Overview

We strive to remain a leader in meeting the financial service needs of the local community and to provide quality service to the individuals and businesses in the market areas that it has served since 1853. Historically, we have been a community-oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. We meet the needs of our local community through a community-based and service-oriented approach to banking.

We have adopted a growth-oriented strategy that has focused on increased emphasis on commercial lending. Our strategy also calls for increasing deposit relationships and broadening its product lines and services. We believe that this business strategy is best for its long-term success and viability, and complements its existing commitment to high-quality customer service. In connection with its overall growth strategy, we seek to:

· grow our commercial and industrial and commercial real estate loan portfolio by targeting businesses in our primary market area and in northern Connecticut as a means to increase the yield on and diversify our loan portfolio and build transactional deposit account relationships;

· focus on expanding our retail banking franchise and increasing the number of households served within our market area; and

· depending on market conditions, refer substantially all of the fixed-rate residential real estate loans to a third-party mortgage company that underwrites, originates and services these loans in order to diversify our loan portfolio, increase fee income and reduce interest rate risk.

Please review our financial results for the quarter ended September 30, 2009 in the context of this strategy.

· Net income was $1.2 million, or $0.04 per diluted share, for the quarter ended September 30, 2009 compared to $2.0 million, or $0.07 per diluted share for the same period in 2008. For the nine months ended September 30, 2009, net income was $3.5 million, or $0.12 per diluted share compared to $6.0 million or $0.20 per diluted share for the same period in 2008.

· FDIC insurance expense increased $78,000 to $102,000 for the three months ended September 30, 2009 from $24,000 for the same period in 2008. The FDIC insurance expense increased $885,000 to $950,000 for the nine months ended September 30, 2009 from $65,000 for the same period in 2008. The nine months ended September 30, 2009 includes $453,000 for a special assessment that was imposed upon all banks at June 30, 2009.

· The provision for loans losses was $620,000 for the three months ended September 30, 2009 compared to $275,000 for the same period in 2008. For the nine months ended September 30, 2009, the provision for loan losses was $2.4 million compared to $690,000 for the same period in 2008. The factors that influenced the increase in the provision for loan losses primarily include an increase in charge-offs and the continued weakening of the local and national economy.

· The three and nine months ended September 30, 2009 includes net losses on the sale of securities of $774,000 and $565,000, respectively, compared to net gains of $486,000 and $805,000, respectively for the same periods in 2008. We incurred losses on the sale of securities of $2.2 million for both the three and nine months ended September 30, 2009, due to a loss on the sale of a single security. The credit quality of the security had deteriorated and management opted to sell it in the third quarter of 2009. The losses were partially offset by gains on the sale of other securities of $1.4 million and $1.6 million, respectively, for the three and nine months ended September 30, 2009.

CRITICAL ACCOUNTING POLICIES

Our critical accounting policies, given our current business strategy and asset/liability structure, are revenue recognition on loans, the accounting for allowance for loan losses and provision for loan losses, the classification of securities as either held to maturity or available for sale, other than-temporary-impairment of securities and the valuation of deferred taxes.

Our general policy is to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more, or earlier if the loan is considered impaired. Any unpaid amounts previously accrued on these loans are reversed from income. Subsequent cash receipts are applied to the outstanding principal balance or to interest income if, in the judgment of management, collection of principal balance is not in question. Loans are returned to accrual status when they become current as to both principal and interest and when subsequent performance reduces the concern as to the collectability of principal and interest. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income over the estimated average lives of the related loans.

Our methodology for assessing the appropriateness of the allowance consists of two key components: a specific allowance for identified problem or impaired loans, and a general allowance for the remainder of the portfolio. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. The appropriateness of the allowance is also reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio. Although management believes it has established and maintained the allowance for loan losses at adequate levels, if management's assumptions and judgments prove to be incorrect due to continued deterioration in economic, real estate and other conditions, and the allowance for loan losses is not adequate to absorb inherent losses, our earnings and capital could be significantly and adversely affected.

Securities, including mortgage-backed securities, that management has the positive intent and ability to hold until maturity are classified as held to maturity and are carried at amortized cost. Securities, including mortgage-backed securities, that have been identified as assets for which there is not a positive intent to hold to maturity are classified as available for sale and are carried at fair value with unrealized gains and losses, net of income taxes, reported as a separate component of equity. Accordingly, a misclassification would have a direct effect on stockholders' equity. Sales or reclassification as available for sale (except for certain permitted reasons) of held to maturity securities may result in the reclassification of all such securities to available for sale. We have never sold held to maturity securities or reclassified such securities to available for sale other than in specifically permitted circumstances. We do not acquire securities or mortgage-backed securities for purposes of engaging in trading activities.

On a quarterly basis, we review securities with unrealized depreciation on a judgmental basis to assess whether the decline in fair value is temporary or other-than-temporary. Declines in the fair value of held to maturity and available for sale securities below their amortized cost basis that are deemed to be other-than-temporarily impaired are recognized in earnings to the extent the impairment is related to credit losses. The amount of the other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the likelihood that it will be required to sell the securities prior to the recovery of their amortized cost basis less any credit losses.

We must make certain estimates in determining income tax expense for financial statement purposes. These estimates occur in the calculation of the deferred tax assets and liabilities, which arise from the temporary differences between the tax basis and financial statement basis of our assets and liabilities. The carrying value of our net deferred tax asset is based on our historic taxable income for the two prior years as well as our belief that it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets. Judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws or other factors which could result in a change in the assessment of the realization of the net deferred tax assets.

COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2009 AND DECEMBER 31, 2008

Total assets increased $152.5 million to $1.3 billion at September 30, 2009. Securities increased $124.0 million to $638.2 million at September 30, 2009 from $514.2 million at December 31, 2008. The increase in securities was the result of reinvesting funds from deposits, short-term borrowings and long-term debt into securities.

The composition of our loan portfolio at September 30, 2009 and December 31, 2008 is summarized as follows:

                                                                September 30,       December 31,
                                                                    2009                2008
                                                                         (In thousands)

Commercial real estate                                         $       226,218     $      223,857
Residential real estate                                                 65,045             62,810
Home equity                                                             34,302             35,562
Commercial and industrial                                              145,125            153,861
Consumer                                                                 3,636              4,248
Total loans                                                            474,326            480,338
Unearned premiums and deferred loan fees and costs, net                    339                593
Allowance for loan losses                                               (7,857 )           (8,796 )
                                                               $       466,808     $      472,135

Net loans decreased by $5.3 million to $466.8 million at September 30, 2009 from $472.1 million at December 31, 2008. The decrease in net loans was primarily the result of a decrease in commercial and industrial loans, partially offset by an increase in commercial real estate loans and residential loans. Commercial and industrial loans decreased $8.8 million to $145.1 million at September 30, 2009 from $153.9 million at December 31, 2008. This was primarily the result of customers decreasing their balances on lines of credit, the charge-off of a single commercial loan relationship for $3.1 million, the majority of which was recorded in the first quarter of 2009, and normal loan payments and payoffs. Commercial real estate loans increased $2.3 million to $226.2 million at September 30, 2009 from $223.9 million at December 31, 2008. Owner occupied commercial real estate loans totaled $99.1 million at September 30, 2009 and $96.3 million at December 31, 2008, while non-owner occupied commercial real estate loans totaled $127.1 million at September 30, 2009 and $127.6 million at December 31, 2008. Residential loans increased $975,000 to $99.3 million.

Nonperforming loans decreased $2.5 million to $6.3 million at September 30, 2009 compared to $8.8 million at December 31, 2008. This represented 1.33 % of total loans at September 30, 2009 and 1.83% of total loans at December 31, 2008. The decrease in nonperforming loans was related to a single commercial manufacturing relationship of $5.5 million. The business was sold in 2009 and resulted in a charge-off of $3.1 million, the majority of which was recorded in the first quarter of 2009.

The following table presents information regarding nonperforming mortgage, consumer and other loans and foreclosed real estate as of the dates indicated. All loans where the interest payment is 90 days or more in arrears as of the closing date of each month are placed on nonaccrual status. At September 30, 2009, we had $6.3 million of nonaccrual loans and no foreclosed real estate. At December 31, 2008, we had $8.8 million of nonaccrual loans and no foreclosed real estate. If all nonaccrual loans had been performing in accordance with their terms, we would have earned additional interest income of $174,000 and $200,000 for the nine months ended September 30, 2009 and the year ended December 31, 2008, respectively.

                                                               September 30, 2009       December 31, 2008
                                                                         (Dollars in thousands)
Nonaccrual real estate loans:
Residential                                                    $             1,277     $               905
Home equity                                                                    195                     239
Commercial real estate                                                       1,366                   1,460
Total nonaccrual real estate loans                                           2,838                   2,604

Other loans:
Commercial and industrial                                                    3,473                   6,195
Consumer                                                                         3                       6
Total nonaccrual consumer and other loans                                    3,476                   6,201
Total nonperforming loans                                                    6,314                   8,805
Foreclosed real estate, net                                                      -                       -
Total nonperforming assets                                     $             6,314     $             8,805
Nonperforming loans to total loans                                            1.33 %                  1.83 %
Nonperforming assets to total assets                                          0.50                    0.79

Asset growth was funded primarily through a $66.2 million increase in deposits and a $45.5 million increase in long-term debt. Total deposits increased $66.2 million to $654.2 million at September 30, 2009 from $588.0 million at December 31, 2008. The increase in deposits was due to an increase in checking accounts and regular savings accounts. Checking accounts increased $31.1 million to $165.7 million at September 30, 2009 from $134.6 million for December 31, 2008. Regular savings accounts increased $25.8 million to $93.9 million at September 30, 2009. The increases in both checking and savings accounts were primarily due to accounts which pay a higher interest rate than comparable products. Time deposit accounts increased $15.3 million to $342.9 million at September 30, 2009.

Long-term debt, which includes FHLB advances and securities sold under repurchase agreements with an original maturity of one year or more, was $218.8 million at September 30, 2009 and $173.3 million at December 31, 2008.

Stockholders' equity at September 30, 2009 and December 31, 2008 was $257.2 million and $259.9 million, respectively, which represented 20.4% of total assets as of September 30, 2009 and 23.4% of total assets as of December 31, 2008. The change in stockholders' equity is comprised of the repurchase of 758,889 shares for $6.9 million related to the stock repurchase plan and dividends declared amounting to $8.9 million. This was partially offset by $6.8 million decrease in other comprehensive loss, net income of $3.5 million and share-based compensation expense of $2.4 million.

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2009 AND SEPTEMBER 30, 2008

General

Net income was $1.2 million, or $0.04 per diluted share, for the quarter ended September 30, 2009 as compared to $2.0 million, or $0.07 per diluted share, for the same period in 2008. Net interest and dividend income was $8.2 million for the three months ended September 30, 2009 and $8.1 million for the same period in 2008.

Net Interest and Dividend Income

The following tables set forth the information relating to our average balance at, and net interest income for, the three months ended September 30, 2009 and 2008 and reflect the average yield on interest-earning assets and average cost of interest-bearing liabilities for the periods indicated. Yields and costs are derived by dividing interest income by the average balance of interest-earning assets and interest expense by the average balance of interest-bearing liabilities for the periods shown. The interest rate spread is the difference between the total average yield on interest-earning assets and the cost of interest-bearing liabilities. Net interest margin represents tax-equivalent net interest and dividend income as a percentage of average interest earning assets. Average balances are derived from actual daily balances over the periods indicated. Interest income includes fees earned from making changes in loan rates and terms and fees earned when the real estate loans are prepaid or refinanced. For analytical purposes, the interest earned on tax-exempt assets is adjusted to a tax-equivalent basis to recognize the income tax savings which facilities comparison between taxable and tax-exempt assets.

                                                             Three Months Ended September 30,
                                                     2009                                        2008
                                                                   Average                                     Average
                                      Average                      Yield /        Average                      Yield /
                                      Balance       Interest        Cost          Balance       Interest        Cost
                                                                  (Dollars in thousands)
ASSETS:
Interest-earning assets
Loans(1)(2)                         $   480,950     $   6,530          5.43 %   $   456,407     $   6,958          6.10 %
Securities(2)                           618,599         6,913          4.47         508,210         6,542          5.15
Short-term investments(3)                12,459             2          0.06          33,390           158          1.89
Total interest-earning assets         1,112,008        13,445          4.84         998,007        13,658          5.47
Total noninterest-earning assets         73,550                                      71,483
Total assets                        $ 1,185,558                                 $ 1,069,490

LIABILITIES AND EQUITY:
Interest-bearing liabilities
NOW accounts                        $    80,674           392          1.94     $    86,203           328          1.52
Savings accounts                         89,869           254          1.13          63,906           211          1.32
Money market accounts                    52,194           113          0.87          65,613           189          1.15
Time deposits                           341,443         2,462          2.88         322,038         2,823          3.51
Short-term borrowings and
long-term debt                          271,615         1,835          2.70         204,011         1,854          3.64
Total interest-bearing
liabilities                             835,795         5,056          2.42         741,771         5,405          2.91
Noninterest-bearing deposits             81,421                                      46,178
Other noninterest-bearing
liabilities                              11,270                                       8,600
Total noninterest-bearing
liabilities                              92,691                                      54,778
Total liabilities                       928,486                                     796,549
Total equity                            257,072                                     272,941
Total liabilities and equity        $ 1,185,558                                 $ 1,069,490
Less: Tax-equivalent
adjustment(2)                                            (147 )                                      (154 )
Net interest and dividend income                    $   8,242                                   $   8,099
Net interest rate spread(4)                                            2.42 %                                      2.56 %
Net interest margin(5)                                                 2.99 %                                      3.29 %

(2) Securities, loan income and net interest income are presented on a tax-equivalent basis using a tax rate of 34%. The tax-equivalent adjustment is deducted from tax-equivalent net interest and dividend income to agree to the amount reported in the statements of income.

(3) Short-term investments include federal funds sold.

(4) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities.

(5) Net interest margin represents tax-equivalent net interest and dividend income as a percentage of average interest earning assets.

The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to:

· Interest income changes attributable to changes in volume (changes in volume multiplied by prior rate);

· Interest income changes attributable to changes in rate (changes in rate multiplied by current volume); and

· The net change.

The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

                                                           Three Months Ended September 30, 2009 compared
                                                              to Three Months Ended September 30, 2008
                                                            Increase (Decrease) Due to
                                                         Volume                    Rate                   Net
                                                                       (Dollars in thousands)
Interest-earning assets
Short-term investments                               $           (99 )       $             (57 )       $    (156 )
Investment securities (1)                                      1,421                    (1,050 )             371
Loans (1)                                                        374                      (802 )            (428 )
Total interest earning assets                                  1,696                    (1,909 )            (213 )

Interest-bearing liabilities
NOW accounts                                                     (21 )                      85                64
Savings accounts                                                  86                       (43 )              43
Money market accounts                                            (39 )                     (37 )             (76 )
Time deposits                                                    170                      (531 )            (361 )
Short-term borrowing and long-term debt                          614                      (633 )             (19 )
Total interest-bearing liabilities                               810                    (1,159 )            (349 )
Change in net interest and dividend income           $           886         $            (750 )       $     136

Net interest and dividend income increased $143,000 to $8.2 million for the three months ended September 30, 2009 from $8.1 million for the same period in 2008. The net interest margin, on a tax-equivalent basis, was 2.99% for the three months ended September 30, 2009 as compared to 3.29% for the same period in 2008. Interest and dividend income, on a tax-equivalent basis, decreased $213,000 to $13.4 million for the three months ended September 30, 2009 from $13.7 million for the same period in 2008. The average yield on interest-earning assets decreased 63 basis points to 4.84% for the three months ended September 30, 2009 from 5.47% for the same period in 2008.

The decrease in interest income was partially offset by a decrease in interest expense. Interest expense decreased $349,000 to $5.1 million for the three months ended September 30, 2009 from $5.4 million for the same period in 2008. The average cost of interest-bearing liabilities decreased 49 basis points to 2.42% for the three months ended September 30, 2009 from 2.91% for the same period in 2008, as a result of the declining rate environment.

Provision for Loan Losses

The amount that we provided for loan losses during the three months ended September 30, 2009 was based upon the changes that occurred in the loan portfolio during that same period. The changes in the loan portfolio, described in detail below, include an increase in charge-offs, the continued weakening of the local and national economy. After evaluating these factors, we provided $620,000 for loan losses for the three months ended September 30, 2009, compared to $275,000 for the same period in 2008. The allowance was $7.9 million at September 30, 2009 and $6.4 million at September 30, 2008. The allowance for loan losses was 1.66% of total loans at September 30, 2009 and 1.38% at September 30, 2008.

Net charge-offs were $99,000 for the three months ended September 30, 2009. This was comprised of charge-offs of $117,000 for the three months ended September 30, 2009, partially offset by recoveries of $18,000 for the same period. Net recoveries were $6,000 for the three months ended September 30, 2008. This was comprised of charge-offs of $11,000 for the three months ended September 30, 2008, partially offset by recoveries of $17,000 for the same period.

. . .