UNION NATIONAL FINANCIAL CORP / PA - FORM 10-Q

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EX-32 - UNION NATIONAL FINANCIAL CORP / PA	v201700_ex32.htm
EX-31.2 - UNION NATIONAL FINANCIAL CORP / PA	v201700_ex31-2.htm
EX-31.1 - UNION NATIONAL FINANCIAL CORP / PA	v201700_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2010

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

For the transition period from to

Commission file number 0-19214

UNION NATIONAL FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Pennsylvania		23-2415179
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

570 Lausch Lane, Suite 300 Lancaster, Pennsylvania		17601
(Address of Principal Executive Offices)		(Zip Code)

(717) 492-2222

(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ¨ No ¨

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

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes ¨ No x

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

3,054,895 shares, of $0.25 par value, common stock were outstanding as of November 9, 2010.

UNION NATIONAL FINANCIAL CORPORATION

FORM 10-Q

INDEX

		PAGE NO.

PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Consolidated Statements of Financial Condition
	As of September 30, 2010 and December 31, 2009	1

	Consolidated Statements of Operations
	For the Three and Nine Months Ended September 30, 2010 and 2009	2

	Consolidated Statements of Changes in Stockholders’ Equity
	For the Nine Months Ended September 30, 2010 and 2009	3

	Consolidated Statements of Cash Flows
	For the Nine Months Ended September 30, 2010 and 2009	4

	Notes to Unaudited Consolidated Financial Statements	5 - 27

Item 2.	Management’s Discussion and Analysis of
	Financial Condition and Results of Operations	28 - 47

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48

Item 4.	Controls and Procedures	48

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	48

Item 1A.	Risk Factors	49

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 3.	Defaults upon Senior Securities	49

Item 4.	(Removed and Reserved)	49

Item 5.	Other Information	49

Item 6.	Exhibits	49

Signatures		53

Unless the context otherwise requires, the terms “Union National,” “we,” “us,” and “our” refer to Union National Financial Corporation and its consolidated subsidiary.

PART I ─ FINANCIAL INFORMATION

Item 1. Financial Statements

Union National Financial Corporation

Consolidated Statements of Financial Condition

(Unaudited; Dollars in thousands, except share and per share data)

	September 30, 2010			December 31, 2009
Assets
Cash and Due from Banks	$	6,918		$	8,807
Short-Term Investments		900		–
Interest-Bearing Demand Deposits in Other Banks		41,878			34,533
Total Cash and Cash Equivalents		49,696			43,340

Interest-Bearing Time Deposits in Other Banks		2,792			9,229
Investment Securities Available for Sale		47,160			60,546

Loans and Leases, Net of Unearned Income		329,239			339,274
Less: Allowance for Credit Losses		(6,341	)		(5,858	)
Net Loans and Leases		322,898			333,416

Premises and Equipment, Net		10,773			11,403
Restricted Investment in Bank Stocks		3,727			3,727
Bank-Owned Life Insurance		11,842			11,539
Other Real Estate Owned		8,418			5,383
Other Assets		10,766			11,061

Total Assets	$	468,072		$	489,644

Liabilities
Deposits:
Noninterest-Bearing	$	66,995		$	54,331
Interest-Bearing		330,550			350,434
Total Deposits		397,545			404,765
Long-Term Debt		10,834			33,334
Junior Subordinated Debentures		17,341			17,341
Other Liabilities		11,607			2,868
Total Liabilities		437,327			458,308

Stockholders’ Equity
Preferred Stock (Series A), liquidation value $1,000 per share Shares authorized - 5,000; Issued – 25 at September 30, 2010 and 1,275 at December 31, 2009		25			1,275
Common Stock, par value $0.25 per share Shares authorized - 20,000,000; Issued – 3,423,084 and 3,109,105 at September 30, 2010 and December 31, 2009, respectively; Outstanding - 3,054,895 and 2,740,916 at September 30, 2010 and December 31, 2009, respectively		856			777
Surplus		15,068			13,891
Retained Earnings		21,962			22,921
Accumulated Other Comprehensive Income (Loss)		167			(195	)
Treasury Stock, at cost; 368,189 at September 30, 2010 and December 31, 2009		(7,333	)		(7,333	)
Total Stockholders’ Equity		30,745			31,336

Total Liabilities and Stockholders’ Equity	$	468,072		$	489,644

See accompanying notes to unaudited consolidated financial statements.

Union National Financial Corporation

Consolidated Statements of Operations

(Unaudited; Dollars in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009

Interest Income
Interest and Fees on Loans and Leases	$	5,013		$	5,597		$	15,020		$	16,478
Investment Securities:
Taxable Interest		125			297			959			1,264
Tax-Exempt Interest		110			71			125			160
Dividends		9			9			27			31
Other		56			78			184			165
Total Interest Income		5,313			6,052			16,315			18,098

Interest Expense
Deposits		1,392			2,022			4,567			6,540
Long-Term Debt		198			468			982			1,629
Junior Subordinated Debentures		196			201			577			645
Total Interest Expense		1,786			2,691			6,126			8,814
Net Interest Income		3,527			3,361			10,189			9,284
Provision for Credit Losses		422			522			1,546			1,446
Net Interest Income after Provision for Credit Losses		3,105			2,839			8,643			7,838

Non-Interest Income
Service Charges on Deposit Accounts		459			588			1,415			1,601
Other Service Charges, Commissions, Fees		305			294			909			858
Alternative Investment Sales Commissions		189			125			523			428
Income from Fiduciary Activities		43			39			131			132
Earnings from Bank-Owned Life Insurance		99			108			303			323
Other Income		40			46			123			422
Net Gain on Sale of Investment Securities		577			397			943			1,791

Other-than-temporary Impairments (“OTTI”) of Securities		(104	)		(170	)		(1,664	)		(1,471	)
Portion of OTTI Recognized in Other Comprehensive Income		–			–			–			–
Net OTTI Losses on Securities		(104	)		(170	)		(1,664	)		(1,471	)
Total Non-Interest Income		1,608			1,427			2,683			4,084

Non-Interest Expense
Salaries, Wages, and Employee Benefits		1,737			1,680			5,198			5,297
Net Occupancy		439			414			1,343			1,313
Data and ATM Processing		434			406			1,301			1,236
Professional Fees and Regulatory Assessments		273			316			685			817
Furniture and Equipment		203			227			641			713
FDIC Insurance		236			238			703			898
Pennsylvania Shares Tax		95			89			286			267
Advertising and Marketing		41			42			131			159
Supplies and Postage		69			66			188			214
Merger and Acquisition Expense		337			–			773			–
Other Expense		867			689			1,788			1,747

Total Non-Interest Expense		4,731			4,167			13,037			12,661
(Loss) Income Before Benefit from Income Taxes		(18	)		99			(1,711	)		(739	)
Benefit from Income Taxes		(95	)		(48	)		(787	)		(482	)
Net Income (Loss)		77			147			(924	)		(257	)
Preferred Stock Dividends		–			–			35			–
Net Income (Loss) Available to Common Stockholders	$	77		$	147		$	(959	)	$	(257	)
Income (Loss) Per Common Share
Basic and Diluted	$	0.03		$	0.05		$	(0.34	)	$	(0.09	)
Cash Dividends Paid Per Common Share		–			–			–			–

See accompanying notes to unaudited consolidated financial statements.

Union National Financial Corporation

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited; Dollars in thousands, except share data)

	Nine Months Ended September 30, 2010
	Shares of Common Stock Outstanding		Preferred Stock			Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive (Loss) Income			Treasury Stock			Total
Balance at December 31, 2009		2,740,916	$	1,275		$	777	$	13,891	$	22,921		$	(195	)	$	(7,333	)	$	31,336

Comprehensive Loss:
Net Loss		–		–			–		–		(924	)		–			–			(924	)
Net Change in Unrealized Gains on Available- for-Sale Securities, Net of Tax		–		–			–		–		–			362			–			362
Total Comprehensive Loss																				(562	)
Preferred Stock Converted to Common Stock		312,500		(1,250	)		78		1,172		–			–			–			–
Issuance of Common Stock under
Dividend Reinvestment Plan		1,479		–			1		5		–			–			–			6
Cash Dividends Paid to Preferred Stockholders		–		–			–		–		(35	)		–			–			(35	)

Balance at September 30, 2010		3,054,895	$	25		$	856	$	15,068	$	21,962		$	167		$	(7,333	)	$	30,745

	Nine Months Ended September 30, 2009
	Shares of Common Stock Outstanding		Preferred Stock		Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive Income			Treasury Stock			Total
Balance at December 31, 2008		2,720,076	$	–	$	785		$	14,868		$	23,434		$	36		$	(8,329	)	$	30,794

Comprehensive Income:
Net Loss		–		–		–			–			(257	)		–			–			(257	)
Reclassification Adjustment for Cumulative Effect of ASC Topic 320, “Investments – Debt and Equity Securities”, Net of Tax		–		–		–			–			202			(202	)		–			–
Net Change in Unrealized Gains onAvailable-for-Sale Securities, Net of Tax		–		–		–			–			–			289			–			289
Total Comprehensive Income																					32
Issuance of Preferred Stock		–		700		–			(30	)		–			–			–			670
Issuance of Common Stock under
Dividend Reinvestment Plan		19,248		–		4			58			–			–			–			62
Retirement of Treasury Stock (50,000 shares)		–		–		(12	)		(984	)		–			–			996			–

Balance at September 30, 2009		2,739,324	$	700	$	777		$	13,912		$	23,379		$	123		$	(7,333	)	$	31,558

See accompanying notes to unaudited consolidated financial statements.

Union National Financial Corporation

Consolidated Statements of Cash Flows

(Unaudited; Dollars in thousands)

	Nine Months Ended September 30,
	2010			2009
Cash Flows from Operating Activities
Net Loss	$	(924	)	$	(257	)
Adjustments to Reconcile Net Loss to Net Cash Provided by Operating Activities:
Depreciation and Amortization		782			891
Provision for Credit Losses		1,546			1,446
Net Amortization of Investment Securities Premiums		343			414
Net Investment Securities Gains on Sales		(943	)		(1,791	)
OTTI Losses on Investment Securities		1,664			1,471
Benefit from Deferred Income Taxes		(732	)		(626	)
Earnings from Bank-Owned Life Insurance		(303	)		(323	)
Decrease (Increase) in Accrued Interest Receivable		75			(80	)
Decrease (Increase) in Other Assets		738			(965	)
Increase in Other Liabilities		8,739			443
Net Cash Provided by Operating Activities		10,985			623

Cash Flows from Investing Activities
Proceeds from Sales of Available-for-Sale Securities		109,182			183,337
Proceeds from Maturities and Principal Repayments on Available-for-Sale Securities		17,150			19,927
Purchases of Available-for-Sale Securities		(113,460	)		(185,007	)
Proceeds from Calls, Maturities and Sales (Purchases) of Time Deposits in Other Banks		6,437			(10,149	)
Net Decrease in Loans and Leases		5,661			4,549
Proceeds from Sale of Loans		–			9,800
Purchases of Premises, Equipment and Software		(126	)		(342	)
Net Increase of Restricted Investments in Bank Stocks		–			(2	)
Proceeds from Sale of Other Real Estate Owned		276			349
Net Cash Provided by Investing Activities		25,120			22,462

Cash Flows from Financing Activities
Net (Decrease) Increase in Demand Deposits and Savings Accounts		(4,471	)		25,146
Net (Decrease) Increase in Time Deposits		(2,749	)		6,239
Payments on Long-Term Debt		(22,500	)		(17,000	)
Issuance of Common Stock, Net of Costs		6			62
Issuance of Preferred Stock, Net of Costs		–			670
Cash Dividends Paid to Preferred Stockholders		(35	)		–
Net Cash (Used In) Provided by Financing Activities		(29,749	)		15,117

Net Increase in Cash and Cash Equivalents		6,356			38,202
Cash and Cash Equivalents at Beginning of Period		43,340			31,837
Cash and Cash Equivalents at End of Period	$	49,696		$	70,039

Supplemental Disclosures of Cash Flow Information
Interest Paid	$	6,173		$	8,893
Income Tax Paid	$	–		$	750

Supplemental Schedule of Noncash Activities
Transfers to Other Real Estate Owned	$	3,311		$	419
Retirement of Treasury Stock (50,000 shares in 2009)	$	–		$	996

See accompanying notes to unaudited consolidated financial statements.

Union National Financial Corporation

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements include the accounts of Union National Financial Corporation (“Union National”) and its subsidiary Union National Community Bank (the “Bank”). All material intercompany accounts and transactions have been eliminated in consolidation. Union National’s trust subsidiaries, Union National Capital Trust I and Union National Capital Trust II, which were established during 2003 and 2004 for the purpose of issuing $11,000,000 of trust capital securities, are not consolidated.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The consolidated financial statements contain all adjustments (consisting only of normal recurring accruals and adjustments) necessary to present fairly our financial position as of September 30, 2010 and December 31, 2009, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the periods ended September 30, 2010 and 2009. The results of operations for interim periods are not necessarily indicative of operating results expected for the full year. These interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in Union National’s Annual Report on Form 10-K for the year ended December 31, 2009, and with Union National’s Forms 10-Q and 8-K, and other reports, that were filed during 2010 with the SEC.

Union National has evaluated events and transactions occurring subsequent to the balance sheet date of September 30, 2010, for items that potentially should be recognized or disclosed in the consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

Note 2 – Use of Estimates

The process of preparing consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect the reported amounts of certain types of assets, liabilities, revenues and expenses. Accordingly, actual results may differ from estimated amounts. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, the valuation of deferred tax assets, the assessment of other-than-temporary impairment of investment securities, the potential impairment of restricted stock and fair value disclosures.

Note 3 – Recent Accounting Pronouncements

ASU 2009-16. In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-16, “Transfers and Servicing (Accounting Standards Codification (“ASC”) Topic 860) - Accounting for Transfers of Financial Assets”. This ASU amends the Codification for the issuance of FASB Statement No. 166, Accounting for Transfers of Financial Assets - an amendment of FASB Statement No. 140.

The amendments in this ASU improve financial reporting by eliminating the exceptions for qualifying special-purpose entities from the consolidation guidance and the exception that permitted sale accounting for certain mortgage securitizations when a transferor has not surrendered control over the transferred financial assets. In addition, the amendments require enhanced disclosures about the risks that a transferor continues to be exposed to because of its continuing involvement in transferred financial assets. Comparability and consistency in accounting for transferred financial assets will also be improved through clarifications of the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting.

This guidance became effective January 1, 2010, and did not have a material impact on Union National’s financial condition or results of operations.

ASU 2009-17. In October 2009, the FASB issued ASU 2009-17, “Consolidations (ASC Topic 810) - Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities”. This Update amends the Codification for the issuance of FASB Statement No. 167, “Amendments to FASB Interpretation No. 46(R)”.

The amendments in this ASU replace the quantitative-based risks and rewards calculation for determining which reporting entity, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which reporting entity has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which reporting entity has a controlling financial interest in a variable interest entity. The amendments in this ASU also require additional disclosures about a reporting entity’s involvement in variable interest entities, which will enhance the information provided to users of financial statements.

This guidance became effective January 1, 2010, and did not have a material impact on Union National’s financial condition or results of operations.

ASU 2010-18. In April 2010, the FASB issued ASU 2010-18, “Receivables (ASC Topic 310): Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset”, codifies the consensus reached in EITF Issue No. 09-I, “Effect of a Loan Modification When the Loan Is Part of a Pool That Is Accounted for as a Single Asset.” The amendments to the Codification provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. ASU 2010-18 does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.

ASU 2010-18 is effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Upon initial adoption of ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under ASC Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration. Union National’s adoption of this new pronouncement did not have a material impact on Union National’s consolidated financial statements.

ASU 2010-20. In July 2010, the FASB issued ASU 2010-20, “Receivables (ASC Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”, which will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures.

This ASU requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators. Both new and existing disclosures must be disaggregated by portfolio segment or class. The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.

The amendments in this update apply to all public and nonpublic entities with financing receivables. Financing receivables include loans and trade accounts receivable. However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments.

For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010. The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010. Union National is assessing the impact of this new ASC, but believes the adoption of this new pronouncement will not have a material impact on its consolidated financial statements.

Note 4 – Earnings (Loss) Per Common Share

Basic earnings (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per common share reflects the potential dilution that could occur if (i) preferred stock shares were converted to common stock shares, and (ii) options to issue common stock were exercised. The terms of the potential conversion of preferred stock to common stock shares are discussed in Note 8 – Stock Issued Under Private Placement Offerings and Dividend Reinvestment Plan. Potential common shares that may be issued related to outstanding stock options are determined using the treasury stock method. For the three and nine months ended September 30, 2010, there were 1,250 preferred stock shares converted to common stock shares, which had a dilutive effect. The dilutive earnings (loss) per common share for each period was not affected by the impact of stock options. At September 30, 2010 and 2009, there were 77,517 and 91,958 stock options outstanding, respectively, which had no intrinsic value.

The computation of basic and diluted earnings (loss) per common share, net income (loss) available to common shareholders, and weighted-average number of shares outstanding for the three and nine months ended September 30, 2010 and 2009, are presented below (amounts, except earnings (loss) per share, in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010			2009
Net Income (Loss) Available to Common Stockholders	$	77	$	147	$	(959	)	$	(257	)
Weighted-average Common Shares Outstanding		2,957		2,738		2,814			2,727
Basic Earnings (Loss) Per Common Share	$	0.03	$	0.05	$	(0.34	)	$	(0.09	)

Weighted-average Common Shares Outstanding		2,957		2,738		2,814			2,727
Effect of Diluted Securities:
Convertible Preferred Stock (1)		104	–		–			–
Stock Options	–		–		–			–
Total Weighted-average Common Shares and Equivalents		3,061		2,738		2,814			2,727
Diluted Earnings (Loss) Per Common Share	$	0.03	$	0.05	$	(0.34	)	$	(0.09	)

(1) Had Union National not been in a loss position for the nine months ended September 30, 2010, the calculation of diluted loss per common share would have included an additional 247,000 weighted-average common shares outstanding for convertible preferred stock that was issued beginning in September 2009. Had Union National not been in a loss position for the nine months ended September 30, 2009, the calculation of diluted loss per common share would have included an additional 1,000 weighted-average common shares. This would reflect the potential dilution that could occur for each period if all of preferred stock shares were converted to common stock shares.

Note 5 – Investment Securities Available For Sale

The amortized cost and fair value of investment securities are presented in the tables below as of September 30, 2010 and December 31, 2009 (in thousands). The unrealized gains (losses) for these investment securities have been recorded in accumulated other comprehensive income (loss), net of related tax expense (benefit), which amounted to a net unrealized gain of $167,000 at September 30, 2010, as compared to a net unrealized loss of ($195,000) at December 31, 2009, recorded in accumulated other comprehensive income (loss). At September 30, 2010, the amortized cost of the private issuer mortgage-backed securities reflect cumulative reductions for other-than-temporary impairment charges of $1,642,000. During 2009, other-than-temporary impairment charges on the private issuer mortgage-backed securities were adjusted accordingly for the cumulative effect of the adoption of ASC Topic 320, “Investments – Debt and Equity Securities”, as discussed on page 11 under the section of this note titled “Other-Than-Temporary Impairment of Investment Securities”.

	At September 30, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Obligations of State and Political Subdivisions	$	25,349	$	299	$	(35	)	$	25,613
U.S. Agency Bonds and Structured Notes		19,488		17		(5	)		19,500
U.S. Agency Mortgage-Backed Securities		1,929		–		(16	)		1,913
Private Issuer Mortgage-Backed Securities		70		–		–			70
Equity Securities		70		7		(13	)		64
Total Investment Securities	$	46,906	$	323	$	(69	)	$	47,160

	At December 31, 2009
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. Agency Mortgage-Backed Securities	$	53,752	$	26	$	(384	)	$	53,394
Private Issuer Mortgage-Backed Securities		2,468		170		–			2,638
Obligations of State and Political Subdivisions		4,016		–		(201	)		3,815
Corporate Securities		535		96		–			631
Equity Securities		71		8		(11	)		68
Total Investment Securities	$	60,842	$	300	$	(596	)	$	60,546

Investment securities carried at fair value of $39,468,000 and $57,209,000 at September 30, 2010 and December 31, 2009, respectively, were pledged to secure public and government entity deposits, trust deposits, and as collateral for the Bank’s borrowing availability at the Federal Reserve Bank.

The amortized cost and fair value of investment securities at September 30, 2010 and December 31, 2009, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

	September 30, 2010				December 31, 2009
Maturity	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in One Year or Less	$	–	$	–	$	–	$	–
Due After One Year Through Five Years		7,015		7,025		–		–
Due After Five Years Through Ten Years		12,473		12,475		–		–
Due After Ten Years		25,349		25,613		4,551		4,446
		44,837		45,113		4,551		4,446

U.S. Agency Mortgage-Backed Securities		1,929		1,913		53,752		53,394
Private Issuer Mortgage-Backed Securities		70		70		2,468		2,638
Equity Securities		70		64		71		68
Total Investment Securities	$	46,906	$	47,160	$	60,842	$	60,546

The following tables present investment securities with gross unrealized losses that are not deemed to be other-than-temporarily impaired. These securities are aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2010 and December 31, 2009 (in thousands):

	At September 30, 2010
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Obligations of State and Political Subdivisions	$	3,297	$	(35	)	$	–	$	–		$	3,297	$	(35	)
U.S. Agency Bonds and Structured Notes		7,975		(5	)		–		–			7,975		(5	)
U.S. Agency Mortgage-Backed Securities		1,913		(16	)		–		–			1,913		(16	)
Equity Securities		–		–			16		(13	)		16		(13	)
Temporarily Impaired Securities	$	13,185	$	(56	)	$	16	$	(13	)	$	13,201	$	(69	)

	At December 31, 2009
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Agency Mortgage-Backed Securities	$	41,565	$	(384	)	$	–	$	–		$	41,565	$	(384	)
Obligations of State and Political Subdivisions		3,815		(201	)		–		–			3,815		(201	)
Equity Securities		–		–			18		(11	)		18		(11	)
Temporarily Impaired Securities	$	45,380	$	(585	)	$	18	$	(11	)	$	45,398	$	(596	)

Debt securities include mortgage-backed securities, obligations of state and political subdivisions, obligations of U.S. government agencies, structured agency notes and corporate securities. At September 30, 2010, there were sixteen debt securities with unrealized losses of $56,000 that amounted to 0.4% of their amortized cost, as compared to December 31, 2009, when there were twenty-seven debt securities with unrealized losses of $585,000 that amounted to 1.3% of their amortized cost. Management believes that the unrealized losses reflect temporary declines primarily due to changes in interest rates and the yield curve subsequent to the acquisition of specific securities. These temporary declines have been accounted for in other comprehensive income (loss).

Equity securities held are comprised primarily of common stock holdings in other financial institutions. There were nine and ten equity securities with unrealized losses of $13,000 and $11,000 at September 30, 2010 and December 31, 2009, respectively. Union National has the ability and intent to hold these investments for a reasonable period of time sufficient for each security to increase in value to Union National’s cost, and none are securities of companies with known debt defaults or deferrals. Management does not consider the equity securities to be other-than-temporarily impaired at September 30, 2010.

For the three months ended September 30, 2010 and 2009, Union National received gross proceeds of $47,784,000 and $112,142,000, respectively, on the sale of investment securities. The following tables present information related to the realized gains and losses on the sales of investment securities, and losses recognized on the other-than-temporary impairment of investment securities, for the three months ended September 30, 2010 and 2009 (in thousands):

	Three Months Ended September 30, 2010
	Gross Realized Gains		Gross Realized Losses		Other-than-temporary Impairment Losses			Net Gains (Losses)
Obligations of State and Political Subdivisions	$	416	$	–	$	–		$	416
U.S. Agency Mortgage-Backed Securities		136		–		–			136
U.S. Agency Bonds and Structured Notes		25		–		–			25
Private Issuer Mortgage-Backed Securities		–		–		(104	)		(104	)
Total	$	577	$	–	$	(104	)	$	473

	Three Months Ended September 30, 2009
	Gross Realized Gains		Gross Realized Losses			Other-than-temporary Impairment Losses			Net Gains (Losses)
U.S. Agency Mortgage-Backed Securities	$	170	$	(27	)	$	–		$	143
Obligations of State and Political Subdivisions		134		(4	)		–			130
U.S. Agency Bonds and Structured Notes		130		(25	)		–			105
U.S. Treasuries		19		–			–			19
Private Issuer Mortgage-Backed Securities		–		–			(160	)		(160	)
Corporate Securities		–		–			(10	)		(10	)
Total	$	453	$	(56	)	$	(170	)	$	227

For the nine months ended September 30, 2010 and 2009, Union National received gross proceeds of $109,182,000 and $183,337,000, respectively, on the sale of investment securities. The following tables present information related to the realized gains and losses on the sales of investment securities, and losses recognized on the other-than-temporary impairment of investment securities, for the nine months ended September 30, 2010 and 2009 (in thousands):

	Nine Months Ended September 30, 2010
	Gross Realized Gains		Gross Realized Losses		Other-than-temporary Impairment Losses			Net Gains (Losses)
U.S. Agency Mortgage-Backed Securities	$	453	$	–	$	–		$	453
Obligations of State and Political Subdivisions		440		–		–			440
U.S. Agency Bonds and Structured Notes		44		–		–			44
Private Issuer Mortgage-Backed Securities		–		–		(1,555	)		(1,555	)
Corporate Securities		5		–		(109	)		(104	)
Equity Securities		1		–		–			1
Total	$	943	$	–	$	(1,664	)	$	(721	)

	Nine Months Ended September 30, 2009
	Gross Realized Gains		Gross Realized Losses			Other-than-temporary Impairment Losses			Net Gains (Losses)
U.S. Agency Mortgage-Backed Securities	$	1,636	$	(70	)	$	–		$	1,566
Private Issuer Mortgage-Backed Securities		–		–			(612	)		(612	)
Obligations of State and Political Subdivisions		134		(4	)		–			130
U.S. Agency Bonds and Structured Notes		140		(25	)		–			115
U.S. Treasuries		19		–			–			19
Corporate Securities		–		–			(859	)		(859	)
Equity Securities		–		(39	)		–			(39	)
Total	$	1,929	$	(138	)	$	(1,471	)	$	320

Other-Than-Temporary Impairment of Investment Securities

In determining fair value and assessing the potential for other-than-temporary impairment (“OTTI”) of investment securities as of September 30, 2010, management primarily considered accounting principles and guidance from ASC Topic 320, “Investments – Debt and Equity Securities”, and ASC Topic 820, “Fair Value Measurements and Disclosures”. Additionally, management considered SEC guidance including SAB Topic 5M, “Miscellaneous Accounting – Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities”, and additional interpretive guidance from SEC Press Release #2008-234, “SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting”.

In order to determine whether unrealized losses in the fair value of investment securities are other-than-temporary, management regularly reviews the entire portfolio of investment securities for possible OTTI, analyzing factors including but not limited to the underlying creditworthiness of the issuing organization, the length of time for which the fair value of the investment securities has been less than cost, and independent analysts’ opinions about circumstances that could affect the performance of the investment securities. In assessing potential OTTI for debt securities, other considerations include (i) whether management intends to sell the security, or (ii) if it is more likely than not that management will be required to sell the security before recovery, or (iii) if management does not expect to recover the entire amortized cost basis.

In assessing potential OTTI for equity securities, an additional consideration is management’s intention and ability to hold the securities until recovery of any unrealized losses.

Effective April 1, 2009, the accounting principles and guidance referenced above requires that the credit-related portion of OTTI on debt securities be recognized in earnings, while the noncredit-related portion of OTTI on debt securities not expected by management to be sold be recognized in other comprehensive income. Management determined that OTTI recorded in 2008 against a private-issuer mortgage-backed security, not expected to be sold, had both credit-related and noncredit-related portions of OTTI; however, in 2008, the entire OTTI charge on this investment security was recognized in earnings. The noncredit-related portion was determined to be $306,000 pre-tax. Accordingly, on April 1, 2009, a cumulative effect adjustment was recorded in the after-tax amount of $202,000 to increase retained earnings and decrease unrealized gains (losses) in accumulated other comprehensive income (loss) for the noncredit-related portion of the OTTI recorded in 2008.

During 2009, one of the previously impaired corporate securities (USCap Funding V) was fully impaired, completely written off and declared as a worthless asset for tax purposes. This impaired corporate security had a cumulative credit related OTTI of $936,000 at December 31, 2009. The following table (in thousands) summarizes the cumulative credit related OTTI charges recognized as components of earnings for investment securities held with a recorded fair value at September 30, 2010 (the beginning balance on January 1, 2010, was adjusted to reflect the elimination of the worthless security discussed above):

Cumulative OTTI charges at January 1, 2010	$	2,352
Sale of impaired securities during the nine months ended September 30, 2010		(2,374	)
Additional OTTI taken for credit losses during the nine months ended September 30, 2010		1,664
Cumulative OTTI charges at September 30, 2010	$	1,642

As of September 30, 2010, Union National’s investment portfolio includes one security with recorded impairments. The fair value of this impaired investment was $70,000 as compared to an original amortized cost of $3,018,000. Since the original purchase of this security, Union National has received $1,388,000, which has been applied toward principal and has reduced the current amortized cost. The following table provides additional information related to this investment security (in thousands):

At September 30, 2010

Original

Amortized

Investment Rating

Current

Amortized

Fair

OTTI

Description of Investment Security

Cost

Original

Current

Cost

Value

Taken

Countrywide Alt Ln 2005-83CB A3

3,018

AAA

1,642

At December 31, 2009, Union National’s investment portfolio included four investment securities with recorded impairments. The fair value of these impaired investments was $3,269,000 as compared to an original amortized cost of $7,950,000. The following table provides additional information related to these four investment securities (in thousands):

			At December 31, 2009
	Original Amortized		Investment Rating		Current Amortized		Fair		OTTI
Description of Investment Security	Cost		Original	Current	Cost		Value		Taken

Private Issuer Mortgage-Backed Securities:
Countrywide Alt Ln 2005-83CB A3	$	3,018	AAA	CC	$	1,214	$	1,333	$	711
Countrywide Alt Ln 2005-75CB A4		2,932	AAA	CCC		1,254		1,305		480
Total Mortgage-Backed Securities	$	5,950			$	2,468	$	2,638	$	1,191

Corporate Securities:
InCaps Funding II Senior Note	$	1,000	A-	BB	$	279	$	322	$	631
InCaps Funding II Junior Note		1,000	BBB	B		256		309		530
Total Corporate Securities	$	2,000			$	535	$	631	$	1,161

Total Securities with OTTI	$	7,950			$	3,003	$	3,269	$	2,352

During 2009, four of the Bank’s private issuer securities were downgraded to below investment grade (another private issuer mortgage-backed security was downgraded to below investment grade in 2008). Accordingly, the Bank recorded $1,504,000 of other-than-temporary impairment charges for the year ended December 31, 2009 including (i) $859,000 related to three corporate securities supported primarily by obligations from other financial industry entities, and (ii) $645,000 related to two private issuer mortgage-backed securities not guaranteed by the U.S. government ($170,000 of the $1,504,000 other-than-temporary impairment charges for the year ended December 31, 2009, were recorded in the third quarter of 2009). Management determined that at that time, due to severe illiquidity and distress in the financial markets, the unrealized declines in the value of these investments were other-than-temporary and credit related, requiring the write-down and related impairment charge to earnings. For the securities with impairment charges recorded, interest income payments received subsequent to impairment were fully applied to principal further reducing the amortized cost of these investments. Also, during 2009, one of the previously impaired corporate securities (USCap Funding V) was fully impaired, completely written-off and declared as a worthless asset for tax purposes. This impaired corporate security had a cumulative credit related OTTI of $936,000 at December 31, 2009.

During the first quarter of 2010, one of the impaired corporate securities (InCaps Funding II Senior Note) held at December 31, 2009, was sold for $277,000. At the time of the sale, the security had $631,000 of previously recorded impairments, and an adjusted amortized cost of $272,000, which resulted in a $5,000 gain recorded on the sale. The three remaining impaired securities experienced further downgrades and/or a reduction in cash flows during the second quarter of 2010. As a result, management made the determination to sell the securities. The Bank recorded $1,664,000 of other-than-temporary impairment charges for the nine months ended September 30, 2010, including (i) $1,555,000 related to the two private issuer mortgage-backed securities not guaranteed by the U.S. government, and (ii) $109,000 related to one corporate security supported primarily by obligations from other financial industry entities.

During the third quarter of 2010, the last corporate security (InCaps Funding II Junior Note) was sold for $120,000, and one of the private issuer mortgage-backed securities (Countrywide Alt Ln 2005-75CB A4) was sold for $396,000, which were the recorded values at the time of the sale. At the time of the sales, the impaired securities had $639,000 and $1,104,000, respectively, of previously recorded impairments.

As discussed more thoroughly in Note 12 – Fair Value Measurements of Assets and Liabilities and Fair Value of Financial Instruments, the fair value of these investment securities for quarters ended prior to June 30, 2010, was determined by calculating the net present value of the expected future cash flows of each security, with qualitative risk-adjusted discounting for potential credit risks and nonperformance in the underlying issuers, and market sector illiquidity concerns. In accordance with ASC Topic 820, when an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable. For quarters ended prior to June 30, 2010, management’s judgment was that the facts and circumstances indicated significant illiquidity and an inactive market for these types of investments when other relevant observable inputs were not available; therefore, expected cash flows were used as a reasonable basis in determining the fair value of the corporate investment securities.

As of September 30, 2010, Union National’s investment portfolio includes one security with previously recorded impairments, and was valued based upon current distressed market trading values. All principal and interest payments received on this impaired investment security are fully applied to principal.

As of September 30, 2010, management determined that further impairments were not warranted on the one remaining impaired investment security because the carrying value was below distressed trading levels.

Note 6 – De-Leveraging and Restructuring Activities

In 2010, the Bank continued with de-leveraging activities by prepaying $22,500,000 of FHLB advances, including $20,000,000 prepaid during the third quarter of 2010. The FHLB debt prepaid in 2010 had a fixed weighted average interest cost of 5.31%, and Union National incurred $480,000 of debt prepayment penalties, which were included in other non-interest expense. The penalties are expected to be more than offset by future cumulative savings on interest expense that would have been incurred if such debt was not paid until its scheduled maturity. The balance of long-term debt was reduced to $10,834,000 at September 30, 2010 from $33,334,000 at December 31, 2009.

During the nine months ended September 30, 2009, and in total for 2009, the Bank prepaid $17,000,000 of FHLB advances, which had a fixed weighted average interest cost of 5.36%, incurring $536,000 of debt prepayment penalties. During 2009, the Bank also repaid a $5,241,000 brokered CD with an interest cost of 3.90% that matured on October 15, 2009.

Note 7 – Junior Subordinated Debentures

Union National had three issuances of junior subordinated debentures, totaling $17,341,000, outstanding as of September 30, 2010 and December 31, 2009.

On July 28, 2006, the Bank issued $6,000,000 of subordinated debentures due September 15, 2021 with a five-year initial fixed rate of 7.17%, and then an annual coupon rate, reset quarterly, based on three-month London Interbank Offered Rate (“LIBOR”) plus 1.65%.

In December 2003, Union National Capital Trust I (“UNCT I”) issued $8,248,000 of floating-rate debentures due January 23, 2034, of which $248,000 is related to Union National’s capital contribution. UNCT I provides for quarterly distributions at a variable annual coupon rate that is reset quarterly, based on three-month LIBOR plus 2.85%. The coupon rate was 3.33% and 3.13% at September 30, 2010 and December 31, 2009, respectively.

In October 2004, Union National Capital Trust II (“UNCT II”) issued $3,093,000 of debentures due November 23, 2034, of which $93,000 is related to Union National’s capital contribution. UNCT II provides for quarterly distributions at a variable annual coupon rate that is reset quarterly, based on three-month LIBOR plus 2.00%. The coupon rate was 2.34% and 2.27% at September 30, 2010 and December 31, 2009, respectively.

All of the junior subordinated debentures are callable at Union National’s option beginning at five years from the date of issuance. These debentures do not have to be called in full. UNCT I became callable in December 2008, UNCT II became callable in October 2009, and the Bank’s junior subordinated debenture will become callable in July 2011. All three issuances of junior subordinated debentures qualify as a component of risk-based capital for regulatory capital purposes.

Interest expense on junior subordinated debentures was $196,000 and $201,000 for the three months ended September 30, 2010 and 2009, respectively. For the nine months ended September 30, 2010 and 2009, interest expense on junior subordinated debentures was $577,000 and $645,000, respectively.

Union National, as directed by the Federal Reserve, has deferred making interest payments on the UNCT I and UNCT II debentures beginning on July 23, 2010 and August 23, 2010, respectively. Interest expense continues to accrue on these debentures. For additional information related to Federal Reserve requirements and actions related to interest payments on UNCT I and UNCT II, refer to the section Memorandum of Understanding with the Federal Reserve Bank in Note 9 – Enforcement Actions with Bank Regulatory Agencies.

Note 8 – Stock Issued Under Private Placement Offerings and Dividend Reinvestment Plan

Preferred Stock Private Placement Offering

On September 15, 2009, Union National filed with the Pennsylvania Department of State two Statements with Respect to Shares which, effective upon filing, designated two series of preferred stock as “5% Non-Cumulative Non-Voting Convertible Perpetual Preferred Stock, Series A” (“Series A Preferred Stock”), and “6% Non-Cumulative Non-Voting Non-Convertible Perpetual Preferred Stock, Series B” (“Series B Preferred Stock”), and set forth the voting and other powers, designations, preferences and relative, participating, optional or other rights, and the qualifications, limitations or restrictions of the Series A Preferred Stock and Series B Preferred Stock. On March 1, 2010, Union National terminated the offering of both series of its Convertible Perpetual Preferred Stock. At September 30, 2010, there were no Series B Preferred stock shares outstanding as there were no Series B Preferred stock shares sold or issued during the offering.

Terms of the Series A Preferred Stock:

Dividends on the Series A Preferred Stock are payable quarterly in arrears if, when, and as declared by Union National’s Board of Directors, at a rate of 5.00% per year on the liquidation preference of $1,000 per share. Dividends, if declared, will be payable quarterly on January 31, April 30, July 31, and October 31 of each year (each a “Dividend Payment Date”). In 2010, a dividend was paid on January 31 and April 30, however, the next dividend due to be paid on July 31 was not paid. For additional information related to Federal Reserve pre-approval requirements related to dividend payments on Preferred Stock, refer to the section Memorandum of Understanding with the Federal Reserve Bank in Note 9 – Enforcement Actions with Bank Regulatory Agencies. In the case of the dividend payable on January 31, 2010, such dividend was prorated based on the number of days elapsed from the date of purchase to January 31, 2010 over a quarterly dividend period of ninety (90) days. Dividends on the Series A Preferred Stock are non-cumulative.

Holders of the Series A Preferred Stock may convert their shares into common stock at any time upon approval of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), if required, at the conversion prices listed below:

Conversion Date:	Conversion Price per Share
September 15, 2009 through September 14, 2010	$	4.00
September 15, 2010 through September 14, 2011	$	6.25
September 15, 2011 through September 14, 2012	$	7.50
September 15, 2012 through September 14, 2013	$	8.75
On or After September 15, 2013	$	10.00

The Series A Preferred Stock only may be redeemed by Union National upon prior approval of the Federal Reserve. If Union National redeems the Series A Preferred Stock on or prior to September 14, 2014, the redemption price will include a premium decreasing over time from 2.5% to 0.5% of the liquidation preference. The holders of the Series A Preferred Stock do not have voting rights except as required by Pennsylvania Business Corporation Law of 1988, as amended.

Sales of Preferred Stock:

Union National sold 1,275 shares of its Non-Cumulative Non-Voting Convertible Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), in transactions exempt from registration under the Securities Act of 1933, pursuant to Section 4(2) thereof, for total gross proceeds of $1,275,000, which were offset by issuance costs of $57,000.

The following table summarizes the Series A Preferred Stock shares sold and the gross proceeds received through the private placement offering (dollars in thousands):

Period	Shares		Gross Proceeds
September 25, 2009 – September 30, 2009		700	$	700
October 1, 2009 – December 31, 2009		575		575
January 1, 2010 – February 28, 2010 (1)		–		–
Total		1,275	$	1,275

(1)	On March 1, 2010, Union National terminated the offering of both series of its Preferred Stock.

During the third quarter of 2010, 1,250 Series A Preferred Stock Shares converted to common stock at a conversion price of $4.00 per common share in accordance with the terms of the preferred stock offering. This conversion resulted in an increase of 312,500 common stock shares outstanding at September 30, 2010.

Dividend Reinvestment Plan

Union National maintains a Dividend Reinvestment Plan (“DRIP”) for record holders of Union National’s common stock to provide a convenient method of investing cash dividends payable upon their common stock and to provide participants with the opportunity to make voluntary cash payments, from a minimum of $500 to a maximum of $50,000 per calendar quarter, to purchase additional common shares at a 10% discount to the fair market value of the shares on the effective purchase date as defined by the DRIP. There were no common dividends paid by Union National during 2010; however, eligible stockholders made voluntary cash payments totaling $6,000, which were used to purchase 1,479 common shares. Union National reserved 200,000 common stock shares to be issued under the DRIP, of which, 24,471 shares have been issued as of September 30, 2010. As part of the proposed merger with Donegal Financial Services Corporation, and as discussed in Note 14 – Proposed Merger, the ability of stockholders to make direct cash purchases was suspended effective June 30, 2010.

Note 9 – Enforcement Actions with Bank Regulatory Agencies

Formal Written Agreement with the Office of the Comptroller of the Currency (“OCC”)

On August 27, 2009, the Bank entered into a formal written agreement (the “Agreement”) with the OCC. Specifically, the Agreement requires the Bank to (1) establish a compliance committee to monitor and coordinate the Bank’s adherence to the provisions of the Agreement, (2) have the Board of Directors evaluate and monitor executive management performance, (3) update its three year strategic plan in accordance with specific guidelines set forth in the Agreement, (4) update its three year capital program, (5) develop and implement systems to provide for effective loan portfolio management, (6) take action to protect criticized assets and implement a written program to eliminate the basis of criticism of assets criticized by the OCC, (7) strengthen the Bank’s contingency funding plan, (8) implement a written consumer compliance program, and (9) not exceed the level of brokered deposits as of the date of the Agreement without prior OCC approval.

The Agreement superseded the previous Memorandum of Understanding (“MOU”) entered into between the Bank and the OCC on June 20, 2007. The Agreement effectively extends several of the provisions under the MOU, including requiring a three year strategic plan and three year capital plan, improving the Bank’s loan portfolio management, implementing an effective risk-based consumer compliance audit program, and establishing a compliance committee.

Separate from the Agreement, the OCC established individual minimum capital requirements for the Bank, requiring Tier 1 Capital to Average Total Assets of at least eight percent (8%), Tier 1 Capital to Risk-Based Assets of at least nine and one-half percent (9.5%), and Total Capital to Risk-Based Assets of at least twelve percent (12%) effective beginning September 30, 2009. These minimum capital ratios are similar to the capital ratio targets agreed to between the Bank and the OCC under the MOU which were Tier I Capital to Average Total Assets of 8%, Tier I Capital to Risk-Based Assets of 9%, and Total Capital to Risk-Based Assets of 12%. At September 30, 2010, the Bank’s measure of Tier I Capital to Average Total Assets was 8.44%, Tier I Capital to Risk-Based Assets was 10.51%, and Total Capital to Risk-Based Assets was 13.33%, with all three ratios exceeding the respective OCC individual minimum capital requirements. The Bank capital ratios reflect the infusion to the Bank subsidiary of $700,000 of the $1,275,000 proceeds raised in Union National’s preferred stock private placement as discussed in Note 8 – Stock Issued Under Private Placement Offerings and Dividend Reinvestment Plan.

Management and the Board of Directors are committed to taking the necessary actions to fully maintain the OCC-established minimum capital ratios and address the provisions of the Agreement, and believe that the Bank has already made measurable progress in addressing these requirements. If the Bank does not continue to meet the OCC’s requirements, the OCC could subject the Bank to additional enforcement actions or sanctions as the OCC considers necessary.

Memorandum of Understanding with the Federal Reserve Bank

On January 28, 2010, Union National entered into an informal Memorandum of Understanding with the Federal Reserve Bank (“FRB”). Union National is the registered bank holding company that wholly owns the Bank (the Bank subsidiary is separately supervised by the Office of the Comptroller of the Currency). The Memorandum of Understanding, which is not a “written agreement” for purposes of Section 8 of the Federal Deposit Insurance Act, requires, among other things, Union National to seek prior approval by the FRB before (i) declaring or paying dividends to stockholders, (ii) distributing interest, principal or other sums on UNCT I and UNCT II junior subordinated debentures, and (iii) incurring, increasing or guaranteeing any additional debt.

The FRB approved Union National’s request to pay preferred stock dividends and distributions on its two issuances of trust-preferred securities for the first and second quarters of 2010. Union National made a similar request for the third quarter of 2010, but the FRB denied the request. Accordingly, Union National has acted to suspend the preferred stock dividend and to defer distributions on its trust-preferred securities indefinitely. Third quarter 2010 distributions on one class of trust preferred securities, issued by UNCT I, were scheduled for July 23, 2010 and distributions on the other class, issued by UNCT II, were scheduled for August 23, 2010. Dividend payments on the preferred stock were scheduled for July 31, 2010. Union National’s preferred stock is non-cumulative so the suspension of dividends will not result in any accrued dividend liability. The deferral of distributions on the trust-preferred securities will continue to accrue as interest expense payable by Union National. Union National is prohibited from declaring or paying any dividends on its common stock or preferred stock while distributions on the trust-preferred securities are in arrears.

Note 10 – Commitments, Guarantees and Contingencies

Credit Commitments

In the ordinary course of business, Union National makes commitments to extend credit to its customers through letters of credit, loan commitments and lines of credit. As of September 30, 2010, the Bank had $106,822,000 outstanding in loan commitments and other unused lines of credit extended to its customers, as compared to $110,791,000 at December 31, 2009. The Bank does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit are conditional commitments, written and issued by Union National to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued, have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral and/or personal guarantees supporting these commitments. There were $4,911,000 and $6,199,000 of standby letters of credit outstanding as of September 30, 2010 and December 31, 2009, respectively.

Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payments required under the corresponding standby letters of credit. The current amount of the liability at September 30, 2010 and December 31, 2009, for Bank guarantees under standby letters of credit issued is not considered to be material.

Health Care Consortium

Effective July 1, 2008, the Bank joined a health care expense management consortium with other Pennsylvania banks. The purpose of the consortium is to pool the risks of covered groups of employees, and to provide effective claims-based expense management, administrative efficiencies, and use of high-dollar claim stop loss insurance coverage, to reduce the overall health care costs to the consortium member banks, while maintaining high quality coverage for employees. Through September 30, 2010, the Bank’s payments to the consortium to cover estimated claims expenses, administrative expenses, and stop loss insurance premiums exceeded the actual processed expenses by $342,000. However, the Bank reduced the amount of this prepaid benefit by a contingent reserve of $65,000 reflecting an actuarial estimate by the consortium of the Bank’s unpaid claim liability as of September 30, 2010 to include potential (i) unreported claims, (ii) reported but unprocessed claims, and (iii) processed but unpaid claims, related to both medical and drug coverage.

Proposed Merger

Union National entered into an Agreement and Plan of Merger (the “Merger Agreement”) on April 19, 2010, as amended and restated as of May 20, 2010, with Donegal Financial Services Corporation (“DFSC”), the parent company of Province Bank FSB (“Province”), and certain affiliated entities of DFSC, pursuant to which Union National will merge with and into DFSC. DFSC is wholly owned by Donegal Mutual Insurance Company and Donegal Group Inc. (For additional information on the proposed merger, refer to Note 14 – Proposed Merger).

On June 16, 2010, Union National and DFSC, an affiliate of Donegal Group Inc. and Donegal Mutual Insurance Company, became aware of a filing of a complaint on June 14, 2010 in the Court of Common Pleas of Lancaster County, Pennsylvania against Union National, each of the Directors of Union National, DFSC and certain affiliated entities of DFSC (collectively, the "Donegal Parties"). The complaint purported to be a class action filed on behalf of the holders of Union National common stock arising from certain alleged actions by Union National and its Board of Directors in connection with the proposed merger of Union National with and into DFSC. On October 1, 2010, Union National learned that the claim was withdrawn and the case was dismissed.

Management is not aware of any other litigation that would have a material adverse effect on the consolidated financial position or results of operations of Union National.

Note 11 – Stock-Based Compensation

In accordance with ASC Topic 718, “Compensation – Stock Compensation”, Union National recognizes compensation expense for share-based awards based upon an assessment of the fair value on the grant date. The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model. Stock compensation expense is recognized on a straight-line basis over the vesting period of the award.

Union National has two plans with stock options outstanding as of September 30, 2010: (i) the Employee Stock Incentive Plan (“SIP”); and, (ii) the Independent Directors’ Stock Option Plan (“IDSOP”). Neither of these plans had remaining options available for grant as of September 30, 2010. Options granted under the SIP are incentive stock options with terms up to 10 years and option prices equal to the fair value of the shares on the date of the grant. SIP options vest over six months, become exercisable nine months after the grant date, and generally lapse 90 days after termination of employment. Options granted under the IDSOP consist of non-qualified stock options with terms up to 10 years. IDSOP options have exercise prices equal to the fair value of the shares on the date of the grant and expire one year after departure from the Board of Directors. It is Union National’s policy to issue new shares from its authorized shares upon the exercise of stock options.

No share-based awards were granted or vested during the three and nine months ended September 30, 2010 and 2009; accordingly, no compensation expense was recorded for these periods. There were 77,517 and 78,674 stock options outstanding at September 30, 2010 and December 31, 2009, respectively, with exercise prices ranging from $11.52 to $22.14 for both of these periods.

Stock option activity for the nine months ended September 30, 2010, is summarized below:

	Shares			Weighted-Average Exercise Price
Beginning of Period		78,674		$	18.83
Granted		–			–
Exercised		–			–
Forfeited		(1,157	)		15.42
Expired		–			–
End of Period		77,517		$	18.88

All stock options outstanding at September 30, 2010, had no intrinsic value (the amount by which the market price exceeds the exercise price) and were fully vested and exercisable, and consisted of the following:

Number of options		77,517
Weighted-average contractual remaining term	3.7 Years
Weighted-average exercise price	$	18.88
Aggregate intrinsic value	$	–

Note 12 – Fair Value Measurement of Assets and Liabilities and Fair Value of Financial Instruments

ASC Topic 820, “Fair Value Measurements and Disclosures” defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that a transaction to sell an asset or transfer a liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is not a forced transaction, but rather a transction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities.

Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact. ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability based upon the best information available in the circumstances. In that regard, ASC Topic 820 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

The fair value hierarchy is as follows:

Level 1	-	Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

Level 2	-	Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;

Level 3	-	Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

ASC Topic 820 provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with fair value measurement and disclosure guidance. Further, ASC Topic 820 clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly, and Union National must evaluate the weight of evidence to determine whether the transactions are orderly. It provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. The valuation methodologies were applied to all of Union National’s financial assets and financial liabilities carried at fair value, effective January 1, 2008. In addition, Union National adopted fair value measurement and disclosure guidance for non-financial assets and non-financial liabilities on January 1, 2009.

Securities Available for Sale

Equity securities, comprised mostly of financial institutions, traded on a national securities exchange are reported at fair value using the Level 1 valuation hierarchy because these securities tend to trade frequently, and quoted prices are considered active. Other equity securities, comprised mostly of smaller financial institutions, traded on the OTC Bulletin Board (“OTCBB”) or privately are reported at fair value using the Level 2 valuation hierarchy because these securities tend to trade infrequently, and quoted prices are not considered active. Debt securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs. For these securities, Union National obtained fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.

Level 3 inputs are for certain corporate investment security positions that are not traded in active markets or are subject to transfer restrictions, and/or where valuations are adjusted to reflect illiquidity and/or non-transferability. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Management only changes Level 3 inputs and assumptions when corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent transactions or rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity or debt markets, and changes in financial ratios or cash flows. As of September 30, 2010, Union National’s investment portfolio includes one security with previously recorded impairments, and was valued based upon current distressed market trading values. All principal and interest payments received on this impaired investment security are fully applied to principal and, as a result, as of September 30, 2010, the investment security’s carrying value was below distressed trading levels.

For quarters ended prior to June 30, 2010, the fair value of impaired securities valued using Level 3 inputs was determined by calculating the net present value of the expected future cash flows of each security, with qualitative risk-adjusted discounting for potential credit risks and nonperformance in the underlying issuers, and market sector illiquidity concerns.

The following tables summarize available-for-sale investment securities measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009, segregated by the level of the valuation inputs within the hierarchy utilized to measure fair value (in thousands). There were no transfers of securities between fair value hierarchy classifications Level 1 and Level 2 for the nine months ended September 30, 2010.

	At September 30, 2010
	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Obligations of State and Political Subdivisions	$	–	$	25,613	$	–	$	25,613
U.S. Agency Bonds and Structured Notes		–		19,500		–		19,500
U.S. Agency Mortgage-Backed Securities		–		1,913		–		1,913
Private Issuer Mortgage-Backed Securities		–		–		70		70
Equity Securities		9		55		–		64
Total Investment Securities	$	9	$	47,081	$	70	$	47,160

	At December 31, 2009
	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
U.S. Agency Mortgage-Backed Securities	$	–	$	53,394	$	–	$	53,394
Obligations of State and Political Subdivisions		–		3,815		–		3,815
Private Issuer Mortgage-Backed Securities		–		–		2,638		2,638
Corporate Securities		–		–		631		631
Equity Securities		13		55		–		68
Total Investment Securities	$	13	$	57,264	$	3,269	$	60,546

The following is a reconciliation of the beginning and ending balances of recurring fair value measurements of certain available-for-sale securities using Level 3 inputs (in thousands):

	Available-For-Sale Securities
Beginning Balance at January 1, 2010	$	3,269
Payments received (applied to principal), net of accretion		(476	)
Net proceeds received on sales of impaired securities		(793	)
Total realized and unrealized losses
Included in net loss		(1,664	)
Included in other comprehensive loss		(266	)
Ending Balance at September 30, 2010	$	70

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

Impaired Loans. Certain impaired loans are reported at the fair value of the underlying collateral (usually real estate and/or equipment) if repayment is expected solely from the liquidation of collateral. Collateral values are estimated using Level 3 inputs based upon customized discounting criteria.

The balance of loans and leases that were considered to be impaired under GAAP was $5,532,000 and $8,715,000, which consisted of eight and ten loan and lease relationships to unrelated borrowers, at September 30, 2010 and December 31, 2009, respectively. At September 30, 2010, two loan relationships represented $3,640,000 or 66% of the total impaired loans and leases of $5,532,000. The overall decrease in impaired loans and leases during the first nine months of 2010 resulted from certain impaired loans that were either charged-off or had the real estate collateral transferred to the Bank’s possession as other real estate owned. Management continues to diligently monitor and evaluate the existing portfolio, and identify credit concerns and risks, including those resulting from the current economy.

Impaired Loans With a Related Allowance. Union National had $5,150,000 and $5,916,000 of impaired loans and leases with a related allowance for credit losses at September 30, 2010 and December 31, 2009, respectively. These consisted of six and five loan and lease relationships to unrelated borrowers, with a related allowance for credit losses of $1,162,000 and $1,458,000 at September 30, 2010 and December 31, 2009, respectively. This group of impaired loans and leases has a related allowance due to the probability that the borrower is not able to continue to make principal and interest payments due under the contractual terms of the loan or lease. These loans and leases appear to have insufficient collateral and Union National’s principal may be at risk; as a result, a related allowance is established to estimate future potential principal losses.

Repossessed Assets. Repossessed assets are reported at fair value on a non-recurring basis. Values are estimated using Level 3 inputs, based on appraisals that consider the sales prices of similar assets.

Other Real Estate Owned. Assets included in other real estate owned are reported at fair value on a non-recurring basis. Values are estimated using Level 3 inputs, based on appraisals that consider the sales prices of properties similar in nature and / or proximity, and considering estimated liquidation costs.

The following table summarizes financial assets and financial liabilities measured at fair value on a nonrecurring basis as of September 30, 2010 and December 31, 2009, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value (in thousands):

	September 30, 2010
Assets:	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Impaired Loans	$	–	$	–	$	3,988	$	3,988
Other Real Estate Owned		–		–		8,418		8,418
Repossessed Assets		–		–		136		136
Total	$	–	$	–	$	12,542	$	12,542

	December 31, 2009
Assets:	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
Impaired Loans	$	–	$	–	$	4,458	$	4,458
Other Real Estate Owned		–		–		5,383		5,383
Repossessed Assets		–		–		436		436
Total	$	–	$	–	$	10,277	$	10,277

ASC Topic 825, “Financial Instruments” requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The estimated fair values of financial instruments as of September 30, 2010 and December 31, 2009, are set forth in the table below (in thousands). The information in the table should not be interpreted as an estimate of the fair value of Union National in its entirety since a fair value calculation is only provided for a limited portion of Union National’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between Union National’s disclosures and those of other companies may not be meaningful.

	September 30, 2010				December 31, 2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash and Cash Equivalents	$	49,696	$	49,696	$	43,340	$	43,340
Interest-Bearing Time Deposits in Other Banks		2,792		2,835		9,229		9,252
Investment Securities Available for Sale		47,160		47,160		60,546		60,546
Loans and Leases, Net		322,898		315,334		333,416		317,459
Restricted Investment in Bank Stocks		3,727		3,727		3,727		3,727
Accrued Interest Receivable		1,494		1,494		1,569		1,569
Mortgage Servicing Assets and Credit Enhancement Fees Receivable		48		247		48		267
Liabilities:
Demand and Savings Deposits		207,985		207,985		212,457		212,457
Time Deposits		189,560		191,420		192,308		194,218
Long-Term Debt		10,834		11,417		33,334		34,798
Junior Subordinated Debentures		17,341		17,251		17,341		17,017
Accrued Interest Payable		891		891		938		938

Off-balance-sheet Items:
Commitments to Extend Credit and Standby Letters of Credit		–		–		–		–

The following methods and assumptions were used by Union National to estimate the fair value of its financial instruments at September 30, 2010 and December 31, 2009:

Cash and cash equivalents: The carrying amounts of cash and short-term investments (U.S. Treasury Bills with a maturity of less than 60 days) approximate their fair values.

Interest-bearing time deposits in other banks: The carrying amounts of interest-bearing time deposits in other banks approximate their fair values. The Bank generally purchases amounts below the insured limit, limiting the amount of credit risk on these time deposits.

Investment securities: The carrying values of securities available for sale (carried at fair value) are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Internal cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.

Loans and leases: For variable-rate loans that reprice frequently and which entail no significant changes in credit risk, carrying value approximates fair value. The fair value of other loans and leases are estimated by calculating the present value of future cash flows, discounted at the interest rates currently being offered for loans with similar terms to borrowers with similar credit quality.

Restricted investment in bank stocks: The carrying amounts reported in the consolidated statements of financial condition for restricted investment in bank stocks approximate their fair values.

Accrued interest receivable: The carrying amount of accrued interest receivable approximates its fair value.

Mortgage servicing assets and credit enhancement fees receivable: The fair value of servicing assets and credit enhancement fees receivable is based on the present value of estimated future cash flows on pools of mortgages stratified by rate and maturity date.

Deposit liabilities: The fair values of deposits with no stated maturities, such as demand deposits, savings accounts, NOW and money market deposits, equal their carrying amounts, which represent the amount payable on demand. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Long-term debt: The fair values of long-term debt are estimated using discounted cash flow analyses, based on Union National's incremental borrowing rates for similar types of borrowing arrangements.

Junior subordinated debentures: For floating-rate debentures, fair value is based on the difference between current interest rates for similar types of borrowing arrangements and the current coupon rate. For debentures that are at a fixed rate for a period of time, the fair value is determined using discounted cash flow analyses, based on current interest rates for similar types of borrowing arrangements.

Accrued interest payable: The carrying amount of accrued interest payable approximates its fair value.

Off-balance-sheet instruments: Union National's off-balance-sheet instruments consist of commitments to extend credit, and financial and performance standby letters of credit. The estimated fair value is based on fees currently charged to enter into similar agreements, taking into account the remaining term of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

Note 13 – Comprehensive Income (Loss)

GAAP requires that recognized revenue, expenses, gains, and losses be included in net income (loss). Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the consolidated statements of financial condition, such items, along with net income (loss), are components of comprehensive income (loss). The components of comprehensive income (loss) and related tax effects are as follows (in thousands):

	Three Months Ended September 30, 2010									Nine Months Ended September 30, 2010
	Before Tax Amount			Tax Impact			Net-of-Tax Amount			Before Tax Amount			Tax Impact			Net-of-Tax Amount
Net Income (Loss)	$	(18	)	$	(95	)	$	77		$	(1,711	)	$	(787	)	$	(924	)
Other Comprehensive Income:
Unrealized Gains (Losses) on Available-for-Sale Securities Arising During the Period		697			237			460			(173	)		(59	)		(114	)
Reclassification Adjustment for Securities Gains included in Net Income (Loss)		(577	)		(196	)		(381	)		(943	)		(321	)		(622	)
Reclassification Adjustment for Impairment Charges on Investment Securities		104			36			68			1,664			566			1,098
Other Comprehensive Income		224			77			147			548			186			362
Total Comprehensive Income (Loss)	$	206		$	(18	)	$	224		$	(1,163	)	$	(601	)	$	(562	)

	Three Months Ended September 30, 2009									Nine Months Ended September 30, 2009
	Before Tax Amount			Tax Impact			Net-of-Tax Amount			Before Tax Amount			Tax Impact			Net-of-Tax Amount
Net Income (Loss)	$	99		$	(48	)	$	147		$	(739	)	$	(482	)	$	(257	)
Other Comprehensive Income:
Unrealized Gains on Available-for-Sale Securities Arising During the Period		415			141			274			452			154			298
Reclassification Adjustment for Cumulative Effect of ASC Topic 320. “Investments – Debt and Equity Securities”		–			–			–			306			104			202
Reclassification Adjustment for Securities Gains included in Net Income (Loss)		(397	)		(135	)		(262	)		(1,791	)		(609	)		(1,182	)
Reclassification Adjustment for Impairment Charges on Investment Securities		170			58			112			1,471			500			971
Other Comprehensive Income		188			64			124			438			149			289
Total Comprehensive Income (Loss)	$	287		$	16		$	271		$	(301	)	$	(333	)	$	32

Note 14 – Proposed Merger

On April 19, 2010, Union National entered into an Agreement and Plan of Merger as amended and restated as of May 20, 2010 and as of September 1, 2010 (the “Merger Agreement”), with Donegal Financial Services Corporation (“DFSC”), the parent company of Province Bank FSB (“Province”), and certain affiliated entities of DFSC, pursuant to which Union National will merge with and into DFSC. DFSC is wholly owned by Donegal Mutual Insurance Company (“DMIC”) and Donegal Group Inc. (“DGI”).

As part of the transaction, UNCB will merge with and into Province (the “Bank Merger”). The merged bank will operate as a federally-chartered savings association under a new bank name to be mutually determined by UNCB and Province and will continue to operate the UNCB offices.

On September 1, 2010, DFSC and Union National executed an amendment to the agreement and plan of merger as amended and restated as of May 20, 2010. The amendment provides that, upon the merger, each share of Union National will become the right to receive 0.2134 share of Class A common stock of DGI and that amount of cash as equals $8.25 less the value of 0.2134 share of DGI Class A common stock, based on the average closing price of DGI Class A common stock for the five trading days immediately preceding the date of the merger, but in no event less than $5.05 in cash per Union National share nor more than $5.90 in cash per Union National share. Union National and DFSC did not amend the merger agreement in any other respect.

Following the consummation of the transactions, the executive officers of the merged entities will include: Donald H. Nikolaus, currently the President of DFSC and the Chairman of Province, will continue as President of DFSC and Chairman of the merged bank; Mark D. Gainer, currently Chairman, President and Chief Executive Officer of Union National and UNCB, will become a Senior Vice President of DFSC and President and Chief Executive Officer of the merged bank; Gregory J. Diehl, currently President of Province, will become Executive Vice President and Chief Operating Officer of the merged bank; and Michael D. Peduzzi, currently Treasurer and Chief Financial Officer of Union National and Executive Vice President and Chief Financial Officer of UNCB, will become a Vice President of DFSC and Executive Vice President and Chief Financial Officer of the merged bank. The Directors of DFSC immediately after the merger will be the Directors of DFSC immediately prior to the merger plus Mark D. Gainer and two other current members of Union National’s Board of Directors. In addition, the Directors of the merged bank immediately after the Bank Merger will consist of six current Directors of Province and five current Directors of UNCB.

On September 16, 2010, Union National’s shareholders, at a special meeting of shareholders, voted to approve the pending merger with DFSC. Holders of more than 85% of outstanding shares voted to approve the merger.

The transaction is also subject to other customary closing conditions, including the receipt of regulatory approvals. If the merger is not consummated under certain circumstances, Union National has agreed to pay DFSC a termination fee of $800,000. Currently, the merger is expected to be completed by year-end.

The foregoing summary of the Merger Agreement is not complete and is qualified in its entirety by reference to the complete text of the definitive agreement, which was filed as Exhibit 2.1 to Forms 8-K that were filed by Union National on April 23, 2010, May 21, 2010 and September 2, 2010.

Through September 30, 2010, Union National has incurred merger and acquisition related expenses of $773,000, which include primarily legal and investment banking costs associated with the proposed merger.

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

Overview. Management’s discussion and analysis represents an overview of the financial condition and results of operations, and highlights the significant changes in the financial condition and results of operations, as presented in the accompanying consolidated financial statements for Union National Financial Corporation (“Union National”), a bank holding company, and its wholly-owned subsidiary, Union National Community Bank (the “Bank”). Union National’s consolidated financial condition and results of operations consist primarily of the Bank’s financial condition and results of operations. Union National’s trust subsidiaries, Union National Capital Trust I and Union National Capital Trust II, were established for the purpose of issuing $11,000,000 of trust capital securities during 2003 and 2004.

Forward Looking Statements. This quarterly report contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results and trends of Union National Financial Corporation (“Union National”) and Union National Community Bank (the “Bank”) could differ materially from those set forth in such statements due to various risks, uncertainties and other factors. Such risks, uncertainties and other factors that could cause actual results and experience to differ include, but are not limited to, the following: strategic initiatives and business plans, including prospective business combinations, may not be satisfactorily completed or executed, if at all; increased demand or prices for the Bank’s financial services and products may not occur; changing economic and competitive conditions; technological developments; the effectiveness of Union National’s business strategy due to changes in current or future market conditions; actions of the U.S. government, the Federal Reserve, the Office of the Comptroller of the Currency (“OCC”) and other governmental and regulatory bodies for the purpose of stabilizing the financial markets; enforcement actions with bank regulatory agencies restricting certain transactions of Union National and the Bank; effects of deterioration of economic conditions on customers, specifically the effect on loan customers to repay loans; inability of Union National to raise or achieve desired or required levels of regulatory capital; paying significantly higher Federal Deposit Insurance Corporation (“FDIC”) premiums in the future; the effects of competition, and of changes in laws and regulations, including industry consolidation and development of competing financial products and services; interest rate movements; relationships with customers and employees; challenges in establishing and maintaining operations; volatilities in the securities markets and related potential impairments of investment securities; deteriorating economic conditions and declines in housing prices and real estate values; and other risks and uncertainties, including those detailed in Union National’s filings with the Securities and Exchange Commission. When we use words such as “believes”, “expects”, “anticipates”, or similar expressions, we are making forward-looking statements. Union National undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.

Readers should carefully review the risk factors described in the Annual Report and other documents that we periodically file with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2009, Union National’s Forms 10-Q and 8-K, and other reports, that were filed during 2010 with the SEC.

Critical Accounting Policies. Union National’s consolidated financial statements are prepared based upon the application of U.S. generally accepted accounting principles (“GAAP”). The reporting of our financial condition and results of operations is impacted by the application of accounting policies by management, some of which are particularly sensitive and require significant judgments, estimates and assumptions to be made in matters that are inherently uncertain. These accounting policies, along with the disclosures presented in other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant impact on the consolidated financial statements. Management currently views the determination of the allowance for credit losses, the fair value of investment securities and the fair value of other real estate owned to be critical accounting policies.

Determination of the Allowance for Credit Losses. The level of the allowance for credit losses and the provision for credit losses involve significant estimates by management. In evaluating the adequacy of the allowance for credit losses, management considers the specific collectability of impaired and nonperforming loans, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect borrowers ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant qualitative factors. While we use available information to make such evaluations, future adjustments to the allowance for credit losses and the provision for credit losses may be necessary if economic conditions, loan credit quality, or collateral issues differ substantially from the factors and assumptions used in making the evaluation.

Fair Value of Investment Securities. Investments are carried at fair value with any unrealized gains and losses, considered to be temporary, reported net of tax as an adjustment to stockholders’ equity. In order to determine whether unrealized losses in the fair value of investment securities reflect other-than-temporary impairment (“OTTI”), management regularly reviews the entire portfolio of investment securities for possible impairment, analyzing factors including, but not limited to, the underlying creditworthiness of the issuing organization, the length of time for which the fair value of the investment securities may be less than cost, and independent analysts’ opinions about circumstances that could affect the performance of the investment securities. In assessing potential OTTI for debt securities with fair values less than cost, other considerations include (i) whether management intends to sell the security, or (ii) if it is more likely than not that management will be required to sell the security before recovery, or (iii) if management does not expect to recover the entire amortized cost basis. In assessing potential OTTI for equity securities with fair values less than cost, additional factors include management’s intention and ability to hold the securities until recovery of any unrealized losses. After considering such factors, it is a matter of judgment on the part of management to make the determination of whether or not the decline in market value is other-than-temporary.

Fair Value of Other Real Estate Owned. Other Real Estate Owned (“OREO”) includes property acquired through foreclosure, deed in-lieu of foreclosure, and an in-substance foreclosure. OREO is held for sale. The carrying value of the property is recorded at the fair value of the property as determined based upon an independent appraisal, less estimated costs to sell at the time of acquisition. Any excess of the loan balance over the carrying value of the property at the time of transfer from loans to OREO is charged to the allowance for credit losses. Subsequent to the transfer to OREO, if the sales price of the property less actual costs to sell is less than the carrying value of the property, the deficiency is charged against income as a loss on sale. Due to changing market conditions, there are inherent uncertainties upon liquidation with respect to determining the fair value of OREO. Therefore, the amount ultimately realized upon liquidation may differ from the carrying value reflected in the accompanying consolidated financial statements.

FINANCIAL CONDITION

Total assets decreased by $21,572,000 or 4% to $468,072,000 at September 30, 2010 from $489,644,000 at December 31, 2009. The decrease was primarily related to de-leveraging activities, with Union National selling investments and using excess liquidity to prepay $22,500,000 of FHLB debt during 2010.

Investment Securities. Investment securities were $47,160,000 at September 30, 2010, as compared to $60,546,000 at December 31, 2009. All of Union National’s investment securities were classified as available for sale at September 30, 2010 and December 31, 2009. Investment securities classified as available for sale are marketable equity securities, and those debt securities that we intend to hold for an undefined period of time, but not necessarily to maturity. In addition to the investment portfolio generating interest income, it serves other primary financial management functions such as a reliable source of liquidity and a tool to manage interest rate risk. In order to support these functions, the entire investment securities portfolio has been designated as being available for sale. Any decision to sell an available-for-sale investment security would be based on various factors, including significant movements in interest rates, changes in maturity mix of assets and liabilities, liquidity needs, regulatory capital considerations, reasonable gain realization, changes in the creditworthiness of the issuing entity, changes in investment strategy and portfolio mix, and other similar factors. Changes in unrealized gains or losses on available-for-sale investment securities, net of taxes, are recorded as other comprehensive income (loss), a component of stockholders’ equity.

Certain types of mortgage-backed and asset-backed securities are purchased to better position the investment securities portfolio for a subsequent increase or decrease in interest rates, as aligned with our interest rate risk position. These investment securities may be purchased at premiums or discounts, with short, mid, or long-term average expected lives or maturities. Overall yields on these investment securities will increase or decrease based on changes in prepayment speeds and subsequent cash flow reinvestments.

Investment security purchases and sales generally occur to manage the Bank’s liquidity requirements, pledging requirements, interest rate risk, and to enhance net interest margin and capital management. The investment securities portfolio is evaluated regularly for possible opportunities to increase earnings through potential sales or portfolio repositioning. In the first nine months of 2010, proceeds of $109,182,000 were received on sales, and $943,000 was recognized in net gains, while investment securities of $113,460,000 were purchased.

Investment securities of $39,468,000 and $57,209,000 were pledged to secure certain public, trust, and government deposits and for other purposes at September 30, 2010 and December 31, 2009, respectively.

In addition to the credit risk present in the loan portfolio, we also have credit risk associated with our investment security holdings. Based on recent national economic trends and other factors, we are closely monitoring credit ratings on our private issuer mortgage-backed security as published by national statistical rating organizations.

Investment securities consisted of the following at September 30, 2010 and December 31, 2009, (in thousands):

	September 30, 2010		December 31, 2009
Market Value of Debt Securities	$	47,096	$	60,478
Market Value of Equity Securities		64		68
Total Market Value of Investment Securities	$	47,160	$	60,546

Debt securities include mortgage-backed securities, obligations of state and political subdivisions, obligations of U.S. government agencies, structured notes and corporate securities. At September 30, 2010, there were sixteen debt securities with unrealized losses of $56,000 that amounted to 0.4% of their amortized cost, as compared to December 31, 2009, when there were twenty-seven debt securities with unrealized losses of $585,000 that amounted to 1.3% of their amortized cost. Management believes that the unrealized losses reflect temporary declines primarily due to changes in interest rates and the yield curve subsequent to the acquisition of specific securities. These temporary declines have been provided for in other comprehensive income (loss).

Equity securities held are comprised primarily of common stock holdings in other financial institutions. There were nine and ten equity securities with unrealized losses of $13,000 and $11,000 at September 30, 2010 and December 31, 2009, respectively. Union National has the ability and intent to hold these investments for a reasonable period of time sufficient for the fair value of each equity security to increase to Union National’s cost. Management does not consider the equity securities to be other-than-temporarily impaired at September 30, 2010.

As of September 30, 2010, (i) $9,000 of the fair value of the total investment securities portfolio was measured using Level 1 inputs as defined by fair value measurement and disclosure guidance, (ii) $47,081,000 or 99.8% of the fair value of total investment securities was measured using Level 2 inputs, and (iii) $70,000 or 0.2% of the fair value of total investment securities was measured using Level 3 inputs (for additional information, refer to Note 12 – Fair Value Measurement of Assets and Liabilities and Fair Value of Financial Instruments to the consolidated financial statements).

The fair value of Level 3 investment securities decreased to $70,000 at September 30, 2010, as compared to $3,269,000 at December 31, 2009. Of the decrease in value, $1,664,000 was related to additional other-than-temporary impairment of investment securities, $476,000 was related to principal and interest payments received and fully applied to principal, $793,000 was related to net proceeds received on the sales of impaired investment securities, and $266,000 was related to net unrealized losses (with a corresponding after-tax impact to stockholders’ equity of $176,000 recorded as other comprehensive loss).

In order to determine whether unrealized losses in the fair value of investment securities are OTTI, management regularly reviews the entire portfolio of investment securities for possible impairment, analyzing factors including but not limited to the underlying creditworthiness of the issuing organization, the length of time for which the fair value of the investment securities has been less than cost, and independent analysts’ opinions about circumstances that could affect the performance of the investment securities. In assessing potential OTTI for debt securities, other considerations include (i) whether management intends to sell the security, or (ii) if it is more likely than not that management will be required to sell the security before recovery, or (iii) if management does not expect to recover the entire amortized cost basis. In assessing potential OTTI for equity securities, additional factors considered include management’s intention and ability to hold the securities until recovery of any unrealized losses.

Accounting Standards Codification (“ASC”) Topic 320, “Investments – Debt and Equity Securities” provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value in accordance with fair value measurement and disclosure guidance. Further, fair value measurement and disclosure guidance clarifies that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly, and the Corporation must evaluate the weight of evidence to determine whether the transactions are orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value.

As discussed more thoroughly in Note 12 – Fair Value Measurement of Assets and Liabilities and Fair Value of Financial Instruments, the fair value of these investment securities for quarters ended prior to June 30, 2010, was determined by calculating the net present value of the expected future cash flows of each security, with qualitative risk-adjusted discounting for potential credit risks and nonperformance in the underlying issuers, and market sector illiquidity concerns. In accordance with ASC Topic 820, when an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable. For quarters ended prior to June 30, 2010, management’s judgment was that the facts and circumstances indicated significant illiquidity and an inactive market for these types of investments when other relevant observable inputs were not available; therefore, expected cash flows were used as a reasonable basis in determining the fair value of the corporate investment securities.

During the third quarter of 2010, the last corporate security (InCaps Funding II Junior Note) was sold for $129,000, and one of the private issuer mortgage-backed securities (Countrywide Alt Ln 2005-75CB A4) was sold for $396,000, which were the recorded values at the time of the sale. At the time of the sales, the impaired securities had $639,000 and $1,104,000, respectively, of previously recorded impairments.

Loans and Leases, Credit Quality and Credit Risk. Loans and leases at September 30, 2010 were $329,239,000 as compared to $339,274,000 at December 31, 2009. Outstanding loans decreased by $10,035,000 from December 31, 2009 to September 30, 2010, primarily due to reduced loan demand from creditworthy borrowers and the impact of certain loans at December 31, 2009, that subsequently involved collateral ownership transfer to the Bank with such assets being recorded as other real estate owned (“OREO”) at September 30, 2010, in the Consolidated Statements of Financial Condition (for additional information, refer to the discussion on “Non-Performing Assets” on page 36). Union National continues to focus lending on creditworthy consumers and businesses, with necessary consideration given to increased credit risks posed by the current economy and weak housing and real estate market. The economy and the housing and real estate market, and increased unemployment, continue to affect some of Union National’s borrowers, and may result in additional nonperforming loans and credit losses.

At September 30, 2010, the Bank had $67,457,000 of loans specifically pledged to the FHLB for providing collateral on FHLB long-term debt, as compared to $72,287,000 of pledged loans at December 31, 2009.

Allowance for Credit Losses. In accordance with GAAP, the allowance for credit losses is maintained at a level believed by management to be adequate to absorb estimated probable loan and lease principal losses. The allowance for credit losses is established through provisions charged against net interest income. The uncollectible principal portion of impaired loans and leases is charged against the allowance for credit losses, and subsequent principal recoveries are credited to the allowance for credit losses.

Management’s evaluation of the adequacy of the allowance is based on the Bank’s past loan and lease loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant qualitative factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans and leases that may be susceptible to significant change.

The allowance for credit losses is evaluated based on an assessment of the losses inherent in the loan and lease portfolio. This assessment results in an allowance that consists of specific, general and unallocated components. The specific component relates to loans and leases that are classified as impaired. For such loans and leases, an allowance is established when (i) the discounted cash flows, or (ii) collateral value, or (iii) observable market price of the impaired loan or lease is lower than the carrying value. The general component covers all other loans and leases, including criticized loans that are not impaired, and is based on historical loss experience adjusted for relevant qualitative factors. Separate qualitative adjustments are made for higher-risk criticized loans that are not impaired. An unallocated component is maintained to cover uncertainties that could affect our estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan and lease portfolio.

Union National closely monitors the loan portfolio, and the underlying borrower financial performance and collateral values, identifying credit concerns and risks, including those resulting from the uncertain and weakened economy. Future adjustments may be necessary to the allowance for credit losses, and consequently the provision for credit losses, if economic conditions or loan credit quality differ substantially from the assumptions management used in the evaluation of the level of the allowance as compared to the balance of outstanding loans and leases.

The allowance for credit losses was $6,341,000 at September 30, 2010, as compared to $5,858,000 at December 31, 2009. A provision for credit losses of $1,546,000 was made for the nine months ended September 30, 2010, as compared to $1,446,000 for the same period in 2009. The provision for credit losses for the nine months ended September 30, 2010 (for additional information, refer to the related discussion on “Provision for Credit Losses” on pages 41 and 45) reflects both the level of charge-offs for the first nine months of 2010, and the increased credit risk in the loan portfolio, including those resulting from the current economy and weak real estate market. With the credit loss provision for the first nine months of 2010 exceeding net loan charge-offs by $483,000, and the decrease in the loan and lease portfolio, the allowance for credit losses increased to 1.93% of loans at September 30, 2010 as compared to 1.73% of loans at December 31, 2009. Management believes, based on information then currently available, that the allowance for credit losses as of September 30, 2010, was adequate to meet probable credit losses at that date.

The following table summarizes the changes in the allowance for credit losses for the three and nine months ended September 30, 2010 and 2009 (dollars in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Allowance for Credit Losses, Beginning of Period	$	5,989		$	4,364		$	5,858		$	4,358

Charge-Offs		(70	)		(132	)		(1,065	)		(1,065	)
Recoveries		–			44			2			59
Net Charge-Offs		(70	)		(88	)		(1,063	)		(1,006	)
Addition to Provision for Credit Losses		422			522			1,546			1,446
Allowance for Credit Losses, End of Period	$	6,341		$	4,798		$	6,341		$	4,798

Loans and Leases – Average	$	331,515		$	351,446		$	334,329		$	352,401

Gross Loans and Leases – Actual							$	329,239		$	342,506

Ratio of Gross Loans and Leases Charged Off to Average Loans and Leases (Annualized)		0.08	%		0.15	%		0.42	%		0.40	%

Ratio of The Allowance for Credit Losses to Gross Loans and Leases								1.93	%		1.40	%

Impaired Loans. Other than as described herein, management does not believe there are any significant trends, events or uncertainties that are reasonably expected to have a material impact on the loan and lease portfolio to affect future results of operations, liquidity or capital resources. However, based on known information, management believes that the effects of current and past economic conditions and other unfavorable business conditions may impact certain borrowers’ abilities to comply with their repayment terms and therefore may have an adverse effect on future results of operations, liquidity, or capital resources. Management closely monitors economic and business conditions and their impact on borrowers’ financial strength. For certain loans and leases, management has determined that it is probable that all principal and interest payments due according to the contractual terms of the loan agreements will not be collected. These loans are considered to be impaired as defined by GAAP.

Impaired Loans Without a Related Allowance. Union National had $382,000 and $2,799,000 of impaired loans and leases without a related allowance at September 30, 2010 and December 31, 2009, respectively. These consisted of two and five separate loan and lease relationships at September 30, 2010 and December 31, 2009, respectively. The decrease in impaired loans without a related allowance from December 31, 2009 to September 30, 2010, was related to one relationship for which management established a related allowance during 2010, which resulted from continuing stress with certain commercial real estate property values. This group of impaired loans and leases is considered impaired due to the likelihood of the borrower not being able to continue to make principal and interest payments due under the contractual terms of the loan or lease. However, these loans and leases appear to have sufficient collateral and Union National’s principal does not appear to be at risk of probable principal losses; as a result, management believes a related allowance is not necessary.

Substandard Loans and Leases. Under the Bank’s current internal risk rating system, loans and leases with a rating of “substandard” that were performing, and not determined to be impaired, amounted to $34,025,000 and $32,410,000 at September 30, 2010 and December 31, 2009, respectively. Despite these credits not being impaired, management believes these substandard credits reflect increased risks to the loan portfolio, including risks resulting from the current economy and weak housing and real estate markets. Management considered such increased risks in determining the provision for credit losses (refer to the related discussion on “Provision for Credit Losses” on pages 41 and 45). Management closely monitors the loan portfolio, and the underlying borrower financial performance and collateral values, identifying credit concerns and risks, including those resulting from the current weak economy and the current weak housing and real estate market. Management considers both impaired and these substandard loans to be potential problem loans, and believes that the current persisting and weakened economic conditions may result in additional loans being classified as substandard or nonperforming in future periods.

Non-Performing Assets. Nonperforming assets consist of nonperforming loans and leases, other real estate owned (“OREO”), and repossessed assets. The following table provides a summary of nonperforming assets at September 30, 2010 and December 31, 2009 (dollars in thousands):

	September 30, 2010			December 31, 2009
Nonaccruing Loans	$	5,938		$	8,034
Accruing Loans – 90 days or more past due		366			506
Total Nonperforming Loans and Leases		6,304			8,540
Other Real Estate Owned		8,418			5,383
Repossessed Assets		136			436
Total Nonperforming Assets	$	14,858		$	14,359

Gross Loans and Leases	$	329,239		$	339,274

Allowance for Credit Losses	$	6,341		$	5,858

Nonperforming Loans and Leases as a % of Gross Loans and Leases		1.9	%		2.5	%

Nonperforming Assets as a % of Total Assets		3.2	%		2.9	%

Allowance for Credit Losses as a % of Nonperforming Loans and Leases		101	%		69	%

Nonperforming loans and leases consist of loans and leases that are nonaccruing, and those that are 90 days or more past due. Nonaccruing loans and leases are no longer accruing interest income because of apparent financial difficulties of the borrower. Interest received on nonaccruing loans and leases is recorded as income only after the past due principal is brought current and deemed collectible in full. Total nonperforming loans and leases decreased to $6,304,000, or 1.9%, of gross loans and leases at September 30, 2010, as compared to $8,540,000, or 2.5% of gross loans and leases, at December 31, 2009. The decrease in nonperforming loans and leases primarily resulted from both increased net charge-offs and certain loans being foreclosed on in 2010 and reported as OREO in the Consolidated Statements of Financial Condition at September 30, 2010. The percentage of nonperforming loans to gross loans for the five year-end periods ended December 31, 2009, was an average of 1.2%.

OREO includes assets acquired through foreclosure, deed in-lieu of foreclosure, and loans identified as in-substance foreclosures. A loan is classified as an in-substance foreclosure when effective control of the collateral has been taken prior to completion of formal foreclosure proceedings. OREO is held for sale and is recorded at fair value less estimated costs to sell. Costs to maintain OREO and subsequent gains and losses attributable to OREO liquidation are included in the Consolidated Statements of Operations in other income and other expense as realized. No depreciation or amortization expense is recognized. OREO was $8,418,000 and $5,383,000 at September 30, 2010 and December 31, 2009, respectively. The increase was primarily the result of Union National foreclosing on two commercial mortgages in 2010. At September 30, 2010, $7,375,000, or 88% of the total OREO balance, consisted of two large commercial properties in Lancaster, PA. The remaining $1,043,000, or 12% of the total OREO balance, was comprised of five smaller commercial and residential properties.

Repossessed assets consist of (i) vehicles and other equipment acquired from lessees, who defaulted on their contractual lease obligation, and (ii) mobile homes where the Bank does not own the underlying real estate. Repossessed assets were $136,000 and $436,000 at September 30, 2010 and December 31, 2009, respectively. The decrease in repossessed assets during the first nine months of 2010 resulted primarily from sales of repossessed assets, as well as the write-down of certain repossessed leased assets to fair market value, with such write-downs amounting to $144,000.

Stockholders’ Equity. Stockholders’ equity decreased by $591,000 to $30,745,000 at September 30, 2010, as compared to $31,336,000 at December 31, 2009. The decrease in stockholders’ equity was primarily the result of decreases to retained earnings resulting from the year-to-date net loss and dividends paid to preferred stockholders, offset by other comprehensive income during the period and proceeds received through the Dividend Reinvestment Plan (“DRIP”).

Regulatory Capital. Bank regulatory authorities in the United States issue risk-based capital standards. These capital standards relate a bank’s capital to the risk profile of its assets and provide the basis by which all banks are evaluated in terms of its capital adequacy. Union National and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Union National and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require Union National and the Bank to maintain minimum amounts and ratios of Tier 1 capital to average assets and of total capital (as defined in the regulations) to risk-weighted assets.

As of September 30, 2010 and December 31, 2009, Union National and the Bank exceeded the current regulatory requirements to be considered a quantitatively “well capitalized” financial institution, i.e. a leverage ratio exceeding 5%, Tier 1 risk-based capital exceeding 6%, and total risk-based capital exceeding 10%.

In addition to the above regulatory capital standards, effective September 30, 2009, the OCC established individual minimum capital requirements for the Bank (for additional information, refer to Note 9 – Enforcement Actions with Bank Regulatory Agencies to the consolidated financial statements). The specific capital requirements established for the Bank were 8% for Tier 1 capital to average total assets, 9.5% for Tier 1 capital to risk-based assets, and 12% for total capital to risk-based assets. At September 30, 2010, the Bank’s measure of Tier I capital to average Total assets was 8.44%, Tier 1 capital to risk-based assets of 10.51% and total capital to risk-based assets of 13.33%. At September 30, 2010, all three ratios exceeded the respective individual minimum capital requirements established by the OCC.

Union National and the Bank’s regulatory capital levels as of September 30, 2010 and December 31, 2009, are as follows (dollars in thousands):

	Actual					Minimum Required For Capital Adequacy Purposes					To Be Well- Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio (1)			Amount		Ratio

Union National Financial Corporation
September 30, 2010:
Tier 1 (leverage) capital	$	40,765		8.50	%	$	19,183		4.00	%		N/A		N/A
Tier 1 risk-based capital		40,765		10.58			15,411		4.00			N/A		N/A
Total risk-based capital		52,408		13.60			30,823		8.00			N/A		N/A

December 31, 2009:
Tier 1 (leverage) capital	$	42,036		8.52	%	$	19,744		4.00	%		N/A		N/A
Tier 1 risk-based capital		42,036		9.93			16,929		4.00			N/A		N/A
Total risk-based capital		53,825		12.72			33,858		8.00			N/A		N/A

Union National Community Bank
September 30, 2010:
Tier 1 (leverage) capital	$	40,357		8.44	%	$	19,118		4.00	%	$	23,898		5.00	%
Tier 1 risk-based capital		40,357		10.51			15,361		4.00			23,041		6.00
Total risk-based capital		51,178		13.33			30,721		8.00			38,401		10.00

December 31, 2009:
Tier 1 (leverage) capital	$	40,910		8.31	%	$	19,686		4.00	%	$	24,608		5.00	%
Tier 1 risk-based capital		40,910		9.69			16,881		4.00			25,322		6.00
Total risk-based capital		52,194		12.37			33,762		8.00			42,203		10.00

(1)

The OCC requires the Bank to meet higher individual minimum capital ratios effective September 30, 2009 (for additional information, refer to Note 9 – Enforcement Actions with Bank Regulatory Agencies).

Included in Tier 1 regulatory capital of Union National is $10,193,000 of trust capital securities issued through the UNCT I and UNCT II subsidiaries of Union National. The balance of these trust capital securities, $807,000, is included in Tier 2 regulatory capital of Union National. Additionally, included in Tier 2 regulatory capital of the Bank and Union National is $6,000,000 of junior subordinated debentures issued by the Bank. These securities would become callable if the Federal Reserve makes a determination that trust capital securities can no longer be considered in regulatory capital.

Regulatory capital requirements may be increased in the future. Union National will closely monitor and evaluate its capital position as the regulatory capital environment changes, and if regulatory capital requirements are changed.

Restrictions. Banking regulations limit the amount of investments, loans, extensions of credit and advances the Bank can make to Union National at any time to 10% of the Bank’s total regulatory capital. At September 30, 2010, this limitation amounted to approximately $5,118,000. These regulations also require any such investment, loan, extension of credit or advance to be secured by securities having a market value in excess of the amount thereof.

The Bank is subject to certain restrictions in connection with the payment of dividends. National banking laws require the approval of the Office of the Comptroller of the Currency if the total of all dividends declared by a national bank in any calendar year exceeds the net profits of the Bank for that year (as defined) combined with the Bank’s retained net operating results for the preceding two calendar years. Under this formula, the Bank’s retained net operating results for the preceding two calendar years was ($189,000). The Bank had a net loss of $554,000 for the nine months ended September 30, 2010, restricting the Bank from declaring or making any dividend payment to Union National at September 30, 2010.

On January 28, 2010, Union National entered into an informal Memorandum of Understanding with the Federal Reserve Bank (“FRB”) of Philadelphia. The Memorandum of Understanding, which is not a “written agreement” for purposes of Section 8 of the Federal Deposit Insurance Act, requires, among other things, Union National to seek prior approval by the FRB before Union National (i) declares or pays dividends to shareholders, (ii) distributes interest, principal or other sums on UNCT I and UNCT II junior subordinated debentures, and (iii) incurs, increases or guarantees any additional debt. The FRB approved Union National’s request to pay preferred stock dividends and distributions on its two issuances of trust-preferred securities for the first and second quarters of 2010. Union National made a similar request for the third quarter of 2010, but the FRB denied the request. Accordingly, Union National has acted to suspend the preferred stock dividend and to defer distributions on its trust-preferred securities indefinitely. Distributions on one class of trust preferred securities, issued by UNCT I, were scheduled for July 23, 2010 and distributions on the other class, issued by UNCT II, were scheduled for August 23, 2010. Dividend payments on the preferred stock were scheduled for July 31, 2010. Union National’s preferred stock is non-cumulative so the suspension of dividends will not result in any accrued dividend liability. The deferral of distributions on the trust-preferred securities will continue to accrue as interest expense payable by Union National. Union National is prohibited from declaring or paying any dividends on its common stock or preferred stock while distributions on the trust-preferred securities are in arrears.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

Overview. Union National reported net income available to common stockholders of $77,000 for the third quarter of 2010, as compared to net income available to common stockholders of $147,000 for the same period in 2009. Basic and diluted earnings per common share were $0.03 for the third quarter of 2010, as compared to $0.05 for the same period in 2009.

The third quarter of 2010 operating results also reflect merger and acquisition related expenses of $337,000 (for additional information, refer to Note 14 – Proposed Merger to the unaudited consolidated financial statements).

The discussion that follows further explains the changes in the components of the operating results when comparing the three months ended September 30, 2010 to the same period in 2009.

Net Interest Income. Net interest income, our primary source of revenue, is the amount by which interest income on loans and investments exceeds interest incurred on deposits and borrowings. The amount of net interest income is affected by changes in interest rates and by changes in the volume and mix of interest-sensitive assets and liabilities. Net interest income and corresponding yields are presented in the discussion and analysis below on a taxable-equivalent basis. Income from tax-exempt assets, primarily loans to or securities issued by state and local governments, is adjusted by an amount equivalent to the federal income taxes which would have been paid if the income received on these assets was taxable at the statutory rate of 34%.

Although the effective interest rate impact on earning assets and funding sources can be reasonably estimated at current interest rate levels, the options selected by customers, and the future mix of the loan, investment and deposit products in the Bank’s portfolios, may significantly change the estimates used in the simulation models. In addition, our net interest income may be impacted by further interest rate actions of the Federal Reserve Bank and movements in the London Interbank Offered Rate (“LIBOR”) upon which certain variable rate loans and debentures are priced.

Net interest income as adjusted for tax-exempt financial instruments was $3,628,000 for the three months ended September 30, 2010, as compared to $3,435,000 for the same period in 2009. A benefit of a lower cost of funds resulted in less interest paid on average interest-bearing liabilities, which more than offset the decrease in the yield on interest-earning assets, which resulted in a higher net interest margin for the three months ended September 30, 2010, as compared to the same period in 2009. The taxable-equivalent net interest margin percentage for the third quarter of 2010 was 3.39%, as compared to 2.89% for the same period in 2009. The interest rate paid on average interest-bearing liabilities decreased by 60 basis points to 1.91% for the three months ended September 30, 2010, as compared to 2.51% for the same period in 2009. The yield on interest-earning assets decreased by 9 basis points to 5.06% for the three months ended September 30, 2010, as compared to 5.15% for the same period in 2009.

Interest and fees on loans and leases, on a taxable-equivalent basis, decreased by $577,000, or 10%, to $5,057,000 for the three months ended September 30, 2010, as compared to $5,634,000 for the same period in 2009. The decrease in interest and fees on loans and leases primarily resulted from the decrease in loans outstanding. The average balance of loans and leases decreased by $19,931,000 for the three months ended September 30, 2010, as compared to the same period in 2009, due to reduced loan demand from creditworthy borrowers, the impact of nearly $10 million of loan participations sold for capital and risk management purposes in the third quarter of 2009, and the impact of approximately $8.7 million of loan assets that were ultimately transferred to OREO since September 30, 2009. The average yield decreased by 31 basis points to 6.05% for the three months ended September 30, 2010, as compared to 6.36% for the same period in 2009. The variable rate structure of many of Union National’s loans reduced the overall yield due to the persistent low market interest rates.

Interest and dividends earned on investment securities on a taxable-equivalent basis decreased by $113,000, or 28%, to $292,000 for the three months ended September 30, 2010, as compared to $405,000 for the same period in 2009. The decrease in interest and dividends earned on investment securities primarily resulted from a decrease in the average balance of investment securities, which decreased by $36,142,000 for the three months ended September 30, 2010, as compared to the same period in 2009. The substantial portion of this decrease funded the prepayment of $20,000,000 of FHLB debt in the third quarter of 2010. Proceeds from investment maturities and sales were re-invested at higher yields, as a result, the average yield on investment securities increased by 82 basis points to 2.95% for the three months ended September 30, 2010, as compared to 2.13% for the same period in 2009, which slightly offset the impact of a decrease in interest and dividends earned on investment securities resulting from the decrease in the average balance of investment securities.

Interest expense on deposits decreased by $630,000, or 31%, to $1,392,000 for the three months ended September 30, 2010, as compared to $2,022,000 for the same period in 2009. The decrease in interest expense on deposits was primarily driven by a decrease of 53 basis points in the average rate paid on deposits. The average rate paid on deposits was 1.64% for the third quarter of 2010, as compared to 2.17% for the same period in 2009.

Interest expense on long-term debt decreased by $270,000, or 58%, to $198,000 for the three months ended September 30, 2010, as compared to $468,000 for the same period in 2009. Union National continued to take measures to reduce its cost of borrowings, prepaying $22,500,000 and $17,000,000 of higher-cost long-term debt in the first nine months of 2010 and for the full year of 2009, respectively, which contributed to a $20,489,000 decrease in the average balance of long-term debt for the third quarter of 2010, as compared to the same period in 2009.

Provision for Credit Losses. The provision for credit losses is an expense charged against net interest income to provide for estimated losses attributable to uncollectible loans and leases. The provision is based on management’s analysis of the adequacy of the allowance for credit losses. The provision for credit losses was $422,000 for the three months ended September 30, 2010, as compared to $522,000 for the same period in 2009. The provision for both periods reflects both the level of charge-offs for the respective period and the increased credit risk related to the loan portfolio at September 30, 2010, as compared to September 30, 2009 (refer to the related discussions on the “Allowance for Credit Losses” on page 33 and “Substandard Loans and Leases” on page 36). Management closely monitors the loan portfolio and the adequacy of the allowance for credit loss reserve considering underlying borrower financial performance and collateral values, and increasing credit risks. Future material adjustments may be necessary to the provision for credit losses, and consequently the allowance for credit losses, if economic conditions or loan credit quality differ substantially from the assumptions we used in making our evaluation of the level of the allowance for credit losses as compared to the balance of outstanding loans and leases.

Non-Interest Income. Non-interest income increased by $181,000, or 13%, to $1,608,000 for the three months ended September 30, 2010, as compared to $1,427,000 for the same period in 2009. Increases (decreases) in the components of non-interest income when comparing the three months ended September 30, 2010 to the same period in 2009, are as follows (in thousands):

	Three Months Ended September 30,						Increase
Non-Interest Income	2010			2009			(Decrease)
Service Charges on Deposit Accounts	$	459		$	588		$	(129	)
Other Service Charges, Commissions, Fees		305			294			11
Alternative Investment Sales Commissions		189			125			64
Income from Fiduciary Activities		43			39			4
Earnings from Bank-Owned Life Insurance		99			108			(9	)
Other Income		40			46			(6	)
Net Gain on Sale of Investment Securities		577			397			180
Other-than-temporary Impairments (“OTTI”) of Securities		(104	)		(170	)		66
Portion of OTTI Recognized in Other Comprehensive Income		–			–			–
Net OTTI Losses on Securities		(104	)		(170	)		66
Total Non-Interest Income	$	1,608		$	1,427		$	181

A significant portion of the $181,000 increase in non-interest income was related to investment securities activities. The third quarter of 2010 included $577,000 in net gains on the sale of investment securities, as compared to $397,000 for the same period in 2009. Additionally, the third quarter of 2010 included $104,000 in other-than-temporary investment impairment charges, as compared to $170,000 for the same period in 2009. The impairment charges for both periods are reflective of investment rating downgrades on private-issuer mortgage-backed securities and corporate securities, resulting in values being reduced to reflect distressed market conditions and lower investment cash flows.

During the third quarter of 2010, new regulations took effect, which requires Union National to receive the customer’s permission before covering overdrafts for debit card transactions made with ATM or debit cards. The implementation of this new legislation significantly reduced income related to service charges on deposit accounts.

Non-Interest Expense. Non-interest expense was $4,731,000 for the three months ended September 30, 2010, as compared to $4,167,000 for the same period in 2009. Increases (decreases) in the components of non-interest expense when comparing the three months ended September 30, 2010, to the same period in 2009, are as follows (in thousands):

	Three Months Ended September 30,				Increase
Non-Interest Expense	2010		2009		(Decrease)
Salaries, Wages, and Employee Benefits	$	1,737	$	1,680	$	57
Net Occupancy		439		414		25
Data and ATM Processing		434		406		28
Professional Fees and Regulatory Assessments		273		316		(43	)
Furniture and Equipment		203		227		(24	)
FDIC Insurance		236		238		(2	)
Pennsylvania Shares Tax		95		89		6
Advertising and Marketing		41		42		(1	)
Supplies and Postage		69		66		3
Merger and Acquisition Expenses		337		–		337
Other Expense		867		689		178
Total Non-Interest Expense	$	4,731	$	4,167	$	564

Non-interest expense for the third quarter of 2010 reflects merger and acquisition related expenses of $337,000. These expenses are comprised of primarily merger-related legal and investment banking fees. As previously disclosed, Union National entered into the Merger Agreement on April 19, 2010, as amended and restated as of May 20, 2010 and as amended on September 1, 2010, with DFSC pursuant to which Union National will merge with and into DFSC. If the transaction is approved by the regulators, and meets all closing conditions, Union National Community Bank also will merge with and into Province. On September 16, 2010, Union National’s shareholders, at a special meeting of shareholders, voted to approve the pending merger with DFSC. Holders of more than 85% of the outstanding shares voted to approve the merger.

The increase in other expense was primarily the result of $384,000 of FHLB debt prepayment penalties incurred during the three months ended September 30, 2010, as compared to similar debt prepayment penalties of $143,000 for the same period in 2009.

Income Taxes. An income tax benefit of $95,000 and $48,000 was recorded for the three months ended September 30, 2010 and 2009, respectively. For the three months ended September 30, 2010, the income tax benefit resulted from a pre-tax loss as well as from the benefits of tax-exempt income. For the three months ended September 30, 2009, the income tax benefit resulted primarily from the benefits of tax-exempt income. Generally, Union National’s effective tax rate is below the statutory rate due to tax-exempt earnings on loans, investments, and bank-owned life insurance, and the impact of tax credits.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009

Overview. Union National reported a net loss available to common stockholders of ($959,000) or basic and diluted losses per common share of ($0.34) for the nine months ended September 30, 2010, as compared to a net loss available to common stockholders of ($257,000) or basic and diluted losses per common share of ($0.09) for the same period in 2009.

The discussion that follows further explains the changes in the components of the operating results when comparing the nine months ended September 30, 2010 to the same period in 2009.

Net Interest Income. Net interest income as adjusted for tax-exempt financial instruments was $10,377,000 for the nine months ended September 30, 2010, as compared to $9,493,000 for the same period in 2009. A benefit of a lower cost of funds resulted in less interest paid on average interest-bearing liabilities, which more than offset the decrease in the yield on interest-earning assets, which resulted in a higher net interest margin for the first nine months of 2010, as compared to the same period in 2009. The taxable-equivalent net interest margin percentage for the first nine months of 2010 was 3.14%, as compared to 2.71% for the same period in 2009. The interest rate paid on average interest-bearing liabilities decreased by 69 basis points to 2.09% for the first nine months of 2010, as compared to 2.78% for the same period in 2009. The yield on interest-earning assets decreased by 23 basis points to 4.99% for the first nine months of 2010, as compared to 5.22% for the same period in 2009.

Interest and fees on loans and leases, on a taxable-equivalent basis, decreased by $1,459,000 or 9%, to $15,143,000 for the nine months ended September 30, 2010, as compared to $16,602,000 for the same period in 2009. The decrease in interest and fees on loans and leases primarily resulted from the decrease in loans outstanding. The average balance of loans and leases decreased by $18,072,000 for the first nine months of 2010, as compared to the same period in 2009 due to reduced loan demand from creditworthy borrowers, the impact of nearly $10 million of loan participations sold for capital and risk management purposes in the third quarter of 2009, and the impact of approximately $8.7 million of loans that were ultimately transferred to OREO since September 30, 2009. The average yield on loans decreased by 24 basis points to 6.06% for the first nine months of 2010, as compared to 6.30% for the same period in 2009. The variable rate structure of many of Union National’s loans reduced the overall yield due to the persistent low market interest rates.

Interest and dividends earned on investment securities on a taxable-equivalent basis decreased by $359,000 or 24%, to $1,148,000 for the nine months ended September 30, 2010, as compared to $1,507,000 for the same period in 2009. The decrease in interest and dividends earned on investment securities primarily resulted from a decrease in the average balance of investment securities, which decreased by $17,824,000 for the first nine months of 2010, as compared to the same period in 2009. The substantial portion of this decrease funded the prepayment of $20,000,000 of FHLB debt in the third quarter of 2010. Proceeds from investment maturities and sales were re-invested at higher yields, as a result, the average yield on investment securities increased by 8 basis points to 2.98% for the nine months ended September 30, 2010, as compared to 2.90% for the same period in 2009, which slightly offset the impact of a decrease in interest and dividends earned on investment securities resulting from the decrease in the average balance of investment securities.

Interest expense on deposits decreased by $1,973,000, or 30%, to $4,567,000 for the nine months ended September 30, 2010, as compared to $6,540,000 for the same period in 2009. The decrease in interest expense on deposits was primarily driven by a decrease of 64 basis points in average rate paid on deposits. The average rate paid on deposits was 1.76% for the first nine months of 2010, as compared to 2.40% for the same period in 2009.

Interest expense on long-term debt decreased by $647,000 or 40%, to $982,000 for the nine months ended September 30, 2010, as compared to $1,629,000 for the same period in 2009. Union National continued to take measures to reduce its cost of borrowings, prepaying $22,500,000 and $17,000,000 of higher-cost long-term debt in 2010 and for the full year of 2009, respectively, which contributed to a $16,473,000 decrease in the average balance of long-term debt for the first nine months of 2010, as compared to the same period in 2009.

Provision for Credit Losses. The provision for credit losses was $1,546,000 for the nine months ended September 30, 2010, as compared to $1,446,000 for the same period in 2009. The provision for both periods reflects both the level of charge-offs and the increased credit risk related to the loan portfolio at September 30, 2010, as compared to September 30, 2009 (refer to the related discussions on the “Allowance for Credit Losses” on page 33 and “Substandard Loans and Leases” on page 36). Management continues to closely monitor the loan portfolio and the adequacy of the allowance for credit loss reserve considering underlying borrower financial performance and collateral values, and increasing credit risks. Future material adjustments may be necessary to the provision for credit losses, and consequently the allowance for credit losses, if economic conditions or loan credit quality differ substantially from the assumptions we used in making our evaluation of the level of the allowance for credit losses as compared to the balance of outstanding loans and leases.

Non-Interest Income. Non-interest income decreased by $1,401,000, or 34%, to $2,683,000 for the nine months ended September 30, 2010, as compared to $4,084,000 for the same period in 2009. Increases (decreases) in the components of non-interest income when comparing the nine months ended September 30, 2010 to the same period in 2009, are as follows (in thousands):

	Nine Months Ended September 30,						Increase
Non-Interest Income	2010			2009			(Decrease)
Service Charges on Deposit Accounts	$	1,415		$	1,601		$	(186	)
Other Service Charges, Commissions, Fees		909			858			51
Alternative Investment Sales Commissions		523			428			95
Income from Fiduciary Activities		131			132			(1	)
Earnings from Bank-Owned Life Insurance		303			323			(20	)
Other Income		123			422			(299	)
Net Gain on Sale of Investment Securities		943			1,791			(848	)

Other-than-temporary Impairments (“OTTI”) of Securities		(1,664	)		(1,471	)		(193	)
Portion of OTTI Recognized in Other Comprehensive Income		–			–			–
Net OTTI Losses on Securities		(1,664	)		(1,471	)		(193	)
Total Non-Interest Income	$	2,683		$	4,084		$	(1,401	)

A significant portion of the $1,401,000 decrease in non-interest income was related to investment securities activities. Net gains on the sale of investment securities were $943,000 for the nine months ended September 30, 2010, as compared to $1,791,000 for the same period in 2009. Additionally, other-than-temporary investment impairment charges were $1,664,000 for the nine months ended September 30, 2010, as compared to $1,471,000 for the same period in 2009. The impairment charges for both periods are reflective of investment rating downgrades on private-issuer mortgage-backed securities and corporate securities, and lower realized and expected investment cash flows, resulting in values being reduced.

Other income decreased by $299,000 for the nine months ended September 30, 2010, as compared to the same period in 2009, which was primarily the result of other income recorded during the second quarter 2009 from an insurance payment to Union National in recovery of a 2008 fidelity bond claim. There was no such insurance recovery for the nine months ended September 30, 2010.

Non-Interest Expense. Non-interest expense was $13,037,000 for the nine months ended September 30, 2010, as compared to $12,661,000 for the same period in 2009. Increases (decreases) in the components of non-interest expense when comparing the nine months ended September 30, 2010, to the same period in 2009, are as follows (in thousands):

	Nine Months Ended September 30,				Increase
Non-Interest Expense	2010		2009		(Decrease)
Salaries, Wages, and Employee Benefits	$	5,198	$	5,297	$	(99	)
Net Occupancy		1,343		1,313		30
Data and ATM Processing		1,301		1,236		65
Professional Fees and Regulatory Assessments		685		817		(132	)
Furniture and Equipment		641		713		(72	)
FDIC Insurance		703		898		(195	)
Pennsylvania Shares Tax		286		267		19
Advertising and Marketing		131		159		(28	)
Supplies and Postage		188		214		(26	)
Merger and Acquisition Expenses		773		–		773
Other Expense		1,788		1,747		41
Total Non-Interest Expense	$	13,037	$	12,661	$	376

Non-interest expense for 2010 reflects merger and acquisition related expenses of $773,000. These expenses are comprised of primarily merger-related legal and investment banking fees. As previously disclosed, Union National entered into the Merger Agreement on April 19, 2010, as amended and restated as of May 20, 2010 and as amended on September 1, 2010, with DFSC pursuant to which Union National will merge with and into DFSC. If the transaction is approved by the regulators, and meets all closing conditions, Union National Community Bank also will merge with and into Province. On September 16, 2010, Union National’s shareholders, at a special meeting of shareholders, voted to approve the pending merger with DFSC. Holders of more than 85% of the outstanding shares voted to approve the merger.

As noted in the table below (in thousands), operating results also reflect lower Federal Deposit Insurance Corporation (“FDIC”) insurance assessments when comparing the nine months ended September 30, 2010, to the same period in 2009. FDIC base insurance assessments amounted to $703,000 for the nine months ended September 30, 2010, representing a $42,000 or 6% increase over the same period in 2009. The increase in FDIC base insurance assessments was the direct result of increased base assessment rates, as determined by the FDIC. Additionally, the nine months ended September 30, 2009, included $237,000 related to an FDIC special assessment on deposit-insured institutions. There was no such special assessment in the first nine months of 2010.

	Nine Months Ended September 30,				Increase
FDIC Insurance Expense	2010		2009		(Decrease)
Base Insurance Assessments	$	703	$	661	$	42
Special Insurance Assessments		–		237		(237	)
Total FDIC Insurance Expense	$	703	$	898	$	(195	)

The increase in other expense was primarily the result of expenses associated with OREO and repossessed assets for the nine months ended September 30, 2010, as compared to the same period in 2009.

Income Taxes. An income tax benefit of $787,000 and $482,000 was recorded for the nine months ended September 30, 2010 and 2009, respectively. For both of these periods, the benefit resulted from a pre-tax loss as well as the benefits of tax-exempt income. Generally, Union National’s effective tax rate is below the statutory rate due to tax-exempt earnings on loans, investments, and bank-owned life insurance, and the impact of tax credits. The realization of deferred tax assets is dependent upon future earnings. Management anticipates that future earnings will be adequate to fully utilize deferred tax assets.

LIQUIDITY

The Bank’s objective is to maintain adequate liquidity to meet funding needs at a reasonable cost and to provide contingency plans to meet unanticipated funding needs or a loss of funding sources, while minimizing interest rate risk. Adequate liquidity provides resources for credit needs of borrowers, for depositor withdrawals and for funding corporate operations. Sources of liquidity are as follows:

A growing core retail deposit base;

Proceeds from the sale or maturity of investment securities;

Payments received on loans and mortgage-backed securities; and,

Overnight correspondent bank borrowings credit lines, and borrowing capacity available from the Federal Reserve Bank and the Federal Home Loan Bank of Pittsburgh.

Management believes that the Bank’s core deposits remain fairly stable. Liquidity and funds management is governed by policies and measured on a daily basis, with supplementary weekly and monthly analyses. These measurements indicate that liquidity generally remains stable and exceeds our minimum defined levels of adequacy. Other than the trends of continued competitive pressures and volatile interest rates, there are no known demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, liquidity increasing or decreasing in any material way.

The Bank had liquid assets of $49,691,000 at September 30, 2010.

OFF-BALANCE SHEET COMMITMENTS

In the normal course of business, we are party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Total commitments to extend credit amounted to $106,822,000 at September 30, 2010 as compared to $110,791,000 at December 31, 2009. Total standby letters of credit amounted to $4,911,000 at September 30, 2010 as compared to $6,199,000 at December 31, 2009.

In addition, in the normal course of business operations, we routinely enter into contracts for services. These contracts may require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contracts. In January 2007, the contract with our core data processor was renegotiated, resulting in a new maturity date of November 2013. Any early termination will require the payment of a substantial penalty. For the three months ended September 30, 2010, there has been no material change in contracts for services since this contract was renegotiated.

REGULATORY MATTERS

From time to time, various types of federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of Union National and the Bank. As a consequence of the extensive regulation of commercial banking activities in the United States, Union National’s and the Bank’s business is particularly susceptible to being affected by federal and state legislation and regulations that may increase the cost of doing business. Also, Union National is susceptible to changes in tax law that may increase the cost of doing business or impact Union National’s ability to realize the value of deferred tax assets. Further, the business of Union National is affected by the state of the financial services industry in general. Please refer to Note 9 – Enforcement Actions with Bank Regulatory Agencies to the consolidated financial statements for a discussion on specific regulatory matters impacting Union National.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required for smaller reporting companies.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. Union National maintains controls and procedures designed to ensure that information required to be disclosed in the reports that Union National files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of September 30, 2010, Union National’s Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were adequate.

Changes in Internal Controls. There were no changes during the quarter ended September 30, 2010 in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, these controls.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Union National entered into an Agreement and Plan of Merger (the “Merger Agreement”) on April 19, 2010, as amended and restated as of May 20, 2010 and as amended on September 1, 2010 (the “Merger Agreement”), with Donegal Financial Services Corporation (“DFSC”), the parent company of Province Bank FSB (“Province”), and certain affiliated entities of DFSC, pursuant to which Union National will merge with and into DFSC. DFSC is wholly owned by Donegal Mutual Insurance Company and Donegal Group Inc. (For additional information on the proposed merger, refer to Note 14 – Proposed Merger).

On June 16, 2010, Union National and DFSC, an affiliate of Donegal Group Inc. and Donegal Mutual Insurance Company, became aware of a filing of a complaint on June 14, 2010 in the Court of Common Pleas of Lancaster County, Pennsylvania against Union National, each of the Directors of Union National, DFSC and certain affiliated entities of DFSC (collectively, the "Donegal Parties"). The complaint purported to be a class action filed on behalf of the holders of Union National common stock arising from certain alleged actions by Union National and its Board of Directors in connection with the previously announced proposed merger of Union National with and into DFSC. On October 1, 2010, Union National learned that the claim was withdrawn and the case was dismissed.

Management is not aware of any other litigation that would have a material adverse effect on the consolidated financial position or results of operations of Union National.

ITEM 1A. RISK FACTORS

Recently enacted regulatory reform may have a material impact on our operations.

On July 21, 2010, the President signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act restructures the regulation of depository institutions. The Dodd-Frank Act contains various provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. Also included is the creation of a new federal agency to administer and enforce consumer and fair lending laws, a function that is now performed by the depository institution regulators. The federal preemption of state laws currently accorded federally chartered depository institutions will be reduced as well. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased compliance costs resulting from possible future consumer and fair lending regulations.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. (REMOVED AND RESERVED)

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

3. The following Exhibits are filed herewith, or incorporated by reference as a part of this Report:

3(i)		Union National Financial Corporation’s Amended and Restated Articles of Incorporation. (Incorporated by reference to Exhibit 3.1 to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on May 13, 2009.)

3(ii)		Union National Financial Corporation’s Amended and Restated By-laws. (Incorporated by reference to Exhibit 3(ii) to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on February 27, 2009.)

4.1		Rights Agreement, dated August 27, 2007, between Registrar and Transfer Company and Union National Financial Corporation. (Incorporated by reference to Exhibit 4 to Union National Financial Corporation’s current report on Form 8-K, filed August 30, 2007.)

4.2		Certificate of Designations of the Series A Preferred Stock (Incorporated by reference to Exhibit 3.1 to Union National’s Current Report on Form 8-K dated September 15, 2009).

10.1	**	Union National Financial Corporation 1988 Stock Incentive Plan. (Incorporated by reference to Exhibit 4.3 to Union National Financial Corporation’s Registration Statement No. 333-27837 on Form S-8, filed with the Commission on May 27, 1997.)

10.2	**	Union National Financial Corporation 1997 Stock Incentive Plan. (Incorporated by reference to Exhibit 4.5 to Union National Financial Corporation’s Registration Statement No. 333-27837 on Form S-8, filed with the Commission on May 27, 1997 and incorporated by reference to Amendment 1 to Union National Financial Corporation’s Registration Statement No. 333-107326 on Form S-8 filed with the commission on July 25, 2003.)

10.3	**	Union National Financial Corporation’s Employee Stock Purchase Plan (Incorporated by Reference to Exhibit 4.4 to Union National Financial Corporation’s Registration Statement No. 333-27837 on Form S-8, filed with the Commission on May 27, 1997).

10.4	*	Group Term Replacement Plan for Certain Officers, CEO, dated January 1, 2004 between Mark D. Gainer and Union National Community Bank. (Incorporated by reference to Exhibit 10.12 to Union National Financial Corporation’s Annual Report on Form 10-K, filed with the Commission on March 30, 2004.)

10.5	**	Union National Financial Corporation, 1999 Independent Directors Stock Option Plan. (Incorporated by Reference to Exhibit 4.3 to Union National Financial Corporation’s Registration Statement No. 333-80739 on Form S-8, filed with the Commission on September 15, 1999.)

10.6		Office Lease between Lausch Lane Associates LP as Landlord andUnion National Community Bank as Tenant for 570 Lausch Lane, Lancaster, PA 17601. (Incorporated by reference to Exhibit 99.1 to Union National Financial Corporation’s Current Report of Form 8-K, filed with the Commission on May 17, 2005.)

10.7	*	Amended and Restated Employment Agreement and Amended and Restated Executive Salary Continuation Agreement dated as of December 29, 2006, with Mark D. Gainer, Chairman, President and Chief Executive Officer. (Incorporated by reference to Exhibit 10.15 to Union National Financial Corporation’s 2006 Annual Report on Form 10-K, filed with the Commission on March 28, 2007.)

10.8		Amended and Restated Declaration of Trust of Union National Capital Trust II, dated as of October 14, 2004, among Union National Financial Corporation, as sponsor, the Delaware and institutional trustee named therein, and the administrators named therein. (Incorporated by reference to Exhibit 10.17 to Union National Financial Corporation’s 2006 Annual Report on Form 10-K, filed with the Commission on March 28, 2007.)

10.9		Indenture, dated as of October 14, 2004, between Union National Financial Corporation, as issuer, and the trustee named therein, relating to the Junior Subordinated Debt Securities due 2034. (Incorporated by reference to Exhibit 10.18 to Union National Financial Corporation’s 2006 Annual Report on Form 10-K, filed with the Commission on March 28, 2007.)

10.10		Guarantee Agreement, dated as of October 14, 2004, between Union National Financial Corporation and the guarantee trustee named therein. (Incorporated by reference to Exhibit 10.19 to Union National Financial Corporation’s 2006 Annual Report on Form 10-K, filed with the Commission on March 28, 2007.)

10.11		Indenture, dated as of July 27, 2006, between Union National Community Bank, as issuer, and the trustee named therein, relating to the Junior Subordinated Debt Securities due 2036. (Incorporated by reference to Exhibit 4.1 to Union National Financial Corporation’s quarterly report on Form 10-Q, filed with the Commission on August 14, 2006.)

10.12	*	Employment Agreement, dated March 8, 2007 (with an expiration date of March 7, 2010), between Stephen D. Staman, Executive Vice President and Chief Revenue Officer and Union National Financial Corporation and its subsidiary, Union National Community Bank. (Incorporated by reference to Exhibit 10.16 to Union National Financial Corporation’s 2007 Annual Report on Form 10-K, filed with the Commission on April 1, 2008.)

10.13	*	Change of Control Agreement, dated September 4, 2007, between Michael D. Peduzzi, Executive Vice President, Chief Financial Officer and Union National Financial Corporation and its subsidiary, Union National Community Bank. (Incorporated by reference to Exhibit 99.1 to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on September 6, 2007.)

10.14	*	Change of Control Agreement among Union National Financial Corporation, Union National Community Bank and each of the following officers: Michael L. Maurer and Bradley A. Willow, filed August 13, 2008, as Item 10.18 to Form 10-Q for the fiscal quarter ended September 30, 2008 (No. 0-19214) and incorporated herein by reference.

10.15	*	Change of Control Agreement among Union National Financial Corporation, Union National Community Bank and each of the following officers: R. Michael Mohn, Steve D. Garber and Kevin Hersh, filed August 13, 2008, as Item 10.19 to Form 10-Q for the fiscal quarter ended September 30, 2008 (No. 0-19214) and incorporated herein by reference.

10.16	***	Stock Bonus Plan and the 2009 Stock Purchase Plan, filed December 3, 2008, and incorporated by reference to Exhibit 99.1 to Union National Financial Corporation’s current report on Form 8-K.

10.17		Formal agreement with the Comptroller of the Currency (“OCC”) and Union National Community Bank, filed August 31, 2009, as Item 8.01 to Form 8-K and incorporated by reference.

10.18		Form of stock subscription agreement for Series A Preferred Stock (Incorporated by reference to Exhibit 10.1 to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on October 1, 2009).

10.19		Agreement and Plan of Merger among Union National Financial Corporation, Donegal Financial Services Corporation (“DFSC”) and certain affiliated entities of DFSC (Incorporated by reference to Exhibit 2.1 to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on April 23, 2010).

10.20		Amended and Restated Agreement and Plan of Merger by and among Donegal Acquisition Inc., Donegal Financial Services Corporation, Donegal Mutual Insurance Company, Donegal Group Inc. and Union National Financial Corporation dated as of May 20, 2010 (Incorporated by reference to Exhibit 2.1 to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on May 21, 2010).

10.21		Amendment to the Agreement and Plan of Merger by and among Donegal Acquisition Inc., Donegal Financial Services Corporation, Donegal Mutual Insurance Company, Donegal Group Inc. and Union National Financial Corporation dated as of September 1, 2010 (Incorporated by reference to Exhibit 2.1 to Union National Financial Corporation’s current report on Form 8-K, filed with the Commission on September 2, 2010).

14		Union National Financial Corporation Directors and Senior Management Code of Ethics. (Incorporated by reference to Exhibit 14 to Union National Financial Corporation’s 2009 Annual Report on Form 10-K, filed with the Commission on March 31, 2010.)

31.1		Certification of Principal Executive Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-14(a) as added by Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

31.2		Certification of Principal Financial Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-14(a) as added by Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.

32		Certification of Principal Executive Officer and Principal Financial Officer Pursuant to U.S.C. Section 1350 as added by Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.

*	Management contract or compensatory plan arrangement.

**	Stockholder approved compensatory plan pursuant to which the Registrant’s Common Stock may be issued to employees of the Corporation.

***	Non-stockholder approved compensatory plan pursuant to which the Registrant's Common Stock may be issued to employees of the Corporation.

SIGNATURES

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

		Union National Financial Corporation
		(Registrant)

Date: November 10, 2010	By	/s/ Mark D. Gainer
		Mark D. Gainer Chairman, CEO and President (Principal Executive Officer)

Date: November 10, 2010	By	/s/ Michael D. Peduzzi
		Michael D. Peduzzi Executive Vice President and Chief Financial Officer (Principal Financial Officer)

UNION NATIONAL FINANCIAL CORP / PA - FORM 10-Q - November 10, 2010

Attached files

UNION NATIONAL FINANCIAL CORP / PA Reports