*Management’s
      Discussion and Analysis of Financial Condition and Results of Operations
      analyzes the major elements of our consolidated balance sheets and statements
      of
      income. This section should be read in conjunction with our consolidated
      financial statements and accompanying notes.*




**Executive
      Summary**




Our
      competitive strategy utilizes a retail model, which is built on the gathering
      and retention of low cost core deposits. Management believes deposit growth
      continues to be the primary driver of our success and that service and a
      superior retail experience, not interest rates, drive deposit growth. The
      consistent growth of low cost, long-term deposit relationships allows us to
      focus our investments on less risky loans and securities. In addition, our
      significant cash flow allows us ongoing reinvestment opportunities as interest
      rates change.




In
      2006,
      the Company continued to expand its unique retail model while challenged with
      an
      extremely difficult interest rate environment. The 2006 highlights are
      summarized below.




●
      Initiating our expansion into Lancaster County, we opened two new stores during
      the fourth quarter, one each in Manheim Township and in East Hempfield
      Township.




●
In
      late
      March, we completed the relocation of our executive, lending, financial,
      training and other support departments to Commerce Center, our new Headquarters,
      Operations and Training Facility located at Techport Center in Dauphin County,
      Pennsylvania.




●
The
      Central Pennsylvania Business Journal named us one of the Top Fifty Fastest
      Growing Companies in Central Pennsylvania for the 10 th consecutive year.




●
Total
      deposits grew 18% and total core deposits grew 20%.




●
Total
      loans grew 19% while asset quality remained pristine.




Total
      deposits increased $245.7 million from $1.37 billion at December 31, 2005 to
      $1.62 billion at December 31, 2006. The growth in total deposits was due to
      a
      combination of growth from four new stores that opened in 2005, two new stores
      that opened in 2006 and from same store deposit growth of $163.3 million, or
      14%. We measure same store deposit growth as the annual percentage increase
      in
      core deposits for stores open two years or more. As of December 31, 2006, 24
      of
      our 30 stores had been open for two years or more. Our core deposits include
      all
      deposits except for public fund time deposits.




During
      2006, our total net loans (including loans held for sale) increased by $162.4
      million from $826.0 million as of December 31, 2005 to $988.4 million at
      December 31, 2006. This growth was represented across all loan categories,
      reflecting a continuing commitment to the credit needs of our market areas.
      We
      have taken great strides over the past 3 years to strengthen the structure
      and
      depth of our lending function and we believe that the growth in total loans
      is a
      result of these efforts. In recent years, there has been significant
      consolidation in financial institutions in our market areas. We believe this
      consolidation has caused dislocation, and therefore has provided us with the
      opportunity to gain customers and hire experienced local banking professionals.
      Our average loan to average deposit ratio at December 31, 2006 was 62.5%, as
      compared to 58.9% as of December 31, 2005.




During
      2006 our total assets grew by $225.4 million from $1.64 billion at December
      31,
      2005 to $1.87 billion as of December 31, 2006. During this same time period,
      interest earning assets (primarily loans and investments) increased by $189.1
      million from $1.54 billion to $1.73 billion. The growth in earning assets was
      funded by the previously mentioned deposit growth of $245.7 million offset
      by a
      reduction of short-term borrowings of $45.1 million.




The
      year
      was marked by a rare interest rate environment in which long-term rates had
      the
      same level of yields as did short-term rates for the first half of the year
      and
      then were actually lower than short-term rates for the 2 nd six
      months of 2006. Characterized as an inverted yield curve, the unique rate
      environment affected banks nationwide, including Commerce, adding pressure
      to
      our net interest margin and constraining our historical net interest income
      growth. We feel this net interest margin compression should be a short-term
      hurdle and we remain committed to the expansion of the Commerce Bank Model
      and
      to delivering legendary service to our Customers.




The
      continued flattening and eventual inversion of the yield curve throughout 2006
      produced an extremely difficult interest rate environment, which reduced the
      Company’s net interest margin to 3.18% from 3.77% in 2005. Despite the current
      interest rate environment, our continued deposit growth enabled us to grow
      revenue by 10%. Net income and diluted net income per share results reflect
      the
      challenging interest rate environment experienced in 2006. The financial
      highlights for 2006 compared to 2005 are summarized on the next page.







1




**December
                    31,****2006**
                
                **2005**
                
                **%**Change*(dollars
                    in millions)*Total
                    Assets
                
                **$**
                **1,866.5**
                
                $
                1,641.1
                
                
                14
                %Total
                    Loans (Net)
                
                
                **973.0**
                
                
                815.4
                
                
                19
                %Total
                    Deposits
                
                
                **1,616.8**
                
                
                1,371.1
                
                
                18
                %
  **December
                    31,****2006**
                
                **2005**
                
                **%**Change*(dollars
                    in millions, except per share data)*Total
                    Revenues
                
                **$**
                **71.5**
                
                $
                65.1
                
                
                10
                %Net
                    Income
                
                
                **7.3**
                
                
                8.8
                
                
                (18)
                %Diluted
                    Net Income
                  Per
                    Share
                
                
                **1.12**
                
                
                1.38
                
                
                (19)
                %




We
      expect
      that we will continue our pattern of expanding our footprint by branching into
      contiguous areas of our existing markets, and by filling gaps between existing
      store locations. We opened two stores in 2006, giving us a total of 30
      full-service stores as of December 31, 2006. We are targeting to open
      approximately 20-25 new stores over the next five years. As a result of our
      targeted growth, we expect that expenses related to salaries, employee benefits,
      occupancy, furniture and equipment, and advertising will increase in subsequent
      periods. Our long-range plan targets a total of 60 stores by the end of 2012.
      We
      believe that the demographics of the South Central Pennsylvania market should
      provide significant opportunities for us to continue to grow both deposit and
      lending relationships.




**Application
      of Critical Accounting Policies**




Our
      accounting policies are fundamental to understanding Management’s Discussion and
      Analysis of Financial Condition and Results of Operations. Our accounting
      policies are more fully described in Note 1 of the *Notes
      to Consolidated Financial Statements* for
      December 31, 2006 included herein. Our consolidated financial statements are
      prepared in conformity with accounting principles generally accepted in the
      United States of America. These principles require our management to make
      estimates and assumptions about future events that affect the amounts reported
      in our consolidated financial statements and accompanying notes. Since future
      events and their effects cannot be determined with absolute certainty, actual
      results may differ from those estimates. Management makes adjustments to its
      assumptions and estimates when facts and circumstances dictate. We evaluate
      our
      estimates and assumptions on an ongoing basis and predicate those estimates
      and
      assumptions on historical experience and on various other factors that are
      believed to be reasonable under the circumstances. Management believes the
      following critical accounting policies encompass the more significant
      assumptions and estimates used in preparation of our consolidated financial
      statements.




*Allowance
      for Loan Losses.* The
      allowance for loan losses represents the amount available for estimated probable
      losses existing in our lending portfolio. While the allowance for loan losses
      is
      maintained at a level believed to be adequate by management for estimated losses
      in the loan portfolio, the determination of the allowance is inherently
      subjective, as it involves significant estimates by management, all of which
      may
      be susceptible to significant change.




While
      management uses available information to make such evaluations, future
      adjustments to the allowance and the provision for loan losses may be necessary
      if economic conditions or loan credit quality differ substantially from the
      estimates and assumptions used in making the evaluations. The use of different
      assumptions could materially impact the level of the allowance for loan losses
      and, therefore, the provision for loan losses to be charged against earnings.
      Such changes could impact future results.




We
      perform monthly, systematic reviews of our loan portfolios to identify inherent
      losses and assess the overall probability of collection. These reviews include
      an analysis of historical default and loss experience, which results in the
      identification and quantification of loss factors. These loss factors are used
      in determining the appropriate level of allowance to cover the estimated
      probable losses existing in each lending category. Management judgment involving
      the estimates of loss factors can be impacted by many variables, such as the
      number of years of actual default and loss history included in the evaluation
      and the volatility of forecasted net credit losses.




The
      methodology used to determine the appropriate level of the allowance for loan
      losses and related provisions differs for commercial and consumer loans, and
      involves other overall evaluations. In addition, significant estimates are
      involved in the determination of the appropriate level of allowance related
      to
      impaired loans. The portion of the allowance related to impaired loans is based
      on discounted cash flows using the loan’s effective interest rate, or the fair
      value of the collateral for collateral-dependent loans, or the observable market
      price of the impaired loan. Each of these variables involves judgment and the
      use of estimates. For instance, discounted cash flows are based on estimates
      of
      the amount and timing of expected future cash flows.




In
      addition to estimation and testing of loss factors, we periodically evaluate
      changes in levels and trends of charge-offs, delinquencies and nonaccrual loans,
      trends in volume and term loans, changes in underwriting standards and
      practices, portfolio mix, tenure of the loan officers and management, changes
      in
      credit concentrations, and national and local economic trends and conditions.
      Management judgment
      is involved at many levels of these evaluations.






2




An
      integral aspect of our risk management process is allocating the allowance
      for
      loan losses to various components of the lending portfolio based upon an
      analysis of risk characteristics, demonstrated losses, industry and other
      segmentations, and other more judgmental factors, such as recent loss
      experience, industry concentrations, and the impact of current economic
      conditions on historical or forecasted net credit losses.






*Stock-Based
      Compensation* .
      Prior
      to 2006, the Company accounted for stock-based compensation issued to directors
      and employees using the intrinsic value method in accordance with Accounting
      Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”
(“APB 25”). This method required that compensation expense be recognized to the
      extent that the fair value of the stock exceeded the exercise price of the
      stock
      award at the grant date. The Company generally did not recognize compensation
      expense related to stock option awards because the stock options generally
      had
      fixed terms and exercise prices that were equal to or greater than the fair
      value of the Company’s common stock at the grant date. The pro forma impact to
      net income and earnings per share that would have occured had compensation
      expense been recognized in 2005 and 2004, based on the estimated fair value
      of
      the options on the date of grant, is disclosed in Note 1 of the *Notes
      to the Consolidated Financial Statements* for
      December 31, 2006.






Effective
      January 1, 2006, the Company adopted Financial Accounting Standards Board (FASB)
      Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) using the modified
      prospective method. FAS 123(R) requires compensation costs related to
      share-based payment transactions to be recognized in the income statement (with
      limited exceptions) based on the grant-date fair value of the stock-based
      compensation issued. Compensation costs are recognized over the period that
      an
      employee provides service in exchange for the award. The adoption of Statement
      of Financial Accounting Standards (“SFAS”) 123(R) had an unfavorable impact
      on our net income and net income per share in 2006 and will continue to do
      so in
      future periods as we recognize compensation expense for stock option awards.






In
      conjunction with FAS123(R), the Company also adopted FASB Staff Position (“FSP”)
      FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as
      Defined in FAS 123(R)” effective January 1, 2006. FSP 123(R)-2
      provides guidance on the application of grant date as defined in FAS 123(R).
      In
      accordance with this standard, a grant date of an award exists if (a) the
      award is a unilateral grant and (b) the key terms and conditions of the
      award are expected to be communicated to an individual recipient within a
      relatively short time period from the date of approval. The adoption of this
      standard did not have a material impact on our consolidated financial position,
      results of operations, or cash flows for the year ended December 31,
      2006.




**Results
      of Operations**




***Average
      Balances and Average Interest Rates***




Table
      1
      on the following page sets forth balance sheet items on a daily average basis
      for the years ended December 31, 2006, 2005 and 2004 and presents the daily
      average interest rates earned on assets and the daily average interest rates
      paid on liabilities for such periods. During 2006, average interest-earning
      assets were $1.64 billion, an increase of $290.8 million, or 22%, over 2005.
      This was the result of an increase in the average balance of investment
      securities of $114.3 million and an increase in the average balance of loans
      receivable of $176.7 million, offset by a decrease in the average balance of
      federal funds sold of $148,000. The growth in the average balance of interest
      earning assets was funded primarily by an increase in the average balance of
      deposits (including noninterest bearing demand deposits) of $210.2 million
      and
      an increase in the average level of short-term borrowings of $94.1 million.




The
      tax-equivalent yield on total interest-earning assets increased by 44 basis
      points, from 5.92% in 2005 to 6.36% in 2006. This increase was mostly due to
      the
      increasing rate environment during 2006 which contributed toward higher yields
      on our floating rate loans, which comprise 33% of our loan portfolio.




The
      aggregate cost of interest-bearing liabilities increased 113 basis points from
      2.52% in 2005 to 3.65% in 2006. The average rate paid on savings deposits
      increased by 80 basis points, from 1.55% in 2005 to 2.35% in 2006. The average
      rate paid on interest checking accounts and money market accounts combined,
      comprised of money market accounts that are swept overnight to money market
      balances, increased from 2.49% in 2005 to 3.68% in 2006. At December 31, 2006,
      $432.1 million of the sweep accounts were public fund interest checking accounts
      that are priced in relation to the yield on the 90-day treasury bill, which
      increased from 4.08% at December 31, 2005 to 4.88% at December 31, 2006. For
      time deposits, the average rate paid in 2006 was 3.87%, up 90 basis points
      from
      2005 and public funds time deposits incurred an increase of 115 basis points
      in
      2006 on the average rate paid. The majority of our public funds are deposits
      of
      local school districts and municipalities.




Our
      aggregate cost of funding sources increased 102 basis points in 2006 to 3.14%
      from 2.12% in 2005. This increase resulted primarily from higher average rates
      paid on total interest bearing deposits. In Table 1, nonaccrual loans have
      been
      included in the average loan balances. Securities include securities available
      for sale and securities held to maturity. Securities available for sale are
      carried at amortized cost for purposes of calculating the average rate received on taxable securities. Yields on
      tax-exempt securities and loans are computed on a tax-equivalent
      basis.






3




**T** **ABLE** **1**


**Years
                Ended December 31,***(dollars
                in thousands)*
            
            **2006**
            
            2005
            
            2004Earning
                Assets
            
            **Average
                Balance**
            
            **Interest**
            
            **Average
                Rate**
            
            Average
                Balance
            
            Interest
            
            Average
                Rate
            
            Average
                Balance
            
            Interest
            
            Average
                RateSecurities:Taxable
            
            **$**
            **733,990**
            
            **$**
            **38,845**
            
            
            **5.29**
            **%**
            $
            615,779
            
            $
            30,822
            
            
            5.01
            %
            $
            498,016
            
            $
            24,789
            
            
            4.98
            %Tax-exempt
            
            
            **1,985**
            
            
            **130**
            
            
            **6.55**
            
            
            5,887
            
            
            538
            
            
            9.14
            
            
            6,838
            
            
            608
            
            
            8.89Total
                securities
            
            
            **735,975**
            
            
            **38,975**
            
            
            **5.30**
            
            
            621,666
            
            
            31,360
            
            
            5.04
            
            
            504,854
            
            
            25,397
            
            
            5.03Federal
                funds sold
            
            
            **0**
            
            
            **0**
            
            
            **0.00**
            
            
            148
            
            
            5
            
            
            3.38
            
            
            3,638
            
            
            67
            
            
            1.84Loans
                receivable:Mortgage
                and construction
            
            
            **452,781**
            
            
            **32,267**
            
            
            **7.05**
            
            
            392,697
            
            
            26,328
            
            
            6.70
            
            
            337,257
            
            
            21,777
            
            
            6.46Commercial
                loans and lines of credit
            
            
            **259,280**
            
            
            **20,914**
            
            
            **7.96**
            
            
            193,779
            
            
            13,474
            
            
            6.95
            
            
            144,127
            
            
            8,534
            
            
            5.92Consumer
            
            
            **170,535**
            
            
            **11,412**
            
            
            **6.69**
            
            
            134,004
            
            
            8,147
            
            
            6.08
            
            
            93,166
            
            
            5,122
            
            
            5.50Tax-exempt
            
            
            **23,788**
            
            
            **1,582**
            
            
            **6.65**
            
            
            9,218
            
            
            638
            
            
            6.92
            
            
            6,095
            
            
            442
            
            
            7.25Total
                loans receivable
            
            
            **906,384**
            
            
            **66,175**
            
            
            **7.23**
            
            
            729,698
            
            
            48,587
            
            
            6.66
            
            
            580,645
            
            
            35,875
            
            
            6.18Total
                earning assets
            
            **$**
            **1,642,359**
            
            **$**
            **105,150**
            
            
            **6.36**
            **%**
            $
            1,351,512
            
            $
            79,952
            
            
            5.92
            %
            $
            1,089,137
            
            $
            61,339
            
            
            5.63
            %Sources
                of FundsInterest-bearing
                deposits:Regular
                savings
            
            **$**
            **363,515**
            
            **$**
            **8,533**
            
            
            **2.35**
            **%**
            $
            325,218
            
            $
            5,043
            
            
            1.55
            %
            $
            276,862
            
            $
            2,804
            
            
            1.01
            %Interest
                checking and money market
            
            
            **605,043**
            
            
            **22,282**
            
            
            **3.68**
            
            
            479,310
            
            
            11,941
            
            
            2.49
            
            
            347,212
            
            
            4,264
            
            
            1.23Time
                deposits
            
            
            **194,611**
            
            
            **7,541**
            
            
            **3.87**
            
            
            179,428
            
            
            5,330
            
            
            2.97
            
            
            164,765
            
            
            4,024
            
            
            2.44Public
                funds time
            
            
            **32,873**
            
            
            **1,406**
            
            
            **4.28**
            
            
            34,992
            
            
            1,094
            
            
            3.13
            
            
            45,855
            
            
            817
            
            
            1.78Total
                interest-bearing deposits
            
            
            **1,196,042**
            
            
            **39,762**
            
            
            **3.32**
            
            
            1,018,948
            
            
            23,408
            
            
            2.30
            
            
            834,694
            
            
            11,909
            
            
            1.43Short-term
                borrowings
            
            
            **199,742**
            
            
            **10,267**
            
            
            **5.07**
            
            
            105,620
            
            
            3,821
            
            
            3.62
            
            
            79,049
            
            
            1,070
            
            
            1.35Long-term
                debt
            
            
            **17,669**
            
            
            **1,731**
            
            
            **9.80**
            
            
            13,600
            
            
            1,418
            
            
            10.43
            
            
            13,600
            
            
            1,418
            
            
            10.43Total
                interest-bearing liabilities
            
            
            **1,413,453**
            
            
            **51,760**
            
            
            **3.65**
            
            
            1,138,168
            
            
            28,647
            
            
            2.52
            
            
            927,343
            
            
            14,397
            
            
            1.55Noninterest-bearing
                funds (net)
            
            
            **228,906**
            
            
            
            
            
            
            
            
            213,344
            
            
            
            
            
            
            
            
            161,794Total
                sources to fund assets
            
            **$**
            **1,642,359**
            
            **$**
            **51,760**
            
            
            **3.14**
            **%**
            $
            1,351,512
            
            $
            28,647
            
            
            2.12
            %
            $
            1,089,137
            
            $
            14,397
            
            
            1.32
            %Net
                interest income and margin on a tax- equivalent basis
            
            
            
            
            **$**
            **53,390**
            
            
            **3.22**
            **%**
            
            
            
            $
            51,305
            
            
            3.80
            %
            
            
            
            $
            46,942
            
            
            4.31
            %Tax-exempt
                adjustment
            
            
            
            
            
            **599**
            
            
            
            
            
            
            
            
            400
            
            
            
            
            
            
            
            
            357Net
                interest income and margin
            
            
            
            
            **$**
            **52,791**
            
            
            **3.18**
            **%**
            
            
            
            $
            50,905
            
            
            3.77
            %
            
            
            
            $
            46,585
            
            
            4.28
            %Other
                BalancesCash
                & due from banks
            
            **$**
            **49,210**
            
            
            
            
            
            
            
            $
            42,225
            
            
            
            
            
            
            
            $
            35,285Other
                assets
            
            
            **79,815**
            
            
            
            
            
            
            
            
            58,837
            
            
            
            
            
            
            
            
            47,161Total
                assets
            
            
            **1,771,384**
            
            
            
            
            
            
            
            
            1,452,574
            
            
            
            
            
            
            
            
            1,171,583Noninterest-bearing
                demand deposits
            
            
            **253,671**
            
            
            
            
            
            
            
            
            220,566
            
            
            
            
            
            
            
            
            180,355Other
                liabilities
            
            
            **8,558**
            
            
            
            
            
            
            
            
            4,889
            
            
            
            
            
            
            
            
            5,750Stockholders’
                equity
            
            
            **95,702**
            
            
            
            
            
            
            
            
            88,951
            
            
            
            
            
            
            
            
            58,135




***Net
      Interest Income and Net Interest Margin***




Net
      interest income is the difference between interest income on loans, investment
      securities, and other interest-earning assets and the interest expense paid
      on
      deposits and borrowed funds. Changes in net interest income and net interest
      margin result from the interaction between the volume and composition of earning
      assets, related yields and associated funding costs. Net interest income is
      our
      primary source of earnings. There are several factors that affect net interest
      income, including:




·
            the
                volume, pricing mix, and maturity of earning assets and interest-bearing
                liabilities;


·
            market
                interest rate fluctuations; and


·
            asset
                quality.






4




Net
      interest income on a tax-equivalent basis (which adjusts for the tax-exempt
      status of income earned on certain loans and investment securities in order
      to
      show such income as if it were taxable) for 2006 increased $2.1 million, or
      4%,
      over 2005 to $53.4 million. Interest income on a tax-equivalent basis totaled
      $105.2 million, an increase of $25.2 million, or 32%, over 2005. The majority
      of
      this increase was related to volume increases in the investment securities
      and
      loans receivable portfolios. Interest expense for 2006 increased $23.2 million,
      or 81%, from $28.6 million in 2005 to $51.8 million in 2006. This increase
      was
      related to both the increases in deposit and short-term borrowing rates paid
      in
      addition to the increase in the average level of deposits and other borrowed
      money.




Changes
      in net interest income are frequently measured by two statistics: net interest
      rate spread and net interest margin. Net interest rate spread is the difference
      between the average rate earned on earning assets and the average rate incurred
      on interest-bearing liabilities. Net interest margin represents the difference
      between interest income, including net loan fees earned, and interest expense,
      reflected as a percentage of average earning assets. Our net interest rate
      spread decreased to 2.71% in 2006 from 3.40% in 2005 on a fully tax equivalent
      basis. The net interest margin decreased 59 basis points from 3.77% in 2005
      to
      3.18% in 2006.




In
      late
      June 2004, the Federal Reserve Board began a measured reversal of their
      accommodative stance on monetary policy that had been in place over the previous
      three years. The targeted federal funds rate began increasing in the second
      half
      of 2004 and the trend continued throughout the first half of 2006. Short-term
      interest rates increased 200 basis points in 2005 followed by an additional
      100
      basis point increase in 2006. As a result, our cost of funds significantly
      increased during this period, however, we did not experience a similar increase
      in the yields on our interest earning assets due to the continued flattening
      yield curve throughout 2005 followed by an inverted yield curve in 2006. While
      our continuing ability to grow core deposits produces net interest income
      despite rate compression, we do not expect to see expansion in the net interest
      margin until long-term interest rates increase and/or the yield curve improves.







5






Table
      2
      demonstrates the relative impact on net interest income of changes in the volume
      of earning assets and interest-bearing liabilities and changes in rates earned
      and paid by us on such assets and liabilities. For purposes of this table,
      nonaccrual loans have been included in the average loan balances and tax-exempt
      loans and securities are reported on a fully taxable-equivalent basis.




**T** **ABLE** **2**


**2006
                v. 2005**
            
            2005
                v. 2004**Increase
                (Decrease)**
            
            Increase
                (Decrease)**Due
                to Changes in (1)**
            
            Due
                to Changes in (1)*(in
                thousands)*
            
            **Volume**
            
            **Rate**
            
            **Total**
            
            Volume
            
            Rate
            
            TotalInterest
                on securities:Taxable
            
            **$**
            **6,156**
            
            **$**
            **1,867**
            
            **$**
            **8,023**
            
            $
            5,877
            
            $
            156
            
            $
            6,033Tax-exempt
            
            
            **(340**
            **)**
            
            **(68**
            **)**
            
            **(408**
            **)**
            
            (86
            )
            
            16
            
            
            (70
            )Federal
                funds sold
            
            
            **(5**
            **)**
            
            **0**
            
            
            **(5**
            **)**
            
            (64
            )
            
            2
            
            
            (62
            )Interest
                on loans receivable:Mortgage
                and construction
            
            
            **4,561**
            
            
            **1,438**
            
            
            **5,999**
            
            
            3,582
            
            
            922
            
            
            4,504Commercial
            
            
            **4,994**
            
            
            **2,385**
            
            
            **7,379**
            
            
            3,430
            
            
            1,557
            
            
            4,987Consumer
            
            
            **2,282**
            
            
            **984**
            
            
            **3,266**
            
            
            2,434
            
            
            591
            
            
            3,025Tax-exempt
            
            
            **978**
            
            
            **(34**
            **)**
            
            **944**
            
            
            194
            
            
            2
            
            
            196Total
                interest income
            
            
            **18,626**
            
            
            **6,572**
            
            
            **25,198**
            
            
            15,367
            
            
            3,246
            
            
            18,613Interest
                on deposits:Regular
                savings
            
            
            **1,867**
            
            
            **1,623**
            
            
            **3,490**
            
            
            723
            
            
            1,516
            
            
            2,239Interest
                checking and money market
            
            
            **4,343**
            
            
            **5,998**
            
            
            **10,341**
            
            
            2,540
            
            
            5,137
            
            
            7,677Time
                deposits
            
            
            **976**
            
            
            **1,235**
            
            
            **2,211**
            
            
            718
            
            
            588
            
            
            1,306Public
                funds
            
            
            **(65**
            **)**
            
            **377**
            
            
            **312**
            
            
            (194
            )
            
            471
            
            
            277Short-term
                borrowings
            
            
            **4,378**
            
            
            **2,068**
            
            
            **6,446**
            
            
            469
            
            
            2,282
            
            
            2,751Long-term
                debt
            
            
            **398**
            
            
            **(85**
            **)**
            
            **313**
            
            
            0
            
            
            0
            
            
            0Total
                interest expense
            
            
            **11,897**
            
            
            **11,216**
            
            
            **23,113**
            
            
            4,256
            
            
            9,994
            
            
            14,250Net
                increase (decrease)
            
            **$**
            **6,729**
            
            **$**
            **(4,644**
            **)**
            **$**
            **2,085**
            
            $
            11,111
            
            $
            (6,748
            )
            $
            4,363




*(1)
      Changes due to both volume and rate have been allocated on a prorata
      basis to either rate or volume.*




**Provision
      for Loan Losses**




We
      recorded $1.6 million to the allowance for loan losses in 2006, the same amount
      as in 2005. Management undertakes a rigorous and consistently applied process
      in
      order to evaluate the allowance for loan losses and to determine the level
      of
      provision for loan losses. Net charge-offs during 2006 were $1.2 million, or
      0.13%, of average loans outstanding as compared to $176,000, or 0.02%, of
      average loans outstanding in 2005. The majority of the net charge-off figure
      for
      2006 was related to one loan for approximately $900,000. See the Application
      of
      Critical Accounting Policies section in this Management’s Discussion and
      Analysis regarding the allowance for loan losses as well as Note 1 in the Notes
      to Consolidated Financial Statements for December 31, 2006 included herein
      for
      further discussion regarding our methodology for determining the provision
      for
      loan losses.




**Noninterest
      Income**




Noninterest
      income for 2006 increased by $4.6 million, or 33%, over 2005 to $18.8 million.
      Service charges and fees increased $4.4 million, or 35%. The increase was
      primarily due to increases in other operating income attributable to servicing
      a
      higher volume of deposit and loan accounts. Included in total noninterest income
      in 2006 were gains of $1.1 million on the sale of residential loans, student
      loans, small business administration loans, and business and industry loans
      and
      a gain on the sale of securities of $160,000. Included in total noninterest
      income in 2005 were gains of $1.3 million on the sale of residential loans,
      student loans, small business administration loans, and business and industry
      loans offset by a net loss on the sale of securities of $60,000.




***Noninterest
      Expenses***




Noninterest
      expenses totaled $59.3 million for 2006, an increase of $8.9 million, or 18%,
      over 2005. Staffing levels, occupancy, furniture and equipment, and related
      expenses increased as a result of opening two full service stores in 2006 and
      four full service stores in 2005. A comparison of noninterest expenses for
      certain categories for 2006 and 2005 is discussed below.






6




Salary
      expenses and employee benefits, which represent the largest component of
      noninterest expenses, increased by $4.6 million, or 18%, in 2006 over 2005.
      The
      increased level of these expenses includes the impact of salary and benefit
      costs associated with the additional staff hired to operate the new stores
      opened in October 2006 and November 2006 as well as the full-year impact of
      the
      employees hired to operate the four new stores opened in 2005. The Company
      also
      hired additional staff in 2006 to support compliance, audit and loan operation
      functions.




Occupancy
      expenses totaled $6.6 million in 2006, an increase of $1.2 million, or 22%,
      over
      2005 while furniture and equipment expenses increased by $854,000, or 31%,
      to
      $3.6 million. The full year impact of the four stores opened in 2005 along
      with
      the additional two stores opened in 2006 contributed to the increases in
      occupancy and furniture and equipment expenses in 2006 over 2005. In late March
      2006, we discontinued leasing two facilities that previously housed the majority
      of our executive, lending, financial and operational staff departments and
      relocated approximately 300 employees to Commerce Center, our new Headquarters,
      Operations and Training Center. Discontinued occupancy and furniture expenses
      associated with the two previously leased facilities partially offset higher
      levels of expense associated with the new building and its furniture and
      equipment.




Advertising
      and marketing expenses were $3.0 million for 2006, a decrease of $490,000,
      or
      14%, below 2005. The decrease was partially the result of grand opening expenses
      associated with only two new stores in 2006 as opposed to four new store
      openings in 2005. Our advertising markets include Berks, Lancaster, Lebanon,
      Dauphin, Cumberland, and York counties of South Central
      Pennsylvania.




Data
      processing expenses increased by $1.6 million, or 41%, in 2006 over 2005. The
      primary increases were due to costs associated with processing additional
      transactions as a result of growth in the number of accounts serviced, the
      costs
      associated with additional stores, adding additional electronic products and
      services for customer use and enhancements and upgrades to existing systems.




Postage
      and supplies expenses of $1.6 million were $313,000, or 24%, higher than the
      prior year. The increase was attributed to the growth in the number of account
      statements mailed to customers as well as a 5% increase in postal rates
      effective January 2006.




Other
      noninterest expenses totaled $8.3 million for 2006, compared to $7.4 million
      for
      2005. Components of the increase include expenses related to: insurance,
      telephone, customer relations, legal, check fraud, and regulatory
      compliance.




Our
      current strategic plan calls for the construction of two to four new stores
      in
      2007. The costs associated with these planned facilities will continue to result
      in higher levels of staff, occupancy, furniture, equipment, and related expenses
      in 2007 and in future periods.




One
      key
      measure used to monitor progress in controlling overhead expenses is the ratio
      of net noninterest expenses to average assets. For purposes of this calculation,
      net noninterest expenses equal noninterest expenses less noninterest income
      (exclusive of gains or losses on sales of investment securities). This ratio
      equaled 2.29% for 2006, compared to 2.52% for 2005. Another productivity measure
      is the operating efficiency ratio. This ratio expresses the relationship of
      noninterest expenses to net interest income plus noninterest income (excluding
      gains or losses on sales of investment securities). For 2006, the operating
      efficiency ratio was 82.9% compared to 77.9% for 2005. Our operating efficiency
      ratio remains above our peer group primarily due to our aggressive growth
      expansion activities.




***Provision
      for Federal Income Taxes***




The
      provision for federal income taxes was $3.4 million for 2006, compared to $4.3
      million for 2005. The effective tax rate, which is the ratio of income tax
      expense to income before taxes, was 31.7% in 2006 compared to 32.7% in 2005.
      See
      Note 11 of the *Notes
      to Consolidated Financial Statements* for
      December 31, 2006, included herein, for an additional analysis of the provision
      for income taxes for 2006 and 2005.




In
      accordance with Statement of Financial Accounting Standard No. 109 (SFAS No.
      109), “Accounting for Income Taxes”, income taxes are accounted for under the
      liability method. Under the liability method, deferred tax assets and
      liabilities are recognized for future tax consequences attributable to temporary
      differences between the financial state-ment and tax bases of existing assets
      and liabilities.




At
      December 31, 2006, deferred tax assets amounted to $5.9 million and deferred
      tax
      liabilities amounted to $3.4 million. Deferred tax assets are realizable
      primarily through carryback of existing deductible temporary differences to
      recover taxes paid in prior years, and through future reversal of existing
      taxable temporary differences. Management currently anticipates future earnings
      will be adequate to utilize the net deferred tax assets.




***Net
      Income and Net Income Per Share***




Net
      income for 2006
      was
      $7.3 million, a decrease of $1.5 million, or 18%, from the $8.8 million recorded
      in 2005. This decrease was due to an increase in net interest income of $1.9
      million and an increase in noninterest income of $4.6 million, offset by an
      increase in the provision for loan losses of $74,000, and an increase in
      noninterest expenses of $8.9 million.




Basic
      earnings per common share were $1.18 in 2006 compared to $1.47 in 2005. Diluted
      earnings per common share were $1.12 for 2006 and $1.38 for 2005. See Note
      13 in
      the *Notes
      to Consolidated Financial Statements* for
      December 31, 2006, included herein, for an analysis of earnings per
      share.









7




**Return
      on Average Assets and Average Equity**




Return
      on
      average assets, referred to as “ROA,” measures our net income in relation to our
      total average assets. Our ROA was 0.41% for 2006 and 0.61% for 2005. This
      decrease is the result of 14% growth in total assets combined with an 18%
      decrease in net income. Contributing to these results was the deployment of
      $3.6
      million of funds to the construction of our new Headquarters, Operations and
      Training Center as opposed to channeling these funds into interest-earning
      assets as well as the addition of the new stores in 2006 and 2005 and their
      related costs.




Return
      on
      average equity, referred to as “ROE,” indicates how effectively we can generate
      net income on the capital invested by our shareholders. ROE is calculated by
      dividing net income by average stockholders’ equity. ROE for 2006 was 7.58%,
      compared to 9.91% for 2005.




Both
      ROA
      and ROE in 2006 were impacted by the inverted yield curve and the resulting
      impact on the Company’s net interest income.




**Results
      of Operations**




***2005*** **versus 2004**




Net
      income for 2005 rose to $8.8 million, an increase of $226,000, or 3%, over
      the
      $8.6 million recorded in 2004.




Diluted
      earnings per common share decreased by 15% to $1.38 for 2005 from $1.63 in
      2004.
      This reflected the impact of a 21% increase in the number of average shares
      outstanding in 2005 versus the prior year, primarily the result of a public
      stock offering in the fourth quarter of 2004.




Net
      interest income for 2005 increased $4.3 million, or 9%, over 2004 to $50.9
      million. Interest income on earning assets totaled $80.0 million, an increase
      of
      $18.6 million, or 30%, over 2004. Interest expense for 2005 increased by $14.2
      million, or 99%, from $14.4 million to $28.6 million.




Our
      net
      interest rate spread decreased to 3.40% in 2005 from 4.08% in 2004 and the
      net
      interest margin decreased 51 basis points from 4. 31% in 2004 to 3.80% in 2005
      on a fully tax-equivalent basis.




Noninterest
      income for 2005 increased by $2.9 million, or 25%, over 2004 to $14.2 million.
      The increase was primarily due to increases in other operating income
      attributable to service charges and fees associated with servicing a higher
      volume of deposit and loan accounts. Included in total noninterest income in
      2005 were gains of $1.3 million on the sale of residential loans, student loans,
      small business administration loans, and business and industry loans offset
      by a
      net loss on the sale of securities of $60,000. Included in total noninterest
      income in 2004 were gains of $630,000 on the sale of residential and student
      loans.




Noninterest
      expenses totaled $50.4 million for 2005, an increase of $7.9 million, or 19%,
      over 2004. Staffing levels, occupancy, furniture and equipment, and related
      expenses increased as a result of opening four full service stores in 2005
      and
      one full service store in late 2004.




Salary
      expenses and employee benefits increased by $4.4 million, or 20%, in 2005 over
      2004. This increase was partially due to an increase in the level of full-time
      equivalent employees from 576 at December 31, 2004 to 787 at year-end 2005.




Occupancy
      expenses totaled $5.4 million in 2005, an increase of $1.0 million, or 23%,
      over
      2004 while furniture and equipment expenses increased by $230,000, or 9%, to
      $2.7 million.




Advertising
      and marketing expenses were $3.5 million for 2005, an increase of $353,000,
      or
      11%, over 2004. Data processing expenses increased by $921,000, or 32%, in
      2005
      over 2004. Postage and supplies expenses of $1.3 million were $167,000, or
      15%,
      higher than the prior year.




Other
      noninterest expenses totaled $7.4 million for 2005, compared to $6.6 million
      for
      2004.




**Financial
      Condition**




***Securities***




Securities
      are purchased and sold as part of our overall asset and liability management
      function. The classification of all securities is determined at the time of
      purchase. Securities expected to be held for an indefinite period of time are
      classified as securities available for sale and are carried at fair value.
      Decisions by management to purchase or sell these securities are based on an
      assessment of financial and economic conditions, including changes in prepayment
      risks and interest rates, liquidity needs, capital adequacy, collateral
      requirements for pledging, alternative asset and liability management
      strategies, tax considerations, and regulatory requirements.






8




Securities
      are classified as held to maturity if, at the time of purchase, management
      has
      both the intent and ability to hold the securities until maturity. Securities
      held to maturity are carried at amortized cost. Sales of securities in this
      portfolio should only occur in unusual and rare situations where significant
      unforeseeable changes in circumstances may cause a change in intent. Examples
      of
      such instances would include deterioration in the issuer’s creditworthiness that
      is evidently supportable and significant or a change in tax law that eliminates
      or reduces the tax-exempt status of interest (but not the revision of marginal
      tax rates applicable to interest income). Held to maturity securities cannot
      be
      sold based upon any of the decisions used to sell securities available for
      sale
      as listed above. See Note 3 in the *Notes
      to Consolidated Financial Statements* for
      December 31, 2006, included herein, for further analysis of our securities
      portfolio.




Our
      investment securities portfolio consists primarily of U.S. Government agency
      and
      mortgage-backed obligations. These securities have very little, if any, credit
      risk because they are either backed by the full faith and credit of the U.S.
      Government, their principal and interest payments are guaranteed by an agency
      of
      the U.S. Government, or they are AAA rated. The majority of these investment
      securities carry fixed rate coupons that do not change over the life of the
      securities. Since most securities are purchased at premiums or discounts, their
      yield and average life will change depending on any change in the estimated
      rate
      of prepayments. We amortize premiums and accrete discounts over the estimated
      average life of the securities. Changes in the estimated average life of the
      securities portfolio will lengthen or shorten the period in which the premium
      or
      discount must be amortized or accreted, thus affecting our securities yields.
      For the year ended December 31, 2006, the yield on our securities portfolio
      was
      5.30%, up 26 basis points from 5.04% in 2005.




At
      December 31, 2006, the weighted average life and duration of our securities
      portfolio was approximately 5.2 and 4.1 years, respectively, as compared to
      4.9
      years and 3.9 years, respectively, at December 31, 2005. The weighted average
      life of the portfolio is calculated by estimating the average rate of repayment
      of the underlying collateral of each security. Mortgage-backed obligations
      historically experience repayment rates in excess of the scheduled repayments,
      causing a shorter weighted average life of the security. Our securities
      portfolio contained no “high-risk” securities or derivatives as of December 31,
      2006 or 2005.




Securities
      available for sale increased by $11.2 million in 2006 (excluding the effect
      of
      changes in unrealized gains or losses) primarily as a result in purchases of
      $124.5 million, offset by principal repayments and maturities of $112.5 million.
      The securities available for sale portfolio is comprised of U.S. Government
      Agency securities, mortgage-backed securities, and AAA Whole Loan CMO
      securities. At December 31, 2006, the unrealized loss on securities available
      for sale included in stockholders’ equity totaled $4.5 million, net of tax,
      compared to the $4.4 million, net of tax, unrealized loss on securities
      available for sale included in stockholders’ equity at December 31, 2005.




During
      2006, securities held to maturity increased by $13.4 million primarily as a
      result of purchases of $60.4 million offset by principal repayments of $44.8
      million and a sale of one bond totaling $2.0 million. The sale consisted of
      a
      $2.1 million debt security which was sold due to the expected and impending
      call
      of the security by the issuer. The sale was near the call date and changes
      in
      market rates had no effect on the security’s fair value. The amount of the gain
      on sale was essentially the same as the call premium that would have been
      recognized on the call date. An $80,000 premium on the call of another debt
      security was also realized in net income for 2006. The securities held in this
      portfolio include U.S. Government Agency securities, mortgage-backed securities,
      tax-exempt municipal bonds, AAA Whole Loan CMO securities, and corporate debt
      securities.




The
      book
      value of available for sale and held to maturity securities are summarized
      in
      Table 3 as of December 31, for each of the years 2004 through 2006.




**T** **ABLE** **3**


**December
                31,***(in
                thousands)*
            
            **2006**
            
            **2005**
            
            **2004****Available
                for Sale**U.S.
                Government Agency securities
            
            **$**
            **5,000**
            
            **$**
            5,000
            
            $
            10,000Mortgage-backed
                securities
            
            
            **393,909**
            
            
            382,498
            
            
            302,133Corporate
                debt securities
            
            
            **0**
            
            
            0
            
            
            2,009Total
                available for sale
            
            **$**
            **398,909**
            
            $
            387,498
            
            $
            314,142Held
                to MaturityU.S.
                Government Agency securities
            
            **$**
            **175,043**
            
            $
            136,135
            
            $
            70,981Municipal
                securities
            
            
            **1,619**
            
            
            2,617
            
            
            6,827Mortgage-backed
                securities
            
            
            **131,979**
            
            
            150,394
            
            
            114,963Corporate
                debt securities
            
            
            **10,987**
            
            
            17,120
            
            
            17,146Total
                held to maturity
            
            **$**
            **319,628**
            
            $
            306,266
            
            $
            209,917










9




The
      contractual maturity distribution and weighted average yield of our available
      for sale and held to maturity portfolios at December 31, 2006 are summarized
      in
      Table 4. Weighted average yield is calculated by dividing income within each
      maturity range by the outstanding amount of the related investment and has
      been
      tax effected, assuming a tax rate of 35%, on tax-exempt
      obligations.




**T** **ABLE** **4**


**December
                  31, 2006**
              
              **Due
                  Under 1 Year**
              
              **Due
                  1-5 Years**
              
              **Due
                  5-10 Years**
              
              **Due
                  Over 10 Years**
              
              **Total***(dollars
                  in thousands)*
              
              **Amount/Yield**
              
              **Amount/Yield**
              
              **Amount/Yield**
              
              **Amount/Yield**
              
              **Amount/Yield**Available
                  for Sale:U.S.
                  Government Agency obligations
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              **$**
              **5,000**
              
              
              **5.00**
              **%**
              **$**
              **5,000**
              
              
              **5.00**
              **%**Mortgage-backed
                  obligations
              
              **$**
              **8**
              
              
              **7.63**
              **%**
              **$**
              **66**
              
              
              **5.11**
              **%**
              **$**
              **232**
              
              
              **5.97**
              **%**
              
              **393,603**
              
              
              **5.32**
              
              
              **393,909**
              
              
              **5.32**Total
                  available for sale
              
              **$**
              **8**
              
              
              **7.63**
              **%**
              **$**
              **66**
              
              
              **5.11**
              **%**
              **$**
              **232**
              
              
              **5.97**
              **%**
              **$**
              **398,603**
              
              
              **5.32**
              **%**
              **$**
              **398,909**
              
              
              **5.32**
              **%**Held
                  to Maturity:U.S.
                  Government Agency obligations
              
              **$**
              **18,908**
              
              
              **6.45**
              **%**
              **$**
              **37,000**
              
              
              **5.01**
              **%**
              **$**
              **94,135**
              
              
              **5.32**
              **%**
              **$**
              **25,000**
              
              
              **5.60**
              **%**
              **$**
              **175,043**
              
              
              **5.42**
              **%**Municipal
                  obligations
              
              
              **0**
              
              
              **----**
              
              
              **0**
              
              
              **----**
              
              
              **653**
              
              
              **5.54**
              
              
              **966**
              
              
              **6.67**
              
              
              **1,619**
              
              
              **6.21**Mortgage-backed
                  obligations
              
              
              **3**
              
              
              **8.30**
              
              
              **372**
              
              
              **5.33**
              
              
              **273**
              
              
              **6.07**
              
              
              **131,331**
              
              
              **5.08**
              
              
              **131,979**
              
              
              **5.09**Corporate
                  debt securities
              
              
              **0**
              
              
              **----**
              
              
              **6,485**
              
              
              **6.60**
              
              
              **0**
              
              
              **----**
              
              
              **4,502**
              
              
              **7.26**
              
              
              **10,987**
              
              
              **6.87**Total
                  held to maturity
              
              **$**
              **18,911**
              
              
              **6.45**
              **%**
              **$**
              **43,857**
              
              
              **5.25**
              **%**
              **$**
              **95,061**
              
              
              **5.32**
              **%**
              **$**
              **161,799**
              
              
              **5.23**
              **%**
              **$**
              **319,628**
              
              
              **5.34**
              **%**




*Note:*  *Securities
      available for sale are carried at amortized cost in the table above for purposes
      of calculating the weighted average yield received on such
      securities.*




**Loan
      Portfolio**




The
      following table summarizes the composition of our loan portfolio by type as
      of
      December 31, for each of the years 2002 through 2006.




**T** **ABLE** **5**


**December
                31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004
            
            2003
            
            2002Commercial
                mortgage
            
            **$**
            **325,244**
            
            $
            299,219
            
            $
            239,576
            
            $
            194,609
            
            $
            144,959Construction
                and land development
            
            
            **61,365**
            
            
            47,334
            
            
            39,467
            
            
            26,895
            
            
            31,034Residential
                real estate mortgage loans
            
            
            **83,690**
            
            
            83,213
            
            
            79,672
            
            
            72,713
            
            
            66,190Tax-exempt
                loans
            
            
            **31,446**
            
            
            17,055
            
            
            6,303
            
            
            5,720
            
            
            5,629Commercial,
                industrial and other business loans
            
            
            **203,723**
            
            
            138,174
            
            
            97,198
            
            
            58,894
            
            
            49,226Consumer
                loans
            
            
            **182,058**
            
            
            148,906
            
            
            109,568
            
            
            71,007
            
            
            34,598Commercial
                lines of credit
            
            
            **95,192**
            
            
            90,769
            
            
            74,559
            
            
            46,106
            
            
            37,245Total
                loans
            
            **$**
            **982,718**
            
            $
            824,670
            
            $
            646,343
            
            $
            475,944
            
            $
            368,881




We
      manage
      risk associated with our loan portfolio in part through diversification, with
      what we believe are sound policies and underwriting procedures that are
      reviewed, updated, and approved at least annually, and ongoing loan monitoring
      efforts. Additionally, we monitor concentrations of loans or loan relationships
      by industry. At December 31, 2006, there was no concentration greater than
      5% of
      our loan portfolio to any one industry and there is no concentration greater
      than 2% to any one borrower.




Our
      commercial mortgage and our construction and land development loans are
      typically made to small and medium-sized investors, builders and developers
      and
      are secured by mortgages on real property located principally in south central
      Pennsylvania (principally office buildings, multifamily residential, land
      development and other commercial properties). The average loan size in this
      category is approximately $575,000. Our underwriting policy has established
      maximum terms for commercial mortgage and construction loans depending on the
      type of loan within the commercial real estate category. A five-year call option
      is standard on commercial mortgages. Our underwriting policy generally requires
      a loan-to-value ratio of no more than 80% on loans in this category and
      typically requires owner guarantees and other collateral depending on our total
      risk assessment of the transaction.




Our
      commercial, industrial and other business loans and lines of credit are
      typically made to small and medium-sized businesses. The average loan size
      in
      this category is approximately $400,000. Based on our underwriting standards,
      loans may be secured in whole or in part by collateral such as liquid assets,
      accounts receivable, equipment, inventory, and real property. Additionally,
      our
      underwriting policy has established maximum terms for these loans depending
      on
      the loan type within the commercial, industrial and other business loans
      category. The value of the collateral in this category may vary depending on
      market conditions. The Bank maintains advance rates for particular collateral
      categories to mitigate the risk that the borrower defaults and the value of
      the
      collateral is not sufficient to cover the outstanding loan balance. We also
      actively manage the unused portion of commercial lines of credit and would
      freeze a commitment if a borrower were in default. As of December 31, 2006,
      outstanding balances under commercial lines of credit were $95.2 million and
      unused commitments were $207.2 million.






10




Residential
      real estate mortgage loans represented approximately 9% of our total loans
      at
      December 31, 2006. Loans in this category are collateralized by first mortgages
      on residential properties located in South Central Pennsylvania. Our
      underwriting policy provides that all residential loans are to be written based
      upon standards used by the secondary market.




Consumer
      loans and consumer lines of credit represented approximately 19% of our total
      loans at December 31, 2006. These loans and lines are secured by first and
      second mortgages, personal assets of the borrower, or may be unsecured. As
      of
      December 31, 2006, 79% of consumer loans and consumer lines of credit were
      secured by second liens. When originating consumer loans, our underwriting
      policy sets limitations on the term of the loan, defines allowable collateral
      and the valuation of the collateral, outlines acceptable debt to income ratios
      as well as acceptable credit sources to identify those loan applicants with
      a
      proven record of credit management. We actively manage the unused portion of
      our
      consumer lines of credit and would freeze a commitment if a borrower becomes
      delinquent. As of December 31, 2006, unused commitments under consumer lines
      of
      credit were $55.0 million.




During
      2006, total gross loans increased by $162.8 million from $835.3 million at
      December 31, 2005, to $998.1 million at December 31, 2006, including $15.3
      million of loans held for sale on December 31, 2006 and $10.6 million of loans
      held for sale on December 31, 2005. The loans held for sale represent student
      loans and certain residential and small business administration loans our
      management intends to sell and reinvest in higher yielding loans and securities.
      Also included in gross loans are deposit accounts that are reclassified as
      loans
      as a result of overdrawn deposit account balances. The total of overdrawn
      deposit accounts reclassified as loans aggregated $531,000 at December 31,
      2006
      and $940,000 at December 31, 2005. The increase in loans receivable in 2006
      was
      represented across all loan categories.




During
      2006, commercial mortgage loans increased by $26.0 million, or 9%, and
      commercial, industrial and other business loans increased by $65.5 million,
      or
      47%. The addition to our staff of experienced lenders with long-term ties to
      the
      business communities in our markets has enhanced our lending portfolio and,
      as a
      result, our access to commercial lending opportunities. Construction and land
      development loans increased $14.0 million, or 30%, and tax-exempt loans
      increased $14.4 million, or 84%, to $31.4 million. Total consumer loans
      increased by $33.2 million in 2006 to $182.1 million at year-end compared to
      $148.9 million at year-end 2005. This increase of 22% was a direct result of
      a
      focused effort by management to increase the size of the consumer loan portfolio
      across all markets of our store footprint. Lines of credit experienced growth
      in
      2006 as well, increasing by $4.4 million, or 5%, from $90.8 million to $95.2
      million. Residential real estate mortgage loans experienced minimal growth
      in
      2006. Given the relatively low yield on these loans versus the long-term
      interest rate risk, the Bank’s residential loans are originated with the intent
      to sell to the secondary market unless the loan is nonconforming to the
      secondary market standards or due to a customer request, we agree not to sell
      the loan.




Total
      loans outstanding represented 61% of total deposits and 52% of total assets
      at
      December 31, 2006, excluding the loans held for sale, compared to 60% and 50%,
      respectively, at December 31, 2005.




The
      maturity ranges of the loan portfolio and the amounts of loans with
      predetermined interest rates and floating interest rates in each maturity range,
      as of December 31, 2006, are presented in the following table.




**T** **ABLE** **6**


**December
                31, 2006***(in
                thousands)*
            
            **Due
                Within One Year**
            
            **Due
                1-5 Years**
            
            **Due
                Over Five Years**
            
            **Total**Real
                estate:Commercial
                mortgage
            
            **$**
            **14,104**
            
            **$**
            **20,850**
            
            **$**
            **290,290**
            
            **$**
            **325,244**Construction
                and land development
            
            
            **28,362**
            
            
            **22,539**
            
            
            **10,464**
            
            
            **61,365**Residential
                mortgage
            
            
            **127**
            
            
            **22,534**
            
            
            **61,029**
            
            
            **83,690**Tax-exempt
            
            
            **27**
            
            
            **1,611**
            
            
            **29,808**
            
            
            **31,446****42,620**
            
            
            **67,534**
            
            
            **391,591**
            
            
            **501,745**Commercial
            
            
            **48,136**
            
            
            **64,876**
            
            
            **90,711**
            
            
            **203,723**Consumer
            
            
            **19,885**
            
            
            **20,157**
            
            
            **142,016**
            
            
            **182,058**Commercial
                lines of credit
            
            
            **70,376**
            
            
            **23,837**
            
            
            **979**
            
            
            **95,192**Total
                loans
            
            **$**
            **181,017**
            
            **$**
            **176,404**
            
            **$**
            **625,297**
            
            **$**
            **982,718**Interest
                rates:Predetermined
            
            **$**
            **22,656**
            
            **$**
            **104,018**
            
            **$**
            **529,621**
            
            **$**
            **656,295**Floating
            
            
            **158,361**
            
            
            **72,386**
            
            
            **95,676**
            
            
            **326,423**Total
                loans
            
            **$**
            **181,017**
            
            **$**
            **176,404**
            
            **$**
            **625,297**
            
            **$**
            **982,718**






11




***Concentrations
      of Credit Risk***




The
      largest portion of loans, 33%, on our balance sheet is for commercial mortgage
      related loans. Our commercial real estate loan portfolio is principally to
      borrowers throughout Cumberland, Dauphin, Lancaster, Lebanon, York and Berks
      counties of Pennsylvania where we have full-service store locations. Commercial
      real estate, construction, and land development loans aggregated $386.6 million
      at December 31, 2006, compared to $346.6 million at December 31, 2005.
      Commercial real estate loans are collateralized by the related project
      (principally office building, multi-family residential, land development, and
      other properties) and we generally require loan-to-value ratios of no greater
      than 80%. Collateral requirements on such loans are determined on a case-by-case
      basis based on managements’ credit evaluations of the respective
      borrowers.




Commercial
      loans represented 21% of total loans at December 31, 2006. Collateral for these
      types of loans varies depending upon managements’ credit evaluations of the
      respective borrowers and generally includes the following: business assets,
      personal guarantees, and/or personal assets of the borrower.




Consumer
      loans comprised 19%, or $182.1 million, of total loans at December 31, 2006.
      Approximately $144.7 million of consumer loans are secured by real estate,
      $36.5
      million of consumer loans are loans collateralized by personal assets of the
      borrower, and $885,000 of consumer loans are unsecured.




On
      a
      monthly basis, the Bank’s credit services personnel prepare two different loan
      concentration reports: one using standardized North American Industry
      Classification codes and the second report by loan product type. Management
      reviews and uses these concentration reports to monitor risks. Quarterly, a
      Risk
      Management Booklet is prepared and reviewed by both management and our board
      of
      directors, which identifies areas of risk and quantifies if any exceptions
      were
      made to policies and procedures in the lending area during the preceding
      quarter. Management and the board utilize the Risk Management Booklet as a
      tool
      to identify and limit procedure and policy exceptions and to reduce any
      unnecessary risk in the lending function.




***Non-Performing
      Loans and Assets***




Total
      non-performing assets (non-performing loans, foreclosed real estate and loans
      past due 90 days or more and still accruing interest) at December 31, 2006,
      were
      $3.5 million, or .19%, of total assets as compared to $2.7 million, or 0.16%,
      of
      total assets at December 31, 2005. Total non-performing loans (nonaccrual loans,
      90 days or more past due loans and restructured loans) at December 31, 2006
      were
      $3.4 million compared to $2.5 million a year ago. Total delinquent loans (those
      loans 30 days or more delinquent) as a percentage of total loans were 0.56%
      at
      December 31, 2006, compared to 0.36% at December 31, 2005. We generally place
      a
      loan on nonaccrual status and cease accruing interest when loan payment
      performance is deemed unsatisfactory and the loan is past due 90 days or more,
      unless the loan is both well-secured and in the process of collection. At
      December 31, 2006, loans past due 90 days and still accruing interest amounted
      to $2,000 compared to $233,000 at December 31, 2005. Additional loans considered
      by our internal loan review department as potential problem loans of $11.5
      million at December 31, 2006, compared to $1.6 million at December 31, 2005,
      have been evaluated as to risk exposure in determining the adequacy of the
      allowance for loan losses.




Foreclosed
      real estate totaled $159,000 as of December 31, 2006 and December 31, 2005.
      These properties have been written down to the lower of cost or fair value
      less
      disposition costs. We obtain updated appraisals on non-performing loans secured
      by real estate. In those instances where appraisals reflect reduced collateral
      values, an evaluation of the borrower’s overall financial condition is made to
      determine the need for possible write-downs or appropriate additions to the
      allowance for loan losses.









12





The
      following table summarizes information regarding non-performing loans and
      non-performing assets as of December 31, 2002 through 2006.




**T** **ABLE** **7**


**December
                31,***(dollars
                in thousands)*
            
            **2006**
            
            2005
            
            2004
            
            2003
            
            2002Nonaccrual
                loans:Commercial
            
            **$**
            **984**
            
            $
            684
            
            $
            308
            
            $
            143
            
            $
            958Consumer
            
            
            **19**
            
            
            296
            
            
            11
            
            
            68
            
            
            42Real estate:       
                Construction
            
            
            **247**
            
            
            0
            
            
            0
            
            
            159
            
            
            0Mortgage
            
            
            **2,129**
            
            
            1,322
            
            
            267
            
            
            417
            
            
            599Total
                nonaccrual loans
            
            
            **3,379**
            
            
            2,302
            
            
            586
            
            
            787
            
            
            1,599Loans
                past due 90 days or more and still accruing
            
            
            **2**
            
            
            233
            
            
            0
            
            
            385
            
            
            55Restructured
                loans
            
            
            **0**
            
            
            0
            
            
            271
            
            
            0
            
            
            0Total
                non-performing loans
            
            
            **3,381**
            
            
            2,535
            
            
            857
            
            
            1,172
            
            
            1,654Foreclosed
                real estate
            
            
            **159**
            
            
            159
            
            
            507
            
            
            236
            
            
            118Total
                non-performing assets
            
            **$**
            **3,540**
            
            $
            2,694
            
            $
            1,364
            
            $
            1,408
            
            $
            1,772Non-performing
                loans to total loans
            
            
            **0.34**
            **%**
            
            0.31
            %
            
            0.13
            %
            
            0.25
            %
            
            0.45
            %Non-performing
                assets to total assets
            
            
            **0.19**
            **%**
            
            0.16
            %
            
            0.11
            %
            
            0.13
            %
            
            0.23
            %Interest
                income received on nonaccrual loans
            
            **$**
            **133**
            
            $
            106
            
            $
            30
            
            $
            37
            
            $
            79Interest
                income that would have been recorded under the
              original terms of the loans
            
            **$**
            **196**
            
            $
            114
            
            $
            10
            
            $
            45
            
            $
            193




***Allowance
      for Loan Losses***




The
      allowance for loan losses is a reserve established through charges to expense
      in
      the form of a provision for loan losses and reduced by loan charge-offs net
      of
      recoveries. Charge-offs occur when loans are deemed to be uncollectible.
      Management has established an allowance for loan losses that it believes is
      adequate for estimated inherent losses in the loan portfolio. In conjunction
      with an internal loan review function that operates independently of the lending
      function, management monitors the loan portfolio to identify risks on a timely
      basis so that an appropriate allowance is maintained. Based on an evaluation
      of
      the loan portfolio, management presents a quarterly review of the allowance
      for
      loan losses to the Board of Directors, indicating any changes in the allowance
      since the last review and any recommendations as to adjustments in the
      allowance. In making the evaluation, management considers the results of recent
      regulatory examinations, which typically include a review of the allowance
      for
      loan losses as an important part of the examination process.




In
      establishing the allowance, management evaluates on a quantitative basis
      individual large classified loans and nonaccrual loans, and determines an
      aggregate reserve for those loans based on that review. An allowance for the
      remainder of the loan portfolio is also determined based on historical loss
      experience within the components of the portfolio. These allocations may be
      modified if current conditions indicate that loan losses may differ from
      historical experience, based on factors and changes in portfolio mix and
      volume.




In
      addition, a portion of the allowance is established for losses inherent in
      the
      loan portfolio, which have not been identified by the more quantitative
      processes described above. This determination inherently involves a higher
      degree of subjectivity, and considers risk factors that may not have yet
      manifested themselves in historical loss experience. Those factors include
      changes in levels and trends of charge-offs, delinquencies and nonaccrual loans,
      trends in volume and terms of loans, changes in underwriting standards and
      practices, portfolio mix, tenure of the loan officers and management, changes
      in
      credit concentrations, and national and local economic trends and conditions.




More
      specifically, the methodology we use to assess the adequacy of our allowance
      includes:




·
            Identifying
                loans for individual review under FASB Statement of Financial Accounting
                Standards No. 114, “Accounting by Creditors for Impairment of a Loan”
                (Statement 114). In general, the loans identified for individual
                review
                under Statement 114 consist of large balance commercial loans and
                commercial mortgages.




·
            Assessing
                whether the loans identified for review under Statement 114 are “impaired”
                based on the probability that all amounts due under the loan will
                not be
                collected according to the contractual terms of the loan
                agreement.




·
            For
                loans identified as impaired, calculating the estimated fair value
                of the
                loan, using one of the following methods, a) observable market prices,
                b)
                discounted cash flows or c) the value of the underlying
                collateral.




·
            Classifying
                all non-impaired, large balance loans based on credit risk ratings
                and
                allocating an allowance for loan losses based on appropriate factors,
                including recent loss history for similar
                loans.




·
            Identifying
                other loans for evaluation collectively under the provisions of Statement
                of Financial Accounting Standards No. 5 “Accounting for Contingencies”
                (Statement 5). In general, these other loans include residential
                mortgages, consumer loans, and installment
                loans.








13




·
            Segmenting
                Statement 5 loans into groups with similar characteristics and allocating
                an allowance for loan losses to each segment based on recent loss
                history
                and other relevant information.




·
            Reviewing
                the results to determine the appropriate balance of the allowance
                for loan
                losses. This review gives additional consideration to factors such
                as the
                mix of loans in the portfolio, the balance of the allowance relative
                to
                total loans and non-performing assets, trends in the overall risk
                profile
                of the portfolio, trends in delinquencies and nonaccrual loans and
                local
                and national economic conditions.




While
      the
      allowance for loan losses is maintained at a level believed to be adequate
      by
      management for covering estimated losses in the loan portfolio, determination
      of
      the allowance is inherently subjective, as it requires estimates, all of which
      may be susceptible to significant change. Changes in these estimates may impact
      the provisions charged to expense in future periods.




The
      Bank
      recorded provisions of $1.6 million to the allowance for loan losses in 2006,
      the same amount as for 2005. During 2006, net charge-offs amounted to $1.2
      million, or 0.13%, of average loans outstanding for the year, compared to
      $176,000, or 0.02%, of average loans outstanding for 2005. The majority of
      the
      total net charge-off figure for 2006 was related to one loan for approximately
      $900,000. The allowance for loan losses decreased as a percentage of loans
      receivable from 1.12% of total loans outstanding at December 31, 2005, to 0.99%
      of total loans outstanding at December 31, 2006 and provided coverage of 287%
      of
      non-performing loans. Based upon a consistent application of our loan loss
      reserve methodology, the allowance level increased by $454,000 to $9.7 million,
      or 0.99%, of total loans at December 31, 2006, but decreased as a percentage
      of
      total loans due to 19% growth in the loan portfolio in 2006.




Table
      8
      presents, for the years 2002 through 2006, information regarding our provision
      and allowance for loan losses.




**T** **ABLE** **8**


**Years
                Ended December 31,***(dollars
                in thousands)*
            
            **2006**
            
            2005
            
            2004
            
            2003
            
            2002Balance
                at beginning of year
            
            **$**
            **9,231**
            
            $
            7,847
            
            $
            6,007
            
            $
            5,146
            
            $
            4,544Provisions
                charged to operating expenses
            
            
            **1,634**
            
            
            1,560
            
            
            2,646
            
            
            1,695
            
            
            1,435**10,865**
            
            
            9,407
            
            
            8,653
            
            
            6,841
            
            
            5,979Recoveries
                of loans previously charged-off:Commercial
            
            
            **34**
            
            
            546
            
            
            110
            
            
            66
            
            
            93Consumer
            
            
            **71**
            
            
            50
            
            
            113
            
            
            85
            
            
            2Real
                estate
            
            
            **0**
            
            
            0
            
            
            8
            
            
            115
            
            
            21Total
                recoveries
            
            
            **105**
            
            
            596
            
            
            231
            
            
            266
            
            
            116Loans
                charged-off:Commercial
            
            
            **(895**
            **)**
            
            (627
            )
            
            (528
            )
            
            (483
            )
            
            (561
            )Consumer
            
            
            **(390**
            **)**
            
            (135
            )
            
            (350
            )
            
            (331
            )
            
            (70
            )Real
                estate
            
            
            **0**
            
            
            (10
            )
            
            (159
            )
            
            (286
            )
            
            (318
            )Total
                charged-off
            
            
            **(1,285**
            **)**
            
            (772
            )
            
            (1,037
            )
            
            (1,100
            )
            
            (949
            )Net
                charge-offs
            
            
            **(1,180**
            **)**
            
            (176
            )
            
            (806
            )
            
            (834
            )
            
            (833
            )Balance
                at end of year
            
            **$**
            **9,685**
            
            $
            9,231
            
            $
            7,847
            
            $
            6,007
            
            $
            5,146Net
                charge-offs (recoveries) to average loans outstanding
            
            
            **0.13**
            **%**
            
            0.02
            %
            
            0.14
            %
            
            0.20
            %
            
            0.23
            %Allowance
                for loan losses to year-end loans
            
            
            **0.99**
            **%**
            
            1.12
            %
            
            1.21
            %
            
            1.26
            %
            
            1.40
            %




***Allocation
      of the Allowance for Loan Losses***




The
      following table details the allocation of the allowance for loan losses to
      the
      various categories. The allocation is made for analytical purposes and it is
      not
      necessarily indicative of the categories in which future credit losses may
      occur. The total allowance is available to absorb losses from any segment of
      loans. The allocations in the table below were determined by a combination
      of
      the following factors: specific allocations made on loans considered impaired
      as
      determined by management and the loan review committee, a general allocation
      on
      certain other impaired loans, and historical losses in each loan type category
      combined with a weighting of the current loan composition.







14




**T** **ABLE** **9**


**Allowance
                for Loan Losses at December 31,****2006**
            
            2005
            
            2004
            
            2003
            
            2002*(dollars
                in thousands)*
            
            **Amount**
            
            **%
                Gross Loans**
            
            Amount
            
            %
                Gross Loans
            
            Amount
            
            %
                Gross Loans
            
            Amount
            
            %
                Gross Loans
            
            Amount
            
            %
                Gross LoansCommercial
                loans and lines of credit
            
            **$**
            **4,417**
            
            
            **32**
            **%**
            $
            3,675
            
            
            28
            %
            $
            3,063
            
            
            27
            %
            $
            2,636
            
            
            21
            %
            $
            2,428
            
            
            24
            %Consumer
            
            
            **1,868**
            
            
            **19**
            
            
            1,785
            
            
            18
            
            
            1,657
            
            
            17
            
            
            717
            
            
            15
            
            
            452
            
            
            9Real
                estate, construction and land development:Commercial
            
            
            **2,695**
            
            
            **39**
            
            
            3,058
            
            
            42
            
            
            2,540
            
            
            43
            
            
            2,157
            
            
            47
            
            
            1,698
            
            
            48Residential
            
            
            **705**
            
            
            **10**
            
            
            713
            
            
            12
            
            
            587
            
            
            13
            
            
            497
            
            
            17
            
            
            568
            
            
            19Total
            
            **$**
            **9,685**
            
            
            **100**
            **%**
            $
            9,231
            
            
            100
            %
            $
            7,847
            
            
            100
            %
            $
            6,007
            
            
            100
            %
            $
            5,146
            
            
            100
            %




**Bank
      Premises and Equipment**




Premises
      and equipment at December 31, 2006 was $83.7 million, up $17.4 million, or
      26%,
      over premises and equipment of $66.3 million at December 31, 2005. The majority
      of the increase is related to additional capital expenditures associated with
      our new Headquarters, Operations and Training facility which opened in March
      2006. Also included are the capitalized costs associated with three newly
      constructed stores in 2006. Two of the new stores marked our initial entry
      into
      the Lancaster market as previously discussed. The third was a relocation of
      our
      flagship office from a leased facility at Senate Avenue in Camp Hill to a newly
      constructed prototype store just minutes away in Lemoyne, PA.




**Other
      Assets**




Other
      assets increased by $4.7 million from $13.8 million at December 31, 2005 to
      $18.5 million at December 31, 2006. This change was primarily due to a $3.0
      million increase in miscellaneous receivables that resulted from a security
      sale
      with a trade date in late December and a settlement date in early
      January.




**Deposits**




Total
      deposits at December 31, 2006, were $1.62 billion, up $245.7 million, or 18%,
      over total deposits of $1.37 billion at December 31, 2005. We remain a
      deposit-driven financial institution with emphasis on core deposit accumulation
      and retention as a basis for sound growth and profitability. We regard core
      deposits as all deposits other than public certificates of deposits. Deposits
      in
      the various core categories increased $268.4 million, or 20%, in 2006 over
      2005.
      Total deposits averaged $1.45 billion for 2006, an increase of $210.2 million,
      or 17%, over the 2005 average of $1.24 billion. The average balance on
      noninterest-bearing demand deposits increased in 2006 by $33.1 million, or
      15%,
      over the prior year. The average balance of interest bearing demand accounts
      (money market and interest checking accounts) for 2006 increased by $125.7
      million, or 26%, over the average balance for the prior year. The average total
      balance of all savings accounts was $363.5 million, a $38.3 million, or 12%,
      increase over the average balance for 2005. The average balance of all time
      deposits in 2006 was $227.5 million, an increase of $13.1 million, or 6%, over
      the average balance for 2005. For 2006, the deposit cost of funds was 2.42%
      as
      compared to 1.73% in 2005.




We
      believe that our record of sustaining core deposit growth is reflective of
      our
      retail approach to banking which emphasizes a combination of free checking
      accounts, convenient store locations, extended hours of operation, unparalleled
      quality customer service, and active marketing.




The
      average balances and weighted average rates paid on deposits for 2006, 2005
      and
      2004 are presented below. ****




**T** **ABLE** **10**


**Years
                Ended December 31,****2006
                Average**
            
            2005
                Average
            
            2004
                Average*(dollars
                in thousands)*
            
            **Balance/Rate**
            
            Balance/Rate
            
            Balance/RateDemand
                deposits:Noninterest-bearing
            
            **$**
            **253,671**
            
            
            
            
            $
            220,566
            
            
            
            
            $
            180,355Interest-bearing
                (money market and checking)
            
            
            **605,043**
            
            
            **3.68**
            **%**
            
            479,310
            
            
            2.49
            %
            
            347,212
            
            
            1.23
            %Savings
            
            
            **363,515**
            
            
            **2.35**
            
            
            325,218
            
            
            1.55
            
            
            276,862
            
            
            1.01Time
            
            
            **227,484**
            
            
            **3.93**
            
            
            214,420
            
            
            3.00
            
            
            210,620
            
            
            2.30Total
                deposits
            
            **$**
            **1,449,713**
            
            
            
            
            $
            1,239,514
            
            
            
            
            $
            1,015,049







15






The
      remaining maturity for certificates of deposit of $100,000 or more as of
      December 31, 2006, 2005 and 2004 is presented in Table 11.




**T** **ABLE** **11**


*(in
                thousands)*
            
            **2006**
            
            2005
            
            20043
                months or less
            
            **$**
            **25,696**
            
            $
            20,002
            
            $
            39,2703
                to 6 months
            
            
            **22,759**
            
            
            6,487
            
            
            15,5306
                to 12 months
            
            
            **38,901**
            
            
            29,582
            
            
            13,344Over
                12 months
            
            
            **20,034**
            
            
            69,028
            
            
            36,811Total
            
            **$**
            **107,390**
            
            $
            125,099
            
            $
            104,955




**Short-Term
      Borrowings** **and Repurchase Agreements**




Short-term
      borrowings used to meet temporary funding needs consist of overnight and
      short-term advances from the Federal Home Loan Bank, securities sold under
      agreements to repurchase and overnight federal funds lines of credit. For 2006,
      short-term borrowings averaged $174.3 million and repurchase agreements averaged
      $25.4 million. The weighted average rate paid during 2006 was 5.07% for both
      short-term borrowings and repurchase agreements. At December 31, 2006,
      short-term borrowings totaled $112.8 million at an average rate of 5.40%. As
      of
      December 31, 2005, short-term borrowings totaled $157.9 million at an average
      rate of 4.24%. The maximum short-term borrowings outstanding at any month-end
      were $227.1 million in 2006 and $183.2 million in 2005. The maximum repurchase
      agree-ments outstanding at any month-end were $55.0 million in 2006 and $70.0
      million in 2005.




**Long-Term
      Debt**




On
      September 29, 2006, the Company issued $15 million of 7.75% Trust Capital
      Securities to Commerce Bank, N.A. through Commerce Harrisburg Capital Trust
      III,
      a Delaware statutory trust subsidiary. Long-term debt totaled $29.4 at December
      31, 2006 as compared to $13.6 million at December 31, 2005. Our long-term debt
      consisted solely of Trust Capital Securities through Commerce Harrisburg Capital
      Trust I, Commerce Harrisburg Capital Trust II and Commerce Harrisburg Capital
      Trust III, our Delaware business trust subsidiaries. At December 31, 2006,
      all
      of the Capital Trust Securities qualified as Tier I capital for regulatory
      capital purposes. Proceeds of the trust capital securities were used for general
      corporate purposes, including additional capitalization of our wholly-owned
      banking subsidiary. See Note 10 in the *Notes
      to Consolidated Financial Statements* for
      further analysis of our long-term debt.




**Stockholders’
      Equity and Capital Adequacy**




At
      December 31, 2006, stockholders’ equity totaled $101.1 million, up $9.5 million,
      or 10%, over stockholders’ equity at December 31, 2005. This increase was due to
      our net income for the year as well as proceeds for shares issued under our
      stock purchase and stock option plans. Stockholders’ equity as a percent of
      total assets was 5.42% at December 31, 2006, compared to 5.58% at December
      31,
      2005. See Note 12 of *Notes
      to Consolidated Financial Statements* for
      December 31, 2006, included herein, for additional discussion regarding
      Stockholders’ Equity.




Risk-based
      capital provides the basis for which all banks are evaluated in terms of capital
      adequacy. The risk-based capital standards require all banks to have Tier 1
      capital of at least 4% and total capital, including Tier 1 capital, of at least
      8% of risk-adjusted assets. Tier 1 capital includes common stockholders’ equity
      and qualifying perpetual preferred stock together with related surpluses and
      retained earnings. Total capital may be comprised of total Tier 1 capital plus
      limited life preferred stock, qualifying debt instruments, and the allowance
      for
      loan losses.




Table
      12
      provides a comparison of the Bank’s risk-based capital ratios and leverage
      ratios to the minimum regulatory requirements for the periods
      indicated.




**T** **ABLE** **12**


**Actual**
              **December
                31,**
            
            MinimumRegulatory**2006**
            
            2005
            
            RequirementsTier
                1 Capital
            
            
            **9.98**
            **%**
            
            9.77
            %
            
            4.00
            %Total
                Capital
            
            
            **10.71**
            
            
            10.60
            
            
            8.00Leverage
                ratio
              (to total assets)
            
            
            **7.30**
            
            
            6.68
            
            
            3.00-4.00




At
      December 31, 2006, the consolidated capital levels of the Company and of the
      Bank met the regulatory definition of a “well-capitalized” financial
      institution, i.e., a leverage capital ratio exceeding 5%, a Tier 1 risk-based
      capital ratio exceeding 6%, and a total risk-based capital ratio exceeding
      10%.







16




Our
      common stock trades on the NASDAQ Global Select Market under the symbol COBH.
      As
      of December 31, 2006, there were approximately 2,500 holders of record of the
      Company’s common stock.




Sales
                PriceQuarter
                Ended:
            
            High
            
            LowMarch 31, 2006
            
            **$**
            **33.50**
            
            **$**
            **30.01**June 30, 2006
            
            
            **32.00**
            
            
            **26.54**September 30, 2006
            
            
            **31.68**
            
            
            **25.58**December 31, 2006
            
            
            **26.84**
            
            
            **24.77**March 31, 2005
            
            $
            33.97
            
            $
            28.93June 30, 2005
            
            
            38.00
            
            
            29.11September 30, 2005
            
            
            36.68
            
            
            33.05December 31, 2005
            
            
            36.00
            
            
            30.72




The
      following graph shows the yearly percentage change in the Company’s cumulative
      total shareholder return on its common stock from December 31, 2001 to December
      31, 2006 compared with the cumulative total return of a NASDAQ Bank Index and
      the NASDAQ Composite Market Index.




**COMPARISON
      OF FIVE-YEAR CUMULATIVE TOTAL RETURN**




**Pennsylvania
      Commerce Bancorp (“COBH”) NASDAQ Bank Index**




**NASDAQ
      Composite Market Index**




**Year-End
      2001 to Year-End 2006**







We
      offer
      a Dividend Reinvestment and Stock Purchase Plan by which dividends on our Common
      Stock and optional cash payments of up to $10,000 per month (subject to change)
      may be invested in our Common Stock at a 3% discount (subject to change) to
      the
      market price and without payment of brokerage commissions.






17




**Interest
      Rate Sensitivity**




The
      management of interest rate sensitivity seeks to avoid fluctuating net interest
      margins and to provide consistent net interest income through periods of
      changing interest rates.




Our
      risk
      of loss arising from adverse changes in the fair value of financial instruments,
      or market risk, is composed primarily of interest rate risk. The primary
      objective of our asset/liability management activities is to maximize net
      interest income while maintaining acceptable levels of interest rate risk.
      Our
      Asset/Liability Committee (ALCO) is responsible for establishing policies to
      limit exposure to interest rate risk, and to ensure procedures are established
      to monitor compliance with those policies. Our board of directors reviews the
      guidelines established by ALCO.




An
      interest rate sensitive asset or liability is one that, within a defined time
      period, either matures or experiences an interest rate change in line with
      general market interest rates. Historically, the most common method of
      estimating interest rate risk was to measure the maturity and repricing
      relationships between interest-earning assets and interest-bearing liabilities
      at specific points in time, referred to as “GAP,” typically one year. Under this
      method, a company is considered liability sensitive when the amount of its
      interest-bearing liabilities exceeds the amount of its interest-earning assets
      within the one-year horizon. However, assets and liabilities with similar
      repricing characteristics may not reprice at the same time or to the same
      degree. As a result, our GAP does not necessarily predict the impact of changes
      in general levels of interest rates on net interest income. Table 13 shows
      our
      GAP position as of December 31, 2006. The repricing assumptions used in the
      table are as follows:




·
            Fixed
                rate loans receivable are scheduled according to their contractual
                amortization and payment schedules specific to each loan. A market
                consensus Constant Prepayment Rate is applied to Residential Mortgage
                Fixed rate loans.




·
            Floating
                rate loans receivable are scheduled in the 1-90 day category as they
                are
                tied to a floating index such as New York Prime and available for
                immediate repricing.




·
            Securities
                with pre-payment characteristics such as mortgage-backed securities
                and
                collateralized mortgage obligations are scheduled based upon their
                remaining weighted average lives as calculated utilizing a market
                consensus Constant Prepayment Rate. Securities with call options
                are
                analyzed in the context of the existing interest rate environment
                to
                estimate the likelihood of their call, and to project their resulting
                payment schedule. All other securities are assumed to reprice at
                their
                contractual maturity.




·
            Fixed
                rate transaction accounts are scheduled to reprice in accordance
                with
                their estimated decay rates as determined in a core deposit study
                produced
                by an independent consultant. Floating rate transaction accounts
                are
                scheduled in the 1-90 day category as they are tied to a floating
                index
                such as the 91 Day Treasury Bill.




·
            Time
                deposit accounts, short-term borrowings, and trust capital securities
                are
                scheduled based upon their contractual maturity
                dates.




**T** **ABLE** **13**


**December
                31, 2006***(dollars
                in thousands)*
            
            **1
                - 90**
              **Days**
            
            **91
                - 180**
              **Days**
            
            **181
                - 365**
              **Days**
            
            **1
                - 5**
              **Years**
            
            **Beyond
                5**
              **Years**
            
            **Total**Interest-earning
                assets:Loans
                receivable
            
            **$**
            **374,070**
            
            **$**
            **25,668**
            
            **$**
            **45,345**
            
            **$**
            **423,013**
            
            **$**
            **129,968**
            
            **$**
            **998,064**Securities
            
            
            **98,827**
            
            
            **20,722**
            
            
            **44,699**
            
            
            **348,301**
            
            
            **217,717**
            
            
            **730,266**Total
                interest-earning assets
            
            
            **472,897**
            
            
            **46,390**
            
            
            **90,044**
            
            
            **771,314**
            
            
            **347,685**
            
            
            **1,728,330**Interest-bearing
                liabilities:Transaction
                accounts, excluding DDA
            
            
            **714,367**
            
            
            **6,994**
            
            
            **13,988**
            
            
            **72,663**
            
            
            **308,735**
            
            
            **1,116,747**Time
                deposits
            
            
            **59,543**
            
            
            **52,847**
            
            
            **74,498**
            
            
            **38,005**
            
            
            **0**
            
            
            **224,893**Short-term
                borrowings
            
            
            **112,800**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **112,800**Long-term
                debt
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **29,400**
            
            
            **29,400**Total
                interest-bearing liabilities
            
            
            **886,710**
            
            
            **59,841**
            
            
            **88,486**
            
            
            **110,668**
            
            
            **338,135**
            
            
            **1,483,840**Period
                GAP
            
            
            **(413,813**
            **)**
            
            **(13,451**
            **)**
            
            **1,558**
            
            
            **660,646**
            
            
            **9,550**
            
            **$**
            **244,490**Cumulative
                GAP
            
            **$**
            **(413,813**
            **)**
            **$**
            **(427,264**
            **)**
            **$**
            **(425,706**
            **)**
            **$**
            **234,940**
            
            **$**
            **244,490**Cumulative
                RSA / RSL
            
            
            **53.33**
            **%**
            
            **54.86**
            **%**
            
            **58.87**
            **%**
            
            **120.51**
            **%**
            
            **116.48**
            **%**




*Notes:
      Nonaccrual loans, deferred fees on loans and overdrafts have been excluded
      in
      the loans receivable balances. Securities are reported at current face value
      for
      purposes of this table. RSA means rate sensitive assets; RSL means rate
      sensitive liabilities.*




Shortcomings
      are inherent in any GAP analysis since certain assets and liabilities may not
      move proportionately as interest rates change. As the interest rate environment
      has become more volatile, we have continued to place greater reliance on
      interest income sensitivity modeling and less on GAP reporting.






18




Our
      management understands that the preparation of GAP reports can only provide
      a
      guide to the impact of the movement of interest rates. Modeling is the best
      means to predict the movement in interest rates. This is true because even
      with
      the achievement of a perfectly matched balance sheet (per a GAP report), we
      may
      be subject to interest rate risk due to: differences in the timing of repricing,
      basis risk, market risk, customer ability to prepay loans or withdraw funds
      and
      yield curve risk.




Our
      management believes the simulation of net interest income in different interest
      rate environments provides a more meaningful measure of interest rate risk.
      Income simulation analysis captures not only the potential of all assets and
      liabilities to mature or reprice, but also the probability that they will do
      so.
      Income simulation also attends to the relative interest rate sensitivities
      of
      these items, and projects their behavior over an extended period of time.
      Finally, income simulation permits management to assess the probable effects
      on
      the balance sheet not only of changes in interest rates, but also of proposed
      strategies for responding to them.




Our
      income simulation model analyzes interest rate sensitivity by projecting net
      interest income over the next 24 months in a flat rate scenario versus net
      interest income in alternative interest rate scenarios. Our management
      continually reviews and refines its interest rate risk management process in
      response to the changing economic climate. Currently, our model projects a
      200
      basis point increase and a 200 basis point decrease during the next year, with
      rates remaining constant in the second year.






Our
      Asset/Liability Committee (ALCO) policy has established that income sensitivity
      will be considered acceptable if net interest income in the above mentioned
      interest rate scenario is within 4% of forecasted net interest income in the
      first year and within 5% using a two year time frame.




The
      following table compares the impact on forecasted net income at December 31,
      2006 of a plus 200 and minus 200 basis point (bp) change in interest rates
      to
      the impact at December 31, 2005 in the same scenarios.




Plus
                200
            
            Minus
                200December
                31, 2006:Twelve
                Months
            
            
            **(4.1**
            **)%**
            
            **4.4**
            **%**Twenty-Four
                Months
            
            
            **(2.9**
            **)%**
            
            **2.8**
            **%**December
                31, 2005:Twelve
                Months
            
            
            (4.0
            )%
            
            2.9
            %Twenty-Four
                Months
            
            
            (3.5
            )%
            
            0.5
            %




The
      forecasted net interest income variability is slightly outside of the
      established limit in the twelve month plus 200 bp rate scenario, but moves
      within the acceptable limit in this rate scenario when expanding the time frame
      to include twenty-four months. All other interest rate scenarios indicate levels
      of future interest rate risk within the acceptable parameters per the policies
      established by ALCO. Management is closely monitoring the plus 200 bp rate
      scenario in the context of the perceived probability of this interest rate
      environment, to determine the appropriate course of action. Actions that would
      reduce the level of risk could include the sale of a portion of our available
      for sale investment portfolio, the use of risk management strategies such as
      interest rate swaps and caps, adjusting the investment leverage position funded
      by short-term borrowings, or fixing the cost of our short-term borrowings.




Many
      assumptions were used by us to calculate the impact of changes in interest
      rates. Actual results may not be similar to our projections due to several
      factors including the timing and frequency of rate changes, market conditions
      and the shape of the yield curve. In general, a flattening of the yield curve
      would result in reduced net interest income compared to the current flat rate
      scenario and proportionate rate shift assumptions. Actual results may also
      differ due to Management's actions, if any, in response to the changing
      rates.




Management
      also monitors interest rate risk by utilizing a market value of equity model.
      The model assesses the impact of a change in interest rates on the market value
      of all our assets and liabilities, as well as any off balance sheet items.
      The
      model calculates the market value of our assets and liabilities in excess of
      book value in the current rate scenario, and then compares the excess of market
      value over book value given an immediate 200 basis point increase and a 200
      basis point decrease in rates. Our ALCO policy indicates that the level of
      interest rate risk is unacceptable if the immediate change would result in
      the
      loss of 50% or more of the excess of market value over book value in the current
      rate scenario. At December 31, 2006, the market value of equity indicates an
      acceptable level of interest rate risk under this measurement.




The
      market value of equity model reflects certain estimates and assumptions
      regarding the impact on the market value of our assets and liabilities given
      an
      immediate 200 basis point change in interest rates. One of the key assumptions
      is the market value assigned to our core deposits, or the core deposit premium.
      Using an independent consultant, we have completed and updated comprehensive
      core deposit studies in order to assign our own core deposit premiums as
      permitted by regulation. The studies have consistently confirmed management’s
      assertion that our core deposits have stable balances over long periods of
      time,
      are relatively insensitive to changes in interest rates and have significantly
      longer average lives and durations than our loans and investment securities.
      Thus, these core deposit balances provide an internal hedge to market
      fluctuations in our fixed rate assets. Management believes the core deposit
      premiums produced by its market value of equity model at December 31, 2006
      provide an accurate assessment of our interest rate risk.






19




***Liquidity***




The
        objective of liquidity management is to ensure our ability to meet our financial
        obligations. These obligations include the payment of deposits on demand
        at
        their contractual maturity; the repayment of borrowings as they mature; the
        payment of lease obligations as they become due; the ability to fund new
        and
        existing loans and other funding commitments; and the ability to take advantage
        of new business opportunities. Our ALCO is responsible for implementing the
        policies and guidelines of our board governing liquidity.
  Liquidity
        sources are found on both sides of the balance sheet. Liquidity is provided
        on a
        continuous basis through scheduled and unscheduled principal reductions and
        interest payments on outstanding loans and investments. Liquidity is also
        provided through the availability and maintenance of a strong base of core
        customer deposits; maturing short-term assets; the ability to sell marketable
        securities; short-term borrowings and access to capital markets.
  Liquidity
        is measured and monitored daily, allowing management to better understand
        and
        react to balance sheet trends. On a monthly basis, a comprehensive liquidity
        analysis is reviewed by our Board of Directors. The analysis provides a summary
        of the current liquidity measurements, projections and future liquidity
        positions given various levels of liquidity stress. Management also maintains
        a
        detailed liquidity contingency plan designed to respond to an overall decline
        in
        the condition of the banking industry or a problem specific to the
        Company.
  The
        Consolidated Statements of Cash Flows provide additional information on our
        sources and uses of funds. From a funding standpoint, we have been able to
        rely
        over the years on a stable base of strong “core” deposit growth. We generated
        $4.2 million in cash from operating activities during 2006 versus $4.5 million
        during 2005. This decrease was primarily attributed to the change in balances
        of
        other assets and other liabilities from one year to the next. Investing
        activities resulted in a net cash outflow of $206.5 million during 2006 compared
        to $379.0 million in 2005. A reduction of investment purchases of $190.6
        million
        contributed to the decrease in investing activities in 2006 from 2005. Financing
        activities resulted in a net inflow of $218.4 million in 2006 compared to
        $370.0
        million in 2005. The cash inflow in 2006 was mostly from net deposit growth
        of
        $245.7 million and was offset by a decrease in short-term borrowings of $45.1
        million. For 2005, cash inflows resulted from $210.5 million in net deposit
        growth and from an increase in short-term borrowings of $157.9 million.
  At
        December 31, 2006, liquid assets (defined as cash and cash equivalents,
        short-term investments, mortgages available for sale, securities available
        for
        sale, and non-mortgage-backed securities held to maturity due in one year
        or
        less) totaled $470.1 million, or 25%, of total assets. This compares to $421.9
        million, or 26%, of total assets, at December 31, 2005.
  Our
        investment portfolio consists mainly of mortgage-backed securities, which
        do not
        have stated maturities. Cash flows from such investments are dependent upon
        the
        performance of the underlying mortgage loans, and are generally influenced
        by
        the level of interest rates. As rates increase, cash flows generally decrease
        as
        prepayments on the underlying mortgage loans slow. As rates decrease, cash
        flows
        generally increase as prepayments increase.
  The
        Company and the Bank’s liquidity are managed separately. On an unconsolidated
        basis, the principal source of our revenue is dividends paid to the Company
        by
        the Bank. The Bank is subject to regulatory restrictions on its ability to
        pay
        dividends to the Company. The Company’s net cash outflows consist principally of
        interest on the trust-preferred securities, dividends on the preferred stock
        and
        unallocated corporate expenses.
  We
        also
        maintain secondary sources of liquidity consisting of federal funds lines
        of
        credit, repurchase agreements, and borrowing capacity at the Federal Home
        Loan
        Bank, which can be drawn upon if needed. As of December 31, 2006, our total
        potential liquidity through these secondary sources was $598.0 million of
        which $485.2 million was currently available, as compared to $521.1 million
        at
        December 31, 2005 of which $363.2 million was currently available.
  Subject
        to regulatory approvals, we are targeting to open up to 30 new stores over
        the
        next six years. The cost to construct and furnish a new store will be
        approximately $2.0 million, excluding the cost to lease or purchase the land
        on
        which the store is located.
  20


**Aggregate
      Contractual Obligations**




The
      following table represents our on-and-off balance sheet aggregate contractual
      obligations to make future payments as of December 31, 2006:




**T** **ABLE** **14**


**December
                31, 2006***(in
                thousands)*
            
            **Less
                than**
              **1
                Year**
            
            **1
                to 3**
              **Years**
            
            **3
                to 5**
              **Years**
            
            **Over
                5**
              **Years**
            
            **Total**Time
                Deposits
            
            **$**
            **186,888**
            
            **$**
            **22,780**
            
            **$**
            **15,225**
            
            **$**
            **0**
            
            **$**
            **224,893**Long-Term
                Debt
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **29,400**
            
            
            **29,400**Operating
                Leases
            
            
            **1,987**
            
            
            **3,698**
            
            
            **3,595**
            
            
            **27,618**
            
            
            **36,898**Sponsorship
                Obligation
            
            
            **300**
            
            
            **551**
            
            
            **467**
            
            
            **1,632**
            
            
            **2,950**Total
            
            **$**
            **189,175**
            
            **$**
            **27,029**
            
            **$**
            **19,287**
            
            **$**
            **58,650**
            
            **$**
            **294,141**




For
      further discussion regarding our commitments and contingencies, please see
      Note
      18 in the Notes
      to
      Consolidated Financial Statements for December 31, 2006, included
      herein.




**Off-Balance
      Sheet Arrangements**




In
      the
      conduct of ordinary business operations we routinely enter into contracts for
      services. These contracts may require payment for services to be provided in
      the
      future and may also contain penalty clauses for the early termination of the
      contract. Management is not aware of any additional commitments or contingent
      liabilities, which may have a material adverse impact on our liquidity or
      capital resources.




We
      are
      also party to financial instruments with off-balance sheet risk in the normal
      course of business to meet the financing needs of its customers. These financial
      instruments include commitments to extend credit and standby letters of credit.
      See Note 5 in the *Notes
      to the Consolidated Financial Statements* for
      December 31, 2006, included herein, for additional information.




***Forward-Looking
      Statements***




The
      Company may, from time to time, make written or oral “forward-looking
      statements”, including statements contained in the Company’s filings with the
      Securities and Exchange Commission (including the annual report on Form 10-K
      and
      the exhibits thereto), in its reports to stockholders and in other
      communications by the Company, which are made in good faith by the Company
      pursuant to the “safe harbor” provisions of the Private Securities Litigation
      Reform Act of 1995.




These
      forward-looking statements include statements with respect to the Company’s
      beliefs, plans, objectives, goals, expectations, anticipations, estimates and
      intentions that are subject to significant risks and uncertainties and are
      subject to change based on various factors (some of which are beyond the
      Company’s control). The words “may”, “could”, “should”, “would”, “believe”,
“anticipate”, “estimate”, “expect”, “intend”, “plan” and similar expressions are
      intended to identify forward-looking statements. The following factors, among
      others, including those discussed in Item 1A “Risk Factors” and Item 7 &
“Management’s Discussion and Analysis of Financial Condition and Results of
      Operations” and elsewhere in this annual report could cause the Company’s
      financial performance to differ materially from that expressed in such
      forward-looking statements:




●
the
      strength of the United States economy in general and the strength of the local
      economies in which the Company conducts operations;




●
the
      effects of, and changes in, trade, monetary and fiscal policies, including
      interest rate policies of the Board of Governors of the Federal Reserve System;




●
      inflation;




●
      interest rate, market and monetary fluctuations;




●
the
      timely development of competitive new products and services by the Company
      and
      the acceptance of such products and services by customers;




●
the
      willingness of customers to substitute competitors’ products and services for
      the Company’s products and services and vice versa;




●
the
      impact of changes in financial services’ laws and regulations (including laws
      concerning taxes, banking, securities and insurance);




●
the
      impact of the rapid growth of the Company;




●
the
      Company’s dependence on Commerce Bancorp, Inc. to provide various services to
      the Company;




●
changes
      in the Company’s allowance for loan losses;






21




●
effect
      of terrorists attacks and threats of actual war;




●
      unanticipated regulatory or judicial proceedings;




●
changes
      in consumer spending and saving habits;




●
and
      the
      success of the Company at managing the risks involved in the
      foregoing.




Because
      such forward-looking statements are subject to risks and uncertainties, actual
      results may differ materially from those expressed or implied by such
      statements. The Company cautions that the foregoing list of important factors
      is
      not exclusive. The Company does not undertake to update any forward-looking
      statements, whether written or oral, that may be made from time to time by
      or on
      behalf of the Company. For information concerning events or circumstances after
      the date of this report, refer to the Company’s filings with the Securities and
      Exchange Commission (“ SEC”).




***Impact
      of Inflation and Changing Prices***




Interest
      rates have a more significant impact on our performance than do the effects
      of
      general levels of inflation, since most of our assets and liabilities are
      monetary in nature. Interest rates do not necessarily move in the same direction
      or in the same magnitude as the prices of goods and services as measured by
      the
      Consumer Price Index. The liquidity and maturity structure of our assets and
      liabilities are critical to the maintenance of acceptable performance
      levels.




***Quantitative
      and Qualitative Disclosures about Market Risk***




Our
      exposure to market risk principally includes interest rate risk, which was
      previously discussed. Historically, our net interest margin has remained fairly
      stable; however, our net interest margin for the year ended December 31, 2006
      was 3.18%, a decrease of 59 basis points from 3.77% for the year ended December
      31, 2005 as a result of the inverted yield curve in effect throughout 2006.
      See
      the section titled “Net Interest Income and Net Interest Margin” in this
      Management’s Discussion and Analysis for further discussion regarding our net
      interest margin performance.




Currently,
      we have 98% of our deposits in accounts which we consider core deposits. These
      accounts, which have a relatively low cost of deposits, have historically
      contributed significantly to the net interest margin. ****  22




**Pennsylvania
      Commerce Bancorp, Inc.**


**Report
      on Management’s Assessment of Internal Control Over**


**Financial
      Reporting**




Pennsylvania
      Commerce Bancorp, Inc. is responsible for the preparation, integrity, and fair
      presentation of the consolidated financial statements included in this annual
      report. The consolidated financial statements and notes included in this annual
      report have been prepared in conformity with United States generally accepted
      accounting principles and necessarily include some amounts that are based on
      management’s best estimates and judgments.




We,
      as
      management of Pennsylvania Commerce Bancorp, Inc., are responsible for
      establishing and maintaining effective internal control over financial reporting
      that is designed to produce reliable financial statements in conformity with
      United States generally accepted accounting principles. 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 the Company; provide
      reasonable assurance that the transactions are recorded as necessary to permit
      preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the Company are
      only being made in accordance with authorizations of management and directors
      of
      the Company; and provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the Company’s
      assets that could have a material effect on the financial statements. The system
      of internal control over financial reporting as it relates to the financial
      statements is evaluated for effectiveness by management and tested for liability
      through a program of internal audits. Actions are taken to correct potential
      deficiencies as they are identified.




Any
      system of internal control, no matter how well designed, has inherent
      limitations, including the possibility that a control can be circumvented or
      overridden and misstatements due to error or fraud may occur and not be
      detected. Also, because of changes in conditions, internal control effectiveness
      may vary over time. Accordingly, even an effective system of internal control
      will provide only reasonable assurance with respect to financial statement
      preparation.




Management
      assessed the Company’s system of internal control over financial reporting as of
      December 31, 2006, in relation to criteria for effective internal control over
      financial reporting as described in Internal Control - Integrated Framework,
      issued by the Committee of Sponsoring Organizations of the Treadway Commission.
      Based on this assessment, management concludes that, as of December 31, 2006,
      its system of internal control over financial reporting is effective and meets
      the criteria of the Internal Control - Integrated Framework. Beard Miller
      Company LLP, independent registered public accounting firm, has issued an
      attestation report on management’s assessment of internal control over financial
      reporting and the effectiveness of the Company’s internal control over financial
      reporting as of December 31, 2006.




/s/
                  Gary L. NalbandianGary
                  L. NalbandianChairman,
                  President and Chief Executive Officer(Principal
                  Executive Officer)/s/
                        Mark A. ZodyMark
                  A. ZodyExecutive
                  Vice President and Chief Financial Officer(Principal
                  Financial and Accounting
                  Officer)




March
      9,
      2007


23




**Report
      of Independent Registered Public Accounting Firm**




To
      the
      Board of Directors and Stockholders


Pennsylvania
      Commerce Bancorp, Inc.


Harrisburg,
      Pennsylvania




We
      have
      audited management's assessment, included in the accompanying Report on
      Management's Assessment of Internal Control over Financial Reporting, that
      Pennsylvania Commerce Bancorp, Inc. maintained effective internal control over
      financial reporting as of December 31, 2006, based on criteria established
      in
      Internal Control--Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission ("COSO"). Pennsylvania Commerce
      Bancorp’s management is responsible for maintaining effective internal control
      over financial reporting and for its assessment of the effectiveness of internal
      control over financial reporting. Our responsibility is to express an opinion
      on
      management's assessment and an opinion on the effectiveness of the company's
      internal control over financial reporting based on our audit.




We
      conducted our audit 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 effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management's assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




A
      company'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 generally accepted accounting principles. A company's internal control
      over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company's
      assets that could have a material effect on the financial statements.




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.




In
      our
      opinion, management's assessment that Pennsylvania Commerce Bancorp, Inc.
      maintained effective internal control over financial reporting as of December
      31, 2006, is fairly stated, in all material respects, based on criteria
      established in Internal Control--Integrated Framework issued by the Committee
      of
      Sponsoring Organizations of the Treadway Commission (“COSO”). Also in our
      opinion, Pennsylvania Commerce Bancorp, Inc. maintained, in all material
      respects, effective internal control over financial reporting as of December
      31,
      2006, based on criteria established in Internal Control--Integrated Framework
      issued by the Committee of Sponsoring Organizations of the Treadway Commission
      (“COSO”).




We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheets of Pennsylvania
      Commerce Bancorp, Inc. and subsidiaries as of December 31, 2006 and 2005, and
      the related consolidated statements of income, stockholders' equity, and cash
      flows for the each of the years in the three-year period ended December 31,
      2006
      and our report dated March 14 ,
      2007,
      expressed an unqualified opinion thereon.




/s/
      Beard
      Miller Company LLP






Beard
      Miller Company LLP


Harrisburg,
      Pennsylvania


March
      14 ,
      2007


24




**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors and Stockholders


Pennsylvania
      Commerce Bancorp, Inc.


Harrisburg,
      Pennsylvania




We
      have
      audited the accompanying consolidated balance sheets of Pennsylvania Commerce
      Bancorp, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related
      consolidated statements of income, stockholders' equity, and cash flows for
      the
      each of the years in the three-year period ended December 31, 2006. These
      consolidated financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these consolidated
      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
      consolidated financial statements are free of material misstatement. An audit
      includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the consolidated financial statements. An audit also includes
      assessing the accounting principles used and significant estimates made by
      management, as well as 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 Pennsylvania Commerce
      Bancorp, Inc. and subsidiaries as of December 31, 2006 and 2005 and the results
      of their operations and their cash flows for the each of the years in the
      three-year period ended December 31, 2006 in conformity with accounting
      principles generally accepted in the United States of America.




As
      discussed in Note 1 to the consolidated financial statements, the Company
      changed its method of accounting for stock based compensation in
      2006.




We
      have
      also audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of Pennsylvania Commerce
      Bancorp, Inc.'s internal control over the financial reporting as of December
      31,
      2006, 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 14 ,
      2007
      expressed an unqualified opinion on management's assessment of internal control
      over financial reporting and an unqualified opinion on the effectiveness of
      internal control over financial reporting.




/s/
      Beard
      Miller Company LLP





Beard
      Miller Company LLP


Harrisburg,
      Pennsylvania


March
      14 ,
      2007


25




**Consolidated
      Balance Sheets**




**December
                31,***(in
                thousands, except share amounts)*
            
            **2006**
            
            2005**Assets**Cash
                and due from banks
            
            **$**
            **52,500**
            
            $
            36,422Federal
                funds sold
            
            
            **0**
            
            
            0Cash
                and cash equivalents
            
            
            **52,500**
            
            
            36,422Securities,
                available for sale at fair value
            
            
            **392,058**
            
            
            380,836Securities,
                held to maturity at cost(fair
                value 2006: $314,837; 2005: $301,978)
            
            
            **319,628**
            
            
            306,266Loans,
                held for sale
            
            
            **15,346**
            
            
            10,585Loans
                receivable, net of allowance for loan losses(allowance
                2006: $9,685; 2005: $9,231)
            
            
            **973,033**
            
            
            815,439Restricted
                investments in bank stocks
            
            
            **11,728**
            
            
            11,463Premises
                and equipment, net
            
            
            **83,679**
            
            
            66,264Other
                assets
            
            
            **18,511**
            
            
            13,846**Total
                assets**
            
            **$**
            **1,866,483**
            
            $
            1,641,121**Liabilities
                and Stockholders’ Equity**Deposits:Noninterest-bearing
            
            **$**
            **275,137**
            
            $
            248,101Interest-bearing
            
            
            **1,341,640**
            
            
            1,122,961Total
                deposits
            
            
            **1,616,777**
            
            
            1,371,062Short-term
                borrowings and repurchase agreements
            
            
            **112,800**
            
            
            157,900Long-term
                debt
            
            
            **29,400**
            
            
            13,600Other
                liabilities
            
            
            **6,398**
            
            
            6,916Total
                liabilities
            
            
            **1,765,375**
            
            
            1,549,478Stockholders’
                Equity:Preferred
                stock - Series A noncumulative; $10.00 par value;1,000,000
                shares authorized; 40,000 shares issued and outstanding
            
            
            **400**
            
            
            400Common
                stock - $1.00 par value; 10,000,000 shares authorized;(issued
                and outstanding 2006: 6,149,155; 2005: 6,013,859)
            
            
            **6,149**
            
            
            6,014Surplus
            
            
            **67,072**
            
            
            64,859Retained
                earnings
            
            
            **31,941**
            
            
            24,767Accumulated
                other comprehensive income (loss)
            
            
            **(4,454**
            **)**
            
            (4,397
            )Total
                stockholders’ equity
            
            
            **101,108**
            
            
            91,643**Total
                liabilities and stockholders’ equity**
            
            **$**
            **1,866,483**
            
            $
            1,641,121





*See
      accompanying notes.*


26


**Consolidated
      Statements of Income**




**Years
                Ended December
                31,***(in
                thousands, except per share amounts)*
            
            **2006**
            
            2005
            
            2004**Interest
                Income**Loans
                receivable, including fees:Taxable
            
            **$**
            **64,592**
            
            $
            47,949
            
            $
            35,433Tax-exempt
            
            
            **1,029**
            
            
            421
            
            
            292Securities:Taxable
            
            
            **38,845**
            
            
            30,822
            
            
            24,789Tax-exempt
            
            
            **85**
            
            
            355
            
            
            401Federal
                funds sold
            
            
            **0**
            
            
            5
            
            
            67**Total
                interest income**
            
            
            **104,551**
            
            
            79,552
            
            
            60,982**Interest
                Expense**Deposits
            
            
            **39,762**
            
            
            23,408
            
            
            11,909Short-term
                borrowings
            
            
            **10,267**
            
            
            3,821
            
            
            1,070Long-term
                debt
            
            
            **1,731**
            
            
            1,418
            
            
            1,418**Total
                interest expense**
            
            
            **51,760**
            
            
            28,647
            
            
            14,397**Net
                interest income**
            
            
            **52,791**
            
            
            50,905
            
            
            46,585Provision
                for loan losses
            
            
            **1,634**
            
            
            1,560
            
            
            2,646Net
                interest income after provision for loan losses
            
            
            **51,157**
            
            
            49,345
            
            
            43,939**Noninterest
                Income**Service
                charges and other fees
            
            
            **16,816**
            
            
            12,430
            
            
            10,252Other
                operating income
            
            
            **640**
            
            
            466
            
            
            414Gains
                on sales of loans
            
            
            **1,136**
            
            
            1,320
            
            
            630Gains
                (losses) on sales of securities
            
            
            **160**
            
            
            (60
            )
            
            0**Total
                noninterest income**
            
            
            **18,752**
            
            
            14,156
            
            
            11,296**Noninterest
                Expenses**Salaries
                and employee benefits
            
            
            **30,864**
            
            
            26,267
            
            
            21,824Occupancy
            
            
            **6,568**
            
            
            5,380
            
            
            4,375Furniture
                and equipment
            
            
            **3,587**
            
            
            2,733
            
            
            2,503Advertising
                and marketing
            
            
            **2,971**
            
            
            3,461
            
            
            3,108Data
                processing
            
            
            **5,420**
            
            
            3,843
            
            
            2,922Postage
                and supplies
            
            
            **1,621**
            
            
            1,308
            
            
            1,141Other
            
            
            **8,263**
            
            
            7,411
            
            
            6,593**Total
                noninterest expenses**
            
            
            **59,294**
            
            
            50,403
            
            
            42,466Income
                before taxes
            
            
            **10,615**
            
            
            13,098
            
            
            12,769Provision
                for federal income taxes
            
            
            **3,361**
            
            
            4,281
            
            
            4,178**Net
                income**
            
            **$**
            **7,254**
            
            $
            8,817
            
            $
            8,591**Net
                Income per Common Share***Basic*
            
            **$**
            **1.18**
            
            $
            1.47
            
            $
            1.75*Diluted*
            
            **$**
            **1.12**
            
            $
            1.38
            
            $
            1.63**Average
                Common and Common Equivalent Shares Outstanding***Basic*
            
            
            **6,099**
            
            
            5,948
            
            
            4,856*Diluted*
            
            
            **6,381**
            
            
            6,318
            
            
            5,218





*See
      accompanying notes.*


27


**Consolidated
      Statements of Stockholders’ Equity**




**Preferred**
                **Stock**
              
              **Common**
                **Stock**
              
              **Surplus**
              
              **Retained**
                **Earnings**
              
              **Accumulated
                  Other**
                **Comprehensive**
                **Income
                  (Loss)**
              
              **Total****January
                  1, 2004**
              
              **$**
              **400**
              
              **$**
              **2,292**
              
              **$**
              **38,725**
              
              **$**
              **7,758**
              
              **$**
              **549**
              
              **$**
              **49,724**Comprehensive
                  income:Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              8,591
              
              
              -
              
              
              8,591Change
                  in unrealized gains (losses) on securities, net of taxes
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (600
              )
              
              (600
              )Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              7,991Dividends
                  declared on preferred stock
              
              
              -
              
              
              -
              
              
              -
              
              
              (80
              )
              
              -
              
              
              (80
              )Common
                  stock of 68,204 shares issued under stock option plans, including
                  tax
                  benefit of $319
              
              
              -
              
              
              68
              
              
              1,233
              
              
              -
              
              
              -
              
              
              1,301Common
                  stock of 590 shares issued under employee stock purchase
                  plan
              
              
              -
              
              
              1
              
              
              27
              
              
              -
              
              
              -
              
              
              28Proceeds
                  from issuance of 13,842 shares of common stock in connection with
                  dividend
                  reinvestment and stock purchase plan
              
              
              -
              
              
              14
              
              
              661
              
              
              -
              
              
              -
              
              
              675Proceeds
                  from issuance of 560,000 shares of common stock in connection with
                  stock
                  offerings
              
              
              -
              
              
              560
              
              
              24,848
              
              
              -
              
              
              -
              
              
              25,408Other
                  stock transactions (362 shares issued)
              
              
              -
              
              
              -
              
              
              231
              
              
              (239
              )
              
              -
              
              
              (8
              )2-for-1
                  stock split in the form of a dividend (2,934,803 shares
                  issued)
              
              
              -
              
              
              2,935
              
              
              (2,935
              )
              
              -
              
              
              -
              
              
              -**December
                  31, 2004**
              
              **$**
              **400**
              
              **$**
              **5,870**
              
              **$**
              **62,790**
              
              **$**
              **16,030**
              
              **$**
              **(51**
              **)**
              **$**
              **85,039**Comprehensive
                  income:Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              8,817
              
              
              -
              
              
              8,817Change
                  in unrealized gains (losses) on securities, net of taxes and
                  reclassification adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (4,346
              )
              
              (4,346
              )Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,471Dividends
                  declared on preferred stock
              
              
              -
              
              
              -
              
              
              -
              
              
              (80
              )
              
              -
              
              
              (80
              )Common
                  stock of 96,144 shares issued under stock option plans, including
                  tax
                  benefit of $474
              
              
              -
              
              
              96
              
              
              1,252
              
              
              -
              
              
              -
              
              
              1,348Common
                  stock of 340 shares issued under employee stock purchase
                  plan
              
              
              -
              
              
              -
              
              
              14
              
              
              -
              
              
              -
              
              
              14Proceeds
                  from issuance of 23,989 shares of common stock in connection with
                  dividend
                  reinvestment and stock purchase plan
              
              
              -
              
              
              24
              
              
              759
              
              
              -
              
              
              -
              
              
              783Accelerated
                  vesting of stock options
              
              
              -
              
              
              -
              
              
              68
              
              
              -
              
              
              -
              
              
              68Other
                  stock transactions (23,780 shares issued)
              
              
              -
              
              
              24
              
              
              (24
              )
              
              -
              
              
              -
              
              
              -**December
                  31, 2005**
              
              **$**
              **400**
              
              **$**
              **6,014**
              
              **$**
              **64,859**
              
              **$**
              **24,767**
              
              **$**
              **(4,397**
              **)**
              **$**
              **91,643**Comprehensive
                  income:Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              7,254
              
              
              -
              
              
              7,254Change
                  in unrealized gains (losses) on securities, net of taxes
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (57
              )
              
              (57
              )Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              7,197Dividends
                  declared on preferred stock
              
              
              -
              
              
              -
              
              
              -
              
              
              (80
              )
              
              -
              
              
              (80
              )Common
                  stock of 95,561 shares issued under stock option plans, including
                  tax
                  benefit of $513
              
              
              -
              
              
              96
              
              
              877
              
              
              -
              
              
              -
              
              
              973Common
                  stock of 210 shares issued under employee stock purchase
                  plan
              
              
              -
              
              
              -
              
              
              6
              
              
              -
              
              
              -
              
              
              6Proceeds
                  from issuance of 39,525 shares of common stock in connection with
                  dividend
                  reinvestment and stock purchase plan
              
              
              -
              
              
              39
              
              
              1,001
              
              
              -
              
              
              -
              
              
              1,040Common
                  stock share-based awards
              
              
              -
              
              
              -
              
              
              329
              
              
              -
              
              
              -
              
              
              329**December
                  31, 2006**
              
              **$**
              **400**
              
              **$**
              **6,149**
              
              **$**
              **67,072**
              
              **$**
              **31,941**
              
              **$**
              **(4,454**
              **)**
              **$**
              **101,108**




*See
      accompanying notes.*




28




**Consolidated
      Statements of Cash Flows**





**Years
                Ended December
                31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004**Operating
                Activities**Net
                income
            
            **$**
            **7,254**
            
            $
            8,817
            
            $
            8,591Adjustments
                to reconcile net income to net cash provided by operating
                activities:Provision
                for loan losses
            
            
            **1,634**
            
            
            1,560
            
            
            2,646Provision
                for depreciation and amortization
            
            
            **4,004**
            
            
            3,006
            
            
            2,397Deferred
                income taxes
            
            
            **1,319**
            
            
            (1,303
            )
            
            708Amortization
                of securities premiums and accretion of discounts, net
            
            
            **776**
            
            
            1,216
            
            
            1,219Net
                (gains) losses on sales/call of securities
            
            
            **(160**
            **)**
            
            60
            
            
            0Proceeds
                from sales of loans
            
            
            **93,789**
            
            
            104,627
            
            
            75,619Loans
                originated for sale
            
            
            **(97,524**
            **)**
            
            (100,032
            )
            
            (80,112
            )Gains
                on sales of loans
            
            
            **(1,136**
            **)**
            
            (1,320
            )
            
            (630
            )Loss
                on disposal of equipment
            
            
            **270**
            
            
            99
            
            
            187Tax
                benefit on exercise of stock options
            
            
            **0**
            
            
            474
            
            
            319Noncash
                compensation
            
            
            **329**
            
            
            68
            
            
            0(Increase)
                decrease in other assets
            
            
            **(5,847**
            **)**
            
            (1,500
            )
            
            7,716Increase
                (decrease) in other liabilities
            
            
            **(518**
            **)**
            
            (11,265
            )
            
            14,443**Net
                cash provided by operating activities**
            
            
            **4,190**
            
            
            4,507
            
            
            33,103**Investing
                Activities**Securities
                held to maturity:Proceeds
                from principal repayments and maturities
            
            
            **44,844**
            
            
            49,709
            
            
            36,967Proceeds
                from sales/call
            
            
            **2,160**
            
            
            5,456
            
            
            0Purchases
            
            
            **(60,400**
            **)**
            
            (151,046
            )
            
            (46,893
            )Securities
                available for sale:Proceeds
                from principal repayments and maturities
            
            
            **112,533**
            
            
            94,077
            
            
            113,389Proceeds
                from sales
            
            
            **0**
            
            
            55,263
            
            
            0Purchases
            
            
            **(124,527**
            **)**
            
            (224,441
            )
            
            (154,071
            )Proceeds
                from sales of loans receivable
            
            
            **1,181**
            
            
            10,005
            
            
            0Net
                increase in loans receivable
            
            
            **(160,299**
            **)**
            
            (188,082
            )
            
            (171,205
            )Net
                (purchase) redemption of restricted investments in bank
                stock
            
            
            **(265**
            **)**
            
            (5,747
            )
            
            (489
            )Proceeds
                from sale of premises and equipment
            
            
            **827**
            
            
            0
            
            
            0Purchases
                of premises and equipment
            
            
            **(22,516**
            **)**
            
            (24,181
            )
            
            (9,594
            )**Net
                cash used by investing activities**
            
            
            **(206,462**
            **)**
            
            (378,987
            )
            
            (231,896
            )**Financing
                Activities**Net
                increase in demand, interest checking, money market, and savings
                deposits
            
            
            **249,695**
            
            
            193,634
            
            
            224,257Net
                increase(decrease) in time deposits
            
            
            **(3,978**
            **)**
            
            16,881
            
            
            29,763Net
                increase (decrease) in short-term borrowings
            
            
            **(45,100**
            **)**
            
            157,900
            
            
            (79,000
            )Proceeds
                from issuance of long term debt
            
            
            **15,800**
            
            
            0
            
            
            0Proceeds
                from common stock options exercised
            
            
            **460**
            
            
            874
            
            
            982Proceeds
                from dividend reinvestment and common stock purchase plan
            
            
            **1,040**
            
            
            783
            
            
            675Proceeds
                from issuance of common stock in connection with stock
                offerings
            
            
            **0**
            
            
            0
            
            
            25,408Tax
                benefit on exercise of stock options
            
            
            **513**
            
            
            0
            
            
            0Cash
                dividends on preferred stock and cash in lieu of fractional
                shares
            
            
            **(80**
            **)**
            
            (80
            )
            
            (97
            )**Net
                cash provided by financing activities**
            
            
            **218,350**
            
            
            369,992
            
            
            201,988Increase
                (decrease) in cash and cash equivalents
            
            
            **16,078**
            
            
            (4,488
            )
            
            3,195Cash
                and cash equivalents at beginning of year
            
            
            **36,422**
            
            
            40,910
            
            
            37,715**Cash
                and cash equivalents at year-end**
            
            **$**
            **52,500**
            
            $
            36,422
            
            $
            40,910





*See
      accompanying notes.*


29




Notes
      to
      Consolidated Financial Statements




**1.**  **Significant
      Accounting Policies**




***Nature
      of Operations and Basis of Presentation***




The
      consolidated financial statements presented include the accounts of Pennsylvania
      Commerce Bancorp, Inc. (the Company) and its wholly-owned subsidiary Commerce
      Bank/Harrisburg, N.A. (Commerce or Bank). All material intercompany transactions
      have been eliminated. The Company was formed July 1, 1999 and is subject to
      regulation of the Federal Reserve Bank.




The
      Company is a one-bank holding company head-quartered in Harrisburg, Pennsylvania
      and provides full banking services through its subsidiary Commerce Bank. As
      a
      national bank, Commerce is subject to regulation of the Office of the
      Comptroller of the Currency and the Federal Deposit Insurance Corporation.
      The
      Bank serves primarily the Harrisburg, York, Reading and Lancaster markets of
      South Central Pennsylvania.




***Estimates***




The
      financial statements are prepared in conformity with accounting principles
      generally accepted in the United States of America. These principles require
      management to make estimates and assumptions that affect reported amounts of
      assets and liabilities and require disclosure of contingent assets and
      liabilities. In the opinion of management, all adjustments considered necessary
      for fair presentation have been included and are of a normal, recurring nature.
      Actual results could differ from these estimates. Material estimates that are
      particularly susceptible to significant change in the near term relate to the
      determination of the allowance for loan losses, the valuation of deferred tax
      assets, and the valuation of securities available for sale.




***Significant
      Group Concentrations of Credit Risk***




Most
      of
      the Company’s activities are with customers located within the South Central
      Pennsylvania Region. Note 3 discusses the types of securities that the Company
      invests in. Notes 4 and 6 discuss the types of lending that the Company engages
      in as well as loan concentrations. The Company does not have any significant
      concentrations to any one industry or customer.




***Securities***




Securities
      classified as held to maturity are those debt securities that the Company has
      both the intent and ability to hold to maturity regardless of changes in market
      conditions, liquidity needs, or general economic conditions. These securities
      are carried at cost adjusted for amortization of premium and accretion of
      discount, computed by the interest method over the estimated average life of
      the
      securities.




Securities
      classified as available for sale are those debt securities that the Company
      intends to hold for an indefinite period of time, but not necessarily to
      maturity. Any decision to sell a security classified as available for sale
      would
      be based on various factors, including significant movements in interest rates,
      changes in the maturity mix of the Company’s assets and liabilities, liquidity
      needs, regulatory capital considerations, and other similar factors. Securities
      available for sale are carried at fair value. Unrealized gains or losses are
      reported in other comprehensive income, net of the related deferred tax effect.
      Realized gains or losses, determined on the basis of the cost of specific
      securities sold, are included in earnings. Premiums and discounts are recognized
      in interest income using the interest method over the estimated average life
      of
      the securities. Declines in the fair value of held-to-maturity and
      available-for-sale securities below their cost that are deemed to be other
      than
      temporary are reflected in earnings as realized losses. In estimating
      other-than-temporary impairment losses, management considers (1) the length
      of
      time and the extent to which the fair value has been less than cost, (2) the
      financial condition and near-term prospects of the issuer, and (3) the intent
      and ability of the Company to retain its investment in the issuer for a period
      of time sufficient to allow for any anticipated recovery in fair
      value.




Management
      determines the appropriate classification of debt securities at the time of
      purchase and re-evaluates such designation as of each balance sheet
      date.




***Loans
      Receivable***




Loans
      receivable that management has the intent and ability to hold for the
      foreseeable future or until maturity or payoff are stated at their outstanding
      unpaid principal balances, net of an allowance for loan losses and any deferred
      fees and costs. Interest income is accrued on the unpaid principal balance.
      Loan
      origination fees and costs are deferred and recognized as an adjustment of
      the
      yield (interest income) of the related loans. The Bank is generally amortizing
      these amounts over the contractual life of the loan or call date.




The
      accrual of interest is generally discontinued when the contractual payment
      of
      principal or interest has become 90 days past due or management has serious
      doubts about further collectibility of principal or interest, even though the
      loan is currently performing. A loan may remain on accrual status if it is
      in
      the process of collection and is either guaranteed or well secured. When a
      loan
      is placed on nonaccrual status, unpaid interest credited to income in the
      current year is reversed and unpaid interest accrued in prior years is charged
      against the allowance for loan losses. Interest received on nonaccrual loans
      generally is either applied against principal or reported as interest income,
      according to management’s judgment as to the collectibility of principal.
      Generally, loans are restored to accrual status when the obligation is brought
      current, has performed in accordance with the contractual terms for a reasonable
      period of time and the ultimate collectibility of the total contractual
      principal and interest is no longer in doubt.






30




***Allowance
      for Loan Losses***




The
      allowance for loan losses is established through provisions for loan losses
      charged against income. Loans deemed to be uncollectible are charged against
      the
      allowance for loan losses, and subsequent recoveries, if any, are credited
      to
      the allowance. The evaluation is inherently subjective as it requires estimates
      that are susceptible to significant revision as more information becomes
      available.




The
      allowance consists of specific and general components. The specific component
      relates to loans that are classified impaired. For such loans, an allowance
      is
      established when the discounted cash flows (or collateral value or observable
      market price) of the impaired loan is lower than the carrying value of that
      loan. The general component covers non-classified loans and is based on
      historical loss experience adjusted for qualitative factors. Additionally,
      the
      general component is maintained to cover uncertainties that could affect
      management’s estimates of probable losses. This component reflects the margin of
      imprecision inherent in the underlying assumptions used in the methodologies
      for
      estimating losses in the portfolio.




The
      allowance for loan losses is maintained at a level considered adequate to
      provide for losses that can be reasonably anticipated. Management’s periodic
      evaluation of the adequacy of the allowance is based on the Bank’s past loan
      loss experience, known and inherent risks in the portfolio, adverse situations
      that may affect the borrower’s ability to repay, the estimated value of any
      underlying collateral, composition of the loan portfolio, current economic
      conditions, and other relevant factors. This evaluation is inherently subjective
      as it requires material estimates that may be susceptible to significant change,
      including the amounts and timing of future cash flows expected to be received
      on
      impaired loans. A loan is considered impaired when, based on current information
      and events, it is probable that the Bank will be unable to collect the scheduled
      payments of principal or interest when due according to the contractual terms
      of
      the loan agreement. Factors considered by management in determining impairment
      include payment status, collateral value and the probability of collecting
      scheduled principal and interest payments when due. Loans that experience
      insignificant payment delays and payment shortfalls generally are not classified
      as impaired. Management determines the significance of payment delays and
      payment shortfalls on a case-by-case basis, taking into consideration all of
      the
      circumstances surrounding the loan and the borrower, including the length of
      the
      delay, the reasons for the delay, the borrower’s prior payment record and the
      amount of the shortfall in relation to the principal and interest owed.
      Impairment is measured on a loan by loan basis for commercial and construction
      loans by either the present value of expected future cash flows discounted
      at
      the loan’s effective interest rate, the loan’s obtainable market price or the
      fair value of the collateral if the loan is collateral dependent.




All
      nonaccrual loans, including any non-homogenous portfolio residential mortgages
      and home equity loans with balances greater than $25,000, **** are
      evaluated individually to determine whether a valuation allowance is necessary
      due to collateral deficiencies that may exist within the loan. Large groups
      of
      smaller balance homogeneous loans are collectively evaluated for impairment,
      unless such loans are the subject of a restructuring agreement.




***Loans
      Held for Sale***




Loans
      held for sale are comprised of student loans and selected residential loans
      the
      Company originates with the intention of selling in the future. Occasionally,
      loans held for sale also include selected small business administration loans
      and business and industry loans that the Company decides to sell. These loans
      are carried at the lower of cost or estimated fair value, calculated in the
      aggregate.




***Restricted
      Investments in Bank Stock***




Restricted
      investments in bank stocks include Federal Home Loan Bank (FHLB) and Federal
      Reserve Bank Stocks. Federal law requires a member institution of the FHLB
      system to hold stock of its district FHLB according to a predetermined formula.
      At December 31, 2006, $6.0 million of the Company’s $9.2 million of FHLB stock
      was purchased to cover the Company’s borrowing level on its credit line at the
      FHLB. The stock is carried at cost.




***Advertising
      Costs***




The
      Company follows the policy of charging the costs of advertising to expense
      as
      incurred.




***Income
      Taxes***




Deferred
      income taxes are provided on the liability method whereby deferred tax assets
      are recognized for deductible temporary differences and deferred tax liabilities
      are recognized for taxable temporary differences. Temporary differences are
      the
      differences between the reported amounts of assets and liabilities and their
      tax
      bases. Deferred tax assets and liabilities are adjusted through the provision
      for income taxes for the effects of changes in tax laws and rates on the date
      of
      enactment.






31




***Bank
      Premises and Equipment***




Bank
      premises and equipment are carried at cost less accumulated depreciation and
      amortization. Depreciation is charged to operations over the estimated useful
      lives of the respective assets. Leasehold improvements are amortized over the
      terms of the respective leases or the estimated useful lives of the
      improvements, whichever is shorter. Depreciation and amortization are determined
      on the straight-line methods for financial reporting purposes, and accelerated
      methods for income tax purposes.




***Foreclosed
      Assets***




Assets
      acquired through, or in lieu of, loan foreclosure are held for sale and are
      initially recorded at fair value at the date of foreclosure, establishing a
      new
      cost basis. Subsequent to foreclosure, valuations are periodically performed
      by
      management and the assets are carried at the lower of carrying amount or fair
      value less cost to sell. Revenue and expenses from operations and changes in
      the
      valuation allowance are included in net expenses from foreclosed assets.
      Foreclosed assets are included in other assets.




***Transfers
      of Financial Assets***




Transfers
      of financial assets, including sales of loans and loan participations, are
      accounted for as sales, when control over the assets has been surrendered.
      Control over transferred assets is deemed to be surrendered when (1) the assets
      have been isolated from the Company, (2) the transferee obtains the right (free
      of conditions that constrain it from taking advantage of that right) to pledge
      or exchange the transferred assets, and (3) the Company does not maintain
      effective control over the transferred assets through an agreement to repurchase
      them before their maturity.




***Per
      Share Data***




Basic
      earnings per share represent income available to common stockholders divided
      by
      the weighted-average number of common shares outstanding during the period.
      Diluted earnings per share reflect additional common shares that would have
      been
      outstanding if dilutive potential common shares had been issued as well as
      any
      adjustments to income that would result from the assumed issuance. Potential
      common shares that may be issued by the Company relate solely to outstanding
      stock options, and are determined using the treasury stock method.




***Off
      Balance Sheet Financial Instruments***




In
      the
      ordinary course of business, the Company has entered into off balance sheet
      financial instruments consisting of commitments to extend credit, commercial
      letters of credit, and standby letters of credit. Such financial instruments
      are
      recorded on the balance sheet when they become payable by the borrower to the
      Company.




***Cash
      Flow Information***




For
      purposes of the statements of cash flows, the Company considers cash and due
      from banks and federal funds sold as cash and cash equivalents. Generally,
      federal funds are purchased and sold for one-day periods. Cash paid during
      the
      years ended December 31, 2006, 2005, and 2004 for interest was
      $51.5 million, $28.5 million, and $14.4 million respectively. Income taxes
      paid totaled $2.7 million, $3.9 million, and $3.7 million in 2006, 2005, and
      2004, respectively.




***Stock-Based
      Compensation***




Prior
      to
      2006, the Company accounted for stock-based compensation issued to directors
      and
      employees using the intrinsic value method in accordance with Accounting
      Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”
(“APB 25”). This method required that compensation expense be recognized to the
      extent that the fair value of the stock exceeded the exercise price of the
      stock
      award at the grant date. The Company generally did not recognize compensation
      expense related to stock option awards because the stock options generally
      had
      fixed terms and exercise prices that were equal to or greater than the fair
      value of the Company’s common stock at the grant date.




Effective
      January 1, 2006, the Company adopted Financial Accounting Standards Board (FASB)
      Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) using the modified
      prospective method. FAS 123(R) requires compensation costs related to
      share-based payment transactions to be recognized in the income statement (with
      limited exceptions) based on the grant-date fair value of the stock-based
      compensation issued. Compensation costs are recognized over the period that
      an
      employee provides service in exchange for the award. The adoption of Statement
      of Financial Accounting Standards (“SFAS”) 123(R) had an unfavorable impact
      on our net income and net income per share in 2006 and will continue to do
      so in
      future periods as we recognize compensation expense for stock option awards.




In
      conjunction with FAS123(R), the Company also adopted FASB Staff Position (“FSP”)
      FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as
      Defined in FAS 123(R)” effective January 1, 2006. FSP 123(R)-2
      provides guidance on the application of grant date as defined in FAS 123(R).
      In
      accordance with this standard, a grant date of an award exists if (a) the
      award is a unilateral grant and (b) the key terms and conditions of the
      award are expected to be communicated to an individual recipient within a
      relatively short time period from the date of approval. The adoption of this
      standard did not have a material impact on our consolidated financial position,
      results of operations, or cash flows for the year ended December 31,
      2006.






32




On
      December 16, 2005, the Company’s Board of Directors approved the accelerated
      vesting of all outstanding unvested stock options awarded prior to July 1,
      2005
      to employees and directors. This acceleration was effective as of December
      18,
      2005. The Company recorded a one-time charge in the fourth quarter of 2005
      of
      approximately $70,000, or $.01 per share, as a result of the accelerated
      vesting. The decision to accelerate the vesting of the options was to enable
      the
      Company to reduce the amount of non-cash compensation expense that would have
      been recorded in the Company’s income statement in future periods upon the
      adoption of FAS 123(R) in January 2006. The Company has placed a restriction
      on
      the members of senior management and the Board of Directors that would prevent
      the sale, or any other transfer, of any stock obtained through exercise of
      an
      accelerated option prior to the earlier of the original vesting date or the
      individual’s termination of employment. As a result of the acceleration, options
      to purchase approximately 176,000 shares of common stock became immediately
      exercisable in December 2005.




The
      fair
      value of each option grant was established at the date of grant using the
      Black-Scholes option pricing model. The Black-Scholes option valuation model
      was
      developed for use in estimating the fair value of traded options, which have
      no
      vesting restrictions and are fully transferable. In addition, option
      valuation models require the input of highly subjective assumptions including
      the stock price volatility. Because the Company's stock options have
      characteristics significantly different from those of traded options, and
      because changes in the subjective input assumptions can materially affect the
      fair value estimate, in management's opinion, the existing models do not
      necessarily provide a reliable single measure of the fair value of the Company’s
      stock options. The Black-Scholes model used the following weighted-average
      assumptions for 2006, 2005, and 2004 respectively: risk-free interest rates
      of 4.6%, 4.1% and 3.6%; volatility factors of the expected market price of
      the
      Company's common stock of .19, .26 and .21; weighted average expected lives
      of
      the options of 8.2 years, 7.3 years and 6.1 years and no cash dividends. Based
      upon these assumptions, the weighted average fair value of options granted
      were
      $11.11, $12.32, and $8.96, for the years ended December 31, 2006, 2005 and
      2004,
      respectively.




As
      a
      result of adopting FAS 123(R) on January 1, 2006, the Company recorded
      compensation expense of approximately $329,000 for the year ended December
      31,
      2006.  The tax benefit associated with compensation expense was
      $51,000.




The
      following table illustrates the impact on net income and earnings per share
      had
      the Company applied FAS No. 123 (R) for the years ended December 31, 2005 and
      2004.




*(In thousands*
            
            
            
            **Year
                Ended December 31,***except
                per share amounts)*
            
            
            
            2005
            
            2004Net
                income:As
                reported
            
            
            
            
            $
            8,817
            
            $
            8,591Total
                stock-based compensation cost, net of tax,
              that
                would have been included in the determination of
              net
                income if the fair value based method had been applied
              to
                all awards
            
            
            
            
            
            (2,542
            )
            
            (1,121
            )Pro-forma
            
            
            
            
            $
            6,275
            
            $
            7,470Reported
                earnings per share:*Basic*
            
            
            
            
            $
            1.47
            
            $
            1.75*Diluted*
            
            
            
            
            
            1.38
            
            
            1.63Pro-forma
                earnings per share:*Basic*
            
            
            
            
            $
            1.04
            
            $
            1.52*Diluted*
            
            
            
            
            
            0.97
            
            
            1.42




Prior
      to
      the adoption of FAS 123(R), the Company presented tax benefits of deductions
      resulting from the exercise of stock options as operating cash flows in the
      Consolidated Statement of Cash Flows. FAS 123(R) requires the cash flows
      resulting from the tax benefits due to deductions in excess of the compensation
      cost recognized for those options (excess tax benefits) to be classified as
      financing cash flows. The $513,000 excess tax benefit classified as a financing
      cash flow in 2006 would have been classified as an operating cash inflow if
      the
      Company had not adopted FAS 123(R).






33




**Recent
      Accounting Standards**




In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments”. SFAS No. 155 amends FASB Statement No. 133 and FASB
      Statement No. 140, and improves the financial reporting of certain hybrid
      financial instruments by requiring more consistent accounting that eliminates
      exemptions and provides a means to simplify the accounting for these
      instruments. Specifically, SFAS No. 155 allows financial instruments that have
      embedded derivatives to be accounted for as a whole (eliminating the need to
      bifurcate the derivative from its host) if the holder elects to account for
      the
      whole instrument on a fair value basis. SFAS No. 155 is effective for all
      financial instruments acquired or issued after the beginning of an entity’s
      first fiscal year that begins after September 15, 2006. The Company is required
      to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal
      year
      2007. Management does not believe the adoption of SFAS No. 155 will have a
      material impact on the Company’s financial position and results of
      operations.




In
      July
      2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty
      in
      Income Taxes." The interpretation clarifies the accounting for uncertainty
      in
      income taxes recognized in a company's financial statements in accordance with
      Statement of Financial Accounting Standards No. 109, "Accounting for Income
      Taxes." Specifically, the pronouncement prescribes a recognition threshold
      and a
      measurement attribute for the financial statement recognition and measurement
      of
      a tax position taken or expected to be taken in a tax return. The interpretation
      also provides guidance on the related derecognition, classification, interest
      and penalties, accounting for interim periods, disclosure, and transition of
      uncertain tax positions. The interpretation is effective for fiscal years
      beginning after December 15, 2006. The Company is evaluating the impact, if
      any,
      of this new pronouncement on its consolidated financial statements.




In
      September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements,
      which defines fair value, establishes a framework for measuring fair value
      under
      GAAP, and expands disclosures about fair value measurements. FASB Statement
      No.
      157 applies to other accounting pronouncements that require or permit fair
      value
      measurements. The new guidance is effective for financial statements issued
      for
      fiscal years beginning after November 15, 2007, and for interim periods within
      those fiscal years. We are currently evaluating the potential impact, if any,
      of
      the adoption of FASB Statement No. 157 on our consolidated financial position,
      results of operations and cash flows.




In
      September 2006, the Securities and Exchange Commission “SEC” issued Staff
      Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive guidance
      on how the effects of the carryover or reversal of prior year misstatements
      should be considered in quantifying a potential current year misstatement.
      Prior
      to SAB 108, Companies might evaluate the materiality of financial-statement
      misstatements using either the income statement or balance approach, with the
      income statement approach focusing on new misstatements added in the current
      year, and the balance sheet approach focusing on the cumulative amount of
      misstatement present in a company’s balance sheet. Misstatements that would be
      material under one approach could be viewed as immaterial under another
      approach, and not be corrected. SAB 108 now requires that companies view
      financial statement misstatements as material if they are material according
      to
      either the income statement or balance sheet approach. The Company has analyzed
      SAB 108 and determined that upon adoption in the fourth quarter of
      2006 it had no impact on the Company’s reported results of operations or
      financial condition.




In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
      Financial Assets and Financial Liabilities-Including an amendment of FASB
      Statement No. 115.” SFAS No. 159 permits entities to choose to measure many
      financial instruments and certain other items at fair value. Unrealized gains
      and losses on items for which the fair value option has been elected will be
      recognized in earnings at each subsequent reporting date. SFAS No. 159 is
      effective for our Company January 1, 2008. The Company is evaluating the impact
      that the adoption of SFAS No. 159 will have on our consolidated financial
      statements.




***Segment
      Reporting***




Commerce
      acts as an independent community financial services provider, and offers
      traditional banking and related financial services to individual, business
      and
      government customers. Through its stores, the Company offers a full array of
      commercial and retail financial services.




Management
      does not separately allocate expenses, including the cost of funding loan
      demand, between the commercial and retail operations of the Company. As such,
      discrete financial information is not available and segment reporting would
      not
      be meaningful.




***Reclassifications***




Certain
      amounts in the 2006 financial statements have been reclassified to conform
      to
      the 2006 presentation format. Such reclassifications had no impact on the
      Company’s net income.






34




**2.**  **Restrictions
      on Cash and Due From Bank Accounts**




The
      Bank
      is required to maintain average reserves, in the form of cash and balances
      with
      the Federal Reserve Bank, against its deposit liabilities. The average amount
      of
      these reserve balances maintained for 2006 and 2005 was approximately $22.6
      million and $19.0 million, respectively.




**3.**  **Securities**




The
      amortized cost and fair value of securities are summarized in the following
      tables.




**December
                31, 2006***(in
                thousands)*
            
            **Amortized
                Cost**
            
            **Gross
                Unrealized Gains**
            
            **Gross
                Unrealized Losses**
            
            **Fair
                Value****Available
                for Sale**U.S.
                Government Agency securities
            
            **$**
            **5,000**
            
            **$**
            **0**
            
            **$**
            **(193**
            **)**
            **$**
            **4,807**Mortgage-backed
                securities
            
            
            **393,909**
            
            
            **75**
            
            
            **(6,733**
            **)**
            
            **387,251**Total
            
            **$**
            **398,909**
            
            **$**
            **75**
            
            **$**
            **(6,926**
            **)**
            **$**
            **392,058****Held
                to Maturity**U.S.
                Government Agency securities
            
            **$**
            **175,043**
            
            **$**
            **15**
            
            **$**
            **(1,984**
            **)**
            **$**
            **173,074**Municipal
                securities
            
            
            **1,619**
            
            
            **13**
            
            
            **(2**
            **)**
            
            **1,630**Mortgage-backed
                securities
            
            
            **131,979**
            
            
            **66**
            
            
            **(3,240**
            **)**
            
            **128,805**Corporate
                debt securities
            
            
            **10,987**
            
            
            **341**
            
            
            **0**
            
            
            **11,328**Total
            
            **$**
            **319,628**
            
            **$**
            **435**
            
            **$**
            **(5,226**
            **)**
            **$**
            **314,837**





December
                31, 2005*(in
                thousands)*
            
            Amortized
                Cost
            
            Gross
                Unrealized Gains
            
            Gross
                Unrealized Losses
            
            Fair
                Value**Available
                for Sale**U.S.
                Government Agency securities
            
            $
            5,000
            
            $
            0
            
            $
            (208
            )
            $
            4,792Mortgage-backed
                securities
            
            
            382,498
            
            
            67
            
            
            (6,521
            )
            
            376,044Total
            
            $
            387,498
            
            $
            67
            
            $
            (6,729
            )
            $
            380,836**Held
                to Maturity**U.S.
                Government Agency securities
            
            $
            136,135
            
            $
            0
            
            $
            (1,976
            )
            $
            134,159Municipal
                securities
            
            
            2,617
            
            
            8
            
            
            (3
            )
            
            2,622Mortgage-backed
                securities
            
            
            150,394
            
            
            130
            
            
            (3,189
            )
            
            147,335Corporate
                debt securities
            
            
            17,120
            
            
            742
            
            
            0
            
            
            17,862Total
            
            $
            306,266
            
            $
            880
            
            $
            (5,168
            )
            $
            301,978




The
      amortized cost and fair value of debt securities at December 31, 2006 by
      contractual maturity are shown in the following table. Expected maturities
      will
      differ from contractual maturities because borrowers may have the right to
      call
      or prepay obligations.




**Held
                to Maturity**
            
            **Available
                for Sale***(in
                thousands)*
            
            **Amortized**
              **Cost**
            
            **Fair
                Value**
            
            **Amortized
                Cost**
            
            **Fair
                Value**Due
                in one year or less
            
            **$**
            **18,908**
            
            **$**
            **18,901**
            
            **$**
            **0**
            
            **$**
            **0**Due
                after one year through five years
            
            
            **43,485**
            
            
            **43,269**
            
            
            **0**
            
            
            **0**Due
                after five years through ten years
            
            
            **94,788**
            
            
            **93,573**
            
            
            **0**
            
            
            **0**Due
                after ten years
            
            
            **30,468**
            
            
            **30,289**
            
            
            **5,000**
            
            
            **4,807****187,649**
            
            
            **186,032**
            
            
            **5,000**
            
            
            **4,807**Mortgage-backed
                securities
            
            
            **131,979**
            
            
            **128,805**
            
            
            **393,909**
            
            
            **387,251**Total
            
            **$**
            **319,628**
            
            **$**
            **314,837**
            
            **$**
            **398,909**
            
            **$**
            **392,058**




There
      were no sales of securities in the available for sale portfolio in 2006.
      Additionally, a gross gain of $80,000 was realized on the sale of one security
      from the held to maturity portfolio. This sale consisted of a $2.1 million
      debt
      security which was sold due to the expected and impending call of the security
      by the issuer. The sale was near the call date and changes in market interest
      rates had no effect on the security’s fair value. The amount of gain on sale was
      essentially the same as the call premium that would have been recognized on
      the
      call date. An $80,000 premium on the call of another debt security was also
      realized in net income for 2006.






35




Gross
      gains of $186,000 and gross losses of $859,000 were realized in sales of
      securities available for sale in 2005. Additionally, gross gains of $613,000
      and
      gross losses of $0 were realized on sales of securities held to maturity. The
      sale of the held to maturity security consisted of a $5.5 million municipal
      bond
      which was sold solely due to a continued deterioration in the issuer’s
      creditworthiness.




At
      December 31, 2006 and 2005, securities with a fair value of $486.4 million
      and
      $470.1 million respectively, were pledged to secure public deposits and for
      other purposes as required or permitted by law.




The
      following table shows the Company’s investments’ gross unrealized losses and
      fair value, aggregated by investment category and length of time that individual
      securities have been in a continuous unrealized loss position.




**December
                31, 2006****Less
                than 12 months**
            
            **12
                months or more**
            
            **Total***(in
                thousands)*
            
            **Fair
                Value**
            
            **Unrealized
                Losses**
            
            **Fair
                Value**
            
            **Unrealized
                Losses**
            
            **Fair
                Value**
            
            **Unrealized
                Losses****Available
                for Sale**U.S.
                Government Agency securities
            
            **$**
            **0**
            
            **$**
            **0**
            
            **$**
            **4,807**
            
            **$**
            **(193**
            **)**
            **$**
            **4,807**
            
            **$**
            **(193**
            **)**Mortgage-backed
                securities
            
            
            **32,725**
            
            
            **(136**
            **)**
            
            **339,060**
            
            
            **(6,597**
            **)**
            
            **371,785**
            
            
            **(6,733**
            **)**Total
            
            **$**
            **32,725**
            
            **$**
            **(136**
            **)**
            **$**
            **343,867**
            
            **$**
            **(6,790**
            **)**
            **$**
            **376,592**
            
            **$**
            **(6,926**
            **)****Held
                to Maturity**U.S.
                Government Agency securities
            
            **$**
            **33,853**
            
            **$**
            **(54**
            **)**
            **$**
            **134,204**
            
            **$**
            **(1,930**
            **)**
            **$**
            **168,057**
            
            **$**
            **(1,984**
            **)**Municipal
                securities
            
            
            **344**
            
            
            **0**
            
            
            **308**
            
            
            **(2**
            **)**
            
            **652**
            
            
            **(2**
            **)**Mortgage-backed
                securities
            
            
            **2,561**
            
            
            **(4**
            **)**
            
            **116,898**
            
            
            **(3,236**
            **)**
            
            **119,459**
            
            
            **(3,240**
            **)**Total
            
            **$**
            **36,758**
            
            **$**
            **(58**
            **)**
            **$**
            **251,410**
            
            **$**
            **(5,168**
            **)**
            **$**
            **288,168**
            
            **$**
            **(5,226**
            **)**December
                31, 2005Less
                than 12 months
            12
                months or more
            Total*(in
                thousands)*
            
            
            Fair
                Value
            
            
            Unrealized
                Losses
            
            
            Fair
                Value
            
            
            Unrealized
                Losses
            
            
            Fair
                Value
            
            
            Unrealized
                Losses**Available
                for Sale**U.S.
                Government Agency securities
            
            $
            4,792
            
            $
            (208
            )
            $
            0
            
            $
            0
            
            $
            4,792
            
            $
            (208
            )Mortgage-backed
                securities
            
            
            285,951
            
            
            (4,267
            )
            
            86,506
            
            
            (2,254
            )
            
            372,457
            
            
            (6,521
            )Total
            
            $
            290,743
            
            $
            (4,475
            )
            $
            86,506
            
            $
            (2,254
            )
            $
            377,249
            
            $
            (6,729
            )**Held
                to Maturity**U.S.
                Government Agency securities
            
            $
            112,823
            
            $
            (1,312
            )
            $
            21,336
            
            $
            (664
            )
            $
            134,159
            
            $
            (1,976
            )Municipal
                securities
            
            
            1,122
            
            
            (3
            )
            
            0
            
            
            0
            
            
            1,122
            
            
            (3
            )Mortgage-backed
                securities
            
            
            94,200
            
            
            (1,671
            )
            
            38,486
            
            
            (1,518
            )
            
            132,686
            
            
            (3,189
            )Total
            
            $
            208,145
            
            $
            (2,986
            )
            $
            59,822
            
            $
            (2,182
            )
            $
            267,967
            
            $
            (5,168
            )




At
      December 31, 2006, six mortgage-backed securities, four U.S. Government Agency
      securities, and one municipal security have been in a continuous unrealized
      loss
      position for less than twelve months. For the same period, 88 mortgage-backed
      securities, 16 U.S. Government Agency securities, and one municipal security
      have been in a continuous unrealized loss position for twelve months or
      more.




The
      unrealized losses on the Company’s investments in direct obligations of U.S.
      Government Agency securities were caused by interest rate increases. The
      contractual terms of those investments do not permit the issuer to settle the
      securities at a price less than the amortized cost of the investment. Because
      the Company has the ability and intent to hold those investments until a
      recovery of fair value, which may be maturity, the Company does not consider
      those investments to be other-than-temporarily impaired at December 31,
      2006.




The
      unrealized losses on the Company’s investment in federal agency mortgage-backed
      securities were caused by interest rate increases as well. The Company purchased
      those investments at a discount relative to their face amount, and the
      contractual cash flows of those investments are guaranteed by an agency of
      the
      U.S. government. Accordingly, it is expected that the securities would not
      be
      settled at a price less than the amortized cost of the Company’s investment.
      Because the decline in market value is attributable to changes in interest
      rates
      and not credit quality, and because the Company has the ability and intent
      to
      hold those investments until a recovery of fair value, which may be maturity,
      the Company does not consider those investments to be other-than-temporarily
      impaired at December 31, 2006.




36




In
      management’s opinion, the unrealized losses reflect changes in general market
      interest rates subsequent to the acquisition of specific securities and
      represent only temporary impairment of the securities. The Company believes
      it
      will collect all amounts contractually due on these securities as it has the
      ability to hold these securities until the fair value is at least equal to
      the
      carrying value.




**4.**  **Loans
      Receivable and Allowance for Loan Losses**




A
      summary
      of loans receivable is as follows:




**December
                31,***(in
                thousands)*
            
            **2006**
            
            2005Real
                Estate:Commercial
                Mortgage
            
            **$**
            **325,244**
            
            $
            299,219Construction
                and land development
            
            
            **61,365**
            
            
            47,334Residential
                Mortgage
            
            
            **83,690**
            
            
            83,213Tax-Exempt
            
            
            **31,446**
            
            
            17,055Commercial
                Business
            
            
            **203,723**
            
            
            138,174Consumer
            
            
            **182,058**
            
            
            148,906Commercial
                Lines of Credit
            
            
            **95,192**
            
            
            90,769**982,718**
            
            
            824,670Less:
                Allowance for Loan Losses
            
            
            **9,685**
            
            
            9,231Net
                Loans Receivable
            
            **$**
            **973,033**
            
            $
            815,439




The
      following is a summary of the transactions in the allowance for loan
      losses.




**Years
                Ended December 31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004Balance
                at beginning of year
            
            **$**
            **9,231**
            
            $
            7,847
            
            $
            6,007Provision
                charged to expense
            
            
            **1,634**
            
            
            1,560
            
            
            2,646Recoveries
            
            
            **105**
            
            
            596
            
            
            231Loans
                charged off
            
            
            **(1,285**
            **)**
            
            (772
            )
            
            (1,037
            )Balance
                at end of year
            
            **$**
            **9,685**
            
            $
            9,231
            
            $
            7,847




At
      December 31, 2006 and 2005, the recorded investment in loans considered to
      be
      impaired under FASB Statement No. 114 “Accounting by Creditors for Impairment of
      a Loan” totaled $13.9 million and $6.9 million, respectively. At December 31,
      2006, $3.9 million of impaired loans have a specific valuation allowance of
      $1.0
      million as compared to $1.4 million of impaired loans having a specific
      valuation allowance of $740,000 at December 31, 2005. Total nonaccrual loans
      at
      December 31, 2006 and 2005 totaled $3.4 million and $2.3 million, respectively.
      Loans past due 90 days or more and still accruing interest totaled $2,000 at
      December 31, 2006 and $233,000 at December 31, 2005.




Impaired
      loans averaged approximately $10.5 million, $7.3 million and $8.9 million during
      2006, 2005 and 2004, respectively. Interest income recognized on these loans
      amounted to $1.4 million, $682,000 and $507,000 during 2006, 2005 and 2004,
      respectively.




Certain
      directors and executive officers of the Company, including their associates
      and
      companies, have loans with the Bank. Such loans were made in the ordinary course
      of business at the Bank’s normal credit terms including interest rate and
      collateralization, and do not represent more than a normal risk of collection.
      Total loans to these persons and companies amounted to approximately $13.4
      million and $13.6 million at December 31, 2006 and 2005, respectively. During
      2006, $7.4 million of new advances were made and repayments totaled
      $7.6 million .




**5.**  **Loan
      Commitments and Standby Letters of Credit**




Loan
      commitments are made to accommodate the financial needs of Commerce’s customers.
      Standby letters of credit commit the Bank to make payments on behalf of
      customers when certain specified future events occur. They primarily are issued
      to facilitate the customers’ normal course of business transactions.
      Historically, almost all of the Bank’s standby letters of credit expire
      unfunded.




Both
      types of lending arrangements have credit risk essentially the same as that
      involved in extending loans to customers and are subject to the Bank’s normal
      credit policies. Letter of credit commitments are agreements to lend to a
      customer as long as there is no violation of any condition established in the
      contract. Since many of the commitments are expected to expire without being
      drawn upon, the total commitment amounts do not necessarily represent future
      cash requirements. Commitments generally have fixed expiration dates or other
      termination clauses and may require payment of a fee.






37




Outstanding
      letters of credit written are conditional commitments issued by the Bank to
      guarantee the performance of a customer to a third party. The majority of these
      standby letters of credit expire within the next twenty-four months. The credit
      risk involved in issuing letters of credit is essentially the same as that
      involved in extending other loan commitments. The Bank requires collateral
      supporting these letters of credit as deemed necessary. Management believes
      that
      the proceeds obtained through a liquidation of such collateral would be
      sufficient to cover the maximum potential amount of future payments required
      under the corresponding guarantees. The current amount of the liability as
      of
      December 31, 2006 for guarantees under standby letters of credit issued is
      $0.




The
      Bank’s maximum exposure to credit loss for loan commitments (unfunded loans and
      unused lines of credit, including home equity lines of credit) and standby
      letters of credit outstanding were as follows:




**December
                31,***(in
                thousands)*
            
            **2006**
            
            2005Commitments
                to grant loans
            
            **$**
            **7,350**
            
            $
            16,145Unfunded
                commitments of existing loans
            
            
            **330,468**
            
            
            290,608Standby
                letters of credit
            
            
            **26,546**
            
            
            16,037Total
            
            **$**
            **364,364**
            
            $
            322,790




**6.**  **Concentrations
      of Credit Risk**




The
      Company’s loan portfolio is principally to borrowers throughout Cumberland,
      Dauphin, York, Lebanon, Lancaster and Berks counties of Pennsylvania where
      it
      has full-service stores. Commercial real estate loans and loan commitments
      for
      commercial real estate projects aggregated $424.1 million at December 31, 2006.




Commercial
      real estate loans are collateralized by the related project (principally office
      buildings, multifamily residential, land development, and other properties)
      and
      the Company generally requires loan-to-value ratios of no greater than 80%.
      Collateral requirements on such loans are determined on a case-by-case basis
      based on management’s credit evaluations of the respective
      borrowers.




**7.**  **Bank
      Premises, Equipment and Leases**




Bank
      premises and equipment are stated at cost less accumulated depreciation.
      Depreciation expense for 2006, 2005, and 2004 was $4.0 million, $3.0 million,
      and $2.4 million, respectively, and is computed on the straight-line method
      over
      the following estimated useful lives of the related assets:




**Years**Buildings
                and leasehold improvements
            1
                -
                39.5Furniture,
                fixtures and equipment
            5
                -
                10Computer
                equipment and software
            3
                -
                5




A
      summary
      of premises and equipment is as follows:




**December
                31,***(in
                thousands)*
            
            **2006**
            
            2005Land
            
            **$**
            **14,720**
            
            $
            11,707Buildings
            
            
            **58,386**
            
            
            35,969Construction
                in process
            
            
            **1,971**
            
            
            12,819Leasehold
                improvements
            
            
            **2,008**
            
            
            3,661Furniture,
                fixtures and equipment
            
            
            **21,522**
            
            
            17,189**98,607**
            
            
            81,345Less
                accumulated depreciation and amortization
            
            
            **14,928**
            
            
            15,081**$**
            **83,679**
            
            $
            66,264







38




Land,
      buildings, and equipment are leased under non-cancelable operating lease
      agreements that expire at various dates through 2033. Total rental expense
      for
      operating leases in 2006, 2005, and 2004 was $2.3 million, $2.3 million, and
      $1.7 million, respectively. At December 31, 2006, future minimum lease payments
      for noncancelable operating leases are payable as follows:




*(in
                thousands)*2007
            
            $
            1,9872008
            
            
            1,9072009
            
            
            1,7912010
            
            
            1,7762011
            
            
            1,819Thereafter
            
            
            27,618Total
                minimum lease payments
            
            $
            36,898




**8.**  **Deposits**




The
      composition of deposits is as follows:




**December
                31,***(in
                thousands)*
            
            **2006**
            
            2005Demand
            
            **$**
            **275,137**
            
            $
            248,101Interest
                checking and money market
            
            
            **720,180**
            
            
            548,909Savings
            
            
            **396,567**
            
            
            345,181Time
                certificates $100,000 or more
            
            
            **107,390**
            
            
            125,099Other
                time certificates
            
            
            **117,503**
            
            
            103,772**$**
            **1,616,777**
            
            $
            1,371,062




At
      December 31, 2006, the scheduled maturities of time deposits are as
      follows:




*(in
                thousands)*2007
            
            $
            186,8882008
            
            
            11,5572009
            
            
            11,2232010
            
            
            8,7802011
            
            
            6,445$
            224,893




**9.**  **Short-term
      Borrowings**




Short-term
      borrowings consist of securities sold under agreements to repurchase and lines
      of credit. The Bank has a line of credit commitment from the Federal Home Loan
      Bank (FHLB) for borrowings up to $508 million and certain qualifying assets
      of
      the Bank collateralize the line. There was $103.5 million outstanding at a
      rate
      of 5.40% at December 31, 2006 and $145.2 million outstanding at a rate of 4.22%
      at December 31, 2005 on this line of credit. The Bank has availability under
      two
      repurchase agreements to borrow up to $75 million of which $0 was outstanding
      as
      of both December 31, 2006 and 2005. The Company did not have any securities
      pledged at December 31, 2006 or 2005 under these repurchase agreements. In
      addition, the Bank has a line of credit of $15 million from another bank. There
      was $9.3 million outstanding at a rate of 5.35% at December 31, 2006 and $12.7
      million outstanding at a rate of 4.50% at December 31, 2005 on this line of
      credit.




**10. Long-term
      Debt**




On
      June
      15, 2000, the Company issued $5 million of 11% Trust Capital Securities to
      Commerce Bancorp, Inc. through Trust I, a Delaware business trust subsidiary.
      The Trust Capital Securities evidence a preferred ownership interest in the
      Trust, of which the Company owns 100% of the common equity. The proceeds from
      the issuance of the Trust Capital Securities were invested in substantially
      similar Junior Subordinated Debt of the Company. The Company unconditionally
      guarantees the Trust Capital Securities. Interest on the debt is payable
      quarterly in arrears on March 31, June 30, September 30, and December 31 of
      each
      year. The Trust Capital Securities are scheduled to mature on June 15, 2030.
      The
      Trust Capital Securities may be redeemed in whole or in part at the option
      of
      the Company on or after June 15, 2010 at 105.50% of the principal plus accrued
      interest, if any. The redemption price declines by 0.55% on June 15 of each
      year
      from 2011 through 2020 at which time the securities may be redeemed at 100%
      of
      the principal plus accrued interest, if any, to the date fixed for redemption,
      subject to certain conditions. All $5 million of the Trust Capital Securities
      qualified as Tier 1 capital for regulatory capital purposes.






39




On
      September 28, 2001, the Company issued $8 million of 10% Trust Capital
      Securities to Commerce Bancorp, Inc. through Trust II, a Delaware business
      trust
      subsidiary. The issuance of the Trust Capital Securities has similar properties
      as Trust I. The Trust Capital Securities evidence a preferred ownership
      interest in the Trust II of which the Company owns 100% of the common equity.
      The proceeds from the issuance of the Trust Capital Securities were invested
      in
      substantially similar Junior Subordinated Debt of the Company. The Company
      unconditionally guarantees the Trust Capital Securities. Interest on the debt
      is
      payable quarterly with similar terms as in Trust I. The Trust Capital Securities
      are scheduled to mature on September 28, 2031. The Trust Capital Securities
      may
      be redeemed in whole or in part at the option of the Company on or after
      September 28, 2011 at 105.00% of the principal plus accrued interest, if
      any. The redemption price declines by 0.50% on September 28 of each year from
      2012 through 2021 at which time the securities may be redeemed at 100% of the
      principal plus accrued interest, if any, to the date fixed for redemption,
      subject to certain conditions. All $8 million of the Trust Capital Securities
      qualified as Tier 1 capital for regulatory capital purposes.




On
      September 29, 2006, the Company issued $15 million of 7.75% Trust Capital
      Securities to Commerce Bank N.A.. through Trust III, a Delaware business trust
      subsidiary. The issuance of the Trust Capital Securities has similar properties
      as Trust I and Trust II. The Trust Capital Securities evidence a preferred
      ownership interest in Trust III of which the Company owns 100% of the common
      equity. The proceeds from the issuance of the Trust Capital Securities were
      invested in substantially similar Junior Subordinated Debt of the Company.
      The
      Company unconditionally guarantees the Trust Capital Securities. Interest on
      the
      debt is payable quarterly with similar terms as in Trust I and Trust II. The
      Trust Capital Securities are scheduled to mature on September 29, 2036. The
      Trust Capital Securities may be redeemed in whole or in part at the option
      of
      the Company on or after September 29, 2011 at 100.00% of the principal plus
      accrued interest, if any. All $15 million of the Trust Capital Securities
      qualified as Tier 1 capital for regulatory capital purposes.




**11. Income
      Taxes**




A
      reconciliation of the provision for income taxes and the amount that would
      have
      been provided at statutory rates is as follows:




**Year
                Ended December 31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004Provision
                at statutory rate on pre-tax income
            
            **$**
            **3,715**
            
            $
            4,453
            
            $
            4,341Tax-exempt
                income on loans and investments
            
            
            **(339**
            **)**
            
            (245
            )
            
            (226
            )Other
            
            
            **(15**
            **)**
            
            73
            
            
            63**$**
            **3,361**
            
            $
            4,281
            
            $
            4,178




The
      components of income tax expense are as follows:




**Year
                Ended December 31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004Current
            
            **$**
            **2,042**
            
            $
            5,584
            
            $
            3,470Deferred
            
            
            **1,319**
            
            
            (1,303
            )
            
            708**$**
            **3,361**
            
            $
            4,281
            
            $
            4,178




The
      components of the net deferred tax assets were as follows:




**December
                31,***(in
                thousands)*
            
            **2006**
            
            2005Deferred
                tax assets:Allowance
                for loan losses
            
            **$**
            **3,390**
            
            $
            3,138Unrealized
                losses on securities
            
            
            **2,398**
            
            
            2,265Other
            
            
            **123**
            
            
            127Total
                deferred tax assets
            
            
            **5,911**
            
            
            5,530Deferred
                tax liabilities:Premises
                and equipment
            
            
            **(2,054**
            **)**
            
            (1,436
            )Prepaid
                expenses
            
            
            **(284**
            **)**
            
            (172
            )Deferred
                loan fees
            
            
            **(1,060**
            **)**
            
            (223
            )Total
                deferred tax liabilities
            
            
            **(3,398**
            **)**
            
            (1,831
            )Net
                deferred tax assets
            
            **$**
            **2,513**
            
            $
            3,699




Net
      income tax expense of $56,000 and a net income tax benefit of $21,000 were
      recognized on net securities losses during 2006 and 2005, respectively. During
      2006, 2005 and 2004, the Company received a tax benefit on its federal income
      tax return totaling $513,000, $474,000, and $319,000, respectively for the
      exercise of non-qualified stock options and disqualified dispositions of
      employee stock from options exercised.






40




**12. Stockholders’
      Equity**




At
      December 31, 2006, Commerce Bancorp, Inc., owned 40,000 shares of the Company’s
      Series A $10 par value noncumulative nonvoting preferred stock and warrants
      that
      entitle the holder to purchase 287,332 shares (adjusted for common stock
      dividends and splits) of the Company’s common stock, exercisable at $3.48 per
      share (adjusted for common stock dividends and splits), in the event of a
“change in control” (as defined in the Warrant Agreement). Such warrants are
      fully transferable and expire on October 7, 2008. None of these warrants were
      exercised during 2006, 2005, or 2004. The preferred stock is redeemable at
      the
      option of the Company at the price of $25 per share plus any unpaid dividends.
      Dividends on the preferred stock are payable quarterly at a rate of $2 per
      share
      per annum.




The
      Company has implemented a dividend reinvestment and stock purchase plan. Holders
      of common stock may participate in the plan in which reinvested dividends and
      voluntary cash payments of up to $10,000 per month (subject to change) may
      be
      reinvested in additional common shares at a 3% discount (subject to change)
      from
      the current market price. Employees who have been continuously employed for
      at
      least one year are also eligible to participate in the plan under the same
      terms
      as listed above for shareholders. A total of 39,735, 24,329, and 13,842 common
      shares were issued pursuant to this plan in 2006, 2005, and 2004, respectively.
      At December 31, 2006, the Company had reserved approximately 350,000 common
      shares to be issued in connection with the plan.




On
      September 29, 2004, the Company entered into and consummated a Stock Purchase
      Agreement with Commerce Bancorp, Inc., (“Commerce of New Jersey”). Pursuant to
      the Stock Purchase Agreement, Commerce of New Jersey purchased 100,000 shares
      of
      unregistered common stock of the Company (the “Stock”) for a per share price of
      $45.666 and an aggregate price of $4,566,600. Pursuant to the Stock Purchase
      Agreement, the per share price was equal to the average of the closing sale
      prices of the Company’s common stock on the NASDAQ National Market for the five
      trading day period (i.e. dates in which trades occurred) ending on September
      28,
      2004.




On
      November 2, 2004, the Company completed an offering of 460,000 shares of its
      common stock at $49.00 per share. The 60,000 share underwriters’ option to cover
      over-allotments was fully exercised, which is included in the 460,000 share
      total.




On
      January 28, 2005, the Board of Directors declared a 2-for-1 stock split payable
      on February 25, 2005, to stockholders of record on February 10, 2005. Payment
      of
      the stock split resulted in the issuance of approximately 3.0 million additional
      common shares.




All
      common stock and per share data included in these financial statements have
      been
      restated for the stock dividends and split.




**13. Earnings
      per Share**




The
      following table sets forth the computation of basic and diluted earnings per
      share.


**For
                the Years Ended December 31,****2006**
            
            2005
            
            2004*(in
                thousands, except*
              *per
                share amounts)*
            
            **Income**
            
            **Shares**
            
            **Per
                Share Amount**
            
            Income
            
            Shares
            
            Per
                Share Amount
            
            Income
            
            Shares
            
            Per
                Share AmountBasic
                earnings per share:Net
                income
            
            **$**
            **7,254**
            
            
            
            
            
            
            
            $
            8,817
            
            
            
            
            
            
            
            $
            8,591Preferred
                stock dividends
            
            
            **(80**
            **)**
            
            
            
            
            
            
            
            (80
            )
            
            
            
            
            
            
            
            (80
            )Income
                available to common stockholders
            
            
            **7,174**
            
            
            **6,099**
            
            **$**
            **1.18**
            
            
            8,737
            
            
            5,948
            
            $
            1.47
            
            
            8,511
            
            
            4,856
            
            $
            1.75Effect
                of dilutive securities:Stock
                options
            
            
            
            
            
            **282**
            
            
            
            
            
            
            
            
            370
            
            
            
            
            
            
            
            
            362Diluted
                earnings per share:Income
                available to common stockholders plus assumed conversions
            
            **$**
            **7,174**
            
            
            **6,381**
            
            **$**
            **1.12**
            
            $
            8,737
            
            
            6,318
            
            $
            1.38
            
            $
            8,511
            
            
            5,218
            
            $
            1.63




Excluded
      from the computation of diluted earnings per share for the year ended December
      31, 2006 were 112,830 options outstanding at a price of $33.50 per option,
      149,550 options outstanding at a price of $31.25 per option, 3,100 options
      outstanding at a price of $30.57 per option, and 3,050 options outstanding
      at a
      price of $29.92 per option. There were 112,830 options outstanding at a price
      of
      $33.50 per option excluded from the computation of diluted earnings per share
      for the year ended December 31, 2005. All options outstanding were included
      in
      the computation of diluted EPS for the year ended December 31, 2004 because
      the
      options’ exercise price was lower than the average market price of the common
      shares.




**14. Stock
      Option Plans**




In
      2005,
      the Board of Directors adopted and the Company’s shareholders approved the
      adoption of the 2006 Employee Stock Option Plan for the Officers and employees
      of the Company. The Plan commenced January 1, 2006 and replaced the 1996
      Employee Stock Option Plan, which expired December 31, 2005. The Plan covers
      500,000 authorized shares of common stock reserved for issuance upon exercise
      of
      options granted or available for grant to employees and will expire on December
      31, 2015. The Plan provides that the option price of qualified incentive stock
      options will be fixed by the Board of Directors, but will not be less than
      100%
      of the fair market value of the stock at the date of grant. In addition, the
      Plan provides that the option price of nonqualified stock options (NQSO’s) also
      will be fixed by the Board of Directors, however for NQSO’s the option price may
      be less than 100% of the fair market value of the stock at the date of grant.
      Options granted are exercisable one year after the grant date, will vest over
      a
      four-year period, and expire ten years after the grant date.






41




In
      2000,
      the Board of Directors adopted and the Company’s shareholders approved the
      adoption of the 2001 Directors’ Stock Option Plan. The Plan commenced January 1,
      2001 and replaced the 1990 Directors’ Stock Option Plan, which expired December
      31, 2000. The Plan covers 243,100 authorized shares of common stock reserved
      for
      issuance upon exercise of options granted or available for grant to non-employee
      directors and will expire on December 31, 2010. Under the Company’s Directors’
Stock Option Plan, each non-employee director of the Company who is not
      regularly employed on a salaried basis by the Company may be entitled to an
      option to acquire shares, as determined by the Board of Directors, of the
      Company’s common stock during each year in which the Director serves on the
      Board. The Plan provides that the option price will be fixed by the Board of
      Directors, but will not be less than 100% of the fair market value of the stock
      on the date of the grant. Options granted through December 16, 2004 are
      exercisable from the earlier of (1) one year after the date of the option grant,
      or (2) the date of a change in control of the Bank. As a result of a plan
      amendment adopted on December 17, 2004, all options granted subsequent to that
      date will vest over a four-year period.




On
      December 16, 2005, the Company’s Board of Directors approved the accelerated
      vesting of all outstanding unvested stock options awarded prior to July 1,
      2005
      to employees and directors. This acceleration was effective as of December
      18,
      2005. The decision to accelerate the vesting of the options was to enable the
      Company to reduce the amount of non-cash compensation expense that would have
      been recorded in the Company’s income statement in future periods upon the
      adoption of Financial Accounting Standards Board Statement No. 123(R),
“Share-Based Payment”, in January 2006. The Company has placed a restriction on
      senior management and the Board of Directors that would prevent the sale, or
      any
      other transfer, of any stock obtained through exercise of an accelerated option
      prior to the earlier of the original vesting date or the individual’s
      termination of employment.




As
      a
      result of the acceleration, options to purchase approximately 176,000 shares
      of
      common stock became immediately exercisable.




The
      Company recorded a one-time charge in the fourth quarter of 2005 of
      approximately $70,000, or $.01 per share, as a result of the accelerated
      vesting. As of December 31, 2006, there was $1.3 million of total unrecognized
      compensation cost related to nonvested stock option awards. This cost is
      expected to be recognized over an additional 3.2 year period. Cash received
      from
      the exercise of options for 2006, 2005, and 2004 was $460,000, $873,000, and
      $983,000, respectively.




42


Stock
      options transactions under the Plans were as follows:




**Years
                Ended December 31,****2006**
            
            2005
            
            2004**Options**
            
            **Weighted
                Avg. Exercise Price**
            
            Options
            
            Weighted
                Avg. Exercise Price
            
            Options
            
            Weighted
                Avg.
              Exercise
                PriceOutstanding
                at beginning of year
            
            
            **921,966**
            
            **$**
            **17.18**
            
            
            944,967
            
            $
            14.12
            
            
            948,268
            
            $
                11.34Granted
            
            
            **153,650**
            
            
            **31.18**
            
            
            120,505
            
            
            33.42
            
            
            178,220
            
            25.37Exercised
            
            
            **(118,672**
            **)**
            
            **9.61**
            
            
            (124,639
            )
            
            8.57
            
            
            (145,634
            )
            8.28Forfeited
            
            
            **(23,218**
            **)**
            
            **28.08**
            
            
            (18,867
            )
            
            24.83
            
            
            (35,887
            )
            19.42Outstanding
                at end of year
            
            
            **933,726**
            
            **$**
            **20.18**
            
            
            921,966
            
            $
            17.18
            
            
            944,967
            
            $
                14.12Exercisable
                at December 31
            
            
            **786,526**
            
            **$**
            **18.11**
            
            
            921,966
            
            $
            17.18Options
                available for grant at December 31
            
            
            **494,453**
            
            
            
            
            
            125,134Weighted-average
                fair value of options granted during the year
            
            
            
            
            **$**
            **11.11**
            
            
            
            
            $
            12.32
            
            
            
            $8.96








Exercise
      prices for options outstanding as of December 31, 2006 are presented in the
      following table.




**As
                of December 31, 2006**Options
              Outstanding
            
            Weighted
                Avg. Exercise Price
            
            Weighted
                Avg. Contractual Life
            
            Options
              Exercisable
            
            Weighted
                Avg. Exercise PriceOptions
                with exercise prices ranging from $2.09 to $12.13
            
            
            303,282
            
            $
            10.30
            
            
            2.4
                Years
            
            
            303,282
            
            $
            10.30Options
                with exercise prices ranging from $12.14 to $25.38
            
            
            375,789
            
            
            20.02
            
            
            6.1
                Years
            
            
            374,739
            
            
            20.00Options
                with exercise prices ranging from $25.39 to $33.50
            
            
            254,655
            
            
            32.17
            
            
            8.6
                Years
            
            
            108,505
            
            
            33.43Total
                options outstanding with exercise prices ranging from $2.09 to
                $33.50
            
            
            933,726
            
            $
            20.18
            
            
            5.7
                Years
            
            
            786,526
            
            $
            18.11






Number
                  of Shares
              
              Weighted
                  Avg.
                Grant
                  Date Fair ValueNon-vested
                  options, December 31, 2005
              
              
              0
              
              $
              0Granted
              
              
              153,650
              
              
              11.11Vested
              
              
              0
              
              
              0Forfeited/expired
              
              
              (6,450
              )
              
              11.11Non-vested
                  options, December 31, 2006
              
              
              147,200
              
              $
              11.11




**15. Regulatory
      Matters**




Regulatory
      authorities restrict the amount of cash dividends the Bank can declare without
      prior regulatory approval. Presently, the Bank cannot declare cash dividends
      in
      one year in excess of its net profits for the current year plus its retained
      net
      profits for the two preceding years, less any required transfers to surplus.
      In
      addition, dividends paid by the Bank to the Corporation would be prohibited
      if
      the effect thereof would cause the Bank’s capital to be reduced below applicable
      minimum capital requirements.




The
      Company and the Bank are subject to various regulatory capital requirements
      administered by federal banking agencies. Failure to meet minimum capital
      requirements can initiate certain mandatory and possible additional
      discretionary actions by regulators that, if undertaken, could have a direct
      material effect on the Company’s financial statements. Under capital adequacy
      guidelines and the regulatory framework for prompt corrective action, the
      Company and the Bank must meet specific capital guidelines that involve
      quantitative measures of assets, liabilities, and certain off-balance sheet
      items as calculated under regulatory accounting practices. The capital amounts
      and classification are also subject to qualitative judgments by the regulators
      about components, risk weightings and other factors.




Quantitative
      measures established by regulation to ensure capital adequacy require the
      Company and the Bank to maintain minimum amounts and ratios (set forth below)
      of
      total and Tier 1 capital
      (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital
      to average assets. Management believes, as of December 31, 2006, that the
      Company and the Bank meet all capital adequacy requirements to which they are
      subject.






43




As
      of
      December 31, 2006, and December 31, 2005, the most recent notification from
      the
      Office of the Comptroller of the Currency categorized the Bank as well
      capitalized under the regulatory framework for prompt corrective action. To
      be
      categorized as well capitalized the Bank must maintain minimum total risk-based,
      Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below.
      There are no conditions or events since that notification that management
      believes have changed the Bank’s category.




The
      following table presents the risk-based and leverage capital amounts and ratios
      at December 31, 2006 and 2005 for the Company and the Bank.




Actual
            For
                Capital Adequacy Purposes
            To
                Be Well Capitalized
              Under
                Prompt Corrective
              Action
                Provisions*(dollars
                in thousands)*
            Amount
            Ratio
            
            Amount
            
            Ratio
            
            Amount
            
            Ratio**Company**
              **As
                of December 31, 2006**Risk
                based capital ratios:Total
                capital
            **$
                143,247**
            **10.72**
            **%**
            **≥**
            **$
                106,866**
            **≥**
            **8.0**
            **%**
            **≥**
            **N/A**
            **≥**
            **N/A**Tier
                1 capital
            **133,562**
            **10.00**
            
            **≥**
            **53,433**
            **≥**
            **4.0**
            
            **≥**
            **N/A**
            **≥**
            **N/A**Leverage
                ratio
            **133,562**
            **7.31**
            
            **≥**
            **73,071**
            **≥**
            **4.0**
            
            **≥**
            **N/A**
            **≥**
            **N/A****Bank**
              **As
                of December 31, 2006**Risk
                based capital ratios:Total
                capital
            **$
                142,830**
            **10.71**
            **%**
            **≥**
            **$
                106,737**
            **≥**
            **8.0**
            **%**
            **≥**
            **$133,421**
            **≥**
            **10.0**
            **%**Tier
                1 capital
            **133,145**
            **9.98**
            
            **≥**
            **53,369**
            **≥**
            **4.0**
            
            **≥**
            **80,053**
            **≥**
            **6.0**Leverage
                ratio
            **133,145**
            **7.30**
            
            **≥**
            **73,006**
            **≥**
            **4.0**
            
            **≥**
            **91,258**
            **≥**
            **5.0**Company
              As
                of December 31, 2005Risk
                based capital ratios:Total
                capital
            $
                118,270
            10.61
            %
            ≥
            $
                89,146
            ≥
            8.0
            %
            ≥
            N/A
            ≥
            N/ATier
                1 capital
            109,040
            9.79
            
            ≥
            44,573
            ≥
            4.0
            
            ≥
            N/A
            ≥
            N/ALeverage
                ratio
            109,040
            6.69
            
            ≥
            65,152
            ≥
            4.0
            
            ≥
            N/A
            ≥
            N/ABank
              As
                of December 31, 2005Risk
                based capital ratios:Total
                capital
            $
                117,980
            10.60
            %
            ≥
            $
                89,083
            ≥
            8.0
            %
            ≥
            $111,354
            ≥
            10.0
            %Tier
                1 capital
            108,749
            9.77
            
            ≥
            44,542
            ≥
            4.0
            
            ≥
            66,813
            ≥
            6.0Leverage
                ratio
            108,749
            6.68
            
            ≥
            65,120
            ≥
            4.0
            
            ≥
            81,400
            ≥
            5.0





On
      January 29, 2007, Commerce Bank/Harrisburg, N.A. entered into a written
      agreement with the Comptroller of the Currency of the United States of America
      (the “OCC”), the Bank’s primary regulator. The Bank has begun to implement plans
      and procedures to address the matters identified by the OCC.




**16. Employee
      Benefit Plan**




The
      Company has established a 401(k) Retirement Savings Plan for all of its
      employees who meet eligibility require-ments. Employees may contribute up to
      15%
      of their salary to the Plan. The Company will provide a discretionary matching
      contribution for up to 6% of each employee’s salary. In 2006 and 2005, the
      Company’s matching contribution was established at 50% of the employees’ salary
      deferral. For 2004, the Company’s matching contribution was established at 25%
      of the employees’ eligible salary deferral. The amount charged to expense was
      $407,000, $269,000, and $158,000 in 2006, 2005, and 2004,
      respectively.




**17. Comprehensive
      Income**




Accounting
      principles generally require that recognized revenue, expenses, gains, and
      losses be included in net income. Although certain changes in assets and
      liabilities, such as unrealized gains and losses on available for sale
      securities, are reported as a separate component of the equity section of the
      balance sheet, such items, along with net income are components of comprehensive
      income.The only comprehensive income item that the Company presently has is
      unrealized gains (losses) on securities available for sale.
      The
      federal income taxes allocated to the unrealized gains (losses) are presented
      in
      the table below. The reclassification adjustments included in comprehensive
      income are also presented.






44




**Year
                Ended December 31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004Unrealized
                holding losses
              arising during the year
            
            **$**
            **(88**
            **)**
            $
            (7,258
            )
            $
            (909
            )Less
                reclassification adjustment for losses
              on securities available
              for sale included in net income
            
            
            **0**
            
            
            (673
            )
            
            0Net
                unrealized losses
            
            
            **(88**
            **)**
            
            (6,585
            )
            
            (909
            )Income
                tax benefit
            
            
            **31**
            
            
            2,239
            
            
            309Net
                of tax amount
            
            **$**
            **(57**
            **)**
            $
            (4,346
            )
            $
            (600
            )




**18. Commitments
      and Contingencies**




In
      January 2005, the Company entered into an agreement for naming rights to
      Commerce Bank Park (formerly known as Riverside Stadium) located on Harrisburg
      City Island, Harrisburg, Pennsylvania. Commerce Bank Park is home of the
      Harrisburg Senators, an AA team affiliated with Major League Baseball. The
      term
      of the naming rights agreement is 15 years with a total obligation of $3.5
      million spread over the term.




The
      Company has purchased land located at 204 Walnut Street in the City of
      Harrisburg, Dauphin County, Pennsylvania next to the existing Downtown
      Harrisburg store. The Company plans to add additional parking space for this
      store with this purchase.




The
      Company has entered into a land lease for the premises located at 1461 Manheim
      Pike, Manheim Township, Lancaster County, Pennsylvania. The Company plans to
      construct a full service store on this property to be opened in
      2007.




The
      Company has purchased the parcel of land at Linglestown and Patton Roads,
      Harrisburg, Dauphin County, Pennsylvania. The Company plans to construct a
      full-service store on this property to be opened in the future.




The
      Company has purchased the land at the corner of Carlisle Road and Alta Vista
      Road in Dover Township, York County, Pennsylvania. The Company plans to
      construct a full-service store on this property to be opened in the
      future.




The
      Company has entered into a land lease for the premises located at 2121 Lincoln
      Highway East, East Lampeter Township, Lancaster County, Pennsylvania. The
      Company plans to construct a full service store on this property to be opened
      in
      the future.




The
      Company has purchased the parcel of land at Rt 724 and Bradley Avenue, Reading,
      Berks County, Pennsylvania. The Company plans to construct a full-service store
      on this property to be opened in 2007.




In
      addition, the Company is also subject to certain routine legal proceedings
      and
      claims arising in the ordinary course of business. It is management’s opinion
      that the ultimate resolution of these claims will not have a material adverse
      effect on the Company’s financial position and results of
      operations.




**19. Related
      Party Transactions**




Commerce
      Bancorp, Inc. (a 10.8% shareholder of common stock and 100% shareholder of
      Series A preferred stock of the Company), through a subsidiary (Commerce Bank,
      N.A., a national bank located in Cherry Hill, New Jersey), provides various
      services to the Company. These services include maintenance to the store LAN
      network, proof and encoding services, deposit account statement rendering,
      ATM/VISA card processing, data processing, advertising support, implementation
      of new software for systems, and call center support. The Company paid
      approximately $3.1 million, $2.1 million, and $2.0 million for services provided
      by Commerce Bancorp, Inc. during 2006, 2005, and 2004, respectively. Insurance
      premiums and commissions, which are paid to a subsidiary of Commerce Bancorp,
      Inc., are included in the total amount paid. The Company routinely sells loan
      participations to Commerce Bank, N.A. and at December 31, 2006 and 2005,
      approximately $1.9 million and $2.0 million, respectively, of these
      participations were outstanding.




A
      federal
      funds line of credit was established with Commerce Bank N.A. in the amount
      of
      $15 million, which could be drawn upon if needed. The balance was $9.3 million
      at December 31, 2006 and $12.7 at December 31, 2005.




The
      Company has engaged in certain transactions with entities, which would be
      considered related parties. Payments for goods and services, including legal
      services, to these related parties totaled $340,000, $413,000 and $259,000,
      in
      2006, 2005 and 2004, respectively. Management believes disbursements made to
      related parties were substantially equivalent to those that would have been
      paid
      to unaffiliated companies for similar goods and services.






45




**20.**
            **Fair
                Value of Financial
                Instruments**




FASB
      Statement No. 107, “Disclosures about Fair Value of Financial Instruments” (FAS
      107), requires disclosure of fair value information about financial instruments,
      whether or not recognized in the balance sheet, for which it is practical to
      estimate that value. In cases where quoted market prices are not available,
      fair
      values are based on estimates using present value or other valuation techniques.
      These techniques are significantly affected by the assumptions used, including
      the discount rate and estimates of future cash flows.




Management
      uses its best judgment in estimating the fair value of the Company’s financial
      instruments; however, there are inherent weaknesses in any estimation technique.
      Therefore, for substantially all financial instruments, the fair value estimates
      herein are not necessarily indicative of the amounts the Company could have
      realized in a sale transaction on the dates indicated. The estimated fair value
      amounts have been measured as of their respective year ends, and have not been
      re-evaluated or updated for purposes of these financial statements subsequent
      to
      those respective dates. As such, the estimated fair values of these financial
      instruments subsequent to the respective reporting dates may be different than
      the amounts reported at each year-end.




The
      following information should not be interpreted as an estimate of the fair
      value
      of the entire Company since a fair value calculation is only provided for a
      limited portion of the Company’s assets and liabilities. Due to a wide range of
      valuation techniques and the degree of subjectivity used in making the
      estimates, comparisons between the Company’s disclosures and those of other
      companies may not be meaningful. The Company, in estimating its fair value
      disclosures for financial instruments, used the following methods and
      assumptions:




***Cash
      and cash equivalents***




The
      carrying amounts reported approximate those assets’ fair value.




***Securities***




Fair
      values of securities are based on quoted market prices, where available. If
      quoted market prices are not available, fair values are based on quoted market
      prices of comparable instruments.




***Loans
      Receivable***




For
      variable-rate loans that reprice frequently and with no significant change
      in
      credit risk, fair values are based on carrying values. The fair values for
      other
      loans receivable were estimated using discounted cash flow analysis, using
      interest rates currently being offered for loans with similar terms to borrowers
      of similar credit quality. Loans with significant collectibility concerns were
      fair valued on a loan-by-loan basis utilizing a discounted cash flow method
      or
      the fair market value of the underlying collateral.




***Accrued
      Interest Receivable and Payable***




The
      carrying amount of accrued interest receivable and accrued interest payable
      approximate their fair values.




***Deposit
      Liabilities***




The
      fair
      values disclosed for demand deposits (e.g., interest-bearing and
      noninterest-bearing checking, passbook savings, and certain types of money
      market accounts) are, by definition, equal to the amount payable on demand
      at
      the reporting date (i.e., their carrying amounts). Fair values for fixed-rate
      certificates of deposit are estimated using a discounted cash flow calculation
      that applies interest rates currently being offered on certificates of deposit
      to a schedule of aggregated expected monthly maturities on time deposits.




***Short-term
      Borrowings***




The
      carrying amounts reported approximate those liabilities’ fair
      value.




***Long-term
      Debt***




The
      fair
      values for long-term debt were estimated using the interest rate currently
      available from the related party that holds the existing debt.




***Off-balance
      Sheet Instruments***




Fair
      values for the Company’s off-balance sheet instruments are based on fees
      currently charged to enter into similar agreements, taking into account the
      remaining terms of the agreements and the counterparties’ credit
      standing.






46


The
      carrying amounts and fair values of the Company’s financial instruments as of
      December 31 are presented in the following table.




**2006**
            
            2005*(in
                thousands)*
            
            **Carrying
                Amount**
            
            **Fair
                Value**
            
            Carrying
                Amount
            
            Fair
                ValueFinancial
                assets:Cash
                and cash equivalents
            
            **$**
            **52,500**
            
            **$**
            **52,500**
            
            $
            36,422
            
            $
            36,422Securities
            
            
            **711,686**
            
            
            **706,895**
            
            
            687,102
            
            
            682,814Loans,
                net (including loans held for sale)
            
            
            **988,379**
            
            
            **986,975**
            
            
            826,024
            
            
            821,057Restricted
                investments in bank stock
            
            
            **11,728**
            
            
            **11,728**
            
            
            11,463
            
            
            11,463Accrued
                interest receivable
            
            
            **9,401**
            
            
            **9,401**
            
            
            7,681
            
            
            7,681Financial
                liabilities:Deposits
            
            **$**
            **1,616,777**
            
            **$**
            **1,616,192**
            
            $
            1,371,062
            
            $
            1,370,739Long-term
                debt
            
            
            **29,400**
            
            
            **33,282**
            
            
            13,600
            
            
            18,451Short-term
                borrowings
            
            
            **112,800**
            
            
            **112,800**
            
            
            157,900
            
            
            157,900Accrued
                interest payable
            
            
            **932**
            
            
            **932**
            
            
            643
            
            
            643Off-balance
                sheet instruments:Standby
                letters of credit
            
            **$**
            **0**
            
            **$**
            **0**
            
            $
            0
            
            $
            0Commitments
                to extend credit
            
            
            **0**
            
            
            **0**
            
            
            0
            
            
            0




**21. Quarterly
      Financial Data (unaudited)**




The
      following represents summarized unaudited quarterly financial data of the
      Company which, in the opinion of management, reflects adjustments (comprising
      only normal recurring accruals) necessary for fair presentation (in thousands,
      except per share amounts):




**Three
                Months Ended****December
                31**
            
            **September
                30**
            
            **June
                30**
            
            **March
                31****2006****Interest
                income**
            
            **$**
            **27,321**
            
            **$**
            **26,844**
            
            **$**
            **26,098**
            
            **$**
            **24,288****Interest
                expense**
            
            
            **14,331**
            
            
            **13,688**
            
            
            **12,650**
            
            
            **11,091****Net
                interest income**
            
            
            **12,990**
            
            
            **13,156**
            
            
            **13,448**
            
            
            **13,197****Provision
                for loan losses**
            
            
            **225**
            
            
            **428**
            
            
            **506**
            
            
            **475****Gains
                on sales of securities**
            
            
            **160**
            
            
            **0**
            
            
            **0**
            
            
            **0****Provision
                for federal income taxes**
            
            
            **433**
            
            
            **902**
            
            
            **1,008**
            
            
            **1,018****Net
                income**
            
            
            **1,522**
            
            
            **1,645**
            
            
            **2,050**
            
            
            **2,037****Net
                income per share:****Basic**
            
            **$**
            **0.24**
            
            **$**
            **0.27**
            
            **$**
            **0.33**
            
            **$**
            **0.33****Diluted**
            
            
            **0.24**
            
            
            **0.26**
            
            
            **0.32**
            
            
            **0.32**2005Interest
                income
            
            $
            22,923
            
            $
            20,155
            
            $
            19,294
            
            $
            17,180Interest
                expense
            
            
            9,776
            
            
            7,410
            
            
            6,439
            
            
            5,022Net
                interest income
            
            
            13,147
            
            
            12,745
            
            
            12,855
            
            
            12,158Provision
                for loan losses
            
            
            140
            
            
            250
            
            
            625
            
            
            545Gains
                (losses) on sales of securities
            
            
            (859
            )
            
            613
            
            
            186
            
            
            0Provision
                for federal income taxes
            
            
            701
            
            
            1,117
            
            
            1,252
            
            
            1,211Net
                income
            
            
            1,476
            
            
            2,325
            
            
            2,555
            
            
            2,461Net
                income per share:Basic
            
            $
            0.24
            
            $
            0.39
            
            $
            0.43
            
            $
            0.41Diluted
            
            
            0.23
            
            
            0.36
            
            
            0.40
            
            
            0.39







47




**22. Condensed
      Financial Statements of Parent Company**




**Balance
                Sheets****December
                31,***(in
                thousands)*
            
            **2006**
            
            2005**ASSETS**Cash
            
            **$**
            **605**
            
            $
            485Investment
                in subsidiaries:Banking
                subsidiary
            
            
            **128,691**
            
            
            104,353Non-banking
                subsidiaries
            
            
            **1,400**
            
            
            600Other
                assets
            
            
            **215**
            
            
            188**Total
                Assets**
            
            **$**
            **130,911**
            
            $
            105,626**LIABILITIES**Long-term
                debt
            
            **$**
            **29,400**
            
            $
            13,600Other
                liabilities
            
            
            **403**
            
            
            383Total
                liabilities
            
            
            **29,803**
            
            
            13,983**STOCKHOLDERS’
                EQUITY**Preferred
                stock
            
            
            **400**
            
            
            400Common
                stock
            
            
            **6,149**
            
            
            6,014Surplus
            
            
            **67,072**
            
            
            64,859Retained
                earnings
            
            
            **31,941**
            
            
            24,767Accumulated
                other comprehensive loss
            
            
            **(4,454**
            **)**
            
            (4,397
            )Total
                stockholders’ equity
            
            
            **101,108**
            
            
            91,643**Total
                Liabilities and Stockholders’ Equity**
            
            **$**
            **130,911**
            
            $
            105,626




**Statements
      of Income**


**Years
                Ended December 31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004Income:Dividends
                from bank subsidiary
            
            **$**
            **1,725**
            
            $
            1,512
            
            $
            1,044Interest
                income
            
            
            **78**
            
            
            62
            
            
            62**1,803**
            
            
            1,574
            
            
            1,106Expenses:Interest
                expense
            
            
            **1,731**
            
            
            1,418
            
            
            1,418Other
            
            
            **677**
            
            
            717
            
            
            521**2,408**
            
            
            2,135
            
            
            1,939Income
                (loss) before income (taxes) benefit and equity in undistributed
                net
                income of subsidiaries
            
            
            **(605**
            **)**
            
            (561
            )
            
            (833
            )Income
                (taxes) benefit
            
            
            **812**
            
            
            703
            
            
            638**207**
            
            
            142
            
            
            (195
            )Equity
                in undistributed net income of bank subsidiary
            
            
            **7,047**
            
            
            8,675
            
            
            8,786Net
                income
            
            **$**
            **7,254**
            
            $
            8,817
            
            $
            8,591






48




**Statements
      of Cash Flows**




**Years
                Ended December 31,***(in
                thousands)*
            
            **2006**
            
            2005
            
            2004Operating
                Activities:Net
                Income
            
            **$**
            **7,254**
            
            $
            8,817
            
            $
            8,591Adjustments
                to reconcile net income to net cash provided by operating
                activities:Amortization
                of financing costs
            
            
            **6**
            
            
            6
            
            
            6Noncash
                compensation
            
            
            **329**
            
            
            68
            
            
            0Increase
                (decrease) in other liabilities
            
            
            **20**
            
            
            (419
            )
            
            45(Increase)
                decrease in other assets
            
            
            **10**
            
            
            512
            
            
            0Equity
                in undistributed net income of bank subsidiary
            
            
            **(7,047**
            **)**
            
            (8,675
            )
            
            (8,786
            )Net
                cash provided (used) by operating activities
            
            
            **572**
            
            
            309
            
            
            (144
            )Investing
                Activities:Investment
                in bank subsidiary
            
            
            **(16,829**
            **)**
            
            (1,725
            )
            
            (27,018
            )Investment
                in nonbank subsidiary
            
            
            **(800**
            **)**
            
            0
            
            
            0Net
                cash (used) by investing activities
            
            
            **(17,629**
            **)**
            
            (1,725
            )
            
            (27,018
            )Financing
                Activities:Proceeds
                from common stock options exercised
            
            
            **460**
            
            
            874
            
            
            982Proceeds
                from issuance of common stock under stock purchase plan
            
            
            **1,040**
            
            
            783
            
            
            675Proceeds
                from issuance of long-term debt
            
            
            **15,800**
            
            
            0
            
            
            0Proceeds
                from issuance of common stock in connection with stock
                offerings
            
            
            **0**
            
            
            0
            
            
            25,408Cost
                of issuing long term debt
            
            
            **(43**
            **)**
            
            0
            
            
            0Cash
                dividends on preferred stock and cash in lieu of fractional
                shares
            
            
            **(80**
            **)**
            
            (80
            )
            
            (97
            )Net
                cash provided by financing activities
            
            
            **17,177**
            
            
            1,577
            
            
            26,968Increase
                (decrease) in cash and cash equivalents
            
            
            **120**
            
            
            161
            
            
            (194
            )Cash
                and cash equivalents at beginning of the year
            
            
            **485**
            
            
            324
            
            
            518Cash
                and cash equivalents at end of year
            
            **$**
            **605**
            
            $
            485
            
            $
            324