- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended June 30, 2010

Commission File Number: 0-20050

PRINCETON NATIONAL BANCORP, INC.

(Exact name of Registrant as specified in its charter.)

Delaware	36-3210283
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

606 S. Main St. Princeton, Illinois	61356
(Address of principal executive offices)	(Zip code)

(815) 875-4444

(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 R 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 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 the definitions of “large accelerated filer,” “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 R

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

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

Class	Outstanding at July 29, 2010
Common, par value $5.00	3,313,003

Part I: FINANCIAL INFORMATION

The unaudited consolidated financial statements of Princeton National Bancorp, Inc. and Subsidiary and management’s discussion and analysis of financial condition and results of operation are presented in the schedules as follows:

Schedule 1:	Consolidated Balance Sheets
Schedule 2:	Consolidated Statements of Income
Schedule 3:	Consolidated Statements of Stockholders’ Equity
Schedule 4:	Consolidated Statements of Cash Flows
Schedule 5:	Notes to Consolidated Financial Statements
Schedule 6:	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Schedule 7:	Controls and Procedures

Part II: OTHER INFORMATION

Item 1A. Risk Factors

Smaller reporting companies are not required to provide the information required by this item.

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

(a) None.

Item 4. Reserved.

Item 6. Exhibits

31.1	Certification of Chief Executive Officer required by Rule 13a-14(a).
31.2	Certification of Chief Financial Officer required by Rule 13a-14(a).
32.1	Certification of Chief Executive Officer and Chief Financial Officer required by Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.

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.

PRINCETON NATIONAL BANCORP, INC .

By	/s/ Thomas D. Ogaard	By	/s/ Todd D. Fanning

	Thomas D. Ogaard President & Chief Executive Officer July 29 , 2010		Todd D. Fanning Executive Vice President & Chief Financial Officer July 29 , 2010

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Schedule 1

Princeton National Bancorp, Inc.
Consolidated Balance Sheets

(dollars in thousands except per share data)

	June 30, 2010 (unaudited)		December 31, 2009
ASSETS
Cash and due from banks	$	13,165		$	15,546
Interest-bearing deposits with financial institutions		47,280			55,527
Total cash and cash equivalents		60,445			71,073

Loans held-for-sale, at lower of cost or market		1,408			3,296

Investment securities:
Available-for-sale, at fair value		231,295			288,474
Held-to-maturity, at amortized cost (fair value of $15,451 and $13,331)		14,936			12,793
Total investment securities		246,231			301,267

Loans:
Loans, net of unearned interest		741,924			798,074
Allowance for loan losses		(15,975	)		(12,075	)
Net loans		725,949			785,999

Premises and equipment, net of accumulated depreciation		27,496			28,269
Land held for sale, at lower of cost or market		2,354			2,354
Federal Reserve and Federal Home Loan Bank stock		4,498			4,230
Bank-owned life insurance		22,962			22,540
Accrued interest receivable		6,953			9,267
Intangible assets, net of accumulated amortization		2,938			3,347
Other real estate owned		19,701			17,658
Other assets		9,892			11,430

TOTAL ASSETS	$	1,130,827		$	1,260,730

LIABILITIES
Deposits:
Demand	$	122,810		$	136,026
Interest-bearing demand		371,188			374,624
Savings		74,658			68,292
Time		399,198			496,597

Total deposits		967,854			1,075,539

Borrowings:
Customer repurchase agreements		33,135			47,327
Advances from the Federal Home Loan Bank		22,500			31,500
Interest-bearing demand notes issued to the U.S. Treasury		298			1,021
Trust preferred securities		25,000			25,000

Total borrowings		80,933			104,848

Other liabilities		4,435			5,683

TOTAL LIABILITIES		1,053,222			1,186,070

STOCKHOLDERS’ EQUITY
Preferred stock: no par value, 100,000 shares authorized:
25,083 shares issued and outstanding at June 30, 2010 and December 31, 2009		24,972			24,958
Common stock: $5 par value, 7,000,000 shares authorized:
4,478,295 shares issued at June 30, 2010 and December 31, 2009		22,391			22,391
Common stock warrants		150			150
Additional paid-in capital		18,405			18,423
Retained earnings		29,888			29,851
Accumulated other comprehensive income, net of taxes		5,614			2,816
Less: cost of 1,165,292 and 1,171,926 treasury shares at June 30, 2010 and December 31, 2009		(23,815	)		(23,929	)

TOTAL STOCKHOLDERS’ EQUITY		77,605			74,660

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,130,827		$	1,260,730

See accompanying notes to unaudited consolidated financial statements.

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Schedule 2

Princeton National Bancorp, Inc.
Consolidated Statements of Income (unaudited)

(dollars in thousands, except share data)

	THREE MONTHS ENDED June 30, 2010		THREE MONTHS ENDED June 30, 2009		SIX MONTHS ENDED June 30, 2010	SIX MONTHS ENDED June 30, 2009

INTEREST INCOME

Interest and fees on loans	$	9,841		$	11,167	$	20,427		$	22,543
Interest and dividends on investment securities		2,492			3,216		5,335			6,147
Interest on interest-bearing time deposits in other banks		40			35		72			51
Total interest income		12,373			14,418		25,834			28,741

INTEREST EXPENSE

Interest on deposits		2,657			5,103		6,030			10,250
Interest on borrowings		531			686		1,136			1,467
Total interest expense		3,188			5,789		7,166			11,717

Net interest income		9,185			8,629		18,668			17,024
Provision for loan losses		2,650			1,465		6,575			2,635

Net interest income after provision for loan losses		6,535			7,164		12,093			14,389

NON-INTEREST INCOME
Trust & farm management fees		317			394		581			708
Service charges on deposit accounts		958			977		1,849			1,953
Other service charges		507			486		967			900
Gain on sales of securities available-for-sale		80			574		722			761
Brokerage fee income		224			249		413			447
Mortgage servicing rights impairment		(589	)		0		(589	)		(556	)
Mortgage banking income		268			787		763			1,485
Bank-owned life insurance		228			230		457			473
Other operating income		36			34		58			148
Total non-interest income		2,029			3,731		5,221			6,319

NON-INTEREST EXPENSE
Salaries and employee benefits		4,452			4,113		8,864			8,693
Occupancy		633			602		1,333			1,311
Equipment expense		747			763		1,514			1,536
Federal insurance assessments		534			826		1,232			1,523
Intangible assets amortization		201			208		402			416
Data processing		320			339		632			655
Advertising		206			211		382			408
Other real estate expenes, net		387			419		1,122			509
Loan collection expenses		184			97		388			202
Other operating expense		1,152			1,137		2,233			2,222
Total non-interest expense		8,816			8,715		18,102			17,475

Income (Loss) before income taxes		(252	)		2,180		(788	)		3,233
Income tax expense (benefit)		(672	)		282		(1,467	)		178

Net income		420			1,898		679			3,055

Preferred stock dividends		314			317		627			554
Accretion of preferred stock discount		7			6		14			11

Net income available to common stockholders	$	99		$	1,575	$	38		$	2,490

Net income per share available to common stockholders:
BASIC	$	0.03		$	0.48	$	0.01		$	0.75
DILUTED	$	0.03		$	0.48	$	0.01		$	0.75

Basic weighted average shares outstanding		3,309,746			3,300,161		3,308,262			3,299,119
Diluted weighted average shares outstanding		3,309,746			3,300,586		3,308,262			3,299,634

See accompanying notes to unaudited consolidated financial statements.

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Schedule 3

Princeton National Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

(dollars in thousands except per share data)

For the Six Months E nded June 30, 2010	Preferred Stock		Common Stock		Common Stock Warrants	Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Income, net of tax effect		Treasury Stock		Total

Balance, January 1, 2010	$	24,958		$	22,391	$	150		$	18,423		$	29,851		$	2,816		$	(23,929	)	$	74,660

Net income													679									679
Dividends on preferred stock													(628	)								(628	)
Accretion on preferred stock discount		14											(14	)								—
Sale of 4,634 common shares and of treasury common stock										(49	)								80			31
Award of 2,000 shares of restricted common stock of treasury common stock										(14	)		—						34			20
Stock option compensation expense										45												45

Other comprehensive income, net of $1,769 tax effect																2,798						2,798

Balance, June 30, 2010	$	24,972		$	22,391	$	150		$	18,405		$	29,888		$	5,614		$	(23,815	)	$	77,605

For the Six Months Ended June 30, 2009

Balance, January 1, 2009	$	—		$	22,391	$	—		$	18,420		$	54,329		$	1,402		$	(24,071	)	$	72,471

Net income													3,055									3,055
Issuance of 25,083 shares of preferred stock and 155,025 common stock warrants, net of expenses		24,933					150			(63	)											25,020
Dividends on preferred stock													(390	)								(390	)
Accretion on preferred stock discount		11											(11	)								—
Sale of 4,116 shares of treasury common stock										(9	)								70			61
Dividends on common stock ($.42 per share)													(1,386	)								(1,386	)
Stock option compensation expense										47												47
Other comprehensive loss, net of $492 tax effect																(778	)					(778	)

Balance, June 30, 2009	$	24,944		$	22,391	$	150		$	18,395		$	55,597		$	624		$	(24,001	)	$	98,100

See accompanying notes to unaudited consolidated financial statements

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Schedule 4

Princeton National Bancorp, Inc. and Subsidiary
Consolidated Statements of Cash Flows

(Unaudited)
(dollars in thousands)

	For the Six Months Ended June 30
	2010		2009

Operating activities:
Net income	$	679		$	3,055
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,057			1,114
Provision for loan losses		6,575			2,635
Amortization of intangible assets and other purchase accounting adjustments, net		402			417
Amortization of premiums and discounts on investment securities, net		799			516
Gain on sales of securities available-for-sale, net		(722	)		(761	)
Impairment of mortgage servicing rights		589			556
Compensation expense for vested stock options		45			47
Losses on sales and write downs of other real estate owned, net		388			49
Loans originated for sale		(38,962	)		(81,492	)
Proceeds from sales of loans originated for sale		40,850			80,881
(Decrease) increase in accrued interest payable		(959	)		53
Decrease in accrued interest receivable		2,314			1,853
Decrease (increase) in other assets		259			(1,022	)
Decrease in other liabilities		(2,058	)		(344	)

Net cash provided by operating activities		11,256			7,557

Investing activities:
Proceeds from sales of investment securities available-for-sale		42,929			41,310
Proceeds from maturities of investment securities available-for-sale		23,373			38,630
Purchase of investment securities available-for-sale		(5,436	)		(161,550	)
Proceeds from maturities of investment securities held-to-maturity		0			1,105
Purchase of investment securities held-to-maturity		(1,340	)		(2,105	)
Proceeds from sales of other real estate owned		2,309			226
Net decrease in loans		48,742			10,545
Purchases of premises and equipment		(284	)		(752	)

Net cash provided (used) in investing activities		110,293			(72,591	)

Financing activities:
Net (decrease) increase in deposits		(107,685	)		93,525
Net decrease in borrowings		(23,915	)		(23,387	)
Dividends on common stock		0			(1,386	)
Dividends on preferred stock		(628	)		(390	)
Sales of treasury common stock		31			61
Award of restricted stock		20			0
Proceeds from issuance of preferred stock and common stock warrants, net of expenses		0			25,020

Net cash (used) provided by financing activities		(132,177	)		93,443

(Decrease) Increase in cash and cash equivalents		(10,628	)		28,409
Cash and cash equivalents at beginning of period		71,073			20,261

Cash and cash equivalents at June 30	$	60,445		$	48,670

Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest	$	8,125		$	11,664
Income taxes		$1,019			$820


Supplemental disclosures of non-cash flow activities:
Loans transferred to other real estate owned	$	4,740		$	13,038

See accompanying notes to unaudited consolidated financial statements

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Schedule 5

PRINCETON NATIONAL BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(Unaudited)

The accompanying unaudited condensed consolidated financial statements reflect all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the three and six month periods ended June 30, 2010 and 2009, and all such adjustments are of a normal recurring nature. The 2009 year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles.

The unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information required by accounting principles generally accepted in the United States of America for complete financial statements and related footnote disclosures. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered for a fair presentation of the results for the interim period have been included. For further information, refer to the consolidated financial statements and notes included in the Registrant’s 2009 Annual Report on Form 10-K. Results of operations for interim periods are not necessarily indicative of the results that may be expected for the year. Certain amounts in the 2009 consolidated financial statements have been reclassified to conform to the 2010 presentation.

NOTE 1 – CAPITAL PURCHASE PROGRAM

On January 23, 2009, the Corporation received $25,083,000 of equity capital by issuing to the United States Department of Treasury 25,083 shares of the Corporation’s 5.00% Series B Fixed Rate Cumulative Perpetual Preferred Stock, no par value, with a liquidation preference of $1,000 per share and a ten-year warrant to purchase up to 155,025 shares of the Corporation’s common stock, par value $5.00 per share, at an exercise price of $24.27 per share. The proceeds received were allocated to the preferred stock and common stock warrants based on their relative fair values. The resulting discount on the preferred stock is amortized against retained earnings and is reflected in the Corporation’s consolidated statement of income as “Preferred stock dividends,” resulting in additional dilution to the Corporation’s earnings per common share. The warrants are immediately exercisable, in whole or in part, over a term of 10 years. The warrants were included in the Corporation’s diluted average common shares outstanding (subject to anti-dilution). Both the preferred securities and warrants were accounted for as additions to the Corporation’s regulatory Tier 1 and total capital.

The Series B Preferred stock is not mandatorily redeemable and will pay cumulative dividends at a rate of 5% per year for the first five years and 9% per year thereafter. Any redemption requires Federal Reserve approval. The Series B Perpetual Preferred stock ranks senior to the Corporation’s existing authorized Series A Junior Participating Preferred stock.

A company that participates must adopt certain standards for executive compensation, including (a) prohibiting “golden parachute” payments as defined in the Emergency Economic Stabilization Act of 2008 (EESA) to senior Executive Officers; (b) requiring recovery of any compensation paid to senior Executive Officers based on criteria that is later proven to be materially inaccurate; (c) prohibiting incentive compensation that encourages unnecessary and excessive risks that threaten the value of the financial institution; and (d) accepting restrictions on the payment of dividends and the repurchase of common stock.

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NOTE 2 – EARNINGS PER SHARE CALCULATION

The following table sets forth the computation of basic and diluted earnings per share for the periods indicated:

(in thousands, except share data)	Three Months Ended June 30,		Six Months Ended June 30,
	2010		2009		2010	2009
Numerator:
Net income available to common stockholders	$	99		$	1,575	$	38	$	2,490

Denominator:
Basic earnings per share – weighted average common shares		3,309,746			3,300,161		3,308,262		3,299,119
Effect of dilutive securities – stock options		—			425		—		515
Diluted earnings per share adjusted weighted average common shares		3,309,746			3,300,586		3,308,262		3,299,634

Net income per share available for common stockholders:
Basic	$	0.03		$	0.48	$	0.01	$	0.75
Diluted	$	0.03		$	0.48	$	0.01	$	0.75

The following shares were not considered in computing diluted earnings per share for the three and six month periods ended June 30, 2010 and 2009 because they were anti-dilutive:

	Three Months Ended June 30,		Six Months Ended June 30,
	2010		2009	2010	2009

Stock options to purchase shares of common stock		522,511		456,627		522,511	456,627
Average diluted potential common shares associated with common stock warrants		155,025		155,025		155,025	155,025

NOTE 3 – GOODWILL AND INTANGIBLE ASSETS

The balance of intangible assets, net of accumulated amortization, totaled $2,938,000 and $3,347,000 at June 30, 2010 and December 31, 2009, respectively.

The Corporation had a goodwill impairment study performed as of December 31, 2009. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements. The goodwill was deemed impaired as of December 31, 2009 and written off in its entirety.

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The following table summarizes the Corporation’s intangible assets, which are subject to amortization, as of June 30, 2010 and December 31, 2009:

(in thousands)	June 30, 2010		December 31, 2009
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization

Core deposit intangibles	$	9,004		$	(6,118	)	$	9,004	$	(5,715	)
Other intangible assets		234			(182	)		234		(176	)
Total	$	9,238		$	(6,300	)	$	9,238	$	(5,891	)

Amortization expense of all intangible assets totaled $402,000 and $417,000 for of the six months ended June 30, 2010 and 2009, respectively. The amortization expense of these intangible assets will be approximately $402,000 for the remaining two quarters of 2010.

NOTE 4 – ORIGINATED MORTGAGE SERVICING RIGHTS

The Corporation has originated mortgage servicing rights which are included in other assets on the consolidated balance sheets. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income on a basis similar to the interest method using an accelerated amortization method and are subject to periodic impairment testing. A non-cash impairment expense of $589,000 was recognized at June 30, 2010 based upon the results of an independent third party valuation study. Changes in the carrying value of capitalized mortgage servicing rights are summarized as follows:

(in thousands)

Balance, January 1, 2010	$	3,285
Servicing rights capitalized		326
Amortization of servicing rights		(219	)
Impairment of servicing rights		(589	)
Balance, June 30, 2010	$	2,803

Activity in the valuation allowance for mortgage servicing rights was as follows:

(in thousands)

Balance, January 1, 2010	$	185
Additions		589
Reductions		—
Direct write-downs		—
Balance, June 30, 2010	$	774

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The Corporation services loans for others with unpaid principal balances at June 30, 2010 and December 31, 2009 of approximately $377.0 million, and $363.9 million, respectively.

The following table shows the future estimated amortization expense for mortgage servicing rights based on existing balances as of June 30, 2010. The Corporation’s actual amortization expense in any given period may be significantly different from the estimated amounts displayed depending on the amount of additional mortgage servicing rights, changes in mortgage interest rates, estimated prepayment speeds, and market conditions.

Estimated Amortization Expense:

	Amount (in thousands)
For the six months ended December 31, 2010	$	169
For the year ended December 31, 2011		328
For the year ended December 31, 2012		307
For the year ended December 31, 2013		288
For the year ended December 31, 2014		271
For the year ended December 31, 2015		254
Thereafter		1,186

NOTE 5 – OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) components and related taxes for the six months ended June 30, 2010 and 2009 were as follows:

(in thousands)	2010		2009

Net unrealized gains (losses) on securities available-for-sale	$	5,289		$	(509	)
Reclassification adjustment for realized gains included in income		(722	)		(761	)
Other comprehensive income (loss), before tax effect		4,567			(1,270	)
Less: tax expense (benefit)		1,769			(492	)
Other comprehensive income (loss)	$	2,798		$	(778	)

The components of accumulated other comprehensive income, included in stockholders’ equity at June 30, 2010 and 2009 are as follows:

(in thousands)	2010		2009

Net unrealized gain on securities available-for-sale	$	9,694		$	1,549
Net unrealized benefit obligations		(530	)		(530	)
		9,164			1,019
Less: tax effect		(3,550	)		(395	)
Net-of-tax amount	$	5,614		$	624

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NOTE 6 – FEDERAL HOME LOAN BANK STOCK

The subsidiary bank held Federal Home Loan Bank stock totaling $2,373,000 at June 30, 2010 and December 31, 2009. The Federal Home Loan Bank of Chicago is operating under a Cease and Desist Order from their regulator, the Federal Housing Finance Board. The Federal Home Loan Bank will continue to provide liquidity and funding through advances, however, the order prohibits capital stock repurchases until a time to be determined by the Federal Housing Finance Board and requires their approval for dividends. With regard to dividends, the Federal Home Loan Bank will continue to assess its dividend capacity each quarter and make appropriate request for approval. There were no dividends paid by the Federal Home Loan Bank of Chicago during the first six months of 2010 or during 2009. Management performed an analysis and deemed the cost method investment in Federal Home Loan Bank stock was ultimately recoverable as of June 30, 2010 and December 31, 2009.

NOTE 7 – INVESTMENT SECURITIES

The amortized cost and fair value of securities available-for-sale and held-to-maturity are as follows at June 30, 2010:

(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses	Fair Value
Securities available-for-sale
Obligations of U.S. government agencies and sponsored entities (1)(2)	$	17,122		$	920	$	—	$	18,042
Obligations of states and political subdivisions		110,696			5,190		139		115,747
Other mortgage-backed securities, includes CMOs (3)		93,783			3,723		0		97,506
Total securities available-for-sale	$	221,600		$	9,833	$	139	$	231,295
Securities held-to-maturity
Obligations of states and political subdivisions	$	14,936		$	519	$	4	$	15,451
Total securities	$	236,537		$	10,351	$	143	$	246,746

________

(1) Includes obligations of the Government National Mortgage Association (“GNMA”).

(2) Includes obligations of the Federal Home Loan Mortgage Corporation (“FHLMC”) and Fannie Mae Mortgage Association (“FNMA”).

(3) Includes obligations issued or guaranteed by FNMA, FHLMC or GNMA.

The amortized cost and fair value of securities available-for-sale and held-to-maturity are as follows at December 31, 2009:

(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses	Fair Value
Securities available-for-sale
Obligations of U.S. government agencies and sponsored entities (1)(2)	$	95,498		$	1,560	$	(745	)	$	96,313
Obligations of states and political subdivisions		116,864			3,580		(366	)		120,078
Other mortgage-backed securities, includes CMOs (3)		70,985			1,156		(58	)		72,083
Total securities available-for-sale	$	283,347		$	6,296	$	(1,169	)	$	288,474
Securities held-to-maturity
Obligations of states and political subdivisions	$	12,793		$	547	$	9		$	13,331
Total securities	$	296,140		$	6,843	$	(1,160	)	$	301,805

____________

(1) Includes obligations of the FHLMC and FNMA.

(2) Includes obligations of the Federal Home Loan Mortgage Corporation (“FHLMC”) and Fannie Mae Mortgage Association (“FNMA”).

(3) Includes obligations issued or guaranteed by FNMA, FHLMC or GNMA.

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The following is a summary of the fair value of securities held-to-maturity and available-for-sale with unrealized losses and an aging of those unrealized losses:

	June 30, 2010
(in thousands)	Less Than 12 Months		12 Months or More		Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Securities available-for-sale
Obligations of states and political subdivisions	$	7,017		$	(124	)	$	2,507		$	(15	)	$	9,523	$	(139	)

Securities held-to-maturity
Obligations of states and political subdivisions	$	156		$	—		$	400		$	(4	)	$	556	$	(4	)

	December 31, 2009
(in thousands)	Less Than 12 Months		12 Months or More		Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of U.S. government agencies and government-sponsored entities (“GSEs”) (1)(2)	$	39,012		$	(745	)	$	7		$	—		$	39,019	$	(745	)
Obligations of states and political subdivisions		17,114			(255	)		5,344			(120	)		22,458		(375	)
Collateralized mortgage obligations		8,006			(58	)		—			—			8,006		(58	)
Total temporarily impaired securities	$	64,132		$	(1,058	)	$	5,351		$	(120	)	$	69,483	$	(1,178	)

____________

(1) Includes obligations of GNMA.

(2) Includes issues from FNMA and FHLMC.

The unrealized loss on available-for-sale securities is included in other accumulated comprehensive income on the consolidated balance sheets. Management has concluded that no individual unrealized loss as of June 30, 2010, identified in the preceding table, represents other-than-temporary impairment. The Corporation does not intend to sell nor would it be required to sell the securities shown in the table with unrealized losses before recovering their amortized cost.

Maturities of investment securities classified as available-for-sale and held to maturity were as follows at June 30, 2010:

(in thousands)	Adjusted Carrying Value		Fair Value
Available-for-sale:
Due in one year or less	$	1,320		$	1,350
Due after one year through five years		14,896			15,654
Due after five years through ten years		55,949			58,774
Due after ten years		48,518			58,011
		127,819			133,789
Mortgage-backed securities		47,380			49,104
Collateral mortgage obligations		46,403			48,402
	$	221,601		$	231,295

Held-to-maturity:
Due in one year or less	$	3,402		$	3,435
Due after one year through five years		7,609			7,953
Due after five years through ten years		3,617			3,758
Due after ten years		308			305
	$	14,936		$	15,451

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Proceeds from sales of investment securities available-for sale was $42.9 million for the first six months of 2010 compared to $41.3 million for the first six months of 2009. Net gains were realized of $722,000 and $761,000 for the first six months of 2010 and 2009, respectively. The carrying value of securities pledged as collateral, to secure public deposits and for other purposes was $216.9 million at June 30, 2010 and $283.0 million at December 31, 2009.

NOTE 8 – LOANS

The composition of the loan portfolio, excluding loans held for sale was as follows:

(in thousands)	June 30, 2010		December 31, 2009
	Amount		% of Total	Amount		% of Total

Agricultural	$	70,555		9.5	%	$	76,918	9.6	%
Commercial (1)		140,955		19.0			244,049	30.6
Real Estate:
1-4 family residences		100,642		13.6			123,374	15.4
Agricultural		44,940		6.1			61,022	7.6
Construction (1)		111,688		15.1			24,118	3.0
Commercial		208,565		28.1			198,914	24.9

Total Real Estate		465,835		62.8			407,428	51.1

Installment		64,579		8.7			69,679	8.7

Total loans	$	741,924		100.0	%	$	798,074	100.0	%

_______________________

(1) Loans previously classified as commercial have been reclassified as construction.

The allowance for loan losses for the six months ended June 30, 2010 and 2009 were as follows:

(in thousands)	2010		2009

Balance beginning of the year	$	6,159		$	5,064
Provision for loan losses		6,575			2,635
Loans charged-off		2,789			1,640
Recoveries of loans previously charged off		(114	)		(100	)
Balance end of the period	$	10,059		$	6,159

NOTE 9 – FAIR VALUE OF ASSETS AND LIABILITIES

ASC 820 defines the 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 at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

In accordance with ASC 820, the Corporation groups its financial assets and financial liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1	Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2	Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities.

Level 3	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Financial Accounting Standards Board Accounting Standards Codification 820 (ASC 820), “Fair Value Measurements”. ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC 820 has been applied prospectively as of the beginning of the period.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet.

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Available-for-Sale Securities

The fair value of available-for-sale securities are determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1. The Corporation has no securities classified within Level 1. If quoted market prices are not available, then fair values are estimated by using pricing models or quoted prices of securities with similar characteristics. For these investments, the inputs used by the pricing service to determine fair value may include one, or a combination or, observable inputs such as benchmark yields, reported trades, broker/dealer quotes, issurer spreads, two-sided markets, benchmark securities, bids, offers and reference data market research publications and are classified within Level 2 of the valuation hierarchy. Level 2 securities include Obligations of U.S. Treasury securities, Obligations of U.S. government corporations and agencies, obligations of states and political subdivisions, mortgage-backed securities, and collateralized mortgage obligations. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. The Corporation has no securities classified within Level 3.

The following table presents the Corporation’s assets that are measured at fair value on a recurring basis and the level within the ASC 820 hierarchy in which the fair value measurements fall as of June 30, 2010 and December 31, 2009 (in thousands):


June 30, 2010			Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Available-for-sale securities
United States Government and Federal agency and U.S. Government sponsored Enterprises (GSEs)	$	67,146		$	—	$	67,146	$	—
State and Municipal		115,747			—		115,747		—
Collateral mortgage obligations:
GSE Residential		48,402			—		48,402		—
Total	$	231,295		$	—	$	231,295	$	—


December 31, 2009				Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Available-for-sale securities
United States Government and Federal agency and U.S. Government sponsored Enterprises (GSEs)	$	96,313		$	—	$	96,313	$	—
State and Municipal		120,078			—		120,078		—
Collateral mortgage obligations:
GSE Residential		72,083			—		72,083		—
Total	$	288,474		$	—	$	288,474	$	—

Following is a description of the valuation methodologies used for assets and liabilities measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy.

Impaired Loans

Loans for which it is probable that the Corporation will not collect all principal and interest due according to contractual terms are measured for impairment in accordance with the provisions of ASC 310-10-35, authoritative guidance for impairments. Allowable methods for estimating fair value include using the fair value of the collateral for collateral dependent loans or, where a loan is determined not to be collateral dependent, using the discounted cash flow method.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. If the impaired loan is determined not to be collateral dependent, then the discounted cash flow method is used. This method requires the impaired loan to be recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate. The effective interest rate of a loan is the contractual interest rate adjusted for any net deferred loan fees or costs, premiums or discount existing at origination or acquisition of the loan. Impaired loans are classified within Level 3 of the fair value hierarchy.

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Mortgage Servicing Rights

The fair value used to determine the valuation allowance is estimated using discounted cash flow models. Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

Other Real Estate Owned

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

The following table presents the fair value measurement of assets and liabilities measured at fair value on a nonrecurring basis and the level within the ASC 820 fair value hierarchy in which the fair value measurements fall at June 30, 2010 and December 31, 2009 (in thousands):


June 30, 2010				Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)

Impaired loans (collateral dependent)	$	26,248			—		—	$	26,248
Mortgage servicing rights		2,803			—		—		2,803
Other real estate owned		5,418			—		—		5,418


December 31, 2009				Fair Value Measurements Using
(in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)

Impaired loans (collateral dependent)	$	7,970			—		—	$	7,970
Mortgage servicing rights		3,285			—		—		3,285
Other real estate owned		17,658			—		—		17,658

ASC 825, "Disclosures about Fair Value of Financial Instruments," requires all entities to disclose the estimated fair value of their financial instrument assets and liabilities. For the Corporation, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments as defined in ASC 825. Many of the Corporation’s financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is also the Corporation’s general practice and intent to hold its financial instruments to maturity and to not engage in trading or sales activities except for loans held-for-sale and available-for-sale securities. Therefore, significant estimations and assumptions, as well as present value calculations, were used by the Corporation for the purposes of this disclosure.

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Estimated fair values have been determined by the Corporation using the best available data and an estimation methodology suitable for each category of financial instruments. For those loans and deposits with floating interest rates, it is presumed that estimated fair values generally approximate the recorded book balances. The estimation methodologies used, the estimated fair values, and the recorded book balances at June 30, 2010 and December 31, 2009, were as follows:


	June 30, 2010		December 31, 2009
(in thousands)	Carrying Value		Fair Value		Carrying Value	Fair Value
Financial Assets:

Cash and due from banks	$	13,165		$	13,165	$	15,546	$	15,546
Interest-bearing deposits in financial institutions		47,280			47,280		55,527		55,527
Investment securities		246,231			246,746		301,267		301,805
Loans, net, including loans held for sale		727,357			747,590		789,295		793,674
Accrued interest receivable		6,935			6,953		9,267		9,267
Total financial assets	$	1,040,986		$	1,061,733	$	1,170,902	$	1,175,819

Financial Liabilities:

Non-interest bearing demand deposits	$	122,810		$	122,810	$	136,026	$	136,026
Interest-bearing deposits		845,044			845,399		939,513		945,637
Borrowings		80,933			92,940		104,848		119,301
Accrued interest payable		2,040			2,040		2,999		2,999
Total financial liabilities	$	1,050,827		$	1,063,189	$	1,183,386	$	1,203,963

Unrecognized financial instruments (net of contract amount)

Commitments to originate loans	$	—		$	—	$	—	$	—
Lines of credit		—			—		—		—
Letters of credit		—			—		—		—

Financial instruments actively traded in a secondary market have been valued using quoted available market prices. Cash and due from banks, interest-bearing time deposits in other banks, federal funds sold, loans held-for-sale and interest receivable are valued at book value, which approximates fair value.

Financial liability instruments with stated maturities have been valued using a present value discounted cash flow analysis with a discount rate approximating current market for similar liabilities. Interest payable is valued at book value, which approximates fair value.

Financial instrument liabilities with no stated maturities have an estimated fair value equal to both the amount payable on demand and the recorded book balance.

The net loan portfolio has been valued using a present value discounted cash flow. The discount rate used in these calculations is the current rate at which similar loans would be made to borrowers with similar credit ratings, same remaining maturities, and assumed prepayment risk.

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms 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. The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Changes in assumptions or estimation methodologies may have a material effect on these estimated fair values.

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The Corporation’s remaining assets and liabilities, which are not considered financial instruments, have not been valued differently than has been customary with historical cost accounting. No disclosure of the relationship value of the Corporation’s core deposit base is required by ASC 825.

Fair value estimates are based on existing balance sheet financial instruments, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the subsidiary bank has a large fiduciary services department that contributes net fee income annually. The fiduciary services department is not considered a financial instrument, and its value has not been incorporated into the fair value estimates. Other significant assets and liabilities that are not considered financial assets or liabilities include the mortgage banking operation, brokerage network, deferred taxes, premises and equipment, and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Management believes that reasonable comparability between financial institutions may not be likely, due to the wide range of permitted valuation techniques and numerous estimates which must be made, given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

NOTE 10 – INCOME TAXES

A reconciliation of income tax expense at 34 percent of pre-tax income to the Corporation’s actual tax expense (benefit) for the three-month periods ended March 31 is shown below:

(in thousands)


	Three Months Ended June 30,		Six Months Ended June 30,
	2010		2009		2010		2009
Computed “expected” tax (benefit) expense	$	(86	)	$	741		$	(267	)	$	1,099

Increase (decrease) in income taxes resulting from:
Tax-exempt income		(461	)		(435	)		(924	)		(814	)
State income tax, net of federal tax benefit		(42	)		116			(104	)		157
Bank-owned life insurance income		(77	)		(79	)		(159	)		(165	)
Other, net		(6	)		(61	)		(12	)		(99	)
	$	(672	)	$	282		$	(1,467	)	$	178

NOTE 11 – IMPACT OF NEW ACCOUNTING STANDARDS

In July 2010, the FASB issued ASU No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” which will require the Corporation to provide a greater level of disaggregated information about the credit quality of the Corporation’s loans and leases and the Allowance for Loan Losses (the “Allowance”). This ASU will also require the Corporation to disclose additional information related to credit quality indicators, past due information, and information related to loans modified in a troubled debt restructuring. The provisions of this ASU are effective for the Corporation’s reporting period ending December 31, 2010. As this ASU amends only the disclosure requirements for loans and leases and the Allowance, the adoption will have no impact on the Corporation’s statements of income and condition.

NOTE 12 – REGULATORY MATTERS

On March 15, 2010, Citizens First National Bank, Princeton, Illinois (the “Bank”), a subsidiary of Princeton National Bancorp, Inc. (the “Corporation”) entered into a formal written agreement (the “Agreement”) with the Comptroller of the Currency (the “Comptroller”) that contains provisions to lower nonperforming loan levels and foster improvement in the Bank’s policies and procedures with respect to the Bank’s allowance for loan and lease losses, and loan risk rating system. The Bank has begun addressing all of these requirements.

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Pursuant to the Agreement, the Bank’s board is required to review the adequacy of the Bank’s allowance for loan and lease losses and to establish a program for the maintenance of an adequate allowance. A copy of the board’s program is required to be submitted to the Comptroller for review. The Bank is also required to take immediate action to protect its interest in criticized assets identified in the Bank’s most recent Report of Examination with the Comptroller and to adopt individual written workout plans with respect to such assets. A copy of the workout plans is required to be submitted to the Comptroller with respect to any criticized asset equal to or exceeding $100,000. The Bank is prohibited from extending any additional credit to any borrower whose loan is criticized, unless a majority of the Bank’s board (or appropriate committee) has determined that the extension is necessary to promote the best interests of the Bank and such determination is properly recorded. Under the Agreement, the board must ensure that the Bank’s internal ratings of credit relationships are timely, accurate, and consistent with the regulatory credit classification criteria set forth in the Comptroller’s Handbook and related authority. The board must also ensure that any loan relationship with a high probability of payment default or other well-defined weakness is rated no better than “substandard,” regardless of the existence of certain mitigants that reduce credit risk.

The Bank’s board and management has taken relevant actions to comply with the terms of this agreement, including the implementation of remediation steps to protect its interest in criticized assets, enhanced workout plans among other steps.

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PRINCETON NATIONAL BANCORP, INC. AND SUBSIDIARY

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the three and six month periods ended June 30, 2010 and 2009

The following discussion provides information about Princeton National Bancorp, Inc.’s (“PNBC” or the “Corporation”) financial condition and results of operations for the three and six month periods ended June 30, 2010 and 2009. This discussion should be read in conjunction with the attached consolidated financial statements and notes thereto. This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as discussions of the Corporation’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules. The Corporation intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Corporation, are identified by use of the words “believe”, “expect”, “intend”, “anticipate”, “estimate”, “project”, or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties including: the effect of the current severe disruption in financial markets and the United States government programs introduced to restore stability and liquidity, changes in interest rates, general economic conditions and the weakening state of the United States economy, legislative/regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Corporation’s market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Corporation and its business, including a discussion of these and additional factors that could materially affect the Corporation’s financial results, is included in the Corporation’s 2009 Annual Report on Form 10-K under the headings ”Item 1. Business” and “Item 1A. Risk Factors.”

CRITICAL ACCOUNTING POLICIES AND USE OF SIGNIFICANT ESTIMATES

The Corporation has established various accounting policies that govern the application of U.S. generally accepted accounting principles in the preparation of the Corporation’s financial statements. The significant accounting policies of the Corporation are described in the footnotes to the consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and assumptions, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Corporation.

Allowance for Loan Losses

The Corporation believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of its consolidated financial statements. We determine probable incurred losses inherent in our loan portfolio and establish an allowance for those losses by considering factors including historical loss rates, expected cash flows and estimated collateral values. In assessing these factors, we use organizational history and experience with credit decisions and related outcomes. The allowance for loan losses represents our best estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. We evaluate our allowance for loan losses quarterly. If our underlying assumptions later prove to be inaccurate based on subsequent loss evaluations, the allowance for loan losses is adjusted.

We estimate the appropriate level of allowance for loan losses by separately evaluating impaired and non-impaired loans. A specific allowance is assigned to an impaired loan when expected cash flows or collateral do not justify the carrying amount of the loan. The methodology used to assign an allowance to a non-impaired loan is more subjective. Generally, the allowance assigned to non-impaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics, adjusted for qualitative factors including the volume and severity of identified classified loans, changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets. Because the economic and business climate in any given industry or market, and its impact on any given borrower, can change rapidly, the risk profile of the loan portfolio is continually assessed and adjusted when appropriate. Notwithstanding these procedures, there still exists the possibility that our assessment could prove to be significantly incorrect and that an immediate adjustment to the allowance for loan losses would be required.

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Other Real Estate Owned

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

Deferred Income Tax Assets/Liabilities

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

Additionally, the Corporation reviews its uncertain tax positions annually under ASC 740-10. An uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount actually recognized is the largest amount of tax benefit that is greater than 50% likely to be recognized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. A significant amount of judgment is applied to determine both whether the tax position meets the “more likely than not” test as well as to determine the largest amount of tax benefit that is greater than 50% likely to be recognized. Differences between the position taken by management and that of taxing authorities could result in a reduction of a tax benefit or increase to tax liability, which could adversely affect future income tax expense.

Impairment of Intangible Assets

Core deposit and customer relationships, which are intangible assets with a finite life, are recorded on our balance sheets. These intangible assets were capitalized as a result of past acquisitions and are being amortized over their estimated useful lives of up to 15 years. Core deposit intangible assets, with finite lives will be tested for impairment when changes in events or circumstances indicate that its carrying amount may not be recoverable. Core deposit intangible assets were tested for impairment during 2010 and no impairment was recognized.

Mortgaging Service Rights (MSRs)

MSR fair values are very sensitive to movements in interest rates as expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise. For discussion regarding the impairment of MSRs, see Note 4 – “Originated Mortgage Servicing Rights” in the Notes to Consolidated Financial Statements.

Fair Value Measurements

Level 1

Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

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Level 2	Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities.

Level 3	Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Financial Accounting Standards Board Accounting Standards Codification 820 (ASC 820), “Fair Value Measurements”. ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. ASC 820 has been applied prospectively as of the beginning of the period.

At the end of each quarter, the Corporation assesses the valuation hierarchy for each asset or liability measured. From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date. Transfers into or out of hierarchy levels are based upon the fair value at the beginning of the reporting period. A more detailed description of the fair values measured at each level of the fair value hierarchy can be found in Note 8 – “Fair Value of Assets and Liabilities” in the Notes to Consolidated Financial Statements.

RECENT DEVELOPMENTS

Effective as of March 15, 2010, Citizens First National Bank, entered into a formal written agreement (the “Agreement”) with the Comptroller of the Currency (the “Comptroller”) that contains provisions to lower nonperforming loan levels and foster improvement in the Bank’s policies and procedures with respect to the Bank’s allowance for loan and lease losses and loan risk rating system. The Bank has begun addressing all of these requirements.

RESULTS OF OPERATIONS

Net income for the second quarter of 2010 was $420,000, as compared to $1.9 million for the second quarter of 2009. Net income available to common stockholders for the second quarter of 2010 was $99,000, as compared to $1.6 million for the second quarter of 2009. For the second quarter of 2010, basic and diluted earnings per common share available to common stockholders was $0.03, as compared to $0.48 for the second quarter of 2009. The decrease in income for the second quarter of 2010 as compared to the second quarter of 2009 is attributed to a $1.2 million increase in loan loss provisions, a $589,000 non-cash impairment expense of mortgage servicing rights, a $519,000 reduction in mortgage banking income and a $494,000 reduction in gains on sales of securities available-for-sale partially offset by a $556,000 increase in net interest income. The net income available to common stockholders to average assets was 0.03% and 0.51% for the second quarters of 2010 and 2009, respectively. The net income available to common stockholders to average stockholder equity was 0.52% and 6.45% for the second quarters of 2010 and 2009, respectively.

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Net income for the first six months of 2010 was $679,000, as compared to $3.1 million for the first six months of 2009. Net income available to common stockholders was $38,000, as compared to $2.5 million for the first six months of 2009. For the first six months of 2010 basic and diluted earnings per common share available to common stockholders was $0.01, as compared to $0.75 for the first six months of 2009. The decrease in income for the first six months of 2010 as compared to the first six months of 2009 is attributed to a $3.9 million increase in loan loss provisions and a $722,000 decrease in mortgage banking income, a $613,000 increase in other real estate expenses partially offset by an increase of $1.6 million in net interest income. The net income available to common stockholders to average assets was 0.01% and 0.41% for the first six months of 2010 and 2009, respectively. The net income available to common stockholders to average stockholder equity was 0.10% and 5.31% for the first six months of 2010 and 2009, respectively.

Net interest income before the provision for loan losses was $9.2 million for the second quarter of 2010, as compared to $8.6 million for the second quarter of 2009, respectively. This $556,000 (or 6.4%) increase was driven by lower funding costs. The net yield on average earning assets increased by 53 basis points to 3.96% in the second quarter of 2010 from 3.43% in the second quarter of 2009.

Net interest income before the provision for losses was $18.7 million for the first six months of 2010, as compared to $17.0 million for the first six months of 2009, respectively. This $1.6 million (or 9.7%) increase was driven by reductions in interest expenses on deposits and borrowings. The net yield on earning assets increased by 45 basis points to 3.93% in the first six months of 2010 from 3.48% in the second quarter of 2009. Average costs for interest-bearing deposits, time deposits, customer repurchase agreements and FHLB advances have contributed to this increasing net interest margin despite the current level of non-performing assets. For the first six months of 2010 the cost of interest-bearing liabilities declined 90 basis points to 1.46%.

The Corporation’s provision for loan loss expense recorded each quarter is determined by management’s evaluation of the risk characteristics of the loan portfolio. For the second quarter of 2010 the provision for loan losses increased to $2.7 million or 80.9% from $1.5 million for the second quarter of 2009. Net charge-offs increased by $1.0 million or 266.8% to $1.4 million compared to $370,000 for the second quarter of 2009. Annualized net loans charged-off to average loans for the second quarter of 2010 was 0.70% compared to 0.69% in the first quarter of 2010. Net charge-offs increased in the first six months of 2010 by $1.2 million or 73.7% to $2.7 million compared to $1.5 million for the first six months of 2009. The allowance for loan losses is discussed more fully below.

Non-interest income totaled $2.0 million for the second quarter of 2010, as compared to $3.7 for the second quarter of 2009. This decline of $1.7 million (or 45.6%) is attributed to a $589,000 non-cash impairment expense on mortgage servicing rights, a $528,000 decrease in mortgage banking income, a $494,000 reduction in gains on sales of securities available-for-sale and a $77,000 drop in trust and farm management fees. Non-interest income to average assets for the second quarters of 2010 and 2009 was 0.70% and 1.20%, respectively.

Non-interest income totaled $5.2 million for the first six months of 2010, as compared to $6.3 million for the first six months of 2009. This decline of $1.1 million or 17.4% is attributed to the following: a $736,000 decrease in mortgage banking income, a $127,000 drop in trust and farm management fees, a $104,000 decline in service charges on deposit accounts and a $90,000 decrease in other operating income. Non-interest income to average assets for the first six months of 2010 and 2009 was 0.88% and 1.05%, respectively.

Total non-interest expense for the second quarter of 2010 was $8.8 million, as compared to $8.7 million for the first six months of 2009, representing a marginal increase of $101,000. Non-interest expenses to average assets for the second quarter of 2010 and 2009 was 3.04% and 2.81%. respectively.

Total non-interest expense for the first six months of 2010 was $18.1 million, as compared to $17.5 million for the first six months of 2009. This increase of $627,000 or 3.6% is attributed to a $613,000 rise in other real estate expenses. Non-interest expense to average assets for the first six months of 2010 and 2009 was 2.96% and 2.90%, respectively.

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INCOME TAXES

The Corporation recorded an income tax benefit of $672,000 for the second quarter of 2010, as compared to an income tax expense of $282,000 for the second quarter of 2009. The effective tax rate was (266.7%) for the second quarter of 2010, as compared to 12.9% for the second quarter of 2009. For the first six months of 2010, the Corporation recorded an income tax benefit of $1.5 million, as compared to income tax expense of $178,000 for the first six months of 2009. The income tax benefit is due to a pre-tax loss coupled with the effect of tax-exempt investment interest income. For more information on the Corporation’s income taxes see Note 9 – “Income Taxes” in the Notes to Consolidated Financial Statements.

FDIC

On September 29, 2009 the Board of Directors of the FDIC adopted a Notice of Proposed Rulemaking (NPR) that would require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC estimated that the total prepaid assessments collected would be approximately $45 billion. The FDIC Board also voted to adopt a uniform three-basis point increase in assessment rates effective on January 1, 2011, and extend the restoration period from seven to eight years.

Under GAAP accounting rules, unlike special assessments, prepaid assessments would not immediately affect bank earnings. Each institution would record the entire amount of its assessment related to future periods as a prepaid expense (an asset) as of December 31, 2009, the date the payment would be made. The Corporation paid an assessment of $6,763,000 for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.

Beginning January 1, 2010, and each quarter thereafter, each institution would record an expense (charge to earnings) for its regular quarterly assessment and an offsetting credit to the prepaid assessment until the asset is exhausted. At June 30, 2010, the Corporation had a remaining prepaid assessment of $5,292,000. This amount is reflected in the category of Other Assets in the Consolidated Balance Sheets. The Corporation recorded $534,000 of FDIC assessment expense for the second quarter of 2010 and $1.2 million for the first six months of 2009.

LOANS

The Corporation’s loan portfolio largely reflects the profile of the communities in which it operates. The Corporation essentially offers four types of loans: agricultural, commercial, real estate and consumer installment. The Corporation has no foreign loans. The following table summarizes the Corporation’s loan portfolio excluding loans held-for-sale:

(in thousands)	June 30, 2010		December 31, 2009	Change
	Amount		% of Total	Amount		% of Total		Amount	Percentage

Agricultural	$	70,555		9.5	%	$	76,918		9.6	%	$	(6,363	)	(8.3	)%
Commercial (1)		140,955		19.0			244,049		30.6		$	(103,094	)	(42.2	)
Real Estate:
1-4 family residences		100,642		13.6			123,374		15.4			(22,732	)	(18.4	)
Agricultural		44,940		6.1			61,022		7.6			(16,082	)	(26.4	)
Construction (1)		111,688		15.1			24,118		3.0			87,570		363.1
Commercial		208,565		28.1			198,914		24.9			9,651		4.9
Total Real Estate		465,835		62.8			407,428		51.1			58,407		14.3
Installment		64,579		8.7			69,679		8.7			(5,100	)	(7.3	)
Total loans	$	741,924		100.0	%	$	798,074		100.0	%	$	(56,150	)	(7.0	)%
Total assets	$	1,130,827				$	1,260,730
Loans to total assets				65.6	%				63.3	%

_______________________

(1) Loans previously classified as commercial have been reclassified as construction.

Total loans decreased to $741.9 million from $798.1 million (a decrease of $56.2 million or 7.0%), as part of management’s overall asset/liability management plan to increase liquidity and reduce assets. The Corporation continued to work with borrowers to resolve problem loan situations. Commercial and total real estate loans were effected by a call report reclassification review of the loan portfolio. Commercial loans declined at June 30, 2010 to $141.0 million (a decrease of $103.1 million or 42.2%) largely due to the reclassification review. Construction loans increased at June 30, 2010 to $111.7 million (an increase of $87.6 million or 363.1%) largely due to the reclassification review. 1-4 family loans declined to $100.6 million (a decrease of 22.7 million or 18.4%) due to loan repayments including prepayments and sales. Loans to total assets at June 30, 2010 compared to December 31, 2009 increased to 65.6% from 63.3% while the loan portfolio decline by $56.2 million.

ANALYSIS OF FINANCIAL CONDITION

Total assets decreased to $1.131 billion at June 30, 2010 from $1.261 billion at December 31, 2009. This is part of the Company’s plan to “right size” the balance sheet in proportion to capital. Total loans decreased to $741.9 million from $798.1 million (a decrease of $56.2 million or 7.0%). Investment securities decreased to $246.2 million from $301.3 million (a decrease of $55.0 million or 18.3%), as part of management’s overall asset/liability management plan to increase liquidity and reduce assets. Other real estate owned increased to $19.7 million from $17.7 million (increase of $2.0 million or 11.6%).

Total deposits decreased to $967.9 million at June 30, 2010 from $1.076 billion at December 31, 2009. Time deposits have decreased to $399.2 million from $496.6 million (a decrease of $97.4 million or 19.6%). Demand deposits have decreased to $122.8 million from $136.0 million (a decrease of $13.2 million or 9.7%). Interest-bearing deposits decreased to $371.2 million from $374.6 million (a decrease of $3.4 million or 0.9%). Savings deposits have increased to $74.7 million from $68.3 million (an increase of $6.4 million or 9.3%). Deposit pricing reductions have resulted in decreases in Preferred Time Deposits (public funds) and other Time Deposits with some funds flowing into other interest-bearing deposit products. The Corporation has no wholesale Brokered CDs, but does offer its depositors access to the CDARS program. The CDARS deposits are considered for regulatory reporting purposes to be Brokered CDs. CDARS is a network of financial institutions that provides for increased FDIC coverage. (For example, when you place a large deposit with a CDARS Network member, that institution uses the CDARS service to place your funds into CDs issued by other members of the CDARS Network. This occurs in increments below the standard FDIC insurance maximum so that both principal and interest are eligible for FDIC insurance.) The Corporation had $22.7 million of CDARS deposits at June 30, 2010.

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Total borrowings decreased to $80.9 million at June 30, 2010 from $104.8 million at December 31, 2009. Customer repurchase agreements have decreased to $33.1 million from $47.3 million (a decrease of $14.2 million or 30.0%). Advances from the Federal Home Loan Bank have decreased to $22.5 million from $31.5 million (a decrease of $9.0 million or 28.6%). Interest-bearing demand notes issued by the U.S. Treasury decreased to $298,000 from $1.0 million (a decrease of $702,000 or 70.2%).

CAPITAL PURCHASE PROGRAM

On January 23, 2009, the Corporation received $25,083,000 of equity capital by issuing to the United States Department of Treasury 25,083 shares of the Corporation’s 5.00% Series B Fixed Rate Cumulative Perpetual Preferred Stock, no par value, with a liquidation preference of $1,000 per share and a ten-year warrant to purchase up to 155,025 shares of the Corporation’s common stock, par value $5.00 per share, at an exercise price of $24.27 per share. The proceeds received were allocated to the preferred stock and common stock warrants based on their relative fair values. The resulting discount on the preferred stock is amortized against retained earnings and is reflected in the Corporation’s consolidated statement of income as “Preferred stock dividends”, resulting in additional dilution to the Corporation’s earnings per common share. The warrants are immediately exercisable, in whole or in part, over a term of 10 years. The warrants were included in the Corporation’s diluted average common shares outstanding (subject to anti-dilution). Both the preferred securities and warrants were accounted for as additions to the Corporation’s regulatory Tier 1 and total capital.

ASSET QUALITY

For the first six months of 2010, the subsidiary bank charged off $2.8 million of loans and had recoveries of $114,000, compared to charge-offs of $1.6 million and recoveries of $100,000 during the first six months of 2009. The allowance for loan losses is based on factors that include the overall composition of the loan portfolio, types of loans, underlying collateral, past loss experience, loan delinquencies, substandard and doubtful credits, and such other factors that, in management’s reasonable judgment, warrant consideration. The adequacy of the allowance is monitored monthly. At June 30, 2010, the allowance was $16.0 million which is 24.16% of non-performing loans and 2.15% of total loans, compared with $12.1 million which was 20.60% of non-performing loans and 1.51% of total loans at December 31, 2009.

Non-performing loans increased to $66.1 million or 8.91% of net loans at June 30, 2010, as compared to $58.6 million or 7.38% of net loans at December 31, 2009. All loans are individually evaluated and management continues to maintain adequate reserves in the allowance for loan losses.

At June 30, 2010 non-accrual loans were $60.4 million compared to $42.6 million at December 31, 2009. Impaired loans totaled $38.1 million, at June 30, 2010 compared to $12.2 million at December 31, 2009. The total amount of loans ninety days or more past due and still accruing interest at June 30, 2010 was $509,000 compared to $2.1 million at December 31, 2009. There was a specific loan loss reserve on impaired loans of $7.3 million established for impaired loans as of June 30, 2010 compared to a specific loan loss reserve of $2.9 million at December 31, 2009. The Corporation’s management analyzes the allowance for loan losses monthly and believes the current level of allowance is adequate to meet probable losses as of June 30, 2010.

The allowance for loan losses increased to 2.15% of total loans at June 30, 2010 compared to 1.51% at December 31, 2009. This increase was determined by management to be appropriate due to the increases in classified assets, specific reserves for impaired loans, nonperforming loans and the on-going recession. The following table provides information (in thousands) about the Corporation’s non-performing assets:

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The following table provides information (in thousands) about the Corporation’s non-performing assets:


	June 30, 2010		December 31, 2009		June 30, 2009

Non-accrual	$	60,427		$	42,593		$	21,527
90 days past due still accruing		509			2,098			494
Restructured		5,179			13,941			—
Total non-performing loans	$	66,115		$	58,621		$	22,021
Other real estate owned		19,701			17,658			15,250
Total non-performing assets	$	85,816		$	76,279		$	37,271

Non-performing loans to total loans		8.91	%		7.35	%		2.88	%
Non-performing assets to total assets		7.59	%		6.05	%		2.96	%

The allowance for possible loan losses shown in this table below represents the allowance available to absorb losses within the portfolio (in thousands):

(in thousands)	June 30, 2010		December 31, 2009		June 30, 2009

Amount of loans outstanding at end of period (net of unearned interest)	$	741,924		$	798,074		$	765,754
Average amount of loans outstanding for the period (net of unearned interest)	$	765,342		$	743,877		$	741,320
Allowance for possible loan losses at beginning of the period	$	12,075		$	5,064		$	5,064
Charge-offs:
Agricultural		—			21			—
Commercial		2,141			2,516			751
Real estate mortgage		508			511			189
Installment		140			1,208			700
Total charge-offs		2,789			4,256			1,640
Recoveries:
Agricultural		—			—			—
Commercial		30			42			21
Real estate mortgage		—			—			—
Installment		84			163			79
Total recoveries		114			205			100
Net loan charged-off		2,675			4,051			1,540
Provision for loan losses		6,575			11,062			2,635
Allowance for possible loan losses at end of period	$	15,975		$	12,075		$	6,159

Net loans charged-off to average loans (annualized)		0.70	%		0.54	%		0.42	%
Allowance for possible loan losses to total to non-performing loans		24.16	%		20.60	%		27.96	%
Allowance for possible loan losses to total loans at end of period (net of unearned interest)		2.15	%		1.51	%		0.80	%

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CAPITAL RESOURCES

Federal regulations require all financial institutions to evaluate capital adequacy by the risk-based capital method, which makes capital requirements more sensitive to the differences in the level of risk assets. At June 30, 2010, total risk-based capital of PNBC was 12.34%, compared to 11.50% at December 31, 2009. The Tier 1 capital ratio increased from 7.48% at December 31, 2009, to 7.76% at June 30, 2010. Total stockholders’ equity to total assets at June 30, 2010 increased to 6.86% from 5.92% at December 31, 2009.

LIQUIDITY

Liquidity is measured by a financial institution’s ability to raise funds through deposits, borrowed funds, capital, or the sale of assets. Additional sources of liquidity include cash flow from the repayment of loans and the maturity of investment securities. Major uses of cash include the origination of loans and purchase of investment securities. Cash flows provided by investing and operating activities, offset by those used in financing activities, resulted in a net decrease in cash and cash equivalents of $10.6 million from December 31, 2009 to June 30, 2010. This decrease was primarily the result of the proceeds received from the sale of investment securities and a decrease in loans, offset by net decreases in deposits and borrowings. For more detailed information, see PNBC’s Consolidated Statements of Cash Flows.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Corporation generates agribusiness, commercial, mortgage and consumer loans to customers located primarily in North Central Illinois. The Corporation’s loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Although the Corporation has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon economic conditions in the agricultural industry.

In the normal course of business to meet the financing needs of its customers, the subsidiary bank is party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the subsidiary bank has in particular classes of financial instruments.

The subsidiary bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. The subsidiary bank uses the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. At June 30, 2010, commitments to extend credit and standby letters of credit were approximately $95.4 million and $3.9 million respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The subsidiary bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, by the subsidiary bank upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include real estate, accounts receivable, inventory, property, plant and equipment, and income-producing properties.

Standby letters of credit are conditional commitments issued by the subsidiary bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers. The subsidiary bank secures the standby letters of credit with the same collateral used to secure the loan. The maximum amount of credit that would be extended under standby letters of credit is equal to the off-balance sheet contract amount. The standby letters of credit have terms that expire in one year or less.

LAND HELD FOR SALE

The Corporation owns separate lots in Elburn, Aurora and Somonauk, Illinois that have been removed from the land balance and are now shown on the Corporation’s balance sheet as land held-for-sale, at the lower of cost or market. The land in Elburn, approximately 2 acres, was purchased in 2003 for $930,000 in anticipation of the construction of a branch facility. The land in Aurora, consisting of two lots remaining from the original purchase of fourteen acres in 2004 which was used to construct a branch facility has a cost basis of $1,344,000. The land in Somonauk, acquired in 2005 during the acquisition of FSB Bancorp, Inc., consists of approximately two acres with a cost basis of $80,000.

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LEGAL PROCEEDINGS

There are various claims pending against the Corporation’s subsidiary bank, arising in the normal course of business. Management believes, based upon consultation with legal counsel, that liabilities arising from these proceedings, if any, will not be material to the Corporation’s financial position or results of operation.

QUANTIATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Smaller reporting companies are not required to provide the information required by this item.

EFFECTS OF INFLATION

The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

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PRINCETON NATIONAL BANCORP, INC. AND SUBSIDIARY

The following table sets forth (in thousands) details of average balances, interest income and expense, and resulting annualized yields/costs for the Corporation for the periods indicated, reported on a fully taxable equivalent basis, using a tax rate of 34%.

	Six Months Ended, June 30, 2010		Six Months Ended, June 30, 2009
	Average Balance		Interest		Yield/ Cost	Average Balance		Interest		Yield/ Cost
Average Interest-Earning Assets

Interest-bearing deposits	$	61,577		$	72		0.24	%	$	47,171	$	51	0.22	%
Taxable investment securities		134,655			2,647		3.96	%		161,551		3,723	4.65	%
Tax-exempt investment securities		125,765			4,073		6.53	%		114,108		3,673	6.49	%
Federal funds sold		139			0		0.00	%		192		0	0.00	%
Net loans (1)		711,002			20,500		5.81	%		741,320		22,615	6.15	%

Total interest-earning assets		1,033,138			27,292		5.33	%		1,064,342		30,062	5.70	%

Average non-interest earning assets (2)		158,790								151,214

Total average assets	$	1,191,927							$	1,215,556

Average Interest-Bearing Liabilities

Interest-bearing demand deposits	$	383,475			1,683		0.89	%	$	261,839		1,569	1.21	%
Savings deposits		72,716			31		0.09	%		65,198		25	0.08	%
Time deposits		446,103			4,316		1.95	%		579,251		8,656	3.01	%
Interest-bearing demand notes issued to the U.S. Treasury		892			0		0.02	%		1,034		0	0.00	%
Federal funds purchased		0			0		0.00	%		512		1	0.39	%
Customer repurchase agreements		39,130			160		0.82	%		32,563		176	1.09	%
Advances from Federal Home Loan Bank		25,058			266		2.14	%		32,494		484	3.00	%
Trust preferred securities		25,000			710		5.73	%		25,000		710	5.73	%
Note payable		0			0		0.00	%		4,789		96	4.04	%

Total interest-bearing liabilities		992,373			7,166		1.46	%		1,002,680		11,717	2.36	%

Net yield on average interest-earning assets				$	20,126		3.93	%			$	18,345	3.48	%

Average non-interest-bearing liabilities		125,013								118,285

Average stockholders’ equity		76,563								94,591

Total average liabilities and stockholders’ equity	$	1,191,927							$	1,215,556

____________

(1) Excludes nonaccrual loans and overdrafts.

(2) Includes nonaccrual loans and overdrafts.

The following table reconciles tax-equivalent net interest income (as shown above) to net interest income as reported on the Consolidated Statements of Income.

	For the Six Months Ended June 30,
	2010		2009
Net interest income as stated	$	18,668		$	17,024
Tax equivalent adjustment-investments		1,385			1,249
Tax equivalent adjustment-loans		73			72

Tax equivalent net interest income	$	20,126		$	18,345

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Schedule 7

Controls and Procedures

(a)	Disclosure controls and procedures. We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2010. Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file with or submit to the SEC. The President and Chief Executive Officer, and Executive Vice-President and Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, they concluded that, as of the date of their evaluation, our disclosure controls were effective.

(b)	Internal controls. There have not been any significant changes in our internal accounting controls or in other factors during the quarter ended June 30, 2010 that could significantly affect those controls.