Chino Commercial Bancorp - Quarter Report: 2009 March (Form 10-Q)

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

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 (X232.405 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 ¨ No

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

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller Reporting Company þ

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes þ No

2

3

4

5

6

7

Note 1 – The Business of Chino Commercial Bancorp

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

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

The Company’s Administrative Offices are located at 14345 Pipeline Avenue, Chino, California 91710 and the telephone number is (909) 393-8880. References herein to the “Company” include the Company and its consolidated subsidiary, unless the context indicates otherwise.

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

Note 2 – Basis of Presentation and Consolidation

The accompanying unaudited consolidated financial statements for the three months ended March 31, 2009 and 2008 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements. They do not, however, include all of the information and footnotes required by such accounting principles for complete financial statements. In the opinion of management, all adjustments including normal recurring accruals considered necessary for a fair presentation have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for any other interim period or for the year as a whole. Certain prior period amounts have been reclassified to conform to current period classification. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission.

Note 3 – Recent Accounting Pronouncements:

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather, provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. The Company adopted SFAS 157 on January 1, 2008. The FASB approved a one-year deferral for the implementation of the Statement for non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company adopted the provisions of SFAS 157 for non-financial assets and liabilities as of January 1, 2009 without a material impact on the consolidated financial statements.

8

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)). The Standard significantly changed the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes principles for how an acquirer recognizes and measures the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisition dates on or after the beginning of an entity’s first year that begins after December 15, 2008. The Company does not expect the implementation of SFAS 141(R) to have a material impact on its consolidated financial statements, at this time.

In April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP FAS 141(R)-1 amends and clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of FSP FAS 141(R)-1 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. The FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. Earlier adoption is permitted for periods ending after March 15, 2009. The Company does not expect the adoption of FSP FAS 157-4 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. In addition, the FSP amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. The Company does not expect the adoption of FSP FAS 107-1 and APB 28-1 to have a material impact on its consolidated financial statements.

In April 2009, the FASB issued FSP FAS 115-1 and FAS 124-1, “Recognition and Presentation of Other-Than-Temporary Impairments.” FSP FAS 115-1 and FAS 124-1 amend other-than-temporary impairment guidance for debt securities to make guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-1 and FAS 124-1 are effective for interim and annual periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. The Company does not expect the adoption of FSP FAS 115-1 and FAS 124-1 to have a material impact on its consolidated financial statements.

In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (SAB 111). SAB 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities.” SAB 111 maintains the SEC Staff’s previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. The Company does not expect the implementation of SAB 111 to have a material impact on its consolidated financial statements.

Note 4 – Stock Based Compensation

Under the Company’s stock option plan, the Company may grant incentive stock options to officers and employees, and non-qualified stock options to its directors, officers and employees. At March 31, 2009 and 2008, 108,405

9

options were available for granting. At March 31, 2009 and 2008, 97,394 and 113,433 options, respectively, were outstanding. The Plan provides that the exercise price of these options shall not be less than the market price of the common stock on the date granted. Incentive options begin vesting after one year from date of grant at a rate of 33% per year. Non-qualified options vest as follows: 25% on the date of the grant, and 25% per year thereafter. All options expire 10 years after the date of grant. Effective January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based Payment, which requires that compensation cost relating to share-based payment transactions be recognized in the financial statements with measurement based upon the fair value of the equity or liability instruments issued. Based on the stock-based compensation awards outstanding for the three months ended March 31, 2009 and 2008, there was no stock-based compensation to expense.

There were no options granted during the three months ended March 31, 2009 or 2008. The most recent grant of options occurred in 2003.

Note 5 - Earnings per share (EPS)

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

The weighted-average number of shares used in computing basic and diluted earnings per share is as follows:

Note 6 - Off-Balance-Sheet Commitments

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

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. At March 31, 2009 and December 31, 2008, the Company had $6.1 million and $4.9 million, respectively, of off-balance sheet commitments to extend credit. These commitments represent a credit risk to the Company. At March 31, 2009 and December 31, 2008, the Company had $3,000 and $128,000, respectively, in unadvanced standby letters of credit.

Commitments to grant loans are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may

10

require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, equipment, income-producing commercial properties, residential properties, and properties under construction.

Note 7 – Fair Value Measurement

Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157), defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

•  Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

•  Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, 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 to the valuation methodology are unobservable and significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities available for sale

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, securities are classified within Level 2 of the valuation hierarchy and fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s securities available for sale are considered to be Level 2 securities.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2009.

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

11

Loans held for sale

Loans held for sale are required to be measured at the lower of cost or fair value. Under SFAS 157, market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions. Premiums received or to be received on the quotes or bids are indicative of the fact that cost is lower than fair value. At March 31, 2009, there were no loans held for sale.

Impaired loans

SFAS 157 applies to loans measured for impairment using the practical expedients permitted by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, including impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisal or independent valuation which is then adjusted for the cost related to liquidation of the collateral. The Company had no impaired loans at March 31, 2009.

Other Real Estate Owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of SFAS 157.

The following table summarizes the Company’s other real estate owned that were measured at fair value on a nonrecurring basis during the period.

12

This discussion focuses primarily on the results of operations of the Company and its consolidated subsidiary on a consolidated basis for the three months ended March 31, 2009 and 2008, and the financial condition of the Company as of March 31, 2009 and December 31, 2008.

Management’s discussion and analysis is written to provide greater insight into the results of operations and the financial condition of the Company and its subsidiary. For a more complete understanding of the Company and its operations, reference should be made to the consolidated financial statements included in this report and in the Company's 2008 Annual Report on Form 10-K.

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

Critical Accounting Policies

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the Company’s financial statements and accompanying notes. Management believes that the judgments, estimates and assumptions used in preparation of the Company’s financial statements are appropriate given the factual circumstances as of March 31, 2009.

Various elements of the Company’s accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Critical accounting policies are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Company’s results of operation. In particular, management has identified one accounting policy that, due to judgments, estimates and assumptions inherent in this policy, and the sensitivity of the Company’s financial statements to those judgments, estimates and assumptions, is critical to an understanding of the Company’s financial statements. This policy relates to the methodology that determines the Company’s allowance for loan losses. Management has discussed the development and selection of this critical accounting policy with the Company’s Audit Committee of the Board of Directors. Although Management believes the level of the allowance at March 31, 2009 is adequate to absorb losses inherent in the loan portfolio, a further decline in the regional economy may result in increasing losses that cannot reasonably be predicted at this time. For further information regarding the allowance for loan losses and related methodology see “Comparison of Financial Condition at March 31, 2009 and December 31, 2008 – Allowance for Loan Losses” included elsewhere herein.

13

Overview of the Results of Operations and Financial Condition

Results of Operations Summary

Net income for the quarter ended March 31, 2009 was $119,269 compared with $41,471 for the quarter ended March 31, 2008, an increase of 187.6% . Basic and diluted earnings per share for the first quarter of 2009 were $0.17 and $0.16, compared to $0.06 and $0.05 for the first quarter of 2008. The Company’s annualized return on average equity was 7.66% and annualized return on average assets was 0.57% for the quarter ended March 31, 2009, compared to a return on equity of 2.82% and a return on assets of 0.22% for the quarter ended March 31, 2008. The primary reasons for the change in net income during the quarter of 2009 are as follows:

Financial Condition Summary

The Company’s total assets were $88.9 million at March 31, 2009, an increase of $5.5 million, or 6.6% as compared to total assets of $83.4 million at December 31, 2008. The most significant changes in the Company’s consolidated balance sheet during the first quarter of 2009 are outlined below:

Earnings Performance

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

14

For the first quarter ended March 31, 2009, net interest income declined $62,286, or 7.0% to $822,299 in 2009 from $884,585 in 2008. The level of net interest income depends on several factors in combination, including growth in earning assets, yields on earning assets, the cost of interest-bearing liabilities, the relative volumes of earning assets and interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. Occasionally, net interest income is also impacted by the recovery of interest on loans that have been on non-accrual and are either sold or returned to accrual status, or by the reversal of accrued but unpaid interest for loans placed on non-accrual status. The Company’s net interest income, net interest margin, and interest spread are sensitive to general business and economic conditions, including short-term and long-term interest rates, inflation, monetary supply, and the strength of the economy, and the local economics in which the Company conducts business. When net interest income is expressed as a percentage of average earning assets, the results is the net interest margin.

The following tables set forth certain information relating to the Company for the three months ended March 31, 2009 and 2008. The yields and costs are derived by dividing income or expense by the corresponding average balances of assets or liabilities for the periods shown below. Average balances are derived from average daily balances. Yields include fees that are considered adjustments to yields.

¹ Amortization of loan fees are included in the calculation of interest income. Loan fees were approximately $9,060 for the three months ended March 31, 2009 as compared to $9,900 for the three months ended March 31, 2008. Loans are net of deferred fees and related direct costs.

15

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

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

⁴ Average Yield/Rate is based upon actual days in reporting period and based on actual days in the reporting year.

Rate/Volume Analysis

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

As shown above, the pure volume variance negatively impacted net interest income by $53,000 in the first quarter of 2009 relative to the same period of 2008, while the rate variance negatively impacted net interest income by $10,000 for the same comparative period.

The net interest margin was 4.45% for the three months ended March 31, 2009 as compared to 5.30% for the same period in 2008 due principally to a drop in the interest rates and an increase in interest expense due to an increase in average balances of interest-bearing deposits.

Average loans decreased $4.4 million or 8.2% for the first quarter of 2009 compared with the same period of 2008. Interest and fee income on loans decreased $93,098. The decrease in average loans resulted in approximately $73,000 decrease in interest income from loans, while the decrease in interest rate resulted in approximately $20,000 decrease in income. The average yield on loans declined from 7.43% for the quarter ended March 31, 2008 to 7.39% for the quarter ended March 31, 2009.

Income from investment securities and time deposits due from banks for the quarter ended March 31, 2009 increased by $91,481 in comparison to the quarter ended March 31, 2008. The primary contributing factor to the increased interest income from other securities and time deposits due from banks was due to the increase in the

16

average balance of due from banks time of $14.7 million. The volume increase in investment securities and time deposits due from banks contributed approximately $108,000, while the decreased rate variance negatively impacted income by approximately $17,000. The Company reduced its investment in Federal funds sold due to the lowered interest rates. The reduction in Federal funds sold balances caused a reduction of interest income of approximately $12,000, while the rate decrease caused a further decline in interest income of approximately $13,000 from Federal funds sold for the first quarter of 2009 as compared to the same quarter in 2008. The average yield for Federal funds sold declined from 3.48% for the quarter ended March 31, 2008 to 0.21% for the same period in 2009.

Average interest bearing liabilities increased $11.8 million in the first quarter of 2009 as compared to the first quarter of 2008. The Company experienced continued migration of existing deposits to higher yielding accounts and higher yielding accounts opened by new customers resulting in increases in money market and time account balances. The increase in average interest bearing deposits resulted in approximately a $78,000 increase in interest expense which was partially offset by a decrease of approximately $13,000 resulting a decline in rates in the first quarter of 2009 as compared to the first quarter of 2008.

Provision for Loan Losses

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

The provision for loan losses was $16,151 for the three months ended March 31, 2009 as compared to $234,631 for the three months ended March 31, 2008. No principal losses have been reported as of March 31, 2009. The allowance for loan losses was $718,762 or 1.47% of gross loans receivable at March 31, 2009 as compared to $702,409 or 1.41% of gross loans receivable at December 31, 2008 and $1,029,860 or 1.93% of gross loans receivable at March 31, 2008. The Company increased its loan loss provision during the first quarter of 2008 due to credit quality concerns stemming from deteriorating economic conditions, increased weakness in the real estate sector, and the increase in charged-off loans. At March 31, 2009, the Company had no nonperforming loans as compared to one nonperforming loan of $412,343, or 0.83% of total loans at December 31, 2008. Nonperforming loans were $1.2 million or 2.25% of total loans at March 31, 2008.

The Company experienced no credit losses in the first quarter of 2009, and received a recovery for one loan which was charged off in 2008. The Company has not originated, and has no exposure to, sub-prime mortgage loans, or option ARM mortgages.

Non-Interest Income

Non-interest income was $247,452 for the three months ended March 31, 2009 as compared to $264,387 for the three months ended March 31, 2008. Total annualized non-interest income as a percentage of average assets decreased to 1.3% from 1.6% for the three months ended March 31, 2009 as compared to the three months ended March 31, 2008. The decrease of $16,935 or 6.4% in comparison to the three months ended March 31, 2008, was due primarily to a decline in income from service charges on deposit accounts.

The following table sets forth the non-interest income for the three months ended March 31, 2009 as compared to the three ended March 31, 2008:

17

The service charges on deposit accounts, customer fees and miscellaneous income are comprised primarily of fees charged to deposit accounts and depository related services. Fees generated from deposit accounts consist of periodic service fees and fees that relate to specific actions, such as the return or payment of checks presented against accounts with insufficient funds. Depository related services include fees for money orders and cashier’s checks, placing stop payments on checks, check-printing fees, wire transfer fees, fees for safe deposit boxes and fees for returned items or checks that were previously deposited. Service charges decreased $19,597 or 8.4% to $212,961 for the three months ended March 31, 2009. The decrease was primarily attributable to decreased analysis charges and returned item charges. The Company periodically reviews service charges to maximize service charge income while still maintaining competitive pricing. Service charge income on deposit accounts increases with the increased number of accounts and to the extent fees are not waived.

Non-Interest Expense

The following table sets forth the non-interest expense for the three months ended March 31, 2009 as compared to the three ended March 31, 2008:

18

Although non-interest expenses increased, total annualized non-interest expenses as a percentage of average assets decreased to 4.6% from 5.1% for the three months ended March 31, 2009 as compared to three months ended March 31, 2008 due to the increase in average earning assets. Average earning assets were $74.9 million and $67.1 million the quarters ended March 31, 2009 and 2008, respectively. The efficiency ratio increased in the most recent three-month period to 81.4% as compared to 75.1% for the same period in 2008 due mainly to the reduction of net interest income.

Non-interest expenses were $870,574 for the three months ended March 31, 2009 as compared to $862,748 for the three months ended March 31, 2008. The largest component of general and administrative expenses was salary and employee benefits expense of $488,695 for the first quarter of 2009 as compared to $477,792 for the three months ended March 31, 2008. The increase in salaries and benefits expenses was reflective of increased incentive, average compensation, and employee benefit expenses.

Other components of non-interest expense that affected the increase were other expenses that included expenses of other real estate of $13,956 and loan collection expense of $7,125 in the first quarter of 2009 as compared to no expenses of other real estate and $816 of loan collection expense in the first quarter of 2008.

Advertising and Marketing expenses decreased by $11,955, or 43.0%, to $15,874 for the comparable three month period due to a reduction in marketing campaigns performed during the first quarter of 2009 as compared to the same period of 2008. Data and item processing expense decreased by $9,195, or 11.1%, to $73,481 in the quarter ended March 31, 2009 as compared to the same quarter of 2008 due to branch and remote capture and decreased activity.

Provision for Income Taxes

The tax provision was $63,757 for the first quarter ended March 31, 2009, representing approximately 34.8% of pre-tax income for the first quarter. The amount of the tax provision is determined by applying the Company’s statutory income tax rates to pre-tax book income, adjusted for permanent differences between pre-tax book income and actual taxable income. Such permanent differences include but are not limited to tax-exempt interest income; increases in the cash surrender value of bank-owned life insurance, compensation expense associated with stock options and certain other expenses that are not allowed as tax deductions, and tax credits. The tax provision was

19

$10,122 for the first quarter ended March 31, 2008, representing approximately 19.6% of pre-tax income for the first quarter. Of the $51,593 in pre-tax income in the first quarter ended March 31, 2008, approximately $27,000 was tax exempt.

Financial Condition

Comparison of Financial Condition at March 31, 2009 and December 31, 2008

General

Total assets increased from $83.4 million to $88.9 million or 6.6% between December 31, 2008 and March 31, 2009, due to an increase in deposit balances. Although approximately 15% of the deposits are related to a number of the Company’s customers that are engaged in real estate related activities, the Company’s growth in deposits was from other companies and individuals outside of real estate related activities. The Company continues to actively seek to develop alternative and supplemental business relationships with other companies and individuals in an effort to offset the potential reductions and more fully leverage the Company’s capital.

Loan Portfolio

During the three months ended March 31, 2009, the Company’s loan portfolio, net of unearned loan fees, decreased by $723,443 to $49.0 million at March 31, 2009 as compared to $49.7 million at December 31, 2008. The Company experienced moderate increases in balances of Real Estate secured loans while experiencing nominal declines in commercial and consumer real estate loans. The largest loan category at March 31, 2009 was real estate loans, which consist of commercial and consumer real estate loans excluding construction loans, which constitute 80.6% of the loan portfolio. In anticipation of further deterioration in economic conditions, though Management believes these credits to be properly underwritten, the Company has elected to take real estate collateral in an abundance of caution on a number of commercial loans. Though the result of this strategy may be to reflect a concentration of assets into real estate secured credits, Management believes the underlying collateral will support overall credit quality and minimize principal risk of the portfolio. The next largest loan concentration at March 31, 2009 was commercial loans, constituting 18.2% of the loan portfolio. The composition of the Company’s loan portfolio at March 31, 2009 and December 31, 2008 is set forth below:

The average yield on the loan portfolio as of March 31, 2009 was 7.39% and the weighted average contractual term of the loan portfolio is approximately seven years. Individual loan interest rates may require interest rate changes more frequently than at maturity due to adjustable interest rate terms incorporated into certain loans. At March 31, 2009, approximately 62.8% of loans were variable rate loans tied to adjustable rate indices such as Prime Rate.

Off-Balance Sheet Arrangements

During the ordinary course of business, the Company provides various forms of credit lines to meet the financing needs of its customers. These commitments to provide credit represent an obligation of the Company to its customers, which is not represented in any form within the balance sheets of the Company. At March 31, 2009 and December 31, 2008, the Company had $6.1 million and $4.9 million, respectively, of off-balance sheet commitments

20

to extend credit. These commitments are the result of existing unused lines of credit and unfunded loan commitments. These commitments represent a credit risk to the Company. At March 31, 2009 and December 31, 2008, the Company had $3,000 and $128,000, respectively, in unadvanced standby letters of credit. These letters of credit are sometimes unsecured and may not necessarily be drawn upon to the total extent to which the Company is committed.

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

Non-performing Assets

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

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

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

21

At March 31, 2009, the Company had one foreclosed property (OREO) consisting of 21 remaining units, no loans on non-accrual status, and no restructured loans. The Company’s nonperforming assets at March 31, 2009 were 1.19% of the total loans and OREO. The loan on non-accrual status at December 31, 2008 placed on accrual status during the first quarter of 2009. At December 31, 2008, the Company had one foreclosed property consisting of 23 remaining units, one loan on non-accrual status, and no restructured loans. The Company’s nonperforming assets at December 31, 2008 were 2.11% of the total loans and OREO.

Allowance for Loan Losses

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

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

Allowance factors are utilized in the analysis of the allowance for loan losses. Allowance factors ranging from 0.47% to 7.07% are applied to disbursed loans that are unclassified and uncriticized. Allowance factors averaging approximately 0.24% are applied to undisbursed loans. Allowance factors are not applied to loans secured by bank deposits or to loans held for sale, which are recorded at the lower of cost or market.

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

Management looks at a number of economic events occurring in and around the real estate industry and analyzes each credit for associated risks. Accordingly, the Company has established and maintains an allowance for loan losses which amounted to $718,762 at March 31, 2009, $702,409 at December 31, 2008, and $1,029,860 at March 31, 2008. The ratios of the allowance for loan losses to total loans at March 31, 2009, December 31, 2008, and March 31, 2008 were 1.47%, 1.41%, and 1.93% respectively.

The table below summarizes, as of and for the three months ended March 31, 2009 and 2008 and the year ended December 31, 2008, the loan balances at the end of the period and the daily average loan balances during the period; changes in the allowance for loan losses arising from loan charge-offs, recoveries on loans previously charged-off, and additions to the allowance which have been charged against earnings, and certain ratios related to the allowance for loan losses.

22

Allowance for Loan Losses

While Management believes that the amount of the allowance at March 31, 2009 was adequate, there can be no assurances that future economic or other factors will not adversely affect the Company’s borrowers, or that the Company’s asset quality may not deteriorate through rapid growth, failure to identify and monitor potential problem loans or for other reasons, thereby causing loan losses to exceed the current allowance.

23

Investment Portfolio

The market value of the Company’s investment portfolio at March 31, 2009 was $11.7 million having a tax equivalent yield of 4.74% . This compares to an investment portfolio of $12.0 million at December 31, 2008 having a 4.77% tax equivalent yield. The primary category of investment in the portfolio at March 31, 2009 was mortgage-backed securities. At March 31, 2009, approximately 47% of the mortgage-backed securities were tied to adjustable rate indices such as LIBOR or CMT. As loan demand has declined, Management anticipates purchasing additional short-term investment securities and interest-bearing deposits in other banks until loan demand increases.

The following table summarizes the carrying value and market value and distribution of the Company’s investment securities at March 31, 2009 and December 31, 2008:

There were no material changes since December 31, 2008 in the maturities or repricing of the investment securities.

Deposits

Total deposits increased $7.6 million or 10.8% to $78.6 million at March 31, 2009 from $71.0 million at December 31, 2008 due to the increase in interest-bearing deposit balances and demand deposits. Interest-bearing deposits increased $5.1 million or 13.2% to $43.5 million at March 31, 2009 from $38.4 million at December 31, 2008. Demand deposits increased $2.6 million or 7.9% to $35.2 million at March 31, 2009 from $32.6 million at December 31, 2008. The ratio of non-interest bearing funds to total deposits was 44.7% at March 31, 2009 and 45.9% at December 31, 2008.

A comparative distribution of the Company’s deposits at March 31, 2009 and December 31, 2008, by outstanding balance as well as by percentage of total deposits, is presented in the following table:

24