FCEC First Chester County Corp. (MM)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Form 10-K

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

For the fiscal year ended December 31, 2009

Commission File No. 1-12870

FIRST CHESTER COUNTY CORPORATION
(Exact name of Registrant as specified in its charter)

9 North High Street
West Chester, Pennsylvania 19380
(Address of principal executive offices)

(484) 881-4000
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

         Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o     No  ý

         Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o     No  ý

         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  ý     No  o

         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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o  Yes     o  No

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

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

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

         The aggregate market value of the Registrant's Common Stock, par value $1.00 per share, held by nonaffiliates of the Registrant as of June 30, 2010 was $49,174,940.

         The number of shares outstanding of Common Stock of the Registrant as of July 9, 2010 was 6,320,556.

DOCUMENTS INCORPORATED BY REFERENCE

None.

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

        We may, from time to time, make written or oral "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, including statements contained in the Corporation's filings with the Securities and Exchange Commission (the "SEC") (including this Report on Form 10-K), our reports to shareholders and in other communications made by us. These statements can often be identified by the use of forward-looking terminology such as "believes," "expects," "intends," "may," "will," "should" or "anticipates" or similar terminology. These statements involve risks and uncertainties and are based on various assumptions. Although we believe that our expectations are based on reasonable assumptions, investors and prospective investors are cautioned that such statements are only projections. Also, future results may differ materially from our historic results. The risks and uncertainties described in this Report, among others, could cause our actual future results to differ materially from those described in forward-looking statements made in this Report, or presented elsewhere by management from time to time, or from our historic results. The most significant of these risks and uncertainties are discussed in Item 1A, "Risk Factors." Additional discussion may be included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Report. Statements made in this Report are made as of the date of this Report, unless stated to be as of an earlier date, and we are not obligated to update our forward-looking statements, even though our situation may change in the future.

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PART I

Item 1.    Business .

Business

        First Chester County Corporation (the "Corporation," "we," "us" or "our") is a Pennsylvania corporation and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended (the "BHC Act"). We were incorporated on March 9, 1984, for the purpose of becoming a registered bank holding company pursuant to the BHC Act and acquiring First National Bank of Chester County, formerly known as The First National Bank of West Chester (the "Bank"), thereby enabling the Bank to operate within a bank holding company structure. On September 13, 1984, we acquired all of the issued and outstanding shares of common stock of the Bank. The Bank, formed in 1863, is a national banking association under the supervision of the Office of the Comptroller of the Currency (the "OCC"). On August 5, 2001, we became a financial holding company pursuant to the Gramm-Leach-Bliley Act of 1999. Our headquarters is located at 9 North High Street, West Chester, Pennsylvania 19380.

        Our principal activities are the owning and supervising of the Bank, which engages in a general banking business based in Chester County, Pennsylvania. On December 31, 2008, we completed our acquisition of American Home Bank, National Association ("AHB"), which merged with and into the Bank. AHB was established in 2001 and has been engaged in full service community banking, with a primary focus on mortgage-banking activities. The mortgage-banking activities previously conducted by AHB are now operated by a division of the Bank. We direct the policies and coordinate the financial resources of the Bank.

        The Bank is a full service commercial bank offering a broad range of retail banking, commercial banking, internet banking, trust and investment management and insurance services to individuals, businesses, governmental entities, nonprofit organizations, and community service groups. The Bank currently conducts its business through twenty-three primary banking offices located in Chester, Montgomery, Delaware, Lancaster and Cumberland Counties, Pennsylvania, including its main office. In addition, the Bank operates 29 ATM facilities. The Bank is a member of the Federal Reserve System. At December 31, 2009, the Bank had total assets of $1.4 billion, total loans of $901.9 million, total deposits of $1.1 billion and employed 771 persons, of which 717 were full-time and 54 were part-time.

Pending Merger

        On December 27, 2009, we entered into a definitive merger agreement, as amended on March 4, 2010 (the "Merger Agreement"), with Tower Bancorp, Inc. ("Tower"), the holding company for Graystone Tower Bank ("Graystone"), pursuant to which we will merge into Tower (the "Merger"). The Merger Agreement provides that upon consummation of the merger, the Bank will merge into Graystone, with Graystone as the surviving institution. The Merger Agreement additionally provides for the potential sale of the American Home Bank division at or prior to consummation of the merger. Under the terms of the Merger Agreement, our shareholders will receive 0.453 shares of Tower stock for each share of common stock they own, subject to adjustment based on our level of delinquencies, as defined by the merger agreement, as of the last business day of the month immediately preceding the closing of the merger. Consummation of the merger is subject to certain terms and conditions, including, but not limited to, receipt of various regulatory approvals and approval by both Tower's and our shareholders and that our loan delinquencies do not exceed $90 million in the aggregate. As of June 30, 2010, the Merger has received all required regulatory approvals and we expect to complete the Merger during 2010. See "Item 1A—Risk Factors" for certain risks associated with the merger with Tower.

        For more information relating to the pending merger and other recent events, please see "Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations."

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Segments

        We have determined that the Bank has two operating and reporting segments: Community Banking and Mortgage Banking. Through the Bank's Community Banking segment, the Bank offers retail services, including checking accounts, savings programs, money-market accounts, certificates of deposit, safe deposit facilities, consumer loan programs, overdraft checking, automated tellers and extended banking hours, and commercial services, including revolving lines of credit, commercial mortgages, equipment leasing and letter of credit services. These retail and commercial banking activities are provided primarily to consumers and small to mid-sized companies within the Bank's market area. Lending services are focused on commercial, consumer, and real estate lending to local borrowers. The Bank attempts to establish a total borrowing relationship with its customers that may typically include commercial loans, a mortgage loan for the borrower's residence, a consumer loan or a revolving personal credit line.

        The Bank's Wealth Management division operates as part of the Community Banking segment and provides a broad range of trust and investment management services. It administers and provides services for estates, trusts, agency accounts, and individual and employer sponsored retirement plans. At December 31, 2009, the Bank's Wealth Management division administered or provided investment management services to accounts that held assets with an aggregate market value of approximately $548.6 million. For the year ended December 31, 2009, income from the Bank's Wealth Management division and related activities was approximately $3.5 million. In addition to retail and commercial banking and wealth management services, the Bank offers an array of investment opportunities including mutual funds, annuities, retirement planning, education planning and insurance through FNB Insurance Services, LLC, doing business as First National Financial Advisory Services, a wholly-owned subsidiary of the Bank.

        The Bank's retail mortgage-banking business segment, which consists primarily of the operations formerly conducted by AHB, provides mortgages and associated products to customers and sells most of those mortgages into the secondary market on a servicing released basis. The sourcing of mortgage loans is conducted through a direct, retail delivery channel comprised of retail loan offices, affiliated business arrangements with builders and realtors, and a wholesale lending operation. The wholesale operation sources loans through relationships with unrelated mortgage brokers. The Mortgage Banking segment uses a variety of trademark names in its business activities. The Bank has taken action to protect such trademark names through registration where it deems appropriate. The Mortgage Banking segment is subject to changes in demand due to a variety of factors, including interest rates, home prices, general economic conditions and seasonal changes in purchases of new homes. At December 31, 2009, the total assets of the mortgage banking segment were $331.7 million, gross loans and leases were $320.2 million. The results of operations presented in our consolidated income statement for 2008 does not include any revenue or expenses from the Mortgage Banking segment as this segment was created through our acquisition of AHB on December 31, 2008.

        A summary of segment performance for 2009, 2008 and 2007 is presented in the section entitled "Segment Reporting" in the Notes to Consolidated Financial Statements included elsewhere in this report.

Competition

        The Bank's core service area consists primarily of greater Chester County, as well as the fringe of Delaware County, Pennsylvania. The core of the Bank's service area is located within a fifteen-mile radius of the Bank's main office in West Chester, Pennsylvania. As a result of the acquisition of AHB on December 31, 2008, the Bank's service area has been expanded to also include Lancaster and Cumberland Counties, Pennsylvania. In addition, the mortgage-banking activities of the Bank compete to originate residential mortgages nationally. The Bank encounters vigorous competition from bank holding companies, other community banks, thrift institutions, credit unions, Internet banks and other non-bank financial organizations such as mutual fund companies, brokerage firms, mortgage bankers and the

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financing arms of corporate conglomerates. The Bank also competes with banking and financial institutions, some from out of state that have opened branches in the Bank's market, which are substantially larger and have greater financial resources than the Bank.

        The Bank's Wealth Management division competes with a variety of companies including private trust companies, banks with trust departments, private money managers, brokerage firms, mutual fund companies, attorneys, accountants and insurance companies.

Supervision and Regulation

General

        We are a bank holding company and financial holding company subject to supervision and regulation by the Federal Reserve Board (the "Federal Reserve"). In addition, the Bank is subject to supervision, regulation and examination by the Office of the Comptroller of the Currency (the "OCC") and its deposits are insured by the Federal Deposit Insurance Corporation (the "FDIC"). The OCC must approve bank mergers, if the surviving bank would be a national bank, as well as the establishment of new branches and new subsidiaries. Federal and state laws also impose a number of requirements and restrictions on the operations of the Bank, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be made and the types of services which may be offered, restrictions on the ability to acquire deposits under certain circumstances, and requirements relating to the protection of consumers. The following sections discuss more fully some of the principal elements of the regulatory framework applicable to the Corporation and the Bank. This discussion is not intended to be an exhaustive description of the statutes and regulations applicable to the Corporation and the Bank and is subject to, and qualified by, reference to the statutory and regulatory provisions. A change in these statutes, regulations or regulatory policies, or the adoption of new statutes, regulations or regulatory policies, may have a material effect on our business.

Memorandum of Understanding

        On October 16, 2009, the Board of Directors of the Bank entered into a memorandum of understanding ("MOU") with the OCC. An MOU with regulatory authorities is an informal action that is not published or publicly available and that is used when circumstances warrant a milder form of action than a formal supervisory action, such as a formal written agreement or order. Among other things, under the MOU, the Bank has agreed to address the following matters:

•

Develop a comprehensive three-year capital plan;



•

Take action to address criticized assets and adopt and implement a program to eliminate the basis of criticism of such assets;



•

Establish an effective program that provides for early problem loan identification and a formal plan to proactively manage those assets;



•

Review the adequacy of the Bank's information technology activities and Bank Secrecy Act compliance and approve written programs of policies and procedures to provide for compliance; and



•

Establish a Compliance Committee of the Board to monitor and coordinate the Bank's adherence to the provisions of the MOU.

        The Board of Directors and management have already initiated numerous corrective actions to comply with the provisions of the MOU.

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Bank Holding Company Act

        We are required to file with the Federal Reserve an annual report, other periodic reports, and such additional information as the Federal Reserve may require pursuant to the BHC Act. The Federal Reserve also makes examinations of bank holding companies and their subsidiaries. The BHC Act requires each bank holding company to obtain the prior approval of the Federal Reserve before it may acquire substantially all of the assets of any bank, or if it would acquire or control more than 5% of the voting shares of such a bank. The Federal Reserve considers numerous factors, including its capital adequacy guidelines, before approving such acquisitions.

The Community Reinvestment Act

        The Community Reinvestment Act of 1977, as amended (the "CRA"), and the regulations promulgated to implement the CRA, are designed to create a system for bank regulatory agencies to evaluate a depository institution's record in meeting the credit needs of its community. The CRA regulations were completely revised in 1995 to establish performance-based standards for use in examining a depository institution's compliance with the CRA (the "revised CRA regulations"). The revised CRA regulations establish new tests for evaluating both small and large depository institutions' investment in the community. For the purposes of the revised CRA regulations, the Bank is deemed to be a large retail institution, based upon financial information as of December 31, 2009. In connection with its assessment of CRA performance, the FDIC assigns a rating of "outstanding," "satisfactory," "needs to improve," or "substantial noncompliance." The Bank has opted to be examined under a three-part test evaluating the Bank's lending, service and investment performance. The Bank received a "satisfactory" rating in its last CRA examination in March 2008.

Dividend Restrictions

        We are a legal entity separate and distinct from the Bank. Virtually all of our revenue available for payment of dividends on our common stock results from dividends paid to us by the Bank. All such dividends are subject to limitations imposed by federal and state laws and by regulations and policies adopted by federal and state regulatory agencies.

        The Bank, as a national bank, is required by federal law to obtain the approval of the OCC for the payment of dividends if the total of all dividends declared by the Board of Directors of the Bank in any calendar year will exceed the total of the Bank's net income for that year and the retained net income for the preceding two years, less any required transfers to surplus or a fund for the retirement of any preferred stock, subject to the further limitations that a national bank can pay dividends only to the extent that the Bank would not become "undercapitalized" (as defined under federal law). In 2009, the Bank declared and paid $1.4 million in dividends.

        During the fourth quarter of 2009, we received notice from the Federal Reserve that the Federal Reserve must approve any dividends to be paid by us in advance of the declaration or payment of the dividend.

        Dividends may further be restricted if, in the opinion of the applicable regulatory authority, a bank or bank holding company under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank or bank holding company, could include the payment of dividends), such regulatory authority may require such bank or bank holding company to cease and desist from such practice, or to limit dividends in the future. Finally, the several regulatory authorities described herein may, from time to time, establish guidelines, issue policy statements and adopt regulations with respect to the maintenance of appropriate levels of capital by a bank or bank holding company under their jurisdiction. Compliance with the standards set forth in such policy statements, guidelines and regulations could limit the amount of dividends which we and our Bank may pay.

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        For further information regarding our dividend policies and payments, see Item 5 of this report, "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."

Capital Requirements

        The Corporation and the Bank are both subject to minimum capital requirements and guidelines. Both the OCC and the Federal Reserve measure capital adequacy through a risk-based capital framework.

        The Federal Reserve's guidelines currently provide for a minimum total risk-based capital ratio of 8%, a minimum Tier 1 risk-based capital ratio of 4%, and a minimum ratio of Tier 1 capital to average total assets (leverage ratio) of 3% for bank holding companies that meet the Federal Reserve's highest regulatory ratings for bank holding companies and 4% for other bank holding companies. The principal objective of the leverage ratio measure is to constrain the degree to which a bank holding company can leverage its equity capital base. Bank holding companies with supervisory, financial, operational or managerial weaknesses at the holding company or bank level, as well as those anticipating or experiencing significant growth at either level, are expected to maintain capital ratios well above these regulatory minimums. In addition, higher capital ratios may be required of any bank holding company when the Federal Reserve determines that such higher ratios are warranted. The Federal Reserve has not advised us of any such higher ratios that would be applicable to the Corporation. Failure to satisfy regulators that a bank holding company will comply fully with capital adequacy guidelines upon consummation of an acquisition may impede the ability of a bank holding company to consummate such acquisition, particularly if the acquisition involves payment of consideration other than common stock. In many cases, the regulatory agencies will not approve acquisitions by bank holding companies and banks unless their capital ratios are well above regulatory minimums.

        A depository institution's capital category depends upon its capital levels in relation to the various regulatory capital measures. Under OCC regulations, a national bank is considered to be in the "well capitalized" category if it has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, and a leverage ratio of at least 5%, and if it is not subject to any formal regulatory action directing it to meet and maintain a specific capital level for any capital measure. The minimum ratio of total risk-based capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. National banks with capital ratios below those levels are placed in lower capital categories, and are subject to certain supervisory restrictions that become more severe as the bank's capital category declines. These lower capital categories are "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized." An institution may be placed in a lower capital category if it receives an unsatisfactory examination rating, is deemed to be in an unsafe or unsound condition, or engages in unsafe or unsound practices. Banks that are only "adequately capitalized" may not accept brokered deposits unless they receive a waiver from the FDIC, and banks that are "undercapitalized" and below may not accept brokered deposits at all.

        In November 2009, the Bank was advised that the OCC established higher minimum capital ratios for the Bank than the "well capitalized" ratios generally applicable to banks under current regulations. In the case of the Bank, the OCC established higher "individual minimum capital ratios" ("IMCRs") requiring a Tier 1 leverage ratio of at least eight percent (8%), a Tier 1 risk-based capital ratio of at least ten percent (10%) and a total risk-based capital ratio of at least twelve percent (12%) which the Bank was required to achieve by December 31, 2009. Our efforts to raise capital prior to the deadline ultimately resulted in the planned merger with Tower, which was announced on December 28, 2009. In addition, we elected to reduce and subsequently suspend our cash dividends on our common stock beginning with the third quarter of 2009. These actions were taken to conserve capital.

        On November 20, 2009, we entered into a loan agreement with Graystone for a non-revolving one year term loan in the principal amount of $4.0 million at an interest rate of 12%, in order to repay our

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$3.0 million of outstanding debt and for general corporate purposes. The loan is secured by a first priority security interest in all of the outstanding capital stock of the Bank. The loan agreement contains various covenants, limitations and events of default customary for loans of this type to similar borrowers, including limitations on indebtedness. The principal amount of the loan is due and payable upon the earlier of November 20, 2010, or our completion of a capital raising event resulting in proceeds sufficient to both repay the loan and enable the Bank to meet the IMCRs.

        For the purpose of satisfying the IMCRs, during December 2009, we entered into an amendment to our existing loan with Graystone, as described above, to recapitalize the Bank. As of December 31, 2009, we borrowed the full $26.0 million available under the credit facility, at an interest rate of 6%, which was contributed to the Bank as Tier 1 capital. Our regulatory capital ratios as of December 31, 2009 included total risk-based capital of 9.16%, Tier 1 risk-based capital of 7.79% and a Tier 1 leverage capital of 5.71%. The Bank's regulatory capital ratios as of December 31, 2009 included total risk-based capital of 11.74%, Tier 1 risk-based capital of 10.47% and a Tier 1 leverage capital of 7.68%. Additionally, Graystone purchased $52.5 million in first lien residential real estate and commercial loan participations at a 1.5% discount.

        As of December 31, 2009, the Bank met the IMCR threshold for Tier 1 risk-based capital, but was below the IMCR thresholds for Tier 1 leverage and total risk-based capital, and as of March 31, 2010, the Bank met the IMCR thresholds for Tier 1 risk-based capital and total risk-based capital, but was below the IMCR threshold for Tier 1 leverage. Further information relating to Corporation's and Bank's capital ratios can be found under the caption "Regulatory Matters" in the Notes to Consolidated Financial Statements included elsewhere in this report. The OCC may deem the Bank's noncompliance to be an unsafe and unsound banking practice which may subject the Bank to a capital directive, a consent order, or such other administrative actions or sanctions as the OCC considers necessary. It is uncertain what actions, if any, the OCC would take with respect to noncompliance with these ratios, what action steps the OCC might require the Bank to take to remedy this situation, and whether such actions would be successful.

Deposit Insurance Assessments

        The Bank is subject to deposit insurance assessments by the FDIC. The FDIC has developed a risk-based assessment system, under which the assessment rate for an insured depository institution varies according to its level of risk.

        In 2006, the Federal Deposit Insurance Reform Act of 2005 increased FDIC premiums for all commercial banks. This legislation provided a one-time assessment credit for each insured bank. The Bank's assessment credit offset $416 thousand of the insurance premium expense in 2007 and $66 thousand in 2008, and was fully utilized in the first quarter of 2008. The increased premium did not indicate any change in the FDIC risk assessment for the Bank. In 2008 and 2009, the FDIC adopted rules that increased FDIC premiums significantly for all banks for assessment periods beginning in the first quarter of 2009. In addition, the FDIC instituted a special assessment for all banks for the second quarter of 2009. FDIC Deposit Insurance expense for 2009 included approximately $673 thousand for this special assessment recorded in the second quarter of 2009. The increased premium as well as the special assessment caused the Bank's 2009 FDIC premiums and assessment expense to be significantly higher than 2008.

        FDIC insurance expense was $2.4 million, $490 thousand and $87 thousand for the years 2009, 2008 and 2007, respectively.

Financial Holding Company Status and Financial Subsidiary Status

        The Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act ("GLBA"), which became effective in 2000, eliminated many of the restrictions previously placed on the activities of banks and bank holding companies, allowing bank holding companies and national banks to

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participate in a wider array of financial activities, including certain activities that had previously been reserved only for insurance companies and securities firms. In addition, post-GLBA, a bank holding company can now affiliate with an insurance company and a securities firm. GLBA created two new types of entities: the "financial holding company" and the "financial subsidiary."

        Financial holding companies are bank holding companies that may engage in a wider variety of activities than those permissible for other bank holding companies. Financial holding companies may engage in any activity that is "financial in nature," as determined by the Federal Reserve. Activities that the Federal Reserve has so determined include underwriting insurance or annuities, and dealing in securities.

        In order for a bank holding company to qualify to become a financial holding company, all of the bank holding company's depository institution subsidiaries must be "well capitalized" and "well managed" as determined by the depository institutions' primary regulators. We elected to become a financial holding company on August 5, 2001.

        GLBA also allows national banks to use financial subsidiaries to engage in activities that are "financial in nature" that would otherwise not be permissible for the bank to engage in directly. In order to maintain financial subsidiaries, the national bank and all of its depository institution affiliates must be "well capitalized" and "well managed." During 2000, First National Financial Advisory Services was formed as a wholly-owned subsidiary of the Bank for the purpose of offering insurance, full service brokerage, financial planning and mutual fund services. The Bank has elected to operate First National Financial Advisory Services as a financial subsidiary under GLBA.

Control Acquisitions

        The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company, unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of ten percent or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as the Corporation, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company.

        In addition, as described above, under the BHC Act, the Federal Reserve Board must give its prior approval of any transaction pursuant to which any person or persons may acquire 25 percent (5 percent in the case of an acquirer that is a bank holding company) or more of any class of outstanding common stock of a bank holding company, such as the Corporation, or otherwise obtaining control or a "controlling influence" over that bank holding company.

The USA Patriot Act

        The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism of 2002 (the "USA Patriot Act") gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. Through amendments to the Bank Secrecy Act, the USA Patriot Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement agencies. Among other requirements, the USA Patriot Act requires banks to establish anti-money laundering policies, to adopt procedures and controls to detect and report money laundering, and to comply with certain enhanced recordkeeping obligations and due diligence standards with respect to correspondent accounts of foreign banks.

Other Matters

        Federal and state law also contains a wide variety of other provisions that affect the operations of the Corporation and the Bank, including, but not limited to, certain reporting and disclosure requirements;

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standards and guidelines for underwriting, account management and other aspects of lending activities; laws that prohibit discrimination; restrictions on establishing and closing branches; limitations on transactions with affiliates; restrictions on loans to insiders; and requirements relating to privacy and data security.

Effect of Governmental Policies

        The earnings of the Bank and, therefore, of us, are affected not only by domestic and foreign economic conditions, but also by the monetary and fiscal policies of the United States and its agencies (particularly the Federal Reserve Board), foreign governments and other official agencies. The Federal Reserve Board can and does implement national monetary policy, such as the curbing of inflation and combating of recession, by its open market operations in United States government securities, control of the discount rate applicable to borrowings from the Federal Reserve and the establishment of reserve requirements against deposits and certain liabilities of depository institutions. The actions of the Federal Reserve Board influence the level of loans, investments and deposits and also affect interest rates charged on loans or paid on deposits. The nature and impact of future changes in monetary and fiscal policies are not predictable.

        From time to time, various proposals are made in the United States Congress and the Pennsylvania legislature, and before various regulatory authorities, that would alter the powers of different types of banking organizations; remove restrictions on such organizations; and/or change the existing regulatory framework for banks, bank holding companies and other financial institutions. Recently, there have been numerous regulatory initiatives by the Congress, U.S. Department of the Treasury, FDIC, and the Federal Reserve Board to stabilize the financial markets. These governmental bodies continue to evaluate and develop programs designed, among other things, to stimulate the economy, restore confidence, and reverse or forestall declines in the housing markets. It is impossible to predict what the final form of any of such proposals will be and the impact, if any, of such adoption on the business of the Corporation.

Available Information

        Our filings with the SEC, including our annual report on Form 10-K, quarterly reports on Form 10-Q, periodic reports on Form 8-K, and amendments to these reports, as well as our proxy statements and additional solicitation materials, are accessible free of charge at our website at www.1nbank.com as soon as reasonably practicable after filing with the SEC. By making this reference to our website, we do not intend to incorporate into this report any information contained in the website. The website should not be considered part of this Report. You may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington D.C. 20549. You may obtain information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information free of charge regarding issuers, including the Corporation, that file electronically with the SEC.

Item 1A.    Risk Factors

         Our business faces many risks. If any of the events or circumstances described in the following risks actually occur, our business, financial condition or results of operations could suffer, and the trading price of our common stock could decline. Some of the risks described below may apply to more than just the subsection in which we grouped them for the purpose of this presentation. You should consider all of the following risks, together with all of the other information in this Annual Report on Form 10-K, before deciding to invest in our securities.

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Risks related to our business and industry

There is substantial doubt about our ability to continue as a going concern.

        Due to our financial results, failure to comply with the IMCR as of December 31, 2009, the substantial uncertainty throughout the U.S. banking industry and other matters discussed in this report, there is substantial doubt about our ability to continue as a going concern. Continued operations depend on our ability to comply with the terms of the MOU, the IMCRs and the closing of the pending merger with Tower. As of December 31, 2009, we met the IMCR threshold for Tier 1 risk-based capital, but were below the IMCR thresholds for Tier 1 leverage and total risk-based capital. Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future. Our consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. If we are unable to continue as a going concern, you could lose some, if not all, of your investment. In addition, our customers, employees, vendors, correspondent institutions, and others with whom we do business may react negatively to the substantial doubt about our ability to continue as a going concern. This negative reaction may lead to heightened concerns regarding our financial condition that could result in a significant loss in deposits and customer relationships, key employees, vendor relationships and our ability to do business with correspondent institutions upon which we rely.

We presently are subject to, and in the future may become subject to, regulatory enforcement actions that could have a material adverse effect on our business, operations, financial condition, results of operations or the value of our common stock.

        Under federal and state laws and regulations pertaining to the safety and soundness of insured depository institutions, various state regulators (for state chartered banks), the Federal Reserve (for bank holding companies), the Office of the Comptroller of the Currency (for national banks) and separately the Federal Deposit Insurance Corporation ("FDIC") as the insurer of bank deposits, have the authority to compel or restrict certain actions on our part if they determine that we have insufficient capital or are otherwise operating in a manner that may be deemed to be inconsistent with safe and sound banking practices or violate any law or regulation. Under this authority, our bank regulators can require us to enter into informal or formal enforcement orders, including board resolutions, memoranda of understanding, written agreements and consent or cease and desist orders, pursuant to which we would be required to take identified corrective actions to address cited concerns and to refrain from taking certain actions. The regulators could also assess civil money penalties ("CMPs") against us.

        In October 2009, the members of the Board of Directors of the Bank entered into an MOU with the OCC to address certain issues that arose in the Bank's most recent regulatory examination. The issues required to be addressed by management include, among other matters, to take action to address criticized assets, to establish an effective problem loan identification program for early identification of emerging and potential problems, to review and improve the information technology activities and Bank Secrecy Act practices. In November 2009, the OCC also imposed IMCRs requiring the Bank to increase its Tier 1 leverage capital ratio to not less than 8%, its Tier 1 risk-based capital ratio to not less than 10% and its total risk-based capital ratio to not less than 12% by December 31, 2009.

        If we are unable to comply with the terms of the MOU, unable to meet and maintain the IMCRs, or unable to comply with the terms of any future regulatory orders to which we may become subject, then we could become subject to additional, heightened supervisory actions and orders, possibly including cease and desist orders, CMPs, prompt corrective action and/or other regulatory enforcement actions. If our regulators were to take such additional supervisory actions, then we could, among other things, become subject to significant restrictions on our ability to develop any new business, as well as restrictions on our existing business. The terms of any such supervisory action could have a material adverse effect on our business, operating flexibility, financial condition and the value of our common stock.

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We are required to maintain minimum capital to meet regulatory requirements, and if we fail to maintain sufficient capital, we may be subject to further enforcement actions.

        Both we and the Bank must meet regulatory capital requirements and maintain sufficient liquidity. As described above, the OCC recently imposed IMCRs requiring that the Bank achieve a Tier 1 leverage ratio of not less than 8%, a Tier 1 risk-based capital ratio of not less than 10%, and a total risk-based capital ratio of not less than 12% by December 31, 2009, which are higher than the minimum and "well capitalized" capital ratios applicable to banks generally. As of December 31, 2009, the Bank met the IMCR threshold for Tier 1 risk-based capital, but was below the IMCR thresholds for Tier 1 leverage and total risk-based capital, and as of March 31, 2010, the Bank met the IMCR thresholds for Tier 1 risk-based capital and total risk-based capital, but was below the IMCR threshold for Tier 1 leverage. The OCC may deem the Bank's noncompliance to be an unsafe and unsound banking practice which may subject the Bank to a capital directive, a consent order, or such other administrative actions or sanctions as the OCC considers necessary. It is uncertain what actions, if any, the OCC would take with respect to noncompliance with these ratios, what action steps the OCC might require the Bank to take to remedy this situation, and whether such actions would be successful.

Our ability to pay dividends is subject to limitations.

        We are a bank holding company and our operations are conducted by direct and indirect subsidiaries, each of which is a separate and distinct legal entity. Substantially all of our assets are held by our direct and indirect subsidiaries.

        Our ability to pay dividends depends on our receipt of dividends from our direct and indirect subsidiaries. The Bank, our principal banking subsidiary, is our primary source of dividends. Dividend payments from banking subsidiaries are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of banking subsidiaries to pay dividends is also subject to their profitability, financial condition, capital expenditures and other cash flow requirements. Further, payment of dividends by the Bank is limited by our MOU with the OCC. Under the MOU, the Bank is required to request supervisory approval to dividend any funds to us. There is no assurance that the Bank will be able to pay dividends in the future or that we will generate adequate cash flow to pay dividends in the future. Additionally, in efforts to preserve capital, we reduced our dividend per share of common stock during the fourth quarter of 2009, and further eliminated the payment of cash dividends beginning in the first quarter of 2010. Our failure to pay dividends on our common stock could have a material adverse effect on the market price of our common stock. More generally, in the event the Bank is unable to pay dividends to us, we may not be able to service our debt, pay our obligations or pay dividends on our common stock.

Our disclosure controls and procedures and internal control over financial reporting were not effective as of December 31, 2009, and may not be effective in future periods, as a result of newly identified material weaknesses in internal controls.

        Effective internal control over financial reporting is necessary for compliance with the Sarbanes-Oxley Act of 2002 and appropriate financial reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process, under the supervision of our Chief Executive Officer and Chief Financial Officer, designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America ("GAAP"). As disclosed in this report, management's assessment of our internal control over financial reporting identified material weaknesses as discussed in Item 9A. Controls and Procedures . A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Corporation's annual or interim financial statements will not be prevented or detected

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on a timely basis. See Item 9A. Controls and Procedures of this report for remediation status of the material weaknesses identified. However, there can be no assurance that additional material weaknesses will not be identified in the future or that our remediation measures will be effective in mitigation or preventing these specific material weaknesses. As we continue to evaluate and improve our internal control over financial reporting, we may determine to take additional measures to address internal control deficiencies or determine to modify certain of the remediation measures described herein. We may continue to be at an increased risk that our financial statements could contain errors that will be undetected, and we may continue to incur significant expense and management burdens associated with the additional procedures required to prepare our consolidated financial statements.

Our failure to timely file periodic reports with the SEC could result in the delisting of our common stock from the Nasdaq Capital Market.

        If we are unable to maintain compliance with the conditions for continued listing required by Nasdaq, then our shares of common stock may be subject to delisting from the Nasdaq Capital Market. For example, as a result of our failure to timely file with the SEC our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 and our Quarterly Report on Form 10-Q for the period ended March 31, 2010, we were not in full compliance with Nasdaq Marketplace Rule 5250(c)(1), which requires us to make, on a timely basis, all filings with the SEC required by the Securities Exchange Act of 1934. On June 1, 2010, we provided Nasdaq with a plan to regain compliance with the continued listing requirements. On June 10, 2010, Nasdaq granted us the 180 day exception period, or until September 13, 2010, to file all outstanding reports and regain compliance. If our shares of common stock are delisted from the Nasdaq Capital Market, our common stock may not be eligible to trade on any national securities exchange. If our common stock is no longer traded through a market system, the liquidity of our common stock may be greatly reduced, which could negatively affect its price. A delisting from the Nasdaq Capital Market may also have other negative implications, including the potential loss of confidence by customers and employees, the loss of institutional investor interest, and fewer business development opportunities.

The current turmoil in the financial markets may lead to an increased levels of regulation, loan delinquencies, and problem loans, and a reduction of business activity generally.

        We are presently operating in a period of unprecedented economic change and uncertainty. From the second half of 2008 and continuing through the present, the United States has been in a recession with falling home prices and increasing unemployment and underemployment. The U.S. government acted to stabilize the financial markets and to stimulate the economy by enacting legislation of unprecedented proportions. Congress and the U.S. government continue to evaluate and develop programs designed, among other things, to reverse the economic downturn, restore confidence, reverse or forestall declines in the housing markets. It is impossible to predict what the final form of any of such proposals will be and the impact of the adoption of new regulation will be on our business. There can be no assurance as to the impact that any such initiatives or governmental programs will have on the financial markets. In addition, compliance with additional regulation may increase our costs of doing business or impede the efficiency of our internal business processes. The resulting turmoil, uncertainty, regulation and lack of consumer confidence may adversely affect our business, financial condition, results of operations and trading price of our common stock.

Adverse changes in the economic conditions in our market area could materially and negatively affect our business.

        Substantially all of our business is with consumers and small to mid-sized companies located within Chester and Delaware Counties, Pennsylvania, although our mortgage-banking operations involve originations of mortgages nationwide. Our business is directly affected by factors such as economic, political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government monetary and fiscal policies and inflation, all of which are beyond our control.

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A deterioration in economic conditions, whether caused by national, regional or local concerns, including an economic slowdown in southeastern Pennsylvania, could result in the following consequences, any of which could materially harm our business and operating results:

•

the credit quality of our customers may deteriorate;



•

loan delinquencies and losses may increase;



•

problem assets and foreclosures may increase;



•

fluctuations in the value of, or impairment losses with respect to, investment securities;



•

need to increase our allowance for loan and lease losses;



•

demand for our products and services may decrease;



•

competition for low cost or non-interest bearing deposits may increase; and



•

collateral securing loans may decline in value.

Competitive pressures from banks, financial services companies and other companies offering banking services could negatively impact our business.

        We conduct banking operations primarily in southeastern Pennsylvania. Increased competition in our market area may result in reduced loans and deposits, a decline in loan growth and/or loan margins, high customer turnover, and lower interest rate margins. We may not be able to compete successfully against current and future competitors. Many competitors in our market area, including national banks, regional banks and other community banks, offer the same banking services as we offer. We also face competition from many other types of financial institutions, including without limitation, savings and loan institutions, finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. These competitors often have greater resources than we do, affording them competitive advantages, including the ability to maintain numerous banking locations and ATMs and conduct extensive promotional and advertising campaigns.

Changes in interest rates could reduce our net interest margin and net interest income.

        Our income and cash flows and the value of our assets and liabilities depend to a great extent on the difference between the interest rates earned on interest-earning assets such as loans and investment securities, and the interest rates paid on interest-bearing liabilities such as deposits and borrowings. These interest rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, will influence the origination and market value of loans and investment securities and the amounts paid on deposits. If we are unable to timely adjust our interest rates on our loans and deposits in response to any such changes in monetary policy, our earnings could be adversely affected. If the rate of interest we pay on our deposits, borrowings, and other interest-bearing liabilities increases faster than the rate of interest we earn on our loans, investments and other interest-earning assets, our net interest income, and therefore our earnings will decrease. Conversely, our earnings could also be adversely affected if the interest rates on our loans or other investments decline more quickly than those on our deposits and other borrowings.

Significant increases in interest rates may affect customer loan demand and payment habits.

        Significant increases in market interest rates, or the perception that an increase may occur, could adversely impact our ability to generate new variable interest rate loans. An increase in market interest rates may also adversely affect the ability of adjustable rate borrowers to meet repayment obligations, thereby causing non-performing loans and loan charge-offs to increase.

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If our allowance for loan and lease losses is not adequate to cover actual or estimated future loan and lease losses, our earnings may decline.

        We maintain an allowance for loan and lease losses to provide for loan defaults and non-performance by borrowers of their obligations. Our allowance for loan and lease losses may not be adequate to cover actual or estimated future loan and lease losses and future provisions for loan and lease losses could materially and adversely affect our operating results. Our allowance for loan and lease losses is based on prior experience, as well as an evaluation of risks in the current portfolio. However, losses may exceed our current estimates. The amount of future losses is susceptible to changes in economic, operating and other conditions that may be beyond our control, including changes in interest rates, changes in borrowers' creditworthiness and the value of collateral securing loans and leases. Additionally, as our loan and lease portfolios grow, we may need to take additional provision expense to ensure that the allowance remains at levels deemed appropriate by Management for the size and quality of portfolio. Federal regulatory agencies review our loans and allowance for loan and lease losses and may require us to increase our allowance. While we believe that our allowance for loan and lease losses is adequate to cover our anticipated losses, we cannot be certain that that will be the case or that we will not further increase the allowance for loan and lease losses or that regulators will not require us to increase the allowance. Either of these occurrences could materially affect our earnings.

Disruptions in the secondary market for residential mortgage loans may continue to adversely affect the AHB division of the Bank.

        Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for and liquidity of many mortgage loans. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held by the Bank, mortgage loan originations and profits on sale of mortgage loans, or adversely affecting customers' ability to repay their loans. Declining real estate prices and higher interest rates have caused higher delinquencies and losses on certain mortgage loans. These trends could continue. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of job losses, interest rate resets on adjustable rate mortgage loans or other factors could have further adverse effects on borrowers that result in higher delinquencies, greater charge-offs, and increased demands for repurchases, indemnification claims or litigation in future periods, which could adversely affect the Bank's financial condition or results of operations.

Secondary market investors could suspend or terminate their master purchase agreements or correspondent loan purchase agreements with the Bank as a result of breaches of representations, warranties or covenants, which could harm liquidity, financial condition and regulatory compliance.

        Through its AHB division, the Bank sells residential mortgage loans to various secondary market investors under master purchase agreements or correspondent loan purchase agreements. Among other things, each master purchase or correspondent loan agreement requires that we file audited financial statements no later than 90 days from the end of our fiscal year, and that we maintain compliance with all regulatory requirements. Certain investors require that our financial statements include an unqualified audit opinion. In the event we breach these or certain other representations, warranties or covenants, the investor has the ability to suspend or terminate the master purchase or correspondent loan agreement. A suspension or termination could expose the Bank to interest rate and liquidity risk, and also limit the Bank's ability to manage its balance sheet size and maintain compliance with regulatory capital guidelines.

        We are currently in default under these agreements due to our failure to file our audited financial statements within the specified timeframe, our failure to satisfy the IMCRs, and in certain cases the inclusion of a "going concern" explanatory paragraph in the auditors' report regarding the consolidated financial statements included in this report. To date, two of our investors under these agreements have

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terminated their correspondent purchase agreements. Additionally, other investors, to whom we sell nearly 88% of AHB's loan production, have verbally indicated that although we are in breach of the above mentioned requirements, they will forebear the defaults for a unspecified period of time.

The Bank could be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, borrower fraud, or certain borrower defaults, which could harm liquidity, results of operations and financial condition.

        When we sell mortgage loans, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to the purchasers about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. Likewise, we are required to repurchase or substitute mortgage loans if we breach a representation or warranty in connection with a securitization. The remedies available to us against the originating broker or correspondent may not be as broad as the remedies available to a purchaser of mortgage loans against us, and we face the further risk that the originating broker or correspondent may not have the financial capacity to perform remedies that otherwise may be available to us. Therefore, if a purchaser enforces its remedies, we may not be able to recover our losses from the originating broker or correspondent. If repurchase and indemnity demands increase, our liquidity, results of operations and financial condition will be adversely affected.

The AHB division's dependence on certain relationships, such as with Freddie Mac, could adversely affect the mortgage-banking business.

        The secondary mortgage markets are currently experiencing unprecedented disruptions resulting from reduced investor demand for mortgage loans and mortgage-backed securities and increased investor yield requirements for those loans and securities. In addition, we have a substantial relationship with Freddie Mac, including loan sales that are material to our mortgage banking business. A significant portion of the conventional loans that we originate or purchase qualify for inclusion in guaranteed mortgage securities backed by Freddie Mac. A substantial reduction in the volume of loans that Freddie Mac agrees to purchase or the loss of other material financial benefits we receive from Freddie Mac could have a material adverse effect on our results of operation and financial condition. As a government-sponsored enterprise, Freddie Mac is subject to extensive regulation and oversight by governmental agencies. On September 7, 2008, Freddie Mac was placed under the conservatorship of the Federal Housing Finance Agency, Freddie Mac's principal regulator. Substantial changes in Freddie Mac's business and operations are anticipated to occur as a result of such event. This event, together with changes in regulations or the occurrence of other events that adversely impact the business, operations or prospects of Freddie Mac could have a material adverse effect on our mortgage-banking business, operations or prospects.

The scope of our residential mortgage loan production exposes us to risks of noncompliance with a large body of complex laws and regulations at the federal, state and local levels in the United States.

        Because we are authorized to originate, purchase and service mortgage loans in all 50 states, we must comply with the laws and regulations, as well as judicial and administrative decisions, for all of these jurisdictions, in addition to an extensive body of federal law and regulations. The volume of new or modified laws and regulations has increased in recent years, and individual cities and counties in the United States have begun to enact laws that restrict certain loan origination, acquisition and servicing activities in those cities and counties.

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        Our failure to comply with these laws can lead to:

•

civil and criminal liability:



•

loss of licenses and approvals;



•

damage to our reputation in the industry;



•

inability to sell or securitize our loans, or otherwise raise capital;



•

demands for indemnification or loan repurchases from purchasers of our loans;



•

fines and penalties and litigation, including class action lawsuits;



•

administrative enforcement actions;



•

additional regulatory burdens, restrictions, or other changes to our business model;



•

claims that an allegedly non-compliant loan is rescindable or unenforceable; and



•

damage to the reputation of the AHB division, any of which could have a material adverse effect on AHB's business, operations or prospects.

Our mortgage-banking operations rely on other companies to provide key components of its business infrastructure.

        Third parties provide key components of our mortgage-banking business infrastructure, such as banking services, processing, and Internet connections and network access. Any disruption in such services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect our ability to deliver products and services to clients and otherwise to conduct business. Technological or financial difficulties of a third party service provider could adversely affect our business to the extent those difficulties result in the interruption or discontinuation of services provided by that party. We may not be insured against all types of losses as a result of third party failures, and our insurance coverage may be inadequate to cover all losses resulting from system failures or other disruptions. Failures in our mortgage-banking infrastructure could interrupt the operations or increase the costs of doing business.

Significant legal actions could subject us to substantial liabilities or litigation costs.

        The Bank, through the AHB division, is currently involved in various claims and legal actions related to its operations. In general, such matters are believed to be ordinary routine litigation incidental to the conduct of business. Nonetheless, the costs to pursue and defend these legal matters may be significant, and if the claims were determined against the Bank, could adversely affect the results of operations, financial condition, reputation and prospects of the Bank.

The use of correspondents, brokers and other third parties to originate loans outside of its market area subjects our mortgage banking operations to certain risks.

        We utilize mortgage correspondents and brokers to originate mortgage loans, including construction/permanent loans, beyond our local market area. This use of correspondents and brokers may increase the risk of fraudulent representations of a borrower's creditworthiness. We also utilize independent licensed appraisers and inspectors to appraise and inspect properties and work progress on construction/permanent loans, but our employees may not be present in many of these markets. Thus, we rely on the professional opinions and photographic evidence provided by appraisers and inspectors to authorize periodic advances in accordance with applicable loan documents. This reliance may increase the risk of errors or fraud regarding the approval of loans and the making of loan advances.

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Our mortgage-banking operations face prepayment risk from loans sold for which servicing is retained.

        Mortgage loans sold, for which servicing is retained, are subject to prepayment risk. Financial Accounting Board Standards ("FASB") Accounting Standard Code ("ASC") 948 Financial Services—Mortgage Banking requires capitalization of the fair value of originated mortgage servicing rights. If mortgages are repaid faster than the estimated rate used in capitalizing the mortgage servicing rights, the fair value of the mortgage servicing rights would decrease and be reflected as a charge against earnings. Our focus on residential mortgage lending could cause the risk of loss from mortgage prepayments to be material.

Adverse changes in the market value of securities and investments that we manage for others may negatively impact the growth level of our non-interest income.

        We provide a broad range of trust and investment management services for estates, trusts, agency accounts, and individual and employer sponsored retirement plans. Fees for such services are typically based upon a percentage of the market value of such funds under management. The market value of such securities and investments may decline for a variety of factors, many of which are outside our control. Any such adverse changes in the market value of the securities and investments could negatively impact our non-interest income generated from providing these services.

Our branch locations may be negatively affected by changes in regional and local demographics.

        We have strategically selected locations for our branches based upon regional and local demographics. Any unanticipated changes in such demographics may impact our ability to reach or maintain profitability at our branch locations. Changes in regional and local demographics may also affect the relative benefits of certain branch locations and management may be required to reduce the number and/or locations of our branches, which may result in unanticipated expenses.

Changes in the regulatory environment may adversely affect our business or the ability of the Bank to pay dividends to the Corporation.

        The banking industry is highly regulated and we are subject to extensive state and federal regulation, supervision, and legislation. We are subject to regulation and supervision by the Board of Governors of the Federal Reserve System, the OCC, the FDIC and the SEC. Laws restricting our activities include, but are not limited to, the Gramm-Leach-Bliley Act, the Bank Secrecy Act, the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Bank Holding Company Act, the Community Reinvestment Act, the USA Patriot Act and the Real Estate Settlement Procedures Act. These laws may change from time to time, and new laws may be enacted, any of which may limit our ability to offer new products and services, obtain financing, attract deposits, and originate loans. Any changes to these laws may adversely affect loan demand, credit quality, consumer spending and saving habits, interest rate margins, FDIC assessments, and operating expenses, thus negatively affecting our results of operations and financial condition. In addition, if the Bank is restricted in its ability to pay dividends to the Corporation, the Corporation's ability to pay dividends to its shareholders or to meet its financial obligations may be impaired.

Technology costs, new product development, and marketing costs may exceed our expectations and negatively impact our profitability.

        The financial services industry is constantly undergoing technological changes in the types of products and services provided to customers to enhance customer convenience. Our future success will depend upon our ability to address the changing technological needs of our customers. We have invested a substantial amount of resources to update our technology. Our investment in such technology seeks to increase overall efficiency and improve accessibility to customers. We are also investing in the expansion of bank branches,

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improvement of operating systems, and the development of new marketing initiatives. The benefits of such investments may not be achieved as quickly as anticipated, or at all. The costs of implementing technological changes, new product development, and marketing costs may exceed our expectations and negatively impact our results of operations and profitability.

Changes to financial accounting standards may affect our reported results of operations.

        We prepare our financial statements in accordance with GAAP. GAAP is subject to the rules and interpretations of the SEC and various bodies formed to interpret and create appropriate accounting policies. A change in those policies can have a significant effect on our reported results and may even affect our reporting of transactions completed before a change is announced. Accounting rules affecting many aspects of our business, including rules relating to accounting for business combinations, asset impairment, revenue recognition, restructuring or disposal of long-lived assets and stock option grants have recently been revised or are currently under review. Changes to those rules or current interpretation of those rules may have a material adverse effect on our reported financial results or on the way we conduct our business.

Our common stock is thinly traded.

        Our common stock is traded on the Nasdaq Capital Market under the symbol "FCEC." Our common stock is thinly traded compared to larger, more widely known companies in the banking industry. There can be no assurance that a more active trading market for our common stock will develop. As a result, our shareholders may be unable to sell large blocks of our common stock in short time periods or the market price per share may be reduced.

Risks related to the merger with Tower

Termination of the merger agreement could negatively impact the Corporation.

        Tower may terminate the merger agreement for the reasons set forth in the merger agreement, including if the merger has not been consummated on or before September 30, 2010. If the merger agreement is terminated, there may be various consequences including:

•

Our business may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger; and



•

the market price of our common stock might decline to the extent that the current market price reflects a market assumption that the merger will be completed.

        If the merger agreement is terminated and our board of directors seeks another merger or business combination, our shareholders cannot be certain that we will be able to find a party willing to pay an equivalent or more attractive price than the price Tower has agreed to pay in the merger.

If the merger agreement is terminated, certain transactions between Tower and the Corporation designed to alleviate regulatory pressure on the Bank may not have their intended results.

        In November 2009, the OCC imposed IMCRs on the Bank, requiring it to increase its regulatory capital ratios. In efforts to assist the Bank in achieving and maintaining capital ratios consistent with the IMCR pending completion of the merger, and to address the OCC's supervisory concerns, in the fourth quarter of 2009, Tower loaned us $26 million, the proceeds of which were contributed to the Bank as Tier-1 capital. The loan is secured by a pledge of all of the stock of the Bank. The termination of the merger agreement will constitute an event of default and Graystone may declare the loan immediately due and payable.

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        If we cannot repay the loan by its due date, Tower could foreclose on the stock of the Bank under the pledge security agreement. There can be no assurance that we will be able to raise funds sufficient to repay the loan from Tower if the merger agreement is terminated.

Our shareholders cannot be certain of the amount of nor the market value of the merger consideration they will receive because the market price of Tower common stock will fluctuate and the exchange ratio is subject to adjustment in the event that First Chester delinquent loans are less than or equal to $35 million or exceed $55 million.

        Upon completion of the merger, each share of our common stock will be converted into merger consideration consisting of a number of shares of Tower common stock equal to the exchange ratio, which was 0.453 at the time of the signing of the merger agreement. The exchange ratio of 0.453 shares is subject to adjustment, as described in the merger agreement, in the event that certain of our delinquent loans are less than or equal to $35 million or exceed $55 million as of the month end prior to the closing date of the merger. Depending on the amount of our delinquent loans as of such date, the exchange ratio may be reduced to a minimum of 0.237 shares of Tower common stock. However, in the event that our delinquent loans do not exceed $35 million as of the applicable date, the merger agreement provides for an upward adjustment to the exchange ratio from 0.453 to 0.464 shares of Tower common stock.

        In addition, the market value of the merger consideration may vary from the closing price of Tower common stock on the date we announced the merger, on the date of the meetings of Tower and Corporation's shareholders and on the date we complete the merger and thereafter. Any change in the exchange ratio or the market price of Tower common stock prior to completion of the merger will affect the amount of and the market value of the merger consideration that our shareholders will receive upon completion of the merger. Accordingly, at the time of the shareholders meetings, Tower and the Corporation's shareholders will not know or be able to calculate with certainty the amount nor the market value of the merger consideration that would be paid by Tower to our shareholders upon completion of the merger. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in respective businesses, operations and prospects, and regulatory considerations.

The opinion obtained by us from our financial advisor will not reflect changes in circumstances between signing the merger agreement and completion of the merger.

        We have not obtained an updated opinion as of the date of this Form 10-K from our financial advisor as to the fairness from a financial point of view, of the merger consideration. Changes in the operations and prospects of the Corporation or Tower, general market and economic conditions and other factors that may be beyond the control of us or Tower, and on which our financial advisor's opinion was based, may significantly alter the value of the Corporation or the prices of shares of Tower common stock or our common stock by the time the merger is completed. The opinion does not speak as of the time the merger will be completed or as of any date other than the date of such opinion. Because we do not currently anticipate asking our financial advisor to update its opinion, the opinion will not address the fairness of the merger consideration from a financial point of view at the time the merger is completed.

Regulatory approvals for the merger may expire prior to the closing of the merger.

        As of June 30, 2010, all regulatory approvals have been received from the bank regulators. However, certain of these approvals contain expiration dates such that extensions may need to be obtained if the merger is not closed prior to the end of the third quarter of 2010. Although we do not anticipate any problems with requesting and obtaining such extensions, there can be no assurance as to whether the extensions will be received, the timing of those extensions, or whether any conditions will be imposed.

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Tower may fail to realize the anticipated benefits of the merger.

        The success of the merger will depend on, among other things, Tower's ability to realize anticipated cost savings and to combine the businesses in a manner that permits growth opportunities and does not materially disrupt the existing customer relationships of the Bank nor result in decreased revenues resulting from any loss of customers. If Tower is not able to successfully achieve these objectives, the anticipated benefits of the merger may not be realized fully or at all or may take longer to realize than expected.

        Both companies have operated and, until the completion of the merger, will continue to operate, independently. Certain of our employees will not be employed by Tower after the merger. In addition, certain of our employees that Tower wishes to retain may elect to terminate their employment as a result of the merger which could delay or disrupt the integration process. It is possible that the integration process could result in the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the ability of Tower to maintain relationships with customers and employees or to achieve the anticipated benefits of the merger.

Our shareholders will have a reduced ownership and voting interest after the merger and will exercise less influence over management.

        Our shareholders currently have the right to vote in the election of our board of directors and on other matters affecting the Corporation. When the merger occurs, each shareholder that receives shares of Tower common stock will become a shareholder of Tower with a percentage ownership of the combined organization that is much smaller than their current ownership in the Corporation. Because of this, our shareholders will have less influence on the management and policies of Tower than they now have on our management and policies.

The merger agreement limits our ability to pursue alternatives to the merger and raise capital.

        The merger agreement contains no-shop provisions that, subject to limited exceptions, limits our ability to discuss, facilitate or commit to competing third-party proposals. In addition, we have agreed to pay Tower a termination fee in the amount of $3.5 million in the event that we terminate the merger agreement for certain reasons. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of us from considering or proposing that acquisition even if it were prepared to pay consideration with a higher per share market price than that proposed in the merger, or might result in a potential competing acquirors proposing to pay a lower per share price to acquire us than it might otherwise have proposed to pay. We can consider and participate in discussions and negotiations with respect to an alternative proposal so long as our board of directors determines in good faith (after consultation with legal counsel) that failure to do so would be reasonably likely to result in a violation of its fiduciary duties to our shareholders under applicable law.

The merger is subject to closing conditions, that, if not satisfied or waived, will result in the merger not being completed, which may result in material adverse consequences to our business and operations.

        The merger is subject to closing conditions that, if not satisfied, will prevent the merger from being completed. In addition to the required approvals and consents from governmental agencies, the merger is subject to other conditions beyond Tower's and the Corporation's control which may prevent, delay or otherwise materially adversely affect its completion. We cannot predict whether and when these other conditions will be satisfied.

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The shares of Tower common stock to be received by our shareholders as a result of the merger will have different rights from the shares of our common stock.

        Upon completion of the merger, our shareholders will become Tower shareholders and their rights as shareholders will be governed by the certificate of incorporation and bylaws of Tower. The rights associated with our common stock are different from the rights associated with Tower common stock.

Item 1B.    Unresolved Staff Comments .

        None.

Item 2.    Properties .

        The Bank owns eight properties that are not subject to any mortgages. In addition, we lease the Westtown-Thornbury, Exton, Frazer, Kendal at Longwood, Crosslands, Lima Estates, Granite Farms Estates, Hershey's Mill, Bradford Plaza, Freedom Village, Oxford, Jennersville, Phoenixville, Royersford, Longwood (land lease), Downingtown, Mountville, Carlisle, Operations Center and other properties that the Bank utilizes for loan processing operations. Our management believes the Corporation's and the Bank's facilities are suitable and adequate for their respective present needs. Set forth below is a listing of the primary banking offices presently operated by the Bank. Management routinely evaluates all of the properties for ongoing use.

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*

Indicates properties owned by the Bank

**

The Longwood Branch land is leased. The building is owned by the Bank.

Item 3.    Legal Proceedings.

        There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which we, or any of our subsidiaries, are a party or of which any of their respective property is the subject. The Corporation and the Bank are not parties to any legal proceedings under federal and state environmental laws.

Item 4.    Removed and Reserved.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

        Our common stock began trading on the Nasdaq Capital Market under the symbol "FCEC" on October 23, 2009. Prior to the listing on the Nasdaq Capital Market, our common stock traded on the Over-the-Counter Bulletin Board, a Nasdaq sponsored and operated inter-dealer quotation system for equity securities. As of July 9, 2010, we had 6,320,556 shares of common stock issued and outstanding, and held by approximately 950 shareholders of record.

        The following table sets forth the high and low sales price for our common stock during the periods indicated.

        We declared cash dividends per share on our common stock during each quarter of the fiscal years ended December 31, 2009 and 2008, as set forth in the following table:

        The holders of our common stock are entitled to receive such dividends as may be legally declared by our Board of Directors. We have historically paid dividends to our shareholders on a quarterly basis. Dividends from the Bank historically have been our primary source of funds to pay dividends on our common stock. Generally, under the National Bank Act, national banks may in any calendar year, without the approval of the OCC, pay dividends to the extent of net profits for that year, plus retained net profits for the preceding two years (less any required transfers to surplus). In connection with the MOU, the Bank cannot pay us any dividends without prior OCC approval, and in all events must maintain appropriate capital that meets the Bank's increased regulatory requirements.

        During the fourth quarter of 2009, we received notice from the Federal Reserve, our primary regulator, that the Federal Reserve must approve any dividends to be paid by us in advance of the declaration or payment of the dividend. In efforts to preserve capital, we reduced our dividend per share of our common stock to $0.02 in the fourth quarter and during the first quarter of 2010, we announced that we will not be paying any dividends prior to the completion of the proposed merger.

        For further information regarding dividend restrictions, see Item 1 of this Report, "Supervision and Regulation—Dividend Restrictions."

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Issuer Purchases of Equity Securities

Stock Price Performance Graph

        The following graph illustrates a five year comparison of cumulative shareholder return on our common stock as compared to the Nasdaq Composite, the SNL $500 Million to $1 Billion Bank Index, and the SNL $1 Billion to $5 Billion Bank Index for the years ended December 31, 2004, 2005, 2006, 2007, 2008 and 2009. In accordance with SEC regulations, the following graph presents both SNL indices for the five year period.

Total Return Performance

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Item 6.    Selected Financial Data

Statements of Condition

Statements of Operations

Per Share Data (2)

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