*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.




Total
      deposits increased $210.5 million from $1.16 billion at December 31, 2004 to
      $1.37 billion at December 31, 2005. The growth in total deposits was due to
      a
      combination of growth from five new stores that opened between October 2004
      and
      October 2005 and from same store deposit growth of $167.4 million, or 12%.
      We
      measure same store deposit growth as the annual percentage increase in core
      deposits for store offices open two years or more. As of December 31, 2005,
      23
      of our 28 stores had been open for two years or more. Our core deposits include
      all deposits except for public fund time deposits.




During
      2005, our total net loans (including loans held for sale) increased by $173.2
      million from $652.8 million as of December 31, 2004 to $826.0 million at
      December 31, 2005. 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, 2005 was 58.9%, as
      compared to 57.2% as of December 31, 2004.




During
      2005 our total assets grew by $363.8 million from $1.28 billion at December
      31,
      2004 to $1.64 billion as of December 31, 2005. During this same time period,
      interest earning assets (primarily loans and investments) increased by $337.8
      million from $1.20 billion to $1.54 billion. The growth in earning assets was
      funded by the previously mentioned deposit growth of $210.5 million plus
      short-term borrowings of $157.9 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. Characterized as a “flat” 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 is a short-term hurdle and we remain committed to the expansion
      of
      the Commerce Bank Model and to delivering legendary service to our Customers.
      In
      the fourth quarter, we utilized the flat yield curve to reposition approximately
      $48 million of our investment portfolio from fixed to floating rates, a
      protective measure against further net interest margin compression. In doing
      so,
      we incurred an after-tax charge of $567,000, or $0.09 per share. Additionally,
      we accelerated the vesting of all prior stock options in the fourth quarter,
      leaving us with no legacy stock option expense for 2006 and beyond.




Net
      interest income grew by $4.3 million, or 9%, over 2004 due to the increased
      volume in interest earning assets partially offset by the impact of net interest
      margin compression brought on by the flat yield curve. Total revenues (net
      interest income plus noninterest income) increased by $7.2 million, or 12%,
      in
      2005 compared to 2004 and net income increased by 3% from $8.6 million to $8.8
      million. Excluding the impact of the investment portfolio repositioning and
      stock option acceleration, which together totaled $612,000, net of tax, or
      $0.10
      per share, our net income grew 10% to $9.4 million. The increase was achieved
      despite the challenging rate environment and the costs associated with opening
      four new stores during the year. Earnings per share were down 15% to $1.38.
      Excluding the same above mentioned charges, earnings per share were $1.48,
      down
      9% from the previous year. This reflects 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.




The
      financial highlights for 2005 compared to 2004 are summarized on the next
      page.












1




**December
                31,****2005**
              
              **2004**
              
              **%**
                **Change****(dollars
                  in millions)**Total
                  Assets
              
              $
              1,641.1
              
              $
              1,277.4
              
              
              28
              %Total
                  Loans (Net)
              
              
              815.4
              
              
              638.5
              
              
              28
              %Total
                  Deposits
              
              
              1,371.1
              
              
              1,160.5
              
              
              18
              %


**December
                  31,****2005**
                
                **2004**
                
                **%**
                  **Change****(dollars
                    in millions**
                  **except
                    per share data)**Total
                    Revenues
                
                $
                65.1
                
                $
                57.9
                
                
                12
                %Net Income
                
                
                8.8
                
                
                8.6
                
                
                3
                %Net
                    Income Per Share
                
                
                1.38
                
                
                1.63
                
                
                (15)
                %






We
      expect
      that we will continue our pattern of expanding our footprint by branching into
      contiguous areas of our existing market, and by filling gaps between existing
      store locations. We opened four stores in 2005, giving us a total of 28
      full-service stores as of December 31, 2005. We are targeting to open
      approximately 30 new stores over the next six years. In addition, to accommodate
      our growth, we constructed a new Headquarters, Operations and Training Center
      in
      Harrisburg, which we expect to open at the end of the first quarter of 2006.
      The
      total anticipated cost to construct and furnish our new Headquarters, Operations
      and Training Center in Harrisburg will be around $19.0 million. 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 59 store offices
      by
      the end of 2011. 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, 2005 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 periodic 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* .
      As
      permitted by FASB Statement No. 123, “Accounting for Stock-Based Compensation”
(FAS 123), we have historically accounted for stock-based compensation in
      accordance with Accounting Principles Board Opinion No. 25, “Accounting for
      Stock Issued to Employees” (APB 25). The pro forma impact to net income and
      earnings per share that would occur if compensation expense was recognized,
      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, 2005.




In
      December 2004, the Financial Accounting Standards Board (FASB) issued Statement
      No. 123(R), “Share-Based Payment,” (FAS 123(R)). FAS 123(R) revised FAS 123 and
      supersedes APB 25, and its related implementation guidance. FAS 123(R) requires
      compensation costs related to share-based payments to be recognized in the
      income statements (with limited exceptions) based on their fair values and
      no
      longer allows pro forma disclosure as an alternative to reflecting the impact
      of
      share-based payments on net income and net income per share. The amount of
      compensation cost will be measured based on the grant-date fair value of the
      stock-based compensation issued. Compensation cost will be recognized over
      the
      period that an employee provides service in exchange for the award. This
      statement is effective as of the beginning of the first interim or annual
      reporting period that begins after June 15, 2005 and permits public companies
      to
      adapt its requirement using one of two methods: modified prospective or modified
      retrospective. The Company adopted FAS 123(R) effective January 1, 2006.




In
      October 2005, the FASB issued FASB Staff Position (“FSP”)
      FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as
      Defined in FAS 123(R)”. FSP 123(R)-2 provides guidance on the
      application of grant date as defined in SFAS No. 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. We will adopt this standard when we
      adopt
      FAS 123(R), and it will not have a material impact on our consolidated financial
      position, results of operations or cash flows.




In
      November 2005, the FASB issued final FASB Staff Position FAS No. 123(R)-3,
“Transition Election Related to Accounting for the Tax Effects of Share-Based
      Payment Awards.” The FSP provides an alternative method of calculating
      excess tax benefits (the Additional Paid-in Capital “APIC” pool) from the method
      defined in FAS 123(R) for share-based payments. A one-time election to adopt
      the
      transition method in this FSP is available to those entities adopting FAS 123(R)
      using either the modified retrospective or modified prospective method. Up
      to
      one year from the initial adoption of FAS 123(R) or effective date of the FSP
      is
      provided to make this one-time election. However, until an entity makes its
      election, it must follow the guidance in FAS 123(R). FSP 123(R)-3 is effective
      upon initial adoption of FAS 123(R) and will become effective for us in the
      first quarter of fiscal 2006. We are currently evaluating the potential impact
      of calculating the APIC pool with this alternative method and have not
      determined which method we will adopt, or the expected impact on our financial
      position or results of operations.






**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, 2005, 2004 and 2003 and presents the daily
      average interest rates earned on assets and the daily average interest rates
      paid on liabilities for such periods. During 2005, average interest-earning
      assets were $1.35 billion, an increase of $262.4 million, or 24%, over 2004.
      This was the result of an increase in the average balance of investment
      securities of $116.8 million and an increase in the average balance of loans
      receivable of $149.1 million, offset by a decrease in the average balance of
      federal funds sold of $3.5 million. 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 $224.5
      million.




The
      tax-equivalent yield on total interest-earning assets increased by 29 basis
      points, from 5.63% in 2004 to 5.92% in 2005. This increase was mostly due to
      the
      increasing rate environment during 2005 which contributed toward higher yields
      on our floating rate loans, which comprise 34% of our loan portfolio.




The
      aggregate cost of interest-bearing liabilities increased 97 basis points from
      1.55% in 2004 to 2.52% in 2005. The average rate paid on savings deposits
      increased by 54 basis points, from 1.01% in 2004 to 1.55% in 2005. The average
      rate paid on interest checking accounts increased from 0.85% in 2004 to 1.96%
      in
      2005. The average rate paid on money market accounts, comprised of money market
      accounts and interest checking accounts that are swept overnight to money market
      balances, increased from 1.25% in 2004 to 2.52% in 2005. At December 31, 2005,
      $337.2 million of the sweep accounts were public fund interest checking accounts
      that are priced in relation to the 90-day treasury bill, which increased from
      2.22% at December 31, 2004 to 4.08% at December 31, 2005. For time deposits,
      the
      average rate paid was 2.97%, up 53 basis points from 2004 and public funds
      time
      deposits incurred an increase of 135 basis points in 2005 on the average rate
      paid. The majority of our public funds are deposits of local school districts
      and municipalities.






3




Our
      aggregate cost of funding sources increased 80 basis points in 2005 to 2.12%
      from 1.32% in 2004. 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 taxable equivalent basis.




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


**Years
                Ended December 31,***(dollars
                in thousands)*
            
            **2005**
            
            2004
            
            2003Earning
                Assets
            
            **Average
                Balance**
            
            **Interest**
            
            **Average
                Rate**
            
            Average
                Balance
            
            Interest
            
            Average
                Rate
            
            Average
                Balance
            
            Interest
            
            Average
                RateSecurities:Taxable
            
            **$**
            **615,779**
            
            **$**
            **30,822**
            
            
            **5.01**
            **%**
            $
            498,016
            
            $
            24,789
            
            
            4.98
            %
            $
            361,323
            
            $
            17,108
            
            
            4.73
            %Tax-exempt
            
            
            **5,887**
            
            
            **538**
            
            
            **9.14**
            
            
            6,838
            
            
            608
            
            
            8.89
            
            
            6,444
            
            
            686
            
            
            10.65Total
                securities
            
            
            **621,666**
            
            
            **31,360**
            
            
            **5.04**
            
            
            504,854
            
            
            25,397
            
            
            5.03
            
            
            367,767
            
            
            17,794
            
            
            4.84Federal
                funds sold
            
            
            **148**
            
            
            **5**
            
            
            **3.38**
            
            
            3,638
            
            
            67
            
            
            1.84
            
            
            20,653
            
            
            220
            
            
            1.07Loans
                receivable:Mortgage
                and construction
            
            
            **392,697**
            
            
            **26,328**
            
            
            **6.70**
            
            
            337,257
            
            
            21,777
            
            
            6.46
            
            
            263,581
            
            
            18,290
            
            
            6.94Commercial
                loans and lines of credit
            
            
            **193,779**
            
            
            **13,474**
            
            
            **6.95**
            
            
            144,127
            
            
            8,534
            
            
            5.92
            
            
            95,469
            
            
            5,937
            
            
            6.22Consumer
            
            
            **134,004**
            
            
            **8,147**
            
            
            **6.08**
            
            
            93,166
            
            
            5,122
            
            
            5.50
            
            
            54,840
            
            
            3,318
            
            
            6.05Tax-exempt
            
            
            **9,218**
            
            
            **638**
            
            
            **6.92**
            
            
            6,095
            
            
            442
            
            
            7.25
            
            
            5,093
            
            
            327
            
            
            6.42Total
                loans receivable
            
            
            **729,698**
            
            
            **48,587**
            
            
            **6.66**
            
            
            580,645
            
            
            35,875
            
            
            6.18
            
            
            418,983
            
            
            27,872
            
            
            6.65Total
                earning assets
            
            **$**
            **1,351,512**
            
            **$**
            **79,952**
            
            
            **5.92**
            **%**
            $
            1,089,137
            
            $
            61,339
            
            
            5.63
            %
            $
            807,403
            
            $
            45,886
            
            
            5.68
            %Sources
                of FundsInterest-bearing
                deposits:Regular
                savings
            
            **$**
            **325,218**
            
            **$**
            **5,043**
            
            
            **1.55**
            **%**
            $
            276,862
            
            $
            2,804
            
            
            1.01
            %
            $
            234,431
            
            $
            2,381
            
            
            1.02
            %Interest
                checking
            
            
            **27,201**
            
            
            **533**
            
            
            **1.96**
            
            
            19,464
            
            
            166
            
            
            0.85
            
            
            14,760
            
            
            103
            
            
            0.70Money
                market
            
            
            **452,109**
            
            
            **11,408**
            
            
            **2.52**
            
            
            327,748
            
            
            4,098
            
            
            1.25
            
            
            230,504
            
            
            2,104
            
            
            0.91Time
                deposits
            
            
            **179,428**
            
            
            **5,330**
            
            
            **2.97**
            
            
            164,765
            
            
            4,024
            
            
            2.44
            
            
            133,196
            
            
            4,584
            
            
            3.44Public
                funds time
            
            
            **34,992**
            
            
            **1,094**
            
            
            **3.13**
            
            
            45,855
            
            
            817
            
            
            1.78
            
            
            46,562
            
            
            917
            
            
            1.97Total
                interest-bearing deposits
            
            
            **1,018,948**
            
            
            **23,408**
            
            
            **2.30**
            
            
            834,694
            
            
            11,909
            
            
            1.43
            
            
            659,453
            
            
            10,089
            
            
            1.53Short-term
                borrowings
            
            
            **105,620**
            
            
            **3,821**
            
            
            **3.62**
            
            
            79,049
            
            
            1,070
            
            
            1.35
            
            
            16,964
            
            
            207
            
            
            1.22Long-term
                debt
            
            
            **13,600**
            
            
            **1,418**
            
            
            **10.43**
            
            
            13,600
            
            
            1,418
            
            
            10.43
            
            
            13,000
            
            
            1,356
            
            
            10.43Total
                interest-bearing liabilities
            
            
            **1,138,168**
            
            
            **28,647**
            
            
            **2.52**
            
            
            927,343
            
            
            14,397
            
            
            1.55
            
            
            689,417
            
            
            11,652
            
            
            1.69Noninterest-bearing
                funds (net)
            
            
            **213,344**
            
            
            
            
            
            
            
            
            161,794
            
            
            
            
            
            
            
            
            117,986Total
                sources to funds assets
            
            **$**
            **1,351,512**
            
            **$**
            **28,647**
            
            
            **2.12**
            
            $
            1,089,137
            
            $
            14,397
            
            
            1.32
            
            $
            807,403
            
            $
            11,652
            
            
            1.44Net
                interest income and margin on a tax- equivalent basis
            
            
            
            
            **$**
            **51,305**
            
            
            **3.80**
            **%**
            
            
            
            $
            46,942
            
            
            4.31
            %
            
            
            
            $
            34,234
            
            
            4.24
            %Tax-exempt
                adjustment
            
            
            
            
            
            **400**
            
            
            
            
            
            
            
            
            357
            
            
            
            
            
            
            
            
            344Net
                interest income and margin
            
            
            
            
            **$**
            **50,905**
            
            
            **3.77**
            **%**
            
            
            
            $
            46,585
            
            
            4.28
            %
            
            
            
            $
            33,890
            
            
            4.20
            %Other BalancesCash & due from banks
            
            **$**
            **42,225**
            
            
            
            
            
            
            
            $
            35,285
            
            
            
            
            
            
            
            $
            28,390Other assets
            
            
            **58,837**
            
            
            
            
            
            
            
            
            47,161
            
            
            
            
            
            
            
            
            45,369Total assets
            
            
            **1,452,574**
            
            
            
            
            
            
            
            
            1,171,583
            
            
            
            
            
            
            
            
            881,162Noninterest-bearing demand deposits
            
            
            **220,566**
            
            
            
            
            
            
            
            
            180,355
            
            
            
            
            
            
            
            
            142,805Other liabilities
            
            
            **4,889**
            
            
            
            
            
            
            
            
            5,750
            
            
            
            
            
            
            
            
            2,983Stockholders’ equity
            
            
            **88,951**
            
            
            
            
            
            
            
            
            58,135
            
            
            
            
            
            
            
            
            45,957






4




***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.




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 2005 increased $4.3 million, or
      9%,
      over 2004 to $50.9 million. Interest income on a tax-equivalent basis totaled
      $80.0 million, an increase of $18.6 million, or 30%, over 2004. The majority
      of
      this increase was related to volume increases in the investment securities
      and
      loans receivable portfolios. Interest expense for 2005 increased $14.2 million,
      or 99%, from $14.4 million in 2004 to $28.6 million in 2005. 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 3.40% in 2005 from 4.08% in 2004 on a fully tax equivalent
      basis. The net interest margin decreased 51 basis points from 4.28% in 2004
      to
      3.77% in 2005.




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 2005. Federal funds rate
      increased 200 basis points in 2005. As a result, our cost of funds
      significantly increased during this period but we did not experience a similar
      increase in the yields on our interest earning assets due to the continued
      flattening yield curve throughout the year. We would not expect to see expansion
      in the net interest margin until long-term interest rates increase and/or the
      yield curve steepens.




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 tax equivalent basis.




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


**2005
                v. 2004**
            
            2004
                v. 2003**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
            
            **$**
            **5,907**
            
            **$**
            **126**
            
            **$**
            **6,033**
            
            $
            6,814
            
            $
            867
            
            $
            7,681Tax-exempt
            
            
            **(87**
            **)**
            
            **17**
            
            
            **(70**
            **)**
            
            34
            
            
            (112
            )
            
            (78
            )Federal
                funds sold
            
            
            **(118**
            **)**
            
            **56**
            
            
            **(62**
            **)**
            
            (312
            )
            
            159
            
            
            (153
            )Interest
                on loans receivable:Mortgage
                and construction
            
            
            **3,727**
            
            
            **824**
            
            
            **4,551**
            
            
            4,752
            
            
            (1,265
            )
            
            3,487Commercial
            
            
            **3,451**
            
            
            **1,489**
            
            
            **4,940**
            
            
            2,883
            
            
            (286
            )
            
            2,597Consumer
            
            
            **2,485**
            
            
            **540**
            
            
            **3,025**
            
            
            2,106
            
            
            (302
            )
            
            1,804Tax-exempt
            
            
            **216**
            
            
            **(20**
            **)**
            
            **196**
            
            
            73
            
            
            42
            
            
            115Total
                interest income
            
            
            **15,581**
            
            
            **3,032**
            
            
            **18,613**
            
            
            16,350
            
            
            (897
            )
            
            15,453Interest
                on deposits:Regular
                savings
            
            
            **742**
            
            
            **1,497**
            
            
            **2,239**
            
            
            446
            
            
            (23
            )
            
            423Interest
                checking
            
            
            **151**
            
            
            **216**
            
            
            **367**
            
            
            41
            
            
            22
            
            
            63Money
                market
            
            
            **3,137**
            
            
            **4,173**
            
            
            **7,310**
            
            
            1,210
            
            
            784
            
            
            1,994Time
                deposits
            
            
            **432**
            
            
            **874**
            
            
            **1,306**
            
            
            772
            
            
            (1,332
            )
            
            (560
            )Public
                funds
            
            
            **(340**
            **)**
            
            **617**
            
            
            **277**
            
            
            (12
            )
            
            (88
            )
            
            (100
            )Short-term
                borrowings
            
            
            **958**
            
            
            **1,793**
            
            
            **2,751**
            
            
            841
            
            
            22
            
            
            863Long-term
                debt
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            62
            
            
            0
            
            
            62Total
                interest expense
            
            
            **5,080**
            
            
            **9,170**
            
            
            **14,250**
            
            
            3,360
            
            
            (615
            )
            
            2,745Net
                increase (decrease)
            
            **$**
            **10,501**
            
            **$**
            **(6,138**
            **)**
            **$**
            **4,363**
            
            $
            12,990
            
            $
            (282
            )
            $
            12,708




*(1)
      Changes due to both volume and rate have been allocated to volume
      changes.*






5




**Provision
      for Loan Losses**




We
      recorded $1.6 million to the allowance for loan losses in 2005 as compared
      to
      $2.6 million in 2004. 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 2005 were only
      $176,000, or 0.02%, of average loans outstanding as compared to $806,000, or
      0.14%, of average loans outstanding in 2004. 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, 2005 included herein for
      further discussion regarding our methodology for determining the provision
      for
      loan losses.






**Noninterest
      Income**




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***




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. A comparison of noninterest expense for
      certain categories for 2005 and 2004 is presented below.




Salary
      expenses and employee benefits, which represent the largest component of
      noninterest expenses, increased by $4.4 million, or 20%, in 2005 over 2004.
      The
      increased level of these expenses includes the impact of salary and benefit
      costs associated with the 37% increase in the level of full-time equivalent
      employees to 787 at December 31, 2005 from 576 at December 31, 2004. Included
      in
      this increase is the additional staff hired to operate the new stores opened
      in
      April 2005, July 2005, August 2005, and October 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. The full year impact of the one store opened in 2004 along with
      the additional four stores opened in 2005 contributed to the increases in
      occupancy and furniture and equipment expenses in 2005 over 2004. In late March
      2006, we will discontinue leasing two facilities that currently house the
      majority of our executive, lending, financial and operational staff and relocate
      approximately 300 employees to Commerce Center, our new Headquarters, Operations
      and Training Center. Discontinued occupancy and furniture expenses associated
      with the two existing facilities will partially offset higher levels of expense
      associated with the new building and its furniture and equipment.




Advertising
      and marketing expenses were $3.5 million for 2005, an increase of $353,000,
      or
      11%, over 2004. The increase was primarily the result of grand opening expenses
      associated with four new stores in 2005. Our advertising markets include Berks,
      Lebanon, Dauphin, Cumberland, and York Counties of South Central
      Pennsylvania.




Data
      processing expenses increased by $921,000, or 32%, in 2005 over 2004. 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 to existing services.




Postage
      and supplies expenses of $1.3 million were $167,000, or 15%, higher than the
      prior year. The increase was attributed to the growth in the number of account
      statements mailed to customers.




Other
      noninterest expenses totaled $7.4 million for 2005, compared to $6.6 million
      for
      2004. Components of the increase include expenses related to: insurance, ATM
      fee
      refunds, travel, customer relations, and costs associated with compliance with
      section 404 of Sabanes-Oxley Act, offset by a decrease in foreclosed real estate
      expenses.




Our
      current strategic plan calls for the construction of four new stores in 2006,
      one which will result in the relocation of our Main Office to a newly built
      store in Lemoyne, Cumberland County, Pennsylvania. In addition, we are
      completing the construction of our new Headquarters, Operations and Training
      Center in Harrisburg. The costs associated with these planned facilities will
      continue to result in higher levels of staff, occupancy, furniture, equipment,
      and related expenses in 2006 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 2.52% for 2005, compared to 2.66% for 2004. 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 2005, the operating
      efficiency ratio was 77.9% compared to 73.4% for 2004. Our operating efficiency
      ratio remains above our peer group primarily due to our aggressive growth
      expansion activities.






6






***Provision
      for Federal Income Taxes***




The
      provision for federal income taxes was $4.3 million for 2005, compared to $4.2
      million for 2004. The effective tax rate, which is the ratio of income tax
      expense to income before taxes, was 32.7% in both 2005 and 2004. See Note 11
      of
      the *Notes
      to Consolidated Financial Statements* for
      an
      additional analysis of the provision for income taxes for 2005 and
      2004.




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, 2005, deferred tax assets amounted to $5.5 million and deferred
      tax
      liabilities amounted to $1.8 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 2005 was $8.8 million, an increase of $226,000, or 3%, over the
      $8.6
      million recorded in 2004. This increase was due to an increase in net interest
      income of $4.3 million, an increase in noninterest income of $2.9 million,
      and a
      decrease in the provision for loan losses of $1.1 million, partially offset
      by
      an increase in noninterest expenses of $7.9 million.




Basic
      earnings per common share were $1.47 in 2005 compared to $1.75 in 2004. Diluted
      earnings per common share were $1.38 for 2005 and $1.63 for 2004. As previously
      mentioned, the decrease in earnings per share reflects the impact of a 21%
      increase in the number of average shares outstanding in 2005 versus the prior
      year, primarily the result of our public stock offering in the fourth quarter
      of
      2004. See Note 13 in the *Notes
      to Consolidated Financial Statements* for
      an
      analysis of earnings per share.






***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 0.61% for 2005 and 0.73% for 2004. This
      decrease is the result of 28% growth in total assets combined with a 3% increase
      in net income. Contributing to these results was the deployment of $12.8 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 2005 and 2004 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 2005 was 9.91%,
      compared to 14.78% for 2004. As expected, ROE was impacted due to the volume
      of
      additional equity capital raised during the fourth quarter of 2004 through
      our
      public stock offering.






**Results
      of Operations**




***2004
      versus 2003***




Net
      income for 2004 rose to $8.6 million, an increase of $2.0 million, or 31%,
      over
      the $6.6 million recorded in 2003.




Diluted
      earnings per common share increased by 22% to $1.63 for 2004 over $1.34 for
      2003
      after adjusting for the 5% common stock dividends declared in January 2004
      and
      the 2-for-1 stock split declared in January 2005.




Net
      interest income for 2004 increased $12.7 million, or 37%, over 2003 to $46.6
      million. Interest income on earning assets totaled $61.0 million, an increase
      of
      $15.4 million, or 34%, over 2003. Interest expense for 2004 increased by $2.7
      million, or 24%, from $11.7 million to $14.4 million.




Our
      net
      interest rate spread increased to 4.08% in 2004 from 3.99% in 2003 and the
      net
      interest margin increased 8 basis points from 4.20% to 4.28%.




Noninterest
      income for 2004 increased by $1.3 million, or 13%, over 2003 to $11.3 million.
      Included in total noninterest income were gains on the sale of residential
      and
      student loans of $630,000 in 2004 and $765,000 in 2003 and a gain on the sale
      of
      securities in 2003 of $880,000.




Noninterest
      expenses totaled $42.5 million for 2004, an increase of $10.0 million, or 31%,
      over 2003. Staffing levels, occupancy, furniture and equipment, and related
      expenses increased as a result of one full service store in 2004 and five full
      service stores in the second half of 2003.




Salary
      expenses and employee benefits increased by $5.1 million, or 31%, in 2004 over
      2003. This increase was partially due to an increase in the level of full-time
      equivalent employees from 503 at December 31, 2003 to 576 at year-end 2004.




Occupancy
      expenses totaled $4.4 million in 2004, an increase of $955,000, or 28%, over
      2003 while furniture and equipment expenses increased by $659,000, or 36%,
      to
      $2.5 million.






7




Advertising
      and marketing expenses were $3.1 million for 2004, an increase of $683,000,
      or
      28%, over 2003. Data processing expenses increased by $774,000, or 36%, in
      2004
      over 2003. Postage and supplies expenses of $1.1 million were $155,000, or
      16%,
      higher than the prior year.




Other
      noninterest expenses totaled $6.6 million for 2004, compared to $5.0 million
      for
      2003.






**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.




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
      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, 2005, the yield on our securities portfolio
      was
      5.04%, up 1 basis point from 5.03% in 2004.




At
      December 31, 2005, the weighted average life and duration of our securities
      portfolio was approximately 4.9 and 3.9 years, respectively, as compared to
      5.1
      years and 4.2 years, respectively, at December 31, 2004. 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,
      2005 or 2004.




Securities
      available for sale increased by $73.4 million in 2005 (excluding the effect
      of
      changes in unrealized gains or losses) primarily as a result in purchases of
      $224.4 million, offset by principal repayments and maturities of $94.1 million
      and sales of $55.3 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, 2005, the unrealized loss on
      securities available for sale included in stockholders’ equity totaled $4.4
      million, net of tax, compared to the $51,000, net of tax, unrealized loss on
      securities available for sale included in stockholders’ equity at December 31,
      2004.




During
      2005, securities held to maturity increased by $96.3 million primarily as a
      result of purchases of $151.0 million offset by principal repayments of $49.7
      million and a sale of one bond totaling $5.5 million. The
      bond experienced a deterioration in creditworthiness which meets the
      specific exception provided for a sale of a security classified as held to
      maturity. 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
      contractual maturity distribution and weighted average yield of our available
      for sale and held to maturity portfolios at December 31, 2005 are summarized
      in
      Table 3. 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 34%, on tax-exempt
      obligations.







8











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


**December
                  31, 2005**
              
              **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
              
              
              
              
              
              
              
              **$**
              **129**
              
              
              **5.21**
              **%**
              **$**
              **84**
              
              
              **6.09**
              **%**
              
              **382,285**
              
              
              **5.04**
              
              
              **382,498**
              
              
              **5.04**Total
                  available for sale
              
              **$**
              **0**
              
              
              **----**
              
              **$**
              **129**
              
              
              **5.21**
              **%**
              **$**
              **84**
              
              
              **6.09**
              **%**
              **$**
              **387,285**
              
              
              **5.04**
              **%**
              **$**
              **387,498**
              
              
              **5.04**
              **%**Held
                  to Maturity:U.S.
                  Government Agency obligations
              
              
              
              
              
              
              
              **$**
              **10,000**
              
              
              **5.00**
              **%**
              **$**
              **101,135**
              
              
              **5.14**
              **%**
              **$**
              **25,000**
              
              
              **5.61**
              **%**
              **$**
              **136,135**
              
              
              **5.21**
              **%**Municipal
                  obligations
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              **653**
              
              
              **5.45**
              
              
              **1,964**
              
              
              **7.21**
              
              
              **2,617**
              
              
              **6.77**Mortgage-backed
                  obligations
              
              **$**
              **25**
              
              
              **7.08**
              **%**
              
              **593**
              
              
              **5.41**
              
              
              **114**
              
              
              **6.47**
              
              
              **149,662**
              
              
              **5.09**
              
              
              **150,394**
              
              
              **5.09**Corporate
                  debt securities
              
              
              **2,103**
              
              
              **6.24**
              
              
              **6,485**
              
              
              **6.60**
              
              
              
              
              
              
              
              
              **8,532**
              
              
              **7.57**
              
              
              **17,120**
              
              
              **7.04**Total
                  held to maturity
              
              **$**
              **2,128**
              
              
              **6.25**
              **%**
              **$**
              **17,078**
              
              
              **5.62**
              **%**
              **$**
              **101,902**
              
              
              **5.14**
              **%**
              **$**
              **185,158**
              
              
              **5.30**
              **%**
              **$**
              **306,266**
              
              
              **5.27**
              **%**




*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 2001 through 2005.




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


**December
                31,***(in
                thousands)*
            
            **2005**
            
            2004
            
            2003
            
            2002
            
            2001Commercial
                mortgage
            
            **$**
            **299,219**
            
            $
            239,576
            
            $
            194,609
            
            $
            144,959
            
            $
            142,969Construction
                and land development
            
            
            **47,334**
            
            
            39,467
            
            
            26,895
            
            
            31,034
            
            
            32,863Residential
                real estate mortgage loans
            
            
            **83,213**
            
            
            79,672
            
            
            72,713
            
            
            66,190
            
            
            48,415Tax-exempt
                loans
            
            
            **17,055**
            
            
            6,303
            
            
            5,720
            
            
            5,629
            
            
            2,676Commercial,
                industrial and other business loans
            
            
            **138,174**
            
            
            97,198
            
            
            58,894
            
            
            49,226
            
            
            42,399Consumer
                loans
            
            
            **148,906**
            
            
            109,568
            
            
            71,007
            
            
            34,598
            
            
            36,551Commercial
                lines of credit
            
            
            **90,769**
            
            
            74,559
            
            
            46,106
            
            
            37,245
            
            
            36,801Total
                loans
            
            **$**
            **824,670**
            
            $
            646,343
            
            $
            475,944
            
            $
            368,881
            
            $
            342,674




We
      manage
      risk associated with our loan portfolio through diversification, with what
      we
      believe are sound underwriting policies and procedures that are reviewed and
      updated on at least an annual basis, and ongoing loan monitoring efforts.
      Additionally, we monitor concentrations of loans or loan relationships by
      industry and set target percentages for each industry. At December 31, 2005,
      there was no concentration greater than 16.3% of our loan portfolio to any
      one
      industry and there is no concentration greater than 2.0% to any one borrower
      as
      of December 31, 2005.




Our
      commercial mortgage and 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 $495,000. 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 lines
      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, 2005,
      outstandings under commercial lines of credit were $90.8 million and unused
      commitments were $164.8 million,






9




Residential
      real estate mortgage loans represented approximately 10% of our total loans
      at
      December 31, 2005. Loans in this category are collateralized by first mortgages
      on residential properties located in south central Pennsylvania. Our
      underwriting policy provides that all residual loans are to be written based
      upon standards used by the secondary market.




Consumer
      loans and consumer lines of credit represented approximately 18% of our total
      loans at December 31, 2005. These loans and lines are secured by first and
      second mortgages, personal assets of the borrower, or may be unsecured. As
      of
      December 31, 2005, 66% 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
      and outlines 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, 2005, unused commitments under consumer lines
      of
      credit were $44.6 million.




During
      2005, total gross loans increased by $174.7 million from $660.6 million at
      December 31, 2004, to $835.3 million at December 31, 2005, including $10.6
      million of loans held for sale on December 31, 2005 and $14.3 million of loans
      held for sale on December 31, 2004. 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 $940,000 at December 31,
      2005
      and $692,000 at December 31, 2004. The increase in loans receivable in 2005
      was
      represented across all loan categories.




During
      2005, commercial mortgage loans increased by $59.6 million, or 25%, and
      commercial, industrial and other business loans increased by $41.0 million,
      or
      42%. 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.




Total
      consumer loans increased by $39.3 million in 2005 to $148.9 million at year-end
      2005 compared to $109.6 million at year-end 2004. This increase of 36% 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 strong growth in 2005 as well, increasing by $16.2 million,
      or 22%, from $74.6 million to $90.8 million.




Total
      loans outstanding represented 60% of total deposits and 50% of total assets
      at
      December 31, 2005, excluding the loans held for sale, compared to 56% and 51%,
      respectively, at December 31, 2004.




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, 2005, are presented in the following table.




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


**December
                31, 2005***(in
                thousands)*
            
            **Due
                Within**
              **One
                Year**
            
            **Due
                1-5 Years**
            
            **Due
                Over Five Years**
            
            **Total**Real
                estate:Commercial
                mortgage
            
            **$**
            **15,918**
            
            **$**
            **17,126**
            
            **$**
            **266,175**
            
            **$**
            **299,219**Construction
                and land development
            
            
            **22,708**
            
            
            **14,879**
            
            
            **9,747**
            
            
            **47,334**Residential
                mortgage
            
            
            **38,876**
            
            
            **19,042**
            
            
            **25,295**
            
            
            **83,213**Tax-exempt
            
            
            **4,496**
            
            
            **983**
            
            
            **11,576**
            
            
            **17,055****81,998**
            
            
            **52,030**
            
            
            **312,793**
            
            
            **446,821**Commercial
            
            
            **37,874**
            
            
            **55,918**
            
            
            **44,382**
            
            
            **138,174**Consumer
            
            
            **24,721**
            
            
            **15,028**
            
            
            **109,157**
            
            
            **148,906**Commercial
                lines of credit
            
            
            **64,745**
            
            
            **25,362**
            
            
            **662**
            
            
            **90,769**Total
                loans
            
            **$**
            **209,338**
            
            **$**
            **148,338**
            
            **$**
            **466,994**
            
            **$**
            **824,670**Interest
                rates:Predetermined
            
            **$**
            **63,018**
            
            **$**
            **85,323**
            
            **$**
            **397,518**
            
            **$**
            **545,859**Floating
            
            
            **146,320**
            
            
            **63,015**
            
            
            **69,476**
            
            
            **278,811**Total
                loans
            
            **$**
            **209,338**
            
            **$**
            **148,338**
            
            **$**
            **466,994**
            
            **$**
            **824,670**






10




***Concentrations
      of Credit Risk***




The
      largest portion of loans, 36%, on our balance sheet is for commercial mortgage
      related loans. Our commercial real estate loan portfolio is principally to
      borrowers throughout Cumberland, Dauphin, Lebanon, York and Berks counties
      of
      Pennsylvania where we have full-service store locations. Commercial real estate,
      construction, and land development loans aggregated $346.6 million at December
      31, 2005, compared to $279.0 million at December 31, 2004. 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.




Consumer
      loans comprised 18%, or $148.9 million, of total loans at December 31, 2005.
      Approximately $107.0 million of consumer loans are secured by real estate,
      $40.8
      million of consumer loans are loans collateralized by personal assets of the
      borrower, and $1.1 million of consumer loans are unsecured.




Commercial
      loans represented 17% of total loans at December 31, 2005. 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.




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, 2005,
      were
      $2.7 million, or .16%, of total assets as compared to $1.4 million, or 0.11%,
      of
      total assets at December 31, 2004. Total non-performing loans (non-accrual
      loans
      and restructured loans) at December 31, 2005 were $2.5 million compared to
      $857,000 a year ago. Total delinquent loans (those loans 30 days or more
      delinquent) as a percentage of total loans were 0.36% at December 31, 2005,
      compared to 0.29% at December 31, 2004. 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, 2005, loans
      past
      due 90 days and still accruing interest amounted to $233,000 compared to $0
      at
      December 31, 2004. Additional loans considered by our internal loan review
      department as potential problem loans of $1.6 million at December 31, 2005,
      compared to $840,000 at December 31, 2004, 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, 2005 as compared to $507,000
      as
      of December 31, 2004. 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.




The
      following table summarizes information regarding non-performing loans and
      non-performing assets as of December 31, 2001 through 2005.







11










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


**December
                31,***(dollars
                in thousands)*
            
            **2005**
            
            2004
            
            2003
            
            2002
            
            2001Nonaccrual
                loans:Commercial
            
            **$**
            **684**
            
            $
            308
            
            $
            143
            
            $
            958
            
            $
            127Consumer
            
            
            **296**
            
            
            11
            
            
            68
            
            
            42
            
            
            116Real
                estate: Construction
            
            
            **0**
            
            
            0
            
            
            159
            
            
            0
            
            
            0Mortgage
            
            
            **1,322**
            
            
            267
            
            
            417
            
            
            599
            
            
            633Total
                nonaccrual loans
            
            
            **2,302**
            
            
            586
            
            
            787
            
            
            1,599
            
            
            876Loans
                past due 90 days or more and still accruing
            
            
            **233**
            
            
            0
            
            
            385
            
            
            55
            
            
            0Restructured
                loans
            
            
            **0**
            
            
            271
            
            
            0
            
            
            0
            
            
            0Total
                non-performing loans
            
            
            **2,535**
            
            
            857
            
            
            1,172
            
            
            1,654
            
            
            876Foreclosed
                real estate
            
            
            **159**
            
            
            507
            
            
            236
            
            
            118
            
            
            12Total
                non-performing assets
            
            **$**
            **2,694**
            
            $
            1,364
            
            $
            1,408
            
            $
            1,772
            
            $
            888Non-performing
                loans to total loans
            
            
            **0.31**
            **%**
            
            0.13
            %
            
            0.25
            %
            
            0.45
            %
            
            0.26
            %Non-performing
                assets to total assets
            
            
            **0.16**
            **%**
            
            0.11
            %
            
            0.13
            %
            
            0.23
            %
            
            0.15
            %Interest
                income received on nonaccrual loans
            
            **$**
            **106**
            
            $
            30
            
            $
            37
            
            $
            79
            
            $
            33Interest
                income that would have been recorded under the original terms of
                the
                loans
            
            **$**
            **114**
            
            $
            10
            
            $
            45
            
            $
            193
            
            $
            89




***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 they believe is
      adequate for estimated inherent losses in the current 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 can be 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 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 our historical loss experience. Those factors include
      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.




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 observable market prices, discounted cash flows or 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 included residential
                mortgages, consumer loans, and installment
                loans.




·
            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.






12




·
            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 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.




We
      recorded provisions of $1.6 million to the allowance for loan losses for 2005
      compared to $2.6 million for 2004. During 2005, net charge-offs amounted to
      $176,000, or 0.02%, of average loans outstanding for the year, compared to
      $806,000, or 0.14%, of average loans outstanding for 2004. The allowance for
      loan losses decreased as a percentage of loans receivable from 1.21% of total
      loans outstanding at December 31, 2004, to 1.12% of total loans outstanding
      at
      December 31, 2005 and provided coverage of 364% of non-performing loans. Based
      upon a consistent application of our loan loss reserve methodology, the
      allowance level increased by $1.4 million to $9.2 million or 1.12% of total
      loans at December 31, 2005, but decreased as a percentage of total loans due
      to
      28% growth in the loan portfolio in 2005.




The
      table
      below presents, for the years 2001 through 2005, information regarding our
      provision and allowance for loan losses.




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


**Years
                Ended December 31,***(dollars
                in thousands)*
            
            **2005**
            
            2004
            
            2003
            
            2002
            
            2001Balance
                at beginning of year
            
            **$**
            **7,847**
            
            $
            6,007
            
            $
            5,146
            
            $
            4,544
            
            $
            3,732Provisions
                charged to operating expenses
            
            
            **1,560**
            
            
            2,646
            
            
            1,695
            
            
            1,435
            
            
            1,469**9,407**
            
            
            8,653
            
            
            6,841
            
            
            5,979
            
            
            5,201Recoveries
                of loans previously charged-off:Commercial
            
            
            **546**
            
            
            110
            
            
            66
            
            
            93
            
            
            3Consumer
            
            
            **50**
            
            
            113
            
            
            85
            
            
            2
            
            
            21Real
                estate
            
            
            **0**
            
            
            8
            
            
            115
            
            
            21
            
            
            0Total
                recoveries
            
            
            **596**
            
            
            231
            
            
            266
            
            
            116
            
            
            24Loans
                charged-off:Commercial
            
            
            **(627**
            **)**
            
            (528
            )
            
            (483
            )
            
            (561
            )
            
            (475
            )Consumer
            
            
            **(135**
            **)**
            
            (350
            )
            
            (331
            )
            
            (70
            )
            
            (85
            )Real
                estate
            
            
            **(10**
            **)**
            
            (159
            )
            
            (286
            )
            
            (318
            )
            
            (121
            )Total
                charged-off
            
            
            **(772**
            **)**
            
            (1,037
            )
            
            (1,100
            )
            
            (949
            )
            
            (681
            )Net
                charge-offs
            
            
            **(176**
            **)**
            
            (806
            )
            
            (834
            )
            
            (833
            )
            
            (657
            )Balance
                at end of year
            
            **$**
            **9,231**
            
            $
            7,847
            
            $
            6,007
            
            $
            5,146
            
            $
            4,544Net
                charge-offs (recoveries) to average loans outstanding
            
            
            **0.02**
            **%**
            
            0.14
            %
            
            0.20
            %
            
            0.23
            %
            
            0.21
            %Allowance
                for loan losses to year-end loans
            
            
            **1.12**
            **%**
            
            1.21
            %
            
            1.26
            %
            
            1.40
            %
            
            1.33
            %




***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.







13





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


**Allowance
                for Loan Losses at December 31,****2005**
            
            2004
            
            2003
            
            2002
            
            2001*(dollars
                in thousands)*
            
            **Amount**
            
            **%
                Gross Loans**
            
            Amount
            
            %
                Gross Loans
            
            Amount
            
            %
                Gross Loans
            
            Amount
            
            %
                Gross Loans
            
            Amount
            
            %
                Gross LoansCommercial
                loans and lines of credit
            
            **$**
            **3,675**
            
            
            **28**
            **%**
            $
            3,063
            
            
            27
            %
            $
            2,636
            
            
            21
            %
            $
            2,428
            
            
            24
            %
            $
            986
            
            
            23
            %Consumer
            
            
            **1,785**
            
            
            **18**
            
            
            1,657
            
            
            17
            
            
            717
            
            
            15
            
            
            452
            
            
            9
            
            
            157
            
            
            11Real
                estate, construction and land development:Commercial
            
            
            **3,058**
            
            
            **42**
            
            
            2,540
            
            
            43
            
            
            2,157
            
            
            47
            
            
            1,698
            
            
            48
            
            
            3,240
            
            
            50Residential
            
            
            **713**
            
            
            **12**
            
            
            587
            
            
            13
            
            
            497
            
            
            17
            
            
            568
            
            
            19
            
            
            161
            
            
            16Total
            
            **$**
            **9,231**
            
            
            **100**
            **%**
            $
            7,847
            
            
            100
            %
            $
            6,007
            
            
            100
            %
            $
            5,146
            
            
            100
            %
            $
            4,544
            
            
            100
            %




***Bank
      Premises and Equipment***




Premises
      and equipment at December 31, 2005 was $66.3 million, up $21.1 million, or
      47%,
      over premises and equipment of $45.2 million at December 31, 2004. This increase
      is primarily due to additional capital expenditures associated with the four
      new
      stores opened in 2005 as well as construction in process related to our new
      Headquarters, Operations and Training facility.






***Other
      Assets***




Other
      assets increased by $5.0 million from $8.8 million at December 31, 2004 to
      $13.8
      million at December 31, 2005. This change was primarily due to a $2.7 million
      increase in deferred tax assets and a $2.1 million increase in accrued interest
      receivable on loans and investment securities.






**Deposits**




Total
      deposits at December 31, 2005, were $1.37 billion, up $210.5 million, or 18%,
      over total deposits of $1.16 billion at December 31, 2004. 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 $201.8 million, or 18%, in 2005 over
      2004.
      Total deposits averaged $1.24 billion for 2005, an increase of $224.5 million,
      or 22%, over the 2004 average of $1.02 billion. The average balance on
      noninterest-bearing demand deposits increased in 2005 by $40.2 million, or
      22%,
      compared to the prior year. The average balance of interest bearing demand
      accounts (money market and interest checking accounts) for 2005 increased by
      $132.1 million, or 38%, over the average balance for the prior year. The average
      total balance of all savings accounts was $325.2 million, a $48.4 million,
      or
      17%, increase over the average balance for 2004. The average balance of all
      time
      deposits in 2005 was $214.4 million, an increase of $3.8 million, or 2%, over
      the average balance for 2004. For 2005, the deposit cost of funds was 1.73%
      as
      compared to 1.09% in 2004.




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 2005, 2004
      and
      2003 are presented below. ****




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


**Years
                Ended December 31,****2005
                Average**
            
            2004
                Average
            
            2003
                Average*(dollars
                in thousands)*
            
            **Balance/Rate**
            
            Balance/Rate
            
            Balance/RateDemand
                deposits:Noninterest-bearing
            
            **$**
            **220,566**
            
            
            
            
            $
            180,355
            
            
            
            
            $
            142,805Interest-bearing
                (money market and checking)
            
            
            **479,310**
            
            
            **2.49**
            **%**
            
            347,212
            
            
            1.23
            %
            
            245,264
            
            
            0.90
            %Savings
            
            
            **325,218**
            
            
            **1.55**
            
            
            276,862
            
            
            1.01
            
            
            234,431
            
            
            1.02Time
            
            
            **214,420**
            
            
            **3.00**
            
            
            210,620
            
            
            2.30
            
            
            179,758
            
            
            3.07Total
                deposits
            
            **$**
            **1,239,514**
            
            
            
            
            $
            1,015,049
            
            
            
            
            $
            802,258




The
      remaining maturity for certificates of deposit of $100,000 or more as of
      December 31, 2005, 2004 and 2003 is presented in Table 10.






14







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


*(in
                thousands)*
            
            **2005**
            
            2004
            
            20033
                months or less
            
            **$**
            **20,002**
            
            $
            39,270
            
            $
            35,0653
                to 6 months
            
            
            **6,487**
            
            
            15,530
            
            
            21,2026
                to 12 months
            
            
            **29,582**
            
            
            13,344
            
            
            18,520Over
                12 months
            
            
            **69,028**
            
            
            36,811
            
            
            16,612Total
            
            **$**
            **125,099**
            
            $
            104,955
            
            $
            91,399




***Short-Term
      Borrowings***




Short-term
      borrowings, which consist of securities sold under agreement to repurchase
      and
      federal funds purchased, were used in 2005 and 2004 to meet short-term liquidity
      needs. For 2005, short-term borrowings averaged $83.7 million and repurchase
      agreements averaged $21.9 million. The weighted average rate paid during 2005
      was 3.62% for both short-term borrowings and repurchase agreements. At December
      31, 2005, short-term borrowings totaled $157.9 million at an average rate of
      4.24%. As of December 31, 2004, there were no short-term borrowings or
      repurchase agreements. The maximum short-term borrowings outstanding at any
      month-end were $183.2 million in 2005 and $87.5 million in 2004. The maximum
      repurchase agree-ments outstanding at any month-end were $70 million in 2005
      and
      $40 million in 2004.






***Long-Term
      Debt***




Long-term
      debt totaled $13.6 million at December 31, in both 2005 and 2004. Our long-term
      debt consisted of Trust Capital Securities through Commerce Harrisburg Capital
      Trust I and Commerce Harrisburg Capital Trust II, our Delaware business trust
      subsidiaries. At December 31, 2005, 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, 2005, stockholders’ equity totaled $91.6 million, up $6.6 million,
      or 8%, over stockholders’ equity at December 31, 2004. This increase was due to
      our net income for the year and shares issued under stock purchase and stock
      option plans offset by unrealized losses on securities available for sale.
      Stockholders’ equity as a percent of total assets was 5.60% at December 31,
      2005, compared to 6.66% at December 31, 2004. See Note 12 of *Notes
      to Consolidated Financial Statements* at
      December 31, 2005, 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
      11
      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** **11**


**Actual**
              **December
                31,**
            
            MinimumRegulatory**2005**
            
            2004
            
            RequirementsTier
                1 Capital
            
            
            **9.77**
            **%**
            
            11.55
            %
            
            4.00
            %Total
                Capital
            
            
            **10.60**
            
            
            12.48
            
            
            8.00Leverage
                ratio
              (to
                total assets)
            
            
            **6.68**
            
            
            7.78
            
            
            3.00-4.00




At
      December 31, 2005, the consolidated capital levels of the Company and of the
      Bank met the definition of a “well-capitalized” 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%.




Our
      common stock trades on the NASDAQ National Market under the symbol COBH. 
Prior to October 13, 2004, shares of Pennsylvania Commerce Bancorp, Inc. common
      stock were traded on the NASDAQ Small Cap Market under the symbol COBH. 
The table on the next page sets forth the prices on the NASDAQ Small Cap Market
      (adjusted for stock dividends) known to us for each full quarterly period for
      the period January 1, 2004 through October 12, 2004. The table also includes
      the
      prices on the NASDAQ National Market known to us for the period beginning
      October 13, 2004 through December 31, 2005. As of December 31, 2005, there
      were
      approximately 2,200 holders of record of the Company’s common
      stock.






15







Sales
                PriceQuarter
                Ended:
            
            High
            
            LowMarch
                31, 2005
            
            $
            33.97
            
            $
            28.93June
                30, 2005
            
            
            38.00
            
            
            29.11September
                30, 2005
            
            
            36.68
            
            
            33.05December
                31, 2005
            
            
            36.00
            
            
            30.72March
                31, 2004
            
            $
            27.50
            
            $
            23.25June
                30, 2004
            
            
            25.63
            
            
            23.26September
                30, 2004
            
            
            25.05
            
            
            21.88December
                31, 2004
            
            
            31.50
            
            
            22.00







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 Common Stock at a 3% discount (subject to change) to the
      market price and without payment of brokerage commissions.






***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 12 shows
      our
      GAP position as of December 31, 2005. 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.




·
            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. All other securities are assumed
                to
                reprice at their contractual
                maturity.




·
            30%
                of Transaction accounts are expected to reprice within the first
                90 days
                with the remaining 70% repricing after 5
                years.




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










16










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


**December
                31, 2005***(in
                thousands)*
            
            **1
                - 90**
              **Days**
            
            **91
                - 180**
              **Days**
            
            **181
                - 365**
              **Days**
            
            **1
                - 5**
              **Years**
            
            **Beyond
                5**
              **Years**
            
            **Total**Interest-earning
                assets:Loans
                receivable
            
            **$**
            **307,964**
            
            **$**
            **11,097**
            
            **$**
            **30,801**
            
            **$**
            **311,709**
            
            **$**
            **170,468**
            
            **$**
            **832,039**Securities
            
            
            **44,560**
            
            
            **30,504**
            
            
            **43,304**
            
            
            **264,466**
            
            
            **307,727**
            
            
            **690,561**Total
                interest-earning assets
            
            
            **352,524**
            
            
            **41,601**
            
            
            **74,105**
            
            
            **576,175**
            
            
            **478,195**
            
            
            **1,522,600**Interest-bearing
                liabilities:Transaction
                accounts
            
            
            **269,925**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **624,165**
            
            
            **894,090**Time
                deposits
            
            
            **49,130**
            
            
            **18,899**
            
            
            **46,500**
            
            
            **114,342**
            
            
            **0**
            
            
            **228,871**Short-term
                borrowings
            
            
            **157,900**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **157,900**Long-term
                debt
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **13,600**
            
            
            **13,600**Total
                interest-bearing liabilities
            
            
            **476,955**
            
            
            **18,899**
            
            
            **46,500**
            
            
            **114,342**
            
            
            **637,765**
            
            
            **1,294,461**Period
                GAP
            
            
            **(124,431**
            **)**
            
            **22,702**
            
            
            **27,605**
            
            
            **461,833**
            
            
            **(159,570**
            **)**
            **$**
            **228,139**Cumulative
                GAP
            
            **$**
            **(124,431**
            **)**
            **$**
            **(101,729**
            **)**
            **$**
            **(74,124**
            **)**
            **$**
            **387,709**
            
            **$**
            **228,139**Cumulative
                RSA / RSL
            
            
            **73.91**
            **%**
            
            **79.48**
            **%**
            
            **86.33**
            **%**
            
            **159.04**
            **%**
            
            **117.62**
            **%**




*Notes:
      Nonaccrual loans, deferred fees on loans and overdrafts have been excluded
      in
      the loans receivable balances. Securities are reported at current face 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 proportionally 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.




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
      income over the next 24 months in a flat rate scenario versus net 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 income in the above mentioned interest
      rate scenario is within 12% of forecasted net income in the first
      year and within 18% using a two year time frame.




The
        following table compares the impact on forecasted net income at December
        31,
        2005 of a plus 200 and minus 200 basis point (bp) change in interest rates
        to
        the impact at December 31, 2004 of a plus 200 and minus 100 bp change in
        interest rates. Given the overall low level of market interest rates present
        at
        December 31, 2004, we felt it was more practical to measure a minus 100 bp
        change than a minus 200 bp change. Given the 200 bp increase in short-term
        interest rates in 2005, management now uses a minus 200 bp change for modeling
        purposes.


Basis
                Point ChangePlus
                200
            
            Minus
                200
            
            Minus
                100December
                31, 2005:Twelve
                Months
            
            
            (15.0
            )%
            
            12.0
            %
            
            N/ATwenty-Four
                Months
            
            
            (13.0
            )%
            
            2.0
            %
            
            N/ADecember
                31, 2004:Twelve
                Months
            
            
            (3.2
            )%
            
            N/A
            
            
            3.5
            %Twenty-Four
                Months
            
            
            3.2
            %
            
            N/A
            
            
            1.0
            %




All
      of
      these forecasts are within an acceptable level of interest rate risk per the
      policies established by ALCO. In the event the model indicates an unacceptable
      level of risk, Management could undertake a number of actions that would reduce
      this risk, including 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, 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.






17




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 in rates
        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, 2005, the market value of equity indicates
        an
        acceptable level of interest rate risk.
  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 significant
        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, 2005
        provide an accurate assessment of our interest rate risk.
  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 åcoreæ deposit growth. We generated
        $4.4 million in cash from operating activities during 2005 versus $32.9 million
        during 2004. This decrease was primarily attributed to the change in balances
        in
        other assets and other liabilities from one year to the next. Investing
        activities resulted in a net cash outflow of $378.9 million during 2005 compared
        to $231.7 million in 2004. Additional investment purchases of $174.5 million
        contributed to the increase in investing activities in 2005 over 2004. Financing
        activities resulted in a net inflow of $370.1 million in 2005 compared to
        $202.0
        million in 2004. The cash inflow in 2005 was mostly from net deposit growth
        of
        $210.5 million and an increase in short-term borrowings of $157.9 million.
        For
        2004, cash inflows from $254.0 million in deposit growth and $25.4 million
        in
        proceeds from a stock offerings were offset by a cash outflow of $79.0 million
        to pay short-term borrowings.
  At
        December 31, 2005, 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 $421.9 million, or 26% of total assets. This compares to $360.4
        million, or 28% of total assets, at December 31, 2004.
  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, 2005, our total
        potential liquidity through these secondary sources was $521.1 million of
        which
        $363.2 million was currently available, as compared to $394.4 million at
        December 31, 2004 of which all was currently available.


18




Subject
      to regulatory approvals, we are targeting to open approximately 30 new stores
      over the next six years. The cost to construct and furnish a new store will
      be
      approximately $1.7 million, excluding the cost to lease or purchase the land
      on
      which the store is located. To accommodate our growth and perpetuate our culture
      we currently are completing construction on a new Headquarters, Operations
      and
      Training Center in Harrisburg, which we expect to open at the end of March
      2006.
      As of December 31, 2005, the remaining anticipated funding to construct and
      furnish this building is expected to be approximately $8 million.






***Aggregate
      Contractual Obligations***




The
      following table represents our on-and-off balance sheet aggregate contractual
      obligations to make future payments as of December 31, 2005:




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


**December
                31, 2005***(in
                thousands)*
            
            **Less
                than**
              **1
                Year**
            
            **1
                to 3**
              **Years**
            
            **3
                to 5**
              **Years**
            
            **Over
                5**
              **Years**
            
            **Total**Time
                Deposits
            
            **$**
            **114,530**
            
            **$**
            **61,450**
            
            **$**
            **52,891**
            
            **$**
            **0**
            
            **$**
            **228,871**Long-Term
                Debt
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **13,600**
            
            
            **13,600**Operating
                Leases
            
            
            **1,948**
            
            
            **3,722**
            
            
            **3,416**
            
            
            **26,183**
            
            
            **35,269**Purchase
                Obligations
            
            
            **8,000**
            
            
            **0**
            
            
            **0**
            
            
            **0**
            
            
            **8,000**Sponsorship
                Obligation
            
            
            **225**
            
            
            **617**
            
            
            **467**
            
            
            **1,866**
            
            
            **3,175**Total
            
            **$**
            **124,703**
            
            **$**
            **65,789**
            
            **$**
            **56,774**
            
            **$**
            **41,649**
            
            **$**
            **288,915**




For
      further discussion regarding our commitments and contingencies, please see
      Note
      18 in the Notes
      to
      Consolidated Financial Statements at December 31, 2005, 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 at December 31, 2005* ,
      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, 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;
      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.




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 further information, refer to the Company’s filings with the
      SEC.






19




***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 is
      discussed above. Historically, our net interest margin has remained fairly
      stable, however, our net interest margin for the year ended December 31, 2005
      was 3.77%, a decrease of 51 basis points from 4.28% for the year ended December
      31, 2004 as a result of the flattening yield curve in effect throughout 2005.
      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 96% 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. ****




20




**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 statement 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, 2005, 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, 2005,
      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 the effectiveness of the
      Company’s internal control over financial reporting as of December 31,
      2005.







/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
      13,
      2006


21


**Report
        of Independent Registered Public Accounting Firm**
   To
        the
        Board of Directors and Stockholders
 Pennsylvania
        Commerce Bancorp, Inc.
 Camp
        Hill, 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, 2005, 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, 2005, 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,
        2005, 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, 2005 and 2004,
        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,
        2005
        and our report dated March 13, 2006, expressed an unqualified opinion
        thereon.
  /s/
        Beard
        Miller Company LLP
  Beard
        Miller Company LLP
 Harrisburg,
        Pennsylvania
 March
        13,
        2006
  22
   **Report
        of Independent Registered Public Accounting Firm**
 
  To
        the
        Board of Directors and Stockholders
 Pennsylvania
        Commerce Bancorp, Inc.
 Camp
        Hill, Pennsylvania
   We
        have
        audited the accompanying consolidated balance sheets of Pennsylvania Commerce
        Bancorp, Inc. and subsidiaries as of December 31, 2005 and 2004, 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, 2005. 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, 2005 and 2004 and the results
        of their operations and their cash flows for the each of the years in the
        three-year period ended December 31, 2005 in conformity with accounting
        principles generally accepted in the United States of America.
  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,
        2005, 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 13, 2006 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
        13,
        2006
  23
   **Consolidated
        Balance Sheets**
  **December
                31,***(in
                  thousands, except share amounts)*
              
              **2005**
              
              2004**Assets**Cash
                  and due from banks
              
              **$**
              **36,422**
              
              $
              28,910Federal
                  funds sold
              
              
              **0**
              
              
              12,000Cash
                  and cash equivalents
              
              
              **36,422**
              
              
              40,910Securities,
                  available for sale at fair value
              
              
              **380,836**
              
              
              314,065Securities,
                  held to maturity at cost(fair
                  value 2005: $301,978; 2004: $210,908)
              
              
              **306,266**
              
              
              209,917Loans,
                  held for sale
              
              
              **10,585**
              
              
              14,287Loans
                  receivable, net of allowance for loan losses(allowance
                  2005: $9,231; 2004: $7,847)
              
              
              **815,439**
              
              
              638,496Restricted
                  investments in bank stocks
              
              
              **11,463**
              
              
              5,716Premises
                  and equipment, net
              
              
              **66,264**
              
              
              45,188Other
                  assets
              
              
              **13,846**
              
              
              8,788**Total
                  assets**
              
              **$**
              **1,641,121**
              
              $
              1,277,367**Liabilities
                  and Stockholders’ Equity**Deposits:Noninterest-bearing
              
              **$**
              **248,101**
              
              $
              206,393Interest-bearing
              
              
              **1,122,961**
              
              
              954,154Total
                  deposits
              
              
              **1,371,062**
              
              
              1,160,547Short-term
                  borrowings and repurchase agreements
              
              
              **157,900**
              
              
              0Long-term
                  debt
              
              
              **13,600**
              
              
              13,600Other
                  liabilities
              
              
              **6,916**
              
              
              18,181Total
                  liabilities
              
              
              **1,549,478**
              
              
              1,192,328Stockholders’
                  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 2005: 6,013,859; 2004: 5,869,606)
              
              
              **6,014**
              
              
              5,870Surplus
              
              
              **64,859**
              
              
              62,790Retained
                  Earnings
              
              
              **24,767**
              
              
              16,030Accumulated
                  other comprehensive income (loss)
              
              
              **(4,397**
              **)**
              
              (51
              )Total
                  stockholders’ equity
              
              
              **91,643**
              
              
              85,039**Total
                  liabilities and stockholders’ equity**
              
              **$**
              **1,641,121**
              
              $
              1,277,367
  
 *See
        accompanying notes*
  24
  **Consolidated
        Statements of Income**
 
  **Years
                Ended December 31,***(in
                  thousands, except share amounts)*
              
              **2005**
              
              2004
              
              2003**Interest
                  Income**Loans
                  receivable, including fees:Taxable
              
              **$**
              **47,949**
              
              $
              35,433
              
              $
              27,545Tax-exempt
              
              
              **421**
              
              
              292
              
              
              216Securities:Taxable
              
              
              **30,822**
              
              
              24,789
              
              
              17,108Tax-exempt
              
              
              **355**
              
              
              401
              
              
              453Federal
                  funds sold
              
              
              **5**
              
              
              67
              
              
              220**Total
                  interest income**
              
              
              **79,552**
              
              
              60,982
              
              
              45,542**Interest
                  Expense**Deposits
              
              
              **23,408**
              
              
              11,909
              
              
              10,089Short-term
                  borrowings
              
              
              **3,821**
              
              
              1,070
              
              
              207Long-term
                  debt
              
              
              **1,418**
              
              
              1,418
              
              
              1,356**Total
                  interest expense**
              
              
              **28,647**
              
              
              14,397
              
              
              11,652**Net
                  interest income**
              
              
              **50,905**
              
              
              46,585
              
              
              33,890Provision
                  for loan losses
              
              
              **1,560**
              
              
              2,646
              
              
              1,695Net
                  interest income after provision for loan losses
              
              
              **49,345**
              
              
              43,939
              
              
              32,195**Noninterest
                  Income**Service
                  charges and other fees
              
              
              **12,430**
              
              
              10,252
              
              
              7,968Other
                  operating income
              
              
              **466**
              
              
              414
              
              
              377Gains
                  on sales of loans
              
              
              **1,320**
              
              
              630
              
              
              765Gains
                  (losses) on sales of securities
              
              
              **(60**
              **)**
              
              0
              
              
              880**Total
                  noninterest income**
              
              
              **14,156**
              
              
              11,296
              
              
              9,990**Noninterest
                  Expenses**Salaries
                  and employee benefits
              
              
              **26,267**
              
              
              21,824
              
              
              16,702Occupancy
              
              
              **5,380**
              
              
              4,375
              
              
              3,420Furniture
                  and equipment
              
              
              **2,733**
              
              
              2,503
              
              
              1,844Advertising
                  and marketing
              
              
              **3,461**
              
              
              3,108
              
              
              2,425Data
                  processing
              
              
              **3,843**
              
              
              2,922
              
              
              2,148Postage
                  and supplies
              
              
              **1,308**
              
              
              1,141
              
              
              986Other
              
              
              **7,411**
              
              
              6,593
              
              
              4,985**Total
                  noninterest expenses**
              
              
              **50,403**
              
              
              42,466
              
              
              32,510Income
                  before taxes
              
              
              **13,098**
              
              
              12,769
              
              
              9,675Provision
                  for federal income taxes
              
              
              **4,281**
              
              
              4,178
              
              
              3,118**Net
                  income**
              
              **$**
              **8,817**
              
              $
              8,591
              
              $
              6,557**Net
                  Income per Common Share***Basic*
              
              **$**
              **1.47**
              
              $
              1.75
              
              $
              1.44*Diluted*
              
              **$**
              **1.38**
              
              $
              1.63
              
              $
              1.34**Average
                  Common and Common Equivalent Shares Outstanding***Basic*
              
              
              **5,948**
              
              
              4,856
              
              
              4,506*Diluted*
              
              
              **6,318**
              
              
              5,218
              
              
              4,836
  
 *See
        accompanying notes*
  25
  **Consolidated
        Statements of Stockholders’ Equity**
  
 
 *(dollars
                  in thousands )*
              
              
              Preferred
                  Stock
              
              
              Common 
Stock
              
              
              Surplus
              
              
              Retained
                Earnings
              
              
              Accumulated
                  Other
                Comprehensive
                Income
                  (Loss)
              
              
              Total
 **January
                    1, 2003**
                
                **$**
                **400**
                
                **$**
                **2,117**
                
                **$**
                **31,909**
                
                **$**
                **6,866**
                
                **$**
                **1,520**
                
                **$**
                **42,812**Comprehensive
                    income:Net
                    income
                
                
                -
                
                
                -
                
                
                -
                
                
                6,557
                
                
                -
                
                
                6,557Change
                    in unrealized gains (losses) on securities, net of taxes and
                    reclassification adjustment
                
                
                -
                
                
                -
                
                
                -
                
                
                -
                
                
                (971
                )
                
                (971
                )Total
                    comprehensive income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                5,586Dividends
                    declared on preferred stock
                
                
                -
                
                
                -
                
                
                -
                
                
                (80
                )
                
                -
                
                
                (80
                )Common
                    stock of 48,226 shares issued under stock option plans, including
                    tax
                    benefit of $178
                
                
                -
                
                
                48
                
                
                686
                
                
                -
                
                
                -
                
                
                734Common
                    stock of 110 shares issued under employee stock purchase
                    plan
                
                
                -
                
                
                -
                
                
                4
                
                
                -
                
                
                -
                
                
                4Proceeds
                    from issuance of 16,950 shares of common stock in connection
                    with dividend
                    reinvestment and stock purchase plan
                
                
                -
                
                
                17
                
                
                660
                
                
                -
                
                
                -
                
                
                6775%
                    common stock dividend and cash paid in lieu of fractional shares
                    (109,430
                    shares issued)
                
                
                -
                
                
                110
                
                
                5,466
                
                
                (5,585
                )
                
                -
                
                
                (9
                )**December
                    31, 2003**
                
                **$**
                **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**
   *See
        accompanying notes*
  26
 **Consolidated
        Statements of Cash Flows**
 
  **Years
                  Ended December
                  31,***(in thousands)*
              
              **2005**
              
              2004
              
              2003**Operating
                  Activities**Net
                  income
              
              **$**
              **8,817**
              
              $
              8,591
              
              $
              6,557Adjustments
                  to reconcile net income to net cash provided by operating
                  activities:Provision
                  for loan losses
              
              
              **1,560**
              
              
              2,646
              
              
              1,695Provision
                  for depreciation and amortization
              
              
              **3,006**
              
              
              2,397
              
              
              1,831Deferred
                  income taxes
              
              
              **(1,303**
              **)**
              
              708
              
              
              285Amortization
                  of securities premiums and accretion of discounts, net
              
              
              **1,216**
              
              
              1,219
              
              
              3,036Net
                  (gains) losses on sales of securities
              
              
              **60**
              
              
              0
              
              
              (880
              )Proceeds
                  from sales of loans
              
              
              **104,627**
              
              
              75,619
              
              
              106,950Loans
                  originated for sale
              
              
              **(100,032**
              **)**
              
              (80,112
              )
              
              (104,835
              )Gains
                  on sales of loans held for sale
              
              
              **(1,320**
              **)**
              
              (630
              )
              
              (765
              )Noncash
                  compensation
              
              
              **68**
              
              
              0
              
              
              0(Increase)
                  decrease in other assets
              
              
              **(1,026**
              **)**
              
              8,035
              
              
              (10,724
              )Increase
                  (decrease) in other liabilities
              
              
              **(11,265**
              **)**
              
              14,443
              
              
              (93
              )**Net
                  cash provided by operating activities**
              
              
              **4,408**
              
              
              32,916
              
              
              3,057**Investing
                  Activities**Securities
                  held to maturity:Proceeds
                  from principal repayments and maturities
              
              
              **49,709**
              
              
              36,967
              
              
              45,855Proceeds
                  from sales
              
              
              **5,456**
              
              
              0
              
              
              0Purchases
              
              
              **(151,046**
              **)**
              
              (46,893
              )
              
              (148,228
              )Securities
                  available for sale:Proceeds
                  from principal repayments and maturities
              
              
              **94,077**
              
              
              113,389
              
              
              191,681Proceeds
                  from sales
              
              
              **55,263**
              
              
              0
              
              
              8,294Purchases
              
              
              **(224,441**
              **)**
              
              (154,071
              )
              
              (273,431
              )Proceeds
                  from sale of loans receivable
              
              
              **10,005**
              
              
              0
              
              
              0Net
                  increase in loans receivable
              
              
              **(188,082**
              **)**
              
              (171,205
              )
              
              (107,897
              )Net
                  (purchase) redemption of restricted investments in bank
                  stock
              
              
              **(5,747**
              **)**
              
              (489
              )
              
              (3,182
              )Purchases
                  of premises and equipment
              
              
              **(24,082**
              **)**
              
              (9,407
              )
              
              (13,600
              )**Net
                  cash used by investing activities**
              
              
              **(378,888**
              **)**
              
              (231,709
              )
              
              (300,508
              )**Financing
                  Activities**Net
                  increase in demand, interest checking, money market, and savings
                  deposits
              
              
              **193,634**
              
              
              224,257
              
              
              166,787Net
                  increase in time deposits
              
              
              **16,881**
              
              
              29,763
              
              
              12,785Net
                  increase (decrease) in short-term borrowings
              
              
              **157,900**
              
              
              (79,000
              )
              
              79,000Proceeds
                  from common stock options exercised
              
              
              **874**
              
              
              982
              
              
              556Proceeds
                  from dividend reinvestment and common stock purchase plan
              
              
              **783**
              
              
              675
              
              
              677Proceeds
                  from issuance of common stock in connection with stock
                  offerings
              
              
              **0**
              
              
              25,408
              
              
              0Cash
                  dividends on preferred stock and cash in lieu of fractional
                  shares
              
              
              **(80**
              **)**
              
              (97
              )
              
              (89
              )**Net
                  cash provided by financing activities**
              
              
              **369,992**
              
              
              201,988
              
              
              259,716Increase
                  (decrease) in cash and cash equivalents
              
              
              **(4,488**
              **)**
              
              3,195
              
              
              (37,735
              )Cash
                  and cash equivalents at beginning of year
              
              
              **40,910**
              
              
              37,715
              
              
              75,450**Cash
                  and cash equivalents at year-end**
              
              **$**
              **36,422**
              
              $
              40,910
              
              $
              37,715
 
 *See
        accompanying notes.*
  27
   Notes
        to
        Consolidated Financial Statements
  **1.**  **Significant
        Accounting Policies**
  ***Nature
        of Operations and Basis of Presentation***
  The
        2005
        and 2004 consolidated financial statements include the accounts of Pennsylvania
        Commerce Bancorp, Inc. (the Company) and its wholly-owned subsidiary Commerce
        Bank/Harrisburg, N.A. (Commerce or Bank). The 2003 consolidated financial
        statements also include Commerce Harrisburg Capital Trust I (Trust I) and
        Commerce Harrisburg Capital Trust II (Trust II). All material intercompany
        transactions have been eliminated. The Company was formed July 1, 1999 and
        is
        subject to regulation of the Federal Reserve Bank.
  In
        2004,
        as a result of applying the provisions of FASB Interpretation No. 46,
“Consolidation of Variable Interest Entities, an Interpretation of ARB No.
        51,”
which represented new accounting guidance governing when an equity interest
        should be consolidated, the Company was required to deconsolidate Trust I
        and
        Trust II from its financial statements. Prior periods have not been restated.
        The deconsolidation of the net assets and results of operations of the trusts
        had virtually no impact on the Company’s financial statements or liquidity since
        the Company continues to be obligated to repay the debentures held by the
        trusts
        and guarantees repayment of the preferred securities issued by the trusts.
        The
        Company’s total debt obligation related to the trusts did increase, however,
        from $13.0 million to $13.6 million upon deconsolidation, with the difference
        representing the Company’s common ownership interest in the Trusts, which is now
        reported in “Other assets.”
  The
        Company is a one-bank holding company head-quartered in Camp Hill, 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, and Reading 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.
   28
  ***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.
  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.
   ***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, 2005, $6.6 million of the Company’s FHLB stock was purchased to
        cover the Company’s borrowing level on its credit line at the FHLB. The stock is
        carried at cost.
   29
  ***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.
   ***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. Per share
        amounts have been adjusted to give retroactive effect to stock dividends
        and
        stock splits declared through January 28, 2005.
   ***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, 2005, 2004, and 2003 for interest was
        $28.5 million, $14.4 million, and $12.0 million respectively. Income taxes
        paid totaled $3.9 million, $3.7 million, and $2.5 million in 2005, 2004,
        and
        2003, respectively.
   ***Stock-Based
        Compensation***
  The
        Company accounts for stock awards issued to directors, officers, and key
        employees using the intrinsic value method in accordance with Accounting
        Principles Board Opinion No. 25. This method requires that compensation expense
        be recognized to the extent that the fair value of the stock exceeds the
        exercise price of the stock award at the grant date. The Company generally
        does
        not recognize compensation expense related to stock awards because the stock
        awards generally have fixed terms and exercise prices that are equal to or
        greater than the fair value of the Company’s common stock at the grant
        date.
  For
        purposes of pro-forma disclosures, the estimated fair value of the options
        is
        amortized to expense over the options’ vesting period. The Company’s pro-forma
        information is presented in the following table.
   30
  
  **Year
                  Ended December 31,***(in
                  thousands)*
              
              **2005**
              
              2004
              
              2003Net
                  income:As
                  reported
              
              **$**
              **8,817**
              
              $
              8,591
              
              $
              6,557Total
                  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
              )
              
              (814
              )Pro-forma
              
              **$**
              **6,275**
              
              $
              7,470
              
              $
              5,743Reported
                  earnings per share:*Basic*
              
              **$**
              **1.47**
              
              $
              1.75
              
              $
              1.44*Diluted*
              
              **$**
              **1.38**
              
              
              1.63
              
              
              1.34Pro-forma
                  earnings per share:*Basic*
              
              **$**
              **1.04**
              
              $
              1.52
              
              $
              1.26*Diluted*
              
              **$**
              **0.97**
              
              
              1.42
              
              
              1.17
  The
        fair
        value of each option grant is estimated at the date of grant using the
        Black-Scholes option pricing model with the following weighted-average
        -assumptions for 2005, 2004, and 2003 respectively: risk-free interest rates
        of
        4.1%, 3.6% and 3.4%; volatility factors of the expected market price of the
        Company’s common stock of .26, .21, and .21; weighted-average expected life of
        the options of 7.3, 6.1, and 10.0 years; and no cash dividends.
  Had
        compensation costs for stock options granted in 2005, 2004 and 2003 been
        determined based on the fair value at the grant dates for awards under the
        plan
        consistent with the provisions of SFAS No. 123, the Company’s net income and
        earnings per share for the years ended December 31, 2005, 2004 and 2003 would
        have been reduced to the proforma amounts indicated.
  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 (FASB) Statement No. 123(R),
        “Share-Based Payment” 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. The Company estimates that the
        accelerated vesting of these options will eliminate potential pre-tax
        compensation expense in future periods of approximately $1.8 million, including
        approximately $700,000 in 2006.
  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.
  ***Recent
        Accounting Standards***
  In
        March
        2004, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue
        No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its
        Application to Certain Investments.” EITF 03-1 provides guidance on
        other-than-temporary impairment models for marketable debt and equity securities
        accounted for under Statements of Financial Accounting Standards (“SFAS”) 115
        and non-marketable equity securities accounted for under the cost method.
        The
        EITF developed a basic three-step model to evaluate whether an investment
        is
        other-than-temporarily impaired. In November 2005, the FASB approved the
        issuance of FASB Staff Position (“FSP”) SFAS No. 115-1 and FAS 124-1, “The
        Meaning of Other-Than-Temporary Impairment and Its Application to Certain
        Investments.” The FSP addresses when an investment is considered impaired,
        whether the impairment is other-than-temporary and the measurement of an
        impairment loss. The FSP also includes accounting considerations subsequent
        to
        the recognition of an other-than-temporary impairment and requires certain
        disclosures about unrealized losses that have not been recognized as
        other-than-temporary. The FSP is effective for reporting periods beginning
        after
        December 15, 2005 with earlier application permitted. The Company plans to
        adopt the FSP in the 1st quarter of fiscal 2006. The adoption of this accounting
        principle is not expected to have a significant impact on the Company’s
        financial position or results of operations.
  In
        December 2004, the FASB issued Statement No. 123(R), “Share-Based Payment.”
Statement No. 123(R) revised FAS 123, “Accounting for Stock-Based Compensation,”
and supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting
        for Stock Issued to Employees,” and its related implementation guidance. FAS
        123(R) requires compensation costs related to share-based payment transactions
        to be recognized in the income statement (with limited exceptions) based
        on
        their fair values and no longer allows pro-forma disclosure as an alternative
        to
        reflecting the impact of share-based payments on net income and net income
        per
        share. The amount of compensation cost will be measured based on the grant-date
        fair value of the stock-based compensation issued. Compensation cost will
        be
        recognized over the period that an employee provides service in exchange
        for the
        award.
   31
  In
        October 2005, the FASB issued FSP FAS 123(R)-2, “Practical
        Accommodation to the Application of Grant Date as Defined in FAS 123(R).”
FSP 123(R)-2 provides guidance on the application of grant date as defined
        in SFAS No. 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 Company will adopt this standard at the same time as SFAS
        No. 123(R). It is not expected to have a material impact on the Company’s
        consolidated financial position, results of operations, or cash
        flows.
  In
        November 2005, the FASB issued final FSP FAS No. 123(R)-3, “Transition
        Election Related to Accounting for the Tax Effects of Share-Based Payment
        Awards” (“FSP 123(R)-3”). FSP 123(R)-3 provides an alternative method of
        calculating excess tax benefits (the Additional Paid in Capital ("APIC")
        pool)
        from the method defined in FAS 123(R) for share-based payments. A one-time
        election to adopt the transition method in this FSP is available to those
        entities adopting FAS 123(R) using either the modified retrospective or modified
        prospective method. Up to one year from the initial adoption of FAS 123(R)
        or
        effective date of FSP 123(R)-3 is provided to make this one-time election.
        However, until an entity makes its election, it must follow the guidance
        in FAS
        123(R). FSP 123(R)-3 is effective upon initial adoption of FAS 123(R) and
        will
        become effective for the Company in the first quarter of fiscal 2006. The
        Company is currently evaluating the potential impact of calculating the APIC
        pool with this alternative method and has not determined which method to
        adopt, or the expected impact on the Company’s consolidated financial position
        or results of operations.
  The
        Company expects the adoption of SFAS 123(R) to have an unfavorable impact
        on its financial position and results of operations. See Note 1, “Summary
        of Significant Accounting Policies,” of the *Notes
        to Consolidated Financial Statements* for
        information related to the pro forma effects on the Company’s reported net
        income and net income per share of applying the fair value recognition provision
        of the previous SFAS 123 to stock-based compensation.
  The
        impact on reported results of adoption of this statement, which the Company
        will
        be required to utilize for periods beginning January 1, 2006, is presented
        in
        Note 1 above. The impact on operations in future periods will be determined
        by
        amortizing the value imputed to future option grants using the above described
        methods. There is no impact on cash flow.
  The
        Company will adopt SFAS 123(R) using the modified prospective method with
        no
        prior period restatement and have 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. Any
        additional impact that the adoption of this statement will have on the Company’s
        financial position and results of operations will be determined by share-based
        payments granted in future periods and the assumptions on which the value
        of
        those share-based payments is based.
  In
        May
        2005, FASB issued SFAS 154, “Accounting Changes and Error Corrections”. The
        Statement requires retroactive application of a voluntary change in accounting
        principle to prior period financial statements unless it is impracticable.
        SFAS
        154 also requires that a change in method of depreciation, amortization,
        or
        depletion for long-lived, non-financial assets be accounted for as a change
        in
        accounting estimate that is affected by a change in accounting principle. 
SFAS 154 replaces APB Opinion 20, “Accounting Changes”, and SFAS 3, “Reporting
        Accounting Changes in Interim Financial Statements”. SFAS 154 will be
        effective for accounting changes and corrections of errors made in fiscal
        years
        beginning after December 15, 2005. Management currently believes that
        adoption of the provisions of SFAS 154 will not have a material impact on
        the
        Company’s condensed consolidated financial statements.
  In
        October 2005, the FASB issued FASB Staff Position FAS 13-1 (“FSP 13-1”), which
        requires companies to expense rental costs associated with ground or building
        operating leases that are incurred during a construction period. As a result,
        companies that are currently capitalizing these rental costs are required
        to
        expense them beginning in its first reporting period beginning after December
        15, 2005. FSP 13-1 is effective for the Company as of the first quarter of
        fiscal 2006. The Company evaluated the provisions of FSP 13-1 and does not
        believe that its adoption will have a material impact on the
        consolidated financial condition or results of operations.
  ***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 2004 and 2003 financial statements have been reclassified
        to
        conform to the 2005 presentation format. Such reclassifications had no impact
        on
        the Company’s net income.
   32
  **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 their deposit liabilities. The average
        amount
        of these reserve balances maintained for 2005 and 2004 was approximately
        $19.0
        million and $16.3 million, respectively.
  **3.**  **Securities**
  The
        amortized cost and fair value of securities are summarized in the following
        tables.
  **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
 
 **December
                  31, 2004***(in
                  thousands)*
              
              **Amortized
                  Cost**
              
              **Gross
                  Unrealized Gains**
              
              **Gross
                  Unrealized Losses**
              
              **Fair
                  Value****Available
                  for Sale**U.S.
                  Government Agency securities
              
              $
              10,000
              
              $
              0
              
              $
              (202
              )
              $
              9,798Mortgage-backed
                  securities
              
              
              302,133
              
              
              1,614
              
              
              (1,660
              )
              
              302,087Corporate
                  debt securities
              
              
              2,009
              
              
              171
              
              
              0
              
              
              2,180Total
              
              $
              314,142
              
              $
              1,785
              
              $
              (1,862
              )
              $
              314,065**Held
                  to Maturity**U.S.
                  Government Agency securities
              
              $
              70,981
              
              $
              49
              
              $
              (663
              )
              $
              70,367Municipal
                  securities
              
              
              6,827
              
              
              36
              
              
              (29
              )
              
              6,834Mortgage-backed
                  securities
              
              
              114,963
              
              
              1,051
              
              
              (715
              )
              
              115,299Corporate
                  debt securities
              
              
              17,146
              
              
              1,262
              
              
              0
              
              
              18,408Total
              
              $
              209,917
              
              $
              2,398
              
              $
              (1,407
              )
              $
              210,908
  The
        amortized cost and fair value of debt securities at December 31, 2005 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
              
              **$**
              **2,103**
              
              **$**
              **2,105**
              
              **$**
              **0**
              
              **$**
              **0**Due
                  after one year through five years
              
              
              **16,485**
              
              
              **16,715**
              
              
              **0**
              
              
              **0**Due
                  after five years through ten years
              
              
              **101,788**
              
              
              **100,269**
              
              
              **0**
              
              
              **0**Due
                  after ten years
              
              
              **35,496**
              
              
              **35,554**
              
              
              **5,000**
              
              
              **4,792****155,872**
              
              
              **154,643**
              
              
              **5,000**
              
              
              **4,792**Mortgage-backed
                  securities
              
              
              **150,394**
              
              
              **147,335**
              
              
              **382,498**
              
              
              **376,044**Total
              
              **$**
              **306,266**
              
              **$**
              **301,978**
              
              **$**
              **387,498**
              
              **$**
              **380,836**
  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.
   33
  There
        were no sales of securities available for sale or held to maturity in 2004.
  Gross
        gains of $640,000 and gross losses of $0 were realized on sales of securities
        available for sale in 2003. Additionally, gross gains of $240,000 and gross
        losses of $0 were realized on sales of securities held to maturity. The sale
        of
        securities held to maturity consisted of $4.5 million of corporate bonds
        which
        were sold solely due to a continued deterioration in the issuer’s
        creditworthiness over the past three years.
  At
        December 31, 2005 and 2004, securities with a fair value of $470.1 million
        and
        $337.8 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, 2005****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
              
              **$**
              **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**
              **)****December
                    31, 2004****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
              
              **$**
              **4,895**
              
              **$**
              **(105**
              **)**
              **$**
              **4,903**
              
              **$**
              **(97**
              **)**
              **$**
              **9,798**
              
              **$**
              **(202**
              **)**Mortgage-backed
                  securities
              
              
              **152,354**
              
              
              **(1,456**
              **)**
              
              **12,408**
              
              
              **(204**
              **)**
              
              **164,762**
              
              
              **(1,660**
              **)**Total
              
              **$**
              **157,249**
              
              **$**
              **(1,561**
              **)**
              **$**
              **17,311**
              
              **$**
              **(301**
              **)**
              **$**
              **174,560**
              
              **$**
              **(1,862**
              **)****Held
                  to Maturity**U.S.
                  Government Agency securities
              
              **$**
              **26,900**
              
              **$**
              **(80**
              **)**
              **$**
              **29,417**
              
              **$**
              **(583**
              **)**
              **$**
              **56,317**
              
              **$**
              **(663**
              **)**Municipal
                  securities
              
              
              **4,800**
              
              
              **(29**
              **)**
              
              **0**
              
              
              **0**
              
              
              **4,800**
              
              
              **(29**
              **)**Mortgage-backed
                  securities
              
              
              **36,597**
              
              
              **(438**
              **)**
              
              **21,351**
              
              
              **(277**
              **)**
              
              **57,948**
              
              
              **(715**
              **)**Total
              
              **$**
              **68,297**
              
              **$**
              **(547**
              **)**
              **$**
              **50,768**
              
              **$**
              **(860**
              **)**
              **$**
              **119,065**
              
              **$**
              **(1,407**
              **)**
  At
        December 31, 2005, 63 mortgage-backed securities, 12 U.S. Government Agency
        securities, and 3 municipal securities have been in a continuous unrealized
        loss
        position for less than twelve months. For the same period, 33 mortgage-backed
        securities and 4 U.S. Government Agency securities 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,
        2005.
  The
        unrealized losses on the Company’s investment in federal agency mortgage-backed
        securities were caused by interest rate increases. 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, 2005.
   34
  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)*
              
              **2005**
              
              2004Real
                  Estate:Commercial
                  Mortgage
              
              **$**
              **299,219**
              
              $
              239,576Construction
                  and land development
              
              
              **47,334**
              
              
              39,467Residential
                  Mortgage
              
              
              **83,213**
              
              
              79,672Tax-Exempt
              
              
              **17,055**
              
              
              6,303Commercial
                  Business
              
              
              **138,174**
              
              
              97,198Consumer
              
              
              **148,906**
              
              
              109,568Commercial
                  Lines of Credit
              
              
              **90,769**
              
              
              74,559**824,670**
              
              
              646,343Less:
                  Allowance for Loan Losses
              
              
              **9,231**
              
              
              7,847Net
                  Loans Receivable
              
              **$**
              **815,439**
              
              $
              638,496
  The
        following is a summary of the transactions in the allowance for loan
        losses.
  **Years
                  Ended December 31,***(in
                  thousands)*
              
              **2005**
              
              2004
              
              2003Balance
                  at beginning of year
              
              **$**
              **7,847**
              
              $
              6,007
              
              $
              5,146Provision
                  charged to expense
              
              
              **1,560**
              
              
              2,646
              
              
              1,695Recoveries
              
              
              **596**
              
              
              231
              
              
              266Loans
                  charged off
              
              
              **(772**
              **)**
              
              (1,037
              )
              
              (1,100
              )Balance
                  at end of year
              
              **$**
              **9,231**
              
              $
              7,847
              
              $
              6,007
  At
        December 31, 2005 and 2004, the recorded investment in loans considered to
        be
        impaired under FASB Statement No. 114 “Accounting by Creditors for Impairment of
        a Loan” totaled $6.9 million and $9.4 million, respectively. At December 31,
        2005, $1.4 million of impaired loans have a specific valuation allowance
        of
        $740,000 as compared to $2.3 million of impaired loans having a specific
        valuation allowance of $1.3 million at December 31, 2004. Total non-accrual
        loans at December 31, 2005 and 2004 totaled $2.3 million and $586,000,
        respectively. Loans past due 90 days or more and still accruing interest
        totaled
        $233,000 at December 31, 2005 and $0 at December 31, 2004.
  Impaired
        loans averaged approximately $7.3 million, $8.9 million and $5.5 million
        during
        2005, 2004 and 2003, respectively. Interest income recognized on these loans
        amounted to $682,000, $507,000 and $41,000 during 2005, 2004 and 2003,
        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 $13.6
        million and $14.6 million at December 31, 2005 and 2004, respectively. During
        2005, $3.6 million of new advances were made and repayments totaled
        $4.6 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.
   35
  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, 2005 for guarantees under standby letters of credit issued is
        not
        material.
  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)*
              
              **2005**
              
              2004Commitments
                  to grant loans
              
              **$**
              **16,145**
              
              $
              3,668Unfunded
                  commitments of existing loans
              
              
              **290,608**
              
              
              188,869Standby
                  letters of credit
              
              
              **16,037**
              
              
              10,929Total
              
              **$**
              **322,790**
              
              $
              203,466
  **6.**  **Concentrations
        of Credit Risk**
  The
        Company’s loan portfolio is principally to borrowers throughout Cumberland,
        Dauphin, York, Lebanon and Berks counties of Pennsylvania where it has
        full-service stores. Commercial real estate loans and loan commitments for
        commercial real estate projects aggregated $383.8 million at December 31,
        2005.
  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 2005 was $3.0 million 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)*
              
              **2005**
              
              2004Land
              
              **$**
              **11,707**
              
              $
              10,325Buildings
              
              
              **35,969**
              
              
              27,829Construction
                  in process
              
              
              **12,819**
              
              
              2,495Leasehold
                  improvements
              
              
              **3,661**
              
              
              3,122Furniture,
                  fixtures and equipment
              
              
              **17,189**
              
              
              13,667**81,345**
              
              
              57,438Less
                  accumulated depreciation and amortization
              
              
              **15,081**
              
              
              12,250**$**
              **66,264**
              
              $
              45,188
  Land,
        buildings, and equipment are leased under non-cancelable operating lease
        agreements that expire at various dates through 2032. Total rental expense
        for
        operating leases in 2005, 2004, and 2003 was $2.3 million, $1.7 million,
        and
        $1.4 million, respectively. At December 31, 2005, future minimum lease payments
        for noncancelable operating leases are payable as follows:
   36
 
  *(in
                  thousands)*2006
              
              $
              1,9482007
              
              
              1,8352008
              
              
              1,8872009
              
              
              1,7082010
              
              
              1,708Thereafter
              
              
              26,183Total
                  minimum lease payments
              
              $
              35,269
  The
        Company has the option to extend the majority of its store leases beyond
        the
        original terms. If the Company exercised its options, the Company would
        experience an additional $39.0 million in additional lease
        payments.
  **8.**  **Deposits**
  The
        composition of deposits is as follows:
  **December
                  31,***(in
                  thousands)*
              
              **2005**
              
              2004Demand
              
              **$**
              **248,101**
              
              $
              206,393Interest
                  checking and money market
              
              
              **548,909**
              
              
              435,859Savings
              
              
              **345,181**
              
              
              306,305Time
                  certificates $100,000 or more
              
              
              **125,099**
              
              
              104,955Other
                  time certificates
              
              
              **103,772**
              
              
              107,035**$**
              **1,371,062**
              
              $
              1,160,547
  At
        December 31, 2005, the scheduled maturities of time deposits are as
        follows:
  *(in
                  thousands)*2006
              
              $
              114,5302007
              
              
              46,0482008
              
              
              15,4022009
              
              
              19,5312010
              
              
              33,360$
              228,871
  **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 $431 million and certain qualifying assets
        of
        the Bank collateralize the line. There was $145.2 million outstanding at
        a rate
        of 4.22% at December 31, 2005 and $0 outstanding at December 31, 2004 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, 2005 and 2004. The Company did not have any securities pledged
        at December 31, 2005 or 2004 under these repurchase agreements. In addition,
        the
        Bank has a line of credit of $15 million from another bank. There was $12.7
        million outstanding at a rate of 4.50% at December 31, 2005 and $0 outstanding
        at December 31, 2004 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.
   37
  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 the 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 the 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.
  **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)*
              
              **2005**
              
              2004
              
              2003Provision
                  at statutory rate on pre-tax income
              
              **$**
              **4,453**
              
              $
              4,341
              
              $
              3,289Tax-exempt
                  income on loans and investments
              
              
              **(245**
              **)**
              
              (226
              )
              
              (218
              )Other
              
              
              **73**
              
              
              63
              
              
              47**$**
              **4,281**
              
              $
              4,178
              
              $
              3,118
  The
        components of income tax expense are as follows:
  **Year
                  Ended December 31,***(in
                  thousands)*
              
              **2005**
              
              2004
              
              2003Current
              
              **$**
              **2,978**
              
              $
              3,470
              
              $
              2,833Deferred
              
              
              **1,303**
              
              
              708
              
              
              285**$**
              **4,281**
              
              $
              4,178
              
              $
              3,118
  The
        components of the net deferred tax assets were as follows:
  **December
                  31,***(in
                  thousands)*
              
              **2005**
              
              2004Deferred
                  tax assets:Allowance
                  for loan losses
              
              **$**
              **3,138**
              
              $
              2,668Unrealized
                  losses on securities
              
              
              **2,265**
              
              
              26Other
              
              
              **127**
              
              
              120Total
                  deferred tax assets
              
              
              **5,530**
              
              
              2,814Deferred
                  tax liabilities:Premises
                  and equipment
              
              
              **(1,436**
              **)**
              
              (1,618
              )Prepaid
                  expenses
              
              
              **(172**
              **)**
              
              (167
              )Deferred
                  loan fees
              
              
              **(223**
              **)**
              
              (872
              )Total
                  deferred tax liabilities
              
              
              **(1,831**
              **)**
              
              (2,657
              )Net
                  deferred tax assets
              
              **$**
              **3,699**
              
              $
              157
  A
        net
        income tax benefit of $21,000 was recognized on net securities losses during
        2005. During 2005, 2004 and 2003, the Company received a tax benefit on its
        federal income tax return totaling $474,000, $319,000, and $178,000,
        respectively for the exercise of non-qualified stock options and disqualified
        dispositions of employee stock from options exercised.
  **12. Stockholders’
        Equity**
  At
        December 31, 2005, 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 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.
   38
  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 24,329 and 14,432 common shares
        were issued pursuant to this plan in 2005 and 2004, respectively. At
        December 31, 2005, the Company had reserved approximately 390,000 common
        shares to be issued in connection with the plan.
  On
        January 24, 2003, the Board of Directors declared a 5% common stock dividend
        payable on February 24, 2003, to stockholders of record on February 7, 2003.
        Payment of the stock dividend resulted in the issuance of approximately 101,000
        additional common shares.
  On
        January 23, 2004, the Board of Directors declared a 5% common stock dividend
        payable on February 23, 2004, to stockholders of record on February 6, 2004.
        Payment of the stock dividend resulted in the issuance of approximately 109,000
        additional common shares.
  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 its 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,****2005**
              
              2004
              
              2003*(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
              
              **$**
              **8,817**
              
              
              
              
              
              
              
              $
              8,591
              
              
              
              
              
              
              
              $
              6,557Preferred
                  stock dividends
              
              
              **(80**
              **)**
              
              
              
              
              
              
              
              (80
              )
              
              
              
              
              
              
              
              (80
              )Income
                  available to common stockholders
              
              
              **8,737**
              
              
              **5,948**
              
              **$**
              **1.47**
              
              
              8,511
              
              
              4,856
              
              $
              1.75
              
              
              6,477
              
              
              4,506
              
              $
              1.44Effect
                  of dilutive securities:Stock
                  options
              
              
              
              
              
              **370**
              
              
              
              
              
              
              
              
              362
              
              
              
              
              
              
              
              
              330Diluted
                  earnings per share:Income
                  available to common stockholders plus assumed conversions
              
              **$**
              **8,737**
              
              
              **6,318**
              
              **$**
              **1.38**
              
              $
              8,511
              
              
              5,218
              
              $
              1.63
              
              $
              6,477
              
              
              4,836
              
              $
              1.34
  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 years ended December 31, 2004 and December 31, 2003 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 commences January 1, 2006 and replaces 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.
   39
  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, options 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 is 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 estimates that the
        accelerated vesting of these options will eliminate potential pre-tax
        compensation expense in future periods of approximately $1.8 million, including
        approximately $700,000 in 2006.
  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.
  Stock
        options transactions under the Plans were as follows:
  **Years
                    Ended December 31,****2005**
                
                2004
                
                2003**Options**
                
                **Weighted
                    Avg. Exercise Price**
                
                Options
                
                Weighted
                    Avg. Exercise Price
                
                Options
                
                Weighted
                    Avg. Exercise PriceOutstanding
                    at beginning of year
                
                
                **944,967**
                
                **$**
                **14.12**
                
                
                948,268
                
                $
                11.34
                
                
                884,988
                
                $
                9.40Granted
                
                
                **120,505**
                
                
                **33.42**
                
                
                178,220
                
                
                25.37
                
                
                187,440
                
                
                17.98Exercised
                
                
                **(124,639**
                **)**
                
                **8.57**
                
                
                (145,634
                )
                
                8.28
                
                
                (106,578
                )
                
                6.06Forfeited
                
                
                **(18,867**
                **)**
                
                **24.83**
                
                
                (35,887
                )
                
                19.42
                
                
                (17,582
                )
                
                16.46Outstanding
                    at end of year
                
                
                **921,966**
                
                **$**
                **17.18**
                
                
                944,967
                
                $
                14.12
                
                
                948,268
                
                $
                11.34Exercisable
                    at December 31
                
                
                **921,966**
                
                **$**
                **17.18**Options
                    available for grant at December 31
                
                
                **125,134**Weighted-average
                    fair value of options granted during the year
                
                
                
                
                **$**
                **12.32**
                
                
                
                
                $
                8.96
                
                
                
                
                $
                6.27
  Exercise
        prices for options outstanding as of December 31, 2005 are presented in the
        following table.
  **As
                  of December 31, 2005**Options
                  Outstanding
              
              Weighted
                  Avg. Exercise Price
              
              Weighted
                  Avg. Contractual Life
              
              Options
                  Exercisable
              
              Weighted
                  Avg. Exercise PriceOptions
                  with exercise prices ranging from $2.09 to $10.73
              
              
              291,998
              
              $
              8.62
              
              
              2.5
                  Years
              
              
              291,998
              
              $
              8.62Options
                  with exercise prices ranging from $10.74 to $18.03
              
              
              365,710
              
              
              15.53
              
              
              6.2
                  Years
              
              
              365,710
              
              
              15.53Options
                  with exercise prices ranging from $18.04 to $33.50
              
              
              264,258
              
              
              28.90
              
              
              8.6
                  Years
              
              
              264,258
              
              
              28.90Total
                  options outstanding with exercise prices ranging from $2.09 to
                  $33.50
              
              
              921,966
              
              $
              17.18
              
              
              5.7
                  Years
              
              
              921,966
              
              $
              17.18
  **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.
   40
  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, 2005, that the Company and the Bank meet all capital adequacy
        requirements to which they are subject.
  As
        of
        December 31, 2005, and December 31, 2004, 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, 2005 and 2004 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, 2005**Risk
                  based capital ratios:Total
                  capital
              
              **$**
              **118,270**
              
              
              **10.61**
              %
              
              **≥**
              
              **$**
              **89,146**
              
              
              **≥**
              
              
              **8.0**
              %
              
              **≥**
              
              
              **N/A**
              
              
              **≥**
              
              
              **N/A**Tier
                  1 capital
              
              
              **109,040**
              
              
              **9.79**
              %
              
              **≥**
              
              
              **44,573**
              
              
              **≥**
              
              
              **4.0**
              %
              
              **≥**
              
              
              **N/A**
              
              
              **≥**
              
              
              **N/A**Leverage
                  ratio
              
              
              **109,040**
              
              
              **6.69**
              %
              
              **≥**
              
              
              **65,152**
              
              
              **≥**
              
              
              **4.0**
              %
              
              **≥**
              
              
              **N/A**
              
              
              **≥**
              
              
              **N/A****Bank**
                **As
                  of December 31, 2005**Risk
                  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**
              
              
              **≥**
              
              
              **6.0**
              %Leverage
                  ratio
              
              
              **108,749**
              
              
              **6.68**
              %
              
              **≥**
              
              
              **65,120**
              
              
              **≥**
              
              
              **4.0**
              %
              
              **≥**
              
              
              **81,400**
              
              
              **≥**
              
              
              **5.0**
              %Company
                As
                  of December 31, 2004Risk
                  based capital ratios:Total
                  capital
              
              $
              105,936
              
              
              12.49
              %
              
              ≥
              
              $
              67,833
              
              
              ≥
              
              
              8.0
              %
              
              ≥
              
              
              N/A
              
              
              ≥
              
              
              N/ATier
                  1 capital
              
              
              98,090
              
              
              11.57
              %
              
              ≥
              
              
              33,917
              
              
              ≥
              
              
              4.0
              %
              
              ≥
              
              
              N/A
              
              
              ≥
              
              
              N/ALeverage
                  ratio
              
              
              98,090
              
              
              7.79
              %
              
              ≥
              
              
              50,358
              
              
              ≥
              
              
              4.0
              %
              
              ≥
              
              
              N/A
              
              
              ≥
              
              
              N/ABank
                As
                  of December 31, 2004Risk
                  based capital ratios:Total
                  capital
              
              $
              105,708
              
              
              12.48
              %
              
              ≥
              
              $
              67,773
              
              
              ≥
              
              
              8.0
              %
              
              ≥
              
              $
              84,716
              
              
              ≥
              
              
              10.0
              %Tier
                  1 capital
              
              
              97,862
              
              
              11.55
              %
              
              ≥
              
              
              33,886
              
              
              ≥
              
              
              4.0
              %
              
              ≥
              
              
              50,829
              
              
              ≥
              
              
              6.0
              %Leverage
                  ratio
              
              
              97,862
              
              
              7.78
              %
              
              ≥
              
              
              50,326
              
              
              ≥
              
              
              4.0
              %
              
              ≥
              
              
              62,907
              
              
              ≥
              
              
              5.0
              %
  **16. Employee
        Benefit Plan**
  The
        Company has established a 401(k) Retirement Savings Plan for all of its
        employees who meet eligibility requirements. 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 2005, the Company’s
        matching contribution was established at 50% of the employees’ salary deferral.
        For 2004 and 2003, the Company’s matching contribution was established at 25% of
        the employees’ eligible salary deferral. The amount charged to expense was
        $269,000, $158,000, and $96,000 in 2005, 2004, and 2003,
        respectively.
   41
  **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.
  **Year
                  Ended December 31,***(in
                  thousands)*
              
              **2005**
              
              2004
              
              2003Unrealized
                  holding gains(losses)
                arising during the year
              
              **$**
              **(7,258**
              **)**
              $
              (909
              )
              $
              (831
              )Less
                  reclassification adjustment for gains (losses) included in net
                  income
              
              
              **(673**
              **)**
              
              0
              
              
              640Net
                  unrealized gains (losses)
              
              **$**
              **(6,585**
              **)**
              
              (909
              )
              
              (1,471
              )Tax
                  (expense) benefit
              
              
              **2,239**
              
              
              309
              
              
              500Net
                  of tax amount
              
              **$**
              **(4,346**
              **)**
              $
              (600
              )
              $
              (971
              )
  **18. Commitments
        and Contingencies**
  In
        January 2004, 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, a 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 purchased the land located at the corner of Friendship Road and
        TecPort Drive in Swatara Township, Dauphin County, Pennsylvania. The Company
        is
        currently constructing a Headquarters/Operations Facility, to be called Commerce
        Center, on this property to be opened in March of 2006. Management expects
        the
        remaining capital expenditures for this building to be approximately $8.0
        million.
  The
        Company has purchased the parcel of land located at 1249 Market Street, Lemoyne,
        Cumberland County, Pennsylvania. The Company is currently constructing a
        full-service store on this property to be opened in April 2006. This store
        is
        intended to replace the existing store currently located at 100 Senate Avenue,
        Camp Hill, Pennsylvania. In December 2005, the Office of the Comptroller
        of the
        Currency (“OCC”) approved the Company’s request to relocate the main office of
        the Bank from 100 Senate Avenue, Camp Hill, Pennsylvania to 1249 Market Street,
        Lemoyne, Pennsylvania
  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 23 Rohrerstown
        Road, Hempfield Township, Lancaster County, Pennsylvania. The Company plans
        to
        construct a full-service store on this property to be opened in 2006.
  The
        Company has entered into a land lease for the premises located at 1416 Lititz
        Pike in Lancaster County, Pennsylvania. The Company plans to construct a
        full-service store on this property to be opened in 2006.
  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. (an 11.1% 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, and call
        center
        support. The Company paid approximately $2.1 million, $2.0 million, and $1.4
        million for services provided by Commerce Bancorp, Inc. during 2005, 2004,
        and
        2003, 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, 2005 and 2004, approximately $2.0 million and $2.1 million,
        respectively, of these participations were outstanding.
   42
  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 $12.7 million
        at December 31, 2005 and $0 at December 31, 2004.
  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 $413,000, $259,000 and $271,000,
        in
        2005, 2004 and 2003, 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.
  **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.
   43
  ***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.
  The
        carrying amounts and fair values of the Company’s financial instruments as of
        December 31 are presented in the following table.
  **2005**
              
              2004*(in
                  thousands)*
              
              **Carrying
                  Amount**
              
              **Fair
                  Value**
              
              Carrying
                  Amount
              
              Fair
                  ValueFinancial
                  assets:Cash
                  and cash equivalents
              
              **$**
              **36,422**
              
              **$**
              **36,422**
              
              $
              40,910
              
              $
              40,910Securities
              
              
              **687,102**
              
              
              **682,814**
              
              
              523,982
              
              
              524,973Loans,
                  net (including loans held for sale)
              
              
              **826,024**
              
              
              **821,057**
              
              
              652,783
              
              
              657,033Restricted
                  investments in bank stock
              
              
              **11,463**
              
              
              **11,463**
              
              
              5,716
              
              
              5,716Accrued
                  interest receivable
              
              
              **7,681**
              
              
              **7,681**
              
              
              5,582
              
              
              5,582Financial
                  liabilities:Deposits
              
              
              **1,371,062**
              
              
              **1,370,739**
              
              $
              1,160,547
              
              $
              1,162,004Long-term
                  debt
              
              
              **13,600**
              
              
              **18,451**
              
              
              13,600
              
              
              18,008Short-term
                  borrowings
              
              
              **157,900**
              
              
              **157,900**
              
              
              0
              
              
              0Accrued
                  interest payable
              
              
              **643**
              
              
              **643**
              
              
              509
              
              
              509Off-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****2005****Interest
                  income**
              
              **$**
              **22,923**
              
              **$**
              **20,155**
              
              **$**
              **19,294**
              
              **$**
              **17,180****Interest
                  expense**
              
              
              **9,776**
              
              
              **7,410**
              
              
              **6,439**
              
              
              **5,022****Net
                  interest income**
              
              
              **13,147**
              
              
              **12,745**
              
              
              **12,855**
              
              
              **12,158****Provision
                  for loan losses**
              
              
              **140**
              
              
              **250**
              
              
              **625**
              
              
              **545****Gains
                  (losses) on sales of investment securities**
              
              
              **(859**
              **)**
              
              **613**
              
              
              **186**
              
              
              **0****Provision
                  for federal income taxes**
              
              
              **701**
              
              
              **1,117**
              
              
              **1,252**
              
              
              **1,211****Net
                  income**
              
              
              **1,476**
              
              
              **2,325**
              
              
              **2,555**
              
              
              **2,461****Net
                  income per share:****Basic**
              
              **$**
              **0.24**
              
              **$**
              **0.39**
              
              **$**
              **0.43**
              
              **$**
              **0.41****Diluted**
              
              
              **0.23**
              
              
              **0.36**
              
              
              **0.40**
              
              
              **0.39**2004Interest
                  income
              
              $
              16,632
              
              $
              15,638
              
              $
              14,834
              
              $
              13,878Interest
                  expense
              
              
              4,539
              
              
              3,755
              
              
              3,193
              
              
              2,910Net
                  interest income
              
              
              12,093
              
              
              11,883
              
              
              11,641
              
              
              10,968Provision
                  for loan losses
              
              
              721
              
              
              675
              
              
              675
              
              
              575Gains
                  on sales of investment securities
              
              
              0
              
              
              0
              
              
              0
              
              
              0Provision
                  for federal income taxes
              
              
              1,123
              
              
              1,069
              
              
              1,052
              
              
              934Net
                  income
              
              
              2,284
              
              
              2,198
              
              
              2,181
              
              
              1,928Net
                  income per share:Basic
              
              $
              0.41
              
              $
              0.47
              
              $
              0.47
              
              $
              0.41Diluted
              
              
              0.38
              
              
              0.43
              
              
              0.43
              
              
              0.38
   44
  **22. Condensed
        Financial Statements of Parent Company**
 **Balance
                  Sheets****December
                  31,***(in
                  thousands)*
              
              **2005**
              
              2004**ASSETS**Cash
              
              **$**
              **485**
              
              $
              324Investment
                  in subsidiariesBanking
                  subsidiary
              
              
              **104,353**
              
              
              97,811Non-banking
                  subsidiaries
              
              
              **600**
              
              
              600Other
                  assets
              
              
              **188**
              
              
              706**Total
                  Assets**
              
              **$**
              **105,626**
              
              $
              99,441**LIABILITIES**Long-term
                  debt
              
              **$**
              **13,600**
              
              $
              13,600Other
                  liabilities
              
              
              **383**
              
              
              802Total
                  liabilities
              
              
              **13,983**
              
              
              14,402**STOCKHOLDERS’
                  EQUITY**Preferred
                  stock
              
              
              **400**
              
              
              400Common
                  stock
              
              
              **6,014**
              
              
              5,870Surplus
              
              
              **64,859**
              
              
              62,790Retained
                  earnings
              
              
              **24,767**
              
              
              16,030Accumulated
                  other comprehensive loss
              
              
              **(4,397**
              **)**
              
              (51
              )Total
                  stockholders’ equity
              
              
              **91,643**
              
              
              85,039**Total
                  Liabilities and Stockholders’ Equity**
              
              **$**
              **105,626**
              
              $
              99,441
  **Statements
        of Income**
  **Years
                  Ended December 31,***(in
                  thousands)*
              
              **2005**
              
              2004
              
              2003Income:Dividends
                  from bank subsidiary
              
              **$**
              **1,512**
              
              $
              1,044
              
              $
              1,396Interest
                  income
              
              
              **62**
              
              
              62
              
              
              62**1,574**
              
              
              1,106
              
              
              1,458ExpensesInterest
                  expense
              
              
              **1,418**
              
              
              1,418
              
              
              1,418Other
              
              
              **717**
              
              
              521
              
              
              349**2,135**
              
              
              1,939
              
              
              1,767Income
                  (loss) before income (taxes) benefit and equity in undistributed
                  net
                  income of subsidiaries
              
              
              **(561**
              **)**
              
              (833
              )
              
              (309
              )Income
                  (taxes) benefit
              
              
              **703**
              
              
              638
              
              
              580**142**
              
              
              (195
              )
              
              271Equity
                  in undistributed net income of bank subsidiary
              
              
              **8,675**
              
              
              8,786
              
              
              6,286Net
                  income
              
              **$**
              **8,817**
              
              $
              8,591
              
              $
              6,557
   45
 
 **Statements
        of Cash Flows**
  **Years
                  Ended December 31,***(in
                  thousands)*
              
              **2005**
              
              2004
              
              2003Operating
                  ActivitiesNet
                  Income
              
              **$**
              **8,817**
              
              $
              8,591
              
              $
              6,557Adjustments
                  to reconcile net income to net cash provided by operating
                  activitiesAmortization
                  of financing costs
              
              
              **6**
              
              
              6
              
              
              6Noncash
                  compensation
              
              
              **68**
              
              
              0
              
              
              0Increase
                  in other liabilities
              
              
              **(419**
              **)**
              
              45
              
              
              55Decrease
                  in other assets
              
              
              **512**
              
              
              0
              
              
              0Equity
                  in undistributed net income of bank subsidiary
              
              
              **(8,675**
              **)**
              
              (8,786
              )
              
              (6,286
              )Net
                  cash provided (used) by operating activities
              
              
              **309**
              
              
              (144
              )
              
              332Investing
                  Activities:Investment
                  in bank subsidiary
              
              
              **(1,725**
              **)**
              
              (27,018
              )
              
              (1,210
              )Net
                  cash (used) by investing activities
              
              
              **(1,725**
              **)**
              
              (27,018
              )
              
              (1,210
              )Financing
                  Activities:Proceeds
                  from common stock options exercised
              
              
              **874**
              
              
              982
              
              
              556Proceeds
                  from issuance of common stock under stock purchase plan
              
              
              **783**
              
              
              675
              
              
              677Proceeds
                  from issuance of common stock in connection with stock
                  offerings
              
              
              **0**
              
              
              25,408
              
              
              0Cash
                  dividends on preferred stock and cash in lieu of fractional
                  shares
              
              
              **(80**
              **)**
              
              (97
              )
              
              (89
              )Net
                  cash provided by financing activities
              
              
              **1,577**
              
              
              26,968
              
              
              1,144Increase
                  (decrease) in cash and cash equivalents
              
              
              **161**
              
              
              (194
              )
              
              266Cash
                  and cash equivalents at beginning of the year
              
              
              **324**
              
              
              518
              
              
              252Cash
                  and cash equivalents at end of year
              
              **$**
              **485**
              
              $
              324
              
              $
              518
 
 46