Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of the Company. The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and accompanying notes thereto.

Forward Looking Statements

This Form 10-Q contains certain "forward-looking statements" which may be identified by the use of words such as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors that could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, the effect of the current severe disruption in financial markets and the United States government programs introduced to restore stability and liquidity, changes in interest rates, general economic conditions and the weakening state of the United States economy, deposit flows, demand for mortgage and other loans, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing of products and services.

Critical Accounting Policies and Use of Significant Estimates

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. Management believes the following discussion addresses our most critical accounting policies and significant estimates, which are those that are most important to the portrayal of our financial condition and results and require management's most difficult, subjective and complex judgements, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Allowance for Loan Losses - The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses. The allowance is based upon past loan experience and other factors which, in management's judgement, deserve current recognition in estimating loan losses. The evaluation includes a review of all loans on which full collectibility may not be reasonably assured. Other factors considered by management include the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions and historical losses on each portfolio category. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties, which collateralize loans. Management uses the available information to make such determinations. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. While we believe we have established our existing allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request an increase in the allowance for loan losses. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary if loan quality deteriorates.

Other Real Estate Owned - Other real estate owned acquired through loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing fair value when the asset is acquired, the actual fair value of the other real estate owned could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, the asset is written down through a charge to non-interest expense. Operating costs associated with the assets after acquisition are also recorded as non-interest expense. Gains and losses on the disposition of other real estate owned are netted and posted to non-interest expense.

Deferred Income Tax Assets/Liabilities - Our net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine that they are realizable based upon the historical level of our taxable income, estimates of our future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on our future profitability. If we were to experience net operating losses for tax purposes in a future period, the realization of our deferred tax assets would be evaluated for a potential valuation reserve.

Impairment of Goodwill - Goodwill, an intangible asset with an indefinite life, was recorded on our balance sheet in prior periods as a result of acquisition activity. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently.

Mortgage Servicing Rights - Mortgage servicing rights are very sensitive to movements in interest rates as expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise.

Fair Value Measurements - The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Company estimates the fair value of financial instruments using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Company estimates fair value. Other factors such as model assumptions and market dislocations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded.

FASB Statement No. 157, Fair Value Measurements, establishes a framework for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and establishes a three-level hierarchy for determining fair value based upon transparency of inputs to each valuation as of the fair value measurement date. The three levels are defined as follows:

? Level 1 - quoted prices (unadjusted) for identical assets or liabilities in active markets
? Level 2 - inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. ? Level 3 - inputs that are unobservable and significant to the fair value measurement.

At the end of each quarter, the Company assesses the valuation hierarchy for each asset or liability measured. From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date. Transfers into or out of a hierarchy are based upon the fair value at the beginning of the reporting period.

The above listing is not intended to be a comprehensive list of all our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States of America, with no need for management's judgement in their application. There are also areas in which management's judgement in selecting any available alternative would not produce a materially different result.

Federal Deposit Insurance Corporation Insurance Coverage

As with all banks insured by the Federal Deposit Insurance Corporation ("FDIC"), the Company's depositors are protected against the loss of their insured deposits by the FDIC. The FDIC recently made two changes to the rules that broadened the FDIC insurance. On October 3, 2008, the FDIC temporarily increased basic FDIC insurance coverage from $100,000 to $250,000 per depositor until December 31, 2009. In addition, on October 14, 2008 the FDIC instituted a Temporary Liquidity Guaranty Program ("TLGP") which provides full deposit coverage for non-interest bearing transaction deposit accounts, regardless of dollar amount. The FDIC defines a "non-interest bearing transaction account" as a transaction account on which the insured depository institution pays no interest and does not reserve the right to require advance notice of intended withdrawals. This coverage is over and above the $250,000 in coverage otherwise provided to a customer.

The Company has chosen to participate in the TLGP. The additional cost of this program, assessed on a quarterly basis, is a 10 basis point annualized surcharge (2.5 basis points quarterly) on balances in non-interest bearing transaction accounts that exceed $250,000. The Company does not believe this amount will have a material effect on its consolidated financial statements.

Financial Condition

March 31, 2009 Compared to December 31, 2008

Total assets increased $9.5 million to $297.8 million at March 31, 2009 from $288.3 million at December 31, 2008. Net loans decreased $2.1 million to $180.8 million at March 31, 2009. Available-for-sale investment securities decreased $5.7 million primarily due to $5.5 million in calls of U.S. agency bonds. Mortgage-backed securities increased $6.6 million during this same time frame, mostly due to the reinvestment of funds from investment calls. Cash and cash equivalents increased $11.1 million, mostly comprised of an $11.4 million increase in federal funds sold, due to deposit growth and the timing of investment cash flows. Deposits grew $19.1 million during the first quarter of 2009. Other borrowings decreased $10.5 million primarily due to the repayment of $8.5 million in advances from the Federal Home Loan Bank during the first quarter of 2009.

Stockholders' equity equaled $24.3 million at March 31, 2009 and 2008. Changes in stockholders' equity include net income of $501,000, partially offset by the payment of $66,000 in dividends, and a $51,000 increase in unrealized gains, net of tax, on available-for-sale securities. The change in unrealized gains on available-for-sale securities is driven by market conditions and, therefore, can fluctuate daily. Stockholders' equity was also affected by the purchase of $486,000 in common stock during the first quarter of 2009.

Results of Operations

Comparison of Operating Results for the Three Months Ended March 31, 2009 and 2008

General: Net income for the three months ended March 31, 2009 was $501,000, or $0.26 per common share, basic and diluted. Net income was $363,000, or $0.19 per common share, basic and diluted, for the three months ended March 31, 2008. Shares outstanding at March 31, 2009 and 2008 were 1,920,817 and 1,987,904, respectively. The increase of $138,000 is due to increases of $446,000 in net interest income and $108,000 in other income, partially offset by increases of $320,000 in the provision for loan losses, $76,000 in other expense and $20,000 in income taxes. The Company's operations benefited from the steepening of the yield curve, as lower short-term market rates of interest resulted in our deposits repricing faster than our loans, which have yields tied to longer-term rates.

Interest Income: Total interest income for the three months ended March 31, 2009 decreased $282,000 from the same period of 2008. The decrease in interest income reflects decreases in interest income of $122,000 on loans, $78,000 on investment securities, and $115,000 on other interest-earning assets, partially offset by an increase of $33,000 in interest on mortgage-backed securities.

Interest income on loans decreased $122,000 primarily due to a decrease in the average yield to 6.46% during the first quarter of 2009 from 6.97% during the first quarter of 2008. The 51 basis point decrease, primarily reflecting a decrease in market rates, was partially offset by an increase of $6.6 million in the average balance of the loan portfolio to $184.5 million during this same time frame. The increase in the average balance of the portfolio is primarily due to an increase in the commercial real estate portion of the loan portfolio.

The $78,000 decrease in interest income on investment securities reflects a decrease of $8.6 million in the average balance of the portfolio to $46.6 million during the first quarter of 2009, as compared to the first quarter of 2008. The decrease in the average balance is primarily due to calls of U.S. agency securities, the majority of which have been reinvested into tax-free municipal bonds, as well as mortgage-backed securities. The average balance of municipal securities increased $10.2 million during this same time frame. The average yield of investment securities increased 6 basis points to 3.97% from 3.91% during the first quarter of 2009 and 2008, respectively. This reported yield does not reflect the benefit of the higher tax-equivalent yield of the municipal bonds, which is reflected in income tax expense.

Interest income on mortgage-backed securities increased $33,000 during the first quarter of 2009 compared to the first quarter of 2008. The increased interest income on mortgage-backed securities reflects an increase of $4.0 million in the average balance of mortgage-backed securities to $27.9 million during the first quarter of 2009. The growth in mortgage-backed securities has been funded by calls of investment securities. The increase in the average balance was partially offset by a 24 basis point decrease in the average yield of mortgage-backed securities to 4.72% during the three months ended March 31, 2009, compared to the same period of 2008.

Interest income on other interest-earning assets, which consist of interest-earning deposit accounts and federal funds sold, decreased during the first quarter of 2009 primarily due to a 269 basis point decrease in the average yield. The average yield of these other interest-earning assets decreased to 0.19% during the first quarter of 2009 from 2.88% during the first quarter of 2008, reflecting the decrease in short-term market rates. The average balance of these accounts decreased $7.4 million to $9.2 million for the three months ended March 31, 2009 compared to the three months ended March 31, 2008.

Interest Expense: Total interest expense for the three months ended March 31, 2009 decreased $728,000 compared to the three months ended March 31, 2008. The lower interest expense was due to decreases of $635,000 in the cost of deposits and $93,000 in interest expense on borrowed funds.

The decrease in the cost of deposits is primarily due to a decrease in the average rate paid, which decreased to 2.53% during the first quarter of 2009 from 3.53% during the first quarter of 2008. The 100 basis point decrease reflects the decrease in short-term market rates during 2008. Interest expense also benefited from a decrease of $7.3 million in the average balance of deposits during this same time frame. The decrease was mostly due to a decrease of $6.1 million in the average balance of time deposits.

Interest paid on borrowed funds decreased $94,000 primarily due to a 269 basis point decrease in the average rate. The average rate paid on borrowed funds decreased to 1.52% during the first quarter of 2009 compared to 4.21% during the first quarter of 2008, reflecting the decrease in market rates. The average balance of borrowed funds also decreased to $13.6 million during the first quarter of 2009 compared to $13.8 million during the same period of 2008.

Provision for Loan Losses: The provision for loan losses is determined by management as the amount needed to replenish the allowance for loan losses, after net charge-offs have been deducted, to a level considered adequate to absorb inherent losses in the loan portfolio, in accordance with accounting principles generally accepted in the United States of America. The following table shows the activity in the allowance for loan losses for the three months ended March 31, 2009 and 2008.

                                                       Three Months Ended
                                              March 31, 2009        March 31, 2008
                                                         (In thousands)
   Balance at beginning of period            $          1,934      $          1,766
   Charge-offs:
   One-to-four family residential                           4                    31
   Automobile                                               -                     2
   Other Consumer                                           5                     -
   Total                                                    9                    33
   Recoveries:
   Commercial and agricultural real estate                  1                     1
   Home equity/home improvement                             1                     2
   Automobile                                               4                     2
   Other Consumer                                           1                     2
   Total                                                    7                     7
   Net loans charged off                                    2                    26
   Provision expense                                      350                    30
   Balance at end of period                  $          2,282      $          1,770

The allowance for loan losses increased to $2.3 million at March 31, 2009 from $1.9 million at December 31, 2008. The increase of $348,000 is the result of the provision for loan losses exceeding net charge-offs during the first quarter of 2009. Net charge-offs decreased to $2,000 during the first quarter of 2009 compared to net charge-offs of $26,000 during the first quarter of 2008. The provision for loan losses equaled $350,000 during the first quarter of 2009, compared to $30,000 during the first quarter of 2008. Provisions for loan losses have been made to bring the allowance for loan losses to a level deemed adequate following management's evaluation of the repayment capacity and collateral protection afforded by each problem credit identified by management. This review also considered the local economy and the level of bankruptcies and foreclosures in the Company's market area. The following table sets forth information regarding nonperforming assets at the dates indicated.

                                                                        December
                                                   March 31, 2009       31, 2008
                                                           (In thousands)
   Non-accruing loans:
   One-to-four family residential                 $            813     $       445
   Commerical and agricultural real estate                      32              34
   Multifamily residential real estate                         146             152
   Commercial and agricultural business                        253              48
   Home equity/Home improvement                                384             318
   Automobile                                                   13               3
   Other consumer                                                9               5
   Total                                          $          1,650     $     1,005

   Accruing loans delinquent more than 90 days:
   One-to-four family residential                 $              -     $       163
   Automobile                                                    -              18
   Other consumer                                                4               5
   Total                                          $              4     $       186

   Foreclosed assets:
   One-to-four family residential                 $            188     $       565
   Commercial and agricultural real estate                     140             204
   Automobiles                                                   -               9
   Total                                          $            328     $       778

   Total nonperforming assets                     $          1,982     $     1,969

   Total as a percentage of total assets                      0.67 %          0.68 %

The increase in non-accruing one-to-four family residential and commercial business loans is primarily due to the delinquency of one borrower with loans totaling $526,000. These loans are both well secured and in the process of collection, with no loss anticipated.

The following table shows the aggregate principal amount of potential problem credits on the Company's watch list at March 31, 2009 and December 31, 2008. All non-accruing loans are automatically placed on the watch list. The increase in Special Mention credits reflects the addition of four large commercial and commercial real estate borrowers. As of March 31, 2009, each of these loans was current and being monitored by management.

                                     March 31, 2009       December 31, 2008
                                                 (In thousands)
          Special Mention credits    $        10,133     $             7,369
          Substandard credits                  2,665                   2,388
          Total watch list credits   $        12,798     $             9,757

Other Income: Total other income for the three months ended March 31, 2009 increased $108,000 from the comparable period in 2008. The increase in other income is primarily attributed to increases of $237,000 in net income from mortgage banking operations and $59,000 in gains on sales of securities, partially offset by a $163,000 decrease in commission income. The increase in mortgage banking income is due to a higher volume of sales of $32.7 million to the secondary market during the first quarter of 2009, compared to $10.3 million during the same period of 2008. The decrease in commission income reflects current market conditions.

Other Expense: Total other expense for the three months ended March 31, 2009 increased $76,000 from the same period of 2008. The increase in other expense is mainly comprised of an increase of $99,000 in FDIC deposit insurance assessments, partially offset by a decrease of $34,000 in data processing expense. FDIC increased its deposit insurance rates for 2009. The Company has also exhausted its one-time assessment credit, which offset 90% of the FDIC premiums assessed during 2008.

On February 27, 2009, the FDIC adopted a final rule modifying the risk-based assessment system and setting initial base assessment rates beginning April 1, 2009, at 12 to 45 basis points. The new rates take effect during the second quarter of 2009 and are expected to result in an increase of approximately $75,000 per quarter during 2009. On this same date, the FDIC announced it had adopted an interim rule to impose a 20 basis point emergency special assessment on June 30, 2009, which will be collected on September 30, 2009. The interim rule also provides that an additional emergency assessment of up to 10 basis points may be imposed if the reserve ratio of the Deposit Insurance Fund is estimated to fall to a level that the FDIC believes would adversely affect public confidence or to a level which shall be close to zero or negative at the end of a calendar quarter. The 20 basis point assessment is based upon the institution's assessment base which is total deposits. If the June 30, 2009 assessment base is consistent with March 31, 2009, the special assessment would approximate $515,000 in additional expense for the second quarter of 2009. The FDIC has indicated that it would reduce the level of the special assessment to 10 basis points if Congress approves legislation to expand the FDIC's borrowing capacity.

Income Taxes: The provision for income taxes increased $21,000 during the first quarter of 2009 compared to the same period of 2008. The increase in the tax provision reflects an increase in taxable income due to higher income, net of an increase in the benefit of tax-exempt investment income. The effective tax rate equaled 19.50% and 21.66% for the first quarters of 2009 and 2008, respectively.

Liquidity and Capital Resources

The Company's most liquid assets are cash and cash equivalents. The levels of these assets are dependent on the Company's operating, financing, and investing activities. At March 31, 2009 and December 31, 2008, cash and cash equivalents totaled $18.3 million and $7.1 million, respectively. The Company's primary sources of funds include principal and interest repayments on loans (both scheduled payments and prepayments), maturities of investment securities and principal repayments from mortgage-backed securities (both scheduled payments and prepayments). During the past three months, the most significant sources of funds have been growth in deposits and calls of investment securities. These funds have been used primarily for purchases of municipal and mortgage-backed securities.

While scheduled loan repayments and proceeds from maturing investment securities and principal repayments on mortgage-backed securities are relatively predictable, deposit flows and prepayments are more influenced by interest rates, general economic conditions, and competition. The Company attempts to price its deposits to meet asset-liability objectives and stay competitive with local market conditions.

Liquidity management is both a short- and long-term responsibility of management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected purchases of . . .