Edgar Filing: FIRST NATIONAL COMMUNITY BANCORP INC

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

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

For the transition period from to

Commission File No. 000-53869

FIRST NATIONAL COMMUNITY BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

Pennsylvania		23-2900790
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

102 E. Drinker St., Dunmore, PA		18512
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code (570) 346-7667

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO x

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

Large Accelerated Filer o		Accelerated Filer x

Non-Accelerated Filer o		Smaller reporting company o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

Common Stock, $1.25 par value		16,442,119 shares
(Title of Class)		(Outstanding at August 6, 2012)

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FIRST NATIONAL COMMUNITY BANCORP, INC.

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		Page No.

PART I FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Statements of Financial Condition as of September 30, 2011 and December 31, 2010 (unaudited)	4

	Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010 (unaudited)	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2011 and 2010 (unaudited)	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010 (unaudited)	7
	Notes to Consolidated Financial Statements	8
`
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	62

Item 4.	Controls and Procedures	62

PART II OTHER INFORMATION

Item 1.	Legal Proceedings	63

Item 1A.	Risk Factors	63

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	63

Item 3.	Defaults Upon Senior Securities	63

Item 4.	Mine Safety Disclosures	63

Item 5.	Other Information	63

Item 6.	Exhibits	64

Signatures		65

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PART I Financial Information

Item 1. Financial Statements.

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FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(unaudited)

	September 30,			December 31,
(in thousands, except share data)	2011			2010
Assets
Cash and cash equivalents:
Cash and due from banks	$	23,396		$	18,934
Interest-bearing deposits in other banks	150,249			55,571
Total cash and cash equivalents	173,645			74,505
Securities
Available-for-sale, at fair value	204,213			251,072
Held-to-maturity, at amortized cost (fair value $2,139 and $1,857)	2,068			1,994
Stock in Federal Home Loan Bank of Pittsburgh, at cost	8,841			10,311
Loans held for sale	1,969			3,557
Loans, net of allowance for loan and lease losses of $23,106 and $22,575	657,850			735,813
Bank premises and equipment, net	18,933			19,310
Accrued interest receivable	2,515			3,119
Refundable federal income taxes	12,445			12,409
Intangible assets	839			963
Bank-owned life insurance	26,577			25,982
Other real estate owned	7,830			9,633
Other assets	11,740			18,630
Total Assets	$	1,129,465		$	1,167,298

Liabilities
Deposits:
Demand	$	138,063		$	93,215
Interest-bearing demand	330,300			349,185
Savings	88,454			90,037
Time ($100,000 and over)	206,916			189,526
Other time	218,089			260,473
Total deposits	981,822			982,436
Borrowed funds:
FHLB advances	51,911			101,887
Subordinated debentures	25,000			25,000
Junior subordinated debentures	10,310			10,310
Other debt	188			407
Total borrowed funds	87,409			137,604
Accrued interest payable	3,776			2,763
Other liabilities	17,524			12,440
Total liabilities	1,090,531			1,135,243

Shareholders’ Equity
Common Shares ($1.25 par)
Authorized: 50,000,000 shares as of September 30, 2011 and December 31, 2010
Issued and outstanding: 16,441,319 shares as of September 30, 2011 and 16,433,020 shares as of December 31, 2010	20,551			20,541
Additional paid-in capital	61,556			61,539
Accumulated deficit	(38,653		)	(37,882		)
Accumulated other comprehensive loss
Unrealized holding gain (loss) on available-for-sale securities, net of taxes	526			(6,174		)
Unrealized non-credit holding loss on OTTI available-for-sale securities, net	(5,046		)	(5,969		)
Total accumulated other comprehensive loss, net of taxes	(4,520		)	(12,143		)
Total shareholders’ equity	38,934			32,055
Total Liabilities and Shareholders’ Equity	$	1,129,465		$	1,167,298

The accompanying notes to consolidated financial statements are an integral part of these statements.

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FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In thousands, except share data)	2011			2010			2011			2010
Interest income
Interest and fees on loans	$	8,360		$	10,830		$	26,396		$	34,447
Interest and dividends on securities
U.S. Treasury and government agencies	743			1,282			2,492			4,079
State and political subdivisions, tax-free	1,262			1,383			4,078			4,187
State and political subdivisions, taxable	12			13			38			45
Other securities	72			10			174			240
Total interest and dividends on securities	2,089			2,688			6,782			8,551
Interest on federal funds sold	34			44			96			111
Total interest income	10,483			13,562			33,274			43,109
Interest expense
Deposits
Interest-bearing demand	232			825			1,383			2,720
Savings	60			132			242			396
Time ($100,000 and over)	375			838			1,737			2,672
Other time	1,253			1,638			3,661			5,343
Total interest on deposits	1,920			3,433			7,023			11,131
Interest on borrowed funds
Interest on FHLB advances	513			1,298			2,179			4,097
Interest on subordinated debentures	575			575			1,706			1,682
Interest on junior subordinated debentures	51			57			153			158
Interest on other debt	—			1			—			1
Total interest on borrowed funds	1,139			1,931			4,038			5,938
Total interest expense	3,059			5,364			11,061			17,069
Net interest income before provision for loan and lease losses	7,424			8,198			22,213			26,040
Provision (credit) for loan and lease losses	(462		)	7,311			2,047			16,993
Net interest income after provision (credit) for loan and lease losses	7,886			887			20,166			9,047
Non-interest income (loss)
Service charges	803			890			2,313			2,503
Net gain (loss) on the sale of securities	926			(2,869		)	3,228			(1,694		)
Gross other-than-temporary impairment (“OTTI”) gains (losses)	639			(45		)	430			(973		)
Portion of (gain) loss recognized in OCI (before taxes)	(639		)	(1,158		)	(779		)	(3,133		)
Other-than-temporary-impairment losses recognized in earnings	—			(1,203		)	(349		)	(4,106		)
Net gain on the sale of loans held for sale	142			440			440			843
Net (loss) gain on the sale of other real estate owned	(31		)	44			2,536			92
Net (loss) gain on the sale of other assets	—			(88		)	20			(60		)
Bank owned life insurance income	200			198			595			581
Other	300			411			996			1,162
Total non-interest income (loss)	2,340			(2,177		)	9,779			(679		)
Non-interest expense
Salaries and employee benefits	3,563			3,375			10,418			9,712
Occupancy expense	765			582			2,263			1,746
Equipment expense	436			423			1,230			1,309
Advertising expense	142			129			485			462
Data processing expense	519			535			1,538			1,517
FDIC assessment	714			989			2,090			1,960
Bank shares tax	275			255			827			765
Expense of other real estate	1,333			2,185			2,021			3,490
Provision for off-balance sheet commitments	(61		)	(200		)	(252		)	(171		)
Legal expense	837			292			2,238			573
Professional fees	868			368			4,313			868
Insurance expense	260			239			457			239
Other operating expenses	1,009			1,367			3,088			3,752
Total non-interest expense	10,660			10,539			30,716			26,222
Loss before income taxes	(434		)	(11,829		)	(771		)	(17,854		)
Provision for income taxes	—			—			—			—
Net loss	$	(434	)	$	(11,829	)	$	(771	)	$	(17,854	)

Loss Per Share
Basic	$	(0.03	)	$	(0.72	)	$	(0.05	)	$	(1.09	)
Diluted	$	(0.03	)	$	(0.72	)	$	(0.05	)	$	(1.09	)

Cash Dividends Declared Per Common Share	$	—		$	—		$	—		$	—
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING:
Basic	16,441,319			16,383,848			16,438,781			16,328,598
Diluted	16,441,319			16,383,848			16,438,781			16,328,598

The accompanying notes to consolidated financial statements are an integral part of these statements.

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FIRST NATIONAL COMMUNITY BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2011 and 2010 (in thousands)

(Unaudited)

									Accumulated
	Number			Additional					Other			Total
	of Common	Common		Paid-in		Accumulated			Comprehensive			Shareholders’
	Shares	Stock		Capital		Deficit			Loss			Equity
BALANCES, DECEMBER 31, 2009	16,289,970	$	20,362	$	61,190	$	(6,162	)	$	(12,306	)	$	63,084
Net loss for the period	—					(17,854		)				(17,854		)
Other comprehensive income (loss), net of tax:
Net change in unrealized gains and losses on securities available for sale (AFS), net of tax of $828									1,607
Non-credit related losses on OTTI securities not expected to be sold, net of tax benefit of $3,858									3,697
Reclassification adjustment for losses included in net loss, net of tax of $1,972									3,828
Other comprehensive income									9,132			9,132
Total comprehensive loss												(8,722		)
Proceeds from issuance of common shares through dividend reinvestment plan	138,281	173		340								513
Balances, September 30, 2010	16,428,251	$	20,535	$	61,530	$	(24,016	)	$	(3,174	)	$	54,875

BALANCES, DECEMBER 31, 2010	16,433,020	$	20,541	$	61,539	$	(37,882	)	$	(12,143	)	$	32,055
Net loss for the period						(771		)				(771		)
Other comprehensive income, net of tax:
Net change in unrealized gains and losses on securities available for sale (AFS), net of tax of $4,641									9,009
Non-credit related gains on OTTI securities not expected to be sold, net of tax benefit of $265									514
Reclassification adjustment for gains in net loss, net of tax of $979									(1,900		)
Other comprehensive income									7,623			7,623
Total comprehensive income												6,852
Proceeds from issuance of common shares through dividend reinvestment plan	8,299	10		17								27
Balances, September 30, 2011	16,441,319	$	20,551	$	61,556	$	(38,653	)	$	(4,520	)	$	38,934

The accompanying notes to consolidated financial statements are an integral part of these statements.

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FIRST NATIONAL COMMUNITY BANCORP, INC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine months ended September 30,
(In Thousands)	2011			2010
Cash Flows from Operating Activities:
Net Loss	$	(771	)	$	(17,854	)
Reconciliation of Net Loss to Net Cash Provided by Operating Activities:
Investment securities accretion, net	(931		)	(2,053		)
Equity in trust	(3		)	(1		)
Depreciation and amortization	1,163			1,258
Provision for loan and lease losses	2,047			16,993
Provision for off balance sheet commitments	(252		)	(171		)
(Gain) loss on sale of investment securities	(3,228		)	1,694
Other-than temporary impairment losses	349			4,106
Gain on the sale of loans held for sale	(440		)	(843		)
Loss on sale of other assets	—			88
Gain on the sale of other real estate owned	(2,536		)	(92		)
Write-down of other real estate owned	1,134			2,533
Gain on sale of bank premises and equipment	(20		)	(28		)
Bank owned life insurance income	(595		)	(581		)
Proceeds from the sale of loans held for sale	19,494			29,859
Funds used to originate loans held for sale	(17,466		)	(29,007		)
Increase (decrease) in interest payable	1,013			(371		)
Decrease in other liabilities	(154		)	(569		)
Decrease in interest receivable	604			902
Increase (decrease) in refundable federal income taxes	(36		)	3,324
Decrease in prepaid expenses and other assets	6,890			2,242
Net Cash Provided by Operating Activities	6,262			11,429

Cash Flows from Investing Activities:
Investment Securities :
Proceeds from maturities, calls and principal payments	22,142			32,741
Proceeds from sales	50,624			36,620
Purchases	(5,133		)	(86,302		)
Purchases of Federal Reserve Bank stock	—			(336		)
Redemption of FHLB stock	1,470			—
Net decrease in loans to customers	68,617			112,041
Proceeds from the sale of other real estate owned	6,544			3,340
Purchases of bank premises and equipment	(636		)	(925		)
Proceeds from the sale of other assets	32			97
Net Cash Provided by Investing Activities	143,660			97,276

Cash Flows from Financing Activities:
Net increase in demand deposits, money market demand, interest-bearing demand accounts, and savings accounts	24,380			42,721
Net decrease in time deposits	(24,994		)	(60,568		)
Proceeds from issuance of subordinated debentures	—			1,900
Proceeds from FHLB advances	112,362			121,048
Repayment of FHLB advances	(162,338		)	(153,973		)
Repayment of other borrowed funds	(219		)	(29		)
Proceeds from issuance of common shares - dividend reinvestment plan	27			513
Net Cash Used in Financing Activities	(50,782		)	(48,388		)

Net increase in Cash and Cash Equivalents	99,140			60,317
Cash & Cash Equivalents at beginning of period	74,505			86,364
Cash & Cash Equivalents at end of period	$	173,645		$	146,681

Supplemental Cash Flow Information
Cash paid during the period for:
Interest	$	10,048		$	17,440
Other transactions:
Securities purchased but not settled	5,489			—
Principal balance of loans transferred to OREO	3,339			5,782
Transfer from loans held for sale to other assets	947			—
Transfer from other assets to loans	—			1,905
Transfer from loans held for sale to loans	1,969			—

The accompanying notes to consolidated financial statements are an integral part of these statements.

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FIRST NATIONAL COMMUNITY BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Notes to Consolidated Financial Statements

Note 1. Basis of Presentation

The consolidated financial statements of the Company include the accounts of First National Community Bancorp, Inc. and its wholly-owned subsidiary, First National Community Bank (the “Bank”), as well as the Bank’s wholly-owned subsidiaries (collectively, the “Company”). All inter-company transactions and balances have been eliminated. The accounting and reporting policies of the Company conform to U.S. Generally Accepted Accounting Principles (“GAAP”) and general practices within the financial services industry. In the opinion of management, all adjustments necessary to a fair statement of the results for the quarterly period ended September 30, 2011 have been included.

In preparing the consolidated financial statements, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of financial condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to change are the allowance for loan and lease losses (“ALLL”), security valuations, the evaluation of deferred income taxes, and the impairment of securities. The current economic environment has increased the degree of uncertainty inherent in these material estimates.

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s December 31, 2010 audited financial statements filed on Form 10-K and the Company’s March 31, 2011 and June 30, 2011 unaudited financial statements filed on Form 10-Q.

Note 2. New Authoritative Accounting Guidance

In January 2010, the FASB issued an update (Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements). The update provides clarification regarding existing disclosures and requires additional disclosures regarding fair value measurements. Specifically, the guidance now requires reporting entities to disclose the amounts of significant transfers between levels and the reasons for the transfers. In addition, the reconciliation should present separate information about purchases, sales, issuances and settlements. A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value. The new standard is effective for reporting periods beginning after December 15, 2009 except for disclosures about purchases, sales, issuances and settlements which are not effective until reporting periods beginning after December 15, 2010. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements. The disclosures required by this update are included in Note 7 to the consolidated financial statements.

In July 2010, the FASB issued an update (Accounting Standards Update No. 2010-20, Receivables, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses). This update expands the disclosures that an entity must provide about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate, by portfolio segment or class, certain existing disclosures, and to provide certain new disclosures about its financing receivables and related allowances for credit losses. The disclosures as of the end of a reporting period were effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period were effective for interim and annual reporting periods beginning on or after December 15, 2010. The amendment does not require comparative disclosures for earlier reporting periods that ended before adoption; however, an entity should provide comparative disclosures for those reporting periods after initial adoption. The adoption of this amendment did not have a material effect on the Company’s consolidated financial statements. The disclusures required by this update are included in Note 4 to the consolidated financial statements.

In January 2011, the FASB issued an update (Accounting Standards Update No. 2011-01, Receivables) which temporarily delayed the effective date of the disclosures about trouble debt restructurings in Update 2010-20 for public entities. The delay was intended to allow the Board time to complete its deliberations on what constitutes a trouble debt restructuring. The effective date of the new disclosures about troubled debt restructurings and the guidance for determining what constitutes a troubled debt restructuring was effective for interim and annual periods ending after June 15, 2011.

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In April 2011, the FASB issued an update (Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring) which clarifies when creditors should classify loan modifications as troubled debt restructurings. The new guidance was effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. A provision in Update 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by Update 2010-20. The Company elected to adopt Update 2011-02 in the quarter ending March 31, 2011. The adoption of this update did not have a material impact on the Company’s consolidated financial statements.

Accounting Guidance to be Adopted In Future Periods

In May 2011, the FASB issued an update (Accounting Standards Update 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS). This update results in common fair value measurement and disclosure requirements among U.S. GAAP and International Financial Reporting Standards. The amendments in Update 2011-04 include clarifications about the application of existing fair value measurement requirements and changes to principles for measuring fair value. This update also requires additional disclosures about fair value measurements, is required to be applied prospectively, and is effective for interim and annual periods beginning after December 15, 2011. The Company is currently evaluating the impact of adoption of Update 2011-04 on the Company’s consolidated financial statements.

In June 2011, the FASB issued an update (Accounting Standards Update 2011-05, Presentation of Comprehensive Income). This update was issued to improve the comparability, consistency and transparency of financial reporting. The amendment provides the entity an option to present the total of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments do not change the items that must be reported in other comprehensive income. Update 2011-05 is required to be applied retrospectively and is effective for interim and annual periods beginning after December 15, 2011. Update 2011-05 is an update only for presentation and as such will not impact the Company’s consolidated financial statements.

In December 2011, the FASB issued an update (Accounting Standards Update No. 2011-11, Disclosures about Offsetting Assets and Liabilities). The objective of this update is to provide enhanced disclosures that will enable users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. This includes the effect or potential effect of rights of setoff associated with an entity’s recognized assets and recognized liabilities within the scope of this update. The amendments require enhanced disclosures by requiring expanded information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with either Section 210-20-45 or Section 815-10-45. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented.

In December 2011, the FASB issued ASU No. 2011-12 - Comprehensive Income (Topic 220) — “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU No. 2011-05.” This update defers only those changes in ASU No. 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this update supersede certain pending paragraphs in ASU No. 2011-05. All other requirements in ASU No. 2011-05 are not affected by this update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.

Reclassification of Prior Year Financial Statements

Certain reclassifications have been made to the prior year’s consolidated financial statements to conform to the current year’s presentation. Such reclassifications had no impact on results of operations.

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Note 3. Regulatory Matters

The Bank is under a Consent Order (the “Order”) from the Office of the Comptroller of the Currency (“OCC”) dated September 1, 2010. The Company is also subject to a written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”) dated November 24, 2010.

OCC Consent Order. The Bank, pursuant to a Stipulation and Consent to the Issuance of a Consent Order dated September 1, 2010 without admitting or denying any wrongdoing, consented and agreed to the issuance of the Order by the OCC, the Bank’s primary regulator. The Order requires the Bank to undertake certain actions within designated timeframes, and to operate in compliance with the provisions thereof during its term. The Order is based on the results of an examination of the Bank as of March 31, 2009. Since the examination, management has engaged in discussions with the OCC and has taken steps to improve the condition, policies and procedures of the Bank. Compliance with the Order is to be monitored by a committee (the “Committee”) of at least three directors, none of whom is an employee or controlling shareholder of the Bank or its affiliates or a family member of any such person. The Committee is required to submit written progress reports on a monthly basis and the Agreement requires the Bank to make periodic reports and filings with the OCC. The members of the Committee are John P. Moses, Joseph Coccia, Joseph J. Gentile and Thomas J. Melone. The material provisions of the Order are as follows:

(i) By October 31, 2010, the Board of Directors of the Bank (the “Board”) is required to adopt and implement a three-year strategic plan which must be submitted to the OCC for review and prior determination of no supervisory objection; the strategic plan must establish objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital adequacy, reduction in the volume of nonperforming assets, product line development, and market segments that the Bank intends to promote or develop, and is to include strategies to achieve those objectives; if the strategic plan involves the sale or merger of the Bank, it must address the timeline and steps to be followed to provide for a definitive agreement within 90 days after the receipt of a determination of no supervisory objection;

(ii) by October 31, 2010, the Board is required to adopt and implement a three year capital plan, which must be submitted to the OCC for review and prior determination of no supervisory objection;

(iii) by November 30, 2010, the Bank is required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets;

(iv) the Bank may not pay any dividend or capital distribution unless it is in compliance with the higher capital requirements required by the Order, the Capital Plan, applicable legal requirements and, then only after receiving a determination of no supervisory objection from the OCC;

(v) by November 15, 2010, the Committee must review the Board and the Board’s committee structure; by November 30, 2010, the Board must prepare or cause to be prepared an assessment of the capabilities of the Bank’s executive officers to perform their past and current duties, including those required to respond to the most recent examination report, and to perform annual performance appraisals of each officer;

(vi) by October 31, 2010, the Board must adopt, implement and thereafter ensure compliance with a comprehensive conflict of interest policy applicable to the Bank’s and the Company’s directors, executive officers, principal shareholders and their affiliates and such person’s immediate family members and their related interests, employees, and by November 30, 2010, conduct a review of existing relationships with such persons to identify those, if any, not in compliance with the policy; and review all subsequent proposed transactions with such persons or modifications of transactions;

(vii) by October 31, 2010, the Board must develop, implement and ensure adherence to policies and procedures for Bank Secrecy Act (“BSA”) compliance; and account opening and monitoring procedures compliance;

(viii) by October 31, 2010, the Board must ensure the BSA audit function is supported by an adequately staffed department or third party firm; adopt, implement and ensure compliance with an independent BSA audit; and assess the capabilities of the BSA officer and supporting staff to perform present and anticipated duties;

(ix) by October 31, 2010, the Board is required to adopt, implement and ensure adherence to a written credit policy, including specified features, to improve the Bank’s loan portfolio management;

(x) the Board is required to take certain actions to resolve certain credit and collateral exceptions;

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(xi) by October 31, 2010, the Board is required to establish an effective, independent and ongoing loan review system to review, at least quarterly, the Bank’s loan and lease portfolios to assure the timely identification and categorization of problem credits; by October 31, 2010, to adopt and adhere to a program for the maintenance of an adequate ALLL, and to review the adequacy of the Bank’s ALLL at least quarterly;

(xii) by October 31, 2010, the Board must adopt and the Bank implement and adhere to a program to protect the Bank’s interest in criticized assets; and the Bank may only extend additional credit (including renewals) to a borrower whose loans are criticized under specified circumstances;

(xiii) by October 31, 2010, the Board must adopt and ensure adherence to action plans for each piece of other real estate owned;

(xiv) by November 30, 2010, the Board is required to develop, implement and ensure adherence to a policy for effective monitoring and management of concentrations of credit;

(xv) by October 31, 2010, the Board must revise and implement the Bank’s other than temporary impairment policy;

(xvi) by October 31, 2010, the Board must take action to maintain adequate sources of stable funding and liquidity and a contingency funding plan; by October 31, 2010, the Board is required to adopt, implement and ensure compliance with an independent, internal audit program; and

(xvii) take actions to correct cited violations of law; and adopt procedures to prevent future violations and address compliance management.

Federal Reserve Agreement. On November 24, 2010, the Company entered into a written Agreement (the “Agreement”) with the Federal Reserve Bank of Philadelphia (the “Reserve Bank”). The Agreement requires the Company to undertake certain actions within designated timeframes, and to operate in compliance with the provisions thereof during its term. The material provisions of the Agreement include the following:

(i) the Company’s Board must take appropriate steps to fully utilize the Company’s financial and managerial resources to serve as a source of strength to the Bank, including taking steps to ensure that the Bank complies with its Consent Order entered into with the OCC;

(ii) the Company may not declare or pay any dividends without the prior written approval of the Reserve Bank and the Director of the Division of Banking Supervision and Regulation (the “Director”) of the Federal Reserve Board;

(iii) the Company may not take dividends or other payments representing a reduction of the Bank’s capital without the prior written approval of the Reserve Bank;

(iv) the Company and its nonbank subsidiary may not make any payment of interest, principal or other amounts on the Company’s subordinated debentures or trust preferred securities without the prior written approval of the Reserve Bank and the Director;

(v) the Company may not make any payment of interest, principal or other amounts on debt owed to insiders of the Company without the prior written approval of the Reserve Bank and Director;

(vi) the Company and its nonbank subsidiary may not incur, increase or guarantee any debt without the prior written approval of the Reserve Bank;

(vii) the Company may not purchase or redeem any shares of its stock without the prior written approval of the Reserve Bank;

(viii) the Company must submit to the Reserve Bank, by January 23, 2011, an acceptable written plan to maintain sufficient capital at the Company on a consolidated basis. Thereafter, the Company must notify the Reserve Bank within 45 days of the end of any quarter in which the Company’s capital ratios fall below the approved capital plan’s minimum ratios, and submit an acceptable written plan to increase the Company’s capital ratios above the capital plan’s minimums;

(ix) the Company must immediately take all actions necessary to ensure that: (1) each regulatory report accurately reflects the Company’s condition on the date for which it is filed and all material transactions between the Company and its subsidiaries; (2) each such report is prepared in accordance with its instructions; and (3) all records indicating how the report was prepared are maintained for supervisory review;

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(x) the Company must submit to the Reserve Bank, by January 23, 2011, acceptable written procedures to strengthen and maintain internal controls to ensure all required regulatory reports and notices filed with the Board of Governors are accurate and filed in accordance with the instructions for preparation;

(xi) the Company must submit to the Reserve Bank, by January 8, 2011, a cash flow projection for 2011, reflecting the Company’s planned sources and uses of cash, and submit a cash flow projection for each subsequent calendar year at least one month prior to the beginning of such year;

(xii) the Company must comply with: (1) the notice provisions of Section 32 of the FDI Act and Subpart H of Regulation Y in appointing any new director or senior executive officer or changing the duties of any senior executive officer; and (2) the restrictions on indemnification and severance payments of Section 18(k) of the FDI Act and Part 359 of the FDIC’s regulations; and

(xiii) the Board must submit written progress reports within 30 days of the end of each calendar quarter.

The Order and Agreement have not and are not expected to have an impact on the Company’s ability to attract and maintain deposits or the Company’s cost of funds. In order to meet the increased capital requirements imposed under the Order and the Agreement, however, unless the Company is able to raise additional capital, the Company could be limited in the aggregate amount of loans it can have outstanding, which may constrain loan growth. While it is not anticipated that the Order and the Agreement will have an immediate impact on the Company’s net interest margin, the overall cost of compliance with the Order and the Agreement will continue to impact profitability at least through the end of 2012.

Banking regulations also limit the amount of dividends that may be paid without prior approval of the Bank’s regulatory agency. As of August 10, 2012, the Company and the Bank are restricted from paying any dividends, without regulatory approval.

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

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).

In accordance with the Order, the Bank is required to achieve and thereafter maintain a total risk-based capital equal to at least 13% of risk-weighted assets and a Tier 1 capital equal to at least 9% of adjusted total assets. At September 30, 2011, the Bank did not meet these requirements. The minimum capital requirements under the Order take precedence over the standard regulatory capital adequacy definitions described in the tables below. The Company’s and the Bank’s actual capital positions and ratios at September 30, 2011 and December 31, 2010 are presented in the following table:

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FIRST NATIONAL COMMUNITY BANCORP, INC.

CAPITAL ANALYSIS

(in thousands)	September 30, 2011		December 31, 2010

Company
Tier I Capital:
Total Tier I Capital	$	52,581	$	53,297
Tier II Capital:
Subordinated notes	25,000		25,000
Allowable portion of allowance for loan losses	9,875		11,201
Total Tier II Capital	34,875		36,201
Total Risk-Based Capital	87,456		89,498
Total Risk Weighted Assets	$	776,178	$	883,887

Bank
Tier I Capital:
Total Tier I Capital	$	76,804	$	75,659
Tier II Capital:
Allowable portion of allowance for loan losses	9,870		11,197
Total Tier II Capital	9,870		11,197
Total Risk-Based Capital	86,674		86,856
Total Risk Weighted Assets	$	775,824	$	883,535

									To Be Well
									Capitalized
									Under Prompt
					For Capital				Corrective
(in thousands)	Actual				Adequacy Purposes				Action Provision
At September 30, 2011	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital (to Risk Weighted Assets)
Company	$	87,456	11.27	%	$	>62,094	>8.00	%	N/A		N/A
Bank	$	86,674	11.17	%	$	>62,066	>8.00	%	$	>77,582	>10.00	%
Tier I Capital (to Risk Weighted Assets)
Company	$	52,581	6.77	%	$	>31,047	>4.00	%	N/A		N/A
Bank	$	76,804	9.90	%	$	>31,033	>4.00	%	$	>46,549	>6.00	%

Tier I Capital (to Average Assets)
Company	$	52,581	4.78	%	$	>44,029	>4.00	%	N/A		N/A
Bank	$	76,804	6.98	%	$	>44,015	>4.00	%	$	>55,019	>5.00	%

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									To Be Well
									Capitalized
									Under Prompt
					For Capital				Corrective
(in thousands)	Actual				Adequacy Purposes				Action Provision
At December 31, 2010	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total Capital (to Risk Weighted Assets)
Company	$	89,499	10.13	%	$	>70,711	>8.00	%	N/A		N/A
Bank	$	86,856	9.83	%	$	>70,683	>8.00	%	$	>88,354	>10.00	%
Tier I Capital (to Risk Weighted Assets)
Company	$	53,297	6.03	%	$	>35,535	>4.00	%	N/A		N/A
Bank	$	75,659	8.56	%	$	>35,341	>4.00	%	$	>53,012	>6.00	%

Tier I Capital (to Average Assets)
Company	$	53,297	4.27	%	$	>49,964	>4.00	%	N/A		N/A
Bank	$	75,659	6.06	%	$	>49,950	>4.00	%	$	>62,438	>5.00	%

Note 4. Loans

Loans receivable, net, consists of the following at September 30, 2011 and December 31, 2010:

(in thousands)	September 30, 2011			December 31, 2010
Residential real estate	$	82,074		$	87,925
Commercial real estate	256,559			256,327
Construction, land acquisition and development	36,058			77,395
Commercial and industrial loans	177,082			197,697
Consumer loans	109,471			110,853
State and political subdivisions	19,340			27,739
Total loans, gross	680,584			757,936
Unearned discount	(174		)	(332		)
Net deferred loan fees and costs	546			784
Allowance for loan and lease losses	(23,106		)	(22,575		)
Loans, net	$	657,850		$	735,813

The Company has granted loans, letters of credit and lines of credit to certain executive officers and directors of the Company as well as to certain related parties of executive officers and directors. See Note 9 to these consolidated financial statements for more information about related party transactions.

The Company originates one-to-four family mortgage loans primarily for sale in the secondary market. During the three and nine months ended September 30, 2011, the Company sold $3.9 million and $19.2 million, respectively, of one-to-four family mortgages. The Company retains servicing rights on these mortgages.

The Company had $2.0 million and $3.6 million in loans held-for-sale at September 30, 2011 and December 31, 2010, respectively. All loans held for sale are one-to-four family residential mortgage loans.

The Company does not have any lending programs commonly referred to as subprime lending. Subprime lending generally targets borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios.

See Note 2 to the Company’s consolidated financial statements included in the 2010 Form 10-K for the risk characteristics related to the Company’s loan segments.

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The Company provides for loan losses based on the consistent application of its documented ALLL methodology. Loan losses are charged to the ALLL and recoveries are credited to it. Additions to the ALLL are provided by charges against income based on various factors which, in management’s judgment, deserve current recognition of estimated probable losses. Loan losses are charged-off in the period the loans, or portions thereof, are deemed uncollectible. Generally, the Company will record a loan charge-off (including a partial charge-off) to reduce a loan to the estimated recoverable amount based on its methodology detailed below. The Company regularly reviews the loan portfolio and makes adjustments for loan losses in order to maintain the ALLL in accordance with U.S. GAAP. The ALLL consists primarily of the following two components:

(1) Specific allowances are established for impaired loans (defined by the Company as all loans with an outstanding balance greater than $100,000 rated doubtful or substandard and on non-accrual status and all TDRs). The amount of impairment provided for as an allowance is represented by the deficiency, if any, between the carrying value of the loan and either (a) the present value of expected future cash flows discounted at the loan’s effective interest rate, (b) the loan’s observable market price, or (c) the fair value of the underlying collateral, less estimated costs to sell, for collateral dependent loans. Impaired loans that have no impairment losses are not considered for general valuation allowances described below. If the Company determines that collection of the impairment amount is remote, the Company will record a charge-off.

(2) General allowances are established for loan losses on a portfolio basis for loans that do not meet the definition of impaired. The Company divides its portfolio into loan segments, with loans exhibiting similar characteristics. These segments are further disaggregated into classes. Loans rated special mention or substandard and accruing that are embedded in these loan segments are then separated from them. These separated loans are then subject to an analysis placing increased emphasis on the credit risk associated with these specific loans. The Company applies an estimated loss rate to each loan group. The loss rates applied are primarily based on the Company’s own historical loss experience based on the loss rate for each group of loans with similar risk characteristics in its portfolio. In addition management evaluates and applies certain qualitative or environmental factors that are likely to cause estimated credit losses associated with the Company’s existing portfolio that may differ from historical experience, which are discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be significantly more than the ALLL that is established, which could have a material negative effect on the Company’s financial results.

In underwriting a loan secured by real property (unless exempt based on legal requirements), the Company requires an appraisal of the property by an independent licensed appraiser approved by the Company’s board of directors. The appraisal is either reviewed internally or by an independent third party hired by the Company. Generally, management obtains updated appraisals when a loan is deemed impaired. These appraisals may be more limited than those prepared for the underwriting of a new loan. In addition, when the Company acquires OREO upon foreclosure, it generally obtains a current appraisal to substantiate the net carrying value of the asset.

Management makes adjustments for loan losses based on its evaluation of several qualitative and environmental factors, including but not limited to:

· Changes in national, local, and business economic conditions and developments, including the condition of various market segments;

· Changes in the nature and volume of the Company’s loan portfolio;

· Changes in the Company’s lending policies and procedures, including underwriting standards, collection, charge-off and recovery practices and results;

· Changes in the experience, ability and depth of the Company’s lending management and staff;

· Changes in the quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors;

· Changes in the trend of the volume and severity of past due and classified loans, including trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications;

· The existence and effect of any concentrations of credit and changes in the level of such concentrations;

· The effect of external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the Company’s current loan portfolio; and

· Analysis of its customers’ credit quality.

Management evaluates the ALLL based on the combined total of the impaired and general components. Generally, when the loan portfolio increases, absent other factors, the Company’s ALLL methodology results in a higher dollar amount of estimated probable

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losses. Conversely, when the loan portfolio decreases, absent other factors, the Company’s ALLL methodology results in a lower dollar amount of estimated probable losses.

Each quarter, management evaluates the ALLL and adjusts the ALLL as appropriate through a provision for loan losses. While the Company uses the best information available to make evaluations, future adjustments to the ALLL may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of its examination process, the Office of the Comptroller of the Currency periodically reviews the Company’s ALLL. The OCC may require the Company to adjust the ALLL based on its analysis of information available to it at the time of its examination.

The following tables set forth activity in the ALLL, by loan type, for the three and nine months ended September 30, 2011:

	Real Estate									Commercial & Industrial					Consumer
(in thousands)	Residential Real Esate			Commercial Real Estate			Construction, Land Acquisition and Development			Solid Waste Landfills		Other			Indirect Auto			Installment/ HELOC			State and Political Subdivisions			Total
Three Months Ended September 30, 2011:
Allowance for loan losses:

Beginning Balance, June 30, 2011	$	2,238		$	11,586		$	3,663		$	16	$	4,675		$	565		$	607		$	351		$	23,701
Charge-offs	(871		)	(252		)	(171		)	—		(52		)	(128		)	(99		)	—			(1,573		)
Recoveries	20			14			1,236			—		72			94			4			—			1,440
Provisions	574			685			(1,687		)	—		(332		)	149			211			(62		)	(462		)
Ending Balance, September 30, 2011	$	1,961		$	12,033		$	3,041		$	16	$	4,363		$	680		$	723		$	289		$	23,106

Nine Months Ended September 30, 2011:
Allowance for loan losses:

Beginning Balance, January 1, 2011	$	2,176		$	9,640		$	4,170		$	11	$	4,839		$	597		$	576		$	566		$	22,575
Charge-offs	(1,152		)	(2,085		)	(177		)	—		(176		)	(360		)	(204		)	—			(4,154		)
Recoveries	34			38			2,059			—		319			183			5			—			2,638
Provisions	903			4,440			(3,011		)	5		(619		)	260			346			(277		)	2,047
Ending Balance, September 30, 2011	$	1,961		$	12,033		$	3,041		$	16	$	4,363		$	680		$	723		$	289		$	23,106

Changes in the ALLL for the periods indicated are as follows:

	Three months ended				Nine months ended
	September 30,				September 30,
	2011		2010		2011		2010
	(In thousands)
Balance, beginning of period	23,701		27,378		22,575		22,458
Charge offs	(1,573	)	(9,320	)	(4,154	)	(14,185	)
Recoveries	1,440		254		2,638		357
Provisions / (credit)	(462	)	7,311		2,047		16,993
Balance, end of period	23,106		25,623		23,106		25,623

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The following tables represent the allocation of the allowance for loan losses and the related loan by loan portfolio segment disaggregated based on the impairment methodology at September 30, 2011 and December 31, 2010:

	Real Estate						Commercial & Industrial				Consumer
(in thousands)	Residential Real Esate		Commercial Real Estate		Construction, Land Acquisition and Development		Solid Waste Landfills		Other		Indirect Auto		Installment/ HELOC		State and Political Subdivisions		Total
September 30, 2011
Allowance for loan losses:
Individually evaluated for impairment	$	91	$	529	$	430	$	—	$	2	$	—	$	—	$	—	$	1,052
Collectively evaluated for impairment	1,870		11,504		2,611		16		4,361		680		723		289		22,054
Total	$	1,961	$	12,033	$	3,041	$	16	$	4,363	$	680	$	723	$	289	$	23,106

Loans receivable:
individually evaluated for impairment	$	2,448	$	12,777	$	4,675	$	—	$	4,733	$	—	$	31	$	—	$	24,664
collectively evaluated for impairment	79,626		243,782		31,383		42,270		130,079		62,367		47,073		19,340		655,920
Total	$	82,074	$	256,559	$	36,058	$	42,270	$	134,812	$	62,367	$	47,104	$	19,340	$	680,584

December 31, 2010
Allowance for loan losses:
Individually evaluated for impairment	$	785	$	372	$	310	$	—	$	339	$	—	$	—	$	—	$	1,806
Collectively evaluated for impairment	1,391		9,268		3,860		11		4,500		597		576		566		20,769
Total	$	2,176	$	9,640	$	4,170	$	11	$	4,839	$	597	$	576	$	566	$	22,575

Loans receivable:
individually evaluated for impairment	$	2,926	$	9,477	$	11,365	$	—	$	6,029	$	—	$	132	$	—	$	29,929
collectively evaluated for impairment	84,999		246,850		66,030		52,270		139,398		63,509		47,212		27,739		728,007
Total	$	87,925	$	256,327	$	77,395	$	52,270	$	145,427	$	63,509	$	47,344	$	27,739	$	757,936

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Credit Quality Indicators — Commercial Loans

The Company continuously monitors the credit quality of its commercial loan receivables. Credit quality is monitored by reviewing certain credit quality indicators. Management has determined that internally assigned credit risk ratings by loan type are the key credit quality indicators that best help management monitor the credit quality of the Company’s loan receivables.

The Bank’s commercial loan classification and credit grading processes are part of the lending, underwriting, and credit administration functions to ensure an ongoing assessment of credit quality. Accurate and timely loan classification or credit grading is a critical component of loan portfolio management. Loan officers are required to review their loan portfolio risk ratings regularly for accuracy. The loan review function uses the same risk rating system in the loan review process. This allows an independent third party to assess the quality of the portfolio and compare the accuracy of ratings with the loan officer’s and management’s assessment.

A formal loan classification and credit grading system reflects the risk of default and credit losses. The Company maintains a written description of the risk ratings that includes a discussion of the factors used to assign appropriate classifications of credit grades to loans. The process identifies groups of loans that warrant the special attention of management. The risk grade groupings provide a mechanism to identify risk within the loan portfolio and provide management and the Board with periodic reports by risk category. The credit risk ratings play an important role in the establishment and evaluation of ALLL. After determining the historical loss factor which is adjusted for qualitative and environmental factors for each portfolio segment, segment balances collectively evaluated for impairment are multiplied by the general reserve loss factor for the respective portfolio segments in order to determine the general reserve. Loans that have an internal credit rating of special mention or substandard follow the same process; however, the qualitative and environmental factors are further adjusted for the increased risk.

The Company utilizes a loan rating system that assigns a degree of risk to commercial loans based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. Management analyzes these non-homogeneous loans individually grading the loans as to credit risk and probability of collection for each type of class. Commercial loans include commercial indirect auto loans which are not individually risk rated. These loans are monitored on a pool basis due to their homogeneous nature as described in “Credit Quality Indicators — Other Loans” below. The grading system contains the following basic risk categories:

1. Minimal Risk

2. Above Average Credit Quality

3. Average Risk

4. Acceptable Risk

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5. Pass - Watch

6. Special Mention

7. Substandard - Accruing

8. Substandard - Non-Accrual

9. Doubtful

10. Loss

This analysis is performed on a quarterly basis using the following definitions for risk ratings:

Pass - Assets rated 1 through 5 are considered pass ratings. These assets show no current or potential problems and are considered fully collectible. All such loans are considered collectively for ALLL calculation purposes.

Special Mention — Assets classified as special mention do not currently expose the Company to a sufficient degree of risk to warrant an adverse classification but do possess credit deficiencies or potential weaknesses deserving close attention. Special Mention assets have a potential weakness or pose an unwarranted financial risk which, if not corrected, could weaken the asset and increase risk in the future.

Substandard - Assets classified as substandard have well defined weaknesses based on objective evidence and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful - Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable based on current circumstances.

Loss - Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets is not warranted.

The following table details the recorded investment in loans receivable by the aforementioned class of loan and credit quality indicator at September 30, 2011 and December 31, 2010:

	Real Estate						Commercial & Industrial
September 30, 2011 (in thousands)	Residential Real Esate		Commercial Real Estate		Construction, Land Acquisition and Development		Solid Waste Landfills		Other		Installment / HELCO		State and Political Subdivisions		Total
Internal Risk Rating
Pass	$	22,721	$	199,210	$	16,179	$	42,270	$	119,903	$	2,932	$	19,340	$	422,555
Special Mention	305		12,666		225		—		3,049		289		—		16,534
Substandard	2,244		44,683		16,049		—		5,974		175		—		69,125
Doubtful	—		—		—		—		—		—		—		—
Loss	—		—		—		—		—		—		—		—
Total Loans Receivable	$	25,270	$	256,559	$	32,453	$	42,270	$	128,926	$	3,396	$	19,340	$	508,214

	Real Estate						Commercial & Industrial
December 31, 2010 (in thousands)	Residential Real Esate		Commercial Real Estate		Construction, Land Acquisition and Development		Solid Waste Landfills		Other		State and Political Subdivisions		Total
Internal Risk Rating
Pass	$	24,854	$	200,847	$	46,657	$	52,270	$	123,848	$	17,481	$	465,957
Special Mention	1,633		18,455		14,001		—		6,061		10,258		62,208
Substandard	1,308		35,100		10,199		—		7,951		—		42,758
Doubtful	—		1,925		2,611		—		—		—		4,536
Loss	—		—		—		—		—		—		—
Total Loans Receivable	$	27,795	$	256,327	$	73,468	$	52,270	$	137,860	$	27,739	$	575,459

Credit Quality Indicators — Other Loans

Residential, consumer and commercial and consumer indirect auto loans are monitored on a pool basis due to their homogeneous nature. Loans that are delinquent 90 days or more are considered non-accrual. The Company utilizes accruing versus non-accruing status as the credit quality indicator for these loan pools. The following table presents the recorded investment in residential, consumer and indirect auto loans based on payment activity at September 30, 2011 and December 31, 2010.

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	September 30, 2011						December 31, 2010
	Performing		Non-accrual				Performing		Non-accrual
(in thousands)	Loans		Loans		Total		Loans		Loans		Total
Construction, Land Acquisition and Development - Residential	$	3,605	$	—	$	3,605	$	3,927	$	—	$	3,927
Residential Real Estate	54,703		2,101		56,804		57,665		2,465		60,130
Indirect Auto - Consumer	62,353		14		62,367		63,493		16		63,509
Indirect Auto - Commercial	5,886		—		5,886		7,445		—		7,445
Installment/HELOC	43,585		123		43,708		47,245		221		47,466
Total	$	170,132	$	2,238	$	172,370	$	179,775	$	2,702	$	182,477

Included in loans receivable are loans for which the accrual of interest income has been discontinued due to deterioration in the financial condition of the borrowers. The recorded investment in these non-accrual loans was $20.7 million and $28.3 million at September 30, 2011 and December 31, 2010, respectively. Generally, loans are placed on non-accruing status when they become 90 days or more delinquent, and remain on non-accrual status until they are brought current, have six months of performance under the loan terms and factors indicating reasonable doubt about the timely collection of payments no longer exist. Therefore, loans may be current in accordance with their loan terms, or may be fewer than 90 days delinquent and still be on a non-accruing status. Loans past due 90 days or more and still accruing interest were $29 thousand and $99 thousand at September 30, 2011 and December 31, 2010, respectively, and consisted of loans that are well secured and are in the process of renewal.

The following tables set forth the detail, and delinquency status, of past due and non-accrual loans at September 30, 2011 and December 31, 2010:

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	September 30, 2011
	Performing (Accruing) Loans
(in thousands)	0-29 Days Past Due		30-59 Days Past Due		60-89 Days Past Due		>/= 90 Days Past Due		Total Performing Loans
Real Estate
Residential Real Estate	$	77,925	$	640	$	496	$	—	$	79,061
Commercial Real Estate	246,126		1,136		624		29		247,915
Construction, Land Acquisition and Development	32,070		—		—		—		32,070
Total Real Estate	356,121		1,776		1,120		29		359,046

Commercial and Industrial
Solid Waste Landfills	42,270		—		—		—		42,270
Other	128,702		1,069		171		—		129,942
Total Commercial and Industrial	170,972		1,069		171		—		172,212

Consumer
Indirect Auto	61,601		648		104		—		62,353
Installment/HELOC	45,984		777		207		—		46,968
Total Consumer	107,585		1,425		311		—		109,321

State and Political Subdivisions	19,340		—		—		—		19,340

Totals	$	654,018	$	4,270	$	1,602	$	29	$	659,919

	Non-Accruing Loans
	0-29 Days Past Due		30-59 Days Past Due		60-89 Days Past Due		>/= 90 Days Past Due		Total
Real Estate
Residential Real Estate	$	1,110	$	314	$	53	$	1,536	$	3,013
Commercial Real Estate	58		—		107		8,479		8,644
Construction, Land Acquisition and Development	—		470		—		3,518		3,988
Total Real Estate	1,168		784		160		13,533		15,645

Commercial and Industrial
Solid Waste Landfills	—		—		—		—		—
Other	4,467		108		63		232		4,870
Total Commercial and Industrial	4,467		108		63		232		4,870

Consumer
Indirect Auto	—		—		14		—		14
Installment/HELOC	—		13		—		123		136
Total Consumer	—		13		14		123		150

State and Political Subdivisions	—		—		—		—		—

Total Non-accruing loans	$	5,635	$	905	$	237	$	13,888	$	20,665

Total loans receivable	$	659,653	$	5,175	$	1,839	$	13,917	$	680,584

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	December 31, 2010 Performing (Accruing) Loans
(in thousands)	0-29 Days Past Due		30-59 Days Past Due		60-89 Days Past Due		>/= 90 Days Past Due		Total Performing Loans
Real Estate
Residential Real Estate	$	83,371	$	1,095	$	465	$	—	$	84,931
Commercial Real Estate	247,217		949		85		—		248,251
Construction, Land Acquisition and Development	65,785		285		231		99		66,400
Total Real Estate	396,373		2,329		781		99		399,582

Commercial and Industrial
Solid Waste Landfills	52,270		—		—		—		52,270
Other	138,743		567		153		—		139,463
Total Commercial and Industrial	191,013		567		153		—		191,733

Consumer
Indirect Auto	62,269		959		264		—		63,492
Installment/HELOC	47,000		112		11		—		47,123
Total Consumer	109,269		1,071		275		—		110,615

State and Political Subdivisions	27,739		—		—		—		27,739
Totals	$	724,394	$	3,967	$	1,209	$	99	$	729,669

	Non-Accruing Loans
	0-29 Days Past Due		30-59 Days Past Due		60-89 Days Past Due		>/= 90 Days Past Due		Total
Real Estate
Residential Real Estate	$	1,256	$	327	$	240	$	1,171	$	2,994
Commercial Real Estate	3,173		—		200		4,703		8,076
Construction, Land Acquisition and Development	—		—		—		10,995		10,995
Total Real Estate	4,429		327		440		16,869		22,065

Commercial and Industrial
Solid Waste Landfills	—		—		—		—		—
Other	5,319		—		—		645		5,964
Total Commercial and Industrial	5,319		—		—		645		5,964

Consumer
Indirect Auto	—		—		12		5		17
Installment/HELOC	—		—		31		190		221
Total Consumer	—		—		43		195		238

State and Political Subdivisions	—		—		—		—		—

Total Non-accruing loans	$	9,748	$	327	$	483	$	17,709	$	28,267

Total loans receivable	$	734,142	$	4,294	$	1,692	$	17,808	$	757,936

The total recorded investment in impaired loans, which consists of non-accrual loans greater than $100,000 and performing TDRs, amounted to $24.7 million and $29.9 million at September 30, 2011 and December 31, 2010, respectively. The related allowance on impaired loans was $1.1 million and $1.8 million at September 30, 2011 and December 31, 2010, respectively.

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The following tables provide an analysis of our impaired loans at September 30, 2011 and December 31, 2010:

September 30, 2011

(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With No Allowance Recorded:
Residential Real Estate	$	1,524	$	1,823	$	—
Commercial Real Estate	525		529		—
Construction, Land Acquisition and Development	925		925		—
Total Real Estate	2,974		3,277		—

Commercial and Industrial
Solid Waste Landfills	—		—		—
Other	4,609		4,937		—
Total Commercial and Industrial	4,609		4,937		—

Consumer
Indirect Auto	—		—		—
Installment/HELOC	31		35		—
Total Consumer	31		35		—

State and Political Subdivisions	—		—		—
Total With No Allowance Recorded	$	7,614	$	8,249	$	—

With a Related Allowance Recorded:
Residential Real Estate	$	924	$	1,575	$	91
Commercial Real Estate	12,252		14,145		529
Construction, Land Acquisition and Development	3,750		5,448		430
Total Real Estate	16,926		21,168		1,050

Commercial and Industrial
Solid Waste Landfills	—		—		—
Other	124		124		2
Total Commercial and Industrial	124		124		2

Consumer
Indirect Auto	—		—		—
Installment/HELOC	—		—		—
Total Consumer	—		—		—

State and Political Subdivisions	—		—		—
Total with Related Allowance	$	17,050	$	21,292	$	1,052

							Average Balance		Interest Income (2)
Total
Residential Real Estate	$	2,448	$	3,398	$	91	$	2,860	$	4
Commercial Real Estate	12,777		14,674		529		12,628		113
Construction, Land Acquisition and Development	4,675		6,373		430		7,263		26
Total Real Estate	19,900		24,445		1,050		22,751		143

Commercial and Industrial
Solid Waste Landfills
Other	4,733		5,061		2		5,228		9
Total Commercial and Industrial	4,733		5,061		2		5,228		9

Consumer
Indirect Auto
Installment/HELOC	31		35		—		105		—
Total Consumer	31		35		—		105		—

State and Political Subdivisions

Total Impaired Loans (1)	$	24,664	$	29,541	$	1,052	$	28,084	$	152

(1) Non-accrual loans with outstanding balances of less than $100,000 are not considered for individual impairment evaluation and are accordingly not included in the table above. However, these loans are evaluated collectively as homogenous pools in the general allowance calculation under ASC Topic 310. Total non-accrual loans with individual balances of less than $100 thousand equaled $1.5 million at September 30, 2011.

(2) Interest income represents income recognized on performing TDRs.

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December 31, 2010

(in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance
With No Allowance Recorded:
Residential Real Estate	$	1,530	$	1,780	$	—
Commercial Real Estate	4,839		5,693		—
Construction, Land Acquisition and Development	7,936		19,921		—
Total Real Estate	14,305		27,394		—

Commercial and Industrial
Solid Waste Landfills	—		—		—
Other	5,368		5,368		—
Total Commercial and Industrial	5,368		5,368		—

Consumer
Indirect Auto	—		—		—
Installment/HELOC	132		134		—
Total Consumer	132		134		—

State and Political Subdivisions	—		—		—
Total With No Allowance Recorded	$	19,805	$	32,896	$	—

With a Related Allowance Recorded:
Residential Real Estate	$	1,396	$	1,455	$	785
Commercial Real Estate	4,638		12,115		372
Construction, Land Acquisition and Development	3,429		5,077		310
Total Real Estate	9,463		18,647		1,467

Commercial and Industrial
Solid Waste Landfills	—		—		—
Other	661		932		339
Total Commercial and Industrial	661		932		339

Consumer
Indirect Auto	—		—		—
Installment/HELOC	—		—		—
Total Consumer	—		—		—

State and Political Subdivisions	—		—		—
Total with Related Allowance	$	10,124	$	19,579	$	1,806


Total
Residential Real Estate	$	2,926	$	3,235	$	785
Commercial Real Estate	9,477		17,808		372
Construction, Land Acquisition and Development	11,365		24,998		310
Total Real Estate	23,768		46,041		1,467

Commercial and Industrial
Solid Waste Landfills	—		—		—
Other	6,029		6,300		339
Total Commercial and Industrial	6,029		6,300		339

Consumer
Indirect Auto	—		—		—
Installment/HELOC	132		134		—
Total Consumer	132		134		—

State and Political Subdivisions	—		—		—
Total Impaired Loans (1)	$	29,929	$	52,475	$	1,806

The Company recorded $583 thousand of interest income on impaired loans for the nine months ended September 30, 2010. The average recorded balance of impaired loans for the nine months ended September 30, 2010 was $43.2 million. The additional interest income that would have been earned on non-accrual and restructured loans in accordance with their original terms approximated $684 thousand and $1.4 million for the three and nine months ended September 30, 2011, respectively, and $800 thousand and $2.1 million for the three and nine months ended September 31, 2010, respectively.

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Troubled Debt Restructured Loans

Effective January 1, 2011, the Company adopted the provisions of Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. As such, the Company reassessed all loan modifications occurring since January 1, 2011 for identification as TDRs, resulting in no newly identified TDRs.

The book balance of TDRs at September 30, 2011 and December 31, 2010 was $11.1 million and $5.8 million, respectively. The balances at September 30, 2011 included approximately $5.6 million of TDRs on non-accrual status and $5.5 million of TDRs in accrual status compared to $3.3 million of TDRs on non-accrual status and $2.5 million of TDRs on accrual status at December 31, 2010. Approximately $185 thousand and $34 thousand in specific reserves have been established for these loans as of September 30, 2011 and December 31, 2010, respectively.

The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan, an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan. Non-accruing restructured loans remain on non-accrual status until there has been a period of sustained repayment performance for a reasonable period, usually six months. In some instances, where the Company modifies a loan that is delinquent but not on non-accrual status, the restructured loan remains on accrual status provided the repayment performance remains in accordance with the modified terms.

The following tables show the pre- and post- modification recorded investment in loans modified as TDRs by portfolio segment and class of financing receivable during the three and nine months ended September 30, 2011:

	Three Months Ended September 30, 2011					Nine Months Ended September 30, 2011
(In thousands)	Number of Contracts	Pre- Modification Outstanding Recorded Investments		Post- Modification Outstanding Recorded Investments		Number of Contracts	Pre- Modification Outstanding Recorded Investments		Post- Modification Outstanding Recorded Investments
Troubled Debt Restructuring
Residential Real Estate	1	$	124	$	124	3	$	317	$	197
Commercial and Industrial	1	4,681		4,681		1	4,681		4,681
Construction, Land Acquisition & Development	1	470		470		6	1,373		1,373
Total New Troubled Debt Restructuring	3	$	5,275	$	5,275	10	$	6,371	$	6,251

The TDRs described above, for the three and nine months ended September 30, 2011, increased the allowance for loan losses by $122 thousand through the allocation of a specific reserve and resulted in charge-offs of $0 and $120 thousand for the three and nine months ended September 30, 2011.

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The following table shows the types of modifications made during the three and nine months ended September 30, 2011:

	Three months ended September 30, 2011								Nine months ended September 30, 2011
(In thousands)	Residential Real Estate		Commercial and Industrial		Contruction Land Acquisition & Development		Total		Residential Real Estate		Commercial and Industrial		Contruction Land Acquisition & Development		Total
Type of modification
Extension of Term	$	124	$	4,681	$	470	$	5,275	$	142	$	4,681	$	1,373	$	6,196
Extension of Term and Principal Forgiveness	—		—		—		—		55		—		—		55
Total TDRs	$	124	$	4,681	$	470	$	5,275	$	197	$	4,681	$	1,373	$	6,251

The following table summarizes TDRs which have re-defaulted (defined as past due 90 days) during the three and nine months ended September 30, 2011 that were restructured within the twelve months prior to such re-default:

	Three Months Ended September 30, 2011			Nine Months Ended June 30, 2011
(In thousands)	Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment

Commercial Real Estate	—	$	—	1	$	145
Commercial and Industrial	1	90		1	90
Total	1	$	90	2	$	235

Note 5. Other Real Estate Owned

The following table reflects the components of other real estate owned as of September 30, 2011 and December 31, 2010:

	September 30,		December 31,
(in thousands)	2011		2010

Land/Lots	$	5,551	$	8,357
Commercial Real Estate	2,101		1,086
Residential Real Estate	178		190
Total	$	7,830	$	9,633

The following table reflects the activity in OREO for the nine months ended September 30, 2011 and 2010:

	September 30,
(in thousands)	2011			2010

Balance, beginning of year	$	9,633		$	11,184
Additions	3,339			5,782
Write-downs	(1,134		)	(2,533		)
Carrying value of OREO sold	(4,008		)	(3,248		)
Balance, end of period	$	7,830		$	11,185

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The following table details the components of net expense of OREO for the nine months ended September 30, 2011 and 2010:

	Nine Months Ended September 30,
(in thousands)	2011		2010
Insurance	$	25	$	50
Legal fees	114		88
Maintenance	39		214
Losses from the operation of foreclosed properties	11		566
Professional Fees	184		10
Real estate taxes	481		142
Utilities	32		14
Other	1		(127		)
Impairment charges	1,134		2,533
Total	$	2,021	$	3,490

Note 6. Securities

Securities have been classified in the consolidated financial statements according to management’s intent. The amortized cost, gross unrealized gains and losses, and the fair value of the Company’s available-for-sale securities at September 30, 2011 and at December 31, 2010 are as follows:

September 30, 2011 (in thousands)	Amortized cost		Gross unrealized holding gains		Gross unrealized holding losses		Fair value
Obligations of U.S. government agencies	$	7,935	$	189	$	—	$	8,124
Obligations of state and political subdivisions	101,448		3,009		4,844		99,613
Collateralized mortgage obligations:
Government sponsored agency	62,998		1,875		14		64,859
Private Label	5,150		—		80		5,070
Residential mortgage-backed securities:
Government sponsored agency	20,894		769		—		21,663
Pooled Trust Preferred Senior Class	3,869		—		2,416		1,453
Pooled Trust Preferred Mezzanine Class	7,257		—		5,230		2,027
Corporate debt securities	500		—		105		395
Equity securities	1,010		—		1		1,009
Total available-for-sale securities	$	211,061	$	5,842	$	12,690	$	204,213

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December 31, 2010 (in thousands)	Amortized cost		Gross unrealized holding gains		Gross unrealized holding losses		Fair value
Obligations of U.S. government agencies	$	8,068	$	239	$	—	$	8,307
Obligations of state and political subdivisions	121,157		723		10,527		111,353
Collateralized mortgage obligations:
Government sponsored agency	77,172		1,057		413		77,816
Residential mortgage-backed securities:
Government sponsored agency	49,450		557		887		49,120
Pooled Trust Preferred Senior Class	3,863		—		2,441		1,422
Pooled Trust Preferred Mezzanine Class	8,250		—		6,603		1,647
Corporate debt securities	500		—		105		395
Equity securities	1,010		2		—		1,012
Total available-for-sale securities	$	269,470	$	2,578	$	20,976	$	251,072

The amortized cost, gross unrealized gains or losses, and the fair value of the Company’s securities held-to-maturity at September 30, 2011 and December 31, 2010 are as follows:

September 30, 2011 (in thousands)	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses		Fair Value
Obligations of state and political subdivisions	$	2,068	$	71	$	—	$	2,139

December 31, 2010 (in thousands)	Amortized Cost		Gross Unrealized Holding Gains		Gross Unrealized Holding Losses		Fair Value
Obligations of state and political subdivisions	$	1,994	$	—	$	137	$	1,857

At September 30, 2011 and December 31, 2010, securities with a carrying amount of $199.7 million and $220.4 million, respectively, were pledged as collateral to secure public deposits and for other purposes.

The following table shows the approximate fair value of the Company’s debt securities at September 30, 2011 using contractual maturities. Expected maturities will differ from contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Because mortgage-backed securities are not due at a single maturity date, they are not included in the maturity categories in the following maturity summary.

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	Available-for-sale				Held-to-maturity
(in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Amounts maturing in:
One Year or Less	$	—	$	—	$	—	$	—
One Year through Five Years	2,395		2,334		—		—
After Five Years through Ten Years	9,643		9,964		2,068		2,139
After Ten Years	108,971		99,314		—		—
Collateralized mortgage obligations	68,148		69,929		—
Mortgage-backed securities	20,894		21,663		—		—
Total	$	210,051	$	203,204	$	2,068	$	2,139

Gross proceeds from the sale of securities for the three months ended September 30, 2011 and 2010 were $34.5 million and $11.1 million, respectively, with the gross realized gains being $926 thousand and $0 thousand, respectively, and gross realized losses being $0 million and $2.9 million, respectively.

Gross proceeds from the sale of securities for the nine months ended September 30, 2011 and 2010 were $50.6 million and $36.6 million, respectively, with the gross realized gains being $3.2 million and $1.2 million, respectively, and gross realized losses being $0 million and $2.9 million, respectively.

The table below indicates the length of time that individual securities held-to-maturity and available-for-sale have been in a continuous unrealized loss position at September 30, 2011 and December 31, 2010:

	Less than 12 Months				12 Months or Greater				Total
September 30, 2011 (in thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of U.S. government agencies	$	—	$	—	$	—	$	—	$	—	$	—
Obligations of state and political subdivisions	5,557		397		28,732		4,447		34,289		4,844
Collateralized mortgage obligations
Government sponsored agency	1,214		14		—		—		1,214		14
Private label	5,069		80		—		—		5,069		80
Residential mortgage-backed securities
Government sponsored agency	—		—		—		—		—		—
Pooled Trust Preferred Senior Class	—		—		1,453		2,416		1,453		2,416
Pooled Trust Preferred Mezzanine Class	—		—		2,027		5,230		2,027		5,230
Corporate debt securities	—		—		395		105		395		105
Equity Securities	999		1		—		—		999		1
	$	12,839	$	492	$	32,607	$	12,198	$	45,446	$	12,690

	Less than 12 Months				12 Months or Greater				Total
December 31, 2010 (in thousands)	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
Obligations of U.S. government agencies	$	—	$	—	$	—	$	—	$	—	$	—
Obligations of state and political subdivisions	56,751		3,199		23,425		7,465		80,176		10,664
Collateralized mortgage obligations
Government sponsored agency	19,763		413		—		—		19,763		413
Residential mortgage-backed securities	—		—		—		—		—		—
Government sponsored agency	32,957		887		—		—		32,957		887
Pooled Trust Preferred Senior Class	—		—		1,422		2,441		1,422		2,441
Pooled Trust Preferred Mezzanine Class	—		—		1,647		6,603		1,647		6,603
Corporate debt securities	—		—		395		105		395		105
Total	$	109,471	$	4,499	$	26,889	$	16,614	$	136,360	$	21,113

At September 30, 2011, excluding pooled trust preferred securities (“PreTSLs”), 106 of the Company’s debt securities holdings having unrealized losses have depreciated 10.7% from their amortized cost basis. These securities are guaranteed by either the U.S. Government, government sponsored agencies, other governments or corporations, and all are considered investment grade. Seventy-five percent (75%) of the Company’s investment in obligations of state and political subdivisions are also guaranteed by underlying

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insurance which further secures the safety of principal. These unrealized losses relate principally to current interest rates for similar types of securities. The Company does not intend to sell these securities and does not anticipate that it will be required to sell these securities before the full recovery of principal and interest due, which may be at maturity. Therefore, the Company did not consider the carrying value of these securities to be other-than-temporarily impaired (“OTTI”) at September 30, 2011.

At September 30, 2011, all four of the Company’s PreTSLs having realized cumulative OTTI losses of $8.2 million and unrealized losses of $7.6 million have depreciated 69% and 83% from their current amortized cost and face values, respectively.

On a quarterly basis, management evaluates the Company’s investment securities for OTTI. Unrealized losses on securities are considered to be other-than-temporarily-impaired when management believes the security’s impairment is due to factors that could include the issuer’s inability to pay interest or dividends, its potential for default, and/or other factors. When a held-to-maturity or available-for-sale debt security is assessed for OTTI, management must first consider (a) whether management intends to sell the security and (b) whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. If one of these circumstances applies to a security, an OTTI loss is recognized in the statement of operations equal to the full amount of the decline in fair value below amortized cost. If neither of these circumstances applies to a security, but the Company does not expect to recover the entire amortized cost basis, an OTTI loss has occurred that must be separated into two categories: (a) the amount related to credit loss and (b) the amount related to other factors (such as market risk). In assessing the level of OTTI attributable to credit loss, management compares the present value of cash flows expected to be collected with the amortized cost basis of the security. As discussed previously, the portion of the total OTTI related to credit loss is recognized in earnings, while the amount related to other factors is recognized in other comprehensive income. The total OTTI loss is presented in the statement of operations, less the portion recognized in other comprehensive income. When a debt security becomes other-than-temporarily impaired, its amortized cost basis is reduced to reflect the portion of the total impairment related to credit loss.

To determine whether a security’s impairment is other-than-temporary, management considers factors that include:

· the causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility;

· the severity and duration of the decline;

· the Company’s ability and intent to hold equity security investments until they recover in value, as well as the likelihood of such a recovery in the near term;

· the Company’s intent to sell security investments, or if it is more likely than not that the Company will be required to sell such securities before recovery of their individual amortized cost basis less any current period credit loss.

For debt securities, that the Company does not intend to sell, or will not be required to sell, the primary consideration in determining whether impairment is other-than-temporary is whether or not the Company expects to receive all contractual cash flows.

Based on management’s evaluation at September 30, 2011, the Company has determined that the decreases in estimated fair value are temporary with the exception of four PreTSLs. The Company’s estimate of projected discounted cash flows it expects to receive was less than the securities’ carrying value resulting in a credit-related impairment charge to earnings, for the nine months ended September 30, 2011 of $349 thousand.

OTTI of Pooled Trust Preferred Collateralized Debt Obligations:

At September 30, 2011, the amortized cost of the Company’s PreTSLs totaled $11.1 million with an estimated fair value of $3.5 million and were comprised of four securities each of which is collateralized by debt issued by bank holding companies and insurance companies. The Company holds one senior tranche and three mezzanine tranches and all possess credit ratings below investment grade. During 2010, all of the pooled issues were downgraded further by either Moody’s or Fitch. At the time of initial issue, no more than 5% of any pooled security consisted of a security issued by any one institution. At September 30, 2011, three of these securities had no excess subordination and one had excess subordination which was 11.5% of the current performing collateral. Excess subordination is the amount by which the underlying performing collateral exceeds the outstanding bonds in the current class plus all senior classes. It can also be referred to as credit enhancement. As deferrals and defaults of underlying issuers occur, the excess subordination is reduced or eliminated, increasing the risk of the security experiencing principal or interest shortfalls. Conversely, subordination can be increased as collateral transitions from non-performing to performing. The coverage ratio, or overcollateralization, of a specific security measures the rate of performing collateral to a given class of notes. It is calculated by dividing the performing collateral in a transaction by the current balance of the class of notes plus all classes senior to that class. The following table presents information about the Company’s collateral and subordination for its PreTSLs at September 30, 2011:

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Security	Performing Collateral		Bonds Outstanding		Excess/ (Insufficient) Collateral			Coverage Ratio		Excess Subordination		Current Number of Performing Issuers	Actual Deferrals / Defaults as a % of Current Collateral		Expected Future Default Rate
(in thousands)
PreTSL IX	$	303,520	$	322,983	$	(19,463	)	93.97	%	N/A		35	31.0	%	1.61	%
PreTSL XI	401,465		441,612		(40,147		)	90.91	%	N/A		44	30.0	%	1.86	%
PreTSL XIX	507,281		538,861		(31,580		)	94.14	%	N/A		51	27.5	%	1.89	%
PreTSL XXVI	691,700		620,367		71,333			111.50	%	11.50	%	55	28.3	%	1.31	%

The following list details information for each of the Company’s PreTSLs at September 30, 2011:

Security	Class	Amortized Cost		Fair Value		Unrealized Gain/Loss			Moody’s / Fitch Ratings	Credit Impairment Quarter to Date		Credit Impairment Year to Date		Cumulative Credit Impairment
(in thousands)
PreTSL IX	Mezzanine	$	1,320	$	444	$	(876	)	Ca/C	$	—	$	—	$	1,680
PreTSL XI	Mezzanine	1,574		543		(1,031		)	Ca/C	—		—		3,426
PreTSL XIX	Mezzanine	4,363		1,039		(3,324		)	Ca/CC	—		349		2,813
PreTSL XXVI	Senior	3,869		1,454		(2,415		)	B1/CCC	—		—		251
Total		$	11,126	$	3,480	$	(7,646	)		$	—	$	349	$	8,170

The Company’s PreTSLs are measured for OTTI by determining whether an adverse change in estimated cash flows has occurred. The Company uses a third-party service provider to perform this analysis. Determining whether there has been an adverse change in estimated cash flows from the cash flows previously projected involves comparing the present value of remaining cash flows previously projected against the present value of the cash flows estimated at September 30, 2011. The Company considers the discounted cash flow analysis to be our primary evidence when determining whether credit related OTTI exists.

Results of a discounted cash flow test are significantly affected by variables such as the estimate of the probability of default, discount rates, prepayment rates and the creditworthiness of the underlying issuers. The following provides additional information for each of these variables:

· Probability of Default — An issuer level approach is used to analyze each security and default and recovery assumptions are based on the credit quality of the underlying issuers (generally, bank holding companies or insurance companies). Each bank issuer is evaluated based upon an examination of the trends in its earnings, net interest margin, operating efficiency, liquidity, capital position, level of nonperforming loans to total loans, apparent sufficiency of loan loss reserves, Texas ratio and whether the bank received TARP monies. From this information, each issuer bank that is currently performing is assigned a category of Good, Average, Weak, or Troubled. Default rates are then assigned based upon the historical performance of each category. Additionally, because the information available to the Company regarding the underlying insurance company issuers is more limited than for bank issuers, rather than performing an analysis of each issuer’s results and assigning insurance company issuers to these same categories, the Company uses the Moody’s one year long-term default rate assumption for insurance companies. The historical default rates used in this analysis are:

Default Rate

Category	Year 1		Year 2		Year 3		Thereafter
Good	0.50	%	0.60	%	0.60	%	0.40	%
Average	1.80	%	2.30	%	2.30	%	1.50	%
Insurance	1.00	%	1.20	%	1.20	%	0.80	%
Weak	5.80	%	7.20	%	7.20	%	4.80	%
Troubled	9.70	%	12.20	%	12.20	%	8.10	%

Each issuer in the collateral pool is assigned a probability of default for each year until maturity. Banks currently in default or deferring interest payments thus far are assumed to default immediately. A zero percent projected recovery rate is applied to defaults and deferrals. The probability of default is updated quarterly based upon changes in the creditworthiness of each underlying issuer. Timing of defaults and deferrals has a substantial impact on each valuation. As a result of this analysis, each issuer is assigned an expected default rate specific to that issuer.

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· Estimates of Future Cash Flows — While understanding the composition and characteristics of each bank issuer is important in evaluating the security, certain issuers have a disproportionate impact (both positive and negative) based upon other attributes, such as the interest rate payable by each issuer. Each credit is assessed independently, and the timing and nature of each issuer’s performance is assessed. Once assessed, the expected performance of each issuer is applied to a structural cash flow model. Due to the complexity of these transactions, the expected performance of each unique issuer requires an adherence to the governing documents of the securitization to derive a cash flow. A model produced by a third party is utilized to assist in determining cash flows. Utilization of third party cash flow modeling to derive cash flows from assumptions is a market convention for these types of securities.

· Discount Rate — The Company is discounting projected cash flows based upon its discount margin defined at the time of purchase, which constitutes a spread over 3-month LIBOR plus credit premium, consistent with our pre-purchase yield.

· Prepayment Rate — Lack of liquidity in the market for PreTSL securities, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment of these securities. During the early years of PreTSL securities, prepayments were common as issuers were able to refinance into lower cost borrowings. Since the middle of 2007, however, this option has all but disappeared and the Company is operating in an environment which makes early redemption of these instruments unlikely. Accordingly, the Company has assumed zero prepayments when modeling the cash flows of these securities. The Company performed a sensitivity analysis using 1% and 3% prepayment assumptions. As a result of this analysis, the Company determined that employing a 1% and a 3% prepayment assumption rather than assuming zero prepayments would have resulted in an additional credit loss of approximately $103 thousand and $311 thousand, respectively, to the $349 thousand impairment charge taken during the first nine months of 2011. Credit losses would increase as a result of an increase in the prepayment assumption because prepayments reduce the amount of excess subordination that would be available to absorb expected losses.

· Credit Analysis — A quarterly credit evaluation is performed for each of the securities. While the underlying core component of these securities are the credit characteristics of the underlying ‘issuers’, typically banks, other characteristics of the securities and issuers are evaluated and stressed to determine cash flow. These include but are not limited to the interest rate payable by each issuer, certain derivative contracts, default timing, and interest rate volatility. Issuer level credit considers all evidence available to us and includes the nature of the issuer’s business, its years of operating history, corporate structure, loan composition, loan concentrations, deposit mix, asset growth rates, geographic footprint and local environment. Depending upon the security, and its place in the capital structure, certain analytical assumptions are isolated with greater scrutiny. The core analysis for each specific issuer focuses on profitability, return on assets, shareholders’ equity, net interest margin, credit quality ratios, operating efficiency, capital adequacy and liquidity.

The Company has evaluated its PreTSLs considering all available evidence, including information received after the statement of financial condition date but before the filing date, and determined that the estimated discounted projected cash flows are less than the securities’ carrying value, resulting in impairment charges to earnings of $349 thousand for the nine months ended September 30, 2011.

The table below provides a cumulative roll forward of credit losses recognized:

Rollforward of Cumulative Credit Loss

(in thousands)	2011			2010
Beginning Balance January 1	$	22,598		$	20,649
Credit losses on debt securities for which OTTI was not previously recognized	—			—
Additional credit losses on debt securities for which OTTI was previously recognized	349			4,106
Less: Sale of Private Label CMOs for which OTTI was previously recognized	—			(2,322		)
Less: Sale of PreTSLs for which OTTI was previously recognized	(14,777		)	—
Ending Balance, September 30	$	8,170		$	22,433

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2011 and December 31, 2010. Management noted no indicators of impairment for the FHLB of Pittsburgh and FRB of Philadelphia at September 30, 2011.

Note 7. Fair Value Measurements

In determining fair value, the Company uses various valuation approaches, including market, income and cost approaches. Accounting standards establish a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability, which are developed based on market data obtained from sources independent of the Company. Unobservable inputs reflects the Company’s assumptions about the assumptions the market participants would use in pricing an asset or liability, which are developed based on the best information available in the circumstances.

The fair value hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

· Level 1 valuation is based upon unadjusted quoted market prices for identical instruments traded in active markets.

· Level 2 valuation is based upon quoted market prices for similar instruments traded in active markets, quoted market prices for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by market data.

· Level 3 valuation is derived from other valuation methodologies including discounted cash flow models and similar techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in determining fair value.

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

A description of the valuation methodologies used for assets recorded at fair value, and for estimating fair value of financial instruments not recorded at fair value, is set forth below.

Cash, Short-term Investments, Accrued Interest Receivable and Accrued Interest Payable

For these short-term instruments, the carrying amount is a reasonable estimate of fair value.

Securities

The estimated fair values of available-for-sale equity securities are determined by obtaining quoted prices on nationally recognized exchanges (Level 1 inputs). The estimated fair values for the Company’s investments in obligations of U.S. government agencies, obligations of state and political subdivisions, government sponsored agency collateralized mortgage obligations, government sponsored agency residential mortgage backed securities, and corporate debt securities are obtained by the Company from a nationally-recognized pricing service. This pricing service develops estimated fair values by analyzing like securities and applying available market information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing (Level 2 inputs), to prepare valuations. Matrix pricing is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things and are based on market data obtained from sources independent from the Company. The Level 2 investments in the Company’s portfolio are priced using those inputs that, based on the analysis prepared by the pricing service, reflect the assumptions that market participants would use to price the assets. The Company has determined that the Level 2 designation is appropriate for these securities because, as with most fixed-income securities, those in the Company’s portfolio are not exchange-traded, and such non-exchange-traded fixed income securities are typically priced by correlation to observed market data. The Company has reviewed the pricing service’s methodology to confirm its understanding that such methodology results in a valuation based on quoted market prices for similar instruments traded in active markets, quoted markets for identical or similar instruments traded in markets that are not active and model-based valuation techniques for which the significant assumptions can be corroborated by market data as appropriate to a Level 2 designation.

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For those securities for which the inputs used by an independent pricing service were derived from unobservable market information, the Company evaluated the appropriateness and quality of each price. The Company reviewed the volume and level of activity for all classes of securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value (fair values based on Level 3 inputs). If applicable, the adjustment to fair value was derived based on present value cash flow model projections prepared by the Company or obtained from third party providers utilizing assumptions similar to those incorporated by market participants. The estimated fair value of the PreTSLs and private label collateralized mortgage obligations in the Company’s securities portfolio are obtained from a third-party service providers that prepared the valuation using a discounted cash flow approach with inputs derived from unobservable market information (Level 3 inputs). The valuation of PreTSLs is further described below and in Note 6 of these financial statements.

As of September 30, 2011, the Company owned four PreTSLs having an amortized cost of $11.1 million. The market for these securities at September 30, 2011 was not active and markets for similar securities were also not active. PreTSLs were historically priced using Level 2 inputs. However, the decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, the valuation of these investments is now determined using Level 3 inputs. The Company obtained the valuations from a third- party service provider that prepared the valuations using a discounted cash flows approach. The Company takes measures to validate the service provider’s analysis and is actively involved in the valuation process, including reviewing and verifying the assumptions used in the valuation calculations. The difference between the discounted cash flow calculations for the purpose of estimating OTTI credit losses, described in Note 6, and the calculations used for fair value relates only to the discount rate used.

Results of a discounted cash flow test are significantly affected by variables such as the estimate of the probability of default, estimates of future cash flows, discount rates, prepayment rates and the creditworthiness of the underlying issuers. Refer to the discussion of these variables in Note 6. The Company considers these inputs to be unobservable Level 3 inputs because they are based on the Company’s estimates about the assumptions market participants would use in pricing this type of asset and developed based on the best information available in the circumstances rather than on observable inputs. The Company continues to monitor the market for PreTSLs to assess the market activity and the availability of observable inputs and will continue to apply these controls and procedures to the valuations received from its third party service provider for the period it continues to use an outside valuation service. As it relates to fair value measurements, once each issuer is categorized and the forecasted default rates have been applied, the expected cash flows are modeled using the variables described above. The Company then applies a 12% discount rate to PreTSLs XIX and PreTSL XXVI, a 15% discount rate to PreTSL IX, and a 20% discount rate to PreTSL XI to the expected cash flows to estimate fair value.

As of September 30, 2011, the Company owned a state and political subdivision security having an amortized cost of $1.9 million. The security was downgraded by several nationally recognized credit rating agencies in 2010. As a result of the downgrade, the market for this security at September 30, 2011 is no longer active. The security was historically priced using Level 2 inputs. The credit downgrade has resulted in a decline in the level of significant other observable inputs for this investment security at the measurement date. Broker pricing and bid/ask spreads are very limited, the weaker credit rating has resulted in additional price discounts and the absence of a CUSIP limits the amount of information that is available about the credit. As such, the valuation of this investment is now determined using Level 3 inputs. The Company obtained a bid indication from a third party municipal trading desk to determine its fair value.

At September 30, 2011, the Company owned an investment grade Private Label Collateralized Mortgage Obligation, “(PLCMOs)”, having an amortized cost of $5.1 million. PLCMOs are securitized products where payments from residential mortgage loans are pooled together and passed on to different classes of owners in various tranches. The markets for such securities are generally characterized by a limited number of new issuances, a significant reduction in trading volumes and wide bid-ask spreads, all driven by the lack of market participants. Although estimated prices can generally be obtained for such securities, the level of market observable assumptions used is severely limited in the valuation. Specifically, market assumptions regarding credit adjusted cash flows and liquidity influences on discount rates were difficult to observe at the individual security level. Because of the inactivity in the markets and the lack of observable valuation inputs, the security was valued by a third party specialist using a discounted cash flow approach and proprietary pricing model. The model uses inputs such as estimated prepayment speeds, losses, recoveries, default rates that are implied by the underlying performance of collateral in the structure or similar structures, and discount rates that are implied by market prices for similar securities and collateral structure types.

Loans

For non-impaired loans and non-collateral dependent impaired loans, fair values are estimated by discounting the projected future cash flows using market discount rates that reflect the credit, liquidity, and interest rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. The estimated fair value of collateral dependent impaired loans is based on the appraised loan value or other reasonable offers less estimated costs to sell. The Company does not record loans at fair value on a recurring basis. However from time to time, a loan is considered impaired and an allowance for credit losses is established. The specific reserves for collateral dependent impaired loans are based on the fair

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value of the collateral less estimated costs to sell. The fair value of the collateral is based on appraisals. In some cases, adjustments are made to the appraised values due to various factors including age of the appraisal, age of comparables included in the appraisal, and known changes in the market and in the collateral. When significant adjustments are based on unobservable inputs, the resulting fair value measurement is categorized as a Level 3 measurement. See also Note 4 “Loans.”

Loans Held For Sale

Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.

Mortgage Servicing Rights

The fair value of mortgage servicing rights is estimated using a discounted cash flow model that applies current estimated prepayments derived from the mortgage-backed securities market and utilizes a current market discount rate for observable credit spreads. The Bank does not record mortgage servicing rights at fair value on a recurring basis.

Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock

Ownership in equity securities of FHLB of Pittsburgh and the FRB is restricted and there is no established market for their resale. The carrying amount is a reasonable estimate of fair value.

Deposits

The fair value of demand deposits, savings deposits, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated based on discounted cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowed funds

The Bank uses discounted cash flows using rates currently available for debt with similar terms and remaining maturities to estimate fair value.

Commitments to extend credit and standby letters of credit

The fair value of commitments to extend credit and standby letters of credit are estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of off-balance- sheet commitments is insignificant and therefore not included in the table for non-recurring assets and liabilities.

Assets measured on a recurring basis

The following tables detail the financial asset amounts that are carried at fair value and measured at fair value on a recurring basis at September 30, 2011 and December 31, 2010 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:

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	Fair value measurements at September 30, 2011
					Significant		Significant
			Quoted prices		other		other
			in active markets		observable		unobservable
			for identical		inputs		inputs
(in thousands)	Fair value		assets (Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
Obligations of U.S. government agencies	$	8,124	$	—	$	8,124	$	—
Obligations of political and state subdivisions	99,613		—		97,855		1,758
Government sponsored agency CMOs	64,859		—		64,859		—
Private label CMOs	5,070		—		—		5,070
Residential mortgage backed securities	21,663		—		21,663		—
Pooled trust preferred Senior Class	1,453		—		—		1,453
Pooled trust preferred Mezzanine Class	2,027		—		—		2,027
Corporate debt securities	395		—		395		—
Equity securities	1,009		1,009		—		—
Total securities available-for-sale	$	204,213	$	1,009	$	192,896	$	10,308

	Fair value measurements at December 31, 2010
					Significant		Significant
			Quoted prices		other		other
			in active markets		observable		unobservable
			for identical		inputs		inputs
(in thousands)	Fair value		assets (Level 1)		(Level 2)		(Level 3)
Available-for-sale securities:
Obligations of U.S. government agencies	$	8,307	$	—	$	8,307	$	—
Obligations of political and state subdivisions	111,353		—		109,108		2,245
Government sponsored agency CMOs	77,816		—		77,816		—
Residential mortgage backed securities	49,120		—		49,120		—
Pooled trust preferred Senior Class	1,422		—		—		1,422
Pooled trust preferred Mezzanine Class	1,647		—		—		1,647
Corporate debt securities	395		—		395		—
Equity securities	1,012		1,012		—		—
Total securities available-for-sale	$	251,072	$	1,012	$	244,746	$	5,314

The table below presents a reconciliation and statement of operations classifications of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine month periods ended September 30, 2011 and 2010:

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)

(in thousands)	PreTSLs			State and Political Subdivisions			Private Label CMOs		Total
Balance at December 31, 2010	$	3,069		$	2,245		$	—	5,314
Accretion of discount	6			—			—		6
Paydowns	—			(395		)	—		(395		)
Sales	(19		)	—			—		(19		)
Purchases	—			—			5,070		5,070
Total gains or losses (realized/unrealized):									—
Included in earnings	(349		)	—			—		(349		)
Included in other comprehensive income	773			(92		)	—		681
Balance at September 30, 2011	$	3,480		$	1,758		$	5,070	$	10,308

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Fair Value Measurements Using Significant Unobservable Inputs (Level 3)

(in thousands)	PreTSLs			State and Political Subdivisions		Private Label CMOs		Total
Balance at December 31, 2009	$	3,810		$	—	$	—	3,810
Accretion of discount	11			—		—		11
Total gains or losses (realized/unrealized):
Included in earnings	(4,106		)	—		—		(4,106		)
Included in other comprehensive income	3,122			—		—		3,122
Transfers in and out of Level 3	—			2,375		—		2,375
Balance at September 30, 2010	$	2,837		$	2,375	$	—	$	5,212

There were no transfers between levels within the fair value hierarchy during the period ended September 30, 2011.

Assets measured at fair value on a non-recurring basis

Assets measured at fair value on a non-recurring basis are summarized below:

	Fair Value Measurements at September 30, 2011				Fair Value Measurements at December 31, 2010
	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)		Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
	(in thousands)
Collateral dependent impaired loans (1)			$	13,902			$	26,336
Other real estate owned			$	3,698			$	4,923

(1) Represents carrying value and related write-downs for which adjustments are based on appraised value. Management makes adjustments to the appraised values as necessary to consider declines in real estate values since the time of the appraisal. Such adjustments are based on management’s knowledge of the local real estate markets.

Collateral dependent impaired loans are classified as Level 3 assets and the estimated fair value of the collateral is based on the appraised loan value or other reasonable offers less estimated costs to sell. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance or is charged-off. The amount shown is the balance of impaired loans, net of any charge-offs and the related allowance for loan losses.

Other real estate owned properties are recorded at the fair value less the estimated cost to sell at the date of foreclosure. Subsequent to foreclosure, the balance might be subject to additional write-downs. It is the Company’s policy to obtain certified external appraisals of real estate collateral underlying impaired loans, including OREO, and it estimates fair value using those appraisals. Other valuation sources may be used, including broker price opinions, letters of intent and executed sale agreements. The amounts in the table above represent the value of OREO properties at September 30, 2011 and December 31, 2010 that were subject to additional write-downs subsequent to foreclosure.

The Company discloses fair value information about financial instruments, whether or not recognized in the Statement of Financial Condition, for which it is practicable to estimate that value. The following estimated fair value amounts have been determined by the

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Company using available market information and appropriate valuation methodologies. However, management judgment is required to interpret data and develop fair value estimates. Accordingly, the estimates below are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The estimated fair values of the Company’s financial instruments are as follows:

	September 30, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets
Cash and short term investments	$	173,645	$	173,645	$	74,505	$	74,505
Securities	206,281		206,352		253,006		252,929
FHLB and FRB Stock	10,102		10,102		11,572		11,572
Loans, net	657,850		672,366		735,813		736,992
Loans held for sale	1,969		1,969		3,557		3,557
Accrued interest receivable	2,515		2,515		3,119		3,119
Mortgage servicing rights	668		891		751		1,258

Financial Liabilities
Deposits	$	981,822	$	989,185	$	982,436	$	987,675
Borrowed funds	87,409		94,104		137,604		143,025
Accrued interest payable	3,776		3,776		2,763		2,763

Note 8. Earnings per Share

For the Company, the numerator of both the basic and diluted earnings per common share is net income available to common shareholders (which is equal to net income less dividends on preferred stock and related discount accretion). The weighted average number of common shares outstanding used in the denominator for basic earnings per common share is increased to determine the denominator used for diluted earnings per common share by the effect of potentially dilutive common share equivalents utilizing the treasury stock method. For the Company, common share equivalents are outstanding stock options to purchase the Company’s common shares.

The following table shows the calculation of both basic and diluted earnings per common share for the three and nine months ended September 30, 2011 and 2010:

	Three months ended						Nine months ended
	September 30,						September 30,
(In thousands, except share data)	2011			2010			2011			2010

Net loss	$	(434	)	$	(11,829	)	$	(771	)	$	(17,854	)

Basic weighted-average shares outstanding — basic	16,441,319			16,383,848			16,438,781			16,328,598
Plus: Common share equivalents	—			—			—			—
Weighted average shares outstanding — diluted	16,441,319			16,383,848			16,438,781			16,328,598

Earnings per share — basic	$	(0.03	)	$	(0.72	)	$	(0.05	)	$	(1.09	)
Earnings per share — diluted	$	(0.03	)	$	(0.72	)	$	(0.05	)	$	(1.09	)

Common share equivalents, in the table above, exclude stock options with exercise prices that exceed the average market price of the Company’s common shares during the periods presented. Inclusion of these stock options would be anti-dilutive to the diluted earnings per common share calculation.

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Note 9. Related Party Transactions

The Company and the Bank have engaged in and intend to continue to engage in banking and financial transactions in the conduct of its business with directors and the executive officers of the Company and the Bank and their related parties.

The Bank has granted loans, letters of credit and lines of credit to directors, executive officers and their related parties. These loans, letters of credit, and lines of credit were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and, when made, did not involve more than normal risk of uncollectability. The following table summarizes the changes in the total amounts of such outstanding loans, advances under lines of credit as well as repayments during the nine months ended September 30, 2011 and the year ended December 31, 2010:

	September 30,
(In thousands)	2011			2010
Outstanding at beginning of the year	$	92,217		$	102,705
New loans and advances	55,980			59,480
Repayments / reductions	(61,542		)	(56,932		)
Charge-offs	—			(3,188		)
Other*	(566		)	(453		)
Outstanding at end of period	$	86,089		$	101,612

* “other” represents loans to related parties that ceased being related parties during the period.

At September 30, 2011, there were no loans to directors, executive officers and their related parties which were not performing in accordance with the terms of the loan agreements. However, as of September 30, 2011, loans in the amount of $990 thousand to directors, executive officers and their related parties were categorized as criticized loans within the Bank’s risk rating system, meaning they are considered to present a higher risk of collection than other loans.

Included in related party loans is $5.0 million outstanding under a commercial line of credit (“line”) to a company owned by a director. The Company also sold a participation interest in this line to the same director in the amount of $5.2 million, of which $2.0 million is outstanding. The Bank receives a 25 basis point annual servicing fee from this director on the participation balance.

Deposits from directors, executive officers and their related parties held by the Bank at September 30, 2011 and December 31, 2010 amounted to $146.6 million and $131.6 million, respectively. Interest paid on the deposits amounted to $390 thousand and $862 thousand for the nine months ended September 30, 2011 and 2010, respectively.

In the course of its operations, the Company acquires goods and services from and transacts business with various companies affiliated with related parties. The Company believes these transactions were made on the same terms as those for comparable transactions. The Company recorded payments for these services of $1.5 million and $633 thousand for the nine months ended September 30, 2011 and 2010, respectively.

Subordinated notes held by officers and directors and/or their related parties totaled $10 million at September 30, 2011and $11 million at December 31, 2010. Interest paid to directors on these notes totaled $0 thousand and $685 thousand for the nine months ended September 30, 2011 and 2010, respectively. Interest accrued and unpaid on loans to directors totaled $675 thousand at September 30, 2011.

The Company leases its Honesdale branch from a related party. Total lease payments were $6.8 thousand for the nine months ended September 30, 2011 and 2010, respectively.

Note 10. Stock Option Plans

On August 30, 2000, the Company’s Board adopted an Employee Stock Incentive Plan in which options may be granted to key officers and other employees of the Company. The aggregate number of shares which may be issued upon exercise of the options under the plan cannot exceed 1,100,000 shares. Options and rights granted under the plan become exercisable six months after the date the options are awarded and expire ten years after the award date. Upon exercise, the shares are issued from the Company’s authorized but unissued stock. The Stock Incentive Plan expired on August 30, 2010, therefore, no further grants will be made under the plan.

The Board also adopted on August 30, 2000, the Independent Directors Stock Option Plan (the “Directors’ Stock Plan”) for directors who are not officers or employees of the Company. The aggregate number of shares issuable under the Directors’ Stock Plan cannot

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exceed 550,000 shares and are exercisable six months from the date the awards are granted and expire three years after the award date. Upon exercise, the shares are issued from the Company’s authorized but unissued shares. The Directors’ Stock Plan expired on August 30, 2010, therefore, no further grants will be made under the plan.

There was no compensation expense related to options under both the Stock Incentive Plan and the Directors’ Stock Plan for the nine months ended September 30, 2011 and 2010.

In accordance with current accounting guidance, all options are charged against income at their fair value. Awards granted under the plans vest immediately and the entire expense of the award is recognized in the year of grant.

A summary of the status of the Company’s stock option plans is presented below:

	Nine months ended September, 30
	2011				2010
			Weighted				Weighted
			Average				Average
			Exerice				Exerice
	Shares		Price		Shares		Price
Outstanding at the beginning of the period	222,616		$	12.58	366,248		$	12.18
Granted	—		—		—		—
Exercised	—		—		—		—
Forfeited	(13,224	)	$	9.06	(133,721	)	$	11.53
Outstanding at the end of the period	209,392		$	12.81	232,527		$	12.55
Options exercisable at September 30,	209,392		$	12.81	232,527		$	12.55
Weighted average fair value of options granted during the year	—		$	—	—		$	—
Stock-Based Compensation Expense			$	—			$	—

There were no options exercised during these periods. As of September 30, 2011, there was no unrecognized compensation expense.

Information pertaining to options outstanding at September 30, 2011 is as follows:

	Options Outstanding				Options Exercisable
Range of Exercise Price	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price

$5.82-$23.13	209,392	4.0 years	$	12.81	209,392	$	12.81

As of September 30, 2011, there was no aggregate intrinsic value of exercisable options.

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

This Quarterly Report should be read in conjunction with the more detailed and comprehensive disclosures included on our Form 10-K for the year ended December 31, 2010 and our Form 10-Q for the quarters ended March 31, 2011 and June 30, 2011. In addition, please read this section in conjunction with our Consolidated Financial Statements and Notes to Consolidated Financial Statements contained herein.

We are in the business of providing customary retail and commercial banking services to individuals and businesses. Our core market is northeastern Pennsylvania.

FORWARD-LOOKING STATEMENTS

The Company may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the SEC (including this report and the exhibits hereto), in its reports to shareholders and in other communications by the Company,

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which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in the Company’s markets; the effects of, and changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services; the impact of the Company’s ability to comply with its regulatory agreements and orders; the effectiveness of the Company’s revised system of internal controls; the ability of the Company to attract additional capital investment; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; acquisitions; changes in consumer spending and saving habits; the nature, extent, and timing of governmental actions and reforms, and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. Readers are also cautioned not to place undue reliance on any forward-looking statements, which reflect management’s analysis only as of the date of this report, even if subsequently made available by the Company on its website or otherwise. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company to reflect events or circumstances occurring after the date of this report.

Readers should carefully review the risk factors described in the Annual Report and other documents that we periodically file with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2010 and our Forms 10-Q for the quarters ended March 31, 2011 and June 30, 2011.

CRITICAL ACCOUNTING POLICIES

In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Management has identified the policies on the Allowance for Loan and Lease Losses (“ALLL”), securities valuation, other intangible assets, and the evaluation of deferred income tax and the impairment of securities to be critical as management is required to make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available.

The judgments used by management in applying the critical accounting policies discussed below may be affected by a further and prolonged deterioration in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the ALLL in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in the Company’s investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to further impairment losses.

Allowance for Loan and Lease Losses

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings, and is maintained at a level that management considers adequate to absorb losses in the loan portfolio. Loans are charged against the ALLL when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.

The ALLL represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the ALLL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, qualitative factors, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. Various banking regulators, as an integral part of their examination of the Company, also review the

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ALLL. Such regulators may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the ALLL. Additionally, the ALLL is determined, in part, by the composition and size of the loan portfolio.

The ALLL consists of specific and general components. The specific component relates to loans that are classified as impaired. For such loans an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers all other loans and is based on historical loss experience adjusted by qualitative factors. The Company changed its policy for determining the ALLL effective for 2009. The general reserve component of the ALLL, previously based on one aggregated pool of unimpaired loans, was increased after assigning these loans to one of three pools of “Pass”, “Special Mention” or “Accruing and Substandard” and applying historical loss factors and varied qualitative factor basis point allocations based on the risk profile in each pool to determine the appropriate reserve related to those loans. The general reserve component of the ALLL also increased because of higher historical loss experience resulting from the increased loan charge-offs of impaired loans. Substandard loans on non-accrual status are included in impaired loans.

See Note 4 — “Loans” of the consolidated financial statements included in Item 1 hereof for additional information about the ALLL.

Securities Valuation

Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets (level 1) or quoted prices on similar assets or models using inputs that are observable, either directly or indirectly (level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of observable inputs or if markets are illiquid, valuation techniques would be used to determine fair value of any investments that require inputs that are both unobservable and significant to the fair value measurement (level 3). For level 3 inputs, valuation techniques are based on various assumptions, including, but not limited to cash flows, discount rates, rate of return, adjustments for nonperformance and liquidity, and liquidation values. A significant degree of judgment is involved in valuing investments using level 3 inputs. The use of different assumptions could have a positive or negative effect on consolidated financial condition or results of operations. See Notes 6 and 7 of the consolidated financial statements included in Item 1 hereof for more information about our securities valuation techniques.

Management must periodically evaluate if unrealized losses (as determined based on the securities valuation methodologies discussed above) on individual securities classified as held-to-maturity or available-for-sale in the investment portfolio are considered to be OTTI. The analysis of OTTI requires the use of various assumptions, including, but not limited to, the length of time an investment’s fair value is less than book value, the severity of the investment’s decline, any credit deterioration of the issuer, whether management intends to sell the security, and whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. Debt investment securities deemed to be OTTI are written down by the impairment related to the estimated credit loss and the non-credit related impairment loss is recognized in other comprehensive income. The Company recognized OTTI charges on securities of $349 thousand and $4.1 million for the nine months ended September 30, 2011 and September 30, 2010, respectively, within the consolidated statements of operations. For both years, the OTTI charges relate to estimated credit losses on pooled trust preferred securities. See “Financial Condition - Securities” section below and Note 6 — “Securities” to the consolidated financial statements included in Item 1 hereof for additional information about our OTTI charges.

Other Real Estate Owned

Other real estate owned (“OREO”) consists of property acquired by foreclosure or deed in-lieu of foreclosure, are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. The fair value is based on appraised value through a current appraisal, adjusted by the estimated costs to sell the property. At the date of acquisition, any write down to fair value less estimated selling costs is charged to the ALLL. This determination is made on an individual asset basis. Fair value is determined through external appraisals, current letters of intent, broker price opinions or executed agreements of sale. Costs relating to the development and improvement of the OREO properties may be capitalized; holding period costs and subsequent changes to the valuation allowance are charged to expense.

Income Taxes

The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated financial condition or results of operations.

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We record income tax provision or benefit based on the amount of tax currently payable or receivable and the change in deferred tax assets and liabilities. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial and tax reporting purposes. We conduct quarterly assessments of all available evidence to determine the amount of deferred tax assets that are more-likely-than-not to be realized. The available evidence used in connection with these assessments includes taxable income in current and prior periods, cumulative losses in prior periods, projected future taxable income, potential tax-planning strategies, and projected future reversals of deferred tax items. These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.

In connection with determining our income tax provision or benefit, the Company considers maintaining liabilities for uncertain tax positions and tax strategies that management believes contain an element of uncertainty. Periodically, the Company evaluates each of our tax positions and strategies to determine whether a liability for uncertain tax benefits is required. As of September 30, 2011 and December 31, 2010, the Company did not have any uncertain tax positions or tax strategies and no liability was required to be recorded.

New Authoritative Accounting Guidance

In April 2011, the FASB issued an update (Accounting Standards Update No. 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring) which clarifies when creditors should classify loan modifications as troubled debt restructurings. The new guidance was effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after January 1, 2011. A provision in Update 2011-02 also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by Update 2010-20. The Company elected to adopt Update 2011-02 in the quarter ending March 31, 2011. The adoption of provision did not have a material impact on the Company’s consolidated financial statements. The disclosures required by this update did not have a material impact on the Company’s financial condition, results of operations or cash flows.

Accounting Guidance to be Adopted In Future Periods

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fair value. This update also requires additional disclosures about fair value measurements, is required to be applied prospectively, and is effective for interim and annual periods beginning after December 15, 2011. The Company is currently evaluating the impact of adoption of Update 2011-04 on the Company’s consolidated financial statements.

Executive Summary

The following overview should be read in conjunction with our MD&A in its entirety.

The Company recorded a net loss for the three month period ended September 30, 2011 of $434 thousand, or $(0.03) per diluted common share, a decrease of $11.4 million compared to a net loss of $11.8 million or $(0.72) per diluted common share, that was reported for the same period in the prior year. The net loss for the nine month period ended September 30, 2011 was $771 thousand or $(.05) per diluted common share, a decrease of $17.1 million compared to a loss of $17.9 million or $(1.09) per diluted common share for the same period in the prior year. The return on average equity was (1.15%) and (2.22%) for the three and nine months ended September 30, 2011, respectively, compared to (19.01%) and (27.97%) for the comparable periods in 2010. Return on average assets was (0.04%) and (0.07%) for the three and nine months ended September 30, 2011, respectively, compared to (0.90%) and (1.34%) for the comparable periods in 2010.

The $11.4 million decrease in the net loss for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010, was largely due to a $7.8 million decrease in the provision for loan and lease losses that was a direct result of a $125.2 million decrease in gross loans, a $3.8 million increase in the gains recognized on sales of securities, a $2.3 million decrease in total interest expense due to a $71.9 million decrease in deposits combined with a $99.0 million decrease in borrowings, and a $1.2 million decrease in other-than-temporary-impairment losses recorded on PreTSLs. These decreases were offset by a $3.1 million decrease in total interest income due to a decreasing interest rate environment coupled with a decrease in gross loans. The $17.1 million decrease in net loss for the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010, was largely due to a $14.9 million decrease in provision for loan and lease losses that was a direct result of a $125.2 million decrease in gross loans and lower historical charge-offs, a $4.9 million increase in the gains recognized on sales of securities, a $4.1 million decrease in total interest on deposits expense due to a $71.9 million decrease in deposits, a $3.8 million decrease in other-than-temporary-impairment losses recorded on PreTSLs. These decreases were offset by a $9.8 million decrease in total interst income due to a decreasing interest rate environment coupled with a significant decrease in gross loans.

Total assets decreased $37.8 million, or 3.24%, to $1.13 billion, at September 30, 2011, as compared to $1.17 billion at December 31, 2010 primarily due to a $78.0 million decrease in loans net of ALLL, a $46.9 million decrease in available-for-sale securities,

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a $6.9 million decrease in other assets, and a $1.8 million decrease in other real estate owned. These decreases were offset by a $99.1 million increase in total cash and cash equivalents.

Total deposits decreased $614 thousand, or 0.06%, to $981.8 million at September 30, 2011 as compared to $982.4 million at December 31, 2010. During the same period interest bearing demand deposits decreased $18.9 million, or 5.41%, and total time deposits decreased by $25.0 million, or 5.55%. These decreases were partially offset by a $44.8 million, or 48.11%, increase in demand deposits. Borrowed funds decreased by $50.2 million, or 36.48%, to $87.4 million at September 30, 2011 as compared to $137.6 million at December 31, 2010.

Total shareholders’ equity increased $6.9 million, or 21.46%, to $38.9 million at September 30, 2011 from $32.1 million at December 31, 2010. The increase is primarily due to a $7.6 million reduction in accumulated other comprehensive loss for the nine months ended September 30, 2011.

Summary of Performance

Net Interest Income

Net interest income consists of interest income and fees on interest-earning assets less interest expense on deposits and borrowed funds. It represents the largest component of the Company’s operating income and as such is the primary determinant of profitability. The net interest margin on a fully tax equivalent basis is calculated by dividing tax equivalent net interest income by average interest earning assets and is a key measurement used in the banking industry to measure income from earning assets. The net interest margin was 3.27% for the three months ended September 30, 2011, an increase of 23 basis points compared to the same period in 2010. This increase in the net interest margin was due to a decrease of 51 basis points in the tax equivalent cost on total interest-bearing liabilities, partially offset by a decrease of 31 basis points in the tax equivalent yield on total earning assets. Net interest margin was 3.18% for the nine months ended September 30, 2011, an increase of 3 basis points compared to the same period in 2010. This increase in the net interest margin was due to a decrease of 44 basis points in the tax equivalent cost on total interest-bearing liabilities, partially offset by a decrease of 41 basis points in the tax equivalent yield on total earning assets. Rate spread, the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities shown on a fully tax equivalent basis was 3.16% and 3.08% for the three and nine months ended September 30, 2011, an increase of 20 basis points and 3 basis points versus the same periods in 2010, respectively.

Net interest income on a tax equivalent basis decreased $0.9 million and $4.2 million and totaled $8.3 million and $25.0 million for the three and nine months ended September 30, 2011, respectively, compared to $9.2 million and $29.1 million for the comparable periods in 2010. For the nine months ended September 30, 2011, compared to the nine months ended September 30, 2010, average interest-earning assets decreased 15.0% to $1.05 billion from $1.23 billion, and average interest-bearing liabilities decreased by 16.5% to $980.5 million from $1.17 billion. For the three and nine months ended September 30, 2011, the yield on average interest-earning assets decreased 31 and 41 basis points, respectively, while the cost of average interest-bearing liabilities declined 51 and 44 basis points when compared to both the three and nine months ended September 30, 2010.

Interest income on loans on a tax equivalent basis decreased $2.6 million and $8.3 million for the three and nine months ended September 30, 2011, respectively compared to the same periods in 2010. The decrease in interest income for the three months ended September 30, 2011 was as a result of an 18 basis point decline in the tax equivalent yield and a decrease in average loan balances of $176.6 million to $700.3 million. The decrease in interest income for the nine months ended September 30, 2011 was as a result of a 29 basis point decline in the tax equivalent yield and a decrease in average loan balances of $174.1 million to $737.2 million. The decrease in the yield on loans for both the three and nine months ended September 30, 2011 was due to payoffs of higher yielding loans which cannot be replaced in this low interest rate environment and lower loan demand caused by the continuing economic slowdown.

Interest and dividend income on investment securities on a tax equivalent basis decreased by $0.7 million and $1.8 million for the three and nine months ended September 30, 2011, respectively, compared to the same period in 2010 primarily due to the reinvestment of pay downs and maturities into more liquid, lower-yielding assets.

Average interest bearing liabilities totaled $926.9 million and $980.5 million for the three and nine months ended September 30, 2011, respectively, which resulted in a decrease of $236.7 million and $193.9 million, or 20.3% and 16.5%, compared to the same periods in 2010. The decrease for the three months ended September 30, 2011 was primarily due to a decrease in borrowings of $113.0 million, or 54.9%, a decrease in other time deposits of $66.1 million, or 22.7%, a decrease in interest-bearing demand deposits of $41.2 million, or 11.6%, and a decrease in savings deposits of $8.9 million, or 9.1%. The decrease for the nine months ended September 30, 2011 was due to a decrease in borrowings of $91.3 million, or 43.1%, a decrease in other time deposits of $62.1 million, or 20.5%, a decrease in time deposits over $100,000 of $20.7 million, or 9.5%, a decrease in interest-bearing demand deposits of $15.7 million or

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4.5%, and a decrease in savings deposits of $4.1 million, or 4.3%. The average cost of interest-bearing deposits decreased by 50 basis points and 47 basis points to .92% and 1.08% during the three and nine months ended September 30, 201l, respectively, from 1.42% and 1.55% during the same periods in 2010. The decrease in the rate on interest-bearing deposits was driven primarily by pricing decreases from money markets and time deposits, which are sensitive to interest rate changes. The pricing decreases for these products resulted from an overall decrease in market rates.

Average borrowed funds decreased $113.0 million and $91.3 million or 54.9% and 43.1% for the three and nine months ended September 30, 2011 compared to the same periods in 2010. The cost of borrowed funds increased by 119 and 71 basis points to 4.91% and 4.44% for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 due to the Company paying off FHLB advances that were at lower rates. This resulted in higher-rate borrowings, such as the subordinated notes, becoming a larger percentage of total borrowings and causing the cost of borrowed funds to increase.

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amount of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them. The following tables set forth certain information relating to our consolidated statements of financial condition and operations for the three and nine month periods ended September 30, 2011 and September 30, 2010, and reflect the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include amortization of fees which are considered adjustments to yields.

	Three months ended September 30,								Three months ended September 30,
	2011								2010
	Average						Yield/		Average						Yield/
	Balance			Interest			Cost		Balance			Interest			Cost
	(Dollars in thousands)
ASSETS
Interest-Earning Assets (2) (6)
Loans-taxable (7)	$	668,288		$	7,987		4.78	%	$	824,382		$	10,252		4.96	%
Loans-tax free (7)	32,078			566			7.05	%	52,579			875			6.65	%
Total Loans (1)(2)	700,366			8,553			4.89	%	876,961			11,127			5.07	%
Securities-taxable	131,298			827			2.52	%	146,372			1,293			3.53	%
Securities-tax free	107,519			1,912			7.11	%	121,228			2,114			6.98	%
Total Securities (1)(3)	238,817			2,739			4.59	%	267,600			3,407			5.09	%
Federal funds sold	73,241			34			0.19	%	69,799			44			0.25	%
Total interest-earning assets	1,012,424			11,326			4.48	%	1,214,360			14,578			4.79	%
Non interest-earning assets	107,852								135,195
Allowance for loan and lease losses	(25,050		)						(28,510		)
Total Assets	$	1,095,226							$	1,321,045

LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing Liabilities
Interest-bearing demand deposits	313,369			232			0.30	%	354,588			825			0.93	%
Savings deposits	88,940			60			0.27	%	97,798			132			0.53	%
Time deposits over $100,000	207,061			375			0.73	%	214,582			876			1.62	%
Other time deposits	224,557			1,253			2.24	%	290,659			1,601			2.18	%
Total Interest-bearing Deposits	833,927			1,920			0.92	%	957,627			3,434			1.42	%
Borrowed funds and other interest-bearing liabilities	93,009			1,139			4.91	%	206,007			1,930			3.72	%
Total Interest-Bearing Liabilities	926,936			3,059			1.32	%	1,163,634			5,364			1.83	%
Demand deposits	115,546								81,788
Other liabilities	14,981								13,405
Shareholders’ equity	37,763								62,218
Total Liabilities and Shareholders’ Equity	$	1,095,226							$	1,321,045
Net Interest Income/Interest Rate Spread (4)				8,267			3.16	%				9,214			2.96	%
Tax equivalent adjustment				(843		)						(1,016		)
Net interest income as reported				$	7,424							$	8,198

Net Interest Margin (5)							3.27	%							3.04	%

(1)	Interest income is presented on a tax equivalent basis using a 34% rate for 2011 and 2010.
(2)	Loans are stated net of unearned income.
(3)	The yields for securities that are classified as available for sale are based on the average historical amortized cost.
(4)	Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest bearing liabilities and is presented on a tax equivalent basis.
(5)	Net interest income as a percentage of total average interest earning assets.
(6)	Non-accrual loans are included in loans within interest-earning assets.
(7)	Loan fees included in interest income are not significant.

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	Nine months ended September 30,								Nine months ended September 30,
	2011								2010
	Average						Yield/		Average						Yield/
	Balance			Interest			Cost		Balance			Interest			Cost
	(Dollars in thousands)
ASSETS
Interest-Earning Assets (2) (6)
Loans-taxable (7)	$	700,280		$	25,117		4.78	%	$	857,215		$	32,638		5.08	%
Loans-tax free (7)	36,873			1,938			7.01	%	54,071			2,741			6.76	%
Total Loans (1)(2)	737,153			27,055			4.89	%	911,286			35,379			5.18	%
Securities-taxable	136,382			2,704			2.64	%	143,222			4,363			4.06	%
Securities-tax free	117,194			6,179			7.03	%	121,222			6,344			6.98	%
Total Securities (1)(3)	253,576			8,883			4.67	%	264,444			10,707			5.40	%
Federal funds sold	57,918			96			0.22	%	58,223			111			0.25	%
Total interest-earning assets	1,048,647			36,034			4.58	%	1,233,953			46,197			4.99	%
Non interest-earning assets	106,365								123,857
Allowance for loan and lease losses	(24,218		)						(26,114		)
Total Assets	$	1,130,794							$	1,331,696

LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing Liabilities
Interest-bearing demand deposits	330,612			1,383			0.56	%	346,329			2,720			1.05	%
Savings deposits	90,571			242			0.35	%	94,660			396			0.56	%
Time deposits over $100,000	198,052			1,737			1.16	%	218,785			2,772			1.63	%
Other time deposits	240,631			3,661			2.02	%	302,694			5,243			2.32	%
Total Interest-bearing Deposits	859,866			7,023			1.08	%	962,468			11,131			1.55	%
Borrowed funds and other interest-bearing liabilities	120,670			4,038			4.44	%	211,984			5,938			3.73	%
Total Interest-Bearing Liabilities	980,536			11,061			1.50	%	1,174,452			17,069			1.94	%
Demand deposits	99,883								79,979
Other liabilities	15,622								13,433
Shareholders’ equity	34,753								63,832
Total Liabilities and Shareholders’ Equity	$	1,130,794							$	1,331,696
Net Interest Income/Interest Rate Spread (4)				24,973			3.08	%				29,128			3.05	%
Tax equivalent adjustment				(2,760		)						(3,088		)
Net interest income as reported				$	22,213							$	26,040

Net Interest Margin (5)							3.18	%							3.15	%

(1)	Interest income is presented on a tax equivalent basis using a 34% rate for 2011 and 2010.
(2)	Loans are stated net of unearned income.
(3)	The yields for securities that are classified as available for sale are based on the average historical amortized cost.
(4)	Interest rate spread represents the difference between the average yield on interest earning assets and the cost of interest bearing liabilities and is presented on a tax equivalent basis.
(5)	Net interest income as a percentage of total average interest earning assets.
(6)	Non-accrual loans are included in loans within interest-earning assets.
(7)	Loan fees included in interest income are not significant.

The following table shows the effect of changes in volume and interest rates on net interest income. The variance in interest income or expense due to the combination of rate and volume has been allocated proportionately.

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	Three Months Ended September 30, 2011 Compared with September 30, 2010									Nine Months Ended September 30, 2011 Compared with September 30, 2010
	Increase (Decrease) Due to Change in									Increase (Decrease) Due to Change in
(in thousands)	Volume			Rate			Total			Volume			Rate			Total

Interest income:
Loans (taxable)	$	(1,878	)	$	(387	)	$	(2,265	)	$	(5,712	)	$	(1,809	)	$	(7,521	)
Loans (tax-free) (1)	(323		)	14			(309		)	(843		)	40			(803		)
Investment securities (taxable)	(123		)	(343		)	(466		)	(200		)	(1,459		)	(1,659		)
Investment securities (tax-free)(1)	(235		)	33			(202		)	(210		)	45			(165		)
Federal funds sold	2			(12		)	(10		)	(1		)	(14		)	(15		)
Total interest income	(2,557		)	(695		)	(3,252		)	(6,966		)	(3,197		)	(10,163		)

Interest expense:
Interest-bearing demand deposits	(105		)	(488		)	(593		)	(129		)	(1,208		)	(1,337		)
Savings deposits	(13		)	(59		)	(72		)	(18		)	(136		)	(154		)
Time deposits	(389		)	(460		)	(849		)	(1,401		)	(1,216		)	(2,617		)
Other interest-bearing liabilities	(1,267		)	476			(791		)	(2,901		)	1,001			(1,900		)
Total interest expense	(1,774		)	(531		)	(2,305		)	(4,449		)	(1,559		)	(6,008		)
Decrease in interest differential	$	(783	)	$	(164	)	$	(947	)	$	(2,517	)	$	(1,638	)	$	(4,155	)

(1) Changes in interest income and interest expense attributable to changes in both volume and rate have been allocated proportionately to changes due to volume and changes due to rate.

Provision for Loan and Lease Losses

Management closely monitors the loan portfolio and the adequacy of the Allowance for Loan and Lease Losses (“ALLL”) considering underlying borrower financial performance and collateral values and increasing credit risks. Future material adjustments may be necessary to the provision for loan and lease losses and the ALLL if economic conditions or loan performance differ substantially from the assumptions management used in making its evaluation of the ALLL. The provision for loan and lease losses is an expense charged against net interest income to provide for estimated losses attributable to uncollectible loans and is based on management’s analysis of the adequacy of the ALLL. A (credit) provision for loan and lease losses of $(0.5) million and $2.0 million was recorded for the three and nine month periods ended September 30, 2011, respectively, compared to $7.3 million and $17.0 million, respectively, for the same periods in the prior year. The decrease of $7.8 million and $14.9 million for the three and nine month periods ended September 30, 2011 from the same periods in the prior year is the result of a reduction in charge-offs of classified credits and the $125.2 million reduction in gross loans.

During the nine months ended September 30, 2011, non-performing loans decreased $7.7 million to $20.7 million from $28.4 million at December 31, 2010. Net charge-offs decreased $12.3 million to $1.5 million for the nine months ended September 30, 2011 from $13.8 million for the same period in 2010. Non-performing loans primarily consist of loans secured by real estate. Refer to “Financial Condition - Allowance for Loan and Lease Losses”.

Non-interest Income (Loss)

The Company recorded total non-interest income of $2.3 million for the three months ended September 30, 2011, an increase of $4.5 million from the $(2.2) million loss experienced during the comparable period in 2010. The increase in non-interest income was primarily due to a $3.8 million increase in gain on sale of securities and a $1.2 million decrease in OTTI losses recorded on PreTSLs. Non-interest income was $9.8 million for the nine months ended September 30, 2011, an increase of $10.5 million from the $(0.7) million loss for the nine months ended September 30, 2010. The increase in non-interest income was primarily due to a $3.8 million decrease in OTTI losses recorded on PreTSLs, a $2.4 million increase in gain on sale of other real estate owned, and a $4.9 million increase in gain on sale of securities.

Non-interest Expense

Non-interest expense was $10.7 million for the three months ended September 30, 2011, an increase of $0.2 million from the $10.5 million at September 30, 2010. Non-interest expense was $30.7 million for the nine months ended September 30, 2011, an increase of $4.5 million from $26.2 million for the nine months ended September 30, 2010. The increase in non-interest expense for the nine-month period was primarily due to a $3.4 million increase in professional fees and a $1.7 million increase in legal expense both are attributable to increased regulatory compliance expenses.

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Provision for Income Taxes

The Company anticipates that it will have a minimal tax provision or benefit until such time as it is able to reverse the deferred tax asset valuation allowance that it recorded in 2009, and accordingly did not record a provision or benefit during the three or nine months ended September 30, 2011 and 2010.

FINANCIAL CONDITION

Assets

Total assets were $1.13 billion, at September 30, 2011, which is a decrease of $37.8 million, or 3.2%, from $1.17 billion at December 31, 2010.

Cash and Cash Equivalents

Total cash and cash equivalents increased $99.1 million, or 133.1%, during the nine months ended September 30, 2011 to $173.6 million. The Company did not pay any dividends during the quarter ended June 30, 2011 as it suspended paying dividends to conserve capital and comply with regulatory requirements.

Securities

The Company holds debt securities primarily for liquidity, interest rate risk management needs and to provide a source of interest income. Securities are classified as held-to-maturity and carried at amortized cost when the Company has the positive intent and ability to hold them to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. The Company determines the appropriate classification of securities at the time of purchase. The decision to purchase or sell securities is based upon the current assessment of long and short-term economic and financial conditions, including the interest rate environment and other statement of financial condition components. Securities with limited marketability and/or restrictions, such as Federal Home Loan Bank and Federal Reserve Bank stocks, are carried at cost. Federal Reserve Bank stock is carried in other assets.

At September 30, 2011, the Company’s investment portfolio was comprised of U.S Government agency securities, tax-exempt and taxable obligations of states and political subdivisions, government sponsored agency and private label collateralized mortgage obligations, government sponsored agency residential mortgage-backed securities, pooled trust preferred securities (“PreTSLs”) principally collateralized by bank holding companies (“bank issuers”), corporate debt and equity securities.

The Company’s investments in PreTSLs may pose a higher risk of future impairment charges by the Company as a result of the current downturn in the U.S. economy and its potential negative effect on the future performance of these bank issuers. Many of the bank issuers of trust preferred securities within the Company’s investment portfolio remain participants in the U.S. Treasury’s TARP CPP. For TARP participants, dividend payments to trust preferred security holders are currently senior to and payable before dividends can be paid on the preferred stock issued under the TARP CPP. Some bank issuers may elect to defer future payments of interest on such securities either based upon recommendations by the U.S. Treasury and the banking regulators or management decisions driven by potential liquidity needs. Such elections by issuers of securities within our investment portfolio could adversely affect securities valuations and result in future impairment charges if collection of deferred and accrued interest (or principal upon maturity) is deemed unlikely by management. See the “Other-Than-Temporary-Impairment Analysis” section below for further details.

The following table sets forth the carrying value of available-for-sale securities, which are carried at fair value, and held-to-maturity securities, which are carried at amortized cost, at the dates indicated:

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	September 30,		December 31,
	2011		2010
	(In Thousands)
Obligations of U.S. government agencies	$	8,124	$	8,307
Obligation of state and political subdivisions	101,681		113,347
Collateralized mortgage obligations
Government sponsored agency	64,859		77,816
Private label	5,070		—
Residential mortgage-backed securities
Government sponsored agency	21,663		49,120
Pooled trust preferred senior class	1,453		1,422
Pooled trust preferred mezzanine class	2,027		1,647
Corporate debt securities	395		395
Equity secruities	1,009		1,012
Total	$	206,281	$	253,066

During 2010, the Company sold its entire portfolio of private label collateralized mortgage obligation securities to better manage and improve credit risk in its investment portfolio. The Company used proceeds from these sales and cash provided by operations to purchase high quality U.S. Government guaranteed and U.S. Government agency sponsored mortgage-backed securities. During the second quarter of 2011, the Company sold three of the PreTSLs in its securities portfolio to better manage and improve the credit risk in its investment portfolio. During the third quarter of 2011, the Company sold certain of its investments in U.S. Government agency collateralized mortgage obligations (“CMOs”) and reinvested the proceeds in private label CMOs (“PLCMOs”) to reduce its exposure to prepayments and improve yield. It also sold certain of its investments in obligations of state and political subdivisions that were callable and reinvested a portion of the proceeds in taxable municipal securities to reduce its interest rate risk. Additionally, there were no single issuers with an aggregate amortized cost which exceeded ten percent (10%) of total shareholders’ equity.

The following table sets forth the maturities of available-for-sale securities and held-to-maturity securities, based on book value, at September 30, 2011 and the weighted average yields of such securities calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security.

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													Mortgage-
													Backed
													Securities and
													Collateralized
	Within			> 1 – 5			6 - 10			Over			Mortgage			No Fixed
	One Year			Years			Years			10 Years			Obligations			Maturity			Total
Available-for-sale securities
U.S. Treasury securities	$	—		$	—		$	—		$	—		$	—		$	—		$	—
Yield
Obligations of U.S. government agencies										8,124									8,124
Yield										5.62		%							5.62		%
Obligations of state and political subdivisions (1)				2,334			9,965			87,314									99,613
Yield				6.30		%	6.42		%	7.06		%							6.23		%
Corporate debt securities										395									395
Yield										0.99		%							0.99		%
Collateralized mortgage obligations:
Government sponsored agencies													64,859						64,859
Yield													3.75		%				3.75		%
Private label													5,070						5,070
Yield													6.62		%				6.62		%
Residential mortgage-backed securities:
Government sponsored agencies													21,663						21,663
Yield													5.04		%				5.04		%
Pooled Trust Preferred Senior Class										1,453									1,453
Yield										0.00		%							0.00		%
Pooled Trust Preferred Mezzanine Class										2,027									2,027
Yield										0.00		%							0.00		%
Equity securities (2)																1,009			1,009
Yield																4.72		%	4.72		%
Total available-for-sale maturities	$	—		$	2,334		$	9,965		$	99,313		$	91,592		$	1,009		$	204,213
Weighted yield	0.00		%	6.30		%	6.42		%	6.21		%	4.22		%	4.72		%	5.35		%

Held-to-maturity securities
Obligations of state and political subdivisions							2,068												2,068
Yield							4.82		%
Total held-to-maturity securities	$	—		$	—		$	2,068		$	—		$	—		$	—		$	2,068
Weighted yield	0.00		%	0.00		%	4.82		%	0.00		%	0.00		%	0.00		%	4.82		%

Other-Than-Temporary Impairment (“OTTI”)

The Company tests its securities for OTTI using authoritative guidance. Under this guidance, if management has no intent to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost, then other-than-temporary declines in the fair value of the debt security that are related to credit losses must be recognized in earnings as realized losses and those that are related to other factors are recognized in other comprehensive income. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio and may result in OTTI on the Company’s investment securities in future periods.

On a quarterly basis, the Company evaluates its investment securities for OTTI. Unrealized losses on securities are considered to be other-than-temporarily-impaired when the Company believes the security’s impairment is due to factors that could include the issuer’s inability to pay interest or dividends, its potential for default, and/or other factors. Based on current authoritative guidance, when a held-to-maturity or available-for-sale debt security is assessed for OTTI, the Company must first consider (a) whether management intends to sell the security and (b) whether it is more likely than not that the Company will be required to sell the security prior to recovery of its amortized cost basis. If one of these circumstances applies to a security, an OTTI loss is recognized in the statement of operations equal to the full amount of the decline in fair value below amortized cost. If neither of these circumstances applies to a security, but the Company does not expect to recover the entire amortized cost basis, an OTTI loss has occurred that must be separated into two categories: (a) the amount related to credit loss and (b) the amount related to other factors such as market risk. In assessing the level of OTTI attributable to credit loss, the Company compares the present value of cash flows expected to be collected with the amortized cost basis of the security. As discussed above, the portion of the total OTTI related to credit loss is recognized in earnings, while the amount related to other factors is recognized in other comprehensive income. The total OTTI loss is presented in the statement of operations, less the portion recognized in other comprehensive income. When a debt security becomes other-than-temporarily-impaired, its amortized cost basis is reduced to reflect the portion of the total impairment related to credit loss.

To determine whether a security’s impairment is other than temporary, management considers factors that include:

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·	the causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility;
·	the severity and duration of the decline;
·	the Company’s ability and intent to hold equity security investments until they recover in value, as well as the likelihood of such a recovery in the near term;
·	the Company’s intent to sell security investments, or if it is more likely than not that the Company will be required to sell such securities before recovery of their individual amortized cost basis less any current-period credit loss.

Based on the Company’s evaluation at September 30, 2011, the Company has determined that the decreases in estimated fair value of the securities it holds in its portfolio are temporary with the exception of four PreTSLs. The Company’s estimate of discounted cash flows it expects to receive was less than the securities’ carrying value resulting in a credit-related impairment charge to earnings of $349 thousand for the nine months ended September 30, 2011.

OTTI of Pooled Trust Preferred Collateralized Debt Obligations:

At September 30, 2011, the amortized cost of the Company’s PreTSLs totaled $11.1 million with an estimated fair value of $3.5 million and is comprised of four securities each of which is collateralized by debt issued by bank holding companies and insurance companies. The Company holds one senior tranche and three mezzanine tranches and all possess credit ratings below investment grade. During 2010, all of the pooled issues were downgraded further by either Moody’s or Fitch. At the time of initial issue, no more than 5% of any pooled security consisted of a security issued by any one institution. At September 30, 2011, three of these securities had no excess subordination and one had excess subordination which was 11.5% of the current performing collateral. Excess subordination is the amount by which the underlying performing collateral exceeds the outstanding bonds in the current class plus all senior classes. It can also be referred to as credit enhancement. As deferrals and defaults of underlying issuers occur, the excess subordination is reduced or eliminated, increasing the risk of the security experiencing principal or interest shortfalls. Conversely, subordination can be increased as collateral transitions from non-performing to performing. The coverage ratio, or overcollateralization, of a specific security measures the rate of performing collateral to a given class of notes. It is calculated by dividing the performing collateral in a transaction by the current balance of the class of notes plus all classes senior to that class.

The following table presents information about the Company’s collateral and subordination for its PreTSLs at September 30, 2011:

													Actual
												Current	Deferrals /
					Excess/							Number of	Defaults as a %		Expected
	Performing		Bonds		(Insufficient)			Coverage		Excess		Performing	of Current		Future
Security	Collateral		Outstanding		Collateral			Ratio		Subordination		Issuers	Collateral		Default Rate
(in thousands)
PreTSL IX	$	303,520	$	322,983	$	(19,463	)	93.97	%	N/A		35	31.0	%	1.61	%
PreTSL XI	401,465		441,612		(40,147		)	90.91	%	N/A		44	30.0	%	1.86	%
PreTSL XIX	507,281		538,861		(31,580		)	94.14	%	N/A		51	27.5	%	1.89	%
PreTSL XXVI	691,700		620,367		71,333			111.50	%	11.50	%	55	28.3	%	1.31	%

The following list details information for each of the Company’s PreTSLs at September 30, 2011:

									Moody’s /	Credit		Credit		Cumulative
		Amortized		Fair		Unrealized			Fitch	Impairment		Impairment		Credit
Security	Class	Cost		Value		Gain/Loss			Ratings	Quarter to Date		Year to Date		Impairment
(in thousands)
PreTSL IX	Mezzanine	$	1,320	$	444	$	(876	)	Ca/C	$	—	$	—	$	1,680
PreTSL XI	Mezzanine	1,574		543		(1,031		)	Ca/C	—		—		3,426
PreTSL XIX	Mezzanine	4,363		1,039		(3,324		)	Ca/CC	—		349		2,813
PreTSL XXVI	Senior	3,869		1,454		(2,415		)	B1/CCC	—		—		251
Total		$	11,126	$	3,480	$	(7,646	)		$	—	$	349	$	8,170

The Company’s PreTSLs are evaluated for OTTI by determining whether an adverse change in estimated cash flows has occurred. The Company uses a third party service provider to perform this analysis. Determining whether there has been an adverse change in estimated cash flows from the cash flows previously projected involves comparing the present

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value of remaining cash flows previously projected against the present value of the cash flows estimated at September 30, 2011. The Company considers the discounted cash flow analysis to be its primary evidence when determining whether credit related OTTI exists.

· Probability of Default — An issuer level approach is used to analyze each security and default and recovery assumptions are based on the credit quality of the underlying issuers (generally, bank holding companies or insurance companies). Each bank issuer is evaluated based upon an examination of the trends in its earnings, net interest margin, operating efficiency, liquidity, capital position, level of nonperforming loans to total loans, apparent sufficiency of loan loss reserves, Texas ratio and whether the bank received TARP monies. From this information, each issuer bank that is currently performing is assigned a category of Good, Average, Weak, or Troubled. Default rates are then assigned based upon the historical performance of each category. Additionally, because the information available to the Company regarding the underlying insurance company issuers is more limited than for bank issuers, rather than performing an analysis of each such issuer’s results and assigning insurance company issuers to these same categories, the Company uses the Moody’s one year long-term default rate assumption for insurance companies. The historical default rates used in this analysis are:

Default Rate

Category	Year 1		Year 2		Year 3		Thereafter
Good	0.50	%	0.60	%	0.60	%	0.40	%
Average	1.80	%	2.30	%	2.30	%	1.50	%
Insurance	1.00	%	1.20	%	1.20	%	0.80	%
Weak	5.80	%	7.20	%	7.20	%	4.80	%
Troubled	9.70	%	12.20	%	12.20	%	8.10	%

Each issuer in the collateral pool is assigned a probability of default for each year until maturity. Banks currently in default or deferring interest payments thus far are assumed to default immediately. A zero percent projected recovery rate is applied to both deferring and defaulted issuers. The probability of default is updated quarterly based upon changes in the creditworthiness of each underlying issuer. Timing of defaults and deferrals has a substantial impact on each valuation. As a result of this analysis, each issuer is assigned an expected default rate specific to that issuer.

· Prepayment Rate — Lack of liquidity in the market for PreTSL securities, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment of these securities. During the early years of PreTSL securities, prepayments were common as issuers were able to refinance into lower cost borrowings. Since the middle of 2007, however, this option has all but disappeared and the Company is operating in an environment which makes early redemption of these instruments unlikely. Accordingly, the Company has assumed zero prepayments when modeling the cash flows of these securities. The Company will reevaluate its prepayment assumptions from time to time as appropriate. The Company performed a sensitivity analysis using 1% and 3% prepayment assumptions. As a result of this analysis, the Company determined that employing a 1% and a 3% prepayment assumption rather than assuming zero prepayments would have resulted in an additional credit loss of approximately $103 thousand and $311 thousand, respectively, to the $349 thousand impairment charge taken during the first nine months of 2011. Credit losses would increase as a result of an increase in the prepayment assumption because prepayments reduce the amount of excess subordination that would be available to absorb expected losses.

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The Company has evaluated its PreTSLs considering all available evidence, including information received after the statement of financial condition date but before the filing date, and determined that the estimated projected cash flows are less than the securities’ carrying value, resulting in impairment charges to earnings of $0 and $349 thousand for the three and nine months ended September 30, 2011.

The table below provides a cumulative roll forward of credit losses recognized:

Rollforward of Cumulative Credit Loss

(in thousands)

	2011			2010
Beginning Balance, January 1	$	22,598		$	20,649
Credit losses on debt securities for which OTTI was not previously recognized	—			—
Additional credit losses on debt securities for which OTTI was previously recognized	349			4,106
Less: Sale of Private Label CMOs for which OTTI was previously recognized	—			(2,322		)
Less: Sale of PreTSLs for which OTTI was previously recognized	(14,777		)	—
Ending Balance, September 30	$	8,170		$	22,433

Investments in FHLB and FRB stock, which have limited marketability, are carried at cost and totaled $10.1 million and $11.6 million at September 30, 2011 and December 31, 2010, respectively. FRB stock of $1.3 million is included in Other Assets at September 30, 2011 and December 31, 2010. Management noted no indicators of impairment for the FHLB of Pittsburgh and FRB of Philadelphia at September 30, 2011.

Loans

The net loan balance declined during the nine months ended September 30, 2011 primarily as a result of payoffs, and transfers to OREO. Net loans declined $78.0 million, or 10.6%, to $657.9 million at September 30, 2011 from $735.8 million at December 31, 2010. Net loans represented 58.2% of total assets at September 30, 2011, compared to 63.0% at December 31, 2010. Historically, commercial lending activities have represented a significant portion of the Company’s loan activities. This includes commercial and industrial loans, commercial real estate loans and construction, land acquisition and development loans. Furthermore, from a collateral standpoint, a majority of the Company’s loan portfolio consisted of loans secured by real estate. Real estate secured loans, which includes commercial real estate, construction, land acquisition and development, residential real estate, and home equity loans, declined by $44.5 million, or 9.6% to $421.3 million at September 30, 2011, from $465.9 million at December 31, 2010. Real estate secured loans as a percentage of total gross loans was 61.9% at September 30, 2011 compared to 61.5% at December 31, 2010.

Commercial and industrial loans decreased $20.6 million, or 10.4%, during the year from $197.7 million at December 31, 2010 to $177.1 million at September 30, 2011. Commercial and industrial loans consist primarily of equipment loans, working capital financing, revolving lines of credit and loans secured by cash and marketable securities. The decrease was primarily a reduction in borrowings under revolving line of credit facilities within the portfolio. Loans secured by commercial real estate increased $232 thousand, or 0.1%, from $256.3 million at December 31, 2010 to $256.6 million at September 30, 2011. Commercial real estate loans include long-term commercial mortgage financing and are primarily secured by first or second lien mortgages. Construction, land acquisition and development loans decreased $41.3 million, or 53.4%, during the year from $77.4 million at December 31, 2010 to $36.1 million at September 30, 2011. The decrease in construction land acquisition and development loans is primarily attributable to charge-offs, transfers to OREO and a decrease in lending in this segment.

Residential real estate loans decreased $5.9 million, or 6.7%, during the year from $87.9 million at December 31, 2010 to $82.1 million at September 30, 2011. The components of residential real estate loans include fixed and variable rate mortgage loans.

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The Company continues to adhere to a philosophy of underwriting fixed rate purchases and refinancing of residential mortgage loans that are generally then sold in the secondary market to reduce interest rate risk and provide funding for additional loans.

Consumer loans decreased $1.4 million, or 1.3%, during the year from $110.9 million at December 31, 2010 to $109.5 million at September 30, 2011. The decrease is primarily attributable to paydowns.

Loans to state and political subdivisions decreased $8.4 million, or 30.3%, during the year from $27.7 million at December 31, 2010 to $19.3 million at September 30, 2011. The decrease in loans to state and political subdivisions was due to paydowns.

Details regarding the loan portfolio are as follows:

(in thousands)	September 30, 2011			December 31, 2010
Residential real estate	$	82,074		$	87,925
Commercial real estate	256,559			256,327
Construction, land acquisition and development	36,058			77,395
Commercial and industrial	177,082			197,697
Consumer	109,471			110,853
State and political subdivisions	19,340			27,739
Total loans, gross	$	680,584		$	757,936
Unearned discount	(174		)	(332		)
Net deferred loan fees and costs	546			784
Allowance for loan and lease losses	(23,106		)	(22,575		)
Loans, net	$	657,850		$	735,813

Loan Concentrations: At September 30, 2011 and December 31, 2010, the Company’s loan portfolio was concentrated in the following industries. The majority of loans included in the Solid Waste Landfills are fully secured by cash collateral on deposit at the Company.

	September 30, 2011			December 31, 2010
(in thousands)	Amount	% of gross loans		Amount	% of gross loans
Land subdivision	21,546	3.17	%	29,518	3.89	%
Shopping centers/complexes	18,972	2.79	%	26,298	3.47	%
Gas stations	17,496	2.57	%	18,289	2.41	%
Office complexes/units	16,166	2.38	%	16,842	2.22	%
Solid waste landfills	42,270	6.21	%	52,270	6.90	%

Asset Quality

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, net of unearned interest, deferred loan fees and costs, and reduced by the ALLL. The ALLL is established through a provision for loan losses charged to earnings.

The Company manages credit risk through the efforts of loan officers, the loan review function, and the Loan Quality and the ALLL management committees as well as oversight from the board of directors, along with the application of policies and procedures designed to foster sound underwriting and credit monitoring practices. Management continually evaluates this process to ensure it is reacting to problems in the loan portfolio in a timely manner. Although, as is the case with any financial institution, a certain degree of credit risk is dependent in part on local and general economic conditions that are beyond the Company’s control.

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Under the Company’s risk rating system, loans rated as pass/watch, special mention, substandard, doubtful or loss are reviewed regularly as part of the Company’s risk management practices. The Company’s Loan Quality Committee, which consists of key members of senior management and credit administration, meets monthly or more often, as necessary, to review individual problem credits and workout strategies and makes reports to the Board of Directors.

A loan is considered impaired when it is probable that the Bank will be unable to collect all amounts due (including principal and interest) according to the contractual terms of the note and loan agreement. For purposes of the Company’s analysis, loans which are identified as troubled debt restructures (“TDRs”) or are non-accrual and rated substandard or doubtful are considered impaired. Impaired loans are analyzed individually for the amount of impairment. The Company generally utilizes the fair value of collateral method for collateral dependent loans, which make up the majority of the Company’s impaired loans. A loan is considered to be collateral dependent when repayment of the loan is anticipated to come from the liquidation of the collateral held. For loans that are secured by real estate, external appraisals are obtained annually, or more frequently as warranted, to ascertain a fair value so that the impairment analysis can be updated. Should a current appraisal not be available at the time of impairment analysis, other sources of valuation such as current letters of intent, broker price opinions or executed agreements of sale may be used. For non-collateral dependent loans, the Company measures impairment based on the present value of expected future cash flows, net of disposal costs, discounted at the loan’s original effective interest rate.

Loans to borrowers that are experiencing financial difficulty that are modified and result in the Company granting concessions to the borrower are classified as TDRs and are considered to be impaired. Concessions granted under a troubled debt restructuring generally involve an extension of a loan’s stated maturity date or a reduction of the rate, or payment modifications. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification.

Non-performing loans are monitored on an ongoing basis as part of the Company’s loan review process. Additionally, work-out efforts continue and are actively monitored for non-performing loans and OREO through the Loan Quality Committee. Potential loss on non-performing assets is generally evaluated by comparing the outstanding loan balance to the fair market value of the pledged collateral.

Loans are placed on non-accrual when a loan is specifically determined to be impaired or when management believes that the collection of interest or principal is doubtful. This is generally when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection, or when management becomes aware of facts or circumstances that the loan would default before 90 days. The Company determines delinquency status based on the number of days since the date of the borrower’s last required contractual loan payment. When the interest accrual is discontinued, all unpaid interest is reversed and charged back against current earnings. Any cash payments received are applied, first to the outstanding loan amounts, then to the recovery of any charged-off loan amounts. Any excess is treated as a recovery of lost interest. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured and are current for six consecutive months after modification.

Management actively manages impaired loans in an effort to reduce loan balances by working with customers to develop strategies to resolve borrower issues, through sale or liquidation of collateral, foreclosure, and other appropriate means. If real estate values continue to decline, it is more likely that we would be required to further increase our provision for loan and lease losses, which in turn, could result in reduced earnings.

Under the fair value of collateral method, the impaired amount of the loan is deemed to be the difference between the loan amount and the fair value of the collateral, less the estimated costs to sell. For the Company’s calculations on real estate secured loans, a factor of 10% is generally utilized to estimate costs to sell, which is based on typical cost factors, such as a 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. If the valuation indicates that the fair value has deteriorated below the carrying value of the loan, either the entire loan is written off or the difference between the fair value and the principal balance is charged off. For loans which are considered to be impaired, but for which the value of the collateral less costs to sell exceeds the loan value, the impairment is considered to be zero.

The following table reflects non-performing loans, OREO and performing TDRs at the dates noted:

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	September 30,			December 31,
(in thousands)	2011			2010
Non-accrual loans	$	20,665		$	28,267
Loans past due 90 days or more and still accruing	29			99
Total Non-Performing Loans	20,694			28,366
Other Real Estate Owned	7,830			9,633
Total Non-Performing Loans and OREO	28,524			37,999
Performing TDRs	5,509			2,513
Non-performing loans as a percentage of gross loans	3.04		%	3.74		%

	September 30,		December 31,
(in thousands)	2011		2010
Loans with no allocated allowance for loan and lease losses	$	7,614	$	19,805
Loans with allocated allowance for loan and lease losses	17,050		10,124
Total balance of loans considered impaired	$	24,664	$	29,929

In the nine months ended September 30, 2011, total non-performing loans and OREO decreased $9.5 million, or 24.9%, from $38.0 million at December 31, 2010 to $28.5 million at September 30, 2011, as the effects of the prolonged economic downturn continued to impact individual and business customers of the Company. Non-performing loans and OREO represented 73.3% of shareholders’ equity at September 30, 2011, as compared to 118.5% of shareholders’ equity at December 31, 2010. The decrease in non-performing loans and OREO as a percentage of shareholders’ equity was driven primarily as a result of the $9.5 million reduction in non-performing loans and OREO coupled with an increase in the Company’s equity as a result of a $7.6 million decrease in unrealized holding losses on the Company’s available-for-sale securities.

The additional interest income that would have been earned on non-accrual and restructured loans for the three months ended September 30, 2011 and 2010 in accordance with their original terms approximated $300 thousand and $800 thousand, respectively, and for the nine months ended September 30, 2011 and 2010 approximately $1.7 million and $2.1 million, respectively.

Changes in non-performing loans for the periods indicated are as follows:

	Three Months Ended			Nine Months Ended
(in thousands)	September 30, 2011			September 30, 2011
Balance at beginning of period	$	26,861		$	28,366
Newly placed on non-accrual	744			8,312
Loans past due 90 days or more and still accruing	(45		)	29
Transferred to OREO	(983		)	(3,339		)
Transfer to accruing	(2,979		)	(2,979		)
Additional charge-offs	(680		)	(1,894		)
Loan payments	(498		)	(1,348		)
Loan sold	(1,726		)	(6,453		)
Balance at end of period	$	20,694		$	20,694

During the three months ended September 30, 2011, the non-sold portion of a government guaranteed loan secured by commercial real estate in the amount of $900 thousand and a land development loan secured by a residential subdivision in the amount of $400 thousand were transferred to OREO.

During the three months ended September 30, 2011, a participation in an out of area real estate bridge loan made to a non-Bank related customer in the amount of $1.7 million was sold.

During the three months ended September 30, 2011, loans made to a borrower all secured by commercial real estate in the aggregate amount of $3.0 million were returned to accrual status.

During the nine months ended September 30, 2011, a $7.0 million credit was placed on non-accrual status. This credit represents a commercial loan secured by both commercial real estate and a partial guarantee from a government agency. This credit was written down to $5.8 million as of September 30, 2011. Additionally, $90 thousand of the allowance for loan and lease losses is allocated to this credit.

During the nine months ended September 30, 2011, a term loan and line of credit secured by commercial real estate in the amount of $1.8 million was transferred to OREO.

During the nine months ended September 30, 2011, a land development loan secured by a residential subdivision in the amount of $2.2 million and a participation in an out of area real estate bridge loan which was secured by real estate in the amount of $2.5 million were sold.

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The following table outlines delinquency within the Company’s loan portfolio:

	September 30,		December 31,
	2011		2010
30-59 days	0.63	%	0.52	%
60-89 days	0.24	%	0.16	%
90 + days	0.00	%	0.01	%
Non-accrual	3.04	%	3.74	%
Total delinquencies	3.91	%	4.43	%

Delinquencies for accruing loans remained relatively stable in 2011 compared to 2010 due to transfers of loans to non-accrual and more rigorous collection activity. The increases in the delinquency percentages are predominately attributable to the significant decrease in the Company’ loan portfolio. In its evaluation for the ALLL, management considers a variety of qualitative factors including changes in the volume and severity of delinquencies.

As of September 30, 2011, the Company’s ratio of nonperforming loans to total gross loans was 3.04% compared to the 3.74% reported as of December 31, 2010. The Company continues to acknowledge the weakness in local real estate markets, emphasizing strict underwriting standards to minimize the negative impact of the current environment. The increase in the ratio is primarily a result of the decrease in the loan portfolio.

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Allowance for Loan and Lease Losses

The ALLL represents management’s estimate of probable loan losses inherent in the loan portfolio. The ALLL is analyzed in accordance with GAAP and varies from year to year based on management’s evaluation of the adequacy of the ALLL in relation to the risks inherent in the loan portfolio.

In its evaluation, management considers qualitative factors such as changes in lending policies and procedures, changes in concentrations of credit, the nature and volume of the portfolio, the volume and severity of delinquencies, classified and non-accrual loans, competition and legal and regulatory environments, management capabilities, current local and national economic trends, loan review methodology and Board of Directors oversight, as well as various other factors. Consideration is also given to examinations performed by regulatory authorities and loan review.

Doubtful loans, non-accrual and substandard loans and troubled debt restructurings are considered to be impaired and are analyzed individually to determine the amount of impairment. Circumstances such as construction delays, declining real estate values, and the inability of the borrowers to make scheduled payments have resulted in these loan relationships being classified as impaired. The fair value of collateral method is generally used for this measurement unless the loan is non-collateral dependent in which case, a discounted cash flow analysis is performed. Appraisals are received at least annually to ensure that impairment measurements reflect current market conditions. Should a current appraisal not be available at the time of impairment analysis, other valuation sources including current letters of intent, broker price opinions or executed agreements of sale may be used. Only downward adjustments are made based on these supporting values. Included in all impairment calculations is a cost to sell adjustment of approximately 10%, which is based on typical cost factors, including a 6% broker commission, 1% transfer taxes and 3% various other miscellaneous costs associated with the sales process. Sales costs are periodically revised based on actual experience. The ALLL analysis is adjusted for subsequent events that may arise after the end of the reporting period but before the financial reports are filed.

The Company’s ALLL consists of both specific and general components. At September 30, 2011, the ALLL that related to impaired loans was $1.1 million, or 4.6%, of the total ALLL. The ALLL also included a general allocation of $22.0 million, which represented 95.4% of the total ALLL of $23.1 million. The ratio of the ALLL to total loans at September 30, 2011 and December 31, 2010 was 3.40% and 2.98%, respectively, based on total loans of $680.6 million and $757.9 million, respectively.

The following table presents an allocation of the ALLL and percent of loans in each category at September 30, 2011 and December 31, 2010:

Allocation of the Allowance for Loan Losses

(in thousands)

	September 30, 2011				December 31, 2010
	Amount		Percentage of Loans in Each Category to Total Loans		Amount		Percentage of Loans in Each Category to Total Loans
Residential real estate	$	1,961	12.06	%	$	2,175	11.60	%
Commercial real estate	12,033		37.70	%	9,640		33.82	%
Construction, land acquisition & development	3,041		5.30	%	4,170		10.21	%
Commercial and industrial	4,379		26.02	%	4,851		26.08	%
Consumer	1,403		16.08	%	1,173		14.63	%
State and political subdivision	289		2.84	%	566		3.66	%
Total	$	23,106	100.00	%	$	22,575	100.00	%

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The following table outlines the changes in the allowance for loan and lease losses for the three months and nine months ended September 30, 2011 and 2010:

	Analysis of the Allowance for Loan Losses
	For the three months ended September 30,						For the nine months ended September 30,
(in thousands)	2011			2010			2011			2010

Balance at the beginning of the period	$	23,701		$	27,378		$	22,575		$	22,458

Provision for loan losses	(462		)	7,311			2,047			16,993

Loans Charged Off:
Residential real estate	(871		)	(16		)	(1,152		)	(16		)
Commercial real estate	(252		)	(596		)	(2,085		)	(2,238		)
Construction, land acquisition and development	(171		)	(4,085		)	(177		)	(6,500		)
Commercial and industrial	(52		)	(2,859		)	(176		)	(3,183		)
Consumer	(227		)	(204		)	(564		)	(688		)
State and political subdivisions	—			(1,560		)	—			(1,560		)

Total loans charged-off	(1,573		)	(9,320		)	(4,154		)	(14,185		)

Recoveries:
Residential real estate	20			7			34			18
Commercial real estate	14			117			38			144
Construction, land acquisition and development	1,236			5			2,059			5
Commercial and industrial	72			61			319			70
Consumer	98			64			188			120
State and political subdivisions	—			—			—			—

Total recoveries	1,440			254			2,638			357

Net charge-offs	(133		)	(9,066		)	(1,516		)	(13,828		)

Balance at end of period	$	23,106		$	25,623		$	23,106		$	25,623

Ratio of net charge-offs during the period as a percentage of average loans outstanding during the period	0.02		%	1.03		%	0.21		%	1.52		%
Ratio of allowance for loan losses as a percentage of gross loans at end of period	3.40		%	3.18		%	3.40		%	3.18		%

Other Real Estate Owned

OREO totaled $7.8 million at September 30, 2011, which is a decrease of $1.8 million from $9.6 million at December 31, 2010. OREO consisted of 29 properties at September 30, 2011 and 28 properties at December 31, 2010. Seven of the properties held in OREO at September 30, 2011 totaled $5.0 million and represented 63.3% of the total. Included in OREO are five properties totaling $798 thousand, or 10.2%, of OREO, located outside of the Company’s general market area. Additionally, $6.3 million, or 80.6%, of OREO is located in the Pocono Mountains region located within the Company’s primary market area that has been hit particularly hard during the current economic recession.

The Company is actively marketing these properties for sale through a variety of channels including internal marketing and the use of outside brokers/realtors. The carrying value of OREO is generally calculated at an amount not greater than 90% of the most recent fair market appraised value. A 10% factor is generally used to estimate costs to sell, which is based on typical cost factors, such as 6% broker commission, 1% transfer taxes, and 3% various other miscellaneous costs associated with the sales process. This market value is updated on an annual basis or more frequently if new valuation information is available. Further deterioration in the real estate market could result in additional losses on these properties.

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The following table reflects the roll forward of OREO for the nine months ended September 30, 2011 and 2010:

	September 30,
(in thousands)	2011			2010
Balance, beginning of year	$	9,633		$	11,184
Additions	3,339			5,782
Write-downs	(1,134		)	(2,533		)
Carrying value of OREO sold	(4,008		)	(3,248		)
Balance, end of period	$	7,830		$	11,185

The following table reflects a breakdown of OREO for the periods presented:

	September 30,		December 31,
(in thousands)	2011		2010

Land/Lots	$	5,551	$	8,357
Commercial Real Estate	2,101		1,086
Residential Real Estate	178		190
Total	$	7,830	$	9,633

Liabilities

Total liabilities were $1.09 billion at September 30, 2011, a decrease of $44.7 million, or 3.9%, from $1.14 billion at December 31, 2010. The decrease is primarily attributable to the decrease in borrowed funds, which decreased $50.2 millon, or 36.5%, as the Company used the proceeds generated by net loan repayments to pay down FHLB advances.

Equity

Total shareholders’ equity increased $6.9 million, or 21.5%, to $38.9 million at September 30, 2011 from $32.1 million at December 31, 2010. The increase is primarily due to a $7.6 million reduction in accumulated other comprehensive loss from $12.1 million at December 31, 2010 to $4.5 million at September 30, 2011. The decrease in accumulated other comprehensive loss was primarily attributed to the increase in the fair value of securities held in the available-for-sale portfolio. Book value per common share was $2.37 at September 30, 2011 compared to $1.95 at December 31, 2010.

Liquidity

The term liquidity refers to the ability of the Company to generate sufficient amounts of cash to meet its cash flow needs. Liquidity is required to fulfill the borrowing needs of the Company’s credit customers and the withdrawal and maturity requirements of its deposit customers, as well as to meet other financial commitments. Cash and cash equivalents (cash and due from banks and federal funds sold) are the Company’s most liquid assets. At September 30, 2011, cash and cash equivalents totaled $173.6 million, an increase of $99.1 million from $74.5 million at December 31, 2010. Investing activities provided $143.7 million and operating activities provided $16.3 million of cash and cash equivalents during the year, while financing activities utilized $50.8 million. The cash flows provided by investing activities were largely attributable to the proceeds from sales of investment securities totaling $50.6 million, proceeds from maturities, calls and principal payments of investment securities totaling $22.1 million, and net decrease in loans to customers totaling $68.6 million. The $50.8 million used by financing activities was primarily attributed to $50.0 million of net repayments of FHLB borrowings. The funds provided by operating activities pertain to interest payments received on loans and investments.

Interest Rate Risk

Our consolidated statements of financial position have been prepared in accordance with U.S. GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering the changes in fair value of certain investments due to changes in interest rates. Generally, the fair value of financial investments such as loans and securities fluctuates inversely with changes in interest rates. As a result, increases in interest rates could result in decreases in the fair value of our interest-

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earning assets which could adversely affect our results of operation if such assets were sold, or, in the case of securities classified as available-for-sale, decreases in our shareholders’ equity, if such securities were retained.

We manage the mix of interest-earning assets and interest-bearing liabilities on a continuous basis to maximize return and adjust our exposure to interest rate risk. This report quantifies the potential changes in net interest income and net portfolio value should interest rates go up or down (shocked) 200 basis points, assuming the yield curves of the rate shocks will be parallel to each other. Net portfolio value is defined as the market value of assets net of the market value of liabilities. The fair value of assets and liabilities is determined using a discounted cash flow calculation. The net portfolio value ratio is the ratio of the net portfolio value to the market value of assets. All changes in income and value are measured as percentage changes from the projected net interest income and net portfolio value at the base interest rate scenario. The base interest rate scenario assumes interest rates at September 30, 2011. Various estimates regarding prepayment assumptions are made at each level of rate shock. However, prepayment penalty income is excluded from this analysis. Actual results could differ significantly from these estimates.

The following table illustrates the simulated impact of a 200 basis point upward or downward movement in interest rates on net interest income and the change in economic value. This analysis assumed that interest-earning asset and interest-bearing liability levels at September 30, 2011 remained constant. The impact of the rate movements were developed by simulating the effect of rates changing over a three-month period from the September 30, 2011 levels.

	RATES + 200		RATES – 200
Earnings at risk:
Percent change in net interest income	3.71	%	(12.39	)%

Economic value at risk:
Percent change in economic value of equity	(16.35	)%	4.64	%

Off-Balance Sheet Arrangements

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with U.S. GAAP, are not recorded in our consolidated financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers’ requests for funding.

For the three and nine month periods ended September 30, 2011, the Company did not engage in any off-balance sheet transactions that would have or would be reasonably likely to have a material effect on its consolidated financial condition.

ITEM 3 — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the company’s exposure to market risk during the first nine months of 2011. For discussion of the Company’s exposure to market risk, refer to Item 7A, Quantitative and Qualitative Disclosure about Market Risk, contained in the Company’s Form 10-K, for the year ended December 31, 2010.

ITEM 4 — CONTROLS AND PROCEDURES

As of September 30, 2011, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). The Company had previously reported that, as of December 31, 2010, it had identified a material weaknesses in its internal control over financial reporting as described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. While the Company made progress in remediating the deficiencies in its internal controls over financial reporting relating to the weaknesses noted in its 2010 Annual Report, all actions were not fully implemented and there was an insufficient period of time to determine whether those processes that were implemented were operating effectively as of September 30, 2011. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of the end of the period covered by this report.

The Company’s weaknesses will not be considered remediated until new internal controls are operational for a sufficient period of time and are tested, and management concludes that these controls are operating effectively. The Company is not aware of any transactions that were improperly undertaken as a result of the material

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weaknesses described in its Annual Report and therefore does not believe that the material weaknesses had any material impact on the Company’s financial statements.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits to the SEC under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are only being made in accordance with authorizations of management and directors of the Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements. Due to inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.

The Company continually seeks to improve the effectiveness and efficiency of its internal control over financial reporting, resulting in frequent process refinements. Except for refinements necessary to correct the deficiencies identified in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, there have been no changes to the Company’s internal control over financial reporting during the quarter ended March 31, 2011that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II Other Information

Item 1 — Legal Proceedings.

Periodically, there have been various claims and lawsuits against the Company, such as claims to enforce liens, condemnation proceedings on properties in which the Company holds security interests, claims involving the making and servicing of real property loans and other issues incident to its business. On August 8, 2011, the Company announced that it has received document subpoenas from the SEC. The information requested generally relates to disclosure and financial reporting by the Company and the restatement of the Company’s financial statements for the year ended December 31, 2009, and the quarters ended March 31, 2010 and June 30, 2010. The Company is cooperating with the SEC in this matter. The Company is not a party to any pending legal proceedings that the Company believes would have a material adverse effect on its financial condition, results of operations or cash flows.

On May 24, 2012, a putative shareholder by the name of Lori Gray filed a complaint in the Court of Common Pleas in Lackawanna County against certain present and former directors of the Company (including all of the current directors except for Steven R. Tokach and Thomas J. Melone) and Demetrius & Company, LLC (‘Demetrius”) alleging, inter alia breach of fiduciary duty, abuse of control, corporate waste, unjust enrichment and, in the case of Demetrius, professional negligence, negligent misrepresentation, breach of contract and aiding and abetting breach of fiduciary duty. The Company has been named as a nominal defendant. This matter is in a preliminary stage. In January 2012, the Board appointed a special litigation committee to investigate the matters raised in the Gray complaint. The special litigation committee retained independent counsel to assist with the investigation. The Company is not a party to any pending legal proceedings that the Company believes would have a material adverse effect on its financial condition, results of operations or cash flows.

Item 1A. — Risk Factors.

Management of the Company does not believe there have been any material changes in the risk factors that were previously disclosed in the Company’s amended Form 10-K for the year ending December 31, 2010.

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3 - Defaults upon Senior Securities.

None.

Item 4 — Mine Safety Disclosures

Note applicable

Item 5 - Other Information.

None.

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Item 6 — Exhibits.

Exhibit 3.1		Amended and Restated Articles of Incorporation (Incorporated by reference to Exhibit 3.1 of the Company’s Form 10-K for the year ended December 31, 2005)
Exhibit 3.2		Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.2 of the Company’s Form 8-K filed on April 6, 2012)
Exhibit 4.1		Form of Subordinated Note (Incorporated by reference to Exhibit 4.1 of the Company’s Form 10-Q filed with the Commission on August 28, 2009)
Exhibit 4.2		Form of Common Stock Certificate of the Company (Incorporated by reference to Exhibit 4.1 of the Company’s Form 10-K for the year ended December 31, 2009)
Exhibit 31.1*		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Exhibit 31.2*		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
Exhibit 32.1+		Certification of Chief Executive Officer and Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
Exhibit 101.INS		XBRL Instance Doucment
Exhibit 101.SCH		XBRL Taxonomy Extension Schema
Exhibit 101.CAL		XBRL Taxonomy Extension Calculation Linkbase
Exhibit 101.DEF		XBRL Taxonomy Extension Definition Linkbase
Exhibit 101.LAB		XBRL Taxonomy Extension Label Linkbase
Exhibit 101.PRE		XBRL Taxonomy Extension Presentation Linkbase

* Filed herewith

+ Furnished Herewith

Table of Contents

SIGNATURES

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

Registrant: FIRST NATIONAL COMMUNITY BANCORP, INC.

Date: August 10, 2012	By:	/s/ Steven R. Tokach
	Steven R. Tokach
	President and Chief Executive Officer


Date: August 10, 2012	By:	/s/ Edward J. Lipkus
	Edward J. Lipkus
	Chief Financial Officer
	Principal Financial Officer