10-K

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

FORM 10-K

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

For the Fiscal Year Ended December 31, 2008

Commission File Number 0-20050

PRINCETON NATIONAL BANCORP, INC.
(Exact name of registrant as specified in its charter)

Delaware	36-32110283
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
606 South Main Street
Princeton, Illinois	61356-2080
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (815) 875-4444

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

Title of each class	Name of each exchange on which registered
Common Stock	The Nasdaq
	Stock Market
Preferred Share
Purchase Rights

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

Indicate by check mark if the registrant is a well-known season issuer, as defined in Rule 405 of the Securities Act.	Yes	o	No	x
Indicate by check mark if the registrant is not required to file reports pursuant to Sections 13 or 15(d) of the Act.	Yes	o	No	x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.	Yes	x	No	o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.		o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer	o	Accelerated filer	x
Non-accelerated filer	o	Smaller reporting company	o
(do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).	Yes	o	No	x
At March 3, 2009, 3,298,041 shares of Common Stock, $5.00 Par Value, were outstanding, and the aggregate market value of the common stock (based upon the closing representative bid price of the common stock on June 30, 2008 of $27.24, the last business day of the Registrant’s most recently completed second quarter, as reported by NASDAQ) held by nonaffiliates was approximately $89,838,637.
Determination of stock ownership by nonaffiliates was made solely for the purpose of responding to this requirement and the registrant is not bound by this determination for any other purpose.
Portions of the following documents are incorporated by reference:
2009 Notice and Proxy Statement for the Annual Meeting of Stockholders April 28, 2009 (the “Proxy Statement”) - Part III and portions of the Corporation’s 2008 Annual Report (the “Annual Report”) - Part II

Page 1 of 70 pages

PART I

Item 1. Business

          Princeton National Bancorp, Inc. (“PNBC”, the “Corporation”, or the “Company”) is a single-bank holding company which operates in one business segment conducting a full-service banking and trust business through its subsidiary bank, Citizens First National Bank (“Citizens Bank”, “the Bank”, or the “subsidiary bank”). PNBC was incorporated as a Delaware corporation in 1981 in contemplation of the acquisition of all of the outstanding common stock of Citizens Bank and other future acquisitions. At December 31, 2008, the Corporation had consolidated total assets of $1,163,130,000 and stockholders’ equity of $72,471,000.

          PNBC operates the Bank as a community bank with offices located for convenience and with professional, highly-motivated, progressive employees who know the Bank’s customers and provide individualized, quality service. As part of its community banking approach, officers of the Bank actively participate in community organizations. In addition, within certain credit and rate of return parameters, the subsidiary bank strives to meet the lending needs of the communities in which offices are located and invests in local municipal securities.

          Corporate policy, strategy and goals are established by the Board of Directors of PNBC. Pursuant to PNBC’s holding company philosophy, operational and administrative policies for the Bank are also established at the holding company level. Within this framework, the Bank focuses on providing personalized services and quality products to its customers to meet the needs of the communities in which its offices are located. In 2008, the majority of the directors of PNBC also served as the directors of Citizens Bank, which further assists PNBC to directly implement its policies at Citizens Bank.

Acquisition and Expansion Strategy

          PNBC seeks to diversify both its market area and asset base and increase profitability through acquisitions and expansion. PNBC’s goal, as reflected by its acquisition policy, is to expand through the acquisition of established financial service organizations (primarily commercial banks to the extent suitable candidates may be identified) and by expanding into potential high-growth areas. In integrating acquisitions, PNBC focuses on, among other actions, implementing the policies established at Citizens Bank, improving asset quality, the net interest margin, and encouraging community involvement. In 2007, PNBC acquired the Plainfield office of HomeStar Bank and in 2005, PNBC acquired Somonauk FSB Bancorp, Inc. and its subsidiary, Farmers State Bank, with branches in Somonauk, Millbrook, Newark and Sandwich (subsequently merged into Citizens Bank).

          PNBC will also consider establishing branch facilities as a means of expanding its presence into new market areas. PNBC opened new branch facilities in the Peru/LaSalle/Oglesby area in 1994, in Minooka in 1994, Hampshire in 1995, Henry in 1999, Huntley in 2001, Plano in 2005 and Aurora in 2006. Several of these locations, along with the Plainfield office, are located in rapidly growing communities that will provide significant loan and deposit growth opportunities, as well as increased revenue potential.

Citizens First National Bank

          Citizens Bank was organized in 1865 as a national banking association under the National Bank Act. Currently in its one hundred and forty-fourth year, Citizens Bank has twenty-one offices in seventeen different communities in north central Illinois: Aurora, DePue, Genoa, Hampshire, Henry, Huntley, Millbrook, Minooka, Newark, Oglesby, Peru, Plainfield, Plano, Princeton, Sandwich, Somonauk, and Spring Valley.

          Citizens Bank serves individuals, businesses and governmental bodies in Bureau, DeKalb, Grundy, Kane, Kendall, LaSalle, Marshall, McHenry, Will and contiguous counties. Citizens Bank operates a full-service community commercial bank and trust business that offers a broad range of financial services to customers. Citizens Bank’s services consist primarily of commercial, real estate and agricultural lending, consumer deposit and financial services, and trust, brokerage, insurance, and farm management services.

Commercial, Real Estate, and Agricultural Lending

          Citizens Bank’s commercial loan department provides secured and to a much lesser extent unsecured loans, including real estate loans, to companies and individuals for business purposes and to governmental units within the Bank’s market area. As of December 31, 2008, Citizens Bank had commercial loans of $225.8 million (28.5% of the Bank’s total loan portfolio) and commercial real estate loans of $182.7 million (23.1% of the Bank’s total loan portfolio). Citizens Bank does not have a concentration of commercial loans in any single industry or business, except for loans to the agricultural industry as more fully disclosed below.

          Agricultural and agricultural real estate loans are primarily related to ventures near our branch locations. As of December 31, 2008, Citizens Bank had agricultural loans of $79.5 million and agricultural real estate loans of $64.2 million, which represent approximately 10.1% and 8.1%, respectively, of the Bank’s total loan portfolio.

          Agricultural loans, many of which are secured by crops, machinery, and real estate, are provided to finance capital improvements and farm operations as well as acquisitions of livestock and machinery. The subsidiary bank’s agricultural loan department has the equivalent of five lending officers and works closely with all agricultural customers, including companies and individual farmers, assisting in the preparation of budgets and cash flow projections for the ensuing crop year. These budgets and cash flow projections are monitored closely by the Bank during the year. In addition, Citizens Bank works closely with governmental agencies, including the Farm Service Agency, to assist agricultural customers in obtaining credit enhancement products, such as loan guaranties.

          In accordance with its loan policy, Citizens Bank maintains a diversified loan portfolio. As part of its loan policy and community banking approach, Citizens Bank does not buy loan syndications with other lending institutions. Citizens Bank does buy and sell loan participations with other community banks. In connection with its credit relationships, Citizens Bank encourages commercial and agricultural borrowers to maintain deposit accounts at the Bank.

Personal Financial Services

          The principal consumer services offered by Citizens Bank are demand, savings and time deposit accounts, home mortgage loans, installment loans, and brokerage services.

          One of the strengths of Citizens Bank is the stability of its retail deposit base. This stability is due primarily to the Bank’s service oriented competitive strategy and the economically diverse populations of the counties encompassing the twenty-one banking offices. These locations provide convenience for customers and visibility for Citizens Bank. A variety of marketing strategies are used to attract and retain stable depositors, the most important of which is the officer call program. Nearly all officers of the Bank call on customers and potential customers of the Bank to maintain and develop relationships.

           Citizens Bank is active in consumer and mortgage lending with approximately $132.1 million in home mortgage loans (16.7 % of the Bank’s total loan portfolio) and $75.1 million in consumer installment loans (9.5% of the Bank’s total loan portfolio) as of December 31, 2008. To better serve its retail customers, Citizens Bank is active in the secondary residential mortgage market. As a matter of policy,

Citizens Bank does not hold, in portfolio, long term, fixed rate, single-family home mortgage loans, however, the servicing of such loans is maintained. As of December 31, 2008, Citizens Bank had $304.6 million of loans that have been sold, but servicing has been maintained. Management believes customers receive a higher level of quality service with this arrangement. Citizens Bank does not have any sub-prime loans in its loan portfolio, or as underlying collateral in its investment portfolio.

          Citizens Bank maintains twenty-five automated teller machines. The Bank is a member of ACCEL/Exchange and NYCE as well as other major nationwide networks such as, CIRRUS and PLUS. To enhance customer service and convenience, Citizens Bank offers ATM & Debit Cards, which can be used anywhere VISA is accepted, and is viewed as a tremendous benefit to our customers. Citizens Bank also offers an entire host of Internet Banking services including Bill Pay as an additional and convenient alternative delivery mechanism for its product and service line.

          Citizens Bank continues to maintain an intensive sales training program, which includes team coaching, setting goals, measuring results, and reward recognition. In 2008, Citizens Bank continued to focus on making quality product referrals and sales.

Citizens Financial Advisors (“CFA”)

          CFA’s Fiduciary and Investment Services departments both faced significant equity and bond market challenges with the nearly 34% decline in the Dow Jones Industrial Average during 2008. Never-the-less, CFA was able to exceed their budgeted 2008 net income goals by a remarkable 13.9%.

          For the second year in a row, Fiduciary Services was able to add two new outstanding staff members to the team, thereby improving on the professional capabilities of the program. Another legally trained, Kent College of Law, officer was hired to fulfill the role of Business Development Officer and a Master of Human Resources officer was hired to oversee the Corporate and Personal Retirement Plans area. These two well trained officers have already brought significant improvements to their areas of responsibility.

          Although the stock markets had an exceedingly bad year, Fiduciary Services did not allow the markets to restrict their results. Through their diligent efforts, $19,436,000 in net new dollars was added to the Assets Under Management (AUM) by the department.

          Due to the excellent performance of the Relationship Managers and the Business Development Officer, Fiduciary Services completed the year with a 1.5% increase in total income to $1,530,000. However, since the department was able to decrease direct and indirect expense by 5.9% and 3.15%, respectively, Fiduciary Services exceeded 2007 net income levels by an impressive 23.5%.

          Similarly, Investment Services (Brokerage) experienced an exceptional year regardless of the market declines. Due to the purposeful shift in financial recommendations that was emphasized to the organizations clients, gross revenue received was $913,000 in 2008, comparable to $920,000 in 2007.

          Brokerage, in the final month of the year, was also able to fill the Client Advisor position created to better service the Eastern Region branches of Aurora, Plainfield, Plano and Minooka. The new Advisor is a very well trained specialist in Financial Planning coming from the Ameriprise program. Although he is new the expectations are high that he will bring a new dimension of profitability to the Eastern Region in 2009.

Competition

          PNBC is committed to community banking and to providing quality products and services at competitive loan rates and deposit pricing in order to remain competitive in its North Central Illinois market. Citizens Bank competes with both small, locally owned banks, as well as regional financial institutions which have numerous offices. The Bank competes with these organizations, as well as with savings and loan associations, credit unions, mortgage companies, insurance companies and other local financial institutions for deposits, loans and other business. The principal methods of competition include loan and deposit pricing, the types and quality of services provided, as well as advertising and marketing programs.

Supervision and Regulation

          Bank holding companies and banks are extensively regulated under federal and state law. The following information describes certain statutes and regulations affecting PNBC and the Bank, and such discussion is qualified in its entirety by reference to such statutes and regulations. Any change in applicable law or regulations may have a material effect on the business of PNBC and the Bank.

          PNBC is registered as a bank holding company with the Board of Governors of the Federal Reserve System (the “FRB”), and is subject to supervision by the FRB under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). PNBC is required to file with the FRB periodic reports and such additional information as the FRB may require pursuant to the BHC Act. The FRB examines PNBC.

          The BHC Act requires prior FRB approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all the assets of any bank or bank holding company, or for a merger or consolidation of a bank holding company with another bank holding company. With certain exceptions, the BHC Act prohibits a bank holding company from acquiring direct or indirect ownership or control of voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or performing services for its authorized subsidiaries. A bank holding company may, however, engage in or acquire an interest in a company that engages in activities which the FRB has determined by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

          In November 1999, the Gramm-Leach-Bliley Act (“GLB Act”) was signed into law. Under the GLB Act, bank holding companies that meet certain standards and elect to become “financial holding companies” are permitted to engage in a wider range of activities than those permitted for bank holding companies, including securities and insurance activities. Specifically, a bank holding company that elects to become a financial holding company may engage in any activity that the FRB, in consultation with the Secretary of the Treasury, determines is (i) financial in nature or incidental thereto, or (ii) complementary to any such financial-in-nature activity, provided that such complementary activity does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. A bank holding company may elect to become a financial holding company only if each of its depository institution subsidiaries is well-capitalized, well-managed, and has a Community Reinvestment Act rating of “satisfactory” or better at their most recent examination.

          The GLB Act specifies many activities that are financial in nature, including lending, exchanging, transferring, investing for others, or safeguarding money or securities; underwriting and selling insurance; providing financial, investment, or economic advisory services; underwriting, dealing in, or making a market in securities; and those activities currently permitted for bank holding companies that are so closely related to banking or managing or controlling banks, as to be a proper incident thereto. PNBC has not elected to be treated as a financial holding company.

          The GLB Act changed federal laws to facilitate affiliation between banks and entities engaged in securities and insurance activities. The law also established a system of functional regulation under which banking activities, securities activities, and insurance activities conducted by financial holding companies and their subsidiaries and affiliates will be separately regulated by banking, securities, and insurance regulators, respectively.

          PNBC is a legal entity separate and distinct from the Bank. The major source of PNBC’s revenue is dividends received from the Bank. The right of PNBC to participate as a stockholder in any distribution of assets of the Bank upon its liquidation or reorganization or otherwise is subject to the prior claims of creditors of the Bank. The Bank is subject to claims by creditors for long-term and short-term debt obligations, including obligations for federal funds purchased and securities sold under repurchase agreements, as well as deposit liabilities. The Bank is subject to regulation and examinations by the Office of Comptroller of the Currency (the “OCC”).

          The Bank may declare dividends out of undivided profits, except that until the surplus fund of the Bank is equal to its common capital, no dividend can be declared until one-tenth of the Bank’s net income for the applicable period has been carried to the surplus fund. The Bank, however, cannot declare or pay a dividend, if after making the dividend, the Bank would be undercapitalized. In addition, prior approval of the OCC is required if dividends declared by the Bank in any calendar year will exceed its net income for that year combined with its retained net income for the preceding two years. Under national banking regulations and capital guidelines, as of December 31, 2008, the Bank was authorized to distribute approximately $10,702,000 as dividends without prior approval from the OCC, based on net income for 2008 and retained net income for 2006 and 2007. As of January 1, 2009, retained net income for the prior two years was approximately $7,141,000 and during 2009 the Bank may pay dividends without prior approval from the OCC equal to that amount plus any 2009 net income. Future payments of dividends by the Bank will be dependent on individual regulatory capital requirements and levels of profitability. The ability of the Bank to pay dividends may be further restricted as a result of regulatory policies and guidelines relating to dividend payments and capital adequacy.

          Federal laws limit certain transactions between the Bank and its affiliates, including PNBC. Such transactions include loans or extensions of credit by the Bank to PNBC, the purchase of assets or securities of PNBC, the acceptance of PNBC’s securities as collateral for loans, and the issuance of a guaranty, acceptance or letter of credit on behalf of PNBC. Transactions of this kind are limited to 10% of the Bank’s capital and surplus for transactions with one affiliate, and 20% of the Bank’s capital and surplus for transactions with all affiliates. Such transactions are also subject to certain collateral requirements. These transactions, as well as other transactions between the Bank and PNBC, must also be on terms substantially the same as, or at least as favorable as, those prevailing at the time for comparable transactions with nonaffiliated companies or, in the absence of comparable transactions, on terms, or under circumstances, including credit standards, that would be offered to, or would apply to, nonaffiliated companies.

          FRB policy requires PNBC to act as a source of financial strength to the Bank and commit resources to support the Bank. The FRB takes the position that in implementing this policy, it may require PNBC to provide such support when PNBC otherwise would not consider itself able to do so.

          The various federal bank regulators, including the FRB and the OCC, have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards establish minimum capital standards in relation to assets and off-balance sheet exposures, as adjusted for credit risks. Capital is classified into two tiers. For bank holding companies, Tier 1 or “core” capital consists of common shareholders’ equity, perpetual preferred stock (subject to certain limitations) and minority interests in the equity accounts of consolidated subsidiaries, and is reduced by goodwill and certain other intangible assets (“Tier 1 Capital”). Tier 2 capital consists of (subject to certain conditions and

limitations) the allowance for possible credit losses, perpetual preferred stock, “hybrid capital instruments,” perpetual debt and mandatory convertible debt securities, and term subordinated debt and intermediate-term preferred stock (“Tier 2 Capital”). Total capital is the sum of Tier 1 Capital and Tier 2 Capital (the latter being limited to 100% of Tier 1 Capital). Components of Tier 1 and Tier 2 Capital for national banks are similar, but not identical, to those for holding companies.

          Under the risk-adjusted capital standards, a minimum ratio of qualifying total capital to risk-weighted assets of 8% and of Tier l Capital to risk-weighted assets of 4% is required. The FRB and OCC also have adopted a minimum leverage ratio of Tier 1 Capital to total assets of 3% for banks rated “1” under the Uniform Financial Institutions Rating System or bank holding companies rated “1” under the rating system of bank holding companies. All other banks and bank holding companies must maintain a leverage ratio of 4%. In addition, all banks and bank holding companies are expected to have capital commensurate with the level and nature of all risks to which they are exposed.

           At December 31, 2008, PNBC had a total capital to risk-weighted assets ratio of 8.30%, a Tier 1 capital to risk-based assets ratio of 7.72%, and a leverage ratio of 6.22%. PNBC is classified as adequately capitalized for the first ratio and well-capitalized for the last two ratios. At December 31, 2008, the Bank had a total capital to risk-weighted assets ratio of 10.00%, a Tier 1 capital to risk-weighted assets ratio of 9.42%, and a leverage ratio of 7.59%. The Bank is classified as well-capitalized for all three ratios.

          Currently, the Bank’s deposits are insured by the Deposit Insurance Fund, which is administered by the Federal Deposit Insurance Corporation (“the FDIC”). The Deposit Insurance Fund was created by the Federal Deposit Insurance Reform Act of 2005 (the “FDIRA”), which merged the Bank Insurance Fund (“BIF”) with the Savings Association Insurance Fund (“SAIF”) during 2006. Deposit accounts are generally insured up to a maximum of $100,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. Effective October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) raised the basic limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. This increase is effective on a temporary basis until December 31, 2009.

          Following the adoption of the FDIRA, the FDIC has the opportunity, through its rulemaking authority, to better price deposit insurance for risk than was previously authorized. The FDIC adopted regulations effective January 1, 2007 that created a system of risk-based assessments. Under the regulations there are four risk categories, and each insured institution is assigned to a risk category based on capital levels and supervisory ratings. Well-capitalized institutions with CAMELS composite ratings of 1 or 2 are placed in Risk Category I while other institutions are placed in Risk Categories II, III or IV depending on their capital levels and CAMELS composite ratings. The assessment rates may be changed by the FDIC as necessary to maintain the insurance fund at the reserve ratio designated by the FDIC, which currently is 1.25% of insured deposits. The FDIC may set the reserve ratio annually at between 1.15% and 1.50% of insured deposits. Deposit insurance assessments are collected for a quarter at the end of the next quarter. Assessments are based on deposit balances at the end of the quarter, except institutions with $1 billion or more in assets and institutions that become insured on or after January 1, 2007 will have their assessment base determined using average daily balances of insured deposits.

          As of September 30, 2008, the reserve ratio of the deposit insurance fund fell to 0.76%. On October 7, 2008, the FDIC established a restoration plan to restore the reserve ratio to at least 1.15% within five years (effective February 27, 2009 the FDIC extended this time to seven years) and proposed rules increasing the assessment rate for deposit insurance and making adjustments to the assessment system. On December 16, 2008, the FDIC adopted and issued a final rule increasing the rates banks pay for deposit insurance uniformly by 7 basis points (annualized) effective January 1, 2009. Under the final rule, risk-based rates for the first quarter 2009 assessment will range between 12 and 50 basis points (annualized). The 2009 first quarter assessment rates established by the FDIC provide that the highest rated institutions, those in Risk Category I, will pay premiums of between 12 and 14 basis points and the lowest rated institutions, those in Risk Category IV, will pay premiums of 50 basis points. On February 27, 2009, the FDIC adopted a

final rule amending the way that the assessment system differentiates for risk and setting new assessment rates beginning with the second quarter of 2009. Beginning April 1, 2009, for the highest rated institutions, those in Risk Category I, the initial base assessment rate will be between 12 and 16 basis points and for the lowest rated institutions, those in Risk Category IV, the initial base assessment rate will be 45 basis points. The final rule modifies the means to determine a Risk Category I institution’s initial base assessment rate. It also provides for the following adjustments to an institution’s assessment rate: (1) a decrease for long-term unsecured debt, including most senior and subordinated debt and, for small institutions, a portion of Tier 1 capital; (2) an increase for secured liabilities above a threshold amount; and (3) for institutions in risk categories other than Risk Category I, an increase for brokered deposits above a threshold amount. After applying these adjustments, for the highest rated institutions, those in Risk Category I, the total base assessment rate will be between 7 and 24 basis points and for the lowest rated institutions, those in Risk Category IV, the total base assessment rate will be between 40 and 77.5 basis points.

          On February 27, 2009, the FDIC also adopted an interim rule, with a request for comments, that imposes an emergency special assessment of up to 20 basis points of an institution’s assessment base on June 30, 2009, which will be collected on September 30, 2009. This interim rule also provides for possible additional special assessments of up to 10 basis points at the end of any calendar quarter whenever the FDIC estimates that the deposit insurance fund reserve ratio will fall to a level that the FDIC believes would adversely affect public confidence or to a level close to zero or negative.

          On November 21, 2008, the FDIC adopted final regulations implementing the Temporary Liquidity Guarantee Program (“TLGP”) pursuant to which depository institutions could elect to participate. Pursuant to the TLGP, the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008 and before June 30, 2009 (the “Debt Guarantee”), and (ii) provide full FDIC deposit insurance coverage for non-interest bearing deposit transaction accounts regardless of dollar amount for an additional fee assessment by the FDIC (the “Transaction Account Guarantee”). These accounts are mainly payment-processing accounts, such as business payroll accounts. The Transaction Account Guarantee will expire on December 31, 2009. Participating institutions will be assessed a 10 basis point surcharge on the portion of eligible accounts that exceeds the general limit on deposit insurance coverage.

          Coverage under the TLGP was available to any eligible institution that did not elect to opt out of the TLGP on or before December 5, 2008. The Bank opted out of the Transaction Account Guarantee portion of the TLGP. PNBC and the Bank did not opt out of the Debt Guarantee program.

          Effective November 17, 2006, the FDIC implemented a one-time credit of $4.7 billion to eligible institutions. The purpose of the credit was to recognize contributions made by certain institutions to capitalize the BIF and SAIF, which have now been merged into the Deposit Insurance Fund. The Bank was an eligible institution and received notice from the FDIC that its share of the credit is $647,000. This amount was not reflected in the accompanying financial statements as it represented contingent future credits against future insurance assessment payments. In 2008 and 2007, FDIC premium credits received totaled $266,000 and $381,000, respectively, against the premium expense, leaving no remaining credit as of December 31, 2008, to offset future premium expense.

          All FDIC-insured depository institutions must pay a quarterly assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds (commonly referred to as FICO bonds) were issued to capitalize the Federal Savings and Loan Insurance Corporation.

          Federal law permits adequately capitalized and adequately managed bank holding companies to acquire banks across state lines, without regard to whether the transaction is prohibited by state law. Any state law relating to the minimum age of target banks (not to exceed five years) or limits on the amount of deposits that may be controlled by a single bank or bank holding company applies. The FRB is not permitted to approve any acquisition if, after the acquisition, the bank holding company would control more

than 10% of the deposits of insured depository institutions nationwide or 30% or more of the deposits in the state where the target bank is located. The FRB could approve an acquisition, notwithstanding the 30% limit, if the state waives the limit either by state regulation or order of the appropriate state official.

          Banks are permitted to merge with one another across state lines and thereby create a main bank with branches in separate states. After establishing branches in a state through an interstate merger transaction, a bank can establish and acquire additional branches at any location in the state where any bank involved in the merger could have established or acquired branches under applicable federal or state law. In addition, the laws of some states, including Illinois, permit a bank with its main office in another state to establish de novo branches or to acquire a branch of another bank without acquiring the entire bank. Therefore, if the laws of another state so permit, the Bank could establish a de novo branch or acquire a branch of a bank in such state, even if the laws of such state require a reciprocal provision.

          PNBC does not have current plans to acquire banking organizations located outside the state of Illinois.

          National banks may establish operating subsidiaries to engage in activities in which the bank could engage directly.

          National banks are also authorized by the GLB Act to engage, through “financial subsidiaries,” in activities that are permissible for financial holding companies and activities that the Secretary of the Treasury, in consultation with the FRB, determines are financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company portfolio investments, and (iv) merchant banking. A national bank’s authority to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank be well-managed and well-capitalized (after deducting from capital the bank’s outstanding investment in financial subsidiaries).

          The GLB Act affected many other changes to federal law applicable to PNBC and the Bank. One of these changes was a requirement that financial institutions take steps to protect customers’ “nonpublic personal information.”

          Pursuant to EESA, the U.S. Department of the Treasury (the “Treasury”) has the authority to among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Pursuant to its authority under EESA, the Treasury created the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”) under which the Treasury was authorized to invest in non-voting, senior preferred stock of U.S. banks and savings associations or their holding companies.

          PNBC elected to participate in the CPP and on January 23, 2009, PNBC completed the sale of $25.1 million of preferred stock to the Treasury. PNBC issued and sold (1) 25,083 shares of Fixed Rate Cumulative Perpetual Preferred Stock Series B, with a liquidation preference of $1,000 per share (the “Series B Preferred Shares”), and (2) a ten-year warrant (the “Warrant”) to purchase up to 155,025 shares of the PNBC’s common stock (“Common Stock”) at an exercise price of $24.27 per share, or an aggregate purchase price of $3.8 million in cash. Cumulative dividends on the Series B Preferred Shares will accrue at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter.

          The securities purchase agreement, dated January 23, 2009 (the “Purchase Agreement”), between PNBC and the Treasury, pursuant to which the Series B Preferred Shares and the Warrant were sold, limits the payment of dividends on the Common Stock to the current quarterly cash dividend of $0.28 per share, limits PNBC’s ability to repurchase its Common Stock, and subjects PNBC to certain of the executive compensation limitations included in the EESA.

          The restrictions on stock repurchases are in effect until the earlier to occur of January 23, 2012 (the third anniversary of the issuance of the Series B Preferred Shares to the Treasury) or the date on which the Company has redeemed all of the Series B Preferred Shares issued or the date on which the Treasury has transferred all of the Series B Preferred Shares to third parties not affiliated with the Treasury.

          As a condition to the closing of the transaction, each of PNBC’s senior executive officers (as defined in the Purchase Agreement) executed a waiver voluntarily waiving any claim against the Treasury or PNBC for any changes to their compensation or benefits, as required to comply with the regulations issued by the Treasury under the TARP CPP. The senior executive officers also acknowledged that the regulations may require modification of the compensation, bonus, incentive and other benefit plans, arrangements and policies and agreements (including so-called “golden parachute” agreements) as they relate to the period the Treasury holds any securities of PNBC acquired through the CPP.

          In addition to EESA, on February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. The ARRA contains numerous provisions which modify EESA and which require additional rule making by various regulatory bodies. Among other things, ARRA sets forth additional limits on executive compensation at all financial institutions receiving federal funds under EESA, including the CPP, both retroactively and prospectively. The executive compensation restrictions in ARRA, which will be further described in rules and regulations to be established, include among others: limits on compensation incentives, prohibitions on “Golden Parachute Payments”, the establishment by publicly registered CPP recipients of a board compensation committee comprised entirely of independent directors for the purpose of reviewing employee compensation plans, and the requirement of a non-binding vote on executive pay packages at each annual shareholder meeting until the government funds are repaid. The precise impact of ARRA and the rules promulgated under it will become known in the coming months.

Employees

          PNBC presently has no employees. However, certain of the employees and executive officers of Citizens Bank provide their services to PNBC. An annual fee for these services is paid by PNBC to Citizens Bank. This fee is based upon an average of the number of hours worked during the year.

          As of December 31, 2008, Citizens Bank employed 273 full-time and 81 part-time employees. The Bank offers a variety of employee benefits. Citizens Bank employees are not represented by a union or a collective bargaining agreement, and employee relations are considered to be excellent.

          Citizens Bank believes one of its strengths is its ability to attract and retain experienced and well-trained personnel who are knowledgeable of the market areas in which it operates. Management believes that PNBC generally has an easier time attracting and retaining quality employees than other banks in North Central Illinois. This is due primarily to its size and management style, which affords greater opportunities to employees for direct participation and development of managerial and banking skills.

          In order to implement PNBC’s community banking philosophy and to promote itself as a community oriented organization, the Bank has a formal officer call program. Nearly every officer of the Bank calls on existing or potential customers and is expected to become actively involved in leadership positions in community organizations. As of December 31, 2008, officers and employees of the Bank participated in approximately 500 community organizations, providing over 15,400 hours of community service.

Available Information

          Our Internet address is www.citizens1st.com. There we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our SEC reports can be accessed through the investor relations section of our Web site.

The information found on our Web site is not part of this or any other report we file with or furnish to the SEC.

          You may also read and copy materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site (www.sec.gov) that contains reports, proxy statements and other information that we electronically file with the SEC.

Item 1A. Risk Factors

          An investment in PNBC’s common stock is subject to risks inherent to the Corporation’s business. An investor should carefully consider the risks described below and information contained in this Annual Report on Form 10-K together with all of the other information incorporated by reference before deciding to purchase PNBC common stock. The risks and uncertainties described below are not the only ones facing the Corporation. Additional risks and uncertainties that management is not aware of or focused on or deems immaterial may arise or become material in the future and affect PNBC’s business. If any of these risks actually occur, PNBC’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of PNBC common stock could decrease significantly.

PNBC’s concentration of agricultural loans is subject to risks that could adversely affect earnings.

          PNBC’s agricultural and agricultural real estate loan portfolio total $143.7 million at December 31, 2008, comprising 18.2% of total loans. The primary risks associated with agricultural loans are weather and borrower’s management. In the event of catastrophic weather conditions, such as severe drought or flooding, these loans would represent a higher risk due to poor crop sales and reduced cash flow that could impact the borrowers’ ability to repay the loan on a timely basis.

Changes in interest rates could adversely impact the financial condition and results of operations.

          PNBC’s ability to make a profit, like that of most financial institutions, substantially depends upon its net interest income. However, certain assets and liabilities may react differently to changes in market interest rates. In a period of changing rates, interest expense may increase at different rates than the interest earned. Accordingly, changes in interest rates could decrease net interest income.

The allowance for loan losses may not be sufficient to cover actual loan losses decreasing earnings.

          In determining the appropriate level of allowance for loan losses, management considers, among other things, the overall composition of the loan portfolio, types of loans, past loss experience, loan delinquencies, potential substandard and doubtful loans, underlying collateral, and other factors that, in management’s best judgment, deserve evaluation. Although management monitors the allowance monthly and considers it adequate to absorb probable losses at December 31, 2008, if any of the assumptions are incorrect, the allowance may not be sufficient to cover future loan losses. Future adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio. Consequently, a problem with one or more loans could require the Corporation to significantly increase the level of its provision for loan losses resulting in a reduction of earnings.

A sustained weakness or weakening in business and economic conditions generally or specifically in the markets in which we do business could adversely affect our business and operating results.

          Our business could be adversely affected to the extent that weaknesses in business and economic conditions have direct or indirect impacts on us or on our customers and counterparties. These conditions could lead, for example, to one or more of the following:

• A decrease in the demand for loans and other products and services offered by us;

• A decrease in customer savings generally and in the demand for savings and investment products offered by us; and

• An increase in the number of customers and counterparties who become delinquent, file for protection under bankruptcy laws, or default on their loans or other obligations to us.

          An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs, provision for credit losses, and valuation adjustments on loans held for sale.

If our stock price declines from levels at December 31, 2008, we will further evaluate our goodwill balances for impairment, and if the values of our businesses have declined, we could recognize an impairment charge for our goodwill.

          We performed an annual goodwill impairment assessment as of December 31, 2008. Based on our analyses, we concluded that the fair value of our reporting units exceeded the fair value of our assets and liabilities and, therefore, goodwill was not considered impaired. The estimated control premium was determined by a review of premiums paid for similar companies over the past five years. It is possible that our assumptions and conclusions regarding the valuation of our lines of business could change adversely, which could result in the recognition of impairment for our goodwill, which could have a material effect on our financial position and future results of operations.

If the Bank or holding company were unable to borrow funds through access to capital markets, we may not be able to meet the cash flow requirements of our depositors, creditors, and borrowers, or the operating cash needed to fund corporate expansion and other corporate activities.

          Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. The liquidity of the Bank is used to make loans and leases and to repay deposit liabilities as they become due or are demanded by customers. Liquidity policies and limits are established by the subsidiary bank’s Funds Management Committee and approved annually by the Board of Directors. The Funds Management Committee regularly monitors the overall liquidity position of the Bank and the parent company to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity. The Funds Management Committee also establishes policies and monitors guidelines to diversify the Bank’s wholesale funding sources to avoid concentrations in any one market source. Wholesale funding sources include Federal funds purchased; securities sold under repurchase agreements; non-core deposits; and medium- and long-term debt. The Bank is also a member of the Federal Home Loan Bank of Chicago (FHLB), which provides funding through advances to members that are collateralized with mortgage-related assets.

          We maintain a portfolio of securities that can be used as a secondary source of liquidity. There are other sources of liquidity available to us should they be needed. These sources include the sale or securitization of loans, the ability to acquire additional national market, non-core deposits, issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common securities in public or private transactions. The Bank also can apply to borrow from the Federal Reserve’s discount window.

          Starting in the middle of 2007, there has been significant turmoil and volatility in worldwide financial markets which is, at present, ongoing. These conditions have resulted in a disruption in the liquidity of financial markets, and could directly impact us to the extent we need to access capital markets to raise funds to support our business and overall liquidity position. This situation could affect the cost of such funds or our ability to raise such funds. If we were unable to access any of these funding sources when needed, we might be unable to meet customers’ needs, which could adversely impact our financial condition, results of operations, cash flows, and level of regulatory-qualifying capital.

The Internal Controls of PNBC may not be effective.

          Management reviews and tests on a quarterly basis its system of internal controls, disclosure controls and procedures, and corporate governance polices and procedures. Any system of internal controls, however well designed, is based on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are actually being met. Any failure or circumvention of these controls could have a material adverse effect on the Corporation’s financial condition and results of operations.

There is competition within the PNBC market areas which may limit growth and profitability.

          Because the banking business is highly competitive, PNBC faces significant competition both in originating loans and attracting deposits. Competition can not only be affected by the pricing of loans and deposits, but also by the variety of products offered. The ability of the Corporation to continue to grow in the markets served while effectively managing interest rate risk is contingent upon being able to operate in this competitive environment, which ultimately affects the Corporation’s profitability.

The success of PNBC is dependent on hiring and retaining key personnel.

          PNBC’s performance is largely dependent on the talents and efforts of highly skilled individuals. The Corporation relies on key personnel to manage and operate its business and the loss of any of these individuals may adversely affect the Corporation’s ability to maintain and/or manage the business effectively. This could have a material adverse effect on the Corporation’s financial condition and results of operations.

PNBC operates in a highly regulated environment.

          PNBC is subject to extensive regulation, supervision and examination. Any changes in the regulations or applicable laws and the failure of the Corporation to comply with any of the regulations and laws could have a material adverse effect on the Corporation’s financial condition and results of operations.

Item 1B. Unresolved Staff Comments

          None.

Item 2. Properties

          PNBC’s headquarters and Citizens Bank’s principal offices are located at 606 South Main Street, Princeton, Illinois. Also located at this address is an annex building completed in 1990. The two buildings at this location are owned by Citizens Bank and contain approximately 36,000 square feet of space, all of which is occupied by PNBC and Citizens Bank. Citizens Bank also has two drive-up facilities in Princeton and branch offices in Aurora, DePue, Genoa, Hampshire, Henry, Huntley, Millbrook, Minooka, Newark, Oglesby, Peru, Plainfield, Plano, Sandwich, Somonauk and Spring Valley. Citizens Bank is the owner of

each of these facilities. None of the facilities owned by the Bank are subject to a mortgage. Additionally, the mortgage banking department of the Bank is located in Spring Valley in a separate location from the branch office. This location is not owned by the Bank and is rented by lease agreement. For additional information regarding these properties, see Footnote 6 of Item 8 of this report.

Item 3. Legal Proceedings

          The Bank is subject to legal proceedings and claims that arise in the ordinary course of business. Although management of the Corporation cannot predict the ultimate outcome of such matters, it believes that the ultimate resolution of these matters will not have a material adverse effect on the Corporation, the Bank, or the Corporation’s financial position, liquidity, and results of operations.

Item 4. Submission of Matters to a Vote of Security Holders

          No matters were submitted to a vote of the security holders during the fourth quarter of 2007.

Supplemental Item - Executive Officers

          The following table sets forth information regarding the executive officers:

Name	Age	Position
Tony J. Sorcic	55	President & Chief Executive Officer
James B. Miller	53	Executive Vice President & Commercial Banking Officer
Todd D. Fanning	46	Senior Vice President & Chief Financial Officer
Jacqualyn L. Karlosky	48	Senior Vice President – Consumer Banking
Patrick Murray	56	Senior Vice President – Citizens Financial Advisors

          Tony J. Sorcic has been President and Chief Executive Officer of PNBC since January, 1997, and first became a director of PNBC in 1986. He joined Citizens Bank in 1981 as Assistant Vice President of Operations and became Executive Vice President in 1986. Mr. Sorcic was named President and Chief Executive Officer of Citizens Bank in 1995.

          James B. Miller joined Citizens Bank in 1979 as an agricultural loan officer and has been the Executive Vice President of PNBC since 1996. Mr. Miller currently is the Executive Vice President and Commercial Banking Manager of Citizens Bank.

          Todd D. Fanning joined Citizens Bank in 1990 as Assistant Vice President & Controller and has been the Chief Financial Officer of PNBC since 1997. Mr. Fanning currently is the Senior Vice-President & Chief Financial Officer of Citizens Bank.

          Jacqualyn L. Karlosky joined Citizens Bank in 1994 as Assistant Vice President & Branch Manager. Ms. Karlosky became Senior Vice President – Consumer Banking in 2002 and remains in that capacity.

          Patrick Murray joined Citizens Bank in 2004 as Senior Vice President in charge of Citizens Financial Advisors and remains in that capacity.

PART II

Item 5. Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securties

          (a) Since May 15, 1992, PNBC’s Common Stock has been listed on the NASDAQ Stock Market, under the symbol PNBC.

          The table below indicates the high and low bid prices, and the dividends declared per share for PNBC Common Stock during the periods indicated. The prices shown reflect interdealer prices and do not include retail markups, markdowns, or commissions which may not necessarily represent actual transactions.

					Cash Dividends Declared
	Prices
	High		Low
2008
Fourth Quarter	$	26.00	$	22.05	$	.28
Third Quarter		28.95		24.78		.28
Second Quarter		29.75		26.00		.28
First Quarter		29.73		23.56		.28
2007
Fourth Quarter	$	27.81	$	23.04	$	.27
Third Quarter		29.07		26.11		.27
Second Quarter		31.36		27.58		.27
First Quarter		33.72		30.00		.27

          On December 31, 2008, PNBC had 785 registered holders of record of its Common Stock.

          The holders of the Common Stock are entitled to receive such dividends as are declared by the Board of Directors of PNBC, which considers payment of dividends quarterly. The ability of PNBC to pay dividends is dependent upon receipt of dividends from the Bank. In determining cash dividends, the Board of Directors considers the earnings, capital requirements, debt servicing requirements, financial ratio guidelines established by the Board, the financial condition of PNBC and other relevant factors. The Bank’s ability to pay dividends to PNBC is subject to regulatory restrictions. See “Supervision and Regulation.”

          PNBC has paid regular cash dividends on the Common Stock since it commenced operations in 1982. PNBC currently anticipates that cash dividends comparable to those that have been paid in the past will continue to be paid in the future. There can be no assurance, however, that any such dividends will be paid by PNBC or that such dividends will not be reduced or eliminated in the future. The timing and amount of dividends will depend upon the earnings, capital requirements, and financial condition of PNBC and the Bank as well as the general economic conditions and other relevant factors affecting PNBC and the Bank. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

(c) The following table provides information about purchases of the Corporation’s common stock by the Corporation during the quarter ended December 31, 2008:

Period	(a) Total number of shares purchased	(b) Average price paid per share			(c) Total number of shares purchased as part of a publicly announced plans or programs (1)	(d) Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
10/1/08 – 10/31-08	0		$	0.00	0	20,000
11/1-08 – 11/30-08	0		$	0.00	0	20,000
12/1-08 – 12/31/08	0		$	0.00	0	20,000
Total	0		$	0.00	0	20,000

(1) On April 24, 2007, the Board of Directors approved the repurchase of up to an aggregate of 50,000 shares of our common stock pursuant to a repurchase program announced the same day (“the Program”). The original expiration date of this Program was April 24, 2008, but was extended to October 24, 2008 by the Board of Directors at their meeting held on April 28, 2008. On October 27, 2008, the Board of Directors approved a new 50,000 share repurchase program that will expire on October 27, 2009. Unless terminated earlier by resolution of our Board of Directors, the Program will expire on the earlier of such expiration date or when we have repurchased all shares authorized for repurchase under the Program.

          The performance graph required by item 201(e) of Regulation S-K is incorporated by reference from Page 49 of the Corporation’s Annual Report.

Item 6. Selected Financial Data

          Information regarding the Corporation’s selected financial data is included on page 47 of the Corporation’s Annual Report, which information is incorporated by reference herein.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

          Information regarding the Corporation’s management’s discussion and analysis of financial condition and results of operations is included on pages 34-46 in the Corporation’s Annual Report, which information is incorporated by reference herein.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

          The information required by Item 305 of Regulation S-K is contained in the Corporation’s Annual Report on pages 42-44, under the headings “Asset Liability Management” and “Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements”, which information is incorporated herein by reference.

Item 8. Consolidated Financial Statements and Supplementary Data

          Information regarding the Corporation’s consolidated financial statements and supplementary data is included on pages 9-32 and page 46 in the Corporation’s Annual Report, which information is incorporated by reference herein.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

          None.

Item 9A. 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 December 31, 2008. 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. Tony J. Sorcic, President and Chief Executive Officer, and Todd D. Fanning, Senior Vice President and Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, Messrs. Sorcic and Fanning 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 December 31, 2008 that could significantly affect those controls.
	The reports required by Item 308 of Regulation S-K are attached hereto as Exhibits 99.1 and 99.2 respectively, and are incorporated herein by reference.

Item 9B. Other Information

          None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

          Certain information regarding executive officers of the Corporation is included as a Supplementary Item at the end of Part I of this Form 10-K.

          Information regarding executive officers and directors of the Corporation and the Corporation’s Audit Committee is included in the Corporation’s Definitive Proxy Statement for the Annual Meeting of Stockholders to be held April 28, 2009 (the “Proxy Statement”) under the captions “Proposal 1-Election of Directors” and “Board of Directors’ Meetings and Committees”, which information is incorporated by reference herein.

          Information regarding compliance with Section 16(a) of the Exchange Act is included in the Proxy Statement under the caption “Section 16(a) Beneficial Ownership Compliance Reporting”, which information is incorporated by reference herein.

          Information regarding the Corporation’s Code of Ethics is included in the Proxy Statement under the caption “Code of Ethics”, which information is incorporated by reference herein.

          Information regarding an Audit Committee Financial Expert is included in the Proxy Statement under the caption “Audit Committee Financial Expert”, which information is incorporated by reference herein.

Item 11. Executive Compensation

          Information regarding executive compensation is included in the Proxy Statement under the captions “Board of Directors’ Meetings and Committees”, “Compensation of Directors”, “Executive Compensation”, “Compensation Discussion and Analysis”, “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report”, which information is incorporated by reference herein.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters

          Information regarding security ownership is included in the Proxy Statement under the captions “Security Ownership of Directors, Nominees for Director, Most Highly Compensated Executive Officers and All Directors and Executive Officers as a Group” and “Security Ownership of Certain Beneficial Owners,” which information is incorporated by reference herein.

Equity Compensation Plan Information

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities in column (a))
	(a)		(b)			(c)
Equity compensation plans approved by security holders		460,061		$	27.53		252,923
Equity compensation plans not approved by security holders		N/A			N/A		4,758	(1)
Total		460,061		$	27.53		257,681

(1) Represents shares issuable under the Company’s Amended and Restated Employee Stock Purchase Plan (the “ESPP”). The ESPP is a broad-based plan which was originally adopted by the Company in October, 1994 and has been amended and restated to increase the number of shares issuable under the ESPP to the current maximum of 80,000 shares. Under the ESPP, eligible employees and

directors may purchase PNBC common stock without incurring any brokerage commissions or service charges using lump sum contributions and/or payroll deductions, in the case of employees.

Item 13. Certain Relationships and Related Transactions, and Director Independence

          Information regarding relationships and transactions is included in the Proxy Statement under the captions “Certain Transactions” and “Board of Directors’ Meetings and Committees,” which information is incorporated by reference herein.

Item 14. Principal Accountant Fees and Services

          Information regarding principal accountant fees and services is included in the Proxy Statement under the caption “Audit Committee Report”, which information is incorporated by reference herein.

Item 15. Exhibits and Financial Statement Schedules

(a)(1)	The following is a list of the Financial Statements included in Part II, Item 8 of this report:
		Report of Independent Registered Public Accounting Firm
		Consolidated Balance Sheets as of December 31, 2008 and 2007.
		Consolidated Statements of Income for the years ended December 31, 2008, 2007 and 2006.
		Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2008, 2007, and 2006.
		Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007, and 2006.
		Notes to Consolidated Financial Statements.
(a)(2)	Financial Statement Schedules
		No consolidated financial statement schedules are required to be included in this Report on Form 10-K.
(a)(3)	Exhibits
	The exhibits filed herewith are listed on the Exhibit Index filed as part of this report on Form 10-K. Each management contract or compensatory plan or arrangement of the Corporation listed on the Exhibit Index is separately identified by an asterisk.

SIGNATURES

          Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registration has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

PRINCETON NATIONAL BANCORP, INC.
By.	/s/ Tony J. Sorcic
	Tony J. Sorcic, President and Chief Executive Officer
Date:  March 16, 2009

          Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Tony J. Sorcic	President and Chief Executive Officer and Director
	(Principal Executive Officer)
Tony J. Sorcic
/s/ Todd D. Fanning	Senior Vice-President & Chief Financial Officer
	(Principal Accounting and Financial Officer)
Todd D. Fanning
/s/ Craig O. Wesner	Chairman of the Board
Craig O. Wesner
/s/ Daryl Becker	Director
Daryl Becker
s/ Gretta E. Bieber	Director
Gretta E. Bieber
/s/ Gary C. Bruce	Director
Gary C. Bruce
/s/ Sharon L. Covert	Director
Sharon L. Covert
	Director
John R. Ernat
/s/ Donald E. Grubb	Director
Donald E. Grubb
	Director
Mark Janko
	Director
Willard Lee
	Director
Ervin I. Pietsch
/s/ Stephen W. Samet	Director
Stephen W. Samet

INDEX TO EXHIBITS

Exhibit
Number			Exhibit
	3.1	Amended and Restated Certificate of Incorporation of Princeton National Bancorp, Inc. (“PNBC”) (incorporated by reference to Exhibit 4.1 to the PNBC Registration Statement on Form S-3 (Registration No. 333-157451).
	3.2	By-Laws of PNBC (incorporated by reference to Exhibit 3.2 of the 2007 PNBC Annual Report on Form 10-K).
	4.1	Certificate of Designation of Series A Junior Participating Preferred Stock (incorporated by reference from Registration Statement on Form 8-A filed by PNBC on August 1, 2003 (File No. 000-20050)) incorporated by reference to Exhibit 4.1 of the 2004 PNBC Annual Report on Form 10-K).
	4.2	Certificate of Designations of Series B Preferred Stock (incorporated by reference from Exhibit 3.1 to Form 8-K filed on January 27, 2009).
	4.3	Trust Preferred Securities Indenture (incorporated by reference to Exhibit 4.1 to PNBC Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
	4.4	Warrant to purchase up to 155,025 shares of Common Stock issued January 23, 2009 (incorporated by reference from Exhibit 4.1 to the Form 8-K filed on January 29, 2009).
	10.1*	Employment Agreement, dated as of December 15, 2008 between PNBC and James B. Miller (incorporated by reference to the 8-K filed by PNBC on December 19, 2008).
	10.2*	Employment Agreement, dated as of December 15, 2008, between PNBC and Tony J. Sorcic (incorporated by reference to the 8-K filed by PNBC on December 19, 2008).
	10.3*	Citizens First National Bank Profit Sharing Plan, as amended and restated January 1, 1989 (incorporated by reference to Exhibit 10.4 to the S-1 Registration Statement (33-46362)).
	10.4*	Citizens First National Bank Defined Contribution Plan and Trust, as amended and restated January 1, 1989 (incorporated by reference to Exhibit 10.5 to the S-1 Registration Statement).
	10.5*	Princeton National Bancorp, Inc. Stock Option Plan (incorporated by reference from Schedule 14A filed by PNBC on March 6, 1998).
	10.6*	Princeton National Bancorp, Inc. Deferred Compensation Plan (incorporated by reference to Exhibit 10.6 of the 2001 PNBC Annual Report on Form 10-K).
	10.7*	Princeton National Bancorp, Inc. 2005 Deferred Compensation Plan, as amended (incorporated by reference from Form 8-K filed on December 19, 2008).
	10.8*	Princeton National Bancorp, Inc. Management Incentive Compensation Plan (incorporated by reference to Exhibit 10.7 of the 2001 PNBC Annual Report on Form 10-K).

10.9*	Princeton National Bancorp, Inc. 2003 Stock Option Plan (incorporated by reference from Schedule 14A filed by PNBC on March 19, 2003).
10.10*	Form of Stock Option Agreement (incorporated by reference to Exhibit 10.9 of the 2004 PNBC Annual Report on Form 10-K).
10.11*	Amendment to Stock Option Agreement (incorporated by reference to Exhibit 10.10 of the 2005 PNBC Annual Report on Form 10-K).
10.12	Trust Preferred Securities Purchase Agreement (incorporated by reference to Exhibit 10.1 to PNBC Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.13	Trust Preferred Securities Declaration of Trust (incorporated by reference to Exhibit 10.2 to PNBC Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.14	Trust Preferred Securities Guarantee Agreement (incorporated by reference to Exhibit 10.3 to PNBC Quarterly Report on Form 10-Q for the quarter ended September 30, 2005).
10.15*	2007 Stock Compensation Plan (incorporated by reference from Schedule 14A filed by PNBC on March 14, 2007).
10.16	Letter Agreement with U.S. Treasury dated January 23, 2009 including Securities Purchase Agreement (incorporated by reference from Form 8-K filed on January 29, 2009).
13	Portions of 2008 Annual Report to Shareholders.
14	Code of Ethics (incorporated by reference to Exhibit 14 of the 2003 PNBC Annual Report on Form 10-K).
21	Subsidiaries of PNBC.
23.1	Consent of BKD, LLP.
31.1	Certification of Tony J. Sorcic required by Rule 13a-14(a).
31.2	Certification of Todd D. Fanning required by Rule 13a-14(a).
32.1	Certification of Tony J. Sorcic required by Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
32.2	Certification of Todd D. Fanning required by Rule 13a-14(b) and Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
99.1	Report of Management on Internal Control Over Financial Reporting
99.2	Report of Independent Registered Public Accounting Firm

*   Management contract or compensatory plan.

EX-13

Exhibit 13

Report of Independent Registered Public Accounting Firm

The Audit Committee, Board Of Directors and Stockholders
Princeton National Bancorp, Inc.

We have audited the accompanying consolidated balance sheets of Princeton National Bancorp, Inc. and subsidiary (“the Corporation”) as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the two-year period ended December 31, 2008. The Corporation’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Princeton National Bancorp, Inc. as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Princeton National Bancorp, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 9, 2009 expressed an unqualified opinion on the effectiveness of the Corporation’s internal control over financial reporting.

As discussed in Note 16, in 2008 the Company changed its method of accounting for fair value measurements in accordance with Statement of Financial Accounting Standards No. 157.

As discussed in Note 15, in 2008 the Company changed its method of accounting for split-dollar life insurance policies in accordance with Emerging Issues Task Force Issue No. 06-4.

Decatur, Illinois

March 9, 2009

9

Consolidated Balance Sheets
(dollars in thousands except share data)

	December 31
	2008			2007
ASSETS
Cash and due from banks	$	20,163		$	25,801
Interest-bearing deposits with financial institutions		98			1,803
Total cash and cash equivalents		20,261			27,604
Loans held-for-sale, at lower of cost or market		2,155			928
Investment securities:
Available-for-sale, at fair value		236,883			213,997
Held-to-maturity, at amortized cost (fair value of $14,461 and $14,799)		14,232			14,578
Total investment securities		251,115			228,575
Loans:
Loans, net of unearned interest		790,837			722,647
Allowance for loan losses		(5,064	)		(3,248	)
Net loans		785,773			719,399
Premises and equipment, net of accumulated depreciation		29,297			30,801
Land held for sale, at lower of cost or market		2,354			1,344
Federal Reserve and Federal Home Loan Bank stock		4,211			4,098
Bank-owned life insurance		21,588			22,461
Accrued interest receivable		9,693			10,876
Other real estate owned		2,487			833
Goodwill		24,521			24,521
Intangible assets, net of accumulated amortization		4,207			5,090
Other assets		5,468			4,172
TOTAL ASSETS	$	1,163,130		$	1,080,702
LIABILITIES
Deposits:
Demand	$	110,559		$	102,452
Interest-bearing demand		246,714			241,749
Savings		61,089			58,401
Time		543,770			488,805
Total deposits		962,132			891,407
Borrowings:
Customer repurchase agreements		35,532			34,217
Federal funds purchased		6,500			26,500
Interest-bearing demand notes issued to the U.S. Treasury		2,441			1,838
Advances from the Federal Home Loan Bank		32,493			6,984
Trust preferred securities		25,000			25,000
Note payable		16,050			14,550
Total borrowings		118,016			109,089
Other liabilities		10,511			11,599
TOTAL LIABILITIES		1,090,659			1,012,095
STOCKHOLDERS’ EQUITY
Common stock: $5 par value, 7,000,000 shares authorized: 4,478,295 shares issued at December 31, 2008 and 2007		22,391			22,391
Surplus		18,420			18,275
Retained earnings		54,329			51,279
Accumulated other comprehensive income, net of tax		1,402			344
Less: cost of 1,180,254 and 1,169,848 treasury shares at December 31, 2008 and 2007, respectively		(24,071	)		(23,682	)
TOTAL STOCKHOLDERS’ EQUITY		72,471			68,607
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,163,130		$	1,080,702

See accompanying notes to consolidated financial statements.

10

Consolidated Statements of Income
(dollars in thousands except share data)

	For the Years Ended December 31
	2008		2007		2006
Interest and dividend income:
Interest and fees on loans	$	47,715	$	49,982	$	41,923
Interest and dividends on investment securities:
Taxable		6,834		6,822		6,370
Tax-exempt		4,148		4,302		4,620
Interest on federal funds sold		71		332		499
Interest on interest-bearing deposits in other banks		54		121		114
Total interest income		58,822		61,559		53,526
Interest expense:
Interest on deposits		23,782		30,324		23,843
Interest on borrowings		3,519		4,181		3,787
Total interest expense		27,301		34,505		27,630
Net interest income		31,521		27,054		25,896
Provision for loan losses		2,968		640		285
Net interest income after provision for loan losses		28,553		26,414		25,611
Non-interest income:
Trust & farm management fees		1,530		1,507		1,467
Service charges on deposit accounts		4,408		4,431		4,235
Other service charges		2,137		1,966		1,782
Gain on sales of securities available-for-sale		405		541		250
Gain on sales of loans		-0-		-0-		90
Brokerage fee income		913		920		736
Mortgage banking income, net		1,069		903		755
Bank-owned life insurance income		874		816		770
Other operating income		257		214		160
Total non-interest income		11,593		11,298		10,245
Non-interest expense:
Salaries and employee benefits		17,692		16,874		15,884
Occupancy		2,559		2,393		1,985
Equipment expense		2,996		3,158		2,933
Federal insurance assessments		845		338		313
Intangible assets amortization		714		704		651
Data processing		1,151		1,101		1,032
Advertising		742		722		841
Other operating expense		4,424		4,275		4,696
Total non-interest expense		31,123		29,565		28,335
Income before income taxes		9,023		8,147		7,521
Income tax expense		1,697		1,377		1,033
Net income	$	7,326	$	6,770	$	6,488
Earnings per share:
Basic	$	2.22	$	2.04	$	1.93
Diluted	$	2.21	$	2.03	$	1.91
Basic weighted average shares outstanding		3,297,990		3,326,467		3,369,567
Diluted weighted average shares outstanding		3,314,439		3,334,406		3,389,765

See accompanying notes to consolidated financial statements.

11

Consolidated Statements of Changes in Stockholders’ Equity
(dollars in thousands except share data)

	Common Stock			Surplus		Retained Earnings			Accumulated Other Comprehensive Income (Loss) net of tax effect			Treasury Stock			Total
Balance, January 1, 2006	$	22,392		$	16,968	$	45,786		$	(482	)	$	(21,520	)	$	63,144
Net income							6,488									6,488
Sale of 2,202 shares of treasury stock					32								38			70
Purchase of 60,000 shares of treasury stock													(2,024	)		(2,024	)
Exercise of stock options and re-issuance of treasury stock (62,766 shares)					1,157		(623	)					1,163			1,697
Adjustment for fractional shares		(1	)		1
Cash dividends ($1.05 per share)							(3,542	)								(3,542	)
Other comprehensive income, net of $90 tax effect										144						144
Adjustment to initially apply FAS 158, net of $393 tax effect										(622	)					(622	)
Balance, December 31, 2006	$	22,391		$	18,158	$	48,109		$	(960	)	$	(22,343	)	$	65,355
Net income							6,770									6,770
Sale of 6,537 shares of treasury stock					63								112			175
Purchase of 50,000 shares of treasury stock													(1,459	)		(1,459	)
Exercise of stock options and re-issuance of treasury stock (500 shares)					7		(3	)					8			12
Cash dividends ($1.08 per share)							(3,597	)								(3,597	)
Amortization of unearned compensation expense					47											47
Other comprehensive income, net of $825 tax effect										1,304						1,304
Balance, December 31, 2007	$	22,391		$	18,275	$	51,279		$	344		$	(23,682	)	$	68,607
Net income							7,326									7,326
Sale of 4,894 shares of treasury stock					40								84			124
Purchase of 20,000 shares of treasury stock													(553	)		(553	)
Exercise of stock options and re-issuance of treasury stock (4,700 shares)					21								80			101
Cash dividends ($1.12 per share)							(3,696	)								(3,696	)
Amortization of unearned compensation expense					84											84
Adjustment to initially apply EITF 06-4							(580	)								(580	)
Other comprehensive income, net of $660 tax effect										1,058						1,058
Balance, December 31, 2008	$	22,391		$	18,420	$	54,329		$	1,402		$	(24,071	)	$	72,471

See accompanying notes to consolidated financial statements

12

Consolidated Statements of Cash Flows
(dollars in thousands)

	For the Years Ended December 31
	2008			2007			2006
Operating activities:
Net income	$	7,326		$	6,770		$	6,488
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		2,219			2,482			2,304
Provision for loan losses		2,968			640			285
Deferred income tax benefit		(602	)		(466	)		(916	)
Amortization of intangible assets and other purchase accounting adjustments, net		714			704			651
Amortization (accretion) of premiums on investment securities, net		56			(217	)		107
Gain on sales of securities available-for-sale, net		(405	)		(541	)		(250	)
Compensation expense for vested stock options		84			47			-0-
Gain on sales of loans		-0-			-0-			(90	)
Loss (gain) on sales of other real estate owned, net		2			47			122
FHLB Stock dividends		-0-			-0-			(24	)
Loans originated for sale		(77,851	)		(56,791	)		(56,864	)
Proceeds from sales of loans originated for sale		76,624			60,375			54,939
(Decrease) increase in accrued interest payable		(669	)		530			1,513
Decrease (increase) in accrued interest receivable		1,183			348			(2,425	)
Increase in other assets		(398	)		(1,465	)		(1,804	)
(Decrease) increase in other liabilities		(1,066	)		466			(1,737	)
Net cash provided by operating activities		10,185			12,929			2,299
Investing activities:
Proceeds from sales of investment securities available-for-sale		38,499			17,455			8,904
Proceeds from maturities of investment securities available-for-sale		53,568			63,876			40,247
Purchase of investment securities available-for-sale		(112,754	)		(44,431	)		(64,954	)
Proceeds from maturities of investment securities held-to-maturity		2,100			3,108			2,370
Purchase of investment securities held-to-maturity		(1,944	)		(2,237	)		(2,025	)
Proceeds from sales of other real estate owned		891			410			377
Proceeds from sales of loan portfolios		-0-			-0-			19,579
Net increase in loans		(71,668	)		(77,600	)		(67,241	)
Purchase of premises and equipment		(1,725	)		(1,457	)		(4,562	)
Purchase of Federal Home Loan and Federal Reserve Bank stock		(113	)		(141	)		(613	)
Payments related to acquisitions, net of cash and cash equivalents acquired		-0-			(10,182	)		-0-
Net cash used in investing activities		(93,146	)		(51,199	)		(67,918	)
Financing activities:
Net increase (decrease) in deposits		70,725			(3,369	)		83,310
Net increase (decrease) in short-term borrowings		(18,082	)		28,877			1,148
Proceeds from borrowings		33,000			6,050			2,200
Repayment of borrowings		(6,001	)		-0-			(1,800	)
Dividends paid		(3,696	)		(3,597	)		(3,542	)
Purchase of treasury stock		(553	)		(1,459	)		(2,024	)
Exercise of stock options and issuance of treasury stock		101			12			1,697
Sales of treasury stock		124			175			70
Net cash provided by financing activities		75,618			26,689			81,059
(Decrease) increase in cash and cash equivalents		(7,343	)		(11,581	)		15,440
Cash and cash equivalents at beginning of year		27,604			39,185			23,745
Cash and cash equivalents at end of year	$	20,261		$	27,604		$	39,185
Cash paid during the year for:
Interest	$	27,970		$	33,975		$	26,117
Income taxes	$	3,123		$	1,817		$	1,267
Supplemental disclosure of non-cash flow activities:
Loans transferred to other real estate owned	$	2,547		$	1,290		$	31
Land transferred to held-for-sale	$	1,010		$	1,344		$	-0-

See accompanying notes to consolidated financial statements.

13

Notes to Consolidated Financial Statements
(dollar amounts in thousands except share data)

1. Summary of Significant Accounting Policies

          The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and conform with general practices within the banking industry. A description of the significant accounting policies follows:

          Nature of Operations - Princeton National Bancorp, Inc. (“the Corporation”) is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary, Citizens First National Bank (“the Bank “ or “subsidiary bank”). The Bank is primarily engaged in providing a full range of banking and financial services to individual and corporate customers located primarily in North Central Illinois. The Bank is subject to competition from other financial institutions. The Bank is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.

          Basis of Consolidation - The consolidated financial statements of the Corporation include the accounts of the Corporation and its wholly-owned subsidiary, Citizens First National Bank. Intercompany accounts and transactions have been eliminated in consolidation. The Corporation, through the subsidiary bank, operates in a single segment engaging in general retail and commercial banking.

          Use of Estimates - In order to prepare the Corporation’s consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make certain estimates that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates may differ from actual results.

          Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, fair value measurements of investment securities, income tax accruals and deferrals, and in the evaluation of impairment of goodwill, and mortgage servicing rights. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held-for-sale, management obtains independent appraisals for significant properties. In connection with goodwill, management obtains an independent appraisal of the fair value of Corporation stock. In connection with the mortgage servicing rights and investment securities, management obtains an independent analysis of the fair value of the assets.

          Investment Securities - Investment securities which the Corporation has the positive intent and ability to hold to maturity are classified as held-to-maturity and recorded at amortized cost. The Corporation does not have a trading portfolio. All other investment securities that are not classified as held-to-maturity are classified as available-for-sale. Investment securities available-for-sale are recorded at fair value, with any changes in fair value reflected as a separate component of stockholders’ equity, net of related tax effects. Gains and losses on the sale of securities are determined using the specific identification method. Premiums and discounts on investment securities are amortized or accreted over the contractual lives of those securities. The method of amortization or accretion results in a constant effective yield on those securities (the interest method). Any security for which there has been other than temporary impairment of value is written down to its estimated market value through a charge to earnings.

          Federal Reserve and Federal Home Loan Bank Stock - The subsidiary bank held Federal Home Loan Bank and Federal Reserve Bank stock totaling $2,373 and $1,838 at December 31, 2008, and $2,373 and $1,725 at December 31, 2007 respectively. During the third quarter of 2007, the Federal Home Loan Bank of Chicago received 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 and redemptions 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 2008. Management performed an analysis and deemed the investment in Federal Home Loan Bank stock was not impaired as of December 31, 2008 or December 31, 2007.

          Loans - Loans are stated at the principal amount outstanding, net of unearned interest and allowance for loan losses. Interest on commercial, real estate and certain installment loans is credited to operations as earned, based upon the principal amount outstanding. Interest on other installment loans is credited to operations using a method which approximates the interest method. Loan origination fees are recognized to income, and loan origination costs are charged to expense, as incurred. The impact of the cash basis of accounting for loan fees and costs is not materially different from the deferral basis.

          It is the subsidiary bank’s policy to discontinue the accrual of interest on any loan when, in the opinion of management, full and timely payment of principal and interest is not expected, or principal and interest is due and remains unpaid for 90 days or more, unless the loan is both well-secured and in the process of collection. Interest on these loans is recorded as income only when the collection of principal has been assured and only to the extent interest payments are received.

          Impaired loans are measured based on current information and events, if it is probable the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Certain groups of small-balance homogeneous loans, which are collectively evaluated for impairment and are generally represented by consumer and residential mortgage loans and loans held-for-sale, are not analyzed individually for impairment. The Corporation generally identifies impaired loans within the non-accrual and restructured commercial and commercial real estate portfolios on an individual loan-by-loan basis. The measurement of impaired loans is generally based on the fair value of the related collateral.

          Allowance for Loan Losses - The allowance for loan losses is increased by provisions charged to operating expense and decreased by charge-offs, net of recoveries, and is available to absorb probable losses on loans. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

          The allowance is based on factors that include overall composition of the loan portfolio, types of loans, past loss experience, loan delinquencies, watchlist, substandard and doubtful credits, and such other factors that, in management’s best judgment, deserve evaluation in estimating loan losses.

          In addition, various regulatory agencies, as an integral part of their examination process, periodically review the subsidiary bank’s allowance for loan losses. Such agencies may require the subsidiary bank to recognize additions to the allowance for loan losses based on their judgments of information available to them at the time of their examination.

          Sales of First Mortgage Loans and Loan Servicing - The subsidiary bank sells certain first mortgage loans on a non-recourse basis. The total cost of these loans is allocated between loans and servicing rights, based on the relative fair value of each. Loan servicing fees are recognized to income, and loan servicing costs are charged to expense, as incurred. Loans held-for-sale are stated at the lower of aggregate cost or market. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets.

          The Corporation recognizes as a separate asset the rights to service mortgage loans for others. Mortgage servicing rights are recorded at the lower of cost or market value and are included in other assets in the consolidated balance sheets. Mortgage servicing rights are amortized in proportion to the amount of principal received on loans serviced. The amortization of capitalized mortgage servicing rights is reflected in the consolidated statements of income as a reduction to mortgage banking income. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. For purposes of measuring impairment, the rights are stratified based on the predominant risk

14

characteristics of the underlying loans. The predominant characteristic currently used for stratification is type of loan. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair value.

          Premises and Equipment - Premises and equipment are carried at cost, less accumulated depreciation. Depreciation is computed on the straight-line basis over the estimated useful lives of the assets, as follows: buildings, fifteen to forty years; furniture and equipment, three to fifteen years. The carrying amounts of assets sold or retired and the related accumulated depreciation are eliminated from the accounts, and any resulting gains or losses are reflected in income.

          Goodwill and Intangible Assets - The Corporation has goodwill from business combinations, identifiable intangible assets assigned to core deposit relationships and customer lists acquired. Identifiable intangible assets generally arise from branches acquired that the Corporation accounted for as purchases. Such assets consist of the excess of the purchase price over the fair value of net assets acquired, with specific amounts assigned to core deposit relationships and customer lists primarily related to insurance agency. Intangible assets are amortized by the straight-line method over various periods up to fifteen years. Management reviews intangible assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

          Other Real Estate - Other real estate represents assets to which the subsidiary bank has acquired legal title in satisfaction of indebtedness. Such real estate is recorded at the lower of cost or fair market value at the date of acquisition, less estimated selling costs. Any deficiency, at the date of transfer, is charged to the allowance for loan losses. Subsequent declines in value, based on changes in market conditions, are recorded to expense as incurred. Gains or losses on the disposition of other real estate are recorded to the income statement in the period in which they are realized.

          Income Taxes - Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using currently enacted tax rates. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are recognized subject to management’s judgment that realization is more likely than not.

          Trust Assets – Assets held in fiduciary or agency capabilities are not included in the consolidated balance sheets since such items are not assets of the Corporation. Fees from trust activities are recorded on an accrual basis over the period in which the service is provided. Fees are a function of the market value of assets managed and administered, the volume of transactions, and fees for other services rendered, as set forth in the underlying client agreement with fiduciary services. This revenue recognition involves the use of estimates and assumptions, including components that are calculated based on estimated asset valuations and transaction volumes. Generally, the actual trust fee is charged to each account on a monthly prorated basis. Any out of pocket expenses or services not typically covered by the fee schedule for trust activities are charged directly to the trust account on a gross basis as trust revenue is incurred. The Corporation manages or administers 966 trust accounts with assets totaling approximately $174,753 at December 31, 2008 and 1,014 trust accounts with assets totaling approximately $197,702 at December 31, 2007.

          Treasury Stock – Treasury stock is stated at cost. Cost is determined by the first-in, first-out method.

          Earnings Per Share – Earnings per share have been computed based upon the weighted average common shares outstanding during each year.

          Cash Flows - The Corporation considers all liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2008 and 2007, cash equivalents consisted primarily of non-interest bearing cash accounts. The financial institution holding the Corporation’s cash accounts is participating in the FDIC’s Transaction Account Guarantee Program. Under that program, through December 31, 2009, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account.

          Reclassification - Certain amounts in the 2007 and 2006 consolidated financial statements have been reclassified to conform to the 2008 presentation. These reclassifications had no effect on net income.

          Stock Options - At December 31, 2008 and 2007, the Corporation has a share-based employee compensation plan, which is described more fully in Note 14. The Corporation accounts for this plan under the recognition and measurement principles of Statement of Financial Accounting Standards No. 123R (FAS 123R), Share-Based Payment. The number of shares of common stock authorized under the stock option plans is 802,500. The exercise price must be at least 100% of the fair market value of the common stock on the date of the grant, and the option term cannot exceed ten years.

          Fair Value Measurements - The Corporation records certain of its assets and liabilities at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are classified within one of three levels in a valuation hierarchy based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

Level 1 -	inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 -	inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 -	inputs to the valuation methodology are unobservable and significant to the fair value measurement. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

          Impact of New Accounting Standards - In September 2006, the FASB issued Statement No. 157. This Statement establishes a common definition for fair value to be applied to GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007. The Corporation adopted FAS 157 effective January 1, 2008. The financial impact of this pronouncement was not material to the Corporation’s consolidated financial statements.

          In February 2008, the FASB issued two Staff Positions (FSPs) on Statement No. 157: FSP 157-1 “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13,” and FSP 157-2, “Effective Date of FASB Statement No. 157.” FSP 157-1 excludes fair value measurements related to leases from the disclosure requirements of Statement No. 157. FSP 157-2 delays the effective date of Statement No. 157 for all non-recurring fair value measurements of nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. The Corporation is applying the deferral guidance in FSP 157-2, and accordingly, has not applied the non-recurring disclosure to non-financial assets or non-financial liabilities valued at fair value on a non-recurring basis.

          In October 2008, the FASB issued FASB Staff Position No. 157-3 (FSP 157-3), “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.” FSP 157-3 clarifies the application of Statement of Financial Accounting Standards No. 157 (FAS 157), “Fair Value Measurements,” in a market that is not active and provides an example to illustrate key considerations in determining fair value of financial assets when the market for that financial asset is not active. FSP 157-3 applies to financial assets within the scope of accounting pronouncements that require or permit fair value measurements in accordance with FAS 157. FSP 157-3 was effective upon issuance and included prior periods for which financial statements had not been issued. The application of FSP 157-3 did not have a material impact on the Corporation’s consolidated financial statements.

15

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

          In February 2007, the FASB issued SFAS No. 159 (FAS 159), “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115”. FAS 159 allows companies to report selected financial assets and liabilities at fair value. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately in the balance sheet. The main intent of the Statement is to mitigate the difficulty in determining reported earnings caused by a “mixed-attribute model” (or reporting some assets at fair value and others using a different valuation attribute such as amortized cost). The project is separated into two phases. This first phase addresses the creation of a fair value option for financial assets and liabilities. A second phase will address creating a fair value option for selected non-financial items. FAS 159 is effective for all financial statements issued for fiscal years beginning after November 15, 2007. The Corporation has not elected the fair value option for any financial assets or liabilities at December 31, 2008.

          In December 2007, the FASB issued SFAS No. 141R (FAS 141R), “Business Combinations”, which revises FAS 141 and changes multiple aspects of the accounting for business combinations. Under the guidance in FAS 141R, the acquisition method must be used, which requires the acquirer to recognize most identifiable assets acquired, liabilities assumed, and non-controlling interests in the acquiree at their full fair value on the acquisition date. Goodwill is to be recognized as the excess of the consideration transferred plus the fair value of the non-controlling interest over the fair values of the identifiable net assets acquired. Subsequent changes in the fair value of contingent consideration classified as a liability are to be recognized in earnings, while contingent consideration classified as equity is not to be re-measured. Costs such as transaction costs are to be excluded from acquisition accounting, generally leading to recognizing expense and additionally, restructuring costs that do not meet certain criteria at acquisition date are to be subsequently recognized as post-acquisition costs. FAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Corporation is currently evaluating the impact that this issuance will have on its financial position and results of operations; however, it anticipates that the standard will lead to more volatility in the results of operations during the periods subsequent to an acquisition.

          In March 2008, the FASB issued SFAS No. 161 (FAS 161), “Disclosures About Derivative Instruments and Hedging Activities – an amendment of FAS 133”. FAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. FAS 161 is effective for fiscal years beginning after November 15, 2008. The Corporation does not expect the implementation of FAS 161 to have a material impact on its consolidated financial statements.

          The FASB issued Statement No. 162 in 2008. FAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). This Statement became effective on November 15, 2008. The impact of adoption was not material to the Corporation’s consolidated financial statements.

          In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) About Transfers of Financial Assets and Interests in Variable Interest Entities. This FSP amends the disclosure guidance in Statement No. 140 and Interpretation No. 46 (revised December 2003). The FSP requires public entities to provide additional disclosures about transfers of financial assets and their involvement with variable interest entities. The application of FSP did not have a material impact on the Corporation’s consolidated financial statements.

          In January 2009, the FASB issued FSP EITF 99-20-1, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20. FSP EITF 99-20-1 amends the impairment guidance in EITF Issue No. 99-20 in order to achieve more consistent determination of whether an other-than-temporary impairment (OTTI) has occurred. Prior to the FSP, the impairment model in EITF 99-20 was different from FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. This FSP amended EITF 99-20 to more closely align the OTTI guidance therein to the guidance in Statement No. 115. Retrospective application to a prior interim or annual period is prohibited. The guidance in this FSP was considered in the assessment of OTTI for various securities at December 31, 2008.

          In December 2007 the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (FAS 160). The Statement requires that noncontrolling interests in subsidiaries be initially measured at fair valued and classified as a separate component of equity. The Statement is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this new Statement will not have a material impact on the Corporation’s consolidated financial statements.

2. Earnings Per Share

          The following table sets forth the computation for basic and diluted earnings per share for the years ended December 31, 2008, 2007 and 2006:

	2008		2007		2006
Numerator:
Net income	$	7,326	$	6,770	$	6,488
Denominator:
Basic earnings per share - weighted average shares outstanding		3,297,990		3,326,467		3,369,567
Effect of dilutive securities - stock options		16,449		7,939		20,198
Diluted earnings per share - adjusted weighted average shares outstanding		3,314,439		3,334,406		3,389,765
Earnings per share:
Basic	$	2.22	$	2.04	$	1.93
Diluted	$	2.21	$	2.03	$	1.91

          The earnings per share calculation for the years ended December 31, 2008, 2007 and 2006 does not include 341,516, 221,583 and 76,500 shares, respectively, which were anti-dilutive.

3. Cash and Due From Banks

          The average compensating balances held at correspondent banks during 2008 and 2007 were $2,847 and $2,666, respectively. The subsidiary bank maintains such compensating balances with correspondent banks to offset charges for services rendered by those banks. In addition, the Federal Reserve Bank required the subsidiary bank to maintain average balances of approximately $2,590 and $1,913, for 2008 and 2007, respectively, as reserve requirements.

16

4. Investment Securities

          The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of available-for-sale and held-to-maturity securities by major security type at December 31 were as follows:

	2008
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale:
United States Government Agencies		89,883		2,344		(29	)		92,198
State and Municipal		89,776		1,336		(1,384	)		89,728
Collateralized mortgage obligations		54,405		579		(27	)		54,957
Total		234,064		4,259		(1,440	)		236,883
Held-to-maturity:
State and Municipal		14,232		294		(65	)		14,461
Total	$	248,296	$	4,553	$	(1,505	)	$	251,344

	2007
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available-for-sale:
United States Government Agencies	$	63,198	$	647	$	(105	)	$	63,740
State and Municipal		80,171		853		(468	)		80,556
Collateralized mortgage obligations		69,511		320		(130	)		69,701
Total		212,880		1,820		(703	)		213,997
Held-to-maturity:
State and Municipal		14,578		246		(25	)		14,799
Total	$	227,458	$	2,066	$	(728	)	$	228,796

          Maturities of investment securities classified as available-for-sale and held-to-maturity were as follows at December 31, 2008:

	Amortized Cost		Estimated Fair Value
Available-for-sale:
Due in one year or less	$	958	$	970
Due after one year through five years		11,478		11,787
Due after five years through ten years		66,510		68,007
Due after ten years		53,088		52,756
		132,034		133,520
Mortgage-backed securities		47,625		48,406
Collateralized mortgage obligations		54,405		54,957
	$	234,064	$	236,883
Held-to-maturity:
Due in one year or less	$	3,639	$	3,674
Due after one year through five years		4,937		5,024
Due after five years through ten years		5,050		5,179
Due after ten years		606		584
	$	14,232	$	14,461

          Proceeds from sales of investment securities available-for-sale during 2008, 2007 and 2006 were $38,499, $17,455, and $8,904, respectively. Gross gains of $431 in 2008, $541 in 2007 and $250 in 2006 (resulting in tax expense of $167, $210 and $97, respectively) were realized on those sales. Gross losses of $26 were realized on the sales in 2008. There were no gross losses from these sales in 2007 or 2006. There were no sales of investment securities classified as held-to-maturity during 2008, 2007 and 2006.

17

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

          Securities with unrealized losses at December 31, 2008 and 2007 not recognized in income are as follows:

	2008
	Less than 12 Months					12 Months or More					Total
	Fair Value		Gross Unrealized Loss			Fair Value		Gross Unrealized Loss			Fair Value		Gross Unrealized Loss
United States Government Agencies	$	1,569	$	(19	)	$	461	$	(10	)	$	2,030	$	(29	)
State and Municipal		17,913		(679	)		22,082		(770	)		39,995		(1,449	)
Collateralized mortgage obligations		3,310		(12	)		3,308		(15	)		6,618		(27	)
Total temporarily impaired	$	22,792	$	(710	)	$	25,851	$	(795	)	$	48,643	$	(1,505	)

	2007
	Less than 12 Months					12 Months or More					Total
	Fair Value		Gross Unrealized Loss			Fair Value		Gross Unrealized Loss			Fair Value		Gross Unrealized Loss
United States Government Agencies	$	2,040	$	(14	)	$	19,344	$	(91	)	$	21,384	$	(105	)
State and Municipal		5,295		(75	)		33,428		(418	)		38,723		(493	)
Collateralized mortgage obligations		3,768		(21	)		18,672		(109	)		22,440		(130	)
Total temporarily impaired	$	11,103	$	(110	)	$	71,444	$	(618	)	$	82,547	$	(728	)

          There are 385 securities in an unrealized loss position in the investment portfolio at December 31, 2008, all due to interest rate changes and not credit events. These unrealized losses are considered temporary and, therefore, have not been recognized into income, because the issuers are of high credit quality (99.7% of the securities in the portfolio are rated AA or higher) and management has the ability and intent to hold for the foreseeable future. The fair value is expected to recover as the investments approach their maturity date or there is a downward shift in interest rates.

          The carrying value of securities pledged as collateral, to secure public deposits and for other purposes was $234,525 at December 31, 2008 and $212,190 at December 31, 2007.

5. Loans

          The composition of the loan portfolio as of December 31 was as follows:

	2008		2007
Loans
Commercial	$	225,806	$	168,936
Agricultural		79,536		85,571
Real estate – construction		31,444		46,874
Real estate – mortgage		378,926		348,920
Installment		75,125		72,346
Total	$	790,837	$	722,647

          Changes in the allowance for loan losses for the years ended December 31 were as follows:

	2008			2007			2006
Balance, January 1	$	3,248		$	3,053		$	3,109
Provision for loan losses		2,968			640			285
Loans charged off		(1,334	)		(664	)		(604	)
Recoveries of loans previously charged off		182			219			263
Balance, December 31	$	5,064		$	3,248		$	3,053

          Non-accrual loans at December 31, 2008, 2007 and 2006 were $30,383, $7,361 and $3,893, respectively. Interest income that would have been recorded on these loans, had they remained current, was approximately $1,449, $734 and $397, respectively. At December 31, 2008, 2007 and 2006, accruing loans delinquent 90 days or more totaled $2,655, $73 and $33, respectively.

          Impaired loans at December 31, 2008, 2007 and 2006 totaled $25,128, $4,523 and $2,123, respectively. Of these totals, $1,976, $540 and $522 of loans had valuation reserves totaling $370, $207 and $150 at December 31, 2008, 2007 and 2006, respectively. For the years ended December 31, 2008, 2007 and 2006, the average recorded investment in impaired loans was approximately $10,414, $3,301 and $2,296, respectively. Interest recognized on impaired loans during the portion of the year that they were impaired was not material.

18

          The Corporation’s subsidiary bank had loans outstanding to directors, executive officers and to their related interests (related parties) of the Corporation and its subsidiary of approximately $6,356, $8,275, and $5,530, at December 31, 2008, 2007 and 2006, respectively. These loans were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers and did not involve more than the normal risk of collectibility. As a practice, the subsidiary bank does not make loans to its executive officers. A summary of the activity in 2008 for loans made to directors, executive officers or principal holders of common stock or to any associate of such persons for which the aggregate to any such person exceeds $60 at December 31, 2008 is as follows:

Balance January 1, 2008		Additions		Payments		Other Changes		Balance December 31, 2008
	$8,275		$10,546		($12,248)		$ (217)		$6,356

6. Premises and Equipment

          As of December 31, the components of premises and equipment (at cost), less accumulated depreciation, were as follows:

	2008		2007
Land	$	6,163	$	7,138
Buildings		30,271		30,391
Furniture and Equipment		21,887		20,464
		58,321		57,993
Less: accumulated depreciation		29,024		27,192
Total	$	29,297	$	30,801

          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 in anticipation of the construction of a branch facility. The land in Aurora, consisting of two lots remaining from the original purchase of 14 acres in 2004 which was used to construct a branch facility, has a cost basis of $1,344. The land in Somonauk, acquired in 2005 during the acquisition of FSB Bancorp, Inc., consists of approximately 2 acres with a cost basis of $80. Recent real estate appraisals have been completed indicating the market value of the lots to be $1,190 (Elburn), $2,000 (Aurora) and $495 (Somonauk).

          Depreciation expense charged to operating expense for 2008, 2007 and 2006 was $2,219, $2,482 and $2,304, respectively.

7. Acquisition

          On February 23, 2007, the Corporation completed the acquisition of the Plainfield, Illinois office of HomeStar Bank in Manteno, Illinois, for $10.2 million in cash, including goodwill of $1.5 million, in order to expand its market presence in the area. The Corporation purchased the existing facility for $4.5 million plus $17.0 million in loans (at book value) and assumed $12.9 million in deposit liabilities. The Plainfield office operates as a branch of the subsidiary bank.

          The transaction has been accounted for as a purchase, and the results of operations of the Plainfield office since the acquisition date have been included in the consolidated financial statements. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of this transaction:

Cash and cash equivalents	$	93
Loans		17,043
Premises and equipment		4,500
Goodwill		1,492
Other assets		85
Total assets acquired		23,213
Deposits		12,865
Other liabilities		145
Total liabilities assumed		13,010
Net assets acquired	$	10,203

          Transaction costs related to the completion of the transaction were considered immaterial. The total fair value of the assets and liabilities acquired exceeded the book value, resulting in goodwill of $1,492 which is not subject to amortization.

19

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

          The following unaudited pro forma condensed combined financial information presents the results of operations of the Corporation, including the effects of the purchase accounting adjustments, had the acquisition taken place at the beginning of each period:

	Pro Forma For the Year Ended December 31, 2007			Pro Forma For the Year Ended December 31, 2006
Net interest income		$	27,094		$	26,169
Provision for loan losses			640			285
Non-interest income			11,333			10,465
Non-interest expense			29,580			29,014
Income before income taxes			8,207			7,335
Income tax expense			1,401			961
Net income		$	6,806		$	6,374
Earnings per share:
Basic		$	2.05		$	1.89
Diluted		$	2.04		$	1.88
Basic weighted average shares outstanding			3,326,467			3,369,567
Diluted weighted average shares outstanding			3,334,406			3,389,765

          The unaudited pro forma condensed combined financial statements do not reflect any anticipated cost savings and revenue enhancements. Additionally, the income statement for 2007 includes merger-related expenses. Accordingly, the pro forma results of operations of the Corporation as of and after the merger may not be indicative of the results that actually would have occurred if the merger had been in effect during the periods presented or of the results that may be attained in the future.

8. Goodwill and Intangible Assets

          The balance of goodwill, net of accumulated amortization, totaled $24,521 at December 31, 2008 and 2007. Goodwill is tested annually for impairment. 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 balance of intangible assets, net of accumulated amortization, totaled $4,207 and $5,090 at December 31, 2008 and December 31, 2007, respectively.

          The following table summarizes the Corporation’s intangible assets, which are subject to amortization, as of December 31, 2008 and 2007:

	2008							2007
	Gross Carrying Amount			Accumulated Amortization				Gross Carrying Amount			Accumulated Amortization
Core deposit intangible		$	9,004		$	(4,869	)		$	9,004		$	(4,006	)
Other acquisition costs			234			(162	)			234			(142	)
Total		$	9,238		$	(5,031	)		$	9,238		$	(4,148	)

          Intangible asset amortization expense charged to operating expense for 2008, 2007 and 2006 was $714, $704 and $651, respectively. The following table shows the future estimated amortization expense for the Corporation’s intangible assets based on existing balances as of December 31, 2008:

           Estimated Amortization Expense for the year ended December 31:

2009	$	860
2010		816
2011		653
2012		549
2013		526
Thereafter		803

          Mortgage servicing rights, which are included in other assets on the consolidated balance sheets, are accounted for on an individual loan-by-loan basis. Accordingly, amortization is recorded in proportion to the amount of principal payment received on loans serviced. The mortgage servicing rights are subject to periodic impairment testing. During the years ended December 31, 2008, 2007 and 2006 no impairment had been recorded and the recorded value was determined to approximate the fair market value. Changes in the carrying value of mortgage servicing rights are summarized as follows:

	2008			2007			2006
Balance, January 1	$	2,498		$	2,079		$	2,002
Servicing rights capitalized		815			662			773
Amortization of servicing rights		(377	)		(243	)		(345	)
Adjustment to recorded mortgage servicing rights related to the Somonauk acquisition reclassified to goodwill		-0-			-0-			(351	)
Balance, December 31	$	2,936		$	2,498		$	2,079

          The following table shows the future estimated amortization expense for mortgage servicing rights based on existing balances as of December 31, 2008. 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.

20

          Estimated amortization expense for the year ended December 31:

2009	$	328
2010		307
2011		288
2012		271
2013		254
2014		238
Thereafter		1,250

          The Corporation services loans for others with unpaid principal balances at December 31, 2008, 2007 and 2006 of approximately $304,551, $268,391 and $236,893, respectively.

9. Deposits

          As of December 31, the aggregate amounts of time deposits in denominations of $100 or more and related interest expense were as follows:

	2008		2007		2006
Amount	$	232,811	$	158,542	$	140,300
Interest expense for the year		4,124		4,204		4,285

          Total interest expense on deposits for the years ending December 31 was as follows:

		2008		2007		2006
Interest-bearing demand	$	3,647	$	6,567	$	4,877
Savings		67		249		326
Time		20,068		23,508		18,640
Total	$	23,782	$	30,324	$	23,843

          At December 31, 2008, the scheduled maturities of time deposits are as follows:

2009	$	463,332
2010		60,828
2011		12,041
2012		6,884
2013		635
Thereafter		50
Total	$	543,770

10. Borrowings

          As of December 31, borrowings consisted of the following:

	2008					2007
	Amount		Weighted Average Rate			Amount		Weighted Average Rate
Customer repurchase agreements	$	35,532		0.86	%	$	34,217		3.69	%
Advances from the Federal Home Loan Bank of Chicago due:
February 1, 2008		-0-		n/a			1,000		4.00
February 27, 2008		-0-		n/a			2,500		5.37
June 19, 2008		-0-		n/a			2,500		5.44
February 27, 2009		2,500		2.74			-0-		n/a
September 19, 2009		4,000		3.40			-0-		n/a
November 2, 2009		993		3.84			984		3.84
November 21, 2009		5,000		2.67			-0-		n/a
February 1, 2010		5,000		2.87			-0-		n/a
March 19, 2010		4,000		3.45			-0-		n/a
September 19, 2010		4,000		3.60			-0-		n/a
December 19, 2010		7,000		2.19			-0-		n/a
Federal funds purchased		6,500		0.45			26,500		4.33
Interest-bearing demand notes issued to the U.S. Treasury		2,441		0.00			1,838		4.00
Trust preferred securities		25,000		5.68			25,000		5.68
Note payable		16,050		4.50			14,550		6.25
Total	$	118,016		2.91	%	$	109,089		4.73	%

21

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

          The subsidiary bank has adopted a collateral pledge agreement whereby they agreed to keep on hand at all times, free of all other pledges, liens and encumbrances, first mortgages with unpaid principal balances aggregating no less than 167% of the outstanding secured advances from the Federal Home Loan Bank of Chicago (FHLB). The advances from the FHLB, which have fixed interest rates ranging from 2.19% to 3.84% as of December 31, 2008, are subject to restrictions or penalties in the event of prepayment. All stock in the FHLB is also pledged as additional collateral for these advances.

          On July 15, 2005, the Corporation, through its subsidiary PNBC Capital Trust I, issued trust preferred securities in the amount of $25,000. These securities were issued to help finance the acquisition of Somonauk FSB Bancorp, Inc. Additionally, these securities have a maturity of thirty years and a fixed interest rate of 5.68% for the first five years. The interest then adjusts to a floating rate at the three-month LIBOR plus 154 basis points. While these securities are recorded as a liability for financial reporting purposes, they qualify as Tier 1 capital for regulatory purposes. According to the provisions of FIN 46(R), “Consolidation of Variable Interest Entities,” PNBC Capital Trust I is a variable interest entity which is not required to be consolidated by the Corporation.

          The Corporation had a note payable with a balance of $16,050 and $14,550 at December 31, 2008 and 2007, respectively. The note payable was a demand note that carried a floating interest rate equal to the higher of two-month LIBOR plus 200 basis points or 4.50% (4.50% at December 31, 2008). The note, which was secured by the capital stock certificates of the subsidiary bank, had a maturity of January 30, 2009 and contained the covenant the subsidiary bank would maintain risk-based capital at a minimum of 10% of risk-weighted assets. The loan was paid off on February 24, 2009 with proceeds from the sale of preferred stock under the Capital Purchase Program.

          Customer repurchase agreements consist of obligations of the Bank to other parties. The obligations are secured by government agency securities and mortgage-backed securities and such collateral is held by the Bank. The maximum amount of outstanding agreements at any month-end during 2008 and 2007 totaled $41,193 and $38,011, respectively, and the daily average of such agreements totaled $36,918 and $33,042 for 2008 and 2007, respectively. The agreements at December 31, 2008 are ongoing and as such have no fixed maturity date.

11. Income Taxes

          Income tax expense (benefit) consisted of the following:

	Current		Deferred			Total
Year ended December 31, 2008:
Federal	$	1,690	$	(391	)	$	1,299
State		609		(211	)		398
Total	$	2,299	$	(602	)	$	1,697
Year ended December 31, 2007:
Federal	$	1,490	$	(440	)	$	1,050
State		353		(26	)		327
Total	$	1,843	$	(466	)	$	1,377
Year ended December 31, 2006:
Federal	$	1,605	$	(966	)	$	639
State		344		50			394
Total	$	1,949	$	(916	)	$	1,033

          Income tax expense differed from the amounts computed by applying the U.S. Federal income tax rate of 34 percent to pretax income as a result of the following for the years ended December 31:

	2008			2007			2006
Computed “expected” tax expense	$	3,068		$	2,770		$	2,557
Increase (decrease) in income taxes resulting from: Tax-exempt income		(1,439	)		(1,499	)		(1,603	)
Non-deductible interest expense		131			203			197
State income taxes, net of federal tax benefit		240			204			170
Bank-owned life insurance income		(285	)		(271	)		(265	)
Other, net		(18	)		(30	)		(23	)
	$	1,697		$	1,377		$	1,033

22

          The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are presented below:

	2008			2007
Deferred tax assets:
Deferred compensation	$	164		$	153
Allowance for loan losses		1,966			1,261
Nonaccrual loan interest income		562			285
AMT credit carry forwards		-0-			577
FAS 158 benefit accrual		440			427
Other, net		110			14
Total gross deferred tax assets		3,242			2,717
Deferred tax liabilities:
Buildings and equipment, principally due to differences in depreciation		(569	)		(527	)
Accretion		(39	)		(125	)
Purchase accounting adjustments		(2,289	)		(2,464	)
FHLB Stock dividends		(276	)		(276	)
Mortgage servicing rights		(1,140	)		(970	)
Prepaid expenses		(83	)		(134	)
Unrealized gain on investment securities available-for-sale		(1,117	)		(434	)
Total gross deferred tax liabilities		(5,513	)		(4,930	)
Net deferred tax liabilities	$	(2,271	)	$	(2,213	)

          Management believes it is more likely than not that the deferred tax assets will be realized. Therefore, no valuation allowance has been recorded at December 31, 2008 and 2007.

12. Comprehensive Income

          Other comprehensive income components and related taxes were as follows:

	2008			2007			2006
Net unrealized gains (losses) on securities available-for-sale	$	2,107		$	2,211		$	484
Less: Reclassification adjustment for realized gains included in income		(405	)		(541	)		(250	)
		1,702			1,670			234
Defined benefit pension plan
Net prior service credit		-0-			640			-0-
Amortization of transition obligation		16			16			-0-
Net loss		-0-			(197	)		-0-
Other comprehensive income, before tax effect		1,718			2,129			234
Tax expense		660			825			90
Other comprehensive income	$	1,058		$	1,304		$	144

The components of accumulated other comprehensive income (loss), included in stockholders’ equity, are as follows:

	2008			2007			2006
Net unrealized gain (loss) on securities available-for-sale	$	2,820		$	1,118		$	(552	)
Net unrealized benefit obligations		(540	)		(556	)		-0-
Adjustment to initially apply FAS 158		-0-			-0-			(1,016	)
		2,280			562			(1,568	)
Tax effect		(878	)		(218	)		608
Net-of-tax amount	$	1,402		$	344		$	(960	)

13. Regulatory Matters

          The Corporation and its subsidiary bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and its subsidiary bank must meet specific capital guidelines that involve quantitative measures of each entity’s assets,

23

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation’s and its subsidiary bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

          Quantitative measures established by regulation to ensure capital adequacy require the Corporation and its subsidiary bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and of Tier 1 capital to average adjusted assets. As of December 31, 2008 and 2007, the subsidiary bank is categorized as well-capitalized for all three ratios under the regulatory framework, while the Corporation is classified as well-capitalized for two ratios and adequately-capitalized for one ratio at December 31, 2008 and 2007.

          The most recent notifications, at December 31, 2008 and 2007, from the federal banking agencies categorized the subsidiary bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Corporation and the subsidiary bank must maintain total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table that follows, at December 31, 2008.

          The Corporation’s and the subsidiary bank’s actual capital amounts and ratios as of December 31, 2008 and 2007 are as follows:

	Actual					For Capital Adequacy Purposes					To Be Well- Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2008:
Total Capital (to risk-weighted assets):
Princeton National Bancorp, Inc.	$	72,112		8.30	%	$	69,490		8.00	%	$	86,862		10.00	%
Citizens First National Bank		86,935		10.00	%		69,528		8.00	%		86,909		10.00	%
Tier 1 Capital (to risk-weighted assets):
Princeton National Bancorp, Inc.	$	67,048		7.72	%	$	34,745		4.00	%	$	52,117		6.00	%
Citizens First National Bank		81,870		9.42	%		34,764		4.00	%		52,146		6.00	%
Tier 1 Capital (to average adjusted assets):
Princeton National Bancorp, Inc.	$	67,048		6.22	%	$	43,132		4.00	%	$	53,916		5.00	%
Citizens First National Bank		81,870		7.59	%		43,127		4.00	%		53,909		5.00	%
	Actual					For Capital Adequacy Purposes					To Be Well- Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2007:
Total Capital (to risk-weighted assets):
Princeton National Bancorp, Inc.	$	66,914		8.44	%	$	63,393		8.00	%	$	79,242		10.00	%
Citizens First National Bank		79,798		10.07	%		63,384		8.00	%		79,230		10.00	%
Tier 1 Capital (to risk-weighted assets):
Princeton National Bancorp, Inc.	$	63,667		8.03	%	$	31,697		4.00	%	$	47,545		6.00	%
Citizens First National Bank		76,550		9.66	%		31,692		4.00	%		47,538		6.00	%
Tier 1 Capital (to average adjusted assets):
Princeton National Bancorp, Inc.	$	63,667		6.33	%	$	40,255		4.00	%	$	50,318		5.00	%
Citizens First National Bank		76,550		7.61	%		40,249		4.00	%		50,311		5.00	%

14. Employee, Officer and Director Benefit Plans

          The subsidiary bank has a defined contribution investment 401(k) plan. Under this plan employees could elect to contribute, on a tax-deferred basis, up to a maximum of $16 ($21 for those employees eligible to make catch-up contributions). In addition, the subsidiary bank will match employees’ contributions up to three percent of each employee’s salary and match 50% of the next two percent contributed. The subsidiary bank’s contribution to the defined contribution investment 401(k) plan for 2008, 2007 and 2006 was $404, $410 and $382, respectively.

          The subsidiary bank has an employee stock purchase program in which employees contribute through payroll deductions. These amounts are pooled and used to purchase shares of the Corporation’s common stock on a quarterly basis at the opening bid price on the last business day of the quarter.

          The subsidiary bank also has a profit sharing plan. Annual contributions to the subsidiary bank’s plan are based on a formula. The total contribution is at the discretion of the Board of Directors. The cost of the profit sharing plan charged to operating expense was $409 in 2008, $350 in 2007 and $350 in 2006.

Stock Based Compensation Plan

          Additionally, the Corporation has non-qualified stock option plans (“the plans”) for the benefit of employees and directors of the subsidiary bank, as well as directors of the Corporation. The plans permit the grant of share options and shares for up to 802,500 shares of common stock. The Corporation believes that such awards better align the interests of its employees with those of its stockholders. Option awards are granted with an exercise price equal to the market price of the Corporation’s stock at the date of grant. The option awards generally vest based on 3 years of continuous service and have 10-year contractual terms.

          The fair value of each option award is estimated on the date of grant using a Black-Scholes closed-form model that uses the assumptions noted in the following table. Expected volatility is based on historical volatility of the Corporation’s stock and other factors. In 2008, 2007 and 2006, the volatility was much lower than in previous years due to a more stable or decreasing stock price as opposed to the rapidly increasing stock price of the preceding years. The Corporation uses historical data to estimate option exercise and employee termination within the valuation model. The expected term of the options granted is derived from the Corporation’s historical option exercise experience and represents the period of time that options granted are expected to be outstanding. The risk-free rate for

24

periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The following assumptions were used in estimating the fair value for options granted in 2008, 2007 and 2006:

	2008			2007			2006
Expected volatility		.080			.100			.061
Expected dividends		4.96	%		4.03	%		3.23	%
Expected term (in years)		3 yrs.			3 yrs.			3 yrs.
Risk-free rate		1.00	%		3.07	%		4.74	%

          A summary of option activity under the Plan as of December 31, 2008, 2007 and 2006, and changes during the years then ended, is presented as follows:

	2008
	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, beginning of year		404,186		$	28.57
Granted		86,125			22.57
Exercised		(4,700	)		17.61
Forfeited or expired		(25,550	)		29.37
Outstanding, end of year		460,061			27.53		7.46 yrs.	$	172
Options exercisable end of year		295,042		$	29.03		6.40 yrs.	$	49

          The intrinsic value of the outstanding shares and the options exercisable noted above excludes 261,566 shares and 235,972 shares, respectively, which were anti-dilutive for 2008.

	2007
	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, beginning of year		319,536		$	29.61
Granted		86,750			24.84
Exercised		(500	)		21.15
Forfeited or expired		(1,600	)		32.81
Outstanding, end of year		404,186		$	28.57		7.86 yrs.	$	208
Options exercisable end of year		262,247		$	29.01		6.92 yrs.	$	208

          The intrinsic value of the outstanding shares and the options exercisable noted above excludes 366,566 shares and 224,627 shares, respectively, which were anti-dilutive for 2007.

	2006
	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, beginning of year		302,718		$	27.52
Granted		83,783			32.55
Exercised		(62,765	)		23.81
Forfeited or expired		(4,200	)		33.25
Outstanding, end of year		319,536		$	29.61		8.28 yrs.	$	939
Options exercisable end of year		235,753		$	28.57		7.67 yrs.	$	938

          There were no anti-dilutive shares for 2006.

          The weighted-average grant date fair value of options granted during the years 2008, 2007 and 2006 was $31, $103 and $151, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was $21, $2 and $455, respectively.

25

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

          A summary of the status of the Corporation’s non-vested shares and changes during the year ended December 31, 2008, 2007 and 2006 is presented below:

	2008
	Shares			Weighted Average Grant-Date Fair Value
Non-vested, beginning of year		141,939		$	1.43
Granted		86,125			0.36
Vested		(37,495	)		1.43
Forfeited		(25,550	)		1.43
Non-vested, end of year		165,019		$	0.59
	2007
	Shares			Weighted Average Grant-Date Fair Value
Non-vested, beginning of year		83,783		$	1.80
Granted		86,750			1.19
Vested		(27,594	)		1.80
Forfeited		(1,000	)		1.80
Non-vested, end of year		141,939		$	1.43
	2006
	Shares			Weighted Average Grant-Date Fair Value
Non-vested, beginning of year		-0-			n/a
Granted		83,783		$	1.80
Vested		-0-			n/a
Forfeited		-0-			n/a
Non-vested, end of year		83,783		$	1.80

          As of December 31, 2008, there was $150 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the plan. That cost is expected to be recognized over a weighted-average period of 3 years. The total fair value of shares vested during the years ended December 31, 2008, 2007, and 2006, was $54, $50 and $0, respectively.

15. Pension and Other Post-Retirement Benefits

Employee Health Benefit Plan

          The Corporation does not have a defined benefit pension plan. The Corporation does have a defined contribution investment plan which is discussed in footnote 14 (“Employee, Officer, and Director Benefit Plans”). The Corporation offers certain retirees the opportunity to continue benefits in the subsidiary bank’s Employee Health Benefit Plan. The Corporation’s level of contribution is based upon an age, service formula, date of employment and retirement date. Employees hired prior to October 1, 1994 who retired prior to July 1, 2008 were eligible to receive benefits under the Bank’s Health Benefit Plan for life. All employees hired on or before October 1, 1994 previously were allowed coverage for life. The plan was amended on December 31, 2007 to require employees hired on or before October 1, 1994 who retire after July 1, 2008 to convert to a Medicare Supplement Plan at age 65. Coverage stops at age 65 for employees hired after October 1, 1994. The Corporation uses a December 31 measurement date for its plan. Information about the plan’s funded status follows:

	Post Retirement Health Benefits
	2008			2007
Change in benefit obligation
Beginning of year	$	1,096		$	1,536
Service cost		20			37
Interest cost		66			92
Amortization of transition obligation		(16	)		-0-
Amortization of prior service cost		(62	)		-0-
Actuarial (gain) loss		69			147
Benefits paid		(73	)		(76	)
Amendments		-0-			(640	)
Funded status at end of year	$	1,100		$	1,096

26

          The components of the 2008, 2007, and 2006 net periodic post-retirement benefit cost are shown below:

	2008			2007		2006
Service cost	$	20		$	37	$	61
Interest cost		66			92		66
Amortization of transition obligation		-0-			16		-0-
Amortization of prior service cost		(62	)		-0-		16
Amortization of net loss		69			58		31
Net periodic post-retirement benefit cost	$	93		$	203	$	174

          Other changes in benefit obligations recognized in other comprehensive income (loss):

	Post Retirement Health Benefits
	2008			2007
Net gain (loss)	$	-0-		$	(197	)
Prior service cost recognized		-0-			640
Prior service credit established		-0-			-0-
Amortization of transition obligation		16			16
Total recognized in other comprehensive income		16			459
Total recognized in net periodic benefit cost and other comprehensive income (loss)	$	(77	)	$	256

          The estimated net loss, prior service cost and transition obligation for the defined benefit plan that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost over the next fiscal year is a net loss of $6.

          Amounts recognized in the balance sheets:

	Post Retirement Health Benefits
	2008		2007
Liabilities	$	1,100	$	1,096

          Amounts recognized in accumulated other comprehensive income and not yet recognized as components of net periodic benefit cost consist of:

	Post Retirement Health Benefits
	2008		2007
Net loss	$	-0-	$	1,017
Unrecognized prior service credit		-0-		(558	)
Transition obligation		16		-0-
	$	16	$	459

          The accumulated benefit obligation for all defined benefit plans was $1,100 and $1,096 at December 31, 2008 and 2007, respectively.

          Significant assumptions include:

	Post Retirement Health Benefits
	2008			2007
Weighted average assumptions used to determine benefit obligation:		6.0	%		6.0	%
Discount rate		n/a			n/a
Rate of compensation increase
Weighted average assumptions used to determine benefit cost:		6.0	%		6.0	%
Discount rate		n/a			n/a
Expected return on plan assets		n/a			n/a
Rate of compensation increase

          For measurement purposes, a 7.0% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2008 and 2007, respectively. The rate was assumed to decrease gradually to 5.0% by the year 2013 and remain at that level thereafter.

27

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

          Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care cost trend rates would have the following effects:

	1-Percentage- Point Increase	1-Percentage- Point Decrease
Effect on total of service and interest cost components	$     8	$   (7)
Effect on post-retirement benefit obligation	78	(70)

          The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as of December 31, 2008:

	Post Retirement Health Benefits
2009		$	44
2010			54
2011			63
2012			52
2013			60
2014-2018			425

Split Dollar Life Insurance

          The Financial Accounting Standards Board Emerging Issues Task Force (“EITF”) issued EITF No. 06-4 “Accounting for Deferred Compensation and Post Retirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,” which requires the Corporation to recognize a liability and compensation expense for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to post retirement periods. The benefit to the employees is the payment of the premiums by the Corporation. The Corporation adopted EITF 06-4 as of January 1, 2008, through a cumulative effect adjustment as a liability and a decrease to retained earnings of $580. In 2008, an expense was recorded as the remaining benefit is earned with a corresponding addition to the post retirement benefit obligation. The amount of the expense for 2008 was $36. For the period from retirement to the estimated date of death for the participants, this liability is reversed into income.

16. Fair Value of Financial Instruments

          Effective January 1, 2008, the Corporation adopted Statement of Financial Accounting Standards No. 157 (FAS 157), “Fair Value Measurements”. FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 has been applied prospectively as of the beginning of the period.

          FAS 157 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. FAS 157 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 FAS 157, 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.

          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.

          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. Level 2 securities include U.S. government agencies, state and municipal, and collateralized mortgage obligation securities. 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 FAS 157 hierarchy in which the fair value measurements fall as of December 31, 2008 (in thousands):

			Fair Value Measurements Using
	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	$	236,883		$	-0-		$	236,883		$	-0-

28

          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 Financial Accounting Standard No. 114 (FAS 114), “Accounting by Creditors for Impairment of a Loan.” 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 hierarchy.

          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 classificaiton of such assets and liabilities pursuant to the valuation hierarchy.

			Fair Value Measurements Using
	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	$	2,494		-0-		-0-	$ 2,494

          Statement of Financial Accounting Standards No. 107 (“FAS 107”), “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 FAS 107. 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.

          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 December 31, 2008 and 2007, were as follows:

	2008				2007
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets:
Cash and due from banks	$	17,487	$	17,487	$	25,801	$	25,801
Interest-bearing deposits in financial institutions		2,774		2,774		1,803		1,803
Investment securities		251,115		251,344		228,575		228,796
Loans, net, including loans held-for-sale		787,928		793,411		720,327		720,715
Accrued interest receivable		9,693		9,693		10,876		10,876
Total Financial Assets	$	1,068,997	$	1,074,709	$	987,382	$	987,991
Financial Liabilities:
Non-interest-bearing demand deposits	$	110,559	$	110,559	$	102,452	$	102,452
Interest-bearing deposits		851,573		862,165		788,955		794,200
Borrowings		118,016		127,816		109,089		107,517
Accrued interest payable		4,472		4,472		5,141		5,141
Total Financial Liabilities	$	1,084,620	$	1,105,012	$	1,005,637	$	1,009,310
Unrecognized financial instruments (net of contract amount)
Commitments to originate loans		-0-		-0-		-0-		-0-
Lines of credit		-0-		-0-		-0-		-0-

          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

29

Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

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.

          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 FAS 107.

          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.

17. Undistributed Earnings of Subsidiary Bank

          National banking regulations and capital guidelines limit the amount of dividends that may be paid by banks. At December 31, 2008, the subsidiary bank had $10,702 available for dividends. Additionally, according to the guidelines, at January 1, 2009, the subsidiary bank had $7,141 available for dividends. Future dividend payments by the subsidiary bank will be dependent upon individual regulatory capital requirements and levels of profitability. Since the Corporation is a legal entity, separate and distinct from the bank, the dividends of the Corporation are not subject to such bank regulatory guidelines.

18. Commitments, Contingencies and Credit 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.

          The current economic environment presents financial institutions with unprecedented circumstances and challenges which in some cases have resulted in large declines in the fair values of investments and other assets, constraints on liquidity and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans. The financial statements have been prepared using values and information currently available to the Corporation.

          Given the volatility of current economic conditions, the values of assets and liabilities recorded in the financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses, and capital that could negatively impact the Corporation’s ability to meet regulatory capital requirements and maintain sufficient liquidity.

          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 December 31, 2008, commitments to extend credit and standby letters of credit were approximately $155,603 and $5,886, respectively. At December 31, 2007, commitments to extend credit and standby letters of credit were approximately $143,506 and $7,690, 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. At December 31, 2008 and 2007, the standby letters of credit have terms that expire in one year or less.

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

19. FDIC Assessment

          Effective November 17, 2006, the FDIC implemented a one-time credit of $4.7 billion to eligible institutions. The purpose of the credit was to recognize contributions made by certain institutions to capitalize the Bank Insurance Fund and Savings Association Insurance Fund, which have now been merged into the Deposit Insurance Fund. The Bank was an eligible institution and received notice from the FDIC that its share of the credit was $647. This amount was not reflected in the accompanying financial statements as it represented contingent future credits against future insurance assessment payments. In 2008 and 2007, FDIC premium credits received totaled $266 and $381, respectively, against the premium expense, leaving a remaining credit of $0, as of December 31, 2008, to offset future premium expense.

          On February 27, 2009, the FDIC announced it had adopted an interim rule to impose a 20 basis point emergency special assessment on June 30, 2009 which will be collected on September 30, 2009. The interim rule also provides that an additional emergency assessment of up to 10 basis points may be imposed if the

30

reserve ratio of the Deposit Insurance Fund is estimated to fall to a level that the Board believes would adversely affect public confidence or to a level which shall be close to zero or negative at the end of a calendar quarter. The 20 basis point assessment is based on the institution’s assessment base which is total deposits. If the June 30, 2009 assessment base is consistent with December 31, 2008, the assessment would approximate $1,874.

20. Capital Purchase Program/Troubled Asset Relief Program (TARP)

          On January 23, 2009, the Corporation received $25,083 of equity capital by issuing to the United States Department of Treasury 25,083 shares of the Corporation’s 5.00% Series B Non-Voting Cumulative Preferred Stock, par value $0.01 per share 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 $0.01 per share, at an exercise price of $24.27 per share. The proceeds received were allocated to the preferred stock and additional paid-in capital based on their relative fair values. The resulting discount on the preferred stock is amortized against retained earnings and will be reflected in the Corporation’s consolidated statement of income as “Dividends on preferred shares,” resulting in additional dilution to the Corporation’s earnings per share. The warrants would be immediately exercisable, in whole or in part, over a term of 10 years. The warrants will be 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 Preferred stock will rank on equal priority with the Corporation’s existing Series A Non-Cumulative Perpetual Convertible 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.

21. Condensed Financial Information of Princeton National Bancorp, Inc.

          The following condensed financial statements are presented for the Corporation on a stand alone basis:

Condensed Balance Sheets

	December 31
	2008			2007
Assets
Cash	$	663		$	240
Interest-bearing deposits in subsidiary bank		180			75
Other assets		1,423			1,651
Investment in subsidiary bank		112,156			106,345
Total assets		114,422			108,311
Liabilities
Borrowings	$	41,050		$	39,550
Other liabilities		901			154
Total liabilities		41,951			39,704
Stockholders’ Equity
Common stock		22,391			22,391
Surplus		18,420			18,275
Retained earnings		54,329			51,279
Accumulated other comprehensive income (loss), net of tax		1,402			344
Less: Cost of treasury shares		(24,071	)		(23,682	)
Total stockholders’ equity		72,471			68,607
Total liabilities and stockholders’ equity	$	114,422		$	108,311

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Notes to Consolidated Financial Statements (Continued)
(dollar amounts in thousands except share data)

Condensed Statements of Income

	For the Years Ended December 31
	2008			2007			2006
Income
Dividends received from subsidiary bank	$	5,600		$	4,300		$	4,200
Interest income		5			7			24
Other income		43			24			37
Total income		5,648			4,331			4,261
Expenses
Interest expense		2,100			2,209			1,887
Amortization and depreciation		7			7			7
Other expenses		253			264			212
Total expenses		2,360			2,480			2,106
Income before income taxes and equity in undistributed income of subsidiary bank		3,288			1,851			2,155
Applicable income tax benefit		(892	)		(924	)		(772	)
Income before equity in undistributed income of subsidiary bank		4,180			2,775			2,927
Equity in undistributed income of subsidiary bank		3,146			3,995			3,561
Net income	$	7,326		$	6,770		$	6,488

Condensed Statements of Cash Flows

	For the Years Ended December 31
	2008			2007			2006
Operating activities:
Net income	$	7,326		$	6,770		$	6,488
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed income of subsidiary bank		(3,146	)		(3,995	)		(3,561	)
Amortization of other intangible assets		7			7			7
(Increase) decrease in other assets		(1,882	)		5,148			(2,416	)
(Decrease) increase in other liabilities		747			(208	)		(1,006	)
Net cash (used) provided by operating activities		3,052			7,722			(488	)
Investing Activities:
Payments related to acquisitions, net of cash and cash equivalents acquired		-0-			(10,182	)		-0-
Net cash used in investing activities		-0-			(10,182	)		-0-
Financing activities:
Net increase in borrowings		1,500			6,050			1,800
Sale of treasury stock		124			175			70
Purchase of treasury stock		(553	)		(1,459	)		(2,024	)
Exercise of stock options and issuance of treasury stock		101			12			1,697
Dividends paid		(3,696	)		(3,597	)		(3,542	)
Net cash (used) provided by financing activities		(2,524	)		1,181			(1,999	)
(Decrease) increase in cash and cash equivalents		528			(1,279	)		(2,487	)
Cash and cash equivalents at beginning of year		315			1,594			4,081
Cash and cash equivalents at end of year	$	843		$	315		$	1,594

32

Notes

33

Management’s Discussion and Analysis of
Financial Condition and Results of Operations
(dollar amounts in thousands except share data)

          The following discussion and analysis provides information about the Corporation’s financial condition and results of operations for the years ended December 31, 2008, 2007, and 2006. This discussion and analysis should be read in conjunction with “Selected Statistical Data”, and the Corporation’s Consolidated Financial Statements and the Notes thereto included in this report.

Overview

          Although earnings slipped in the fourth quarter, the $8.746 million reported for the subsidiary bank was a record, surpassing the previous record set in 2000 and besting last year’s net income by 5.4%. Additionally, net income of $7.326 million for PNBC represents the third highest total in the history of the Corporation.

          Although, fourth quarter earnings were negatively impacted by an increased provision for loan losses, as well as the removal of interest income for loans transferred to non-accrual status, the Corporation’s core earnings remain solid. The following represents PNBC net income, diluted earnings per share, and provision for loan loss expense for each quarter of 2008:

	Net Income			Diluted Earnings per Share			Provision
1st Quarter		$	2,090		$	0.63		$	368
2nd Quarter			2,020			0.61			450
3rd Quarter			2,187			0.66			550
4th Quarter			1,029			0.31			1,600

          It should be noted there was $385 in interest income reversed in the fourth quarter of 2008, in addition to the $1,600 recorded in provision for loan loss expense. With an average amount of activity in these two areas, the Corporation would have recorded earnings of approximately $0.60 per share in the fourth quarter, which is consistent with the other three quarters in 2008.

          One of the biggest reasons for this year’s improvement continues to be the increase in the net interest margin, which improved from 3.20% in 2007, to 3.44% in 2008. This was due to strong pricing control of the Bank’s deposit products along with a favorable change in asset mix as the loan-to-asset ratio increased to 68.0% at December 31, 2008, compared to 66.9% a year ago.

          Non-interest expenses in total were less than budget again in 2008 and, as a percentage of average assets, decreased to 2.81% in 2008 from 2.85% in 2007. This continues a trend over the past few years and is the lowest level the Corporation has seen since the 2.78% recorded in 1989! Non-interest income grew by 2.6% over the past twelve months and remains an integral part of the Corporation’s success.

          On the balance sheet side, the Corporation experienced asset growth of $82.4 million (or 7.6%), ending the year at $1.163 billion in total assets. Loan growth was very steady during 2008 growing by $68.2 million (or 9.4%), while deposits grew by $70.7 million (or 7.9%).

          During the year, the Corporation continued its plan to manage capital balances through stock repurchases and increased dividend payments, the goal of which is to improve long-term stockholder return, as measured by return on average equity and earnings per share. During 2008, the Corporation repurchased 20,000 shares of its common stock at a total cost of $553. Since 1997, the Corporation has repurchased 1,364,271 shares of common stock through repurchase programs. Additionally, the Corporation paid dividends of $1.12 per share in 2008, representing a total of $3,696; increases of $.04 per share (or 3.7%) and $99 (or 2.8%), from 2007, respectively. Total stockholders’ equity increased by $3.9 million (or 5.6%) to $72,471 at December 31, 2008, compared to $68,607 at December 31, 2007.

	Assets at Year-End		Percent Change			Equity at Year-End			Percent Change			Net Income		Percent Change
2008	$	1,163,130		7.63	%		$	72,471		5.63	%	$	7,326		8.21	%
2007		1,080,702		4.72				68,607		4.98		$	6,770		4.35
2006		1,031,959		9.17				65,355		3.50			6,488		(14.34	)

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 nonimpaired 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 nonimpaired loan is more subjective. Generally, the allowance assigned to nonimpaired loans is determined by applying historical loss

34

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.

          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 noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest 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 FASB Interpretation 48, Accounting for Uncertainty in Income Taxes. 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 Goodwill and 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 2008 and 2007, as part of the goodwill impairment test and no impairment was deemed necessary.

          As a result of our acquisition activity, goodwill, an intangible asset with an indefinite life, was reflected on our balance sheet in prior periods. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently than annually.

          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.

          Fair Value Measurements - The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Corporation estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Corporation estimates fair value. The Corporation’s valuation methods consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded.

          FASB Statement No. 157, Fair Value Measurements, establishes a framework for measuring the fair value of financial instrument that considers the attributes specific to particular assets or liabilities and establishes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the fair value measurement date. The three levels are defined as follows:

Level 1 -	quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 -	inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 -	inputs that are unobservable and significant to the fair value measurement.

          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 16 - “Disclosures of Fair Values of Financial Instruments.”

Analysis of Results of Operations

          Net Income. Net income for 2008 increased by $556 (or 8.2%) to $7,326 (or $2.22 per basic and $2.21 per diluted earnings per share), from $6,770 (or $2.04 basic earnings per share and $2.03 diluted earnings per share) in 2007. This increase is due to an improved net interest margin, which generated an additional $4.5 million in net interest income when compared to the prior year. This more than offset the increase in provision for loan losses of $2.3 million. For a more detailed review of the net interest margin, non-interest income and non-interest expense please refer to those sections contained in this Management’s Discussion and Analysis.

35

Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
(dollar amounts in thousands except share data)

          Net income for 2007 increased $282 (or 4.3%) to $6,770 (or $2.04 basic earnings per share and $2.03 diluted earnings per share), from $6,488 (or $1.93 basic earnings per share and $1.91 diluted earnings per share) in 2006. This increase is due to growth in the Corporation’s balance sheet. Average interest-earning assets increased by $65.7 million during 2007 compared to 2006, generating an additional $1.2 million in net interest income.

          Net Interest Income. The Corporation experienced a $4.4 million improvement in net interest income, on a taxable-equivalent basis, during 2008, increasing to $33,739 from $29,361 in 2007, representing an improvement of 14.9%. This positive change was made possible through growth in the balance sheet and an increased focus on reducing the Corporation’s cost of funds in today’s lower interest environment. Average interest-earning assets during 2008 increased to $980.8 million from $918.2 in 2007, representing growth of $62.6 million (or 6.8%). The asset mix of the balance sheet continued to shift more to loans, as the average balance of net loans increased $67.8 million (or 10.1%), while the average balance of total investments fell $4.2 million (or 1.8%). However, on the liability side, although average interest-bearing liabilities increased by $62.3 million (7.2%) to $924.8 million, the interest expense paid for those liabilities decreased from $34,505 in 2007 to $27,301 in 2008, a reduction of $7.2 million (or 20.9%). This was due to controlled pricing and the efficient use of other borrowings. Accordingly, the net yield on interest-earning assets, increased from 3.20% in 2007 to 3.44% in 2008. Again this year, the net yield on interest-earning assets improved each of the first three quarters: from 3.39% in the first quarter, to 3.49% in the second quarter, to 3.50% in the third quarter. The net yield in the fourth quarter of 3.38% was negatively impacted by the reversal of interest for loans that were placed in non-accrual, and would have been 3.53% without such reversals.

          The following table sets forth details of average balances, interest income and expense, and resulting rates for the past three years, reported on a taxable equivalent basis using a tax rate of 34%:

	For the Years Ending December 31
	2008							2007							2006
	Average Balance		Interest		Yield/ Cost			Average Balance		Interest		Yield/ Cost			Average Balance		Interest		Yield/ Cost
Average Interest-Earning Assets
Interest-bearing deposits	$	2,785	$	55		1.97	%	$	2,456	$	122		4.97	%	$	2,232	$	114		5.11	%
Taxable investment securities		143,108		6,834		4.78			152,220		6,822		4.48			154,576		6,370		4.12
Tax-exempt investment securities (a)		94,926		6,284		6.62			89,989		6,518		7.24			100,519		7,001		6.96
Federal funds sold		5,316		71		1.34			6,706		332		4.95			9,777		499		5.10
Net loans (a) (b)		734,672		47,796		6.51			666,853		50,072		7.51			585,382		42,025		7.18
Total interest-earning assets		980,807		61,040		6.22			918,224		63,866		6.96			852,486		56,009		6.57
Average non-interest-earning assets		126,526							118,000							108,278
Total average assets	$	1,107,333						$	1,036,224						$	960,764
Average Interest-Bearing Liabilities
Interest-bearing demand deposits	$	253,982		3,647		1.44	%	$	238,568		6,567		2.75	%	$	216,540		4,877		2.25	%
Savings deposits		61,815		67		0.11			63,357		249		0.39			70,726		326		0.46
Time deposits		506,663		20,068		3.96			481,725		23,509		4.88			431,153		18,640		4.32
Interest-bearing demand notes issued to the U.S. Treasury		1,099		15		1.36			1,035		49		4.73			848		39		4.56
Federal funds purchased and customer repurchase agreements		41,584		757		1.82			34,622		1,556		4.49			32,416		1,486		4.58
Advances from Federal Home Loan Bank		19,362		647		3.34			6,976		366		5.25			7,673		375		4.89
Trust preferred securities		25,000		1,420		5.68			25,000		1,420		5.68			25,000		1,410		5.64
Note payable		15,296		680		4.45			11,224		789		7.03			6,613		477		7.22
Total interest-bearing liabilities		924,801		27,301		2.95			862,507		34,505		4.00			790,969		27,630		3.49
Net yield on average interest-earning assets			$	33,739		3.44	%			$	29,361		3.20	%			$	28,379		3.33	%
Average non-interest-bearing liabilities		113,348							108,093							105,382
Average stockholders’ equity		69,184							65,624							64,414
Total average liabilities and stockholders’ equity	$	1,107,333						$	1,036,224						$	960,764

(a)	Interest income on non-taxable investment securities and non-taxable loans includes the effects of taxable-equivalent adjustments, using a tax rate of 34% in adjusting interest on tax-exempt securities and tax-exempt loans to a taxable equivalent basis. The amount of taxable equivalent adjustments were $2,218 in 2008, $2,307 in 2007 and $2,483 in 2006.
(b)	Includes $32 in 2008, $165 in 2007 and $78 in 2006 attributable to interest from non-accrual loans.

36

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

	2008		2007		2006
Net interest income as stated	$	31,521	$	27,054	$	25,896
Taxable-equivalent adjustment-investments		2,137		2,216		2,381
Taxable-equivalent adjustment-loans		81		91		102
Taxable-equivalent net interest income	$	33,739	$	29,361	$	28,379

          The following table reconciles the net yield on average interest-earning assets to the net yield on average interest-earning assets on a taxable-equivalent basis:

	2008		2007		2006
Net yield on interest-earning assets	3.21	%	2.95	%	3.04	%
Taxable equivalent adjustment-investments	0.22		0.24		0.28
Taxable equivalent adjustment-loans	0.01		0.01		0.01
Taxable equivalent net yield on interest-earning assets	3.44	%	3.20	%	3.33	%

          During 2007, net interest income, on a taxable-equivalent basis, increased to $29,361 from $28,379 in 2006, representing an improvement of $1.0 million (or 3.5%). This enhancement was attributable to an increase in average interest-earning assets during 2007 to $918.2 million from $852.5 in 2006, growth of $65.7 million (or 7.7%). The asset mix of the balance sheet shifted significantly in 2007 as maturities from the investment portfolio were used to help fund the exceptional loan growth during the year. The average balance of net loans increased $81.5 million (or 13.9%), while the average balance of total investments fell $12.9 million (or 5.1%). Accordingly, the average interest rate earned on these assets also increased to 6.96% in 2007 from 6.57% in 2006. The net yield on interest-earning assets, however, decreased from 3.33% in 2006 to 3.20% in 2007, as the compression of the net yield on average interest-earning assets that began in 2005 continued into early 2007. It is important to note, however, that the net yield on interest-earning assets improved each quarter in 2007: from 3.11% in the first quarter, to 3.15% in the second quarter, to 3.23% in the third quarter, and 3.29% in the fourth quarter. This improvement in the net yield on interest-earning assets was a major reason for the overall net income improvement each quarter in 2007 as noted in the Quarterly Results of Operations table contained in this report.

          The following table describes changes in net interest income attributable to changes in the volume of interest-earning assets and interest-bearing liabilities compared to changes in interest rates:

	Year ended December 31
		2008 compared to 2007										2007 compared to 2006										2006 compared to 2005
		Volume(a)				Rate(a)			Net			Volume(a)				Rate(a)			Net			Volume(a)			Rate(a)			Net
Interest from interest-earning assets
Interest-bearing time deposits			$	11		$	(78	)	$	(67	)		$	11		$	(3	)	$	8			$	8	$	39		$	47
Taxable investment securities				(422	)		434			12				(101	)		553			452				800		949			1,749
Tax-exempt investment securities (b)				342			(576	)		(234	)			(748	)		265			(483	)			1,027		179			1,206
Federal funds sold				(44	)		(217	)		(261	)			(154	)		(13	)		(167	)			278		101			379
Net loans (c)				4,752			(7,028	)		(2,276	)			5,983			2,064			8,047				7,047		3,562			10,609
Total income from interest- earning assets				4,639			(7,465	)		(2,826	)			4,991			2,866			7,857				9,160		4,830			13,990
Expense of interest-bearing liabilities
Interest-bearing demand deposits				323			(3,243	)		(2,920	)			551			1,139			1,690				126		1,527			1,653
Savings deposits				(4	)		(178	)		(182	)			(31	)		(46	)		(77	)			84		(25	)		59
Time deposits				1,102			(4,543	)		(3,441	)			2,327			2,542			4,869				3,814		4,530			8,344
Interest-bearing demand notes issued to the U.S. Treasury				2			(36	)		(34	)			9			1			10				3		13			16
Federal funds purchased and securities repurchase agreements				220			(1,019	)		(799	)			100			(30	)		70				289		441			730
Advances from Federal Home Loan Bank				532			(251	)		281				(35	)		26			(9	)			48		(15	)		33
Trust preferred securities				-0-			-0-			-0-				-0-			10			10				733		56			789
Note payable				234			(343	)		(109	)			328			(16	)		312				207		74			281
Total expense from interest-bearing liabilities				2,409			(9,613	)		(7,204	)			3,249			3,626			6,875				5,304		6,601			11,905
Net difference			$	2,230		$	2,148		$	4,378			$	1,742		$	(760	)	$	982			$	3,856	$	(1,771	)	$	2,085

(a)	The change in interest due both to rate and volume has been allocated equally.
(b)	Interest income on non-taxable investment securities and non-taxable loans includes the effects of taxable-equivalent adjustments using a tax rate of 34% in adjusting interest on tax-exempt securities and tax-exempt loans to a taxable-equivalent basis. The amount of taxable-equivalent adjustments were $2,218 in 2008, $2,307 in 2007 and $2,483 in 2006.
(c)	Includes loan fees of $996 in 2008, $1,287 in 2007, and $782 in 2006. Interest income on loans includes the effect of taxable-equivalent adjustments for non-taxable loans using a tax rate of 34% in adjusting interest on tax-exempt loans to a taxable-equivalent basis. Includes non-accrual loans, with year-end balances of $30,383 in 2008, $7,361 in 2007, and $3,893 in 2006.

37

Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
(dollar amounts in thousands except share data)

          Non-interest income. Total non-interest income increased in 2008 by $295, or 2.6%, to $11,593 from the 2007 total of $11,298. The largest increases were seen in the categories of other service charges and mortgage banking income, which increased by $171 (8.7%) and $166 (18.4%), respectively. Other service charges went up because of an increase in debit card income (usage), while mortgage banking income increased because of servicing income from a larger portfolio. The remaining categories of non-interest income showed either slight increases or decreases over the prior year. The Corporation recorded $405 in net gains from the sale of investment securities in 2008, compared to $541 in 2007, a decrease of $136 (or 25.1%).

          The following table provides non-interest income by category, total non-interest income, and non-interest income to average total assets for the periods indicated:

	For the Years ended December 31
	2008			2007			2006
Trust and farm management fees	$	1,530		$	1,507		$	1,467
Service charges on deposit accounts		4,408			4,431			4,235
Other service charges		2,137			1,966			1,782
Gain on sales of securities available-for-sale		405			541			250
Gain on sale of loans		-0-			-0-			90
Brokerage fee income		913			920			736
Mortgage banking income		1,069			903			755
Bank-owned life insurance income		874			816			770
Other operating income		257			214			160
Total non-interest income	$	11,593		$	11,298		$	10,245
Non-interest income to average total assets		1.05	%		1.09	%		1.07	%

          Total non-interest income of $11,298 in 2007 represented an increase of $1,053 (or 10.3%) from the 2006 total of $10,245. The brokerage department and the mortgage banking department had excellent results in 2007, reporting increases of $184 (or 25.0%) and $148 (or 19.6%), respectively. The Corporation recorded $541 in net gains from the sale of investment securities in 2007, compared to $250 in 2006, an increase of $291 (or 116.4%). The service charge categories continued to grow as well, as service charges on deposits increased $196 (or 4.6%) while other service charges increased $184 (or 10.3%), primarily from an increase in the number of accounts.

          Non-interest Expense. Total non-interest expense increased to $31,123 in 2008 from $29,565 in 2007 (an increase of $1,558 or 5.3%). The majority of the increase resulted in the category of salaries and employee benefits, which increased $818 or 4.8% (from $16,874 at December 31, 2007 to $17,692 at December 31, 2008). Additionally, the category of Federal deposit insurance assessments increased to $845 in 2008 from $338 in 2007 (an increase of $507, or 150.0%) due to expiration of credits (see Note 19 to Consolidated Financial Statements) and the accrual of FDIC premiums. In addition, the categories of occupancy expense and other operating expense increased by $183 (or 10.7%) and $199 (or 6.4%), respectively, from 2007 to 2008. As a percentage of average total assets, however, non-interest expense continued to decrease to 2.81% in 2008, compared to 2.85% in 2007.

          The following table provides non-interest expense, and non-interest expense to average total assets for the periods indicated:

	For the Years ended December 31
	2008			2007			2006
Salaries and employee benefits	$	17,692		$	16,874		$	15,884
Occupancy		1,890			1,707			1,458
Equipment expense		2,996			3,158			2,933
Federal insurance assessments		845			338			313
Intangible assets amortization		714			704			651
Data processing		1,151			1,101			1,032
Advertising		742			722			841
Postage		547			542			539
Property taxes		669			686			527
Supplies		347			448			427
Other real estate owned expense		203			157			149
Other operating expense		3,327			3,128			3,581
Total non-interest expense	$	31,123		$	29,565		$	28,335
Non-interest expense to average total assets		2.81	%		2.85	%		2.95	%

          Total non-interest expense increased to $29,565 in 2007 from $28,335 in 2006 (an increase of $1,230 or 4.3%). The majority of the increase resulted in the category of salaries and employee benefits, which increased $990 or 6.2% (from $15,884 at December 31, 2006 to $16,874 at December 31, 2007). This increase was due to a higher number of employees, particularly from the addition of the Plainfield office, as well as salary expense for an entire year in Aurora as opposed to only eight months in 2006. In addition, the categories of occupancy expense and equipment expense increased by $249 (or 17.1%) and $225 (or 7.7%), respectively, from 2006 to 2007. As a percentage of average total assets, however, non-interest expense continued to decrease to 2.85% in 2007, compared to 2.95% in 2006 and 2.97% in 2005.

          Income taxes. Income tax expense totaled $1,697 in 2008, $1,377 in 2007, and $1,033 in 2006. The effective tax rates were 18.8%, 16.9%, and 13.7% for the respective years then ended. The higher effective tax rate in 2008 was primarily due to a decrease in the amount of interest income earned from municipal (tax-exempt) securities.

38

Analysis of Financial Condition

          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:

	December 31
	2008				2007				2006				2005				2004
	Amount		% of Total		Amount		% of Total		Amount		% of Total		Amount		% of Total		Amount		% of Total
Agricultural	$	79,536	10.1	%	$	85,571	11.8	%	$	83,610	13.3	%	$	73,884	12.7	%	$	42,063	10.3	%
Commercial		225,806	28.5			168,936	23.4			134,402	21.4			114,342	19.7			96,390	23.5
Real Estate
1-4 family residences		132,056	16.7			127,656	17.7			120,585	19.1			138,959	23.9			76,644	18.7
Agricultural		64,212	8.1			61,158	8.5			61,511	9.8			56,069	9.6			39,688	9.7
Construction		31,444	4.0			46,874	6.5			42,991	6.8			37,286	6.4			17,271	4.2
Commercial		182,658	23.1			160,106	22.2			130,302	20.7			113,110	19.4			105,073	25.6
Real Estate Total		410,370	51.9			395,794	54.8			355,389	56.4			345,424	59.3			238,676	58.2
Installment		75,125	9.5			72,346	10.0			56,071	8.9			48,074	8.3			32,915	8.0
Total loans	$	790,837	100.0	%	$	722,647	100.0	%	$	629,472	100.0	%	$	581,724	100.0	%	$	410,044	100.0	%
Total assets	$	1,163,130			$	1,080,702			$	1,031,959			$	945,263			$	655,738
Loans to total assets			68.0	%			66.9	%			61.0	%			61.6	%			62.5	%

          Total loans increased $68.2 million (or 9.4%) in 2008 as compared to an increase of $93.2 million (14.8%) in 2007. There were no acquisitions in 2008, thus all loan growth was internal. The increase reflects business expansion in markets served by the subsidiary bank in 2008 as well as expansion of relationship banking in all markets.

          Commercial loans increased $56.9 million (or 33.7%) in 2008, which compares to an increase of $34.5 million (or 25.7%) in 2007. Building relationships with commercial businesses has been the largest component of loan growth in recent years. Increases occurred in both higher growth areas and established markets served by the subsidiary bank. Competition for high quality commercial and agricultural customers remains strong.

          Loans to agricultural operations decreased $6.0 million (or 7.1%) in 2008, which compares to an increase of $2.0 million (or 2.3%) in 2006. Short term agricultural loans are seasonal in nature with paydown from grain sales occurring near the beginning and end of each year. Rapid growth in the bio-fuels industry (primarily ethanol) and rising worldwide food demand have dramatically influenced corn prices since the latter part of 2007. Rising corn prices have influenced soybean prices as the two commodities compete for planted acreage. Corn and soybeans are the two primary crops of the Corporation’s market area. This has created an environment for significant profitability in agricultural crop production, which continued in 2008. While loan repayments are strong, costs of production have also increased maintaining the demand for operating credit. The highly experienced agricultural staff continues to effectively manage risk and seek opportunities in this portfolio. Agricultural loans as a percentage of total loans were 10.1% at year-end 2008, compared to 11.8% at year-end 2007.

          Real estate loans increased $14.6 million (or 3.7%) in 2008 compared to an increase of $40.4 million (or 11.3%) in 2007. The growth in real estate loans was primarily in the commercial area. Residential real estate loans with fixed rates of more than 5 years are generally sold into the secondary market. The Corporation retains the servicing of sold loans maintaining the local relationship with customers and generating servicing fee income. Total home mortgage closings were over $113 million in 2008. This was above budgeted volume which is a notable achievement in a time of reduced real estate sales. The Corporation has not originated any “sub prime” mortgages for our own portfolio or to sell in the secondary market. Construction loans decreased $15.4 million (or 32.9%) reflecting the significant national decline in building activity due to present economic conditions.

          Consumer installment loans increased $2.8 million (or 3.8%) in 2008 from 2007. This follows an increase of $16.3 million (or 29.0%) in 2007. Home equity lending comprises two thirds of the installment portfolio.

          Although the risk of non-payment for any reason exists with respect to all loans, certain other more specific risks are associated with each type of loan. The primary risks associated with commercial loans are quality of the borrower’s management and the impact of national economic factors. With respect to agricultural loans, the primary risks are weather and, like commercial loans, the quality of the borrower’s management. Risks associated with real estate loans include concentrations of loans in a loan type, such as commercial or agricultural, and fluctuating land values. Installment loans also have risks associated with concentrations of loans in a single type of loan. Installment loans additionally carry the risk of a borrower’s unemployment as a result of deteriorating economic conditions. With the notable exception of agricultural lending, the current economic downtrend has increased the risk level in the subsidiary bank’s loan portfolio.

          The Corporation’s strategy with respect to addressing and managing these types of risks, whether loan demand is weak or strong, is for the subsidiary bank to follow its conservative loan policies and underwriting practices, which include (i) granting loans on a sound and collectible basis, (ii) investing funds profitably for the benefit of the stockholders and the protection of depositors, (iii) serving the legitimate needs of the community and the subsidiary bank’s general market area while obtaining a balance between maximum yield and minimum risk, (iv) ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan, (v) administering loan policies through a Directors’ Loan Committee and Officer approvals, (vi) developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each loan category, and (vii) ensuring that each loan is properly documented and, if appropriate, secured or guaranteed by government agencies, and that insurance coverage is adequate, especially with respect to certain agricultural loans because of the risk of poor weather. When problem situations occur bank staff actively work with borrowers to achieve the best resolution possible.

39

Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
(dollar amounts in thousands except share data)

          Non-performing Loans and Other Real Estate Owned. Non-performing loans amounted to 4.18% of total loans at year-end 2008 compared to 1.03% at year-end 2007. The increase reflects a higher level of stress in the building industry as well as the general economy. Approximately eighty percent of the increase in 2008 is attributable to three loan relationships, all of which are development loans in the Corporation’s northern and eastern market areas. As sales have dramatically decreased, developers are facing difficulty in making interest payments, creating the non-performing status. The Corporation has been proactive in obtaining updated appraisals for development projects. No specific loss provisions have been established for these three relationships. Problem credits are closely monitored by the lending staff, and an independent loan review staff provides further assistance in identifying problem situations. Loans over 90 days past due are normally either charged off, or if well secured and in the process of collection, placed on a non-accrual status. Problem credits have a life cycle. They either improve or they move through a workout/liquidation process. The workout process often includes non-accrual status. The allowance for possible loan losses was 15.3% and 43.7% of non-performing loans at year-end 2008 and 2007, respectively. The decrease in the percentage for 2008 is due to an increase in non-performing loans. These loans are substantially collateralized. Total other real estate owned as of December 31, 2008 was $2,487. The Corporation had $833 in other real estate owned as of December 31, 2007. The following table provides information on the Corporation’s non-performing loans since 2004:

	December 31
	2008			2007			2006			2005			2004
Non-accrual	$	30,383		$	7,361		$	3,893		$	3,822		$	328
90 days past due and accruing		2,655			73			33			3			-0-
Restructured		-0-			-0-			-0-			-0-			-0-
Total non-performing loans	$	33,038		$	7,434		$	3,926		$	3,825		$	328
Non-performing loans to total loans (net of unearned interest)		4.18	%		1.03	%		0.62	%		0.66	%		0.08	%

          As of December 31, 2008 and 2007, loans which the Corporation’s management had serious doubts as to the ability of borrowers to comply with loan repayment terms not carried as non-performing loans totaled approximately $551 (or .07% of the total loan portfolio), and $115 (or .02% of the total loan portfolio), respectively.

          Allowance for Possible Loan Losses. The allowance shown in the following table represents the allowance available to absorb losses within the entire portfolio:

	For the Years Ended December 31
	2008			2007			2006			2005			2004
Amount of loans outstanding at end of year (net of unearned interest)	$	790,837		$	722,647		$	629,472		$	581,812		$	410,044
Average amount of loans outstanding for the year (net of unearned interest)	$	734,672		$	666,853		$	585,382		$	482,448		$	390,755
Allowance for loan losses at beginning of year	$	3,248		$	3,053		$	3,109		$	2,524		$	2,250
Allowance of bank acquired		-0-			-0-			-0-			752			-0-
Charge-offs:
Agricultural		-0-			-0-			162			-0-			-0-
Commercial		797			373			227			85			54
Real estate-mortgage		91			22			21			10			3
Installment		446			269			194			252			301
Total charge-offs		1,334			664			604			347			358
Recoveries:
Agricultural		-0-			1			-0-			-0-			-0-
Commercial		37			29			90			2			54
Real estate-mortgage		-0-			17			5			-0-			4
Installment		145			172			168			178			199
Total recoveries		182			219			263			180			257
Net loans charged off		1,152			445			341			167			101
Provision for loan losses		2,968			640			285			-0-			375
Allowance for loan losses at end of year	$	5,064		$	3,248		$	3,053		$	3,109		$	2,524
Net loans charged off to average loans		0.16	%		0.07	%		0.06	%		0.03	%		0.03	%
Allowance for loan losses to non-performing loans		15.33	%		43.69	%		77.76	%		81.28	%		769.51	%
Allowance for loan losses to total loans at end of year (net of unearned interest)		0.64	%		0.45	%		0.49	%		0.53	%		0.62	%

40

          The allowance for loan losses is considered by management to be a critical accounting policy. The allowance for loan losses is increased by provisions charged to operating expense and decreased by charge-offs, net of recoveries. The allowance is based on factors that include the overall composition of the loan portfolio, types of loans, past loss experience, loan delinquencies, potential substandard and doubtful loans, and such other factors that, in management’s best judgment, deserve evaluation in estimating possible loan losses. The adequacy of the allowance for possible loan losses is monitored monthly during the ongoing, systematic review of the loan portfolio by the Loan Review staff of the Audit Department, Senior Lending Officers, Chief Financial Officer, Risk Manager and Chief Executive Officer of the subsidiary bank. The results of these reviews are reported to the Board of Directors of the subsidiary bank on a monthly basis. Monitoring and addressing problem loan situations are primarily the responsibility of the subsidiary bank’s staff, management and its Board of Directors.

          More specifically, the Corporation calculates the appropriate level of the allowance for possible loan losses on a monthly basis using base charge-offs for each loan type, substandard loans, and potential losses with respect to specific loans. In addition to management’s assessment of the portfolio, the Corporation and the subsidiary bank are examined periodically by regulatory agencies. Although the regulatory agencies do not determine whether the subsidiary bank’s allowance for loan losses is adequate, such agencies do review the procedures and policies followed by management of the subsidiary bank in establishing the allowance.

          Given the current state of the economy, management did assess the impact of the recession on each category of loans and adjusted historical loss factors for more recent economic trends. Management utilizes a five-year loss history as one component in assessing the probability of inherent future losses. Given the decline in economic conditions over the past year, management has also increased its allocation to various loan categories for economic factors. Some of the economic factors include the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the decline in and uncertainty regarding grain prices and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the reserve.

          Net charge-offs were 0.16% of average (total loans) in 2008. The allowance for loan losses at year-end 2008 was $5.06 million, .64% of total loans, net of unearned interest, and 15.33% of non-performing loans. The year end 2008 allowance of ..64% of total loans is an increase of 42% from the year end 2007 number of ..45%, reflecting management’s assessment of the present economic environment. Non-performing loans are comprised of credits that management believes will not result in significant losses to the Corporation. There are $818 specific loan loss reserves for the non-performing or impaired loans as of December 31, 2008. Management considers the allowance for loan losses adequate to meet probable losses as of December 31, 2008.

          Investment Securities. The objectives of the investment portfolio are to provide the subsidiary bank with a source of earnings and liquidity. The following table provides information on the book value of investment securities as of the dates indicated:

	December 31
	2008		2007
U.S. Government Agencies	$	92,198	$	63,740
State and Municipal		103,960		95,134
Collateralized mortgage obligations		54,957		69,701
Total	$	251,115	$	228,575

          Investment securities totaled $251.1 million on December 31, 2008, an increase of $22.5 million (or 9.9%) from the December 31, 2007 total of $228.6 million. The increase was primarily due to securities purchased to meet increased pledging requirements for new deposits and a comparison to a lower than average total from 2007. Some changes occurred in the investment mix during 2008. Collateralized Mortgage Obligations (CMOs) decreased by 21.1%, or $14.7 million, and now represent 21.9% of the portfolio, down from 30.5%. Municipal bond holdings increased by $8.8 million or 9.3%. U.S. Government agencies and Mortgage-backed securities (MBS) increased $28.5 million or 44.6%, and now represent 36.7% of the portfolio, up from 27.9%. This can be attributed to the value created in that sector due to market pricing opportunities. The overall yield on the total portfolio rose by 21 basis points from 2007 to 5.51%. This occurred largely from the increase in allocation in mortgage backs and several swap strategies, where gains were captured and yield increases on reinvestment. It should also be noted that the investment portfolio does not contain any sub-prime mortgage securities nor any Fannie Mae or Freddie Mac preferred stock.

          Total investment securities were $228.6 million on December 31, 2007, a decrease of $35.2 million (or 13.4%) from the December 31, 2006 total of $264.0 million. The reduction in the portfolio was primarily due to liquidity needs to meet strong loan demand and a decision to reduce participation in the State of Illinois Ag Link Deposit program. Some changes occurred in the investment mix during 2007, as a result of maturities and principal paydowns that were not reinvested. Collateralized Mortgage Obligations (CMOs) decreased by 25.3%, or $23.6 million, and now represent 30.0% of the portfolio, down from 34.8%. Municipal bond holdings dropped by $10.8 million or 10.2%. The current yield on the total portfolio on a year over year basis fell by 7 basis points from 5.37% to 5.30%. The decrease in the yield of the municipal bond portfolio was the major contributing factor, with a drop of 16 basis points. This decline was largely a function of falling interest rates and subsequent calls exercised on higher coupon securities with imbedded unamortized premiums. Conversely, the current yield improved on all other investment categories.

          Deposits. Total deposits increased in 2008 by approximately $70.7 million, a 7.9% increase over 2007. Time deposits represented an increase of $55.0 million, an 11.2 % increase over the prior year largely due to customers continuing their prior years trend of investing in term accounts rather than liquid accounts. Interest-bearing demand accounts increased $5.0 million, a 2.1% increase over 2007. Non-interest bearing demand accounts showed an increase of $8.1 million (or 7.9%). Regular savings accounts experienced an increase of approximately $2.7 million (or 4.6%), with funds also moving to time deposits and money market products. The average rate for overall deposits decreased .84% in 2008 as a result of certificates of deposits maturing and re-pricing lower, as well as liquid accounts pricing lower. The concentration in the High Yield Money Market portfolio of $119 million and the Freedom IRA portfolio of $31 million were being offered at slightly higher rates than the other liquid products. This shift in deposits continues the trend of customers moving away from the market and into FDIC insured investments over the last several years. Additionally, a strong marketing campaign emphasizing the soundness, strength and experience of the subsidiary bank and the increase in late 2008 of FDIC coverage to $250,000 attracted deposits to the bank. Again this year, the subsidiary bank has experienced growth in all of the markets served. It is particularly noteworthy, the subsidiary bank’s deposits are core deposits and contain no brokered CD’s (other than CDARS relationships).

          Over the last three years, the subsidiary bank has seen overall deposits increase 20.5%. The increase in consumer deposits reflects our continued focus on investing in offices in high growth areas, and continued focus of officers calling on customers and potential customers through our officer call program to develop deposit relationships. This growth also reflects the well trained staff that looks to assist customers by identifying needs and providing sound solutions. There continues to be considerable interest in the alternative delivery mechanisms, such as electronic methods which include ATM’s, Internet Banking with Bill Payment

41

Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
(dollar amounts in thousands except share data)

and Telebanker as a convenient means for customers to better manage their money, maximize return, and have peace of mind by dealing safely and securely with only one financial institution. Due to the diversity within our various market areas, such delivery mechanisms will continue to position us well for the future.

          The following table sets forth the classification of deposits with year-end balances and the average rates paid for the periods indicated:

	For the Years Ended December 31
	2008				2007				2006
	Balance		Rate		Balance		Rate		Balance		Rate
Non-interest bearing demand	$	110,559	n/a		$	102,452	n/a		$	107,834	n/a
Interest-bearing demand		246,714	1.44	%		241,749	2.75	%		231,953	2.25	%
Savings		61,089	0.11			58,401	0.39			66,060	0.46
Time deposits		543,770	3.96			488,805	4.88			476,052	4.32
Total	$	962,132	2.61	%	$	891,407	3.45	%	$	881,899	2.96	%

          The following table summarizes time deposits in amounts of $100 or more by time remaining until maturity as of December 31, 2008. These time deposits are made by individuals, corporations and public entities:

Three months or less	$	92,614
Over three months through six months		46,349
Over six months through one year		71,006
Over one year		22,842
Total	$	232,811

          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, including cash flow from both the repayment of loans and the securitization of assets, are also considered in determining whether liquidity is satisfactory. The funds are used to meet deposit withdrawals, maintain reserve requirements, fund loans, purchase treasury shares, and operate the organization. Liquidity is achieved through growth of core funds (defined as core deposits, 50% of non-public entity certificates of deposit over $100, and repurchase agreements issued to commercial customers) and liquid assets, and accessibility to the money and capital markets. The Corporation and the subsidiary bank have access to short-term funds through their correspondent banks, as well as access to the Federal Home Loan Bank of Chicago, which can provide longer-term funds to help meet liquidity needs.

          The ratio of temporary investments and other short-term available funds (those investments maturing within one year plus twelve months’ projected payments on mortgage-backed securities and collateralized mortgage obligations, and cash and due from banks balances) to volatile liabilities (50% of non-public entity certificates of deposit over $100, repurchase agreements issued to public entities, treasury tax and loan deposits, short-term borrowings from banks, and deposits of public entities) was 32.6% at December 31, 2008 and 45.3% at December 31, 2007, respectively. Core deposits (demand deposits, interest-bearing checking accounts, total savings, and certificates of deposit less than $100) were 83.0 % of total deposits at December 31, 2008 and 90.5% of total deposits at December 31, 2007. Money market accounts of approximately $135.5 million at December 31, 2008 are classified by the Corporation as core deposits.

          In 2008, the Corporation experienced a net decrease of $7.3 million in cash and cash equivalents. The Corporation used $93.1 million for investing activities, which primarily consisted of a $71.7 million increase in net loans and a $22.6 million increase in investments. Offsetting this usage, financing activities provided the Corporation with $75.6 million, consisting of an increase in deposits of $70.7 million and an increase of $8.9 million in borrowings, less $3.7 million in dividends paid to shareholders, and operating activities which provided the Corporation with $10.2 million. Cash and cash equivalents of $20.3 million at December 31, 2008, along with established lines of credit, are deemed more than adequate to meet short-term liquidity needs.

          In 2007, the Corporation experienced a net decrease of $11.6 million in cash and cash equivalents. Investing activities, consisting of a net increase in loans offset by a decrease in investments, used $50.1 million. Providing the Corporation with funds to offset the investing activities were financing activities of $26.7 million (net increase in borrowings) and operating activities of $11.8 million.

          The long-term liquidity needs of the Corporation will be driven by the necessity to grow and change in the marketplace to meet the needs of its customers and to offset strategies of its competitors. The Corporation’s equity base, coupled with common stock available for issuance, a low level of debt, and available borrowing sources provide several options for future financing.

          Asset-Liability Management. The Corporation actively manages its assets and liabilities through coordinating the levels of interest rate sensitive assets and liabilities to minimize changes in net interest income, despite changes in market interest rates. The Corporation defines interest rate sensitive assets and liabilities as any instruments that can be repriced within 180 days, either because the instrument will mature during the period or because it carries a variable interest rate. Changes in net interest income occur when interest rates on loans and investments change in a different time period from changes in interest rates on liabilities, or when the mix and volume of earning assets and interest-bearing liabilities change. The interest rate sensitivity gap represents the total dollar amount of the difference between rate sensitive assets and rate sensitive liabilities within a given time period (GAP). A GAP ratio is determined by dividing rate sensitive assets by rate sensitive liabilities. A ratio of 1.0 indicates a perfectly matched position, in which case the effect on net interest income due to interest rate movements would be zero.

          The Corporation’s strategy with respect to asset-liability management is to maximize net interest income while limiting the Corporation’s exposure to risks associated with volatile interest rates. The subsidiary bank’s Funds Management Committee is responsible for monitoring the GAP position. As a general rule, the subsidiary bank’s policy is to maintain GAP as a percent of total assets within a range from +20% to -20% in any given time period. Based on the simulation of various rising or falling interest rate scenarios in comparison to one considered to be the most likely interest rate scenario, management seeks to operate with net interest income within a range of +10% to -10% of budgeted net interest income during any twelve-month period. The Corporation also performs an interest rate risk analysis, on a monthly basis, on the assets and liabilities of the subsidiary bank. This analysis applies an immediate shift in interest rates of up to +300 basis points and -300 basis points to the assets and liabilities to determine the impact on the net interest income and net income of the subsidiary bank, when

42

compared to a flat rate scenario. This analysis also does not take into account any other balance sheet management plans that may be implemented should such rapid interest rate movement occur.

          The following table shows the estimated changes to net interest income from the base scenario as of December 31, 2008 and 2007:

Change in	Estimated Net Interest Income
Interest Rate	2008		% of change		2007		% of change
300 basis point rise	$	32,774	-11.56	%	$	35,253	0.37	%
200 basis point rise		33,974	-8.32			35,439	0.90
100 basis point rise		35,439	-4.37			35,723	1.71
Base scenario		37,058	—			35,124	—
100 basis point decline		35,528	-4.13			34,004	-3.19
200 basis point decline		32,706	-11.74			32,937	-6.23
300 basis point decline		30,019	-18.99			31,965	-8.99

          Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements. As disclosed in the Notes to Consolidated Financial Statements, the Corporation has certain obligations and commitments to make future payments under contracts. At December 31, 2008, the aggregate contracted obligations (excluding bank deposits) and commercial commitments are as follows:

	Total		Less Than 1 Year		1-3 Years		3-5 Years		Over 5 Years
Contractual Obligations:
Time Deposits	$	543,770	$	463,332	$	72,869	$	7,519	$	50
Customer repurchase agreements		35,532		35,532		-0-		-0-	$	-0-
Interest-bearing demand notes issued to the U.S. Treasury		2,441		2,441		-0-		-0-		-0-
Advances from the Federal Home Loan Bank		32,493		12,500		19,993		-0-		-0-
Federal funds purchased		6,500		6,500		-0-		-0-		-0-
Trust preferred securities		25,000		-0-		25,000		-0-		-0-
Note payable		16,050		16,050		-0-		-0-		-0-
Post-retirement health insurance		698		44		117		112		425	(1)
Total	$	662,484	$	536,399	$	117,979	$	7,631	$	475
Off-Balance Sheet Arrangements:
Commitments to lend	$	155,603	$	155,603	$	-0-	$	-0-	$	-0-
Standby letters of credit		5,886		5,886		-0-		-0-		-0-
Total	$	161,489	$	161,489	$	-0-	$	-0-	$	-0-

(1) For the years 2014 through 2018

          See Note 18 of the Consolidated Financial Statements for additional discussion on Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements.

43

Management’s Discussion and Analysis of
Financial Condition and Results of Operations (Continued)
(dollar amounts in thousands except share data)

          The following table sets forth the Corporation’s interest rate repricing gaps for selected maturity periods at December 31, 2008 (dollars in thousands):

	Rate Sensitive Within
	1 year			1-2 yrs.			2-3 yrs.			3-5 yrs.			Thereafter			Total		Fair Value
Interest-earning assets:
Interest-bearing deposits	$	2,774		$	-0-		$	-0-		$	-0-		$	-0-		$	2,774	$	2,774
Taxable investment securities		34,582			17,386			14,517			14,128			70,753			151,366		151,366
Tax-exempt investment securities		4,574			3,128			1,503			6,504			88,252			103,961		104,190
Loans		408,157			101,384			92,543			132,310			53,533			787,927		793,410
Total rate sensitive assets (“RSA”)	$	450,087		$	121,898		$	108,563		$	152,942		$	212,538		$	1,046,028	$	1,051,740
Interest-bearing liabilities:
Interest-bearing demand deposits	$	246,714		$	-0-		$	-0-		$	-0-		$	-0-		$	246,714	$	246,714
Savings deposits		61,089			-0-			-0-			-0-			-0-			61,089		61,089
Time deposits		463,332			60,828			12,041			7,519			50			543,770		554,362
Customer repurchase agreements		35,532			-0-			-0-			-0-			-0-			35,532		35,532
Advances from the Federal Home Loan Bank		12,500			19,993			-0-			-0-			-0-			32,493		34,083
Federal funds purchased		6,500			-0-			-0-			-0-			-0-			6,500		6,500
Interest-bearing demand notes issued to the U.S. Treasury		2,441			-0-			-0-			-0-			-0-			2,441		2,441
Trust preferred securities		-0-			25,000			-0-			-0-			-0-			25,000		33,210
Note payable		16,050			-0-			-0-			-0-			-0-			16,050		16,050
Total rate sensitive liabilities (“RSL”)	$	844,158		$	105,821		$	12,041		$	7,519		$	50		$	969,589	$	989,981
Interest rate sensitivity GAP (RSA less RSL)	$	(394,071	)	$	16,077		$	96,522		$	145,423		$	212,488
Cumulative GAP	$	(394,071	)	$	(377,994	)	$	(281,472	)	$	(136,049	)	$	76,439
RSA/RSL		53.32	%		115.19	%		901.61	%		2034.07	%		425076.00	%
Cumulative RSA/RSL		53.32	%		60.21	%		70.74	%		85.97	%		107.88	%

          In the table above, interest-bearing demand deposits and savings deposits are included as rate sensitive in the amounts reflected in the 0-3 month time frame, as such interest-bearing liabilities are subject to immediate withdrawal.

          Management of the Corporation considers $55.6 million (one-half) of the interest-bearing checking account balances and $67.8 million (one-half) of the money market account balances (both being the components of interest-bearing demand deposits) and all savings deposits as core, or non-rate sensitive deposits, primarily since interest-bearing demand and savings deposits historically have not been rate sensitive. As a general rule, the subsidiary bank’s policy is to maintain RSA as a percent of RSL within a range of +70% to +120% within a six-month time period.

          At December 31, 2008, savings deposits totaled approximately $61.1 million. If the $61.1 million in savings deposits, the $55.6 million of interest-bearing checking account balances and the $67.8 million in money market account balances reflected in the less than one year time frame are excluded from the rate sensitivity above (consistent with the consideration mentioned in the paragraph above), then rate sensitive liabilities would be approximately $659.7 million decreasing the negative gap to approximately $209.6 million. RSA as a percent of RSL would be 68.2%.

          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.

          Investment Maturities and Yields. The following table sets forth the contractual maturities of the amortized cost of investment securities at December 31, 2008, and the taxable equivalent yields of such securities:

	Due within one year				Due after one but within five years				Due after five years				Other (no stated maturity)
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
U.S. Government Agencies	$	420	5.50	%	$	5,598	3.70	%	$	82,861	5.05	%	$	-0-		—
State and Municipal		4,597	5.54			11,060	5.92			89,354	6.34			-0-		—
Collateralized mortgage obligations		-0-	—			4,295	4.31			50,111	4.71			-0-		—
Total	$	5,017	5.54	%	$	20,953	5.00	%	$	222,326	5.49	%	$	-0-		—

44

          Loan Maturities. The following table sets forth scheduled loan repayments on agricultural, commercial and real estate construction loans at December 31, 2008:

	Due within one year		Due after one but within five years		Due after five years		Non-accrual		Total
Agricultural	$	70,981	$	7,952	$	603	$	-0-	$	79,536
Commercial		160,699		39,043		10,477		15,587		225,806
Real Estate-Construction		27,615		3,829		-0-		-0-		31,444
Total	$	259,295	$	50,824	$	11,080	$	15,587	$	336,786

          Of the loans shown above, the following table sets forth loans due after one year which have predetermined (fixed) interest rates or adjustable (variable) interest rates at December 31, 2008:

	Fixed rate		Variable rate		Total
Due after one year	$	51,207	$	10,697	$	61,904

          Allocation of Allowance for Loan Losses. The subsidiary bank has allocated the allowance for loan losses to provide for the possibility of losses being incurred within the categories of loans set forth in the table below. The allocation of the allowance and the ratio of loans within each category to total loans at December 31 are as follows:

	December 31
	2008				2007				2006				2005				2004
	Allowance amount		Percent of loans in each category to total loans		Allowance amount		Percent of loans in each category to total loans		Allowance amount		Percent of loans in each category to total loans		Allowance amount		Percent of loans in each category to total loans		Allowance amount		Percent of loans in each category to total loans
Agricultural	$	235	10.1	%	$	580	11.8	%	$	830	13.3	%	$	1,011	12.7	%	$	656	10.3	%
Commercial		2,469	28.5			1,188	23.4			1,022	21.4			890	19.7			770	23.5
Real estate-mortgage		1,284	51.9			743	54.8			490	56.4			420	59.3			193	58.2
Installment		890	9.5			486	10.0			540	8.9			484	8.3			359	8.0
Unallocated		186	n/a			251	n/a			171	n/a			304	n/a			546	n/a
Total	$	5,064	100.0	%	$	3,248	100.0	%	$	3,053	100.0	%	$	3,109	100.0	%	$	2,524	100.0	%

          Recent Developments - On January 23, 2009, the Corporation completed the sale of $25.1 million of preferred stock and a warrant to purchase common stock to the United States Department of the Treasury (the “U.S. Treasury”) under U.S. Treasury’s Capital Purchase Program under the Emergency Economic Stabilization Act of 2008 (“EESA”).

          The Corporation issued and sold (1) 25,083 shares of Fixed Rate Cumulative Perpetual Preferred Stock Series B, liquidation preference of $1,000 per share (the “Series B Preferred Shares”), and (2) a ten-year warrant (the “Warrant”) to purchase up to 155,025 shares of the Corporation’s common stock (“Common Stock”) at an exercise price of $24.27 per share, or an aggregate purchase price of $3.8 million in cash. Cumulative dividends on the Series B Preferred Shares will accrue on the liquidation preference at a rate of 5% per annum for the first five years, and at a rate of 9% per annum thereafter.

          The securities purchase agreement, dated January 23, 2009 (the “Purchase Agreement”), between the Corporation and the U.S. Treasury, pursuant to which the Series B Preferred Shares and the Warrant were sold, limits the payment of dividends on the Common Stock to the current quarterly cash dividend of $0.28 per share, limits the Corporation’s ability to repurchase its Common Stock, and subjects the Corporation to certain of the executive compensation limitations included in the EESA.

          As a condition to the closing of the transaction, each of the Corporation’s Senior Executive Officers (as defined in the Purchase Agreement) executed a waiver voluntarily waiving any claim against the Treasury or the Corporation for any changes to their compensation or benefits, as required to comply with the regulation issued by the U.S. Treasury under the TARP Capital Purchase Program. The Senior Executive Officers also acknowledged that the regulation may require modification of the compensation, bonus, incentive and other benefit plans, arrangements and policies and agreements (including so-called “golden parachute” agreements) as they relate to the period the U.S. Treasury holds any equity or debt securities of the Corporation acquired through the Capital Purchase Program.

          In addition to EESA, on February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. The ARRA contains numerous provisions which modify EESA and which require additional rule making by various regulatory bodies. The precise impact of ARRA and the rules promulgated under it will become known in the coming months.

45

Quarterly Results of Operations
(dollars in thousands except share data)

          The following table sets forth certain unaudited income and expense and share data on a quarterly basis for the three-month periods indicated:

	Year Ended December 31, 2008
	1st Qtr		2nd Qtr		3rd Qtr		4th Qtr
Interest income	$	15,066	$	14,473	$	14,812	$	14,471
Interest expense		7,612		6,656		6,640		6,393
Net interest income		7,454		7,817		8,172		8,078
Provision for loan losses		368		450		550		1,600
Net interest income after provision for loan losses		7,086		7,367		7,622		6,478
Non-interest income		3,153		2,751		2,851		2,838
Non-interest expense		7,560		7,509		7,628		8,426
Income before income taxes		2,679		2,609		2,845		890
Income tax expense		589		589		658		(139	)
Net income	$	2,090	$	2,020	$	2,187	$	1,029
Earnings per share:
Basic	$	0.63	$	0.61	$	0.66	$	0.32
Diluted	$	0.63	$	0.61	$	0.66	$	0.31
Cash dividends declared per share	$	0.28	$	0.28	$	0.28	$	0.28
	Year Ended December 31, 2007
	1st Qtr		2nd Qtr		3rd Qtr		4th Qtr
Interest income	$	14,817	$	15,234	$	15,632	$	15,876
Interest expense		8,425		8,647		8,782		8,651
Net interest income		6,392		6,587		6,850		7,225
Provision for loan losses		185		115		250		90
Net interest income after provision for loan losses		6,207		6,472		6,600		7,135
Non-interest income		2,645		2,722		2,935		2,996
Non-interest expense		7,272		7,394		7,387		7,512
Income before income taxes		1,579		1,800		2,148		2,619
Income tax expense		150		247		408		571
Net income	$	1,429	$	1,553	$	1,740	$	2,048
Earnings per share:
Basic	$	0.43	$	0.47	$	0.53	$	0.62
Diluted	$	0.42	$	0.46	$	0.52	$	0.62
Cash dividends declared per share	$	0.27	$	0.27	$	0.27	$	0.27

46

Selected Consolidated Financial Information
(dollars in thousands except share data)

	For the Years Ended December 31
	2008			2007			2006			2005			2004
Summary of Income
Interest income	$	58,822		$	61,559		$	53,526		$	39,971		$	29,719
Interest expense		27,301			34,505			27,630			15,726			9,070
Net interest income		31,521			27,054			25,896			24,245			20,649
Provision for loan losses		2,968			640			285			-0-			375
Non-interest income		11,593			11,298			10,245			8,840			8,315
Non-interest expense		31,123			29,565			28,335			23,253			19,503
Income before income taxes		9,023			8,147			7,521			9,832			9,086
Income tax expense		1,697			1,377			1,033			2,258			2,214
Net income		7,326			6,770			6,488			7,574			6,872
Per Share Data
Basic earnings per share	$	2.22		$	2.04		$	1.93		$	2.39		$	2.22
Diluted earnings per share		2.21			2.03			1.91			2.37			2.21
Book value (at end of period)		21.97			20.74			19.50			18.87			17.13
Cash dividends declared		1.12			1.08			1.05			1.03			0.96
Dividend payout ratio		50.5	%		53.1	%		54.6	%		44.0	%		43.2	%
Selected Balances (at end of year)
Total assets	$	1,163,130		$	1,080,702		$	1,031,959		$	945,263		$	655,738
Earning assets		1,017,732			949,534			904,504			852,286			616,089
Investments		251,115			228,575			267,916			251,486			188,809
Gross loans		792,992			723,575			633,984			584,311			411,345
Allowance for loan losses		5,064			3,248			3,053			3,109			2,524
Deposits		962,132			891,407			881,899			798,558			573,561
Borrowings		118,016			109,089			74,147			72,575			25,535
Stockholders’ equity		72,471			68,607			65,355			63,144			52,369
Selected Financial Ratios
Net income to average stockholders’ equity		10.59	%		10.32	%		10.07	%		13.43	%		13.46	%
Net income to average assets		0.66			0.65			0.68			0.97			1.11
Average stockholders’ equity to average assets		6.25			6.33			6.70			7.21			8.24
Average earning assets to average assets		88.57			88.61			88.73			90.21			91.37
Non-performing loans to total loans at end of year (net of unearned interest)		4.18			1.03			0.62			0.66			0.08
Tier 1 capital to average adjusted assets		6.22			6.33			6.67			7.83			7.88
Risk-based capital to risk-adjusted assets		8.30			8.44			9.18			9.76			11.49
Net loans charged-off to average loans		0.16			0.07			0.06			0.03			0.03
Allowance for loan losses to total loans at end of year (net of unearned interest)		0.64			0.45			0.49			0.53			0.62
Average interest-bearing deposits to average deposits		89.02			89.01			88.27			88.29			88.10
Average non-interest-bearing deposits to average deposits		10.98			10.99			11.73			11.71			11.90

47

Common Stock Price Performance Graph

          The following Common Stock price performance graph compares the monthly change in the Corporation’s cumulative total stockholder returns on its Common Stock, assuming the Common Stock was purchased on December 31, 2003 and sold on December 31, 2008, with the cumulative total return of stocks included in the Russell 3000, the NASDAQ Bank Index and the SNL Midwest Bank Stock Index for the same period. The amounts shown assume the reinvestment of dividends.

Total Return Performance

	Period Ending
Index	12/31/03		12/31/04		12/31/05		12/31/06		12/31/07		12/31/08
Princeton National Bancorp, Inc.		100.00		104.33		124.41		125.70		97.18		92.63
Russell 3000		100.00		111.95		118.80		137.47		144.54		90.61
SNL Midwest Bank Index		100.00		112.84		108.73		125.68		97.96		64.44
NASDAQ Bank		100.00		110.99		106.18		117.87		91.85		69.88

          The Corporation’s Common Stock began trading on the NASDAQ Stock Market under the symbol PNBC on May 8, 1992. On December 31, 2008 and February 27, 2009, the Record Date, the closing bid prices for the Common Stock as quoted on NASDAQ Online were $22.14 and $13.03, respectively.

49

EX-21

Exhibit 21. Subsidiary of Princeton National Bancorp, Inc.

Citizens First National Bank	Princeton National Bancorp, Inc.
	owns 100 percent of the shares
	Citizens First National Bank.

EX-23.1

Exhibit 23.1 Consent of BKD, LLP.

Consent of Independent Registered Public Accounting Firm

The Board of Directors
Princeton National Bancorp, Inc.

We consent to the incorporation by reference in the registration statements (Nos. 333-69019, 333-117663, 333-129484, and 333-153251) on Form S-8 and 333-157451 on Form S-3 of Princeton National Bancorp, Inc. of our reports dated March 17, 2008, with respect to the consolidated balance sheets of Princeton National Bancorp, Inc. and subsidiary as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the two year period ended December 31, 2008, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2008, and the effectiveness of internal control over financial reporting as of December 31, 2008, which reports appear in the December 31, 2008 annual report on Form 10-K of Princeton National Bancorp, Inc.

/sig/ BKD, LLP

Decatur, Illinois
March 16, 2009

EX-31.1

Exhibit 31.1

I, Tony J. Sorcic, certify that:
	1.	I have reviewed this annual report on Form 10-K of Princeton National Bancorp, Inc.;
	2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
	3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
	4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
		a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
		b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
		c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
		d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
	5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
		a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
		b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Tony J. Sorcic

     Tony J. Sorcic

     President & Chief Executive Officer

     March 16, 2009

EX-31.2

Exhibit 31.2

I, Todd D. Fanning, certify that:
	1.	I have reviewed this annual report on Form 10-K of Princeton National Bancorp, Inc.;
	2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
	3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
	4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
		a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
		b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
		c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
		d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
	5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:
		a)	all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
		b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

/s/ Todd D. Fanning

     Todd D. Fanning

     Senior Vice-President & Chief Financial Officer

     March 16, 2009

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Princeton National Bancorp, Inc. (“PNBC”) on Form 10-K for the period ended December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I Tony J. Sorcic, President & Chief Executive Officer of PNBC, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1)	The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly represents, in all material respects, the financial condition and result of operations of PNBC.

/s/ Tony J. Sorcic

Tony J. Sorcic

President & Chief Executive Officer

March 16, 2009

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Princeton National Bancorp, Inc. (“PNBC”) on Form 10-K for the period ended December 31, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I Todd D. Fanning, Vice President & Chief Financial Officer of PNBC, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1)	The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)	The information contained in the Report fairly represents, in all material respects, the financial condition and result of operations of PNBC.

/s/ Todd D. Fanning

Todd D. Fanning

Senior Vice President & Chief Financial Officer

March 16, 2009

EX-99.1

Exhibit 99.1. Report of Management on Internal Control over Financial Reporting.

          Management of Princeton National Bancorp, Inc. (“PNBC”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. PNBC’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes those policies and procedures that:

- pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of PNBC;

- provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America;

- provide reasonable assurance that receipts and expenditures of PNBC are being made only in accordance with authorization of management and directors of PNBC; and

- provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the consolidated financial statements.

          Internal control over financial reporting includes the controls themselves, monitoring and internal auditing practices and actions taken to correct deficiencies as identified.

          Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

          Management assessed the effectiveness of PNBC’s internal control over financial reporting as of December 31, 2008. Management based this assessment on criteria for effective internal control over financial reporting described in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included an evaluation of the design of PNBC’s internal control over financial reporting and testing of the operational effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee of the Board of Directors.

          Based on this assessment, management determined that, as of December 31, 2008, PNBC maintained effective internal control over financial reporting.

          BKD LLP, the independent registered public accounting firm, that audited and reported on the consolidated financial statements of PNBC included in this report, has issued an attestation report on management’s assessment of internal control over financial reporting as of December 31, 2008.

EX-99.2

	225 N. Water Street, Suite 400
	PO. Box 1580
	Decatur, IL 62525-1580 217.429.2411 Fax 217.429.6109 www.bkd.com

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors and Stockholders
Princeton National Bancorp, Inc.
Princeton, Illinois

We have audited the accompanying consolidated balance sheets of Princeton National Bancorp, Inc. as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Princeton National Bancorp, Inc. as of December 31, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Princeton National Bancorp, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 9, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

As discussed in Note 16, in 2008 the Company changed its method of accounting for fair value measurements in accordance with Statement of Financial Accounting Standards No. 157.

As discussed in Note 15, in 2008 the Company changed its method of accounting for split dollar life insurance policies in accordance with Emerging Issues Task Force Issue No. 06-4.

Decatur, Illinois

March 9, 2009