Killbuck Bancshares (KLIB) 10-K 2009 FY Annual report

EXHIBIT 13

Killbuck Bancshares, Inc.

Corporate Profile

Killbuck Bancshares, Inc. (the “Company”) was incorporated under the laws of the State of Ohio for the primary purpose of acquiring and holding all of the outstanding shares of The Killbuck Savings Bank Company (the “Bank”). The principal office of the Company is located at 165 N. Main Street, Killbuck, Ohio.

The Killbuck Savings Bank Company was established under the banking laws of the State of Ohio in September of 1900. The Bank is headquartered in Killbuck, Ohio, in Holmes County. Holmes County is located in northeastern Ohio. The Bank deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”), and it is regulated by the Ohio Division of Financial Institutions (“ODFI”) and the Board of Governors of the Federal Reserve System (“FRB”).

The Bank provides customary retail and commercial banking services to its customers, including checking, savings and time deposit accounts, Health Savings Accounts (“HAS”), internet banking, bill payment, and safe deposit facilities, as well as a full complement of real estate, commercial and consumer loan products.

Stock Market Information

The Company’s common shares are currently quoted by a number of quotation services, including the Over the Counter Bulletin Board (the “OTCBB”), the Pink Sheets Electronic Quotation Service (the “Pink Sheets”), and Community Banc Investments (“CBI”), each of which handles a limited amount of the Corporation’s stock transactions. The OTCBB and the Pink Sheets are both quotation services for “over-the-counter securities,” which are generally considered to be any equity securities not otherwise listed on a national exchange, such as NASDAQ, NYSE or Amex. CBI is a licensed intrastate securities dealer that specializes in marketing the stock of independent banks in Ohio. The Company’s common shares are quoted on the OTCBB and the Pink Sheets under the trading symbol “KLIB.”

The common stock of the Company trades infrequently. Parties interested in buying or selling the Company’s stock are generally referred to CBI. The quarterly share price information in the table below was obtained from CBI and the OTCBB.

Quarter Ended		High		Low		Cash Dividends Paid
2009	March 31	$	116.36	$	104.35		N/A
	June 30		105.12		103.90	$	1.45
	September 30		105.92		104.18		N/A
	December 31		106.40		104.67	$	1.55
2008	March 31	$	119.74	$	114.44		N/A
	June 30		115.40		113.77	$	1.45
	September 30		116.36		113.91		N/A
	December 31		116.36		115.48	$	1.50

At December 31, 2009, the Company had approximately 992 shareholders of record.

Management does not have knowledge of the prices paid in all transactions and has not verified the accuracy of those prices that have been reported. Because of the lack of an established market for the Company’s stock, these prices may not reflect the actual prices at which the stock would trade in a more active market.

Historically, the Company has paid dividends on a semi-annual basis.

Selected Consolidated Financial Data

The following table sets forth general information and ratios of the Company at the dates indicated (in thousands, except share data).

	Year Ended December 31,
	2009			2008			2007			2006			2005
For The Year:
Total interest income	$	15,865		$	18,856		$	21,680		$	20,038		$	16,618
Total interest expense		4,477			6,514			8,068			5,919			4,169
Net interest income		11,388			12,342			13,612			14,119			12,449
Provision for loan losses		2			61			127			215			377
Net interest income after provision for loan losses		11,386			12,281			13,484			13,904			12,072
Total noninterest income		1,673			1,808			1,483			1,307			1,265
Total noninterest expense		9,089			8,529			8,169			7,996			7,613
Income before income taxes		3,970			5,560			6,798			7,215			5,724
Income tax expense		835			1,104			1,893			1,992			1,513
Net income	$	3,135		$	4,456		$	4,905		$	5,223		$	4,211
Per share data
Earnings	$	5.07		$	7.12		$	7.73		$	8.14		$	6.44
Dividends	$	3.00		$	2.95		$	3.75		$	3.50		$	2.20
Book value (at year end)	$	69.83		$	69.09		$	65.31		$	61.28		$	57.20
Average shares outstanding		618,317			625,839			634,458			641,759			653,996
Year-end balances:
Loans receivable, net	$	207,575		$	200,449		$	196,520		$	191,932		$	206,242
Securities		100,422			83,718			83,668			64,746			45,078
Total assets		371,979			341,338			336,337			313,205			298,050
Deposits		321,295			288,947			285,451			264,301			250,349
Borrowings		6,872			8,248			8,282			8,554			9,599
Shareholders’ equity		43,063			42,935			41,118			39,134			37,049
Significant ratios:
Return on average assets		0.89	%		1.32	%		1.51	%		1.74	%		1.44	%
Return on average shareholders’ equity		7.67			11.41			12.88			14.57			12.24
Dividend payout		59.17			41.43			48.51			43.00			34.16
Average shareholders’ equity to average assets		11.65			11.54			11.75			11.96			11.79
Loan to deposits		64.61			69.37			68.85			72.62			82.38
Allowance for loan losses to total loans		1.16			1.26			1.23			1.11			1.22

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Killbuck Bancshares, Inc. is the holding company for its wholly-owned subsidiary, The Killbuck Savings Bank Company (the “Bank”) (hereinafter collectively the “Company”). The following discussion and analysis is intended to provide information about the financial condition and results of operations of the Company and should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, as well as and other discussions appearing elsewhere in this Annual Report and the Company’s Form 10-K.

Certain information presented in this discussion and analysis and other statements concerning future performance, developments or events, and expectations for growth and market forecasts constitute forward-looking statements which are subject to a number of risks and uncertainties, including interest rate fluctuations, changes in local or national economic conditions, and government and regulatory actions which might cause actual results to differ materially from stated expectations or estimates.

Critical Accounting Policies

The Company’s accounting policies are integral to understanding the financial results reported. The Company’s accounting policies are described in detail in the Notes to the Consolidated Financial Statements. Our most complex accounting policies require a high degree of management’s judgment to ascertain the proper valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods which are well controlled and applied consistently from period to period. Further, the policies and procedures are intended to ensure that the process for changing accounting methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management judgment.

Allowance for Loan Losses

Determining the appropriate level of the allowance for loan losses involves a significant degree of management’s judgment. The Company’s allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.

Management uses historical information to assess the adequacy of the allowance for loan losses, as well as prevailing business and other economic environmental factors that may impact the portfolio in a manner currently unforeseen. The allowance is increased by the provision for loan losses and by recoveries of loans previously charged-off, and reduced by loans charged-off. For a more comprehensive discussion of the Company’s methodology of assessing the adequacy of the allowance for loan losses, refer to “Notes to Consolidated Financial Statements” elsewhere herein.

Goodwill and Other Intangible Assets

The Company must assess goodwill and other intangible assets each year for impairment. The assessment process entails estimating cash flows for future periods. If the future cash flows are insufficient to recover the recorded goodwill and other intangible asset balances, the Company would be required to take a charge against earnings to reflect the assets at the lower carrying value.

Financial Overview

Events in the domestic and global financial markets during the three year period under review have presented significant challenges to the Company, as well as all other banking institutions in the United Sates. This statement rang particularly true for the Company in 2009.

Specifically, a worldwide liquidity crisis reached its apex in the first quarter of 2009. The specter of a continuing international liquidity crisis mandated that the Company’s management carry excess liquid assets (cash and short term investments) throughout the year. This environmentally necessitated decision, integrated with the Fed’s easing of interest rates, negatively impacted the Company’s income in 2009 by $800,000 after-tax, as yields on investments and interest-bearing deposits declined precipitously as compared to 2008.

In addition, despite an absence of deteriorating asset quality, and despite maintaining the Bank’s status as a high performance financial institution, the Company was forced to pay for the clean-up of the banking system’s risk-takers. When compared to 2008, FDIC insurance costs increased by approximately $345,000, after tax.

The Company’s $1.3 million decline in comparative net income in 2009 can almost be completely ascribed to the $1.1 million cost of these two environmental variables.

Comparison of Financial Condition at December 31, 2009 and 2008

The Company’s assets at December 31, 2009 totaled $372.0 million, an increase of $30.7 million, or 9.0% over 2008 totals.

The asset growth during 2009 generally reflects a $32.3 million, or 11.2% increase in total deposits. The Company’s deposit growth during the year was enhanced at year-end by the receipt of approximately $15.0 million in temporary noninterest bearing deposits. The vast majority of these deposits were or are expected to be withdrawn in the first quarter of 2010. The remaining deposit growth of $17.3 million, or 6.0% is generally reflective of the Company’s continuing marketing efforts directed at profitable organic growth.

Cash and cash equivalents and investment securities increased by $21.9 million, or 16.9% to $145.9 million at December 31, 2009. The increase was generally reflective of three major components. First, cash was maintained at above normal levels due to the impending withdrawal of the aforementioned large deposit. Secondly, as previously stated, management felt compelled to maintain higher liquid asset balances due to economic uncertainty in the environment. Finally, the Company’s deployment of growth to liquid assets was indicative of less than optimal commercial loan demand during 2009.

Loans receivable increased during 2009 by $7.1 million, or 3.6%, totaling $207.6 million at year-end. Loan growth during 2009 was principally confined to residential real estate credits, which increased during the year by $8.8 million, or 12.2%. The remainder of the Company’s loan products, with the exception of a slight increase in farm credits, showed a modest $2.7 million, or 2.2% decline during 2009. The growth in residential real estate can generally be attributable to the favorable residential mortgage rates available in 2009, while the reduction in commercial and consumer credits essentially mirrors the overall economic slowdown encountered during the period.

The Company’s allowance for loan losses at December 31, 2009 totaled $2.4 million, or 1.16% of total loans, as compared to $2.5 million, or 1.24% of total loans at December 31, 2008. The slight decline in portfolio coverage during 2009 is principally attributable to the complete elimination of nonperforming loans at December 31, 2009, as well as a reduction in all other delinquent loan categories.

The allowance for loan losses is management’s estimate of the amount of probable credit losses in the portfolio. The Company determines the allowance for loan losses based upon an ongoing evaluation. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of cash flows expected to be received on impaired loans that may be susceptible to significant change. Increases to the allowance for loan losses are made by charges to the provision for loan losses. Loans deemed uncollectible are charged against the allowance for loan losses. Recoveries of previously charged-off amounts are credited to the allowance for loan losses.

The Company’s allowance for loan losses is the accumulation of various components calculated based upon independent methodologies. All components of the allowance for loan losses represent an estimation performed according to either Financial Accounting Standards Board Accounting Standards Codification Topic 450-Contingencies, or Topic 310-Receivables. Management’s estimate of each allowance component is based on certain observable data that management believes is the most reflective of the underlying loan losses being estimated. Changes in the amount of each component of the allowance for loan losses are directionally consistent with changes in the observable data and corresponding analyses. Some of the components that management factors in are current economic conditions, loan growth assumptions, credit concentrations, and levels of nonperforming loans.

A key element of the methodology for determining the allowance for loan losses is the Company’s credit-risk-evaluation process, which includes credit-risk grading of individual commercial loans. Loans are assigned credit-risk grades based on an internal assessment of conditions that affect a borrower’s ability to meet its contractual obligation under the loan agreement. The assessment process includes reviewing a borrower’s current financial information, historical payment experience, credit documentation, public information, and other information specific to each individual borrower. Certain commercial loans are reviewed on an annual or rotational basis or as management becomes aware of information affecting a borrower’s ability to fulfill its obligation.

Funds generated in 2009 from deposit growth and operations were partially deployed to reduce amortizing Federal Home Loan Bank advances by approximately $651,000, and retire short-term borrowings by $725,000, or 11.4%.

Shareholders’ equity increased by approximately $128,000 during 2009, totaling $43.1 million at year-end, as compared to $42.9 million at December 31, 2008. The growth in shareholders’ equity during 2009 was comprised of period earnings of $3.1 million, which were partially offset by payment of $1.9 million in cash dividends, a $627,000 decrease in accumulated other comprehensive income and $527,000 of treasury share purchases. The Company purchases treasury shares pursuant to financial objectives and guidelines set forth in its strategic planning process.

The following table sets forth, for the periods indicated, information regarding the total dollar amounts of interest income from average interest-earning assets and the resulting yields, the total dollar amount of interest expense on average interest-bearing liabilities and the resulting rate paid, net interest income, interest rate spread and the net yield on interest-earning assets (dollars in thousands):

Average Balance Sheet and Net Interest Analysis

	For the Year Ended December 31
	2009							2008						2007
	Average Balance			Interest		Yield/ Rate		Average Balance			Interest	Yield/ Rate		Average Balance			Interest	Yield/ Rate
Assets
Interest-earning assets:
Loans (1)(2)	$	207,846		$	12,267	5.90	%	$	201,179		14,136	7.03	%	$	202,692		16,784	8.28	%
Securities – taxable (3)		61,845			2,019	3.26	%		54,804		2,789	5.09	%		41,603		2,144	5.15	%
Securities – nontaxable		34,385			1,427	4.15	%		31,171		1,342	4.31	%		31,955		1,405	4.40	%
Securities – equity (3)(4)		1,756			102	5.80	%		1,707		96	5.60	%		1,681		105	6.25	%
Interest-bearing deposits and other		21,604			50	0.24	%		22,343		493	2.21	%		24,515		1,242	5.07	%
Total interest – earnings assets		327,436			15,865	4.85	%		311,204		18,856	6.06	%		302,446		21,680	7.17	%
Noninterest-earning assets
Cash and due from other institutions		10,066							14,080						10,757
Premises and equipment, net		6,152							6,484						5,952
Accrued interest receivable		1,295							1,401						1,502
Other assets		8,210							7,776						5,843
Less allowance for loan losses		(2,505	)						(2,500	)					(2,477	)
Total	$	350,654						$	338,445					$	324,023
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Interest-bearing demand		26,303			40	0.15	%		26,889		108	0.40	%		27,255		158	0.58	%
Money market accounts		29,025			249	0.86	%		21,830		344	1.58	%		18,961		506	2.67	%
Savings deposits		41,248			171	0.42	%		38,979		276	0.71	%		37,274		382	1.02	%
Time deposits		151,181			3,915	2.59	%		150,375		5,642	3.75	%		144,597		6,724	4.65	%
Short-term borrowings		5,352			12	0.23	%		5,580		18	0.32	%		5,456		135	2.47	%

Average Balance Sheet and Net Interest Analysis (Continued)

	For the Year Ended December 31
	2009						2008						2007
	Average Balance		Interest		Yield/ Rate		Average Balance		Interest		Yield/ Rate		Average Balance		Interest		Yield/ Rate
Federal Home Loan Bank Advances		1,507		90	5.97	%		2,168		126	5.79	%		2,855		163	5.71	%
Total interest bearing liabilities		254,616		4,477	1.76	%		245,821		6,514	2.65	%		236,398		8,068	3.41	%
Noninterest bearing liabilities:
Demand deposits		51,887						49,711						45,452
Accrued expenses and other liabilities		3,283						3,849						4,101
Shareholders’ equity		40,868						39,064						38,072
Total	$	350,654					$	338,445					$	324,023
Net interest income			$	11,388					$	12,342					$	13,612
Interest rate spread (5)					3.09	%					3.41	%					3.76	%
Net yield on interest earning assets (6)					3.48	%					3.97	%					4.50	%

(1) The weighted average loan amounts outstanding are net of deferred loan origination fees.

(2) Nonaccrual loans are included in loan totals and do not have a material impact on the information presented.

(3) Average balance is computed using the carrying value of securities. The average yield has been computed using the historical amortized cost average balance for available for sale securities.

(4) Equity securities are comprised of common stock of the Federal Home Loan Bank, Federal Reserve Bank, and Great Lakes Bankers’ Bank.

(5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities.

(6) Net yield on interest earning assets represents net interest income as a percentage of average interest earning assets.

Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in average volume multiplied by old rate) and (ii) changes in rates (changes in rate multiplied by old average volume). Changes which are not solely attributable to rate or volume are allocated to changes in rate due to rate sensitivity of interest-earning assets and interest-bearing liabilities (dollars in thousands).

	2009 Compared to 2008									2008 Compared to 2007
	Increase (Decrease) Due To									Increase (Decrease) Due To
	Volume			Rate			Net			Volume			Rate			Net
Interest income
Loans	$	469		$	(2,338	)	$	(1,869	)	$	(125	)	$	(2,523	)	$	(2,648	)
Securities-taxable		358			(1,128	)		(770	)		680			(35	)		645
Securities-nontaxable		139			(54	)		85			(34	)		(29	)		(63	)
Securities-equities		3			3			6			2			(11	)		(9	)
Federal funds sold		(356	)		(128	)		(484	)		(110	)		(639	)		(749	)
Due from Federal Reserve		—			—			—			—			—			—
Total interest earning Assets		612			(3,644	)		(3,032	)		413			(3,237	)		(2,824	)
Interest expense
Interest bearing demand		(2	)		(66	)		(68	)		(2	)		(48	)		(50	)
Money market accounts		114			(209	)		(95	)		77			(239	)		(162	)
Savings deposits		16			(121	)		(105	)		17			(123	)		(106	)
Time deposits		30			(1,757	)		(1,727	)		269			(1,351	)		(1,082	)
Short-term borrowing		(1	)		(5	)		(6	)		3			(120	)		(117	)
Federal Home Loan Bank Advances		(38	)		2			(36	)		(39	)		2			(37	)
Total interest bearing Liabilities		119			(2,156	)		(2,037	)		325			(1,879	)		(1,554	)
Net change in interest income	$	493		$	(1,488	)	$	(995	)	$	88		$	(1,358	)	$	(1,270	)

RESULTS OF OPERATIONS

Comparison of the Years Ended December 31, 2009 and 2008

Net Interest Income

The Company’s net interest income for the year ended December 31, 2009 totaled $11.4 million, a reduction of approximately $954,000, or 7.7% from 2008 levels. The principal factor underlying the net decline was a significant reduction in average yields on taxable investments and interest-bearing deposits, which were partially offset by a $16.2 million increase in the volume of interest-earning assets, and a 0.89% decrease in the average cost of interest-bearing liabilities in 2009 as compared to 2008.

Total interest income in 2009 decreased by $3.0 million, or 15.9%, due primarily to a $1.2 million or 36.9% decline in interest on interest-bearing deposits and taxable investments and a $1.9 million, or 13.2%, reduction in interest on loans. These declines in interest income generally reflect the effects of overall reduction in interest rates in the economy resulting from the Fed’s easing of monetary policy. The greatest evidence of this trend in 2009 was depicted in the Company’s $443,000, or 89.9%, decline in yield on interest-bearing deposits in 2009, despite a relatively insignificant $739,000, or 3.3%, reduction in the average balances outstanding year over year.

Total interest expense for the year ended December 31, 2009 declined by $2.0 million, or 31.2%, as compared to 2008. The preponderance of this 2009 reduction emanated from a $1.7 million, or 30.1%, decrease in the cost of time deposits. Similar to the earnings side, this decline in interest costs mirrors the overall reduction of interest rates in the economy. The remaining $300,000 of 2009 interest cost reductions were primarily attributable to accounts subject to daily repricing, e.g. interest-bearing demand, money market and savings deposits. Given the extremely low cost of these deposit types at December 31, 2009, management views it unlikely that the 2009 cost reductions with be replicated in 2010.

The foregoing factors culminated in the Company’s attainment of an interest rate spread of 3.09% and a net yield on earning assets of 3.48% in 2009, compared to 3.41% and 3.97%, respectively, in 2008. Management believes the Company’s reduction in spread and margin in 2009 primarily stems from the need to carry higher levels of liquidity during the year, and does not represent a material adverse trend.

Provision for Loan Losses

The provision for loan losses totaled $2,000 for 2009, as compared to $61,000 for 2008. The reduced loss provision is principally attributable to the elimination of nonperforming loans during 2009, as well as an overall reduction in other delinquent loans year over year. As stated previously, the Company maintains the allowance at a level commensurate with the credit risks inherent in the portfolio.

Noninterest Income

Noninterest income declined by $135,000, or 7.5%, in 2009 as compared to 2008. The reduction in income was principally related to a $217,000 decrease in earnings and recoveries on bank-owned life insurance and a $22,000 decrease in all other fee and service related income accounts, which were partially offset by a $103,000 increase in gains on sale of loans in the secondary market. As stated previously, residential loan originations were enhanced during 2009 by favorable long-term mortgage rates.

Noninterest Expense

The Company’s management stringently monitors noninterest expenses. A continuation of these control efforts in 2009 culminated with a modest $35,000, or 0.5%, increase in all noninterest expense categories with the exception of FDIC deposit insurance. The $524,000 increase in FDIC deposit insurance costs in 2009 comprised virtually all of the $559,000, or 6.6%, increase in noninterest expense compared with the prior year. Management believes the Company’s deposit insurance costs will continue to increase in the future. In December of 2009, the Company prepaid $1.3 million in deposit premiums, constituting three years of premiums at current rates.

Income Taxes

Income tax expense declined to $835,000 in 2009, representing a $269,000, or 24.4%, reduction from the $1.1 million of income tax expense recorded in 2008. The year over year decline is primarily attributable to a $1.6 million, or 28.8%, reduction in pre-tax income. The Company’s effective tax rate was 21.0% in 2009, as compared to 19.9% in 2008. The principal difference between the Company’s effective tax rate in 2009 and 2008 and the 34% statutory tax rate in effect for both years resulted from the beneficial effects of tax-exempt income.

RESULTS OF OPERATIONS

Comparison of the Years Ended December 31, 2008 and 2007

Net Interest Income

The Company’s interest income for 2008 totaled $18.9 million, reflecting a reduction of $2.8 million, or 13.0%, from 2007 levels. The decline was almost solely attributable to a $2.6 million, or 15.8%, decrease in interest income on loans. This reduction in loan portfolio earnings can be almost completely ascribed to a decline in portfolio yield from 8.28% in 2007 to 7.03% in 2008, as the average portfolio balances showed a modest $1.5 million, or 0.7%, decrease year over year. The reduction in interest income on the loan portfolio generally mirrored the overall decline in mortgage and other loan rates during 2008.

Interest income on investments and interest-bearing deposits totaled $4.7 million, an approximate $176,000, or 3.6%, decline from 2007 levels. The primary contribution underlying this trend was a $749,000, or 60.3% reduction in income on interest-bearing deposits. This significant decline was almost completely driven by a 2.86% yield reduction, as average interest-bearing deposits outstanding in 2008 decreased by only $2.2 million, or 8.9%, compared to the prior year.

Total interest expense for 2008 totaled $6.5 million, representing a $1.6 million, or 19.3% decline from 2007 levels. This beneficial reduction in costs can be principally attributed to a $1.1 million, or 16.1%, decline in interest expense on time deposits in 2008 as compared to 2007. The reduction in interest costs on time deposits in 2008 was accomplished despite a $5.8 million, or 4.0%, increase in average outstanding balances year over year.

As interest rates declined in the general economy during 2008, the Company was able to extract an additional $318,000 of interest cost savings from accounts subject to daily repricing, e.g. interest-bearing demand, money market and savings deposits. This favorable movement in costs was accomplished despite a $4.2 million, or 5.0%, increase in average deposit balances outstanding.

The final component underlying the Company’s 2008 reduction in interest expense resulted from a $154,000, or 51.6%, decrease in the cost of borrowings. Approximately $117,000 of this difference is directly related to cost reductions on short-term borrowings, as the average cost of such funds declined from 2.47% in 2007 to 0.032% in 2008.

The integration of the foregoing factors resulted in the Company reporting a $1.3 million, or 9.3%, reduction in net interest income in 2008, as compared to 2007. The Company’s decline in net interest income during 2008 also translated into a lower interest rate spread and yield on earning-assets of 3.41% and 3.97%, which respectively compares to the 3.76% and 4.50% levels reported for the prior year-end.

Provision on Loan Losses

The Company’s provision for loan losses in 2008 totaled $61,000, a reduction of $66,000 from the $127,000 provision recorded in 2007. The decline in the loan loss provision year over year can be primarily attributable to a $766,000, or 91.2% reduction in non performing loans. The Company’s 2008 loss provision brought the allowance for loan losses to 1.24% of total loans, as compared to 1.26% at the prior year end.

As stated previously, the Company records loan loss provisions to maintain the allowance at an acceptable level commensurate with the credit risks in the loan portfolio.

Noninterest Income

The Company’s noninterest income in 2008 totaled $1.8 million, representing an increase of $325,000, or 21.9% over 2007 results. The enhanced revenue level can be almost solely ascribed to a $310,000 increase in earnings and recoveries on bank-owned life insurance policies in 2008.

Noninterest Expense

Total noninterest expense increased $360,000, or 4.4%, to $8.5 million in 2008, as compared to approximately $8.2 million in 2007. The 2008 increase was comprised of an $186,000, or 3.9%, increase in salary and benefits expense, an $89,000 increase in occupancy expense and an $85,000, or 3.5%, increase in all other operating expenses.

The increase in salary and benefits is generally comprised of normal merit increases and growth in employee benefit costs. The increase occupancy expense was attributable to increased costs related to upgrades in the Company’s facilities and computer technologies. Finally, the increase in other operating expense was generally attributable to increased costs of regulatory compliance.

Income Tax Expense

Income tax expense declined by $789,000, or 41.7%, for 2008 to $1.1 million from approximately $1.9 million in 2007. The reduction in income tax expense was primarily attributable to an 18.2% decline in pre-tax income. The Company’s effective tax rates for 2008 and 2007 were 19.9% and 27.8%, respectively. As set forth previously, the Company’s effective tax is beneficially affected by the amount of tax-exempt income earned each year.

QUANTITATIVE AND QUALITATIVE DISCLOSURES

ABOUT MARKET RISK

The Company’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. Because of the nature of the Bank’s operations, the Bank is not subject to currency exchange or commodity price risk and, since the Bank has no trading portfolio, it is not subject to trading risk. The Bank’s loan portfolio, concentrated primarily within the surrounding market area, is subject to risks associated with the local economy. Since all of the interest-earning assets and interest-bearing liabilities are located at the Bank, all of the Company’s interest rate risk resides at the Bank level. As a result, interest rate risk management is conducted at the Bank level.

The Bank actively manages interest rate sensitivity and asset/liability products through an Asset/Liability Management Committee. The principal purposes of asset-liability management are to maximize current net interest income while minimizing the risk to future earnings of negative fluctuations in net interest margin and to insure adequate liquidity exists to meet operational needs.

In an effort to reduce interest rate risk and protect itself from the negative effects or rapid or prolonged changes in interest rates, the Bank has instituted certain asset and liability management measures, including underwriting long-term fixed rate loans that are saleable in the secondary market, offering longer term deposit products and diversifying the loan portfolio into shorter term consumer and commercial business loans. In addition, since the mid-1980’s, the Bank has originated variable rate loans and as of December 31, 2009, such loans comprised approximately 55% of the total loan portfolio.

One of the principal functions of the Bank’s asset/liability management program is to monitor the level to which the balance sheet is subject to interest rate risk. The goal of this program is to manage the relationship between interest-earning assets and interest-bearing liabilities to minimize the fluctuations in the net interest spread and achieve consistent growth in net interest income during periods of changing interest rates.

Interest rate sensitivity is measured as the difference between the volume of assets and liabilities that are subject to repricing in a future period. These differences are known as interest sensitivity gaps. The Bank utilizes gap management as the primary means of measuring interest rate risk. Gap analysis identifies and quantifies the Bank’s exposure or vulnerability to changes in interest rates in relationship to the Bank’s interest rate sensitivity position. A rate sensitive asset or liability is one, which is capable of being repriced (i.e., the interest rate can be adjusted or principal can be reinvested) within a specified period of time. Subtracting total rate sensitive liabilities (RSL) from total rate sensitive assets (RSA) within specified time horizons nets the Bank’s gap positions. These gaps reflect the Bank’s exposure to changes in market interest rates, as discussed below.

Because many of the Bank’s deposit liabilities are capable of being immediately repriced, the Bank offers variable rate loan products in order to help maintain a proper balance in its ability to reprice various interest bearing assets and liabilities. Furthermore, the Bank’s deposit rates are not tied to an external index. As a result, although changing market interest rates impact repricing, the Bank has retained much of its control over repricing.

The Bank also conducts rate sensitivity analysis using a simulation model, which also monitors earnings at risk by projecting earnings of the Bank based upon an economic forecast of the most likely interest rate movement. The model also calculates earnings of the Bank based upon what are estimated to be the largest foreseeable rate increase and the largest foreseeable rate decrease. Such analysis translates interest rate movements and the Bank’s rate sensitivity position into dollar amounts by which earnings may fluctuate as a result of rate changes. Based on December 31, 2009 data, the latest date for which such information is available, a 2.00% immediate increase in interest rates would increase earnings by 11.86% and a 2.00% immediate decrease in interest rates would decrease earnings by 11.72%.

The data included in the table that follows indicates that the Bank is asset sensitive within one year. Generally, an asset sensitive gap could negatively affect net interest income in an environment of declining interest rates as a greater amount of interest-bearing assets could reprice at lower rates. During times of rising interest rates, an asset sensitive gap could positively affect net interest income, as rates would be increased on a larger volume of assets as compared to deposits. As a result, interest income would increase more rapidly than interest expense. A liability sensitive gap indicates that declining interest rates could positively affect net interest income, as expense of liabilities would decrease more rapidly than interest income would decline. Conversely, rising rates could negatively affect net interest income, as income from assets would increase less rapidly than deposit costs. Although rate sensitivity analysis enables the Bank to minimize interest rate risk, the magnitude of rate increases or decreases on assets versus liabilities may not correlate directly. As a result, fluctuations in interest spreads can occur even when repricing capabilities are perfectly matched.

It is the policy of the Bank to generally maintain a gap ratio within a range that is minus 10 percent to plus 20 percent of total assets for the time horizon of one year. When management believes that interest rates will increase, it can take actions to increase the RSA/RSL ratios. Conversely, when management believes interest rates will decline, it can take actions to decrease the RSA/RSL ratio.

Changes in market interest rates can also affect the Bank’s liquidity position through the impact rate changes may have on the market value of the Bank’s investment portfolio. Rapid increases in market rates can negatively impact the market values of investment securities. As securities values decline, it becomes more difficult to sell investments to meet liquidity demands without incurring a loss. The Bank can address this by increasing liquid funds, which may be utilized to meet unexpected liquidity needs when a decline occurs in the value of securities.

The following table presents the Bank’s interest rate sensitivity gap position as of December 31, 2009 (dollars in thousands):

INTEREST RATE SENSITIVITY GAPS

(IN THOUSANDS)

	2010			2011			2012			2013			2014			Thereafter			Total
Interest-earnings assets:
Loans:
Fixed	$	29,223		$	8,634		$	7,554		$	7,309		$	4,956		$	36,460		$	94,136
Variable		93,241			8,528			6,217			5,742			694			1,695			116,117
Securities:
Fixed		8,093			8,346			17,774			16,681			18,397			31,131			100,422
Other interest-earning assets		36,555			—			—			—			—			—			36,555
Total interest-earning assets		167,112			25,508			31,545			29,732			24,047			69,286			347,230
Interest-bearing liabilities:
Demand and savings deposits (1)		33,476			33,476			33,476			33,476			33,476			—			167,382
Time deposits:
Fixed		100,959			28,438			9,454			7,547			7,503			12			153,913
Short-term borrowings		5,660			—			—			—			—			—			5,660
FHLB advances		311			214			214			153			153			167			1,212
Total interest-bearing liabilities		140,406			62,128			43,144			41,176			41,132			179			328,167
Interest rate sensitivity gap		26,706			(36,620	)		(11,599	)		(11,444	)		(17,085	)		69,107
Cumulative rate sensitivity gap	$	26,706		$	(9,914	)	$	(21,514	)	$	(32,958	)	$	(50,043	)	$	19,064
Cumulative interest rate sensitivity gap as a percent of interest earning assets		7.69	%		-2.86	%		-6.20	%		-9.49	%		-14.41	%		5.49	%

(1) Computed based on a five year decay rate.

Liquidity

Liquidity represents our ability to meet normal cash flow requirements of our customers for the funding of loans and repayment of deposits. Both short-term and long-term liquidity needs are generally derived from the repayments and maturities of loans and investment securities, and the receipt of deposits. Management monitors liquidity daily, and on a monthly basis incorporates liquidity management into its asset/liability program. The assets defined as liquid are cash, cash equivalents, and the available for sale security portfolio. The liquidity ratio as of December 31, 2009 and 2008 are 29.8% and 26.9%, respectively.

Operating activities, as presented in the Statement of Cash Flows in the accompanying Consolidated Financial Statements, provided $2.1 million and $4.1 million in cash flows during 2009 and 2008 respectively, principally generated from net income.

Investing activities utilized $25.5 million of the Company’s cash flows during 2009. The preponderance of this total represents the funding of an $18.3 million increase in the investment securities portfolios and a $7.1 million increase in loans receivable.

Financing activities in 2009 provided the Company with net cash inflows totaling $28.6 million. The vast majority of this total consists of a $32.3 million increase in deposits. This deposit growth was partially utilized in other financing activities to retire $1.4 million of borrowings and pay cash dividends of $1.9 million.

In addition to using the loan, investment, and deposit portfolios as sources of liquidity, we have access to funds from the Federal Home Loan Bank of Cincinnati. We also have a ready source of funds through the available-for-sale component of the investment securities portfolio.

Capital Resources

Capital adequacy is our ability to support growth while protecting the interests of shareholders and depositors. Bank regulatory agencies have developed certain capital adequacy requirements that are used to assist them in monitoring the safety and soundness of financial institutions. We continually monitor these capital requirements and believe the Company to be in compliance with these regulations at December 31, 2009.

Our regulatory capital position at December 31, 2009, as compared to the minimum regulatory capital requirements imposed on us by banking regulators at that date is presented in the Notes to the accompanying Consolidated Financial Statements. We are not aware of any actions contemplated by banking regulators, which would result in the Company being in non-compliance with the minimum capital requirements.

Impact of Inflation Changing Prices

The Consolidated Financial Statements and the accompanying Notes presented elsewhere in this document, have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities are monetary in nature. The impact of inflation is reflected in the increased cost of operations. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Killbuck Bancshares, Inc.

Killbuck, Ohio

Audit Report

December 31, 2009

Killbuck Bancshares, Inc.

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

	Page Number
Report of Independent Registered Public Accounting Firm	2
Financial Statements
Consolidated Balance Sheet	3
Consolidated Statement of Income	4
Consolidated Statement of Changes in Shareholders’ Equity	5
Consolidated Statement of Cash Flows	6
Notes to Consolidated Financial Statements	7-27

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Killbuck Bancshares, Inc.

We have audited the accompanying consolidated balance sheets of Killbuck Bancshares, Inc. and subsidiary as of December 31, 2009 and 2008, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Killbuck Bancshares, Inc. and subsidiary as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with U.S. generally accepted accounting principles.

We were not engaged to examine management’s assertion about the effectiveness of Killbuck Bancshares, Inc. internal control over financial reporting as of December 31, 2009, which is included in Form 10-K and, accordingly, we do not express an opinion thereon.

Steubenville, Ohio

February 25, 2010

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Killbuck Bancshares, Inc.

CONSOLIDATED BALANCE SHEET

	December 31,
	2009			2008
ASSETS
Cash and cash equivalents:
Cash and amounts due from depository institutions	$	42,575,944		$	31,868,633
Federal funds sold		2,938,000			8,448,000
Total cash and cash equivalents		45,513,944			40,316,633
Investment securities:
Securities available for sale		65,334,849			51,549,966
Securities held to maturity (fair value of $36,373,611 and $33,265,569)		35,086,821			32,168,512
Total investment securities		100,421,670			83,718,478
Loans (net of allowance for loan losses of $2,441,169 and $2,525,202)		207,575,135			200,448,708
Loans held for sale		271,000			—
Premises and equipment, net		6,009,442			6,321,031
Accrued interest receivable		1,467,901			1,470,883
Goodwill, net		1,329,249			1,329,249
Other assets		9,391,044			7,732,841
Total assets	$	371,979,385		$	341,337,823
LIABILITIES
Deposits:
Noninterest bearing demand	$	63,636,376		$	52,971,305
Interest bearing demand		32,102,301			27,372,343
Money market		28,669,992			23,834,736
Savings		42,973,020			40,496,289
Time		153,913,387			144,272,233
Total deposits		321,295,076			288,946,906
Short-term borrowings		5,660,000			6,385,000
Federal Home Loan Bank advances		1,212,000			1,862,667
Accrued interest and other liabilities		748,901			1,207,652
Total liabilities		328,915,977			298,402,225
SHAREHOLDERS’ EQUITY
Common stock – No par value: 1,000,000 shares authorized, 718,431 shares issued at December 31, 2009 and 2008		8,846,670			8,846,670
Retained earnings		43,742,847			42,461,137
Accumulated other comprehensive income		16,605			643,359
Treasury shares, at cost (101,725 and 96,949 shares at December 31, 2009 and 2008, respectively)		(9,542,714	)		(9,015,568	)
Total shareholders’ equity		43,063,408			42,935,598
Total liabilities and shareholders’ equity	$	371,979,385		$	341,337,823

See accompanying notes to the consolidated financial statements.

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Killbuck Bancshares, Inc.

CONSOLIDATED STATEMENT OF INCOME

	Year Ended December 31,
	2009		2008		2007
INTEREST INCOME
Interest and fees on loans	$	12,267,389	$	14,136,505	$	16,784,112
Investment securities:
Taxable		2,120,835		2,884,342		2,248,837
Exempt from federal income tax		1,426,623		1,342,204		1,405,633
Interest-bearing deposits and other		50,291		493,224		1,241,808
Total interest income		15,865,138		18,856,275		21,680,390
INTEREST EXPENSE
Deposits		4,374,627		6,370,270		7,770,422
Short term borrowings		12,297		18,075		135,038
Federal Home Loan Bank advances		89,915		125,569		163,407
Total interest expense		4,476,839		6,513,914		8,068,867
NET INTEREST INCOME		11,388,299		12,342,361		13,611,523
Provision for loan losses		2,000		61,000		127,119
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		11,386,299		12,281,361		13,484,404
NONINTEREST INCOME
Service charges and fees on deposit accounts		1,155,300		1,179,129		1,159,089
Gain on sale of loans, net		131,256		28,066		20,517
Earnings and recoveries on bank-owned life insurance		237,147		453,821		143,352
Other		148,955		146,464		159,543
Total noninterest income		1,672,658		1,807,480		1,482,501
NONINTEREST EXPENSE
Salaries and employee benefits		5,005,181		4,942,680		4,757,261
Occupancy and equipment		1,010,928		1,070,303		980,920
Other expense		3,072,453		2,516,212		2,430,897
Total noninterest expense		9,088,562		8,529,195		8,169,078
INCOME BEFORE INCOME TAXES		3,970,395		5,559,646		6,797,827
Income taxes		835,443		1,104,013		1,893,128
NET INCOME	$	3,134,952	$	4,455,633	$	4,904,699
EARNINGS PER SHARE	$	5.07	$	7.12	$	7.73
WEIGHTED AVERAGE SHARES OUTSTANDING		618,497		626,151		634,911

See accompanying notes to the consolidated financial statements.

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Killbuck Bancshares, Inc.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

	Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Shares			Total Shareholders’ Equity			Comprehensive Income
BALANCE, JANUARY 1, 2007		8,846,670		37,315,334			4,892			(7,033,099	)		39,133,797
Net income				4,904,699									4,904,699		$	4,904,699
Other comprehensive income:
Unrealized gain on available for sale securities, net of tax of $254,361							493,759						493,759			493,759
Comprehensive income															$	5,398,458
Cash dividends paid ($3.75 per share)				(2,371,463	)								(2,371,463	)
Purchase of treasury shares, at cost (9,060 shares)										(1,043,151	)		(1,043,151	)
BALANCE, DECEMBER 31, 2007		8,846,670		39,848,570			498,651			(8,076,250	)		41,117,641
Net income				4,455,633									4,455,633		$	4,455,633
Other comprehensive income:
Unrealized gain on available for sale securities, net of tax of $74,547							144,708						144,708			144,708
Comprehensive income															$	4,600,341
Cash dividends paid ($2.95 per share)				(1,843,066	)								(1,843,066	)
Purchase of treasury shares, at cost (8,100 shares)										(939,318	)		(939,318	)
BALANCE, DECEMBER 31, 2008		8,846,670		42,461,137			643,359			(9,015,568	)		42,935,598
Net income				3,134,952									3,134,952		$	3,134,952
Other comprehensive income:
Unrealized loss on available for sale securities, net of tax benefits of $322,873							(626,754	)					(626,754	)		(626,754	)
Comprehensive income															$	2,508,198
Cash dividends paid ($3.00 per share)				(1,853,242	)								(1,853,242	)
Purchase of treasury shares, at cost (4,776 shares)										(527,146	)		(527,146	)
BALANCE, DECEMBER 31, 2009	$	8,846,670	$	43,742,847		$	16,605		$	(9,542,714	)	$	43,063,408

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Killbuck Bancshares, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS

	Year Ended December 31,
	2009			2008			2007
OPERATING ACTIVITIES
Net income	$	3,134,952		$	4,455,633		$	4,904,699
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		2,000			61,000			127,119
Depreciation, amortization and accretion, net		1,058,352			439,697			359,585
Gain on sale of loans, net		(131,256	)		(28,066	)		(20,517	)
Origination of loans held for sale		(15,462,950	)		(3,020,600	)		(5,828,620	)
Proceeds from the sale of loans		15,323,206			3,218,666			5,851,637
Bank-owned life insurance benefit income		—			(234,396	)		—
Federal Home Loan Bank stock dividends		—			(53,600	)		(19,700	)
Net changes in:
Accrued interest and other assets		(1,547,978	)		(742,464	)		(304,501	)
Accrued interest and other liabilities		(243,122	)		17,134			6,259
Net cash provided by operating activities		2,133,205			4,113,004			5,075,961
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from maturities and repayments		31,277,140			29,232,154			13,297,670
Purchases		(46,609,702	)		(26,448,780	)		(31,887,283	)
Investment securities held to maturity:
Proceeds from maturities and repayments		6,008,345			4,580,179			4,957,302
Purchases		(8,967,419	)		(7,174,675	)		(4,503,250	)
Net increase in loans		(7,150,927	)		(3,989,827	)		(4,714,930	)
Purchase of premises and equipment		(85,447	)		(243,084	)		(1,302,496	)
Proceeds from sale of other real estate owned		—			—			80,000
Bank-owned life insurance
Proceeds		—			395,915			—
Purchases		—			(2,000,000	)		—
Net cash used in investing activities		(25,528,010	)		(5,648,118	)		(24,072,987	)
FINANCING ACTIVITIES
Net increase in deposits		32,348,171			3,495,565			21,150,829
Net change in short-term borrowings		(725,000	)		640,000			434,719
Repayment of Federal Home Loan Bank advances		(650,667	)		(674,184	)		(706,520	)
Purchase of treasury shares		(527,146	)		(939,318	)		(1,043,151	)
Cash dividends paid		(1,853,242	)		(1,843,066	)		(2,371,463	)
Net cash provided by financing activities		28,592,116			678,997			17,464,414
Increase (decrease) in cash and cash equivalents		5,197,311			(856,117	)		(1,532,612	)
Cash and cash equivalents at beginning of year		40,316,633			41,172,750			42,705,362
Cash and cash equivalents at end of year	$	45,513,944		$	40,316,633		$	41,172,750

See accompanying notes to the consolidated financial statements.

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Killbuck Bancshares, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

A summary of the significant accounting and reporting policies consistently applied in the presentation of the consolidated financial statements follows:

Nature of Operations and Basis of Presentation

Killbuck Bancshares, Inc. (the “Company”) is an Ohio corporation organized as the holding company of The Killbuck Savings Bank Company (the “Bank”). The Bank is an Ohio state-chartered bank. The Company and its subsidiary operate in the single industry of commercial banking and derive substantially all their income from banking and bank-related services which include interest earnings on residential real estate, commercial mortgage, commercial and consumer loan financing as well as interest earnings on investment securities and charges for deposit services to its customers through nine full service branches and one loan production office. The Board of Governors of the Federal Reserve System supervises the Company and Bank, while the Bank is also subject to regulation and supervision by the Ohio Division of Financial Institutions.

The consolidated financial statements of the Company include its wholly-owned subsidiary, the Bank. All intercompany transactions have been eliminated in consolidation. The investment in subsidiary on the parent company financial statements is carried at the parent company’s equity in the underlying net assets.

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). The preparation of consolidated financial statements, in conformity with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosures of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and identification of other-than-temporary impairment of securities. Management believes that the allowance for loan losses represents its best estimate of losses known and inherent in the loan portfolio that are both probable and reasonable to estimate. Additionally, management believes that the evaluation for other-than-temporary impairment of securities has been performed in accordance with GAAP. Actual results may differ from these estimates. The estimate for the loan loss allowance is particularity susceptible to significant near-term changes, including possible material increases in the allowance mandated by the Bank’s primary regulator.

In 2009, the Company adopted the provisions of Financial Accounting Standards Board, or FASB, Accounting Standards Codification, (the “FASB ASC”), which is now the source of authoritative, non-governmental GAAP. While the FASB ASC did not change GAAP, all existing authoritative accounting literature, with certain exceptions, was superseded and codified into the FASB ASC. The references to authoritative accounting literature contained in the Company’s disclosures have been modified to refer to general accounting topics within the FASB ASC.

Investment Securities

Investment securities are classified, at the time of purchase, based upon management’s intention and ability, as either securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost adjusted for amortization of premium and accretion of discount which are computed using the level yield method. Certain other debt and equity securities have been classified as available for sale to serve principally as a potential source of liquidity. Unrealized holding gains and losses on available for sale securities are reported as a separate component of shareholders’ equity, net of the related tax effects, until realized. Realized securities gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned.

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Common stock of the Federal Home Loan Bank, Federal Reserve Bank and Great Lakes Bankers Bank represent ownership in institutions which are wholly-owned by other financial institutions. These securities are accounted for at cost and are classified with other assets.

Securities are periodically reviewed for other-than-temporary impairment based upon a number of factors, including, but not limited to, the length of time and extent to which the market value has been less than cost, the financial condition of the underlying issuer, the ability of the issuer to meet contractual obligations, the likelihood of the security’s ability to recover any decline in its market value, and management’s intent and ability to hold the security for a period of time sufficient to allow for a recovery in market value. Among the factors that are considered in determining management’s intent and ability is a review of the Company’s capital adequacy, interest rate risk position and liquidity. The assessment of a security’s ability to recover any decline in market value, the ability of the issuer to meet contractual obligations and management’s intent and ability requires considerable judgment. A decline in value that is considered to be other-than-temporary is recorded as a loss within noninterest income in the Consolidated Statement of Income.

Bank-Owned Life Insurance

The Company has purchased life insurance policies on certain key employees. Bank-owned life insurance is recorded at its cash surrender value or the amount that can be realized.

Loans

Loans are stated at their outstanding principal, less the allowance for loan losses and any net deferred loan origination fees. Interest income on loans is recognized on the accrual method. Accrual of interest on loans is generally discontinued when it is determined that a reasonable doubt exists as to the collectibility of principal, interest, or both. Loans are returned to accrual status when past due interest is collected, and the collection of principal is probable.

Loan origination and commitment fees, as well as certain direct loan origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. Amortization of deferred loan origination fees is discontinued when a loan is placed on nonaccrual status.

Mortgage loans originated and held for sale in the secondary market are carried at the lower of cost or market value determined on an aggregate basis. Net unrealized losses are recognized in a valuation allowance through charges to income. Gains and losses on the sale of loans held for sale are determined using the specific identification method. All loans are sold to the Federal Home Loan Mortgage Corporation (“FHLMC”).

Allowance for Loan Losses

The allowance for loan losses represents the amount which management estimates is adequate to provide for probable losses inherent in its loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan losses is established through a provision for loan losses which is charged to operations. The provision is based upon management’s periodic evaluation of individual loans, the overall risk characteristics of the various portfolio segments, past experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan losses including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant change in the near term.

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Impaired loans are commercial and commercial real estate loans for which it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. The Company individually evaluates such loans for impairment and does not aggregate loans by major risk classifications. The definition of “impaired loans” is not the same as the definition of “nonaccrual loans,” although the two categories overlap. The Company may choose to place a loan on nonaccrual status due to payment delinquency or uncertain collectibility, while not classifying the loan as impaired, provided the loan is not a commercial or commercial real estate classification. Factors considered by management in determining impairment include payment status and collateral value. The amount of impairment for these types of loans is determined by the difference between the present value of the expected cash flows related to the loan, using the original interest rate, and its recorded value, or as a practical expedient in the case of collateralized loans, the difference between the fair value of the collateral and the recorded amount of the loans. When foreclosure is probable, impairment is measured based on the fair value of the collateral.

Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller balance homogeneous loans and are measured for impairment collectively. Loans that experience insignificant payment delays, which are defined as 90 days or less, generally are not classified as impaired. Management determines the significance of payment delays on a case-by-case basis, taking into consideration all of the circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall in relation to the principal and interest owed.

Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is principally computed on the straight-line method over the estimated useful lives of the related assets, which range from three to ten years for furniture, fixtures and equipment and twenty-five to fifty years for building premises. Leasehold improvements are amortized over the shorter of the estimated useful lives or the respective lease terms, which range from seven to fifteen years. Expenditures for maintenance and repairs are charged against income as incurred. Costs of major additions and improvements are capitalized.

Real Estate Owned

Real estate acquired in settlement of loans is stated at the lower of the recorded investment in the property or its fair value minus estimated costs of sale. Prior to foreclosure, the value of the underlying collateral is written down by a charge to the allowance for loan losses if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income and losses on disposition, are included in other expenses.

Goodwill

Goodwill represents the amount by which the market value of the Company’s stock issued in an acquisition exceeded the fair value of the net assets acquired. Pursuant to the required accounting guidance, the Company employs a two-step process for testing the impairment of goodwill on at least an annual basis. This approach can cause volatility in the Company’s reported net income because impairment losses could occur irregularly and in varying amounts. As of December 31, 2009 and 2008, respectively, net goodwill totaled $1.3 million.

Mortgage Servicing Rights (“MSRs”)

The Company has agreements for the express purpose of selling loans in the secondary market. The Company maintains all servicing rights for these loans. Originated MSRs are recorded by allocating total costs incurred between the loan and servicing rights based on their relative fair values. MSRs are amortized in proportion to the estimated servicing income over the estimated life of the servicing portfolio. Impairment is evaluated based on the fair value of the right, based on portfolio interest rates and prepayment characteristics.

-9-

Employee Benefit Plan

The Bank maintains a profit sharing pension plan which is integrated with a 401(K) plan. The Bank’s contributions are based upon the plan’s contribution formula.

Income Taxes

Using the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases. To the extent that currently available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.

The Company follows FASB guidance which provides clarification on accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB ASC 740. The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the Company’s evaluation of the FASB-issued guidance, no significant income tax uncertainties were identified. Therefore, upon adoption in 2009, the Company recognized no adjustment for unrecognized income tax benefits for the year ended December 31, 2009. Our policy is to recognize interest and penalties on unrecognized tax benefits in income tax expense in the Consolidated Statement of Income. The Company recognized no interest or penalties during the year ended December 31, 2009.

The Company and Bank account for income tax expense pursuant to a tax-sharing agreement whereby the Bank remits, or is refunded, income tax expense based on the Bank’s separate company tax liability.

Concentrations of Risk

Financial instruments which potentially subject the Company and its subsidiary to concentrations of credit risk primarily consist of cash and cash equivalents and loans receivable. Cash and cash equivalents include deposits placed in other financial institutions. At December 31, 2009, the Company had $33.6 million on deposit with the Federal Reserve Bank of Cleveland and federal funds sold of $2.9 million with the Great Lakes Bankers’ Bank. The Bank’s lending activity is primarily concentrated in loans collateralized by real estate in northeastern Ohio. As a result, credit risk is broadly dependent on the real estate market and general economic conditions in that geographic area. Additionally, banking regulations and the Bank’s lending policies limit the amount of credit extended to any single borrower and their related interests thereby limiting the concentration of credit risk to any single borrower.

Earnings Per Share

The Company currently maintains a simple capital structure; therefore, there are no potential dilutive effects with respect to earnings per share. As a result, earnings per share is calculated using the weighted average number of shares outstanding for the period.

Comprehensive Income

The Company is required to present comprehensive income in a full set of general purpose financial statements for all periods presented. Other comprehensive income is comprised exclusively of net income and unrealized holding gains and losses on the available for sale securities portfolio. The Company has elected to report the effects of other comprehensive income as part of the Consolidated Statement of Changes in Shareholders’ Equity.

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Subsequent Events

The Company has evaluated events and transactions occurring subsequent to the balance sheet date of December 31, 2009 for items that should be disclosed or recognized in these consolidated financial statements. The evaluation was conducted through February 25, 2010.

Cash Flow Information

For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from financial institutions and federal funds sold. Cash payments for interest in 2009, 2008 and 2007 were $4.5 million, $6.7 million, and $8.0 million respectively. Cash payments for income taxes for 2009, 2008, and 2007 were $907,000, $1.3 million and $2.0 million, respectively.

Effects of Recent Accounting Pronouncements

In 2007, the FASB issued a new standard on accounting for business combinations that requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; established the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose the information necessary to evaluate and understand the nature and financial effect of the business combination. This standard applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year that commences after December 31, 2008. The Company will adopt this standard for any business combinations that may occur after December 31, 2008, and believes that application could have a material impact on its accounting for these transactions as compared to the prior accounting guidance.

In 2007, the FASB issued guidance which changed the accounting and reporting for minority interests, which are now recharacterized as non controlling interests and classified as a component of equity within the Consolidated Balance Sheet. This standard was effective as of December 31, 2009, and was adopted by the Company without impact to its consolidated results of operations or financial position.

In 2008, the FASB promulgated an amended standard for derivative instruments and hedging activities. The standard requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. The standard is effective for financial statements issued in 2009. Adoption of the standard did not have a material effect on the Company’s consolidated results of operations or financial position.

Effects of Newly Issued But Not Yet Effective Accounting Pronouncements

In 2009, the FASB issued new accounting guidance related to accounting for transfers of financial assets. This guidance eliminates the concept of qualifying special-purpose entity; changes the requirements for derecognizing financial assets; and requires additional disclosures. This guidance enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and an entity’s continuing involvement in those transferred financial assets. This guidance is effective as of the beginning of a reporting entity’s first annual reporting period that begins after November 2009. The Company believes this standard will not have a material effect on its consolidated results of operations or financial position.

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Also, in 2009, the FASB issued new accounting guidance related to the measurement of the fair value of a liability in the absence of a quoted price in an active market for an identical liability. This guidance is effective for the first reporting period beginning after August 2009, with early application permitted if financial statements for prior periods have not been issued. Revisions resulting from a change in valuation technique or its application shall be accounted for as a change in accounting estimate. In the period of adoption, a reporting entity shall disclose a change, if any, in valuation technique and related inputs resulting from the application of this guidance and quantify the total effect, if practicable. The Company does not have material liabilities measured at fair value on a recurring or non-recurring basis, therefore this guidance will not have a material effect on its financial condition or results of operations.

Reclassification of Comparative Amounts

Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation. These reclassifications had no effect on either shareholders’ equity or net income.

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2. INVESTMENT SECURITIES

The amortized cost of securities and their estimated fair values are as follows:

Securities Available for Sale

	2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Obligations of U.S. Government Agencies and Corporations	$	64,309,692	$	580,166	$	48,906	$	64,840,952
Mutual funds		1,000,000		—		506,103		493,897
Total	$	65,309,692	$	580,166	$	555,009	$	65,334,849
	2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Obligations of U.S. Government Agencies and Corporations	$	49,575,180	$	1,363,875	$	172	$	50,938,883
Mutual funds		1,000,000		—		388,917		611,083
Total	$	50,575,180	$	1,363,875	$	389,089	$	51,549,966
Securities Held to Maturity
	2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Obligations of States and Political Subdivisions	$	35,086,821	$	1,328,071	$	41,281	$	36,373,611
Total	$	35,086,821	$	1,328,071	$	41,281	$	36,373,611
	2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Obligations of States and Political Subdivisions	$	32,168,512	$	1,137,237	$	40,180	$	33,265,569
Total	$	32,168,512	$	1,137,237	$	40,180	$	33,265,569

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2. INVESTMENT SECURITIES (CONTINUED)

The amortized cost and fair values of debt securities at December 31, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.

	Available For Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	5,534,022	$	5,126,229	$	2,966,645	$	3,005,981
Due after one year through five years		47,496,715		47,791,433		15,124,121		15,859,482
Due after five through ten years		10,033,192		10,159,097		16,401,401		16,898,641
Due after ten years		2,245,763		2,258,090		594,654		609,507
	$	65,309,692	$	65,334,849	$	35,086,821	$	36,373,611

Investment securities with an approximate carrying value of $30.4 million and $37.4 million at December 31, 2009 and 2008, respectively, were pledged to secure public deposits, securities sold under agreement to repurchase and for other purposes as required or permitted by law.

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual securities have been in a continuous unrealized loss position, at December 31, 2009 and 2008. As of December 31, 2009, there were a total of thirteen securities in an unrealized loss position.

	2009
	Less Than Twelve Months				Twelve Months or Greater				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
U.S. Government agencies and corporations	$	5,954,780	$	48,906	$	—	$	—	$	5,954,780	$	48,906
Obligations of states and Political subdivisions		3,767,311		41,281		—		—		3,767,311		41,281
Mutual funds		—		—		493,897		506,103		493,897		506,103
Total debt securities	$	9,722,091	$	90,187	$	493,897	$	506,103	$	10,215,988	$	596,290
	2008
	Less Than Twelve Months				Twelve Months or Greater				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
U.S. Government agencies and corporations	$	20,440	$	70	$	286,777	$	102	$	307,217	$	172
Obligations of states and Political subdivisions		2,056,170		40,180		—		—		2,056,170		40,180
Mutual funds		611,083		388,917		—		—		611,083		388,917
Total debt securities	$	2,687,693	$	429,167	$	286,777	$	102	$	2,974,470	$	429,269

The Company’s investment securities portfolio primarily reflects unrealized losses on direct obligations of the United States (U.S.) Government including mortgage-related instruments issued or backed by the full faith and credit of the U.S., as well as debt obligations of states or political subdivisions. Such unrealized losses are viewed as interest rate related, not credit related.

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2. INVESTMENT SECURITIES (CONTINUED)

On a monthly basis, the Company evaluates, the severity and duration of impairment for its investment securities portfolio. Unless the Company has the ability to hold the security to maturity without incurring a loss, impairment is considered other than temporary when an investment security has sustained a decline of ten percent or more for six months.

The Company has concluded that any impairment of its investment securities portfolio is temporary and will not result in a future loss of principal or interest.

3. LOANS

Major classification of loans are summarized as follows:

	2009			2008
Real estate – residential	$	81,505,153		$	72,663,710
Real estate – farm		9,728,761			8,843,146
Real estate – commercial		57,924,239			59,504,843
Real estate – construction		11,872,968			12,076,906
Commercial and other loans		43,068,368			43,239,000
Consumer and credit loans		6,139,962			6,900,712
		210,239,451			203,228,317
Less allowance for loan losses		(2,441,169	)		(2,525,202	)
Less net deferred loan origination fees		(223,147	)		(254,407	)
Loans, net	$	207,575,135		$	200,448,708

Loans held for sale at December 31, 2009 were $271,000 and were carried at cost. Real estate loans serviced for FHLMC, which are not included in the consolidated balance sheet, totaled $49.3 million and $50.3 million at December 31, 2009 and 2008, respectively. The Bank is currently collecting a fee of .25% for servicing these loans.

Total nonaccrual loans and the related interest for the years ended December 31 are as follows.

	2009		2009		2007
Principal outstanding	$	—	$	72,799	$	838,877
Contractual interest due	$	—	$	13,692	$	34,833
Interest income recognized	$	—	$	—	$	—

The Company’s primary business activity is with customers located within its local trade area. Residential, commercial, personal, and agricultural loans are granted. The Company also selectively funds loans originated outside of its trade area provided such loans meet its credit policy guidelines. Although the Company has a diversified loan portfolio at December 31, 2009 and 2008, loans outstanding to individuals and businesses are dependent upon the local economic conditions in its immediate trade area.

The Bank entered into transactions with certain directors, executive officers, significant stockholders, and their affiliates. A summary of loan activity for those directors, executive officers, and their associates with loan balances in excess of $60,000 for the year ended December 31, 2009 is as follows:

Balance December 31, 2008		Additions		Amounts Collected		Balance December 31, 2009
$	4,113,061	$	654,832	$	778,385	$	3,989,508

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4. ALLOWANCE FOR LOAN LOSSES

An analysis of the change in the allowance for loan losses follows:

	2009			2008			2007
Balance, January 1	$	2,525,202		$	2,510,011		$	2,393,705
Add:
Provision charged to operations		2,000			61,000			127,119
Loan recoveries		46,811			67,082			120,973
Less: Loans charged off		(132,844	)		(112,891	)		(131,786	)
Balance, December 31	$	2,441,169		$	2,525,202		$	2,510,011

5. PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows:

	2009			2008
Land	$	2,050,242		$	2,050,242
Building and improvements		5,510,684			5,465,406
Leasehold improvements		78,761			78,761
Furniture, fixtures and equipment		3,695,065			3,682,240
		11,357,252			11,276,649
Less accumulated depreciation		(5,347,810	)		(4,955,618	)
Total	$	6,009,442		$	6,321,031

Depreciation expense charged to operations was $392,000 for 2009, $449,000 for 2008, and $382,000 for 2007.

6. GOODWILL

As of December 31, 2009 and 2008, goodwill had a gross carrying amount of $1.6 million and an accumulated amortization amount of $.3 million resulting in a net carrying value of $1.3 million.

The carrying value of goodwill was tested for impairment in the second quarter of 2009. Due to an increase in overall earnings and asset growth, operating profits and cash flows were greater than originally expected for the reporting unit. As a result, based on the fair value of the reporting unit, which was estimated using the expected present value of future cash flows, no goodwill impairment loss was recognized.

7. DEPOSITS

Time deposits include certificates of deposit in denominations of $100,000 or more. Such deposits aggregated $66.2 million and $57.4 million at December 31, 2009 and 2008, respectively.

Interest expense on certificates of deposit $100,000 and over amounted to $1.5 million in 2009, $2.1 million in 2008, and $2.4 million in 2007.

The following table sets forth the remaining maturity of time certificates of deposits of $100,000 or more at December 31, 2009.

3 months or less	$	12,130,982
Over 3 through 6 months		18,048,618
Over 6 through 12 months		15,552,868
Over 12 months		20,429,223
Total	$	66,161,691

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7. DEPOSITS (CONTINUED)

The following table sets forth the remaining maturity of all time deposits at December 31, 2009.

12 month or less	$	100,958,812
12 months through 24 months		28,438,032
24 months through 36 months		9,453,978
36 months through 48 months		7,547,047
48 months through 60 months		7,503,708
Over 60 months		11,809
	$	153,913,387

8. SHORT-TERM BORROWINGS

Short-term borrowings consist of securities sold under agreements to repurchase. These retail repurchase agreements are with customers in the Company’s respective market areas. These borrowings are collateralized with securities owned by the Company and held in their safekeeping account at an independent correspondent bank. The outstanding balances and related information for short-term borrowings are summarized as follows:

	2009			2008
Short-term borrowings:
Ending balance	$	5,660,000		$	6,385,000
Maximum month-end balance during the year		6,345,000			7,010,000
Average month-end balance during the year		5,390,000			5,662,917
Weighted average rate at year end		0.23	%		0.23	%
Weighted average rate during the year		0.23	%		0.31	%

The Company has pledged investment securities with carrying values of $5.1 million and $8.3 million as of December 31, 2009 and 2008, respectively, as collateral for the repurchase agreements.

9. FEDERAL HOME LOAN BANK ADVANCES

The Federal Home Loan Bank advances have monthly principal and interest payments due with maturity dates from 2009 through 2017. The weighted average rate paid on the advances is 5.92%. The scheduled aggregate minimum future principal payments on the advances outstanding as of December 31, 2009 are as follows:

Year Ending December 31,	Amount
2010	$	606,454
2011		219,845
2012		164,075
2013		82,774
2014		66,440
2015 and thereafter		72,412
Total	$	1,212,000

The Bank maintains a credit arrangement with Federal Home Loan Bank of Cincinnati, Ohio (“FHLB”). The FHLB borrowings, when used, are collateralized by the Bank’s investment in Federal Home Loan Bank stock and a blanket collateral pledge agreement with the FHLB under which the Bank has pledged certain qualifying assets equal to 150 percent of the unpaid amount of the outstanding balances. At December 31, 2009, the Bank had additional borrowing capacity under the FHLB agreement of approximately $41.9 million.

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10. EMPLOYEE BENEFIT PLAN

The Bank maintains a profit sharing pension plan which is integrated with a 401(k) plan. The plan covers substantially all employees who are 21 and have one year’s service.

Under the profit sharing pension plan contribution formula, the Bank, for each plan year, will contribute an amount equal to 8% of an employee’s compensation for the plan year and 5.7% of the amount of an employee’s excess compensation for the plan year. Excess compensation is a participant’s compensation in excess of the designated integration level. This designated integration level is 100% of the taxable wage base in effect at the beginning of the plan year. The federal government annually adjusts the taxable wage base. This plan does not permit nor require employees to make contributions to the plan.

The 401(k) plan allows employees to make salary reduction contributions to the plan up to 20% of a participant’s compensation. For each plan year, the Bank may contribute to the plan an amount of matching contributions for a particular plan year. The Bank may choose not to make matching contributions for a particular plan year. For 2009 and 2008 the Bank matched 25% of the employees’ voluntary contributions up to 1% of the employee’s compensation.

The pension costs charged to operating expense for the years 2009, 2008 and 2007 amounted to $352,000, $343,000, and $319,000, respectively.

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11. OTHER OPERATING EXPENSE

Other operating expense included the following:

	2009		2008		2007
Professional fees	$	375,651	$	371,839	$	276,684
Franchise tax		522,588		502,008		488,388
Telephone		124,123		138,919		169,388
Stationery, supplies and printing		146,555		168,350		165,438
Postage, express and freight		202,223		186,504		183,047
Data processing		204,683		199,010		177,081
Other		1,496,630		949,582		970,871
Total	$	3,072,453	$	2,516,212	$	2,430,897

12. OPERATING LEASES

The Bank leases the space housing the branch located in Berlin, Ohio. The lease expires in five years, with an option to automatically renew for an additional ten year period. Minimum future rental payments are as follows:

Less than 1 year	$	19,664
1 to 3 years		40,515
3 to 5 years		63,861
Greater than 5 years		190,064
	$	314,104

13. INCOME TAXES

The provision for federal income taxes for the years ended December 31 consist of:

	2009		2008			2007
Current payable	$	818,542	$	1,474,256		$	1,885,059
Deferred		16,901		(370,243	)		8,069
Total provision	$	835,443	$	1,104,013		$	1,893,128

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13. INCOME TAXES (CONTINUED)

The following is a reconciliation between the Company’s provision for federal income taxes and the amount of income taxes computed at the 34% statutory rate in effect for all years presented.

	2009					2008					2007
	Amount			% of Pre-Tax Income		Amount			% of Pre-Tax Income		Amount			% of Pre-Tax Income
Provision at statutory rate	$	1,349,934		34.0	%	$	1,890,280		34.0	%	$	2,311,261		34.0	%
Tax exempt income		(567,467	)	(14.3	)		(629,523	)	(11.3	)		(526,655	)	(7.7	)
Non-deductible interest Expense		42,271		1.1			40,852		0.7			52,577		0.8
Other, net		10,705		0.3			(197,595	)	(3.6	)		55,945		0.8
Tax expense and effective rate	$	835,443		21.1	%	$	1,104,013		19.9	%	$	1,893,128		27.8	%

The tax effects of deductible and taxable temporary differences that gave rise to significant portions of the net deferred tax assets and liabilities at December 31 are as follows:

	2009		2008
Deferred Tax Assets:
Allowance for loan losses	$	631,967	$	660,538
Other		170,280		166,893
Deferred tax asset		802,247		827,431
Deferred Tax Liabilities:
Premise and equipment		253,402		281,770
Stock dividends		243,814		243,814
Net unrealized gain on securities		8,553		331,427
Other, net		258		13,975
Deferred tax liabilities	$	506,027	$	870,986
Net deferred tax (liabilities) assets	$	296,220	$	(43,555	)

No valuation allowance was established at December 31, 2009 in view of certain tax strategies coupled with the anticipated future taxable income as evidenced by the company’s earnings potential.

14. COMMITMENTS AND CONTINGENT LIABILITIES

Commitments

In the normal course of business, the Company has outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated balance sheet.

These commitments were comprised of the following at December 31:

	2009		2008
Commitments to extend credit	$	40,789,000	$	42,188,000
Standby letters of credit		1,235,000		895,000
Total	$	42,024,000	$	43,083,000

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14. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED)

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to 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. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The fees earned from issuance of letters are recognized at the origination of the coverage period. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit.

The Company has not been required to perform any financial guarantees during the past two years. The Company has not incurred any losses on its commitments in either 2009, 2008 or 2007.

Contingent Liabilities

The Company and its subsidiary are subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position of the Company.

15. REGULATORY MATTERS

The approval of regulatory authorities is required if the total of all dividends declared by the Bank in any calendar year exceeds net profits as defined for that year combined with its retained net profits for the two preceding calendar years less any required transfers to surplus. Under this formula, the amount available for payment of dividends by the Bank to the Company at December 31, 2009, without the approval of the regulatory authorities is $3.0 million.

Included in cash and due from banks are required federal reserves of $4.2 million and $4.1 million at December 31, 2009 and 2008, respectively, for facilitating the implementation of monetary policy by the Federal Reserve System. The required reserves are computed by applying prescribed ratios to the classes of average deposit balances. These are held in the form of cash on hand and/or balances maintained directly with the Federal Reserve Bank.

Federal law prevents the Company from borrowing from the Bank unless the loans are secured by specific obligations. Further, such secured loans are limited in amount to ten percent of the Bank’s capital. The Company had no such borrowings at December 31, 2009 and 2008.

16. REGULATORY CAPITAL REQUIREMENTS

Federal regulations require the Company and the Bank to maintain minimum amounts of capital. Specifically, each is required to maintain certain minimum dollar amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average total assets.

In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) established five capital categories ranging from “well-capitalized” to “critically undercapitalized.” Should any institution fail to meet the requirements to be considered “adequately capitalized,” it would become subject to a series of increasingly restrictive regulatory actions.

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16. REGULATORY CAPITAL REQUIREMENTS (CONTINUED)

As of December 31, 2009 and 2008, the FDIC categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be classified as a well-capitalized financial institution, Total risk-based, Tier I risk-based, and Tier I Leverage capital ratios must be at least ten percent, six percent, and five percent, respectively. There have been no conditions or events since notification that management believes have changed this category.

The Company’s actual capital ratios are presented in the following table, which shows the Company met all regulatory capital requirements. The capital position of the Bank does not differ significantly from the Company’s.

	2009				2008
Amounts expressed in thousands	Amount		Ratio		Amount		Ratio
Total Risk Based Capital (to Risk Weighted Assets)
Actual	$	44,158	19.17	%	$	43,621	19.21	%
For Capital Adequacy Purposes		18,426	8.00			18,163	8.00
To be well-capitalized		23,033	10.00			22,704	10.00
Tier 1 Capital (to Risk Weighted Assets)
Actual		41,717	18.11	%		41,096	18.10	%
For Capital Adequacy Purposes		9,213	4.00			9,082	4.00
To be well-capitalized		13,820	6.00			13,623	6.00
Tier 1 Capital (to Average Assets)
Actual		41,717	11.62	%		41,096	12.10	%
For Capital Adequacy Purposes		14,357	4.00			13,585	4.00
To be well-capitalized		17,947	5.00			16,981	5.00

17. FAIR VALUE MEASUREMENTS

Effective in 2008, the Company adopted accounting guidance, which, among other things, required enhanced disclosures about assets and liabilities carried at fair value. This guidance establishes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined under the literature are as follows:

Level I:	Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level II:	Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
Level III:	Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

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17. FAIR VALUE MEASUREMENTS (CONTINUED)

The following table presents the assets reported on the consolidated statements of financial condition at their fair value as of December 31, 2009 by level within the fair value hierarchy. As required by the current accounting guidance, financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

	December 31, 2009
	Level I		Level II		Level III		Total
	(In thousands)
Assets:
Securities available for sale	$	—	$	65,335	$	—	$	65,335
Loans held for sale	$	271	$	—	$	—	$	271
	December 31, 2008
	Level I		Level II		Level III		Total
	(In thousands)
Assets:
Securities available for sale	$	—	$	51,550	$	—	$	51,550

18. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS

The carrying amounts and estimated fair values at December 31 are as follows:

	2009				2008
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(In thousands)
Financial assets:
Cash and due from depository institutions	$	42,576	$	42,576	$	31,869	$	31,869
Federal funds sold		2,938		2,938		8,448		8,448
Securities available for sale		65,335		65,335		51,550		51,550
Securities held to maturity		35,087		36,374		32,168		33,266
Loans		207,575		215,102		200,448		211,277
Loans held for sale		271		271		—		—
Accrued interest receivable		1,468		1,468		1,471		1,471
Regulatory stock		1,884		1,884		1,735		1,735
Bank-owned life insurance		5,662		5,662		5,443		5,443
Financial liabilities:
Deposits	$	321,295	$	324,246	$	288,947	$	292,314
Short term borrowings		5,660		5,660		6,385		6,385
Federal Home Loan Bank advances		1,212		1,027		1,863		2,180
Accrued interest payable		183		183		245		245

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18. FAIR VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS (CONTINUED)

Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.

Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced or liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.

If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses, and other factors as determined through various option pricing formulas or simulation modeling. As many of these assumptions result from judgments made by management based upon estimates which are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.

As certain assets and liabilities such as deferred tax assets and liabilities, premises and equipment and many other operational elements of the Company, are not considered financial instruments, but have value, this estimated fair value of financial instruments would not represent the full market value of the Company.

The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:

Cash and Due from Banks, Federal Funds Sold, Accrued Interest Receivable, Regulatory Stock, BOLI, Short-Term Borrowings, and Accrued Interest Payable

The fair value approximates the current carrying value.

Investment Securities and Loans Held for Sale

The fair value of investment securities and loans held for sale are equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.

Loans, Deposits, and Federal Home Loan Bank Advances

The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value. Demand, savings, and money market deposit accounts are valued at the amount payable on demand as of year end. The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposits are valued at the amount payable on demand as of year-end.

Commitments to Extend Credit and Standby Letters of Credit

These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value, represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure. The contractual amounts of unfunded commitments and letters of credit are presented previously in the commitments and contingent liabilities note.

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19. PARENT COMPANY

The following are parent company only condensed financial statements:

CONDENSED BALANCE SHEET

	December 31,
	2009			2008
ASSETS
Cash	$	325,298		$	457,358
Investment in Bank		42,139,648			41,812,375
Investments – available for sale		493,897			611,083
Total assets	$	42,958,843		$	42,880,816
LIABILITIES AND SHAREHOLDERS’ EQUITY
Dividend checks outstanding	$	67,510		$	77,450
Deferred federal income tax payable		(172,075	)		(132,232	)
Shareholders’ equity		43,063,408			42,935,598
Total liabilities and shareholders’ equity	$	42,958,843		$	42,880,816

CONDENSED STATEMENT OF INCOME

	Year Ended December 31,
	2009			2008			2007
INCOME
Dividends from Bank	$	2,300,000		$	2,950,000		$	4,400,000
Operating expenses		63,203			70,135			62,370
Income before income tax benefit		2,236,797			2,879,865			4,337,630
Income tax benefit		(21,472	)		(23,829	)		(21,206	)
Income before equity in undistributed net income of subsidiary		2,258,269			2,903,694			4,358,836
Equity in undistributed net income of Bank		876,683			1,551,939			545,863
NET INCOME	$	3,134,952		$	4,455,633		$	4,904,699

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19. PARENT COMPANY (CONTINUED)

CONDENSED STATEMENT OF CASH FLOWS

	Year Ended December 31,
	2009			2008			2007
OPERATING ACTIVITIES
Net income	$	3,134,952		$	4,455,633		$	4,904,699
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net income of subsidiary		(876,683	)		(1,551,939	)		(545,863	)
Decrease in other liabilities		(9,940	)		(32,698	)		(31,979	)
Net cash provided by operating activities		2,248,329			2,870,996			4,326,857
INVESTING ACTIVITIES
Purchase of investment securities available for sale		—			—			(1,000,000	)
Net cash used in investing activities		—			—			(1,000,000	)
FINANCING ACTIVITIES
Purchase of treasury shares		(527,146	)		(939,318	)		(1,043,151	)
Dividends paid		(1,853,242	)		(1,843,066	)		(2,371,463	)
Advance from subsidiary		—			—			—
Net cash used in financing activities		(2,380,388	)		(2,782,384	)		(3,414,614	)
INCREASE (DECREASE) IN CASH		(132,059	)		88,612			(87,757	)
CASH AT BEGINNING OF YEAR		457,358			368,746			456,503
CASH AT END OF YEAR	$	325,299		$	457,358		$	368,746

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20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) (IN THOUSANDS EXCEPT PER SHARE DATA)

	Three Months Ended
	March 2009		June 2009		September 2009		December 2009
Total interest income	$	4,116	$	4,046	$	3,893	$	3,810
Total interest expense		1,215		1,136		1,083		1,043
Net interest income		2,901		2,910		2,810		2,767
Provision for loan losses		1		1		—		—
Net interest income after provision for loans losses		2,900		2,909		2,810		2,767
Total noninterest income		384		459		414		416
Total noninterest expense		2,235		2,200		2,280		2,373
Income before income taxes		1,049		1,168		944		810
Income taxes		229		281		200		125
Net income	$	820	$	886	$	744	$	685
Per share data:
Net earnings	$	1.32	$	1.43	$	1.20	$	1.12
Weighted average shares outstanding		620,269		618,960		617,932		616,827

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20. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)(CONTINUED) (IN THOUSANDS EXCEPT PER SHARE DATA)

	Three Months Ended
	March 2008		June 2008		September 2008		December 2008
Total interest income	$	5,081	$	4,734	$	4,618	$	4,424
Total interest expense		1,924		1,694		1,527		1,369
Net interest income		3,157		3,040		3,091		3,055
Provision for loan losses		—		—		—		61
Net interest income after provision for loans losses		3,157		3,040		3,091		2,994
Total noninterest income		400		648		393		366
Total noninterest expense		2,253		2,037		2,186		2,053
Income before income taxes		1,304		1,651		1,298		1,307
Income taxes		316		326		200		262
Net income	$	988	$	1,325	$	1,098	$	1,045
Per share data:
Net earnings	$	1.57	$	2.11	$	1.75	$	1.68
Weighted average shares outstanding		628,447		627,276		626,410		622,471

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