as of December 31, 2008 which areexpected to mature, prepay or reprice in each of the future time periodspresented:

 
| **(Dollar amounts in thousands)** | ** ** | **Due in  six months  or less** | ** ** | **Due within  six months  to one year** | ** ** | **Due within  one to  three years** | ** ** | **Due within  three to  five years** | ** ** | **Due in  over  five years** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-----------|------------|
| ** **                                       |
| ** **                                       |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Total  interest-earning assets                   |       | $                                              | 96,261     |                                                        | $          | 44,015                                             |       | $                                                   | 95,673     |                                   | $          | 51,658    |       | $ | 59,922 |   | $ | 347,529 |   |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Total  interest-bearing liabilities              |       | 81,498                                         |       | 32,634                                                      |       | 67,848                                             |       | 51,581                                              |       | 101,280                                |       | 334,841   |       |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Maturity or  repricing gap during the period     |       | $                                              | 14,763     |                                                        | $          | 11,381                                             |       | $                                                   | 27,825     |                                   | $          | 77        |       | $ | (41,358 | ) | $ | 12,688 |   |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Cumulative gap                                   |       | $                                              | 14,763     |                                                        | $          | 26,144                                             |       | $                                                   | 53,969     |                                   | $          | 54,046    |       | $ | 12,688 |   |   |   |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Ratio of gap  during the period to total assets  |       | 3.93                                           | %          | 3.03                                                        | %          | 7.41                                               | %          | 0.02                                                | %          | (11.01                                 | )%         |      |       |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Ratio of  cumulative gap to total assets         |       | 3.93                                           | %          | 6.96                                                        | %          | 14.37                                              | %          | 14.39                                               | %          | 3.38                                   | %          |      |       |
|                                             |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       |      |       |
| Total assets                                     |       |                                           |       |                                                        |       |                                               |       |                                                |       |                                   |       | $         | 375,664    |   |

 

Although certain assetsand liabilities may have similar maturities or periods of repricing, they mayreact in different degrees to changes in market interest rates.  The interest rates on certain types of assetsand liabilities may fluctuate in advance of changes in market interest rates,while interest rates on other types of assets and liabilities may lag behindchanges in market interest rates.  In theevent of a change in interest rates, prepayment and early withdrawal levelswould likely deviate significantly from those assumed in calculating thetable.  The ability of many borrowers toservice their debt may decrease in the event of an interest rate increase.

 

The one-year interestrate sensitivity gap has been the most common industry standard used to measurean institution’s interest rate risk position regarding maturities, repricingand prepayments.  In recent years, inaddition to utilizing interest rate sensitivity gap analysis, the Corporationhas increased its emphasis on the utilization of interest rate sensitivitysimulation analysis to evaluate and manage interest rate risk.

 

***InterestRate Sensitivity Simulation Analysis***

 

The Corporation alsoutilizes income simulation modeling in measuring its interest rate risk andmanaging its interest rate sensitivity. The Finance Committee of the Corporation believes that simulationmodeling enables the Corporation to more accurately evaluate and manage thepossible effects on net interest income due to the exposure to changing marketinterest rates, the slope of the yield curve and different loan and securityprepayment and deposit decay assumptions under various interest rate scenarios.

 

As with gap analysis andearnings simulation modeling, assumptions about the timing and variability ofcash flows are critical in net portfolio equity valuation analysis.  Particularly important are the assumptionsdriving mortgage prepayments and the assumptions about expected attrition of thecore deposit portfolios.  Theseassumptions are based on the Corporation’s historical experience and industrystandards and are applied consistently across the different rate risk measures.

 

K-29

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The Corporation hasestablished the following guidelines for assessing interest rate risk:

 

**Netinterest income simulation.** Given a 200 basis point parallel and gradual increase or decrease inmarket interest rates, net interest income may not change by more than 25% fora one-year period.

 

**Portfolioequity simulation.** Portfolio equity is the net present value of the Corporation’s existingassets and liabilities.  Given a 200basis point immediate and permanent increase or decrease in market interestrates, portfolio equity may not correspondingly decrease or increase by morethan 30% of stockholders’ equity.

 

These guidelines takeinto consideration the current interest rate environment, the Corporation’sfinancial asset and financial liability product mix and characteristics andliquidity sources among other factors. Given the current rate environment, a drop in short-term market interestrates of 200 basis points immediately or over a one-year horizon would seemunlikely.  This should be considered inevaluating modeling results outlined in the table below.

 

The following tablepresents the simulated impact of a 100 basis point or 200 basis point upward ordownward shift of market interest rates on net interest income, for the yearsended December 31, 2008 and 2007, respectively.  This analysis was done assuming that theinterest-earning asset and interest-bearing liability levels at December 31,2008 remained constant.  The impact ofthe market rate movements on net interest income was developed by simulatingthe effects of rates changing gradually during a one-year period from the December 31,2008 levels for net interest income.

 
| ** **                                      | ** ** | **Increase** | ** ** | **Decrease** | ** ** |
|-------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                      | ** ** | **+100**     | ** ** | **+200**     | ** ** | **-100** | ** ** | **-200** | ** ** |
| ** **                                      | ** ** | **BP**       | ** ** | **BP**       | ** ** | **BP** | ** ** | **BP** | ** ** |
|                                            |       |         |       |         |       |   |   |   |   |
| 2008 Net  interest income - increase (decrease) |       | 2.71         | %          | 3.37         | %          | (4.42 | )% | (7.52 | )% |
|                                            |       |         |       |         |       |   |   |   |   |
| 2007 Net  interest income - increase (decrease) |       | 0.26         | %          | (0.66        | )%         | 2.24 | % | 5.15 | % |

 

**Impactof Inflation and Changing Prices**

 

The consolidatedfinancial statements of the Corporation and related notes presented herein havebeen prepared in accordance with accounting principles generally accepted inthe United States of America which require the measurement of financial conditionand operating results in terms of historical dollars, without consideringchanges in the relative purchasing power of money over time due to inflation.

 

Unlike most industrialcompanies, substantially all of the assets and liabilities of a financial institutionare monetary in nature.  As a result,interest rates have a more significant impact on a financial institution’sperformance than the effects of general levels of inflation.  Interest rates do not necessarily move in thesame direction or in the same magnitude as the prices of goods and servicessince such prices are affected by inflation to a larger degree than interestrates.  In the current interest rateenvironment, liquidity and the maturity structure of the Corporation’s assetsand liabilities are critical to the maintenance of acceptable performancelevels.

 

# **CapitalResources**

#  

Total stockholders’equity increased $11.4 million or 46.2% to $36.1 million at December 31,2008 from $24.7 million at December 31, 2007.  Net income of $2.4 million in 2008,represented a decrease in earnings of $267,000 or 9.9% compared to 2007.  Returns on average equity and assets were9.37% and 0.72%, respectively, for 2008.

 

K-30

----

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The Corporation hasmaintained a strong capital position with a capital to assets ratio of 9.6% at December 31,2008, an increase compared to the ratio of 7.9% a year earlier.  While continuing to sustain this strongcapital position, regular dividends increased to $1.7 million in 2008 from $1.5million in 2007.  Stockholders have takenpart in the Corporation’s dividend reinvestment plan introduced during 2003 with42% of registered shareholder accounts active in the plan at December 31,2008.

 

Capitaladequacy is intended to enhance the Corporation’s ability to support growthwhile protecting the interest of shareholders and depositors and to ensure thatcapital ratios are in compliance with regulatory minimum requirements.  Regulatory agencies have developed certaincapital ratio requirements that are used to assist them in monitoring thesafety and soundness of financial institutions. At December 31, 2008, the Corporation and the Bank were in excessof all regulatory capital requirements.

 

**Liquidity**

 

TheCorporation’s primary sources of funds generally have been deposits obtainedthrough the offices of the Bank, borrowings from the FHLB, and amortization andprepayments of outstanding loans and maturing securities.  During 2008, the Corporation used its sourcesof funds primarily to fund loan commitments. As of December 31, 2008, the Corporation had outstanding loancommitments, including undisbursed loans and amounts available under creditlines, totaling $23.6 million, and standby letters of credit totaling $1.1million.  The Bank is required by the OCCto establish policies to monitor and manage liquidity levels to ensure the Bank’sability to meet demands for customer withdrawals and the repayment ofshort-term borrowings, and the Bank is currently in compliance with allliquidity policy limits.

 

At December 31,2008, time deposits amounted to $124.3 million or 43.3% of the Corporation’stotal consolidated deposits, including approximately $49.0 million, which arescheduled to mature within the next year. Management of the Corporation believes that the Corporation has adequateresources to fund all of its commitments, that all of its commitments will befunded as required by related maturity dates and that, based upon pastexperience and current pricing policies, it can adjust the rates of timedeposits to retain a substantial portion of maturing liabilities.

 

Asidefrom liquidity available from customer deposits or through sales and maturitiesof securities, the Corporation has alternative sources of funds such as a lineof credit and term borrowing capacity from the FHLB and, to a more limitedextent, through the sale of loans.  At December 31,2008, the Corporation’s borrowing capacity with the FHLB, net of fundsborrowed, was $138.0 million.

 

TheCorporation paid quarterly cash dividends over the past two years and recentlydetermined to reduce the quarterly cash dividend from $0.32 per share to $0.14per share effective for the second quarter of 2009.  The determination of future dividends on theCorporation’s common stock will depend on conditions existing at that time withconsideration given to the Corporation’s earnings, capital and liquidity needs,among other factors.

 

Management is not awareof any conditions, including any regulatory recommendations or requirements,that would adversely impact its liquidity or its ability to meet funding needsin the ordinary course of business.

 

**Critical Accounting Policies**

 

The Corporation’sconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States of America and followgeneral practices within the industry in which it operates.  Application of these principles requiresmanagement to make estimates or judgments that affect the amounts reported inthe financial statements and accompanying notes.  These estimates are based on informationavailable as of the date of the financial statements; accordingly, as thisinformation changes, the financial statements could reflect different estimatesor judgments.  Certain policiesinherently have a greater reliance on the use of estimates, and as such have agreater possibility of producing results that could be materially differentthan originally reported.  Estimates orjudgments are necessary when assets and liabilities are required to be recordedat fair value, when a decline in the value of an asset not carried on the financialstatements at fair value warrants an impairment write-down or valuation reserveto be established or when an asset or liability needs to be

 

K-31

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recorded contingent upona future event.  Carrying assets andliabilities at fair value inherently results in more financial statementvolatility.  The fair values and theinformation used to record valuation adjustments for certain assets andliabilities are based either on quoted market prices or are provided bythird-party sources, when available. When third-party information is not available, valuation adjustments areestimated in good faith by management primarily though the use of internal cashflow modeling techniques.

 

The most significantaccounting policies followed by the Corporation are presented in Note 1 to theconsolidated financial statements.  Thesepolicies, along with the disclosures presented in the other financial statementnotes provide information on how significant assets and liabilities are valuedin the financial statements and how those values are determined.  Management views critical accounting policiesto be those which are highly dependent on subjective or complex judgments,estimates and assumptions and where changes in those estimates and assumptionscould have a significant impact on the financial statements.  Management has identified the following as acritical accounting policy.

 

***Allowancefor loan losses.*** The Corporation considers that the determination of the allowance forloan losses involves a higher degree of judgment and complexity than its othersignificant accounting policies.  Thebalance in the allowance for loan losses is determined based on management’sreview and evaluation of the loan portfolio in relation to past lossexperience, the size and composition of the portfolio, current economic eventsand conditions and other pertinent factors, including management’s assumptionsas to future delinquencies, recoveries and losses.  All of these factors may be susceptible tosignificant change.  Among the manyfactors affecting the allowance for loan losses, some are quantitative while othersrequire qualitative judgment.  Althoughmanagement believes its process for determining the allowance adequatelyconsiders all of the potential factors that could potentially result in creditlosses, the process includes subjective elements and may be susceptible tosignificant change.  To the extent actualoutcomes differ from management’s estimates, additional provisions for loanlosses may be required that would adversely impact the Corporation’s financialcondition or earnings in future periods.

 

**Item 7A. Quantitative and Qualitative Disclosures About Market Risk**

 

Information required bythis item is included in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in item 7.

 

**Item 8.  Financial Statements andSupplementary Data**

 

Information required bythis item is included herein beginning on page F-1.

 

**Item 9. Changes in and Disagreements With Accountants on Accounting andFinancial Disclosure**

 

None.

 

**Item 9A(T).  Controls and Procedures**

 

The Corporation maintainsdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the Corporation’s Exchange Act reports is recorded,processed, summarized, and reported within the time periods specified in theSEC’s rules and forms, and that such information is accumulated andcommunicated to the Corporation’s Management, including its CEO and PAO, asappropriate, to allow timely decisions regarding required disclosure basedclosely on the definition of “disclosure controls and procedures” in Rule 13a-15(e).

 

As of December 31,2008, the Corporation carried out an evaluation, under the supervision and withthe participation of the Corporation’s Management, including the Corporation’sCEO and PAO, of the effectiveness of the design and operation of theCorporation’s disclosure controls and procedures.  Based on the foregoing, the Corporation’s CEOand PAO concluded that the Corporation’s disclosure controls and procedureswere effective.

 

K-32

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There have been nosignificant changes in the Corporation’s internal controls or in other factorsthat could significantly affect the internal controls subsequent to the datethe Corporation completed its valuation.

 

During the fourth quarterof fiscal year 2008, there has been no change made in the Corporation’sinternal control over financial reporting that has materially affected, or isreasonably likely to materially affect, the Corporation’s internal control overfinancial reporting.

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting for the Corporation.  Internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles.

 

Management completed anassessment of the Corporation’s internal control over financial reporting as ofDecember 31, 2008.  This assessmentwas based on criteria for evaluating internal control over financial reportingestablished in *Internal Control — Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this assessment, managementconcluded that the Corporation’s internal control over financial reporting waseffective as of December 31, 2008.

 

This annual report doesnot include an attestation report of the Corporation’s registered public accountingfirm regarding internal control over financial reporting.  The Corporation’s internal control overfinancial reporting was not subject to attestation by the Corporation’sregistered public accounting firm pursuant to temporary rules of the SECthat permit the Corporation to provide only management’s report in this annualreport.

 

**Item 9B. Other Information**

 

None.

 

**PART III**

 

**Item10.  Directors, Executive Officers andCorporate Governance**

 

The information required by this item is incorporated herein by reference to thesections captioned “Principal Beneficial Owners of the Corporation’s CommonStock”, “Section 16(a) Beneficial Ownership Reporting Compliance” and“Information With Respect to Nominees For Director, Continuing Director andExecutive Officers” in the Corporation’s definitive proxy statement for theCorporation’s Annual Meeting of Stockholders to be held on April 22, 2009(the Proxy Statement) which will be filed no later than 120 days following theCorporation’s fiscal year end.

 

The Corporation maintainsa Code of Personal and Business Conduct and Ethics (the Code) that applies toall employees, including the CEO and the PAO. A copy of the Code has previously been filed with the SEC and is postedon our website at www.farmersnb.com.  Anywaiver of the Code with respect to the CEO and the PAO will be publiclydisclosed in accordance with applicable regulations.

 

**Item11.  Executive Compensation**

 

The information required by this item is incorporatedherein by reference to the section captioned “Executive Compensation” in theProxy Statement.

 

**Item 12. Security Ownership of Certain Beneficial Owners and Management andRelated Stockholder Matters**

 

The informationrequired by this item is incorporated herein by reference to the sectioncaptioned “Principal Beneficial Owners of the Corporation’s Common Stock” inthe Proxy Statement.

 

K-33

----

Table of Contents

 

**Item 13. Certain Relationships and Related Transactions, and DirectorIndependence**

 

The information requiredby this item is incorporated herein by reference to the sections captioned “InformationWith Respect to Nominees For Director, Continuing Directors and Executive Officers”and “Executive Compensation” in the Proxy Statement.

 

**Item 14. Principal Accountant Fees and Services**

 

Theinformation required by this item is incorporated herein by reference to thesection captioned “Relationship With Independent Registered Public AccountingFirm” in the Proxy Statement.

 

**PART IV**

 

**Item15.  Exhibits and Financial StatementSchedules**

 

(a)(1)-(2) FinancialStatements and Schedules:

 

(i)  The financialstatements required in response to this item are incorporated by reference fromItem 8 of this report.

 

(3) Management Contracts or Compensatory Plans:

 

(i) Exhibits 10.1-10.6 listed below in (b) identifymanagement contracts or compensatory plans or arrangements required to be filedas exhibits to this report, and such listing is incorporated herein by reference.

 

(b)                               Exhibits are either attached as part of this Report or incorporatedherein by reference.

 
| 2.1    |   | Agreement  and Plan of Merger by and between Emclaire Financial Corp. and Elk County  Savings and Loan Association. (1)                                                   |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                      |
| 3.1    |   | Articles  of Incorporation of Emclaire Financial Corp. (2)                                                                                                                |
|   |   |                                                                                                                                                                      |
| 3.2    |   | Bylaws  of Emclaire Financial Corp. (2)                                                                                                                                   |
|   |   |                                                                                                                                                                      |
| 3.3    |   | Statement  with respect to shares for Preferred Stock. (3)                                                                                                                |
|   |   |                                                                                                                                                                      |
| 4.0    |   | Specimen  Stock Certificate of Emclaire Financial Corp. (4)                                                                                                               |
|   |   |                                                                                                                                                                      |
| 4.1    |   | Form of  certificate for Preferred Stock. (3)                                                                                                                        |
|   |   |                                                                                                                                                                      |
| 4.2    |   | Warrant  for purchase of shares of Common Stock. (3)                                                                                                                      |
|   |   |                                                                                                                                                                      |
| 10.1   |   | Employment  Agreement between Emclaire Financial Corp., the Farmers National Bank of  Emlenton and certain executive officers, dated as of July 1, 2007. (5)         |
|   |   |                                                                                                                                                                      |
| 10.2   |   | Change  in Control Agreement between Emclaire Financial Corp., the Farmers National  Bank of Emlenton and certain executive officers, dated as of July 1,  2007. (5) |
|   |   |                                                                                                                                                                      |
| 10.3   |   | Group  Term Carve-Out Plan between the Farmers National Bank of Emlenton and 20  Officers and Employees. (6)                                                              |
|   |   |                                                                                                                                                                      |
| 10.4   |   | Supplemental  Executive Retirement Plan Agreement between the Farmers National Bank of  Emlenton and Six Officers. (6)                                                    |

 

K-34

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| 10.5   |   | Adoption  of Farmers National Bank of Emlenton Deferred Compensation Plan. (7)                                                               |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                         |
| 10.6   |   | Letter  Agreement, dated December 23, 2008 between the Corporation and the U.S.  Department of the Treasury. (3)                        |
|   |   |                                                                                                                                         |
| 11.0   |   | Statement  regarding computation of earnings per share (see Note 1 of the Notes to  Consolidated Financial Statements in the Annual Report). |
|   |   |                                                                                                                                         |
| 13.0   |   | Annual  Report to Stockholders for the fiscal year ended December 31, 2008.                                                             |
|   |   |                                                                                                                                         |
| 14.0   |   | Code  of Personal and Business Conduct and Ethics. (8)                                                                                       |
|   |   |                                                                                                                                         |
| 20.0   |   | Emclaire  Financial Corp. Dividend Reinvestment and Stock Purchase Plan. (9)                                                                 |
|   |   |                                                                                                                                         |
| 21.0   |   | Subsidiaries  of the Registrant (see information contained herein under “Item 1. Description  of Business - Subsidiary Activity”). |
|   |   |                                                                                                                                         |
| 31.1   |   | Principal  Executive Officer 302 Certification.                                                                                              |
|   |   |                                                                                                                                         |
| 31.2   |   | Principal  Accounting Officer 302 Certification.                                                                                             |
|   |   |                                                                                                                                         |
| 32.1   |   | Principal  Executive Officer 906 Certification.                                                                                              |
|   |   |                                                                                                                                         |
| 32.2   |   | Principal  Accounting Officer 906 Certification.                                                                                             |

 

----

| (1)    |   | Incorporated by  reference to the Registrant’s Current Report on Form 8-K dated  October 20, 2008.                                                                             |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2)    |   | Incorporated by  reference to the Registrant’s Registration Statement on Form SB-2, as  amended, (File No. 333-11773) declared effective by the SEC on  October 25, 1996. |
| (3)    |   | Incorporated by  reference to the Registrant’s Current Report on Form 8-K dated  December 23, 2008.                                                                            |
| (4)    |   | Incorporated by  reference to the Registrant’s Annual Report on Form 10-K for the year  ended December 31, 1997.                                                               |
| (5)    |   | Incorporated by  reference to the Registrant’s Current Report on Form 8-K dated  June 21, 2007.                                                                                |
| (6)    |   | Incorporated by  reference to the Registrant’s Annual Report on Form 10-K for the year  ended December 31, 2002.                                                               |
| (7)    |   | Incorporated by  reference to the Registrant’s Current Report on Form 8-K dated  December 15, 2008.                                                                            |
| (8)    |   | Incorporated by  reference to the Registrant’s Annual Report on Form 10-K for the year  ended December 31, 2004.                                                               |
| (9)    |   | Incorporated by reference to the  Registrant’s Annual Report on Form 10-K for the year ended  December 31, 2001.                                                               |
|   |   |                                                                                                                                                                                          |

K-35

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Table of Contents

 

SIGNATURES

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 
| ** **                  | **EMCLAIRE FINANCIAL CORP.** |
|-----------------------------|------------------------------|
|                        |                         |
| Dated: March 27,  2009 | By:                          | /s/ William C. Marsh |
|                        |                         | William C. Marsh |
|                        |                         | Chairman, Chief  Executive Officer, President and Director |
|                        |                         | (Duly Authorized  Representative) |

 

Pursuant to therequirement of the Securities Exchange Act of 1934, this Report has been signedbelow by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.

 

| By:                                               | /s/ William C. Marsh           |                                              | By:    | /s/ Amanda L. Engles            |
|---------------------------------------------------|--------------------------------|---------------------------------------------------|--------|---------------------------------|
|                                              | William C. Marsh               |                                              |   | Amanda L. Engles                |
|                                              | Chairman of the Board          |                                              |   | Treasurer                       |
|                                              | Chief Executive Officer        |                                              |   | (Principal Accounting  Officer) |
|                                              | President                      |                                              |   |
|                                              | Director                       |                                              |   |
|                                              | (Principal Executive  Officer) |                                              |   |
|                                              |                           |                                              |
| Date:    March 27,  2009 |                           | Date:    March 27,  2009 |
|                                              |                           |                                              |
| By:                                               | /s/ Ronald L. Ashbaugh         |                                              | By:    | /s/ David L. Cox                |
|                                              | Ronald L. Ashbaugh             |                                              |   | David L. Cox                    |
|                                              | Director                       |                                              |   | Director                        |
|                                              |                           |                                              |
| Date:    March 27,  2009 |                           | Date:    March 27,  2009 |
|                                              |                           |                                              |
|                                              |                           |                                              |
| By:                                               | /s/ James M. Crooks            |                                              | By:    | /s/ George W. Freeman           |
|                                              | James M. Crooks                |                                              |   | George W. Freeman               |
|                                              | Director                       |                                              |   | Director                        |
|                                              |                           |                                              |
| Date:    March 27,  2009 |                           | Date:    March 27,  2009 |
|                                              |                           |                                              |
|                                              |                           |                                              |
| By:                                               | /s/ Mark A. Freemer            |                                              | By:    | /s/ Robert L. Hunter            |
|                                              | Mark A. Freemer                |                                              |   | Robert L. Hunter                |
|                                              | Director                       |                                              |   | Director                        |
|                                              |                           |                                              |
| Date:    March 27,  2009 |                           | Date:    March 27,  2009 |
|                                              |                           |                                              |
|                                              |                           |                                              |
| By:                                               | /s/ John B. Mason              |                                              | By:    | /s/ Brian C. McCarrier          |
|                                              | John B. Mason                  |                                              |   | Brian C. McCarrier              |
|                                              | Director                       |                                              |   | Director                        |
|                                              |                           |                                              |
| Date:    March 27,  2009 |                           | Date:    March 27,  2009 |

 

K-36

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**FinancialStatements**

**Table of Contents**

 
| Report of Independent Registered Public Accounting  Firm         |   | F-2 |
|------------------------------------------------------------------|--------|-----|
| Consolidated Balance Sheets                                      |   | F-3 |
| Consolidated Statements of Income                                |   | F-4 |
| Consolidated Statements of Changes in Stockholders’  Equity |   | F-5 |
| Consolidated Statements of Cash Flows                            |   | F-6 |
| Notes to Consolidated Financial Statements                       |   | F-7 |

 

F-1

----

Table of Contents

 

 

**Audit Committee, Board of Directors and Stockholders**

**Emclaire Financial Corp.**

**Emlenton, Pennsylvania**

 

Wehave audited the accompanying consolidated balance sheets of Emclaire FinancialCorp. and subsidiary (the “Corporation”) as of December 31, 2008 and 2007,and the related consolidated statements of income, changes in stockholders’equity and comprehensive income, and cash flows for each of the years in thetwo-year period ended December 31, 2008. The Corporation’s management is responsible for these financialstatements. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements arefree of material misstatement.  TheCorporation is not required to have, nor were we engaged to perform, an auditof its internal control over financial reporting.  Our audit included consideration of internalcontrol over financial reporting as a basis for designing audit procedures thatare appropriate in the circumstances, but not for the purpose of expressing an opinionon the effectiveness of the Corporation’s internal control over financialreporting.  Accordingly, we express nosuch opinion.  An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe consolidated financial statements, assessing the accounting principles usedand significant estimates made by management, as well as evaluating the overallconsolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Emclaire FinancialCorp. and subsidiary as of December 31, 2008 and 2007, and the results oftheir operations and their cash flows for each of the years in the two-yearperiod ended December 31, 2008, in conformity with accounting principlesgenerally accepted in the United States of America.

 

 
| /s/ Beard Miller Company  LLP |   |
|-------------------------------|--------|
|                          |   |
| Pittsburgh, Pennsylvania      |   |
| March 19, 2009           |   |

 

F-2

----

Tableof Contents

 

**Consolidated Balance Sheets**

*(Dollaramounts in thousands, except share data)*

 
| ** **                                                                                                                                       | ** ** | **December 31,** | ** **  |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| ** **                                                                                                                                       | ** ** | **2008**              | ** **  | **2007** | ** ** |
| **Assets**                                                                                                                                       |       |                  |        |   |   |
| Cash and due from  banks                                                                                                                         |       | $                     | 4,292       |   | $ | 10,288 |   |
| Interest earning  deposits with banks                                                                                                            |       | 12,279                |        | 195 |   |
| Total cash and  cash equivalents                                                                                                                 |       | 16,571                |        | 10,483 |   |
| Securities  available for sale, at fair value                                                                                                    |       | 71,443                |        | 51,919 |   |
| Loans  receivable, net of allowance for loan losses of $2,651 and $2,157                                                                         |       | 264,838               |        | 229,819 |   |
| Federal bank  stocks, at cost                                                                                                                    |       | 3,797                 |        | 2,662 |   |
| Bank-owned life  insurance                                                                                                                       |       | 5,186                 |        | 4,987 |   |
| Accrued interest  receivable                                                                                                                     |       | 1,519                 |        | 1,365 |   |
| Premises and  equipment, net                                                                                                                     |       | 8,609                 |        | 7,904 |   |
| Goodwill                                                                                                                                         |       | 1,422                 |        | 1,422 |   |
| Prepaid expenses  and other assets                                                                                                               |       | 2,279                 |        | 1,159 |   |
| **Total  Assets**                                                                                                                                | ** ** | **$**                 | **375,664** | ** ** | **$** | **311,720** | ** ** |
| **Liabilities  and Stockholders’ Equity**                                                                                                   |       |                  |        |   |   |
| **Liabilities**                                                                                                                                  |       |                  |        |   |   |
| Deposits:                                                                                                                                        |       |                  |        |   |   |
| Non-interest  bearing                                                                                                                            |       | $                     | 56,351      |   | $ | 47,111 |   |
| Interest bearing                                                                                                                                 |       | 230,296               |        | 197,151 |   |
| Total deposits                                                                                                                                   |       | 286,647               |        | 244,262 |   |
| Borrowed funds:                                                                                                                                  |       |                  |        |   |   |
| Short-term                                                                                                                                       |       | 13,188                |        | 5,400 |   |
| Long-term                                                                                                                                        |       | 35,000                |        | 35,000 |   |
| Total borrowed  funds                                                                                                                            |       | 48,188                |        | 40,400 |   |
| Accrued interest  payable                                                                                                                        |       | 761                   |        | 771 |   |
| Accrued expenses  and other liabilities                                                                                                          |       | 3,945                 |        | 1,584 |   |
| **Total  Liabilities**                                                                                                                           |       | 339,541               |        | 287,017 |   |
| **Stockholders’  Equity**                                                                                                                   |       |                  |        |   |   |
| Preferred stock,  $1.00 par value, 3,000,000 shares authorized; 7,500 issued                                                                     |       | 7,412                 |        | — |   |
| Warrants                                                                                                                                         |       | 88                    |        | — |   |
| Common stock,  $1.25 par value, 12,000,000 shares authorized;1,559,421 and 1,395,852  shares issued;  1,431,404 and 1,267,835 shares outstanding |       | 1,949                 |        | 1,745 |   |
| Additional  paid-in capital                                                                                                                      |       | 14,564                |        | 10,902 |   |
| Treasury stock,  at cost; 128,017 shares                                                                                                         |       | (2,653                | )           | (2,653 | ) |
| Retained  earnings                                                                                                                               |       | 15,840                |        | 15,114 |   |
| Accumulated  other comprehensive loss                                                                                                            |       | (1,077                | )           | (405 | ) |
| **Total  Stockholders’ Equity**                                                                                                             |       | 36,123                |        | 24,703 |   |
| **Total  Liabilities and Stockholders’ Equity**                                                                                             | ** ** | **$**                 | **375,664** | ** ** | **$** | **311,720** | ** ** |

 

See accompanying notes to consolidated financial statements.

 

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Tableof Contents

 

**Consolidated Statements of Income**

*(Dollar amounts in thousands, except share data)*

 
| ** **                                                                  | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| **Interest  and dividend income**                                           |       |                                       |       |   |   |
| Loans  receivable, including fees                                           |       | $                                          | 16,162     |   | $ | 15,287 |   |
| Securities:                                                                 |       |                                       |       |   |   |
| Taxable                                                                     |       | 1,992                                      |       | 1,571 |   |
| Exempt from  federal income tax                                             |       | 636                                        |       | 687 |   |
| Federal bank  stocks                                                        |       | 102                                        |       | 144 |   |
| Deposits with  banks                                                        |       | 201                                        |       | 166 |   |
| **Total  interest and dividend income**                                     |       | 19,093                                     |       | 17,855 |   |
| **Interest  expense**                                                       |       |                                       |       |   |   |
| Deposits                                                                    |       | 6,415                                      |       | 6,440 |   |
| Short-term  borrowed funds                                                  |       | 182                                        |       | 33 |   |
| Long-term  borrowed funds                                                   |       | 1,571                                      |       | 1,413 |   |
| **Total  interest expense**                                                 |       | 8,168                                      |       | 7,886 |   |
| **Net  interest income**                                                    |       | 10,925                                     |       | 9,969 |   |
| Provision for  loan losses                                                  |       | 500                                        |       | 256 |   |
| **Net  interest income after provision for loan losses**                    |       | 10,425                                     |       | 9,713 |   |
| **Noninterest  income**                                                     |       |                                       |       |   |   |
| Fees and service  charges                                                   |       | 1,638                                      |       | 1,549 |   |
| Commissions on  financial services                                          |       | 449                                        |       | 448 |   |
| Net gain on  sales of loans                                                 |       | 6                                          |       | 33 |   |
| Net (loss) gain  on available for sale securities                           |       | (391                                       | )          | 207 |   |
| Earnings on  bank-owned life insurance                                      |       | 227                                        |       | 219 |   |
| Other                                                                       |       | 558                                        |       | 487 |   |
| **Total  noninterest income**                                               |       | 2,487                                      |       | 2,943 |   |
| **Noninterest  expense**                                                    |       |                                       |       |   |   |
| Compensation and  employee benefits                                         |       | 6,347                                      |       | 5,090 |   |
| Premises and  equipment                                                     |       | 1,714                                      |       | 1,589 |   |
| Other                                                                       |       | 2,971                                      |       | 2,485 |   |
| **Total  noninterest expense**                                              |       | 11,032                                     |       | 9,164 |   |
| **Income  before provision for income taxes********and extraordinary item** |       | 1,880                                      |       | 3,492 |   |
| Provision for  income taxes                                                 |       | 356                                        |       | 795 |   |
| **Income  before extraordinary item**                                       |       | 1,524                                      |       | 2,697 |   |
| Extraordinary  item, gain on business combination                           |       | 906                                        |       | — |   |
| **Net  income**                                                             | ** ** | **$**                                      | **2,430**  | ** ** | **$** | **2,697** | ** ** |
| **Earnings  per common share**                                              |       |                                       |       |   |   |
| Net income  before extraordinary item                                       | ** ** | **$**                                      | **1.17**   | ** ** | **$** | **2.13** | ** ** |
| Extraordinary  item, gain on business combination                           | ** ** | **0.70**                                   | ** ** | **—** | ** ** |
| Net income  (basic)                                                         | ** ** | **$**                                      | **1.87**   | ** ** | **$** | **2.13** | ** ** |
| Diluted                                                                     | ** ** | **$**                                      | **1.87**   | ** ** | **$** | **2.13** | ** ** |

 

See accompanying notes to consolidated financial statements.

 

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**Consolidated Statements of Changes in Stockholders’ Equity**

*(Dollar amounts in thousands, except share data)*

 
| ** **                                                                               | ** ** | ** **    | ** ** | ** **   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **             | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------|------------|--------------|------------|------------|------------|----------------|------------|--------------|------------|--------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                               | ** ** | ** **    | ** ** | ** **   | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | ** **   | ** ** | **Other**         | ** ** | **Total**              | ** ** |
| ** **                                                                               | ** ** | **Preferred** | ** ** | ** **   | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Treasury** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                               | ** ** | **Stock**     | ** ** | **Warrants** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Stock**    | ** ** | **Earnings** | ** ** | **Loss**          | ** ** | **Equity**             | ** ** |
| **Balance  at January 1, 2007**                                                     | ** ** | **$**         | **—** | ** **   | **$**      | **—** | ** ** | **$**          | **1,745**  | ** **   | **$**      | **10,871**   | ** ** | **$**             | **(2,653** | **)**                  | **$**      | **14,370** | ** ** | **$** | **(416** | **)** | **$** | **23,917** | ** ** |
| Comprehensive  income:                                                                   |       |          |       |         |       |       |       |           |       |         |       |         |       |              |       |                   |       |
| Net income                                                                               |       |          |       |         |       |       |       |           |       |         |       | 2,697        |       |              |       | 2,697                  |       |
| Change in net  unrealized losses on securities available for sale, net of taxes of ($22) |       |          |       |         |       |       |       |           |       |         |       |         |       | (43               | )          | (43                    | )          |
| Change in funded  status of defined benefit plan, net of taxes of $27                    |       |          |       |         |       |       |       |           |       |         |       |         |       | 54                |       | 54                     |       |
| Comprehensive  income                                                                    |       |          |       |         |       |       |       |           |       |         |       |         |       |              |       | 2,708                  |       |
| Stock  compensation expense                                                              |       |          |       |         |       |       |       | 31             |       |         |       |         |       |              |       | 31                     |       |
| Dividends  declared, $1.54 per share                                                     |       |          |       |         |       |       |       |           |       |         |       | (1,953       | )          |              |       | (1,953                 | )          |
| **Balance  at December 31, 2007**                                                   | ** ** | **—**    | ** ** | **—**   | ** ** | **1,745**  | ** ** | **10,902**     | ** ** | **(2,653**   | **)**      | **15,114**   | ** ** | **(405**          | **)**      | **24,703**             | ** ** |
| Comprehensive  income:                                                                   |       |          |       |         |       |       |       |           |       |         |       |         |       |              |       |                   |       |
| Net income                                                                               |       |          |       |         |       |       |       |           |       |         |       | 2,430        |       |              |       | 2,430                  |       |
| Change in net  unrealized losses on securities available for sale, net of taxes of $129  |       |          |       |         |       |       |       |           |       |         |       |         |       | 251               |       | 251                    |       |
| Change in funded  status of defined benefit plan, net of taxes of ($475)                 |       |          |       |         |       |       |       |           |       |         |       |         |       | (923              | )          | (923                   | )          |
| Comprehensive  income                                                                    |       |          |       |         |       |       |       |           |       |         |       |         |       |              |       | 1,758                  |       |
| Issuance of  common stock                                                                |       |          |       |         |       | 204        |       | 3,549          |       |         |       |         |       |              |       | 3,753                  |       |
| Issuance of  preferred stock                                                             |       | 7,412         |       |         |       |       |       |           |       |         |       |         |       |              |       | 7,412                  |       |
| Issuance of  warrants                                                                    |       |          |       | 88           |       |       |       |           |       |         |       |         |       |              |       | 88                     |       |
| Stock  compensation expense                                                              |       |          |       |         |       |       |       | 113            |       |         |       |         |       |              |       | 113                    |       |
| Dividends  declared, $1.30 per share                                                     |       |          |       |         |       |       |       |           |       |         |       | (1,704       | )          |              |       | (1,704                 | )          |
| **Balance  at December 31, 2008**                                                   | ** ** | **$**         | **7,412**  | ** **   | **$**      | **88**     | ** ** | **$**          | **1,949**  | ** **   | **$**      | **14,564**   | ** ** | **$**             | **(2,653** | **)**                  | **$**      | **15,840** | ** ** | **$** | **(1,077** | **)** | **$** | **36,123** | ** ** |

 

See accompanying notes to consolidated financial statements.

 

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**Consolidated Statements of Cash Flows**

*(Dollar amounts in thousands, except share data)*

 
| ** **                                                                         | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| **Cash  flows from operating activities**                                          |       |                                       |       |   |   |
| Net income                                                                         |       | $                                          | 2,430      |   | $ | 2,697 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                       |       |   |   |
| Depreciation and  amortization of premises and equipment                           |       | 737                                        |       | 663 |   |
| Provision for  loan losses                                                         |       | 500                                        |       | 256 |   |
| Amortization of  premiums and (accretion of discounts), net                        |       | (161                                       | )          | 7 |   |
| Amortization of  intangible assets and mortgage servicing rights                   |       | 17                                         |       | 17 |   |
| Realized (gain)  loss on available for sale securities, net                        |       | 391                                        |       | (207 | ) |
| Net gains on  sales of loans                                                       |       | (6                                         | )          | (33 | ) |
| Net gains on  foreclosed real estate                                               |       | (96                                        | )          | (19 | ) |
| Originations of  loans sold                                                        |       | (1,209                                     | )          | (1,737 | ) |
| Proceeds from  the sale of loans                                                   |       | 1,215                                      |       | 1,775 |   |
| Restricted stock  and stock option compensation                                    |       | 113                                        |       | 31 |   |
| Earnings on  bank-owned life insurance, net                                        |       | (199                                       | )          | (193 | ) |
| (Increase)  decrease in accrued interest receivable                                |       | (154                                       | )          | 9 |   |
| (Increase)  decrease in deferred taxes                                             |       | (433                                       | )          | 156 |   |
| Increase in  prepaid expenses and other assets                                     |       | (913                                       | )          | (372 | ) |
| Decrease in  accrued interest payable                                              |       | (10                                        | )          | (54 | ) |
| Increase in  accrued expenses and other liabilities                                |       | 1,438                                      |       | 334 |   |
| **Net  cash provided by operating activities**                                     |       | 3,660                                      |       | 3,330 |   |
| **Cash  flows from investing activities**                                          |       |                                       |       |   |   |
| Loan  originations and principal collections, net                                  |       | (35,818                                    | )          | (16,968 | ) |
| Available for  sale securities:                                                    |       |                                       |       |   |   |
| Sales                                                                              |       | —                                     |       | 1,472 |   |
| Maturities,  repayments and calls                                                  |       | 70,999                                     |       | 17,006 |   |
| Purchases                                                                          |       | (90,361                                    | )          | (18,478 | ) |
| Purchase of  federal bank stocks                                                   |       | (1,135                                     | )          | (445 | ) |
| Proceeds from  the sale of foreclosed real estate                                  |       | 463                                        |       | 241 |   |
| Purchases of  premises and equipment                                               |       | (1,442                                     | )          | (609 | ) |
| **Net  cash used in investing activities**                                         |       | (57,294                                    | )          | (17,781 | ) |
| **Cash  flows from financing activities**                                          |       |                                       |       |   |   |
| Net increase  (decrease) in deposits                                               |       | 42,385                                     |       | (230 | ) |
| Proceeds from  issuance of long-term debt                                          |       | —                                     |       | 5,000 |   |
| Net change in  short-term borrowings                                               |       | 7,788                                      |       | 5,400 |   |
| Proceeds from  sale of preferred stock                                             |       | 7,412                                      |       | — |   |
| Issuance of  warrants                                                              |       | 88                                         |       | — |   |
| Proceeds from  sale of common stock                                                |       | 3,753                                      |       | — |   |
| Dividends paid  on common stock                                                    |       | (1,704                                     | )          | (1,953 | ) |
| **Net  cash provided by financing activities**                                     |       | 59,722                                     |       | 8,217 |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | 6,088                                      |       | (6,234 | ) |
| Cash and cash  equivalents at beginning of period                                  |       | 10,483                                     |       | 16,717 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                          | 16,571     |   | $ | 10,483 |   |
|                                                                               |       |                                       |       |   |   |
| **Supplemental  information:**                                                     |       |                                       |       |   |   |
| Interest paid                                                                      |       | $                                          | 8,178      |   | $ | 7,940 |   |
| Income taxes  paid                                                                 |       | 805                                        |       | 626 |   |
| ** **                                                                         |       |                                       |       |   |   |
| **Supplemental  noncash disclosures:**                                             |       |                                       |       |   |   |
| Transfers from  loans to foreclosed real estate                                    |       | 288                                        |       | 253 |   |

 

Seeaccompanying notes to consolidated financial statements. 

 

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**Notes toConsolidated Financial Statements**

 

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

 

***Basisof Presentation and Consolidation.***  The consolidatedfinancial statements include the accounts of Emclaire Financial Corp. (theCorporation) and its wholly owned subsidiaries, the Farmers National Bank ofEmlenton (the Bank) and Emclaire Settlement Services, LLC (the TitleCompany).  All significant intercompanybalances and transactions have been eliminated in consolidation.

 

***Natureof Operations.*** The Corporation provides a variety offinancial services to individuals and businesses through its offices in WesternPennsylvania.  Its primary depositproducts are checking, savings and term certificate accounts and its primarylending products are residential and commercial mortgages, commercial businessloans and consumer loans.

 

***Useof Estimates and Classifications.***  In preparing consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America (GAAP), management is required to make estimates andassumptions that affect the reported amounts of assets and liabilities as ofthe date of the balance sheet and reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates. Material estimates that are particularly susceptible to significantchange in the near term relate to the determination of the allowance for loanlosses, fair value of financial instruments, goodwill, the valuation ofdeferred tax assets and other than temporary impairment charges.  Certain amounts previously reported may havebeen reclassified to conform to the current year financial statement presentation.  Such reclassifications did not affect netincome or stockholders’ equity.

 

***SignificantGroup Concentrations of Credit Risk.***  Most of the Corporation’s activities are withcustomers located within the Western Pennsylvania region of the country.  Note 4 discusses the type of securities thatthe Corporation invests in.  Note 5discusses the types of lending the Corporation engages in.  The Corporation does not have any significantconcentrations to any one industry or customer.

 

***CashEquivalents.***  Forpurposes of the consolidated statements of cash flows, cash and cashequivalents include cash on hand, cash items, interest-earning deposits withother financial institutions and federal funds sold and due from correspondentbanks.  Interest-earning deposits maturewithin one year and are carried at cost. Federal funds are generally sold or purchased for one day periods.  Net cash flows are reported for loan anddeposit transactions.

 

***Restrictions on Cash.***  Cash on hand or on deposit with the FederalReserve Bank of Cleveland (FRB) of approximately $60,000 was required to meetregulatory reserve and clearing requirements at December 31, 2008 and2007.  Such balances do not earninterest.

 

***Securities. ***Securities includeinvestments primarily in bonds and notes and are classified as either availablefor sale or held to maturity at the time of purchase based on management’sintent.  Securities for which theCorporation has the positive intent and ability to hold to maturity areclassified as held to maturity and are reported at amortized cost.  Securities that are not classified as held tomaturity,  including equity securitieswith readily determinable fair values, are classified as available for sale andrecorded at fair value, with unrealized gains and losses excluded from earningsand reported in accumulated other comprehensive income.

 

F-7

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Tableof Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**1.        Summary of Significant AccountingPolicies (continued)**

 

***Securities(continued). ***Purchasepremiums and discounts on securities are recognized in interest income usingthe interest method over the term of the securities.  Declines in the fair value of securitiesbelow their cost that are deemed other than temporary result in the securitybeing written down to fair value on an individual basis.  Any related write-downs are included inoperations.  Gains and losses on the saleof securities are recorded on the trade date and are determined using thespecific identification method and are included in operations in the periodsold.

 

***Loans Held for Sale.***  Loans originated and intended for sale in thesecondary market are carried at the lower of cost or estimated fair value inthe aggregate.  Net unrealized losses, ifany, are recognized through a valuation allowance by charges to income.  Loans held for sale are generally sold withservicing rights retained.  The carryingvalue of such loans sold is reduced by the cost allocated to the servicingrights.  Gains and losses on sales ofmortgage loans are based on the difference between the selling price and thecarrying value of the related loan sold.

 

***LoansReceivable***.  TheCorporation grants mortgage, commercial and consumer loans to customers.  A substantial portion of the loan portfoliois represented by mortgage loans throughout Western Pennsylvania.  The ability of the Corporation’s debtors tohonor their contracts is dependent upon real estate and general economicconditions in this area.

 

Loansthat management has the intent and ability to hold for the foreseeable futureor until maturity or net pay-off generally are reported at their outstandingunpaid principal balances adjusted for charge-offs, the allowance for loanlosses, and any deferred fees or costs on originated loans or premiums ordiscounts on purchased loans.  Interestincome is accrued on the unpaid principal balance.  Loan origination fees, net of certain directorigination costs, and premiums and discounts are deferred and recognized as anadjustment of the related loan yield using the interest method.

 

The accrual of intereston loans is typically discontinued at the time the loan is 90 days past dueunless the credit is well secured and in the process of collection.  Loans are placed on nonaccrual or charged-offat an earlier date if collection of principal or interest is considereddoubtful.  All interest accrued but notcollected for loans that are placed on nonaccrual status or charged-off isreversed against interest income.  Theinterest on these loans is accounted for on the cash-basis or cost-recoverymethod, until qualifying for return to accrual. Loans are returned to accrual status when all principal and interestamounts contractually due are brought current and future payments arereasonably assured.

 

***Allowance for Loan Losses. ***The allowance for loan losses is established forprobable credit losses through a provision for loan losses charged to earnings.  Loan losses are charged against the allowancewhen management believes the uncollectibility of a loan balance isconfirmed.  Subsequent recoveries, ifany, are typically credited to the allowance.

 

The allowance for loanlosses is evaluated on a regular basis by management and is based uponmanagement’s periodic review of the collectibility of loans in light ofhistoric experience, the nature and volume of the loan portfolio, adversesituations that may affect the borrower’s ability to repay, estimated value ofany underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective asit requires estimates that are susceptible to significant revision as moreinformation becomes available.

 

F-8

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Tableof Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**1.****                          Summaryof Significant Accounting Policies (continued)**

 

***Allowancefor Loan Losses (continued). ***Theallowance consists of specific, general and unallocated components.  The specific component relates to loans thatare classified as either doubtful, substandard or special mention.  For such loans that are also classified asimpaired, an allowance is established when the discounted cash flows (orcollateral value or observable market price) of the impaired loan is lower thanthe carrying value of that loan.  Thegeneral component covers non-classified loans and is based on historical lossexperience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that couldaffect management’s estimate of probable losses.  The unallocated component of the allowancereflects the margin of imprecision inherent in the underlying assumptions usedin the methodologies for estimating specific and general losses in theportfolio.

 

A loan is consideredimpaired when, based on current information and events, it is probable that theCorporation will be unable to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loanagreement.  Factors considered bymanagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on a case-by-casebasis, taking into consideration all of the circumstances surrounding the loanand the borrower, including the length of the delay, the reasons for the delay,the borrower’s prior payment record, and the amount of the shortfall inrelation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans byeither the present value of expected future cash flows discounted at the loanseffective interest rate, the loan’s obtainable market price, or the fair valueof the collateral if the loan is collateral dependent.  Large groups of small balance homogeneousloans are collectively evaluated for impairment.  Accordingly, the Corporation does notseparately identify individual consumer and residential mortgage loans forimpairment disclosures, unless such loans are the subject of a restructuringagreement.

 

***Bank-OwnedLife Insurance (BOLI).***  TheBank purchased life insurance policies on certain key officers andemployees.  BOLI is recorded at its cashsurrender value, or the amount that can be realized.

 

***Premisesand Equipment***. Land is carried at cost. Premises, furniture and equipment, and leasehold improvements arecarried at cost less accumulated depreciation or amortization.  Depreciation is calculated on a straight-linebasis over the estimated useful lives of the related assets, which aretwenty-five to fifty years for buildings and three to ten years for furnitureand equipment.  Amortization of leaseholdimprovements is computed using the straight-line method over the shorter oftheir estimated useful life or the expected term of the leases.  Expected terms include lease option periodsto the extent that the exercise of such option is reasonably assured.  Premises and equipment are reviewed forimpairment when events indicate their carrying amount may not be recoverablefrom future undiscounted cash flows.  Ifimpaired, assets are recorded at fair value.

 

***Goodwilland Intangible Assets***. Goodwill results from business acquisitions and represents the excess ofthe purchase price over the fair value of acquired assets and liabilities.  Core deposit intangible assets arise fromwhole bank or branch acquisitions and are measured at fair value and then areamortized on a straight-line basis over their estimated lives, generally lessthan 10 years.  Customer relationshipintangible assets arise from the purchase of a customer list from anothercompany or individual and then are amortized on a straight-line basis over twoyears.  Goodwill is not amortized and isassessed at least annually for impairment and any such impairment will berecognized in the period identified.

 

F-9

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**Notes to Consolidated Financial Statements *(continued)***

 

**1.****                          Summaryof Significant Accounting Policies (continued)**

 

***Servicing Assets.*** Servicing assets represent the allocated valueof retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of,estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, usinggroupings of the underlying loans as to interest rates.  Fair value is determined using prices forsimilar assets with similar characteristics, when available, or based upondiscounted cash flows using market-based assumptions.  Any impairment of a grouping is reported as avaluation allowance, to the extent that fair value is less than the capitalizedamount for a grouping.

 

***RealEstate Acquired Through Foreclosure (REO). ***Real estate properties acquired throughforeclosure are initially recorded at fair value less cost to sell at the dateof foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by managementand the real estate is carried at the lower of carrying amount or fair valueless cost to sell.  Revenue and expensesfrom operations of the properties, gains and losses on sales and additions tothe valuation allowance are included in operating results.  Real estate acquired through foreclosure isclassified in prepaid expenses and other assets and totaled $50,000 and$129,000 at December 31, 2008 and 2007, respectively.

 

***TreasuryStock. ***Commonstock purchased for treasury is recorded at cost.  At the date of subsequent reissue, thetreasury stock account is reduced by the cost of such stock on the first-in,first-out basis.

 

***IncomeTaxes. ***Deferredincome tax assets and liabilities are determined using the liability (orbalance sheet) method.  Under thismethod, the net deferred tax asset or liability is determined based on the taxeffects of the temporary differences between the book and tax basis of thevarious balance sheet assets and liabilities and gives current recognition tochanges in tax rate and laws.

 

***EarningsPer Common Share (EPS). ***EPSon income before extraordinary income is computed by dividing income beforeextraordinary item by the weighted average number of common shares outstandingduring the period and EPS on the extraordinary item is computed by dividing theextraordinary item by the weighted average number of common shares outstandingduring the period.  Basic EPS excludesdilution and is computed by dividing net income by the weighted average numberof common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur ifsecurities or contracts to issue common stock were exercised or converted intocommon stock or resulted in the issuance of common stock that then shared inthe earnings of the Corporation.  Optionsand restricted stock awards of 98,500 shares of common stock were not includedin computing diluted earnings per share because their effects were not dilutive.

 

***Comprehensive Income.*** Comprehensive income includes net income from operating results and thenet change in accumulated other comprehensive income.  Accumulated other comprehensive income iscomprised of unrealized holding gains and losses on securities available forsale and the over funded or under funded status of pension and otherpostretirement benefit plans on the balance sheet.  The effects of other comprehensive income arepresented as part of the statement of changes in stockholders’ equity.

 

***Operating Segments.***  Operations are managed and financialperformance is evaluated on a corporate-wide basis.  Accordingly, all financial servicesoperations are considered by management to be aggregated in one reportableoperating segment.

 

F-10

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Tableof Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**1.****                          Summaryof Significant Accounting Policies (continued)**

 

***Retirement Plans.***  The Corporation maintains anoncontributory defined benefit plan covering substantially all employees andofficers.  The plan calls for benefits tobe paid to eligible employees at retirement based primarily on years of serviceand compensation rates near retirement. The Corporation also maintains a 401(k) plan, which coverssubstantially all employees, and a supplemental executive retirement plan forkey executive officers.

 

***Stock Compensation Plans. ***In December 2004,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards (SFAS) No. 123 (revised 2004), *Share-Based Payments*(SFAS 123(R)).  SFAS 123(R) requires that thecompensation cost relating to share-based payment transactions be recognized infinancial statements.  That cost will bemeasured based on the fair value of the equity or liability instrumentsissued.  SFAS 123(R) covers a widerange of share-based compensation arrangements including stock options,restricted share plans, performance-based awards, share appreciation rights andemployee share purchase plans.  SFAS 123(R) isa replacement of SFAS 123, *Accounting forStock-Based Compensation,*and supersedes Accounting Principles Board(APB) Opinion No. 25, *Accounting forStock Issued to Employees,*and its related interpretive guidance.  The effect of the statement requires entitiesto measure the cost of employee services received in exchange for the stockoptions based on the grant-date fair value of the award, and to recognize thecost over the period the employee is required to provide services for theaward.  SFAS 123(R) permits entitiesto use any option-pricing model that meets the fair value objective in thestatement.

 

***Transfers of Financial Assets.***  Transfers of financial assets are accountedfor as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed tobe surrendered when (1) the assets have been isolated from theCorporation, (2) the transferee obtains the right (free of conditions thatconstrain it from taking advantage of that right) to pledge or exchange thetransferred assets, and (3) the Corporation does not maintain effectivecontrol over the transferred assets through an agreement to repurchase thembefore their maturity.

 

***Off-BalanceSheet Financial Instruments***.  In the ordinary course of business, theCorporation has entered into off-balance sheet financial instruments,consisting of commitments to extend credit, commitments under line of creditlending arrangements and letters of credit. Such financial instruments are recorded in the financial statements whenthey are funded or related fees are received.

 

***Fair Value of Financial Instruments***.  Fair values of financial instruments areestimated using relevant market information and other assumptions, as morefully disclosed in a separate note.  Fairvalue estimates involve uncertainties and matters of significant judgmentregarding interest rates, credit risk, prepayments, and other factors,especially in the absence of broad markets for particular items.  Changes in assumptions or in marketconditions could significantly affect the estimates.

 

***Recently Adopted Accounting Standards. ***Effective January 1, 2007, SFAS 123(R)*,*which requires that compensation costrelated to share-based payment transactions be recognized in the financialstatements with measurement based upon the fair value of the equity orliability instruments issued.  For theyear ended December 31, 2008 and 2007, the Corporation recognized $113,000and $31,000, respectively, in compensation expense for stock options.

 

F-11

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Tableof Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**1.****                          Summaryof Significant Accounting Policies (continued)**

 

***Recently Adopted Accounting Standards (continued).* **In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*(SFAS 157),which defines fair value, establishes a framework for measuring fair valueunder GAAP and expands disclosures about fair value measurements.  SFAS 157 applies to other accountingpronouncements that require or permit fair value measurements.  The Corporation adopted SFAS 157 effectivefor its fiscal year beginning January 1, 2008.

 

In December 2007, the FASB issued FASB StaffPosition (FSP) No. 157-2, *EffectiveDate of FASB Statement No. 157*, (FSP 157-2).  FSP 157-2 delays the effective date of SFAS157 for all non-financial assets and liabilities, except those that arerecognized or disclosed at fair value on a recurring basis (as least annually)to fiscal years beginning after November 15, 2008 and interim periodswithin those fiscal years.  As such, theCorporation only partially adopted the provisions of SFAS 157, and will beginto account and report for non-financial assets and liabilities in 2009.  In October 2008, the FASB issued FSP No. 157-3,*Determining the Fair Value of a FinancialAsset When the Market for that Asset is Not Active,*(FSP 157-3), toclarify the application of the provisions of SFAS 157 in an inactive market andhow an entity would determine fair value in an inactive market.  FSP 157-3 is effective immediately andapplies to the Corporation’s December 31, 2008 consolidated financialstatements.  The adoption of SFAS 157 andFSP 157-3 had no impact on the amounts reported in the Corporation’sconsolidated financial statements.

 

***Recent Accounting and Regulatory Pronouncements. ***In December 2007, the FASB issued SFAS No. 141(R), *Business Combinations* (SFAS 141(R)).  SFAS 141(R) establishes principles andrequirements for how the acquirer of a business recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,and any noncontrolling interest in the acquiree.  SFAS 141(R) also provides guidance forrecognizing and measuring the goodwill acquired in the business combination anddetermines what information to disclose to enable users of the financialstatements to evaluate the nature and financial effects of the businesscombination.  The guidance will becomeeffective for fiscal years beginning after December 15, 2008.  This new pronouncement will impact theCorporation’s accounting for business combinations completed beginning January 1,2009.

 

InDecember 2007, the FASB issued SFAS No. 160, *NoncontrollingInterest in Consolidated Financial Statements — An Amendment of ARB No. 51*(SFAS 160).  SFAS 160establishes accounting and reporting standards for the noncontrolling interestin a subsidiary and for the deconsolidation of a subsidiary.  The guidance will become effective for fiscalyears beginning after December 15, 2008. The Corporation does not expect that this new pronouncement will have amaterial impact on its consolidated financial statements.

 

InApril 2008, the FASB issued FSP SFAS No. 142-3, *Determinationof the Useful Life of Intangible Assets*(FSP 142-3)*.*  This FSP amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, *Goodwill and OtherIntangible Assets*(SFAS 142). The intent of this FSP is to improve the consistency between the usefullife of a recognized intangible asset under SFAS 142 and the period of expectedcash flows used to measure the fair value of the asset under SFAS 141(R) andother GAAP.  This FSP is effective forfinancial statements issued for fiscal years and interim periods beginningafter December 15, 2008, and interim periods within those fiscalyears.  Early adoption is prohibited.  The Corporation is currently evaluating thepotential impact, if any, that FSP 142-3 will have on its consolidatedfinancial statements.

 

F-12

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Tableof Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**1.**                          Summary of Significant AccountingPolicies (continued)

** **

***Recent Accounting and Regulatory Pronouncements(continued). ***In May 2008, the FASB issued SFAS No. 162,*The Hierarchy of Generally Accepted AccountingPrinciples*(SFAS 162).  SFAS162 identifies the sources of accounting principles and the framework forselecting the principles used in the preparation of financial statements.  This Statement is effective 60 days followingthe SEC’s approval of the Public Company Accounting Oversight Board amendmentsto AU Section 411, *The Meaning of PresentFairly in Conformity with Generally Accepted Accounting Principles.*  The Corporation is currently evaluating thepotential impact the new pronouncement will have on its consolidated financialstatements.

 

InJune 2008, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 07-5,*Determining Whether an Instrument (or an EmbeddedFeature) is Indexed to an Entity’s Own Stock*(EITF 07-5).  EITF 07-5 provides that an entity should usea two step approach to evaluate whether an equity-linked financial instrument(or embedded feature) is indexed to its own stock, including evaluating the instrument’scontingent exercise and settlement provisions. It also clarifies the impact of foreign currency denominated strikeprices and market-based employee stock option valuation instruments on theevaluation.  EITF 07-5 is effective forfiscal years beginning after December 15, 2008.  The Corporation is currently evaluating thepotential impact the new pronouncement will have on its consolidated financialstatements.

 

InNovember 2008, the FASB ratified EITF Issue No. 08-6,*Equity Method Investment Accounting Considerations*(EITF 08-6).  EITF 08-6 clarifies theaccounting for certain transactions and impairment considerations involvingequity method investments.  EITF 08-6 iseffective for fiscal years beginning after December 15, 2008, with earlyadoption prohibited.  The Corporation iscurrently evaluating the effect this will have on its consolidated financialstatements.

 

InDecember 2008, the FASB issued FSP SFAS No. 140-4 and FASBInterpretation (FIN) No. 46(R)-8, *Disclosures by PublicEntities (Enterprises) about Transfers of Financial Assets and Interests inVariable Interest Entities*(FSP SFAS 140-4 and FIN 46(R)-8). FSPSFAS 140-4 and FIN 46(R)-8 amends FASB SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities*, to require public entities to provide additionaldisclosures about transfers of financial assets.  It also amends FIN No. 46(R), *Consolidation of Variable Interest Entities*, to requirepublic enterprises, including sponsors that have a variable interest in avariable interest entity, to provide additional disclosures about theirinvolvement with variable interest entities. Additionally, this FSP requires certain disclosures to be provided by apublic enterprise that is (a) a sponsor of a qualifying special purposeentity (SPE) that holds a variable interest in the qualifying SPE but was notthe transferor of financial assets to the qualifying SPE and (b) aservicer of a qualifying SPE that holds a significant variable interest in thequalifying SPE but was not the transferor of financial assets to the qualifyingSPE.  The disclosures required by FSPSFAS 140-4 and FIN 46(R)-8 are intended to provide greater transparency tofinancial statement users about a transferor’s continuing involvement withtransferred financial assets and an enterprise’s involvement with variableinterest entities and qualifying SPEs. FSP SFAS 140-4 and FIN 46(R)-8 are effective for reporting periodsending after December 15, 2008.  TheCorporation is currently evaluating the effect that these new pronouncementswill have on its consolidated financial statements.

 

InDecember 2008, the FASB issued SFAS No. 132(R)-1, *Employers’ Disclosures about Postretirement Benefit Plan*Assets,**(SFAS 132(R)-1). SFAS 132(R)-1 amends SFAS No. 132(R), *Employers’Disclosures about Pensions and Other Postretirement Benefits*, toprovide guidance on an employer’s disclosures about plan assets of a definedbenefit pension or other postretirement plan. The disclosures about plan assets required by this FSP shall be providedfor fiscal years ending after December 15, 2009.  The Corporation is currently evaluating theeffect that this new pronouncement will have on its consolidated financialstatements.

 

F-13

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Tableof Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**2.**                          Business Combinations

** **

On October 17, 2008,the Corporation completed an acquisition of Elk County Savings and LoanAssociation (ECSLA), a Pennsylvania-chartered savings association located inRidgway, Pennsylvania.  ECSLA convertedfrom the mutual to the stock form of organization and immediately issued all ofits capital stock to the Corporation and merged with and into the Bank.  In connection with the merger, theCorporation issued 163,569 shares of its common stock at a price of $21.15 pershare, resulting in proceeds of $3,459,484, net of discount on common stock of$293,279.

 

The Corporation recordedthe following assets and liabilities of ECSLA as of October 17, 2008.  These amounts represent the carrying value ofECSLA’s assets and liabilities adjusted to reflect the fair value at the dateof the acquisition.  The discounts andpremiums resulting from the fair value adjustments are being accreted andamortized on a level yield basis over the anticipated lives of the underlyingfinancial assets or liabilities.  Thisamortization of premiums and discounts did not have a material impact on theCorporation’s results of operations and is not projected to have a materialimpact on future periods.

 
| ** **                                                  | ** ** | **Acquired on**           |      |
|-------------------------------------------------------------|------------|--------------------------------|-----------|
| **(Dollar amounts in thousands)**            | ** ** | **October 17, 2008** |      |
| **Assets**                                                  |       |                           |      |
| Cash and cash  equivalents                                  |       | $                              | 504       |   |
| Securities  available for sale                              |       | 283                            |      |
| Loans  receivable, net of allowance for loan losses of $206 |       | 7,321                          |      |
| Federal bank  stocks, at cost                               |       | 44                             |      |
| Other assets                                                |       | 47                             |      |
| **Total  assets acquired**                                  | ** ** | **$**                          | **8,199** |   |
| **Liabilities**                                             |       |                           |      |
| Deposits                                                    |       | $                              | 6,221     |   |
| Other  liabilities                                          |       | 119                            |      |
| **Total  liabilities assumed**                              | ** ** | **$**                          | **6,340** |   |

 

The excess fair value ofassets acquired over liabilities assumed, less transaction costs incurred,resulted in negative goodwill of $906,000. This negative goodwill is reflected as an extraordinary item in theCorporation’s consolidated financial statements.

 

The primary purpose ofthe ECSLA acquisition was to expand the Corporation’s deposit market share inRidgway and to provide additional capital to the Bank.  The Corporation’s deposit market shareapproximately doubled and capital was added through the negative goodwillgenerated and the issuance of common stock.

 

F-14

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Table of Contents

** **

**Notes to Consolidated Financial Statements *(continued)***

 

**3.****                          Participationin the U.S. Department of the Treasury (U.S. Treasury) Capital Purchase Program(CPP)**

 

The Corporation enteredinto a Securities Purchase Agreement (the Agreement) on December 23, 2008with the U.S. Treasury In association with its participation in the CPP of theEmergency Economic Stabilization Act of 2008 (EESA).  Pursuant to the agreement, the Corporationsold 7,500 shares of Senior Perpetual Preferred Stock, par value $1.00 pershare, having a liquidation amount equal to $1,000.00 per share, with anattached warrant to purchase 50,111 shares of the Corporation’s common stock,par value $1.25 per share, for the aggregate price of $7.5 million, to the U.S.Treasury.

 

The preferred stockqualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5%per year, for the first five years, and 9% per year thereafter.  Under the terms of the CPP, the preferredstock may be redeemed with the approval of the Federal Reserve in the firstthree years with the proceeds from the issuance of certain qualifying Tier 1capital or after three years at par value plus accrued and unpaid dividends.

 

The warrant has a 10-yearterm with an exercise price equal to $22.45 per share of common stock.

 

**4.****                          Securities**

 

The following tablesummarizes the Corporation’s securities as of December 31:

 
| ** **                                       | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair**  | ** ** |
|--------------------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|-----------|------------|
| **(Dollar amounts in thousands)** | ** ** | **Cost**      | ** ** | **gains**      | ** ** | **losses**     | ** ** | **value** | ** ** |
| ** **                                       |       |          |       |           |       |           |       |      |       |
| **Available  for sale:**                         |       |          |       |           |       |           |       |      |       |
| **December 31,  2008:**                     |       |          |       |           |       |           |       |      |       |
| U.S. Government  agencies and related entities   |       | $             | 19,985     |           | $          | 139            |       | $         | (47        | ) | $ | 20,077 |   |
| Mortgage-backed  securities                      |       | 29,806        |       | 586            |       | (12            | )          | 30,380    |       |
| Municipal  securities                            |       | 13,543        |       | 270            |       | (5             | )          | 13,808    |       |
| Corporate  securities                            |       | 3,984         |       | —         |       | —         |       | 3,984     |       |
| Equity  securities                               |       | 3,893         |       | —         |       | (699           | )          | 3,194     |       |
|                                             |       | $             | 71,211     |           | $          | 995            |       | $         | (763       | ) | $ | 71,443 |   |
| **December 31,  2007:**                     |       |          |       |           |       |           |       |      |       |
| U.S. Government  agencies and related entities   |       | $             | 29,356     |           | $          | 37             |       | $         | (59        | ) | $ | 29,334 |   |
| Mortgage-backed  securities                      |       | 1,932         |       | —         |       | (48            | )          | 1,884     |       |
| Municipal  securities                            |       | 13,685        |       | 566            |       | —         |       | 14,251    |       |
| Corporate  securities                            |       | 2,939         |       | —         |       | —         |       | 2,939     |       |
| Equity  securities                               |       | 4,156         |       | —         |       | (645           | )          | 3,511     |       |
|                                             |       | $             | 52,068     |           | $          | 603            |       | $         | (752       | ) | $ | 51,919 |   |

 

Gains (losses) onavailable for sale securities were as follows:

 
| **(Dollar amounts in thousands)**   | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
|                                               |       |     |       |     |       |
| Proceeds                                           |       | $        | —     |     | $          | 1,472 |   |
| Gross gains  (losses)                              |       | (391     | )          | 207      |       |
| Tax provision  (benefit) related to gains (losses) |       | (133     | )          | 70       |       |
|                                                    |            |          |            |          |            |  |  |

 

F-15

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Table of Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**4.****                          Securities(continued)**

 

The following tablesummarizes scheduled maturities of the Corporation’s securities as of December 31,2008:

 
| ** **                                       | ** ** | **Available for sale** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **Amortized  cost**              | ** ** | **Fair  value** | ** ** |
|                                             |       |                             |       |   |   |
| Due in one year  or less                         |       | $                                | 4,983      |   | $ | 5,011 |   |
| Due after one  year through five years           |       | 7,243                            |       | 7,274 |   |
| Due after five  through ten years                |       | 15,134                           |       | 15,367 |   |
| Due after ten  years                             |       | 39,958                           |       | 40,597 |   |
| No scheduled  maturity                           |       | 3,893                            |       | 3,194 |   |
|                                             |       | $                                | 71,211     |   | $ | 71,443 |   |

 

Expected maturities maydiffer from contractual maturities because issuers may have the right to callor prepay obligations with or without call or prepayment penalties.

 

Securities with carryingvalues of $13.0 million and $11.5 million as of December 31, 2008 and2007, respectively, were pledged to secure public deposits and for otherpurposes required or permitted by law.

 

Information pertaining tosecurities with gross unrealized losses at December 31, 2008 and 2007aggregated by investment category and length of time that individual securitieshave been in a continuous loss position, follows:

 
| ** **                                       | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| **(Dollar amounts in thousands)** | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **Description of Securities**          | ** ** | **Value**                              | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
| ** **                                       |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| **December 31,  2008:**                     |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government  agencies and related entities   |       | $                                      | 6,452      |                                 | $          | (47       | )          | $ | — |   | $ | — |   | $ | 6,452 |   | $ | (47 | ) |
| Mortgage-backed  securities                      |       | 9,185                                  |       | (12                                  | )          | —    |       | — |   | 9,185 |   | (12 | ) |
| Municipal  securities                            |       | 2,352                                  |       | (5                                   | )          | —    |       | — |   | 2,352 |   | (5 | ) |
| Equity  securities                               |       | —                                 |       | —                               |       | 3,128     |       | (699 | ) | 3,128 |   | (699 | ) |
|                                             |       | $                                      | 17,989     |                                 | $          | (64       | )          | $ | 3,128 |   | $ | (699 | ) | $ | 21,117 |   | $ | (763 | ) |
| **December 31,  2007:**                     |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government  agencies and related entities   |       | $                                      | —     |                                 | $          | —    |       | $ | 20,804 |   | $ | (59 | ) | $ | 20,804 |   | $ | (59 | ) |
| Mortgage-backed  securities                      |       | —                                 |       | —                               |       | 1,884     |       | (48 | ) | 1,884 |   | (48 | ) |
| Equity  securities                               |       | 888                                    |       | (184                                 | )          | 2,557     |       | (461 | ) | 3,445 |   | (645 | ) |
|                                             |       | $                                      | 888        |                                 | $          | (184      | )          | $ | 25,245 |   | $ | (568 | ) | $ | 26,133 |   | $ | (752 | ) |

 

Management evaluatessecurities for other than temporary impairment at least on a quarterly basis,and more frequently when economic or market concerns warrant suchevaluation.  Consideration is given to: (1) thelength of time and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer and (3) theintent and ability of the Corporation to retain its investment in the issuerfor a period of time sufficient to allow for any anticipated recovery in fairvalue.

 

F-16

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Table of Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**4.         Securities (continued)**

 

During 2008, managementevaluated the Corporation’s investment portfolio and determined that other thantemporary impairments existed on Fannie Mae and Freddie Mac stocks.  The impairment of these securities wasconsidered to be other than temporary due to continued concerns related to thefinancial condition and near-term prospects of the issuers, economic conditionsof the financial services industry and deteriorating market values.  In accordance with SFAS No. 115, *Accounting for Certain Investment in Debt and Equity Securities*(SFAS115), these securities were written down to their fair market value as of June 30,2008 and again as of September 30, 2008. The resulting impairment losses of $391,000 were recognized in earningsduring the second and third quarters of 2008 and are not included in thepreceding table.

 

As of December 31,2008, there were 25 securities in an unrealized loss position.  These unrealized losses are considered to betemporary impairments.  A decline in thevalue of the debt securities is due only to interest rate fluctuations, ratherthen erosion of quality.  As a result,the payment of contractual cash flows, including principal repayment, is not atrisk.  As management has the intent andability to hold these investments until market recovery or maturity, none ofthe unrealized losses on debt securities are deemed to be other than temporary.

 

Equity securities ownedby the Corporation consist of common stock of various financial servicesproviders that have traditionally been high-performing stocks.  However, as a result of recent market volatility in financial stocks, the fairvalue of most of the stocks held are “under water” as of December 31,2008, and as such, could be considered to be impaired.  The Corporation does not invest in thesesecurities with the intent to sell them for a profit in the near-term.  Management believes these securities havepotential to appreciate in value over the long-term, while providing for areasonable dividend yield.  In addition,stocks can be cyclical and will experience some down periods.  Historically, bank stocks have sustainedcyclical losses followed by periods of substantial gains.  Based on these circumstances and the abilityand intent to hold these securities for a reasonable period of time sufficientfor a recovery of fair value, the Corporation does not consider theseinvestments to be other than temporarily impaired at December 31, 2008.

 

**5.****                         ****Loans Receivable**

 

Thefollowing table summarizes the Corporation’s loans receivable as of December 31:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                       |       |     |       |     |       |
| **Mortgage  loans on real estate:**              |       |     |       |     |       |
| Residential  first mortgages                     |       | $        | 74,130     |     | $          | 65,706 |   |
| Home equity  loans and lines of credit           |       | 57,454   |       | 49,426   |       |
| Commercial real  estate                          |       | 85,689   |       | 71,599   |       |
|                                             |       | 217,273  |       | 186,731  |       |
| **Other  loans:**                                |       |     |       |     |       |
| Commercial business                              |       | 40,787   |       | 35,566   |       |
| Consumer                                         |       | 9,429    |       | 9,679    |       |
|                                             |       | 50,216   |       | 45,245   |       |
| **Total  loans, gross**                          |       | 267,489  |       | 231,976  |       |
| **Less  allowance for loan losses**              |       | 2,651    |       | 2,157    |       |
| **Total  loans, net**                            |       | $        | 264,838    |     | $          | 229,819 |   |

 

F-17

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Table of Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**5.****                         ****Loans Receivable (continued)**

 

Followingis an analysis of the changes in the allowance for loan losses for the yearsended December 31:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Balance at the  beginning of the year            |       | $        | 2,157      |     | $          | 2,035 |   |
| Allowance for  loan losses of ECSLA              |       | 206      |       | —   |       |
| Provision for  loan losses                       |       | 500      |       | 256      |       |
| Charge-offs                                      |       | (252     | )          | (164     | )          |
| Recoveries                                       |       | 40       |       | 30       |       |
| Balance at the  end of the year                  |       | $        | 2,651      |     | $          | 2,157 |   |

 

Non-performing loans,which include primarily non-accrual loans, were $1.0 million at December 31,2008 and 2007, respectively.  TheCorporation is not committed to lend significant additional funds to debtorswhose loans are on non-accrual status. At December 31, 2008 and 2007, there was no recorded investment inloans considered to be impaired.  During2008 and 2007, impaired loans averaged $0 and $255,000, respectively.  The Corporation recognized interest income onimpaired loans of approximately $0 and $98,000, on a cash basis, during 2008and 2007, respectively.  Nonperformingloans and impaired loans are defined differently.  Some loans may be included in both categorieswhereas other loans may be included in only one category.

 

The Corporation isrequired to maintain qualifying collateral with the FHLB to secure alloutstanding loans.  Loans with bookvalues of $140.0 million and $50.0 million as of December 31, 2008 and 2007,respectively, are pledged as qualifying collateral.  The Corporation is in compliance with allFHLB credit policies at December 31, 2008.

 

The Corporation wasservicing residential mortgage loans with unpaid principal balances of $7.9million and $7.7 million at December 31, 2008 and 2007, respectively, fora third party investor.  In addition, theCorporation was servicing commercial loans with unpaid principal balances of$4.8 million and $5.3 million at December 2008 and 2007, respectively, forthird party investors.  Such loans arenot reflected in the consolidated balance sheet and servicing operations resultin the generation of annual fee income of approximately 0.25% of the unpaidprincipal balances of such loans.

 

**6.****                          FederalBank Stocks**

 

The Bank is a member ofthe FHLB and the FRB.  As a member ofthese federal banking systems, the Bank maintains an investment in the capitalstock of the respective regional banks, at cost.  These stocks are purchased and redeemed atpar as directed by the federal banks and levels maintained are based primarilyon borrowing and other correspondent relationships.  The Bank’s investment in FHLB and FRB stockswas $3.5 million and $333,000, respectively, at December 31, 2008, and$2.3 million and $333,000, respectively, at December 31, 2007.  In December 2008, the FHLB notifiedmember banks that it was suspending dividend payments and the repurchase ofcapital stock.

 

F-18

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Table of Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**6.****                          FederalBank Stocks (continued)**

 

Management evaluated theFHLB capital stock for impairment in accordance with Statement of Position(SOP) 01-6, *Accounting by Certain Entities (Including EntitiesWith Trade Receivables) That Lend to or Finance the Activities of Others*(SOP01-6).  Management’s determination ofwhether these investments are impaired is based on their assessment of theultimate recoverability of their cost rather than by recognizing temporarydeclines in value.  The determination ofwhether a decline affects the ultimate recoverability of their cost isinfluenced by criteria such as: (1) the significance of the decline in netassets of the FHLB as compared to the capital stock amount for the FHLB and thelength of time this situation has persisted, (2) commitments by the FHLBto make payments required by law or regulation and the level of such paymentsin relation to the operating performance of the FHLB, and (3) the impactof legislative and regulatory changes on institutions and, accordingly, on thecustomer base of the FHLB.

 

Management believes noimpairment charge is necessary related to the FHLB  capital stock as of December 31, 2008.

 

**7.         Premises and Equipment**

 

Premises andequipment at December 31 are summarized by major classification asfollows:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Land                                             |       | $        | 1,403      |     | $          | 1,088 |   |
| Buildings and  improvements                      |       | 6,710    |       | 5,955    |       |
| Leasehold  improvements                          |       | 744      |       | 733      |       |
| Furniture,  fixtures and equipment               |       | 4,757    |       | 4,428    |       |
| Software                                         |       | 2,104    |       | 1,878    |       |
| Construction in  progress                        |       | 714      |       | 908      |       |
|                                             |       | 16,432   |       | 14,990   |       |
| Less accumulated  depreciation and amortization  |       | 7,823    |       | 7,086    |       |
|                                             |       | $        | 8,609      |     | $          | 7,904 |   |

 

Depreciation andamortization expense for the years ended December 31, 2008 and 2007 were$737,000 and $663,000, respectively.

 

Rent expense undernon-cancelable operating lease agreements for the years ended December 31,2008 and 2007 was $120,000 and $115,000, respectively.  Rent commitments under non-cancelablelong-term operating lease agreements for certain branch offices for the yearsended December 31, are as follows, before considering renewal options thatare generally present:

 
| **(Dollar amounts in thousands)** | ** ** | **Amount** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| 2009                                             |       | $          | 122        |   |
| 2010                                             |       | 112        |       |
| 2011                                             |       | 76         |       |
| 2012                                             |       | 29         |       |
|                                             |       | $          | 339        |   |

 

F-19

----

Table of Contents

 

**Notes to Consolidated Financial Statements *(continued)***

 

**8.****                          Goodwilland Intangible Assets**

 

The following tablesummarizes the Corporation’s acquired goodwill and intangible assets as of December 31:

 
| ** **                                       | ** ** | **2008**                | ** ** | **2007**         | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|------------------|------------|
| ** **                                       | ** ** | **Gross Carrying** | ** ** | **Accumulated**  | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| **(Dollar amounts in thousands)** | ** ** | **Amount**              | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| Goodwill                                         |       | $                       | 1,422      |             | $          | — |   | $ | 1,422 |   | $ | — |   |
| Core deposit  intangibles                        |       | 1,240                   |       | 1,240            |       | 1,240 |   | 1,240 |   |
| Other customer  relationship intangibles         |       | 20                      |       | 20               |       | 20 |   | 20 |   |
| Total                                            |       | $                       | 2,682      |             | $          | 1,260 |   | $ | 2,682 |   | $ | 1,260 |   |

 

Goodwill resulted fromtwo previous branch acquisitions and is no longer amortized.  There was no aggregate amortization expensefor 2008 or 2007.

 

**9.****                          RelatedParty Balances and Transactions**

 

In the ordinary course ofbusiness, the Bank maintains loan and deposit relationships with employees,principal officers and directors.  TheBank has granted loans to principal officers and directors and their affiliatesamounting to $1.1 million and $1.3 million at December 31, 2008 and 2007,respectively.  During 2008, totalprincipal additions and total principal repayments associated with these loanswere $95,000 and $345,000, respectively. Deposits from principal officers and directors held by the Bank at December 31,2008 and 2007 totaled $1.6 million and $2.4 million, respectively.

 

In addition, directorsand their affiliates may provide certain professional and other services to theCorporation and the Bank in the ordinary course of business at market feerates.  During 2008 and 2007, amounts paidto affiliates for such services totaled $174,000 and $120,000, respectively.

 

**10.****                   Deposits**

 

The following tablesummarizes the Corporation’s deposits as of December 31:

 
| ** **                                       | ** ** | **2008**              | ** ** | **2007**   | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **Weighted**          | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Type of accounts**                   | ** ** | **average rate** | ** ** | **Amount** | ** ** | **%** | ** ** | **average rate** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Non-interest  bearing deposits                   |       | —                |       | $          | 56,351     |   | 19.7 | % | — |   | $ | 47,111 |   | 19.3 | % |
| Interest bearing  demand deposits                |       | 1.31                  | %          | 106,042    |       | 37.0 | % | 1.28 | % | 77,614 |   | 31.8 | % |
| Time deposits                                    |       | 3.97                  | %          | 124,254    |       | 43.3 | % | 4.48 | % | 119,537 |   | 48.9 | % |
|                                             |       | 2.21                  | %          | $          | 286,647    |   | 100.0 | % | 2.60 | % | $ | 244,262 |   | 100.0 | % |

 

The Corporation had atotal of $38.8 million and $32.7 million in time deposits of $100,000 or moreat December 31, 2008 and 2007, respectively.

 

F-20

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Table of Contents

 

**Notes to Consolidated FinancialStatements *(Continued)***

 

**10.****                   Deposits(continued)**

 

Scheduledmaturities of time deposits for the next five years are as follows:

 
| **(Dollar amounts in thousands)** | ** ** | **Amount** | ** ** | **%**  | ** ** |
|--------------------------------------------------|------------|------------|------------|--------|------------|
| 2009                                             |       | $          | 49,038     |   | 39.5       | % |
| 2010                                             |       | 25,636     |       | 20.6   | %          |
| 2011                                             |       | 14,997     |       | 12.1   | %          |
| 2012                                             |       | 11,079     |       | 8.9    | %          |
| 2013                                             |       | 20,155     |       | 16.2   | %          |
| Thereafter                                       |       | 3,349      |       | 2.7    | %          |
|                                             |       | $          | 124,254    |   | 100.0      | % |

 

**11.****                   Borrowed Funds**

 

Thefollowing table summarizes the Corporation’s borrowed funds as of and for theyear ended December 31:

 
| ** **                                       | ** ** | **2008**    | ** ** | **2007**    | ** ** |
|--------------------------------------------------|------------|-------------|------------|-------------|------------|
| ** **                                       | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                       | ** ** | ** **  | ** ** | **Average** | ** ** | **Average** | ** ** | **average** | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | **average** | ** ** |
| **(Dollar amounts in thousands)** | ** ** | **Balance** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **rate** | ** ** | **Balance** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **rate** | ** ** |
| **FHLB  advances:**                              |       |        |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Due within 12  months                            |       | $           | 13,188     |        | $          | 10,096 |   | 2.20 | % | 1.80 | % | $ | 5,400 |   | $ | 1,208 |   | 4.58 | % | 2.73 | % |
| Due beyond 12  months but within 5 years         |       | 15,000      |       | 15,000      |       | 4.13 | % | 4.19 | % | 10,000 |   | 10,000 |   | 4.18 | % | 4.24 | % |
| Due beyond 5  years but within 10 years          |       | 20,000      |       | 20,000      |       | 4.64 | % | 4.71 | % | 25,000 |   | 21,233 |   | 4.52 | % | 4.66 | % |
|                                             |       | $           | 48,188     |        | $          | 45,096 |   |   |   |   |   | $ | 40,400 |   | $ | 32,441 |   |   |   |   |   |

 

Borrowedfunds at December 31, 2008 consist of seven, $5.0 million term advances and$13.2 million in overnight borrowings with the FHLB.  The term advances mature between November 2011and October 2017.  If these advancesconvert to adjustable rate borrowings, the Corporation has the opportunity torepay the advances without penalty at or after the conversion date.  All borrowings from the FHLB are secured by ablanket lien of qualified collateral, defined principally as 80% of thecarrying value of first mortgage loans on owner-occupied residential propertiesand 95% of the market value of U.S. Government and federal agency securities.

 

Theinitial three $5.0 million borrowings have fixed rates of 4.61%, 3.74% and4.04%, respectively, after which the rates may adjust at the option of the FHLBto the then three month LIBOR plus 20, 22 or 25 basis points, respectively, butonly if the three month LIBOR exceeds 8.0%.

 

Inaddition, the Corporation borrowed three additional $5.0 million 10 year termadvances at initial interest rates of 4.98%, 4.83% and 4.68%,respectively.  Two of these borrowingsare fixed for the first two years of the term after which the rates may adjustat the option of the FHLB to the then three month LIBOR rate plus 24 basispoints.  The third borrowing is alsofixed for the first two years of the initial term after which the rates mayadjust at the option of the FHLB to the then three month LIBOR plus 24 basispoints, but only if the three month LIBOR exceeds 6.0%.

 

F-21

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Table ofContents

 

**Notes to Consolidated Financial Statements *(Continued)***

 

**11.****                   BorrowedFunds (continued)**

 

During2007, the Corporation entered into an agreement with the FHLB to borrow anadditional $5.0 million for a 10 year term at an initial interest rate of4.09%.  This borrowing is fixed for thefirst three years of the term after which the rates may adjust at the option ofthe FHLB to the then three month LIBOR rate plus 13 basis points.

 

Scheduledmaturities of borrowed funds for the next five years are as follows:

 
| **(Dollar amounts in thousands)** | ** ** | **Amount** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| 2009                                             |       | $          | 13,188     |   |
| 2010                                             |       | —     |       |
| 2011                                             |       | 5,000      |       |
| 2012                                             |       | 5,000      |       |
| 2013                                             |       | 5,000      |       |
| Thereafter                                       |       | 20,000     |       |
|                                             |       | $          | 48,188     |   |

 

TheBank maintains a credit arrangement with the FHLB as a source of additionalliquidity.  The total maximum borrowingcapacity with the FHLB, excluding loans outstanding, at December 31, 2008was $138.0 million.  In addition, theCorporation has $4.0 million and the Bank has $7.0 million of funds availableon unused lines of credit through other correspondent banks.

 

**12.****                   Insuranceof Accounts and Regulatory Matters**

 

#### ***Insurance of Accounts***

#### ** **

The deposits of the Bank have historically beeninsured by the Federal Deposit Insurance Corporation (FDIC) up to $100,000 perinsured depositor, except certain types of retirement accounts, which areinsured up to $250,000 per insured depositor. On October 3, 2008, the maximum amount insured under FDIC depositinsurance was temporarily increased from $100,000 to $250,000 per insureddepositor through December 31, 2009. Additionally, the Bank has elected to participate in the FDIC’sTemporary Liquidity Guarantee Program. Under this program, all noninterest bearing deposit transactionaccounts, lawyers’ trust accounts and NOW accounts that pay interest ratesequal to or less than 50 basis points and public funds held in noninterestbearing accounts with balances over $250,000 will also be fully insured throughDecember 31, 2009.  After December 31,2009, the standard insurance limit will return to $100,000 for all depositcategories except certain retirement accounts, which will continue to beinsured up to $250,000 per insured depositor. To provide this insurance, the Bank must pay an annual premium and isrequired to maintain certain minimum levels of regulatory capital as outlinedbelow.

 

#### ***Restrictionson Dividends, Loans and Advances***

#### ** **

TheBank is subject to a regulatory dividend restriction that generally limits theamount of dividends that can be paid by the Bank to the Corporation.  Prior regulatory approval is required if thetotal of all dividends declared in any calendar year exceeds net profits (asdefined in the regulations) for the year combined with net retained earnings(as defined) for the two preceding calendar years.  In addition, dividends paid by the Bank to theCorporation would be prohibited if the effect thereof would cause the Bank’scapital to be reduced below applicable minimum capital requirements.  As of December 31, 2008, $2.0 million ofundistributed earnings of the Corporation was available for distribution ofdividends without prior regulatory approval.

 

F-22

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Table of Contents

 

**Notes toConsolidated Financial Statements *(Continued)***

 

**12.****                   Insuranceof Accounts and Regulatory Matters (continued)**

 

Loansor advances from the Bank to the Corporation are limited to 10% of the Bank’scapital stock and surplus on a secured basis. Funds available for loans or advances by the Bank to the Corporationamounted to approximately $2.2 million. The Corporation has a $1.1 million commercial line of credit availableat the Bank for the primary purpose of purchasing qualified equityinvestments.  At December 31, 2008,the Corporation had an outstanding balance on this line of $1.1 million.

 

***Minimum Regulatory CapitalRequirements***

 

TheCorporation (on a consolidated basis) and the Bank are subject to variousregulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the Corporation’s and the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Corporation and the Bankmust meet specific capital guidelines that involve quantitative measures oftheir assets, liabilities and certain off-balance-sheet items as calculatedunder regulatory accounting practices. The capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings, and otherfactors.  Prompt corrective actionprovisions are not applicable to bank holding companies.

 

Quantitativemeasures established by regulation to ensure capital adequacy require theCorporation and the Bank to maintain minimum amounts and ratios (set forth inthe following table) of total and Tier 1 capital (as defined in theregulations) to risk-weighted assets (as defined) and of Tier 1 capital (asdefined) to average assets (as defined).

 

As of December 31,2008, the most recent notification from the FDIC categorized the Bank as wellcapitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, aninstitution must maintain minimum total risk-based, Tier 1 risk-based and Tier1 leverage ratios as set forth in the following table.  There are no conditions or events since thenotification that management believes have changed the Bank’s category.

 

Thefollowing table sets forth certain information concerning regulatory capital ofthe consolidated Corporation and the Bank as of the dates presented:

 
| ** **                                       | ** ** | **December 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **Consolidated**                | ** ** | **Bank**                        | ** ** | **Consolidated** | ** ** | **Bank** | ** ** |
| **(Dollar amounts in thousands)** | ** ** | **Amount**                      | ** ** | **Ratio**                       | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **Total  capital to risk-weighted assets:**      |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Actual                                           |       | $                               | 38,727     |                            | 13.85      | % | $ | 36,069 |   | 13.01 | % | $ | 25,002 |   | 10.54 | % | $ | 23,357 |   | 9.95 | % |
| For capital  adequacy purposes                   |       | 22,369                          |       | 8.00                            | %          | 22,174 |   | 8.00 | % | 18,974 |   | 8.00 | % | 18,771 |   | 8.00 | % |
| To be well  capitalized                          |       | N/A                             |       | N/A                             |       | 27,718 |   | 10.00 | % | N/A |   | N/A |   | 23,464 |   | 10.00 | % |
| **Tier 1  capital to risk-weighted assets:**     |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Actual                                           |       | $                               | 36,386     |                            | 13.01      | % | $ | 33,422 |   | 12.06 | % | $ | 23,075 |   | 9.73 | % | $ | 21,260 |   | 9.06 | % |
| For capital  adequacy purposes                   |       | 11,184                          |       | 4.00                            | %          | 11,087 |   | 4.00 | % | 9,487 |   | 4.00 | % | 9,385 |   | 4.00 | % |
| To be well  capitalized                          |       | N/A                             |       | N/A                             |       | 16,631 |   | 6.00 | % | N/A |   | N/A |   | 14,078 |   | 6.00 | % |
| **Tier 1  capital to average assets:**           |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Actual                                           |       | $                               | 36,386     |                            | 10.88      | % | $ | 33,422 |   | 9.21 | % | $ | 23,075 |   | 7.73 | % | $ | 21,260 |   | 7.08 | % |
| For capital  adequacy purposes                   |       | 13,382                          |       | 4.00                            | %          | 14,523 |   | 4.00 | % | 11,936 |   | 4.00 | % | 12,007 |   | 4.00 | % |
| To be well  capitalized                          |       | N/A                             |       | N/A                             |       | 18,154 |   | 5.00 | % | N/A |   | N/A |   | 15,008 |   | 5.00 | % |

 

F-23

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Table of Contents

 

**Notes toConsolidated Financial Statements *(Continued)***

 

**13.      Commitmentsand Legal Contingencies**

 

In theordinary course of business, the Corporation has various outstandingcommitments and contingent liabilities that are not reflected in theaccompanying consolidated financial statements. In addition, the Corporation is involved in certain claims and legalactions arising in the ordinary course of business.  The outcome of these claims and actions arenot presently determinable; however, in the opinion of the Corporation’smanagement, after consulting legal counsel, the ultimate disposition of thesematters will not have a material adverse effect on the consolidated financialstatements.

 

**14.****                   IncomeTaxes**

 

The Corporation and the Bank file a consolidatedfederal income tax return.  The provisionfor income taxes for the years ended December 31 is comprised of thefollowing:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |   |   |
| Current                                          |       | $        | 789        |     | $          | 639 |   |
| Deferred                                         |       | (433     | )          | 156      |       |
|                                             |       | $        | 356        |     | $          | 795 |   |

 

Areconciliation between the provision for income taxes and the amount computedby multiplying operating results before income taxes by the statutory federalincome tax rate `of 34% for the years ended December 31 is as follows:

 
| ** **                                       | ** ** | **2008**   | ** ** | **2007**           | ** ** |
|--------------------------------------------------|------------|------------|------------|--------------------|------------|
| ** **                                       | ** ** | ** ** | ** ** | **% Pre-tax** | ** ** | ** ** | ** ** | **% Pre-tax** | ** ** |
| **(Dollar amounts in thousands)** | ** ** | **Amount** | ** ** | **Income**         | ** ** | **Amount** | ** ** | **Income** | ** ** |
|                                             |       |       |       |               |       |   |   |   |   |   |   |
| Provision at  statutory tax rate                 |       | $          | 947        |               | 34.0       | % | $ | 1,187 |   | 34.0 | % |
| Increase  (decrease) resulting from:             |       |       |       |               |       |   |   |   |   |
| Tax free  interest, net of disallowance          |       | (270       | )          | (9.7               | )%         | (288 | ) | (8.2 | )% |
| Earnings on BOLI                                 |       | (68        | )          | (2.4               | )%         | (65 | ) | (1.9 | )% |
| Effect of  extraordinary gain                    |       | (308       | )          | (11.1              | )%         | — |   | — |   |
| Other, net                                       |       | 55         |       | 2.0                | %          | (39 | ) | (1.1 | )% |
| Provision                                        |       | $          | 356        |               | 12.8       | % | $ | 795 |   | 22.8 | % |

 

F-24

----

Table of Contents

 

**Notes toConsolidated Financial Statements *(Continued)***

 

**14.****                   IncomeTaxes (continued)**

 

Thetax effects of temporary differences between the financial reporting basis andincome tax basis of assets and liabilities that are included in the netdeferred tax asset as of December 31 relate to the following:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                       |       |     |       |     |       |
| **Deferred  tax assets:**                        |       |     |       |     |       |
| Provision for loan  losses                       |       | $        | 848        |     | $          | 680 |   |
| SFAS 158 pension  accrual                        |       | 633      |       | 158      |       |
| Accrued pension  cost                            |       | 252      |       | 73       |       |
| Securities  impairment                           |       | 133      |       | —   |       |
| Accrued contract  termination fees               |       | 122      |       | —   |       |
| Intangible  assets                               |       | 87       |       | 101      |       |
| Other                                            |       | 55       |       | 33       |       |
| Net unrealized  loss on securities               |       | —   |       | 51       |       |
| Gross deferred  tax assets                       |       | 2,130    |       | 1,096    |       |
| **Deferred  tax liabilities:**                   |       |     |       |     |       |
| Depreciation                                     |       | 446      |       | 354      |       |
| Stock gain                                       |       | 172      |       | 172      |       |
| Prepaid expenses                                 |       | 91       |       | 72       |       |
| Net unrealized  gain on securities               |       | 79       |       | —   |       |
| Purchase  accounting adjustments                 |       | 75       |       | 46       |       |
| Deferred loan  fees                              |       | 57       |       | 55       |       |
| Loan servicing                                   |       | 20       |       | 21       |       |
| Gross deferred  tax liabilities                  |       | 940      |       | 720      |       |
| Net deferred tax  asset                          |       | $        | 1,190      |     | $          | 376 |   |

 

TheCorporation determined that it was not required to establish a valuationallowance for deferred tax assets in accordance with SFAS No. 109, *Accounting for Income Taxes*, since it is more likely thannot that the deferred tax asset will be realized through carry-back to taxableincome in prior years, future reversals of existing taxable temporary differences,and, to a lesser extent, future taxable income. The Corporation’s net deferred tax asset is recorded in the consolidatedfinancial statements as a component of other assets.

 

FASBFIN No. 48, *Accounting for Uncertainty in Income Taxes*(FIN 48), provides guidance on determining whether a tax position iseffectively settled for the purpose of recognizing previously unrecognized taxbenefits.  At December 31, 2008 and December 31,2007, the Corporation had no FIN 48 unrecognized tax benefits recorded.  The Corporation does not expect the totalamount of unrecognized tax benefits to significantly increase within the nexttwelve months.  The Corporationrecognizes interest and penalties on unrecognized tax benefits in income taxesexpense in its Consolidated Statements of Income.

 

TheCorporation and the Bank are subject to U.S. federal income tax as well as acapital-based franchise tax in the Commonwealth of Pennsylvania.  The Corporation and the Bank are no longersubject to examination by taxing authorities for years before 2005.  The Corporation’s 2007 federal income taxreturn is currently under examination by the Internal Revenue Service.  No significant adjustments are anticipated toresult from this examination.

 

F-25

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Table of Contents

 

**Notes toConsolidated Financial Statements *(Continued)***

 

**15.      EmployeeBenefit Plans**

 

#### ***DefinedBenefit Plan***

#### ** **

TheCorporation provides pension benefits for eligible employees through a definedbenefit pension plan.  Substantially allemployees participate in the retirement plan on a non-contributing basis, andare fully vested after five years of service. The Corporation uses December 31 as the measurement date for itsplans.  Information pertaining to changesin obligations and funded status of the defined benefit pension plan is asfollows:

 
| **(Dollar amounts in thousands)**                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ** **                                                                            |       |     |       |     |       |
| **Change  in plan assets:**                                                           |       |     |       |     |       |
| Fair value of  plan assets at beginning of year                                       |       | $        | 3,883      |     | $          | 3,525 |   |
| Actual (loss)  return on plan assets                                                  |       | (727     | )          | 246      |       |
| Employer  contribution                                                                |       | 335      |       | 360      |       |
| Benefits paid                                                                         |       | (265     | )          | (248     | )          |
| Fair value of  plan assets at end of year                                             |       | 3,226    |       | 3,883    |       |
| **Change  in benefit obligation:**                                                    |       |     |       |     |       |
| Benefit  obligation at beginning of year                                              |       | 4,508    |       | 4,392    |       |
| Service cost                                                                          |       | 233      |       | 238      |       |
| Interest cost                                                                         |       | 285      |       | 262      |       |
| Actuarial loss                                                                        |       | 8        |       | 118      |       |
| Effect of change  in assumptions                                                      |       | 346      |       | (255     | )          |
| Benefits paid                                                                         |       | (265     | )          | (247     | )          |
| Benefit  obligation at end of year                                                    |       | 5,115    |       | 4,508    |       |
| Funded status  (plan assets less benefit obligation)                                  |       | (1,889   | )          | (625     | )          |
| Unrecognized  prior service cost                                                      |       | (241     | )          | (271     | )          |
| Unrecognized net  actuarial gain                                                      |       | 2,104    |       | 736      |       |
| **Accrued  pension cost**                                                             |       | $        | (26        | )        | $          | (160 | ) |
|                                                                                  |       |     |       |     |       |
| Amounts  recognized in accumulated other comprehensive loss, net of tax, consists of: |       |     |       |     |       |
| Accumulated net  actuarial loss                                                       |       | $        | 1,388      |     | $          | 485 |   |
| Accumulated  prior service benefit                                                    |       | (159     | )          | (179     | )          |
| Amount  recognized, end of year                                                       |       | $        | 1,229      |     | $          | 306 |   |

 

F-26

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Tableof Contents

 

**Notes to Consolidated Financial Statement *(continued)***

 

**15.****                       EmployeeBenefit Plans (continued)**

 

Amountsrecognized in the year end balance sheet consist of:

 
| ** **                                       | ** ** | **Pension Benefits** | ** ** |
|--------------------------------------------------|------------|---------------------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **2008**                  | ** ** | **2007** | ** ** |
|                                             |       |                      |       |   |   |   |   |
| Accrued benefit  cost                            |       | $                         | (26        | ) | $ | (160 | ) |
| Accumulated  other comprehensive loss            |       | (1,863                    | )          | (465 | ) |
| Net amount  recognized                           |       | $                         | (1,889     | ) | $ | (625 | ) |

 

Theaccumulated benefit obligation for the defined benefit pension plan was $5.1million and $4.5 million at year end 2008 and 2007, respectively.

 

Thecomponents of the periodic pension costs are as follows:

 
| **(Dollar amounts in thousands)**          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                      |       |     |       |     |       |   |   |
| Service cost                                              |       | $        | 233        |     | $          | 238 |   |
| Interest cost                                             |       | 285      |       | 262      |       |
| Expected return  on plan assets                           |       | (305     | )          | (303     | )          |
| Amortization of  prior service cost and actuarial expense |       | (12      | )          | —   |       |
| Net periodic  pension cost                                |       | $        | 201        |     | $          | 197 |   |

 

Weighted-averageactuarial assumptions include the following:

 
| ** **                                      | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Discount rate  for net periodic benefit cost    |       | 6.50     | %          | 6.00     | %          |
| Discount rate  for benefit obligations          |       | 6.00     | %          | 6.50     | %          |
| Rate of increase  in future compensation levels |       | 3.50     | %          | 4.50     | %          |
| Expected rate of  return on plan assets         |       | 7.75     | %          | 8.50     | %          |

 

TheCorporation’s pension plan asset allocation at year end 2008 and 2007, targetallocation for 2009, and expected long-term rate of return by asset categoryare as follows:

 
| ** **              | ** ** | **Target**     | ** ** | **Percentage of Plan Assets at** | ** ** | **Weighted-Average Expected**          | ** ** |
|-------------------------|------------|----------------|------------|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **Allocation** | ** ** | **Year End**                                    | ** ** | **Long-Term Rate of Return** | ** ** |
| **Asset Category** | ** ** | **2009**       | ** ** | **2008**                                             | ** ** | **2007**                                    | ** ** | **2008** | ** ** |
|                    |       |           |       |                                                 |       |                                        |       |   |   |
| Equity  Securities      |       | 47             | %          | 47                                                   | %          | 54                                          | %          | 5.5 | % |
| Debt Securities         |       | 24             | %          | 24                                                   | %          | 21                                          | %          | 1.8 | % |
| Other                   |       | 29             | %          | 29                                                   | %          | 25                                          | %          | 0.5 | % |
|                    |       | 100            | %          | 100                                                  | %          | 100                                         | %          | 7.75 | % |

 

F-27

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Table of Contents

 

**Notes to Consolidated Financial Statement *(continued)***

 

**15.****                       EmployeeBenefit Plans (continued)**

 

Theintent of the Plan is to provide a range of investment options for building adiversified asset allocation strategy that will provide the highest likelihoodof meeting the aggregate actuarial projections. In selecting the options and asset allocation strategy, the Corporationhas determined that the benefits of reduced portfolio risk are best receivedthrough asset style diversification.  Thefollowing asset classes or investment categories are utilized to meet the Plan’sobjectives:  Small company stock,International stock, Mid-cap stock, Large company stock, Diversified bond,Money Market/Stable Value and Cash.

 

TheCorporation expects to contribute approximately $350,000 to its pension plan in2009.

 

Estimatedfuture benefit payments, which reflect expected future service, as appropriate,are as follows:

 

| **(Dollar amounts in thousands)**    | ** ** | **Pension**  | ** ** |
|-----------------------------------------------------|------------|--------------|------------|
| **For year ended December 31,** | ** ** | **Benefits** | ** ** |
|                                                |       |         |       |
| 2009                                                |       | $            | 260        |   |
| 2010                                                |       | 225          |       |
| 2011                                                |       | 210          |       |
| 2012                                                |       | 240          |       |
| 2013                                                |       | 250          |       |
| 2014-2017                                           |       | 1,450        |       |
| Thereafter                                          |       | 2,480        |       |
| Benefit Obligation                                  |       | $            | 5,115      |   |

 

The Corporation adopted SFAS No. 158, *Employers’ Accounting for Defined Benefit Pension and Other PostRetirement Plans* (SFAS 158) effective December 31, 2006.  SFAS 158 requires an employer to recognizethe funded status of its defined benefit pension plan as a net asset orliability in its consolidated balance sheet with an offsetting amount inaccumulated other comprehensive income, and to recognize changes in that fundedstatus in the year in which changes occur through comprehensive income.  The provisions of SFAS 158 are to be appliedon a prospective basis; therefore, prior periods presented are notrestated.  As of December 31, 2008,the Corporation’s liability under SFAS 158 was $1.9 million and the charge toaccumulated other comprehensive income was $1.2 million, net of taxes.  Additionally, SFAS requires an employer tomeasure the funded status of its defined benefit pension plan as of the date ofits year-end financial statements.  TheCorporation measures the funded status at December 31.

 

***Defined Contribution Plan***

 

TheCorporation maintains a defined contribution 401(k) Plan.  Employees are eligible to participate byproviding tax-deferred contributions up to 20% of qualified compensation.  Employee contributions are vested at alltimes.  The Corporation provides amatching contribution of up to 4% of the participant’s salary.  Matching contributions for 2008 and 2007 were$150,000 and $130,000, respectively.

 

F-28

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Tableof Contents

 

**Notes to Consolidated Financial Statement *(continued)***

 

**15.****                       EmployeeBenefit Plans (continued)**

 

***Supplemental Executive Retirement Plan***

 

During2003, the Corporation established a Supplemental Executive Retirement Plan(SERP) to provide certain additional retirement benefits to participatingexecutive officers.  The SERP was adoptedin order to provide benefits to such executives whose benefits are reducedunder the Corporation’s tax-qualified benefit plans pursuant to limitationsunder the Internal Revenue Code.  TheSERP is subject to certain vesting provisions and provides that the executivesshall receive a supplemental retirement benefit if the executive’s employmentis terminated after reaching the normal retirement age of 65.  As of December 31, 2008 and 2007, theCorporation’s SERP liability was $285,000 and $215,000, respectively.  For the years ended December 31, 2008and 2007, the Corporation recognized SERP expense of $69,000 and $54,000,respectively.

 

**16.****                       StockCompensation Plans**

 

InMay 2007, the Corporation adopted the 2007 Stock Incentive Plan and Trust.Under the Plan, the Corporation may grant restricted stock awards and optionsto its directors, officers and employees for up to 177,496 shares of commonstock.  Incentive stock options,non-incentive or compensatory stock options and share awards may be grantedunder the Plan.  The exercise price ofeach option shall at least equal the market price of a share of common stock onthe date of grant and have a contractual term of ten years.  Options shall vest and become exercisable atthe rate, to the extent and subject to such limitations as may be specified bythe Corporation.  Effective January 1,2007, the Corporation adopted SFAS 123(R), which requires that compensation costrelated to share-based payment transactions be recognized in the financialstatements with measurement based upon the fair value of the equity orliability instruments issued.  During2008 and 2007, 14,500 and 84,000 options were granted under the plan.  In addition, during 2008, the Corporationgranted restricted stock awards of 4,500 shares with a face value of $101,000,based on the grant date stock price of $22.50. These options and restricted stock awards are 100% vested on the thirdanniversary of the date of grant.  Forthe year ended December 31, 2008 and 2007, the Corporation recognized$113,000 and $31,000, respectively, in stock compensation expense.

 

Thefair value of each option grant is estimated on the date of grant using theBlack-Scholes option-pricing model with the following weighted averageassumptions:

 
| **Weighted-average for the year** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|------------|
| **ended December 31,**                 | ** ** | **2008**   | ** ** | **2007**   | ** ** |
| Dividend yield                                   |       | 5.28       | %          | 4.46       | %          |
| Expected life                                    |       | 10 years   |       | 10 years   |       |
| Expected  volatility                             |       | 12.40      | %          | 14.09      | %          |
| Risk-free  interest rate                         |       | 4.05       | %          | 5.10       | %          |

 

Theexpected volatility is based on historical stock price fluctuations.  The risk-free interest rates for periodswithin the contractual life of the awards are based on the U.S. Treasury yieldcurve in effect at the time of the grant. The expected life is based on the maximum term of the options.  The dividend yield assumption is based on theCorporation’s history and expectation of dividend payouts.

 

F-29

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Tableof Contents

 

**Notes toConsolidated Financial Statement *(continued)***

** **

**16.****                       StockCompensation Plans (continued)**

 

Asummary of option activity under the Plan as of December 31, 2008, andchanges during the period then ended is presented below:

 
| ** **                                | ** ** | ** **  | ** ** | ** **              | ** ** | ** **               | ** ** | **Weighted-Average**    | ** ** |
|-------------------------------------------|------------|-------------|------------|-------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | ** **  | ** ** | **Weighted-Average**    | ** ** | **Aggregate**            | ** ** | **Remaining Term** | ** ** |
| ** **                                | ** ** | **Options** | ** ** | **Exercise Price** | ** ** | **Intrinsic Value** | ** ** | **(in years)**     | ** ** |
| Outstanding at  the beginning of the year |       | 84,000      |       | $                       | 26.00      |                     |       |                    | 8.5        |   |
| Granted                                   |       | 14,500      |       | 23.83                   |       |                     |       | 9.7                     |       |
| Exercised                                 |       | —      |       | —                  |       |                     |       | —                  |       |
| Forfeited                                 |       | 4,500       |       | 26.00                   |       |                     |       | —                  |       |
| Outstanding as  of December 31, 2008 |       | 94,000      |       | $                       | 25.66      |                     | $          | —                  |       | 8.7 |   |
| Exercisable as  of December 31, 2008 |       | —      |       | $                       | —     |                     | $          | —                  |       | — |   |

 

Asummary of the status of the Corporation’s nonvested option shares as of December 31,2008, and changes during the period then ended is presented below:

 
| ** **                              | ** ** | ** **  | ** ** | **Weighted-Average**                | ** ** |
|-----------------------------------------|------------|-------------|------------|-------------------------------------|------------|
| ** **                              | ** ** | **Options** | ** ** | **Grant-date Fair Value** | ** ** |
| Nonvested at the  beginning of the year |       | 84,000      |       | $                                   | 3.39       |   |
| Granted                                 |       | 14,500      |       | 1.72                                |       |
| Vested                                  |       | —      |       | —                              |       |
| Forfeited                               |       | 4,500       |       | 3.39                                |       |
| Nonvested as of  December 31, 2008 |       | 94,000      |       | $                                   | 3.13       |   |

 

Asof December 31, 2008, there was $251,000 of total unrecognizedcompensation cost related to nonvested share-based compensation arrangementsgranted under the Plan.  That cost isexpected to be recognized over an average period of 1.7 years.

 

**17.****                       Fair Valuesof Financial Instruments**

 

Management uses its bestjudgment in estimating the fair value of the Corporation’s financialinstruments; however, there are inherent weaknesses in any estimationtechnique.  Therefore, for substantiallyall financial instruments, the fair value estimates herein are not necessarilyindicative of the amounts the Corporation could have realized in a saletransaction on the dated indicated.  Theestimated fair value amounts have been measured as of their respectiveyear-ends and have not been re-evaluated or updated for purposes of thesefinancial statements subsequent to those respective dates.  As such, the estimated fair values of thesefinancial instruments subsequent to the respective reporting dates may bedifferent than the amounts reported at year-end.

 

In September 2006,FASB issued SFAS 157 which defines fair value, establishes a framework formeasuring fair value under GAAP, and expands disclosures about fair valuemeasurements.  SFAS 157 applies to otheraccounting pronouncements that require or permit fair value measurements.  The Corporation adopted SFAS 157 effectivefor its fiscal year beginning January 1, 2008.

 

F-30

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Tableof Contents

 

**Notes toConsolidated Financial Statement *(continued)***

** **

**17.****                       Fair Valuesof Financial Instruments (continued)**

 

In December 2007, the FASB issued FSP 157-2which delays the effective date of SFAS 157 for all non-financial assets andliabilities, except those that are recognized or disclosed at fair value on arecurring basis (as least annually) to fiscal years beginning after November 15,2008 and interim periods within those fiscal years.  As such, the Corporation only partiallyadopted the provisions of SFAS 157, and will begin to account and report fornon-financial assets and liabilities in 2009. In October 2008, the FASB issued FSP 157-3 to clarify theapplication of the provisions of SFAS 157 in an inactive market and how anentity would determine fair value in an inactive market.  FSP 157-3 is effective immediately andapplies to the Corporation’s December 31, 2008 consolidated financialstatements.  The adoption of SFAS 157 andFSP 157-3 had no impact on the amounts reported in the Corporation’sconsolidated financial statements.

 

SFAS 157 establishes afair value hierarchy that prioritizes the inputs to valuation methods used tomeasure fair value.  The hierarchy givesthe highest priority to unadjusted quoted prices in active markets foridentical assets or liabilities (Level 1 measurements) and the lowest priorityto unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are asfollows:

 

*Level 1*:  Unadjusted quoted prices in active marketsthat are accessible at the measurement date for identical, unrestricted assetsor liabilities.

 

*Level 2*:  Quoted prices in markets that are not active,or inputs that are observable either directly or indirectly, for substantiallythe full term of the asset or liability.

 

*Level 3*:  Prices or valuation techniques that requireinputs that are both significant to the fair value measurement and unobservable(i.e. supported with little or no market activity).

 

An asset or liability’slevel within the fair value hierarchy is based on the lowest level of inputthat is significant to the fair value measurement.

 

For assets measured atfair value on a recurring basis, the fair value measurements by level withinthe fair value hierarchy used at December 31, 2008 are as follows:

 
| ** **                                       | ** ** | ** **                      | ** ** | **(Level 1)**             | ** ** | **(Level 2)** | ** ** | ** **         | ** ** |
|--------------------------------------------------|------------|---------------------------------|------------|--------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                       | ** ** | ** **                      | ** ** | **Quoted Prices in** | ** ** | **Significant**    | ** ** | **(Level 3)** | ** ** |
| ** **                                       | ** ** | ** **                      | ** ** | **Active Markets**        | ** ** | **Other**          | ** ** | **Significant**    | ** ** |
| **(Dollar amounts in thousands)** | ** ** | ** **                      | ** ** | **for Identical**         | ** ** | **Observable**     | ** ** | **Unobservable**   | ** ** |
| **Description**                                  | ** ** | **December 31, 2008** | ** ** | **Assets**                     | ** ** | **Inputs**         | ** ** | **Inputs**         | ** ** |
| Securities  available for sale                   |       | $                               | 71,443     |                           | $          | 3,194              |       | $                  | 68,249     |   | $ | — |   |
|                                             |       | $                               | 71,443     |                           | $          | 3,194              |       | $                  | 68,249     |   | $ | — |   |

 

F-31

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Table of Contents

 

**Notes to Consolidated Financial Statement *(continued)***

 

**17.****                       Fair Valuesof Financial Instruments (continued)**

 

The Corporation’s adoptionof SFAS 157 applies only to its financial instruments required to be reportedat fair value.  The adoption does notapply to non-financial assets and non-financial liabilities until January 1,2009 in accordance with FSP FAS 157-2. The following valuation technique was used to measure fair value ofassets in the table above on a recurring basis as of December 31, 2008:

 

*Availablefor sale securities*— Fair value on available for salesecurities were based upon a market approach. Prices for securities that are fixed income instruments that are notquoted on an exchange, but are traded in active markets, are obtained throughthird party data service providers or dealer market participants which theCorporation has historically transacted both purchases and sales of investmentsecurities.  As of December 31,2008, all fair values on available for sale securities were based on pricesobtained from these sources and were based on actual market quotations for eachspecific security.

 

The following table setsforth the carrying amount and fair value of the Corporation’s financialinstruments included in the consolidated balance sheet as of December 31:

 
| ** **                                       | ** ** | **2008**                 | ** ** | **2007**            | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|---------------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **Carrying amount** | ** ** | **Fair value** | ** ** | **Carrying amount** | ** ** | **Fair value** | ** ** |
| **Financial  assets:**                           |       |                     |       |                |       |   |   |   |   |
| Cash and cash  equivalents                       |       | $                        | 16,571     |                | $          | 16,571 |   | $ | 10,483 |   | $ | 10,483 |   |
| Securities                                       |       | 71,443                   |       | 71,443              |       | 51,919 |   | 51,919 |   |
| Loans receivable                                 |       | 264,838                  |       | 272,662             |       | 229,819 |   | 229,262 |   |
| Federal bank  stocks                             |       | 3,797                    |       | 3,797               |       | 2,662 |   | 2,662 |   |
| Accrued interest  receivable                     |       | 1,519                    |       | 1,519               |       | 1,365 |   | 1,365 |   |
| **Financial  liabilities:**                      |       |                     |       |                |       |   |   |   |   |
| Deposits                                         |       | 286,647                  |       | 290,533             |       | 244,262 |   | 245,829 |   |
| Borrowed funds                                   |       | 48,188                   |       | 52,510              |       | 40,400 |   | 41,644 |   |
| Accrued interest  payable                        |       | 761                      |       | 761                 |       | 771 |   | 771 |   |
|                                                  |            |                          |            |                     |            |  |  |  |  |  |  |  |  |

 

This information should not be interpreted as anestimate of the fair value of the entire Corporation since a fair valuecalculation is only provided for a limited portion of the Corporation’s assetsand liabilities.  Due to a wide range ofvaluation techniques and the degree of subjectivity used in making theestimates, comparisons between the Corporation’s disclosures and those of othercompanies may not be meaningful.  Thefollowing methods and assumptions were used to estimate fair values of theCorporation’s financial instruments at December 31, 2008 and 2007:

 

Carrying amount is theestimated fair value for cash and cash equivalents, short-term borrowings,federal bank stocks, accrued interest receivable and payable, demand deposits,short-term debt, and variable rate loans or deposits that reprice frequentlyand fully.  For fixed rate loans ordeposits and for variable rate loans or deposits with infrequent repricing orrepricing limits, fair value is based on discounted cash flows using currentmarket rates applied to the estimated life and credit risk.  Fair value of debt is based on current ratesfor similar financing.  The fair value ofoff-balance sheet items is based on the current fees or cost that would becharged to enter into or terminate such arrangements and is not material.

 

F-32

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Tableof Contents

 

**Notes to Consolidated Financial Statements (*continued*)**

 

**17.      Fair Values of Financial Instruments(continued)**

 

#### ***Off-Balance Sheet FinancialInstruments***

#### ** **

The Corporation is partyto credit related financial instruments with off-balance sheet risk in thenormal course of business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and commercial letters of credit.  Commitments to extend credit involve, to avarying degree, elements of credit and interest rate risk in excess of amountsrecognized in the consolidated balance sheets. The Corporation’s exposure to credit loss in the event ofnon-performance by the other party for commitments to extend credit isrepresented by the contractual amount of these commitments, less any collateralvalue obtained.  The Corporation uses thesame credit policies in making commitments as for on-balance sheetinstruments.  The Corporation’sdistribution of commitments to extend credit approximates the distribution ofloans receivable outstanding.

 

The following tablepresents the notional amount of the Corporation’s off-balance sheet commitmentfinancial instruments as of December 31:

 
| ** **                                       | ** ** | **2008**            | ** ** | **2007**               | ** ** |
|--------------------------------------------------|------------|---------------------|------------|------------------------|------------|
| **(Dollar amounts in thousands)** | ** ** | **Fixed Rate** | ** ** | **Variable Rate** | ** ** | **Fixed Rate** | ** ** | **Variable Rate** | ** ** |
| Commitments to  make loans                       |       | $                   | 596        |                   | $          | 1,664 |   | $ | 1,054 |   | $ | 3,844 |   |
| Unused lines of  credit                          |       | 1,367               |       | 18,636                 |       | 182 |   | 25,611 |   |
|                                             |       | $                   | 1,963      |                   | $          | 20,300 |   | $ | 1,236 |   | $ | 29,455 |   |

 

Commitments to make loansare generally made for periods of 30 days or less.  The fixed rate loan commitments have interestrates ranging from 4.00% to 11.25% and maturities ranging from 5 to 30 years atboth year end dates.  Commitments toextend credit include agreements to lend to a customer as long as there is noviolation of any condition established in the contract.  These commitments generally have fixedexpiration dates or other termination clauses and may require payment of a fee.  Commitments to extend credit also includeunfunded commitments under commercial and consumer lines of credit, revolvingcredit lines and overdraft protection agreements.  These lines of credit may be collateralizedand usually do not contain a specified maturity date and may be drawn upon tothe total extent to which the Corporation is committed.

 

Standby letters of creditare conditional commitments issued by the Corporation usually for commercialcustomers to guarantee the performance of a customer to a third party.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loan facilitiesto customers.  The Corporation generallyholds collateral supporting those commitments if deemed necessary.  Standby letters of credit were $1.1 millionand $869,000 at December 31, 2008 and 2007, respectively.  The current amount of the liability as of December 31,2008 and 2007 for guarantees under standby letters of credit issued is notmaterial.

 

 

F-33

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Table of Contents

 

**Notes to Consolidated Financial Statements (*continued*)**

 

**18.****                   EmclaireFinancial Corp. – Condensed Financial Statements, Parent Corporation Only**

 

Following are condensedfinancial statements for the parent company as of and for the years ended December 31:

 
| **Condensed Balance Sheets**                      | ** ** | **December 31,**            | ** ** |
|-------------------------------------------------------------|------------|----------------------------------|------------|
| **(Dollar amounts in thousands)**            | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                                  |       |                             |       |   |   |
| **Assets:**                                                 |       |                             |       |   |   |
| Cash and cash  equivalents                                  |       | $                                | 68         |   | $ | 83 |   |
| Securities  available for sale                              |       | 3,138                            |       | 3,188 |   |
| Equity in net  assets of subsidiary bank                    |       | 34,222                           |       | 22,704 |   |
| Other assets                                                |       | 7                                |       | — |   |
| Total Assets                                                |       | $                                | 37,435     |   | $ | 25,975 |   |
| **Liabilities  and Stockholders’ Equity:**             |       |                             |       |   |   |
| Accrued expenses  and other liabilities                     |       | $                                | 1,312      |   | $ | 1,272 |   |
| Stockholders’  equity                                  |       | 36,123                           |       | 24,703 |   |
| Total  Liabilities and Stockholders’ Equity            |       | $                                | 37,435     |   | $ | 25,975 |   |
|                                                        |       |                             |       |   |   |
| **Condensed Statements of Income**                          | ** ** | **Year ended December 31,** | ** ** |
| **(Dollar amounts in thousands)**                           | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                                  |       |                             |       |   |   |
| **Income:**                                                 |       |                             |       |   |   |
| Dividends from  subsidiary                                  |       | $                                | 2,555      |   | $ | 2,159 |   |
| Investment  income                                          |       | 149                              |       | 312 |   |
| Total income                                                |       | 2,704                            |       | 2,471 |   |
| **Expense:**                                                |       |                             |       |   |   |
| Interest expense                                            |       | 68                               |       | 81 |   |
| Noninterest  expense                                        |       | 331                              |       | 201 |   |
| Total expense                                               |       | 399                              |       | 282 |   |
| Net income  before income taxes and equity in undistributed |       |                             |       |   |   |
| operating  results of subsidiary                            |       | 2,305                            |       | 2,189 |   |
| Equity in  undistributed net income of subsidiary           |       | 1,113                            |       | 501 |   |
| Net income  before income taxes and extraordinary item      |       | 3,418                            |       | 2,690 |   |
| Provision for  (benefit from) income taxes                  |       | (59                              | )          | (7 | ) |
| Net income  before extraordinary item                       |       | 3,477                            |       | 2,697 |   |
| Extrordinary  item, loss on business combination            |       | (1,047                           | )          | — |   |
| **Net  income**                                             |       | $                                | 2,430      |   | $ | 2,697 |   |

 

F-34

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Table of Contents

 

**Notes to Consolidated Financial Statements (*continued*)**

 

**18.****                   EmclaireFinancial Corp. – Condensed Financial Statements, Parent Corporation Only(continued)**

 
| **Condensed Statements of Cash Flows**                         | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(Dollar amounts in thousands)**                                   | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| ** **                                                                         |       |                                       |       |   |   |
| **Operating  activities:**                                                         |       |                                       |       |   |   |
| Net income                                                                         |       | $                                          | 2,430      |   | $ | 2,697 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                       |       |   |   |
| Equity in  undistributed operating results of subsidiary                           |       | (1,113                                     | )          | (501 | ) |
| Other, net                                                                         |       | 501                                        |       | (109 | ) |
| Net cash  provided by operating activities                                         |       | 1,818                                      |       | 2,087 |   |
| ** **                                                                         |       |                                       |       |   |   |
| **Investing  activities:**                                                         |       |                                       |       |   |   |
| Purchases of  securities                                                           |       | (129                                       | )          | (1,039 | ) |
| Proceeds from  the sale of available for sale securities                           |       | —                                     |       | 698 |   |
| Net cash used in  investing activities                                             |       | (129                                       | )          | (341 | ) |
| ** **                                                                         |       |                                       |       |   |   |
| **Financing  activities:**                                                         |       |                                       |       |   |   |
| Net change in  borrowings                                                          |       | —                                     |       | 250 |   |
| Dividends paid                                                                     |       | (1,704                                     | )          | (1,953 | ) |
| Net cash used in  financing activities                                             |       | (1,704                                     | )          | (1,703 | ) |
| Increase  (decrease) in cash and cash equivalents                                  |       | (15                                        | )          | 43 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 83                                         |       | 40 |   |
| Cash and cash  equivalents at end of period                                        |       | $                                          | 68         |   | $ | 83 |   |

 

**19.****                   OtherComprehensive Income (Loss)**

 

Othercomprehensive income (loss) components and related taxes were as follows:

 
| **(Dollar amounts in thousands)**                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                 |       |     |       |     |       |   |   |
| Unrealized  holding gains (losses) on available for sale securities  |       | $        | (11        | )        | $          | 142 |   |
| Reclassification  adjustment for (gains) losses recognized in income |       | 391      |       | (207     | )          |
| Amortization of  pension prior service cost                          |       | (30      | )          | (31      | )          |
| Amortization of  pension net actuarial gain (loss)                   |       | (1,368   | )          | 112      |       |
|                                                                 |       |     |       |     |       |
| Net unrealized  gains (losses)                                       |       | (1,018   | )          | 16       |       |
|                                                                 |       |     |       |     |       |
| Tax effect                                                           |       | 346      |       | (5       | )          |
|                                                                 |       |     |       |     |       |   |   |
| Other  comprehensive income (loss)                                   |       | $        | (672       | )        | $          | 11 |   |

 

F-35

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Table of Contents

 

**Notes to Consolidated Financial Statements (*continued*)**

 

**20****.****                   OtherNoninterest Income and Expense**

 

Other noninterest incomeincludes customer bank card processing fee income of $292,000 and $267,000 for2008 and 2007, respectively.

 

The following summarizesthe Corporation’s other noninterest expenses for the years ended December 31:

 
| **(Dollar amounts in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |   |   |
| Professional  fees                               |       | $        | 501        |     | $          | 497 |   |
| Contract  termination fee                        |       | 360      |       | —   |       |
| Customer bank  card processing                   |       | 256      |       | 263      |       |
| Printing and  supplies                           |       | 213      |       | 178      |       |
| Postage and  freight                             |       | 185      |       | 156      |       |
| Travel,  entertainment and conferences           |       | 176      |       | 178      |       |
| Correspondent  bank and courier fees             |       | 165      |       | 204      |       |
| Marketing and  advertising                       |       | 150      |       | 175      |       |
| Pennsylvania  shares and use taxes               |       | 147      |       | 152      |       |
| Contributions                                    |       | 140      |       | 133      |       |
| Telephone and  data communications               |       | 143      |       | 157      |       |
| Other                                            |       | 535      |       | 392      |       |
| **Total  other noninterest expenses**            |       | $        | 2,971      |     | $          | 2,485 |   |

 

F-36

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Table of Contents

 

**Notes to Consolidated Financial Statements (*continued*)**

 

**21.****                   QuarterlyFinancial Data (unaudited)**

 

The following is asummary of selected quarterly data for the years ended December 31:

 
| ** **                                                                         | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(Dollar amounts in thousands, except share data)** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| ** **                                                                         |       |        |       |        |       |        |       |        |       |
| **2008:**                                                                          |       |        |       |        |       |        |       |        |       |
| Interest income                                                                    |       | $           | 4,520      |        | $          | 4,563       |       | $           | 4,847      |   | $ | 5,163 |   |
| Interest expense                                                                   |       | 1,977       |       | 1,999       |       | 2,117       |       | 2,075       |       |
| Net interest  income                                                               |       | 2,543       |       | 2,564       |       | 2,730       |       | 3,088       |       |
| Provision for  loan losses                                                         |       | 60          |       | 85          |       | 140         |       | 215         |       |
| Net interest  income after provision for loan losses                               |       | 2,483       |       | 2,479       |       | 2,590       |       | 2,873       |       |
| Noninterest  income                                                                |       | 660         |       | 496         |       | 620         |       | 711         |       |
| Noninterest  expense                                                               |       | 2,413       |       | 2,293       |       | 2,296       |       | 4,030       |       |
| Income (loss)  before income taxes and extraordinary item                          |       | 730         |       | 682         |       | 914         |       | (446        | )          |
| Provision for  (benefit from) income taxes                                         |       | 171         |       | 141         |       | 198         |       | (154        | )          |
| Income (loss)  before extraordinary item                                           |       | 559         |       | 541         |       | 716         |       | (292        | )          |
| Extraordinary  item, gain on business combination                                  |       | —      |       | —      |       | —      |       | 906         |       |
|                                                                               |       |        |       |        |       |        |       |        |       |   |   |   |   |
| Net income                                                                         |       | $           | 559        |        | $          | 541         |       | $           | 716        |   | $ | 614 |   |
|                                                                               |       |        |       |        |       |        |       |        |       |   |   |   |   |
| Basic earnings  per common share                                                   |       | $           | 0.44       |        | $          | 0.43        |       | $           | 0.56       |   | $ | 0.43 |   |
| ** **                                                                         |       |        |       |        |       |        |       |        |       |
| **2007:**                                                                          |       |        |       |        |       |        |       |        |       |
| Interest income                                                                    |       | $           | 4,312      |        | $          | 4,416       |       | $           | 4,535      |   | $ | 4,592 |   |
| Interest expense                                                                   |       | 2,003       |       | 1,918       |       | 1,939       |       | 2,026       |       |
| Net interest  income                                                               |       | 2,309       |       | 2,498       |       | 2,596       |       | 2,566       |       |
| Provision for  loan losses                                                         |       | 45          |       | 30          |       | 45          |       | 136         |       |
| Net interest  income after provision for loan losses                               |       | 2,264       |       | 2,468       |       | 2,551       |       | 2,430       |       |
| Noninterest  income                                                                |       | 730         |       | 772         |       | 696         |       | 745         |       |
| Noninterest  expense                                                               |       | 2,310       |       | 2,336       |       | 2,255       |       | 2,263       |       |
| Income before  income taxes                                                        |       | 684         |       | 904         |       | 992         |       | 912         |       |
| Provision for  income taxes                                                        |       | 133         |       | 197         |       | 238         |       | 227         |       |
|                                                                               |       |        |       |        |       |        |       |        |       |   |   |   |   |
| Net income                                                                         |       | $           | 551        |        | $          | 707         |       | $           | 754        |   | $ | 685 |   |
|                                                                               |       |        |       |        |       |        |       |        |       |   |   |   |   |
| Basic earnings  per common share                                                   |       | $           | 0.43       |        | $          | 0.56        |       | $           | 0.59       |   | $ | 0.54 |   |

 

The increase innoninterest expense between the third and fourth quarters of 2008 was primarilyrelated to severance charges totaling $590,000 recorded in the fourth quarterof 2008, principally associated with the retirement of the Corporation’s formerChairman of the Board, President and Chief Executive Officer and contracttermination fees of $360,000 recognized in the fourth quarter of 2008 inconnection with an ATM processing conversion planned for 2009.

 

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