Exhibit 13





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 drives deposit growth. The consistent growth of low
cost, long-term deposit relationships allows us to focus our investments on less
risky loans and securities. In addition, our significant cash flow allows us
ongoing reinvestment opportunities as interest rates change.




In 2007,
the Company continued to expand its unique retail model with a challenging, yet
improved, interest rate environment. The 2007 highlights are summarized
below.






● We
opened three new stores during 2007 at the following locations: Shillington Road
in Berks County, Manheim Pike in Lancaster County and Linglestown Road in
Dauphin County.






● On the
national stage, J.D. Power & Associates ranked Commerce Bank #1 in Customer
Satisfaction in the Mid-Atlantic Region.






● For the
fourth straight year, Commerce Bank was voted Best Bank by the Harrisburg
Magazine Simply the Best Readers’ Poll.












● Total
loans grew 18% while asset quality remained pristine.






● Core
deposits exceeded $1.5 billion.






●
Shareholder equity increased $11.2 million, or 11%, to $112
million.






● Total
revenues increased 15%, to $82 million.






● Capital
levels remained strong.






During
2007, our total assets grew by $112.5 million from $1.87 billion at December 31,
2006 to $1.98 billion as of December 31, 2007. During this same time period,
interest earning assets (primarily loans and investments) increased by $111.7
million from $1.73 billion to $1.84 billion.




During
2007, our total net loans (including loans held for sale) increased 18% in going
from $988.4 million at December 31, 2006, to $1.16 billion at December 31,
2007.  This growth was primarily in commercial real estate, commercial
business and home equity consumer loans.  Commerce Bank continues to
be the premier provider of business and personal loans throughout our
footprint.  Our experienced calling officers and lending management
team have continued to take advantage of the bank mergers and poor financial
performance of many of our competitors by gathering both customers and skilled
employees from those affected institutions.  At the same time,
Commerce Bank has avoided the pitfalls of poor performance caused by subprime
lending, out-of market lending and indirect lending.  At Commerce
Bank, we focus on face-to-face relationship lending with creditworthy
individuals and businesses within our market footprint, thereby preserving
shareholder return with strong asset quality.




Total
average deposit balances during 2007 were up $105 million, or 7%, over average
deposits for the prior year, however, total deposits decreased slightly
from $1.62 billion at December 31, 2006 to $1.56 billion at December 31, 2007.
In 2007, we made a strategic decision not to match the unusually “high rate”
deposit pricing on deposits offered by most other banks in our footprint. As a
result, our deposit growth was below our historical norm and we experienced some
run-off of higher priced deposits, especially during the fourth
quarter.




Although
this produced a year-end total deposit figure slightly below year-end 2006, our
pricing discipline served to stabilize and eventually began to lower our overall
cost of funds. In turn, this provided us with increased net interest income and
an improved net interest margin throughout the second half of 2007.




The
unusual and difficult interest rate yield curve present during 2006 and the
first half of 2007 began to correct itself as the Federal Reserve started
lowering short-term interest rates in the fourth quarter of 2007. The decrease
in short-term rates and return of the interest rate yield curve to more of a
traditional slope, has helped to reduce pressure on our net interest margin and
has positioned us well for what we believe will be stronger performance in
2008.




Net
income totaled $7.0 million for 2007, down slightly from the $7.3 million
recorded in 2006 and diluted net income per share was $1.07 vs. $1.12 for the
prior year. These decreases were due to the previously mentioned net interest
margin pressure during the first half of 2007 combined with a higher level of
noninterest expenses throughout the year. Noninterest expenses for 2007 included
the costs associated with our opening of three new stores during the third
quarter as well as the full year impact of expenses associated with two new
stores we opened during the fourth quarter of 2006. Another contributing factor
was the impact of the deposit insurance




1




assessment
which was reinstated by the FDIC during the first quarter of 2007 for all banks
whose deposits are federally insured.




Key
financial highlights for 2007 compared to 2006 are summarized in the following
table.




December
      31,
              
              
              %2007
              
              
              2006
              
              
              Change(dollars
      in millions)Total
      Assets
              
              $
              1,979.0
              
              
              $
              1,866.5
              
              
              
              6
              %Total
      Loans (Net)
              
              
              1,146.6
              
              
              
              973.0
              
              
              
              18Total
      Deposits
              
              
              1,560.9
              
              
              
              1,616.8
              
              
              
              (3
              )December
      31,
              
              %2007
              
              
              2006
              
              
              Change(dollars
      in millions, except per share data)Total
      Revenues
              
              $
              82.3
              
              
              $
              71.5
              
              
              
              15
              %Net
      Income
              
              
              7.0
              
              
              
              7.3
              
              
              
              (3
              )Diluted
      Net Income
                Per
      Share
              
              
              1.07
              
              
              
              1.12
              
              
              
              (4
              )
   In the
future we expect that we will continue our pattern of expanding our footprint by
branching into contiguous areas of our existing markets, and by filling gaps
between existing store locations. We opened three stores in 2007, giving us a
total of 33 full-service stores as of December 31, 2007. We are targeting to
open approximately 15-20 new stores over the next five years. As a result of our
targeted growth, we expect that expenses related to salaries, employee benefits,
occupancy, furniture and equipment, and advertising will increase in subsequent
periods. Our long-range plan targets a total of 50-55 stores by the end of 2012.
We believe that the demographics of the South Central Pennsylvania market should
provide significant opportunities for us to continue to grow both deposit and
lending relationships.




Application
of Critical Accounting Policies




Our
accounting policies are fundamental to understanding Management’s Discussion and
Analysis of Financial Condition and Results of Operations. Our accounting
policies are more fully described in Note 1 of the Notes to Consolidated Financial
Statements for December 31, 2007 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 loan 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.




Monthly,
systematic reviews of our loan portfolio are performed 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 specific loan types. 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 made
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.




In
addition to estimation and testing of loss factors, we periodically evaluate
changes in levels and trends of charge-offs, delinquencies and nonaccrual loans,
trends in the volume and the term of loans, changes in underwriting standards
and practices, tenure of the loan




2




officers
and management, changes in credit concentrations, and national and local
economic trends and conditions, among other things. Management judgment is
involved at many levels of these evaluations.




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






Stock-Based Compensation.
Prior to 2006, the Company accounted for stock-based compensation issued to
directors and employees using the intrinsic value method in accordance with
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees” (“APB 25”). This method required that compensation expense be
recognized to the extent that the fair value of the stock exceeded the exercise
price of the stock award at the grant date. The Company generally did not
recognize compensation expense related to stock option awards because the stock
options generally had fixed terms and exercise prices that were equal to or
greater than the fair value of the Company’s common stock at the grant date. The
pro forma impact to net income and earnings per share that would have occurred
had compensation expense been recognized in 2005, 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, 2007.






Effective
January 1, 2006, the Company adopted Financial Accounting Standards Board (FASB)
Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) using the modified
prospective method. FAS 123(R) requires compensation costs related to
share-based payment transactions to be recognized in the income statement (with
limited exceptions) based on the grant-date fair value of the stock-based
compensation issued. Compensation costs are recognized over the period that an
employee provides service in exchange for the award. Statement of Financial
Accounting Standards (“SFAS”) 123(R) had an unfavorable impact on our net
income and net income per share in 2006 and in 2007 and will continue to do so
in future periods as we recognize compensation expense for stock option
awards.






In
conjunction with FAS 123(R), the Company also adopted FASB Staff Position
(“FSP”) FAS 123(R)-2, “Practical Accommodation to the Application of Grant
Date as Defined in FAS 123(R)” effective January 1, 2006. FSP 123(R)-2
provides guidance on the application of grant date as defined in FAS 123(R). In
accordance with this standard, a grant date of an award exists if (a) the
award is a unilateral grant and (b) the key terms and conditions of the
award are expected to be communicated to an individual recipient within a
relatively short time period from the date of approval. The adoption of this
standard did not have a material impact on our consolidated financial position,
results of operations, or cash flows for the year ended December 31,
2007.






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, 2007, 2006 and 2005 and presents the daily
average interest rates earned on assets and the daily average interest rates
paid on liabilities for such periods. During 2007, average interest-earning
assets were $1.78 billion, an increase of $139.7 million, or 9%, over 2006. This
was the result of an increase in the average balance of loans receivable
(including loans held for sale) of $179.5 million, offset by a decrease in the
average balance of investment securities of $39.8 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 $103.8 million, an increase in the average level of short-term
borrowings of $8.4 million and an increase in the average level of long-term
borrowings of $30.8 million.




The
tax-equivalent yield on total interest-earning assets increased by 17 basis
points, from 6.36% in 2006 to 6.53% in 2007. This increase was mostly due to the
change in mix of interest-earning assets from 2006 to 2007. In 2007, average
loans outstanding were 61% of average interest-earning assets as compared to 55%
of the mix in 2006. The higher yields associated with loans as opposed to
investment securities provided for the yield increase. Our floating rate loans
represent approximately 34% of our total loans receivable portfolio. The
interest rates charged on the majority of these loans are tied to the New York
prime lending rate which decreased by a total of 225 basis points between late
September 2007 and early February 2008, following similar decreases in the
overnight federal funds rate by the Federal Open Market Committee (“FOMC”). The
FOMC is expected to decrease short-term rates further in 2008 to address
weakness in the United States economy. Going forward, we expect these decreases
in the prime lending rate will decrease our interest income received on our
floating rate loans.




Likewise,
yields received on any new investment securities purchased in 2008 are expected
to be lower the yields received on the current existing portfolio due to the
overall lower level of market interest reates in 2008 vs prior
years.




The
aggregate cost of interest-bearing liabilities increased 1 basis point from
3.65% in 2006 to 3.66% in 2007. The average rate paid on savings deposits
increased by 6 basis points, from 2.35% in 2006 to 2.41% in 2007. The average
rate paid on interest checking accounts and money market accounts combined,
including money market accounts that are swept overnight to money market
balances, decreased from 3.68% in 2006 to 3.47% in 2007. For time deposits, the
average rate paid in 2007 was 4.20%, up 33 basis points over 2006 and public
funds time deposits incurred an increase of 63 basis points in 2007 on the
average rate paid.




3




At
December 31, 2007, approximately $688 million, or 44%, of our total deposits
were those of local municipalities, school districts, not-for-profit
organizations or corporate cash management customers, of
which the rate paid on these deposits is indexed to the 3-month United
States Treasury Bill (“T-Bill”). The annual average yield on the 3-month T-Bill
for the year 2007 was 4.41%, down 31 basis points from 4.72% in 2006. More
importantly, the average yield decreased from a high of 4.98% during the first
quarter of 2007 to 3.51% during the fourth quarter. Going forward in 2008, as
the FOMC continues to lower short-term interest rates, it is expected the
average yield on the 3-month T-Bill will continue to decrease and will
serve to dramatically lower our cost of funds in 2008 from that experienced in
2007 related to our index-priced deposits.




The
average rate paid on long-term debt decreased by 262 basis points in 2007 vs.
2006. The Company issued $15.0 million of Trust Preferred Securities at the end
of the third quarter 2006 at an interest rate of 7.75%. The full year impact of
this debt was incurred in 2007. Also, as part of our Asset/Liability management
strategy, we utilized Federal Home Loan Bank convertible select borrowings in
2007 with the purchase of two separate borrowings of $25 million each with
interest rates of 4.29% and 4.49%, respectively. See the Long-Term Debt section
later in this Management’s Discussion and Analysis of Financial Condition and
Results of Operations for further discussion regarding the convertible select
borrowings. See Note 10 in the Notes to Consolidated Financial Statements for
the year ended December 31, 2007 for further discussion of our Trust Capital
Securities.




Our
aggregate cost of funding sources increased 2 basis points in 2007 to 3.16% from
3.14% in 2006. This increase resulted primarily from higher average rates paid
on short-term borrowings. 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 ofcalculating the average
rate received on taxable securities. Yields on tax-exempt securities and loans
are computed on a tax-equivalent basis.





4





TABLE 1




Years
      Ended December 31,(dollars
      in thousands)
            2007
            
            
            2006
            
            
            2005Earning
      Assets
            
            Average
      Balance
            
            
            Interest
            
            
            Average
              Rate
            
            
            Average
      Balance
            
            
            Interest
            
            
            Average
              Rate
            
            
            Average Balance
            
            
            Interest
            
            
            Average
              RateSecurities:Taxable
            
            $
            694,575
            
            
            $
            37,060
            
            
            
            5.34
            %
            
            $
            733,990
            
            
            $
            38,845
            
            
            
            5.29
            %
            
            $
            615,779
            
            
            $
            30,822
            
            
            
            5.01
            %Tax-exempt
            
            
            1,620
            
            
            
            99
            
            
            
            6.11
            
            
            
            1,985
            
            
            
            130
            
            
            
            6.55
            
            
            
            5,887
            
            
            
            538
            
            
            
            9.14Total
      securities
            
            
            696,195
            
            
            
            37,159
            
            
            
            5.34
            
            
            
            735,975
            
            
            
            38,975
            
            
            
            5.30
            
            
            
            621,666
            
            
            
            31,360
            
            
            
            5.04Federal
      funds sold
            
            
            0
            
            
            
            0
            
            
            
            0.00
            
            
            
            0
            
            
            
            0
            
            
            
            0.00
            
            
            
            148
            
            
            
            5
            
            
            
            3.38Loans
      receivable:Mortgage
      and
              construction
            
            
            525,063
            
            
            
            38,288
            
            
            
            7.21
            
            
            
            452,781
            
            
            
            32,267
            
            
            
            7.05
            
            
            
            392,697
            
            
            
            26,328
            
            
            
            6.70Commercial
      loans and
              lines
      of credit
            
            
            307,540
            
            
            
            24,425
            
            
            
            7.83
            
            
            
            259,280
            
            
            
            20,914
            
            
            
            7.96
            
            
            
            193,779
            
            
            
            13,474
            
            
            
            6.95Consumer
            
            
            206,459
            
            
            
            14,040
            
            
            
            6.80
            
            
            
            170,535
            
            
            
            11,412
            
            
            
            6.69
            
            
            
            134,004
            
            
            
            8,147
            
            
            
            6.08Tax-exempt
            
            
            46,840
            
            
            
            3,195
            
            
            
            6.82
            
            
            
            23,788
            
            
            
            1,582
            
            
            
            6.65
            
            
            
            9,218
            
            
            
            638
            
            
            
            6.92Total
      loans receivable
            
            
            1,085,902
            
            
            
            79,948
            
            
            
            7.29
            
            
            
            906,384
            
            
            
            66,175
            
            
            
            7.23
            
            
            
            729,698
            
            
            
            48,587
            
            
            
            6.66Total
      earning assets
            
            $
            1,782,097
            
            
            $
            117,107
            
            
            
            6.53
            %
            
            $
            1,642,359
            
            
            $
            105,150
            
            
            
            6.36
            %
            
            $
            1,351,512
            
            
            $
            79,952
            
            
            
            5.92
            %Sources
      of FundsInterest-bearing
      deposits:Regular
      savings
            
            $
            373,209
            
            
            $
            8,997
            
            
            
            2.41
            %
            
            $
            363,515
            
            
            $
            8,533
            
            
            
            2.35
            %
            
            $
            325,218
            
            
            $
            5,043
            
            
            
            1.55
            %Interest
      checking and
              money
      market
            
            
            712,418
            
            
            
            24,738
            
            
            
            3.47
            
            
            
            605,043
            
            
            
            22,282
            
            
            
            3.68
            
            
            
            479,310
            
            
            
            11,941
            
            
            
            2.49Time
      deposits
            
            
            181,080
            
            
            
            7,604
            
            
            
            4.20
            
            
            
            194,611
            
            
            
            7,541
            
            
            
            3.87
            
            
            
            179,428
            
            
            
            5,330
            
            
            
            2.97Public
      funds time
            
            
            17,464
            
            
            
            858
            
            
            
            4.91
            
            
            
            32,873
            
            
            
            1,406
            
            
            
            4.28
            
            
            
            34,992
            
            
            
            1,094
            
            
            
            3.13Total
      interest-bearing
              deposits
            
            
            1,284,171
            
            
            
            42,197
            
            
            
            3.29
            
            
            
            1,196,042
            
            
            
            39,762
            
            
            
            3.32
            
            
            
            1,018,948
            
            
            
            23,408
            
            
            
            2.30Short-term
      borrowings
            
            
            208,112
            
            
            
            10,804
            
            
            
            5.12
            
            
            
            199,742
            
            
            
            10,267
            
            
            
            5.07
            
            
            
            105,620
            
            
            
            3,821
            
            
            
            3.62Long-term
      debt
            
            
            48,510
            
            
            
            3,494
            
            
            
            7.18
            
            
            
            17,669
            
            
            
            1,731
            
            
            
            9.80
            
            
            
            13,600
            
            
            
            1,418
            
            
            
            10.43Total
      interest-bearing
              liabilities
            
            
            1,540,793
            
            
            
            56,495
            
            
            
            3.66
            
            
            
            1,413,453
            
            
            
            51,760
            
            
            
            3.65
            
            
            
            1,138,168
            
            
            
            28,647
            
            
            
            2.52Noninterest-bearing
      funds
              (net)
            
            
            241,304
            
            
            
            
            
            
            
            
            
            
            
            228,906
            
            
            
            
            
            
            
            
            
            
            
            213,344Total
      sources to fund
              assets
            
            $
            1,782,097
            
            
            $
            56,495
            
            
            
            3.16
            %
            
            $
            1,642,359
            
            
            $
            51,760
            
            
            
            3.14
            %
            
            $
            1,351,512
            
            
            $
            28,647
            
            
            
            2.12
            %Net
      interest income and
              margin
      on a tax-
              equivalent
      basis
            
            
            
            
            
            $
            60,612
            
            
            
            3.37
            %
            
            
            
            
            
            $
            53,390
            
            
            
            3.22
            %
            
            
            
            
            
            $
            51,305
            
            
            
            3.80
            %Tax-exempt
      adjustment
            
            
            
            
            
            
            1,120
            
            
            
            
            
            
            
            
            
            
            
            599
            
            
            
            
            
            
            
            
            
            
            
            400Net
      interest income and
              margin
            
            
            
            
            
            $
            59,492
            
            
            
            3.30
            %
            
            
            
            
            
            $
            52,791
            
            
            
            3.18
            %
            
            
            
            
            
            $
            50,905
            
            
            
            3.77
            %Other
      Balances:Cash
      & due from banks
            
            $
            51,874
            
            
            
            
            
            
            
            
            
            
            $
            49,210
            
            
            
            
            
            
            
            
            
            
            $
            42,225Other
      assets
            
            
            90,437
            
            
            
            
            
            
            
            
            
            
            
            79,815
            
            
            
            
            
            
            
            
            
            
            
            58,837Total
      assets
            
            
            1,924,408
            
            
            
            
            
            
            
            
            
            
            
            1,771,384
            
            
            
            
            
            
            
            
            
            
            
            1,452,574Noninterest-bearing
              demand
      deposits
            
            
            269,353
            
            
            
            
            
            
            
            
            
            
            
            253,671
            
            
            
            
            
            
            
            
            
            
            
            220,566Other
      liabilities
            
            
            8,035
            
            
            
            
            
            
            
            
            
            
            
            8,558
            
            
            
            
            
            
            
            
            
            
            
            4,889Stockholders’
      equity
            
            
            106,227
            
            
            
            
            
            
            
            
            
            
            
            95,702
            
            
            
            
            
            
            
            
            
            
            
            88,951







5




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 2007 increased $7.2 million, or 14%,
over 2006 to $60.6 million. Interest income on a tax-equivalent basis totaled
$117.1 million, an increase of $12.0 million, or 11%, over 2006. The majority of
this increase was related to volume increases in the loans receivable portfolio
which was partially offset by a volume decrease in the investment securities
portfolio. Interest expense for 2007 increased $4.7 million, or 9%, from $51.8
million in 2006 to $56.5 million in 2007. 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, short-term borrowings and long-term
debt.




During
the first half of 2006, the Federal Reserve Board (“FRB”) continued to increase
short-term interest rates by increasing the targeted federal funds rate four
times for a total of 100 bps from January 1, 2006 through June 30, 2006. These
increases followed a total increase of 200 bps in short-term interest rates
throughout 2005. As a result, our cost of funds increased significantly in 2006
and the first half of 2007 over levels experienced in recent years. The
increase in short-term rates, while significant in direction, had little impact
on long-term interest rates, and as a result, we did not experience a similar
increase in the yields on our interest-earning assets. This served to
constrain our historical net interest income growth and also materially reduced
our net interest margin. During 2007, however, the United States Treasury yield
curve began to move from flat (and sometimes inverted) to a more traditional
slope with short-term rates lower than long-term rates. As a result, the Company
began to experience a lower cost of deposits and lower cost of borrowings,
thereby improving our net interest margin.  On September 18, 2007 the FRB
decreased the overnight federal funds rate by 50 basis points (bps) and during
the fourth quarter of 2007, lowered the overnight federal funds interest rate by
an additional 25 bps from 4.75% to 4.50%. The decreases in the federal funds
rate has led to a lower level of interest rates associated with our overnight
short-term borrowings as well as a lower yield on the 91-day Treasury bill to
which approximately 44% of our deposits are priced. In 2008, we expect some
level of continued growth in our overall level of net interest income as a
result of an anticipated lower level of interest expense associated with a
decrease in our overall total cost of funding sources.




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 increased to 2.87% in 2007 from 2.71% in 2006 on a fully tax equivalent
basis. The net interest margin increased 12 basis points from 3.18% in 2006 to
3.30% in 2007.




6




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





TABLE 2
 2007
      v. 2006
              
              
              2006
      v. 2005Increase
      (Decrease)
              
              
              Increase
      (Decrease)Due
      to Changes in (1)
              
              
              Due
      to Changes in (1)(in
      thousands)
              
              Volume
              
              
              Rate
              
              
              Total
              
              
              Volume
              
              
              Rate
              
              
              TotalInterest
      on securities:Taxable
              
              $
              (2,059
              )
              
              $
              274
              
              
              $
              (1,785
              )
              
              $
              6,156
              
              
              $
              1,867
              
              
              $
              8,023Tax-exempt
              
              
              (23
              )
              
              
              (8
              )
              
              
              (31
              )
              
              
              (340
              )
              
              
              (68
              )
              
              
              (408
              )Federal
      funds sold
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              (5
              )
              
              
              0
              
              
              
              (5
              )Interest
      on loans receivable:Mortgage
      and construction
              
              
              5,390
              
              
              
              631
              
              
              
              6,021
              
              
              
              4,561
              
              
              
              1,438
              
              
              
              5,999Commercial
              
              
              3,255
              
              
              
              256
              
              
              
              3,511
              
              
              
              4,994
              
              
              
              2,385
              
              
              
              7,379Consumer
              
              
              2,199
              
              
              
              429
              
              
              
              2,628
              
              
              
              2,282
              
              
              
              984
              
              
              
              3,266Tax-exempt
              
              
              1,570
              
              
              
              43
              
              
              
              1,613
              
              
              
              978
              
              
              
              (34
              )
              
              
              944Total
      interest income
              
              
              10,332
              
              
              
              1,625
              
              
              
              11,957
              
              
              
              18,626
              
              
              
              6,572
              
              
              
              25,198Interest
      on deposits:Regular
      savings
              
              
              848
              
              
              
              (384
              )
              
              
              464
              
              
              
              1,867
              
              
              
              1,623
              
              
              
              3,490Interest
      checking and money market
              
              
              4,269
              
              
              
              (1,813
              )
              
              
              2,456
              
              
              
              4,343
              
              
              
              5,998
              
              
              
              10,341Time
      deposits
              
              
              (277
              )
              
              
              340
              
              
              
              63
              
              
              
              976
              
              
              
              1,235
              
              
              
              2,211Public
      funds
              
              
              (659
              )
              
              
              111
              
              
              
              (548
              )
              
              
              (65
              )
              
              
              377
              
              
              
              312Short-term
      borrowings
              
              
              434
              
              
              
              103
              
              
              
              537
              
              
              
              4,378
              
              
              
              2,068
              
              
              
              6,446Long-term
      debt
              
              
              1,905
              
              
              
              (142
              )
              
              
              1,763
              
              
              
              398
              
              
              
              (85
              )
              
              
              313Total
      interest expense
              
              
              6,520
              
              
              
              (1,785
              )
              
              
              4,735
              
              
              
              11,897
              
              
              
              11,216
              
              
              
              23,113Net
      increase (decrease)
              
              $
              3,812
              
              
              $
              3,410
              
              
              $
              7,222
              
              
              $
              6,729
              
              
              $
              (4,644
              )
              
              $
              2,085
  (1)
Changes due to both volume and rate have been allocated on a pro rata basis to
either rate or volume.




Provision
for Loan Losses




We
recorded $1.8 million to the allowance for loan losses in 2007 compared to $1.6
million in 2006. 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 2007 were $705,000,
or 0.07%, of average loans outstanding as compared to $1.2 million, or 0.13%, of
average loans outstanding in 2006. One loan totaling $165,000 made up the
largest single loan charge-off for 2007. All other loans charged-off were under
$100,000 each. The majority of the net charge-off figure for 2006 was related to
one loan for approximately $900,000. See the Application of Critical Accounting
Policies section in this Management’s Discussion and Analysis regarding the
allowance for loan losses as well as Note 1 in the Notes to Consolidated Financial
Statements for December 31, 2007 included herein for further discussion
regarding our methodology for determining the provision for loan
losses.






Noninterest
Income




Noninterest
income for 2007 increased by $4.1 million, or 22%, over 2006 to $22.8 million.
Service charges and fees increased $3.9 million, or 23%. The increase was
primarily due to increases in other operating income attributable to servicing a
higher volume of deposit and loan accounts. Included in total noninterest income
in 2007 were gains of $1.3 million on the sale of residential loans, student
loans, small business administration loans, and business and industry loans as
well as a $171,000 gain on the call of securities. Total noninterest income in
2006 included gains of $1.1 million on the sale of residential loans, student
loans, small business administration loans and business and industry loans as
well as gains on the sale and call of securities of $160,000.






Noninterest
Expenses




Noninterest
expenses totaled $70.8 million for 2007, an increase of $11.5 million, or 19%,
over 2006. Staffing levels, occupancy, furniture and equipment, and related
expenses increased as a result of opening three full service stores in 2007 as
well as the opening of two full service stores in the fourth quarter of 2006.
Also, noninterest expenses for 2007 include a significant impact for premiums
related to Federal Deposit Insurance Corporation, (“FDIC”) deposit insurance
coverage which were not incurred during 2006 or 2005. Beginning January 1, 2007,
the FDIC began charging insured Banks for such coverage for the first time since
1997. Banks which were in operation and paying deposit insurance premiums during
1997 and prior received a one time credit in 2007 based upon premiums paid
during those previous years. Commerce utilized 100% of this credit during the
first quarter of 2007 to partially reduce its expense costs and therefore
incurred the full impact of this additional expense during each of the second,
third and fourth quarters of 2007.A comparison of noninterest
expenses for certain categories for 2007 and 2006 is discussed
below.




7




Salary
expenses and employee benefits, which represent the largest component of
noninterest expenses, increased by $3.6 million, or 12%, in 2007 over 2006. The
increased level of these expenses includes the impact of salary and benefit
costs associated with the additional staff hired to operate the new stores
opened in the third quarter of 2007 as well as the full-year impact of the
employees hired to operate the two new stores opened in the fourth quarter of
2006. Also included in these expenses were the full year impact of salary and
benefits for a significant amount of additional staff hired throughout 2006 to
support the compliance, audit and loan operations functions. Benefit costs for
2007 included an increase of approximately $750,000 for employee medical and
prescription plan costs over the level incurred in 2006. The increase in total
salary and benefit expenses were somewhat offset by a reduction of such costs
directly related to call center processing. On October 1, 2006, the Company
outsourced call center functions to a third party and, as a result, the expenses
associated with salary and benefits for call center employees were not included
in this line item for 2007. Rather those costs are now reflected on the income
statement in a line titled Telephone expenses which are discussed further
below.




Occupancy
expenses totaled $7.6 million in 2007, an increase of $1.0 million, or 15%, over
2006 while furniture and equipment expenses increased by $488,000, or 14%, to
$4.1 million. The full year impact of the two stores opened in late 2006 along
with the additional three stores opened in 2007 contributed to the increases in
occupancy and furniture and equipment expenses in 2007 over 2006. In late March
2006, we discontinued leasing two facilities that previously housed the majority
of our executive, lending, financial and operational staff departments and
relocated approximately 300 employees to Commerce Center, our new Headquarters,
Operations and Training Center. Discontinued occupancy and furniture expenses
associated with the two previously leased facilities partially offset higher
levels of expense associated with the new building and its furniture and
equipment.




Advertising
and marketing expenses were $3.3 million for 2007, an increase of $363,000, or
12%, over 2006. This increase was partially the result of grand opening expenses
associated with three new stores in 2007 as compared to two new store openings
in 2006. During the fourth quarter of 2006, we added Lancaster as a new market
and, as a result, in 2007, we experienced one full year of expense for
advertising in that market. Our advertising markets now include Berks,
Lancaster, Lebanon, Dauphin, Cumberland, and York counties of South Central
Pennsylvania.




Data
processing expenses increased by $1.1 million, or 20%, in 2007 over 2006. 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 operating additional stores, adding additional electronic
products and services for customer use and enhancements and upgrades to existing
systems.




Postage
and supplies expenses of $2.0 million were $342,000, or 21%, higher than the
prior year. The increase was attributed to the growth in the number of account
statements mailed to customers as well as a 5% increase in postal rates
effective May 2007.




Regulatory
expenses of $3.1 million in 2007 were $2.6 million higher than 2006. This
increase is primarily due to the previously-mentioned deposit insurance
assessment which was reinstated by the FDIC during the first quarter of 2007 for
all banks whose deposits are federally insured. Also included in total
regulatory expenses for 2007 were costs incurred to address the matters
identified by the Office of the Comptroller of the Currency (“OCC”) in the
formal written agreement which the Bank entered into with the OCC on January 29,
2007 as well as costs incurred during the fourth quarter of 2007 with respect to
the Consent Order entered into with the OCC on February 5, 2008.




Telephone
expenses of $2.4 million were $1.2 million higher for 2007 compared to 2006.
This increase is primarily due to our outsourcing of the call center services to
a third party in October 2006 as mentioned previously. Rather than booking
salary and benefit costs directly to those line items for call center staff as
was done in prior years, the Company now receives a monthly bill for total call
center expenses based on a per call charge and those expenses are reflected in
this line item in 2007 and going forward.




Other
noninterest expenses totaled $7.4 million for 2007, compared to $6.6 million for
2006. Components of the increase include expenses related to: consulting fees,
coin shipment expenses due to our popular and convenient Penny Arcade Machines
located in all of our stores, customer relations, problem loan expenses and
Pennsylvania shares tax.




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/calls of investment securities). This
ratio equaled 2.49% for 2007, compared to 2.29% for 2006. 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 2007, the
operating efficiency ratio was 86.0% compared to 82.9% for 2006. Our operating
efficiency ratio remains above our peer group primarily due to our aggressive
growth expansion activities.






Provision
for Federal Income Taxes




The
provision for federal income taxes was $2.7 million for 2007, compared to $3.4
million for 2006. The effective tax rate, which is the ratio of income tax
expense to income before taxes, was 28.2% in 2007 compared to 31.7% in 2006
partially due to the proportion of tax-exempt loan and investment income to
total pretax income. See Note 11 of the Notes to Consolidated Financial
Statementsfor December 31, 2007, included herein, for an additional
analysis of the provision for income taxes for 2007 and 2006.




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




8




future
tax consequences attributable to temporary differences between the financial
state­ment and tax bases of existing assets and liabilities.




At
December 31, 2007, deferred tax assets amounted to $5.9 million and deferred tax
liabilities amounted to $3.9 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 2007 was $7.0 million, a decrease of $253,000, or 3%, from the $7.3
million recorded in 2006. This decrease was due to an increase in net interest
income of $6.7 million an increase in noninterest income of $4.1 million and a
decrease in the provision for federal income taxes of $616,000, offset by an
increase in the provision for loan losses of $128,000 and an increase in
noninterest expenses of $11.5 million.




Basic
earnings per common share were $1.11 in 2007 compared to $1.18 in 2006. Diluted
earnings per common share were $1.07 for 2007 and $1.12 for 2006. The decrease
in earnings per share for 2007 was a direct result of a slightly lower level of
net income combined with a higher number of average common and common equivalent
shares outstanding in 2007 vs. 2006. See Note 13 in the Notes to Consolidated Financial
Statementsfor December 31, 2007, included herein, 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 0.36% for 2007 and 0.41% for 2006. This
decrease is the result of 6% growth in total assets combined with a 3% decrease
in net income. Contributing to these results was the deployment of funds for the
addition of the new stores in 2007 and 2006 and their related costs as opposed
to channeling these funds into interest-earning assets.




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 2007 was 6.59%,
compared to 7.58% for 2006.




Both ROA
and ROE in 2007 were impacted by the unusual shape of the yield curve during the
first half of 2007 and the resulting impact on the Company’s net interest
income.




The
average equity to assets ratio at December 31, 2007 was 5.52% compared to 5.40%
at December 31, 2006.






Results
of Operations




2006
versus 2005




Net
income for 2006 was $7.3 million, a decrease of $1.5 million, or 18%, from the
$8.8 million recorded in 2005.




Diluted
earnings per common share decreased to $1.12 for 2006 from $1.38 in
2005.




Net
interest income on a tax-equivalent basis for 2006 increased $2.1 million, or
4%, over 2005 to $53.4 million. Interest income on a tax-equivalent basis on
earning assets totaled $105.2 million, an increase of $25.2 million, or 32%,
over 2005. Interest expense for 2006 increased by $23.2 million, or 81%, from
$28.6 million to $51.8 million.




Our net
interest rate spread decreased to 2.71% in 2006 from 3.40% in 2005 and the net
interest margin decreased 58 basis points from 3.80% in 2005 to 3.22% in 2006 on
a fully tax-equivalent basis.




Noninterest
income for 2006 increased by $4.6 million, or 33%, over 2005 to $18.8 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
2006 were gains of $1.1 million on the sale of residential loans, student loans,
small business administration loans, and business and industry loans and a gain
the sale of securities of $160,000. Included in total noninterest income in 2005
were gains of $1.3 million on the sale of residential loans, student loans,
small business administration loans, and business and industry loans offset by a
net loss on the sale of securities of $60,000.




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




Salary
expenses and employee benefits increased by $4.6 million, or 18%, in 2006 over
2005 primarily to staff the new stores mentioned above.




Occupancy
expenses totaled $6.6 million in 2006, an increase of $1.2 million, or 22%, over
2005 while furniture and equipment expenses increased by $854,000, or 31%, to
$3.6 million.  Again, the increase was related to the new stores as
well as expenses related to the opening of our new Headquarters, Operations and
Training Center in late March 2006.




Advertising
and marketing expenses were $3.0 million for 2006, a decrease of $490,000, or
14%, below 2005. Data processing




9




expenses
increased by $1.6 million, or 41%, in 2006 over 2005. Postage and supplies
expenses of $1.6 million were $313,000, or 24%, higher than the prior
year.




Other
noninterest expenses totaled $8.3 million for 2006, compared to $7.4 million for
2005.






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 December 31, 2007, included herein, for further analysis
of our securities portfolio.




Our
investment securities portfolio consists primarily of U.S. Government agency and
mortgage-backed obligations. These securities have very little, if any, credit
risk because they are either backed by the full faith and credit of the U.S.
Government, their principal and interest payments are guaranteed by an agency of
the U.S. Government, or they are AAA rated. The majority of these investment
securities carry fixed rate coupons that do not change over the life of the
securities. Since most securities are purchased at premiums or discounts, their
yield and average life will change depending on any change in the estimated rate
of prepayments. We amortize premiums and accrete discounts over the estimated
average life of the securities. Changes in the estimated average life of the
securities portfolio will lengthen or shorten the period in which the premium or
discount must be amortized or accreted, thus affecting our securities yields.
For the year ended December 31, 2007, the yield on our securities portfolio was
5.34%, up 4 basis points from 5.30% in 2006.




At
December 31, 2007, the weighted average life and duration of our securities
portfolio was approximately 5.0 and 4.0 years, respectively, as compared to 5.2
years and 4.1 years, respectively, at December 31, 2006. 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,
2007 or 2006.




Securities
available for sale decreased by $5.9 million in 2007 (excluding the effect of
changes in unrealized gains or losses) primarily as a result in purchases of
$49.9 million, offset by principal repayments and maturities of $55.4 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, 2007, the unrealized loss on securities available
for sale included in stockholders’ equity totaled $3.9 million, net of tax,
compared to the $4.5 million, net of tax, unrealized loss on securities
available for sale included in stockholders’ equity at December 31,
2006.




During
2007, securities held to maturity decreased by $62.2 million primarily as a
result of purchases of $87.6 million offset by principal repayments of $74.5
million and the call of seven bonds and two trust preferred securities totaling
$75.3 million. A $171,000 premium on the call of securities was realized in net
income for 2007. 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.




10




The
amortized cost of available for sale and held to maturity securities are
summarized in Table 3 as of December 31, for each of the years 2005 through
2007.




TABLE 3December
      31,(in
      thousands)
            
            2007
            
            
            2006
            
            
            2005Available
      for Sale:U.S.
      Government Agency securities
            
            $
            5,000
            
            
            $
            5,000
            
            
            $
            5,000Mortgage-backed
      securities
            
            
            388,000
            
            
            
            393,909
            
            
            
            382,498Total
      available for sale
            
            $
            393,000
            
            
            $
            398,909
            
            
            $
            387,498Held
      to Maturity:U.S.
      Government Agency securities
            
            $
            133,303
            
            
            $
            175,043
            
            
            $
            136,135Municipal
      securities
            
            
            1,621
            
            
            
            1,619
            
            
            
            2,617Mortgage-backed
      securities
            
            
            116,058
            
            
            
            131,979
            
            
            
            150,394Corporate
      debt securities
            
            
            6,485
            
            
            
            10,987
            
            
            
            17,120Total
      held to maturity
            
            $
            257,467
            
            
            $
            319,628
            
            
            $
            306,266







The
contractual maturity distribution and weighted average yield of our available
for sale and held to maturity portfolios at December 31, 2007 are summarized in
Table 4. For mortgage-backed obligations, the contractual maturities may be
significantly different than actual maturities. Changes in payment patterns and
prepayments may occur depending on the market conditions and economic variables.
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.




TABLE 4December
      31, 2007
            
            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/YieldAvailable
      for Sale:U.S.
      Government Agency
              obligations
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            5,000
            
            
            
            5.00
            %
            
            $
            5,000
            
            
            
            5.00
            %Mortgage-backed
              obligations
            
            $
            50
            
            
            
            5.17
            %
            
            $
            0
            
            
            
            ----
            %
            
            $
            178
            
            
            
            5.98
            %
            
            
            387,772
            
            
            
            5.31
            
            
            
            388,000
            
            
            
            5.31Total
      available for sale
            
            $
            50
            
            
            
            5.17
            %
            
            $
            0
            
            
            
            ----
            %
            
            $
            178
            
            
            
            5.98
            %
            
            $
            392,772
            
            
            
            5.30
            %
            
            $
            393,000
            
            
            
            5.30
            %Held
      to Maturity:U.S.
      Government Agency
              obligations
            
            $
            1,303
            
            
            
            4.31
            %
            
            $
            37,000
            
            
            
            5.05
            %
            
            $
            40,000
            
            
            
            5.31
            %
            
            $
            55,000
            
            
            
            5.86
            %
            
            $
            133,303
            
            
            
            5.46
            %Municipal
      obligations
            
            
            0
            
            
            
            ----
            
            
            
            310
            
            
            
            5.33
            
            
            
            344
            
            
            
            5.55
            
            
            
            967
            
            
            
            6.55
            
            
            
            1,621
            
            
            
            6.11Mortgage-backed
              obligations
            
            
            245
            
            
            
            5.23
            
            
            
            0
            
            
            
            ----
            
            
            
            203
            
            
            
            6.04
            
            
            
            115,610
            
            
            
            5.08
            
            
            
            116,058
            
            
            
            5.08Corporate
      debt securities
            
            
            2,501
            
            
            
            6.72
            
            
            
            3,984
            
            
            
            6.52
            
            
            
            0
            
            
            
            ----
            
            
            
            0
            
            
            
            ----
            
            
            
            6,485
            
            
            
            6.60Total
      held to maturity
            
            $
            4,049
            
            
            
            5.85
            %
            
            $
            41,294
            
            
            
            5.20
            %
            
            $
            40,547
            
            
            
            5.32
            %
            
            $
            171,577
            
            
            
            5.34
            %
            
            $
            257,467
            
            
            
            5.32
            %




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.




11




Loan
Portfolio




The
following table summarizes the composition of our loan portfolio by type as of
December 31, for each of the years 2003 through 2007.




TABLE 5December
      31,(in
      thousands)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Commercial
      mortgage
            
            $
            430,778
            
            
            $
            365,259
            
            
            $
            299,219
            
            
            $
            239,576
            
            
            $
            194,609Construction
      and land development
            
            
            54,475
            
            
            
            61,365
            
            
            
            47,334
            
            
            
            39,467
            
            
            
            26,895Residential
      real estate mortgage loans
            
            
            80,575
            
            
            
            83,690
            
            
            
            83,213
            
            
            
            79,672
            
            
            
            72,713Tax-exempt
      loans
            
            
            53,690
            
            
            
            31,446
            
            
            
            17,055
            
            
            
            6,303
            
            
            
            5,720Commercial,
      industrial and other business loans
            
            
            192,390
            
            
            
            163,708
            
            
            
            138,174
            
            
            
            97,198
            
            
            
            58,894Consumer
      loans
            
            
            211,536
            
            
            
            182,058
            
            
            
            148,906
            
            
            
            109,568
            
            
            
            71,007Commercial
      lines of credit
            
            
            133,927
            
            
            
            95,192
            
            
            
            90,769
            
            
            
            74,559
            
            
            
            46,106Total
      loans
            
            $
            1,157,371
            
            
            $
            982,718
            
            
            $
            824,670
            
            
            $
            646,343
            
            
            $
            475,944




We manage
risk associated with our loan portfolio in part through diversification, with
what we believe are sound policies and underwriting procedures that are
reviewed, updated, and approved at least annually, as well as through our
ongoing loan monitoring efforts. Additionally, we monitor concentrations of
loans or loan relationships by industry. At December 31, 2007, there was no
concentration greater than 8% of our loan portfolio to any one industry and
there is no concentration greater than 2% to any one borrower.




Our
commercial mortgage and our construction and land development loans are
typically made to small and medium-sized investors, builders and developers and
are secured by mortgages on real property located principally in south central
Pennsylvania (principally office buildings, multifamily residential, land
development and other commercial properties). The average loan size originated
in 2007 in this category was approximately $725,000. 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
originated in 2007 in this category was approximately $720,000. Based on our
underwriting standards, loans may be secured in whole or in part by collateral
such as liquid assets, accounts receivable, equipment, inventory, and real
property. Additionally, our underwriting policy has established maximum terms
for these loans depending on the loan type within the commercial, industrial and
other business loans category. The value of the collateral in this category may
vary depending on market conditions. The Bank maintains advance rates for
particular collateral categories to mitigate the risk that the borrower defaults
and the value of the collateral is not sufficient to cover the outstanding loan
balance. We also actively manage the unused portion of commercial lines of
credit and would freeze a commitment if a borrower were in default. As of
December 31, 2007, outstanding balances under commercial lines of credit were
$133.9 million and unused commitments were $208.4 million.




Residential
real estate mortgage loans represented approximately 7% of our total loans at
December 31, 2007. Loans in this category are collateralized by first mortgages
on residential properties located in South Central Pennsylvania. Our
underwriting policy provides that all residential loans are to be written based
upon standards used by the secondary market.




Consumer
loans and consumer lines of credit represented approximately 18% of our total
loans at December 31, 2007. These loans and lines are secured by first and
second mortgages, personal assets of the borrower, or may be unsecured. As of
December 31, 2007, 38% of consumer loans and consumer lines of credit were
secured by second liens. When originating consumer loans, our underwriting
policy sets limitations on the term of the loan, defines allowable collateral
and the valuation of the collateral, outlines acceptable debt to income ratios
as well as acceptable credit sources to identify those loan applicants with a
proven record of credit management. We actively manage the unused portion of our
consumer lines of credit and would freeze a commitment if a borrower becomes
delinquent. As of December 31, 2007, unused commitments under consumer lines of
credit were $57.5 million.




During
2007, total gross loans increased by $173.5 million from $998.1 million at
December 31, 2006, to $1.2 billion at December 31, 2007, which included $14.1
million of loans held for sale on December 31, 2007 and $15.3 million of loans
held for sale on December 31, 2006. 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 $740,000 at December 31, 2007
and $531,000 at December 31, 2006. The increase in loans receivable in 2007 was
represented across various loan categories.




During
2007, commercial mortgage loans increased by $65.5 million, or 18%, and
commercial, industrial and other business loans increased by $28.7 million, or
18%. 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. Tax-exempt loans
increased $22.2 million, or 71%, to $53.7 million. Total consumer loans
increased by $29.5 million in 2007 to $211.5 million at year-




12




end
compared to $182.1 million at year-end 2006. Lines of credit experienced growth
in 2007 as well, increasing by $38.7 million, or 41%, from $95.2 million to
$133.9 million. Construction and land development loans decreased $6.9 million,
or 11%.  Residential real estate mortgage loans experienced a minimal
decline in 2007.  Given the relatively low yield on these loans versus the
long-term interest rate risk, the Bank’s residential loans are originated with
the intent to sell to the secondary market unless the loan is nonconforming to
the secondary market standards or due to a customer request, we agree not to
sell the loan.




Total
loans outstanding represented 74% of total deposits and 58% of total assets at
December 31, 2007, excluding the loans held for sale, compared to 61% and 52%,
respectively, at December 31, 2006.




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, 2007, are presented in the following table.




TABLE6December
      31, 2007(in
      thousands)
            
            Due
      Within One Year
            
            
            Due
      1-5 Years
            
            
            Due
      Over Five Years
            
            
            TotalReal
      estate:Commercial
      mortgage
            
            $
            80,274
            
            
            $
            30,714
            
            
            $
            319,790
            
            
            $
            430,778Construction
      and land development
            
            
            20,842
            
            
            
            25,967
            
            
            
            7,666
            
            
            
            54,475Residential
      mortgage
            
            
            2,150
            
            
            
            20,326
            
            
            
            58,099
            
            
            
            80,575Tax-exempt
            
            
            5,627
            
            
            
            599
            
            
            
            47,464
            
            
            
            53,690108,893
            
            
            
            77,606
            
            
            
            433,019
            
            
            
            619,518Commercial
            
            
            31,817
            
            
            
            52,328
            
            
            
            108,245
            
            
            
            192,390Consumer
            
            
            23,647
            
            
            
            22,952
            
            
            
            164,937
            
            
            
            211,536Commercial
      lines of credit
            
            
            97,719
            
            
            
            35,658
            
            
            
            550
            
            
            
            133,927Total
      loans
            
            $
            262,076
            
            
            $
            188,544
            
            
            $
            706,751
            
            
            $
            1,157,371Interest
      rates:Predetermined
            
            $
            42,413
            
            
            $
            111,681
            
            
            $
            612,524
            
            
            $
            766,618Floating
            
            
            219,663
            
            
            
            76,863
            
            
            
            94,227
            
            
            
            390,753Total
      loans
            
            $
            262,076
            
            
            $
            188,544
            
            
            $
            706,751
            
            
            $
            1,157,371




Concentrations
of Credit Risk




The
largest portion of loans, 37%, on our balance sheet is for commercial mortgage
related loans. Our commercial real estate loan portfolio is principally to
borrowers throughout Cumberland, Dauphin, Lancaster, Lebanon, York and Berks
counties of Pennsylvania where we have full-service store locations. Commercial
real estate, construction, and land development loans aggregated $485.3 million
at December 31, 2007, compared to $426.6 million at December 31, 2006.
Commercial real estate loans are collateralized by the related project
(principally office building, multi-family residential, land development, and
other properties) and we generally require loan-to-value ratios of no greater
than 80%. Collateral requirements on such loans are determined on a case-by-case
basis based on managements’ credit evaluations of the respective
borrowers.




Commercial
loans represented 17% of total loans at December 31, 2007. Collateral for these
types of loans varies depending upon managements’ credit evaluations of the
respective borrowers and generally includes the following: business assets,
personal guarantees, and/or personal assets of the borrower.




Consumer
loans comprised 18%, or $211.5 million, of total loans at December 31, 2007.
Approximately $205.0 million of consumer loans are secured by real estate, $3.7
million are loans collateralized by personal assets of the borrower, and $2.8
million are unsecured.




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






Non-Performing
Loans and Assets




Total
non-performing assets (non-performing loans, foreclosed real estate and loans
past due 90 days or more and still accruing interest) at December 31, 2007, were
$3.4 million, or 0.17%, of total assets as compared to $3.5 million, or 0.19%,
of total assets at December 31, 2006. Total non-performing loans (nonaccrual
loans, 90 days or more past due loans and restructured loans) at December 31,
2007 were $2.9 million compared to $3.4 million a year ago. Total delinquent
loans (those loans 30 days or more delinquent) as a percentage of total loans
were 0.46% at December 31, 2007, compared to 0.56% at December 31, 2006. 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, 2007, there were no




13




loans
past due 90 days and still accruing interest as compared to $2,000 at December
31, 2006. Additional loans considered by our internal loan review department as
potential problem loans of $17.2 million at December 31, 2007, compared to $11.5
million at December 31, 2006, have been evaluated as to risk exposure in
determining the adequacy of the allowance for loan losses.




Foreclosed
real estate totaled $489,000 as of December 31, 2007 as compared to $159,000 as
of December 31, 2006. 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, 2003 through 2007.




TABLE7December
      31,(dollars
      in thousands)
            2007
            
            2006
            
            2005
            
            2004
            
            2003Nonaccrual
      loans:Commercial
            $     534
            
            $     984
            
            $     684
            
            $    308
            
            $    143Consumer
            57
            
            19
            
            296
            
            11
            
            68Real
      estate:   Construction
            385
            
            247
            
            0
            
            0
            
            159Mortgage
            1,959
            
            2,129
            
            1,322
            
            267
            
            417Total
      nonaccrual loans
            2,935
            
            3,379
            
            2,302
            
            586
            
            787Loans
      past due 90 days or more and still accruing
            0
            
            2
            
            233
            
            0
            
            385Restructured
      loans
            0
            
            0
            
            0
            
            271
            
            0Total
      non-performing loans
            2,935
            
            3,381
            
            2,535
            
            857
            
            1,172Foreclosed
      real estate
            489
            
            159
            
            159
            
            507
            
            236Total
      non-performing assets
            $
      3,424
            
            $
      3,540
            
            $
      2,694
            
            $
      1,364
            
            $
      1,408Non-performing
      loans to total loans
            0.25%
            
            0.34%
            
            0.31%
            
            0.13%
            
            0.25%Non-performing
      assets to total assets
            0.17%
            
            0.19%
            
            0.16%
            
            0.11%
            
            0.13%Interest
      income received on nonaccrual loans
            $    157
            
            $    133
            
            $    106
            
            $      30
            
            $      37Interest
      income that would have been recorded under the
              original
      terms of the loans
            $    123
            
            $    196
            
            $    114
            
            $      10
            
            $      45




Allowance
for Loan Losses




The
allowance for loan losses (ALLL) is a reserve established in the form of a
provision expense for loan losses and is reduced by loan charge-offs net of
recoveries. When loans are deemed to be uncollectible, they are charged off.
Management has established a reserve that it believes is adequate for estimated
losses in the loan portfolio. In conjunction with an internal loan review
function that operates independently of the lending function, management
monitors the loan portfolio to identify risks on a timely basis so that an
appropriate allowance is maintained. Based on an evaluation of the loan
portfolio, management presents a quarterly review of the allowance for loan
losses to the Board of Directors, indicating any changes in the allowance since
the last review. 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 integral part of the examination
process.




In
establishing the allowance, management evaluates on a quantitative basis
individual classified loans and nonaccrual loans, and determines an aggregate
reserve for those loans based on that review. In addition, an allowance for the
remainder of the loan portfolio is determined based on historical loss
experience within certain 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 quantitative processes
described above. This determination inherently involves a higher degree of
subjectivity, and considers risk factors that may not have yet manifested
themselves in historical loss experience. These factors include:




·
            Changes
      in lending policies and procedures, including changes in underwriting
      standards and collection, charge-off and recovery practices. Changes in
      the volume and severity of past due loans, the volume of nonaccrual loans,
      and the volume and severity of adversely classified or graded
      loans.·
            Changes
      in the nature and volume of the portfolio and the terms of
      loans.·
            Changes
      in the value of underlying collateral for collateral-dependent
      loans.·
            Changes
      in the quality of the institution’s loan review system.·
            Changes
      in the experience, ability, and depth of lending management and other
      relevant staff.·
            The
      existence and effect of any concentrations of credit, and changes in the
      level of such concentrations.




14




·
            Changes
      in international, national, regional, and local economic and business
      conditions and developments that affect the collectibility of the
      portfolio, including the condition of various market segments, and the
      effect of other external factors such as competition and legal and
      regulatory requirements on the level of estimated credit losses in the
      institution’s existing portfolio.







More
specifically, the methodology utilized to assess the adequacy of the allowance
includes:




·
            Identifying
      loans for individual review under 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 larger balance commercial loans and
      commercial mortgages.·
            Assessing
      whether the loans identified for review under Statement 114 are “impaired”
      based on the probability that all amounts due under the loan will not be
      collected according to the contractual terms of the loan
      agreement.·
            For
      loans identified as impaired, calculating the estimated fair value of the
      loan, using one of the following methods, a) observable market price, b)
      discounted cash flow or c) the value of the underlying
      collateral.·
            Classifying
      all non-impaired, loans based on credit risk ratings and allocating an
      allowance for loan losses based on appropriate factors, including recent
      loss history for similar loans.·
            Identifying
      other loans for evaluation collectively under the provisions of Statement
      of Financial Accounting Standards No. 5 “Accounting for Contingencies”
      (Statement 5). In general, these other loans include residential mortgages
      and consumer 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.·
            Reviewing
      the results to determine the appropriate balance of the allowance for loan
      losses.







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




The Bank
recorded provisions of $1.8 million to the allowance for loan losses in 2007,
compared to $1.6 million for 2006. During 2007, net charge-offs amounted to
$705,000, or 0.07%, of average loans outstanding for the year, compared to $1.2
million, or 0.13%, of average loans outstanding for 2006. One loan totaling
$165,000 made up the largest single loan charge-off for 2007. All other loans
charged-off were under $100,000 each. The majority of the total net charge-off
figure for 2006 was related to one loan for approximately $900,000. The
allowance for loan losses decreased as a percentage of loans receivable from
0.99% of total loans outstanding at December 31, 2006, to 0.93% of total loans
outstanding at December 31, 2007 while still providing coverage of 366% of
non-performing loans. Based upon a consistent application of our loan loss
reserve methodology, the allowance level increased by $1.1 million to $10.7
million at December 31, 2007, but decreased as a percentage of total loans. The
decrease in the allowance as a percentage of total loans was primarily due to
18% growth in the loan portfolio in 2007 while asset quality remained very
strong.




Table 8
presents, for the years 2003 through 2007, information regarding our provision
and allowance for loan losses.




TABLE8Years
      Ended December 31,(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Balance
      at beginning of year
            
            $
            9,685
            
            
            $
            9,231
            
            
            $
            7,847
            
            
            $
            6,007
            
            
            $
            5,146Provisions
      charged to operating expenses
            
            
            1,762
            
            
            
            1,634
            
            
            
            1,560
            
            
            
            2,646
            
            
            
            1,69511,447
            
            
            
            10,865
            
            
            
            9,407
            
            
            
            8,653
            
            
            
            6,841Recoveries
      of loans previously charged-off:Commercial
            
            
            11
            
            
            
            34
            
            
            
            546
            
            
            
            110
            
            
            
            66Consumer
            
            
            53
            
            
            
            71
            
            
            
            50
            
            
            
            113
            
            
            
            85Real
      estate
            
            
            8
            
            
            
            0
            
            
            
            0
            
            
            
            8
            
            
            
            115Total
      recoveries
            
            
            72
            
            
            
            105
            
            
            
            596
            
            
            
            231
            
            
            
            266Loans
      charged-off:Commercial
            
            
            (634
            )
            
            
            (895
            )
            
            
            (627
            )
            
            
            (528
            )
            
            
            (483
            )Consumer
            
            
            (69
            )
            
            
            (390
            )
            
            
            (135
            )
            
            
            (350
            )
            
            
            (331
            )Real
      estate
            
            
            (74
            )
            
            
            0
            
            
            
            (10
            )
            
            
            (159
            )
            
            
            (286
            )Total
      charged-off
            
            
            (777
            )
            
            
            (1,285
            )
            
            
            (772
            )
            
            
            (1,037
            )
            
            
            (1,100
            )Net
      charge-offs
            
            
            (705
            )
            
            
            (1,180
            )
            
            
            (176
            )
            
            
            (806
            )
            
            
            (834
            )Balance
      at end of year
            
            $
            10,742
            
            
            $
            9,685
            
            
            $
            9,231
            
            
            $
            7,847
            
            
            $
            6,007Net
      charge-offs to average loans outstanding
            
            
            0.07
            %
            
            
            0.13
            %
            
            
            0.02
            %
            
            
            0.14
            %
            
            
            0.20
            %Allowance
      for loan losses to year-end loans
            
            
            0.93
            %
            
            
            0.99
            %
            
            
            1.12
            %
            
            
            1.21
            %
            
            
            1.26
            %




15




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.




TABLE9Allowance
      for Loan Losses at December 31,2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003(dollars
      in thousands)
            
            Amount
            
            
            %
      Gross Loans
            
            
            Amount
            
            
            %
      Gross Loans
            
            
            Amount
            
            
            %
      Gross Loans
            
            
            Amount
            
            
            %
      Gross Loans
            
            
            Amount
            
            
            %
      Gross LoansCommercial
      loans
              and
      lines of credit
            
            $
            4,253
            
            
            
            31
            %
            
            $
            4,417
            
            
            
            28
            %
            
            $
            3,675
            
            
            
            28
            %
            
            $
            3,063
            
            
            
            27
            %
            
            $
            2,636
            
            
            
            21
            %Consumer
            
            
            1,800
            
            
            
            18
            
            
            
            1,868
            
            
            
            19
            
            
            
            1,785
            
            
            
            18
            
            
            
            1,657
            
            
            
            17
            
            
            
            717
            
            
            
            15Real
      estate,
              construction
      and land
              development:Commercial
            
            
            3,796
            
            
            
            43
            
            
            
            2,695
            
            
            
            43
            
            
            
            3,058
            
            
            
            42
            
            
            
            2,540
            
            
            
            43
            
            
            
            2,157
            
            
            
            47Residential
            
            
            893
            
            
            
            8
            
            
            
            705
            
            
            
            10
            
            
            
            713
            
            
            
            12
            
            
            
            587
            
            
            
            13
            
            
            
            497
            
            
            
            17Total
            
            $
            10,742
            
            
            
            100
            %
            
            $
            9,685
            
            
            
            100
            %
            
            $
            9,231
            
            
            
            100
            %
            
            $
            7,847
            
            
            
            100
            %
            
            $
            6,007
            
            
            
            100
            %




Bank
Premises and Equipment




Premises
and equipment at December 31, 2007 was $89.3 million, up $5.6 million, or 7%,
over premises and equipment of $83.7 million at December 31, 2006. The increase
is primarily related to the capitalized costs associated with three newly
constructed stores in 2007 offset by depreciation expense in 2007.






Other
Assets




Other
assets decreased by $3.4 million from $18.5 million at December 31, 2006 to
$15.1 million at December 31, 2007. This change resulted from a receivable for
proceeds from a security sold in December 2006 and funded in January
2007.






Deposits




Total
deposits at December 31, 2007, were $1.56 billion, down $55.9 million, or 3%,
from total deposits of $1.62 billion at December 31, 2006. In 2007, we made a
strategic decision not to match the unusually “high rate” deposit pricing on
deposits offered by most other banks in our footprint. As a result, our deposit
growth was below our historical norm and we experienced some run-off of higher
priced deposits, especially during the fourth quarter.




Although
this produced a year-end total deposit figure slightly below year-end 2006, our
pricing discipline served to stabilize and eventually began to lower our overall
cost of funds. In turn, this provided us with increased net interest income and
an improved net interest margin throughout the second half of 2007.




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 decreased $29.7 million, or 2%, in 2007
over 2006. Total deposits averaged $1.55 billion for 2007, an increase of $103.8
million, or 7%, over the 2006 average of $1.45 billion. The average balance on
noninterest-bearing demand deposits increased in 2007 by $15.7 million, or 6%,
over the prior year. The average balance of interest bearing demand accounts
(money market and interest checking accounts) for 2007 increased by $107.4
million, or 18%, over the average balance for the prior year. The average total
balance of all savings accounts was $373.2 million, a $9.7 million, or 3%,
increase over the average balance for 2006. The average balance of all time
deposits in 2007 was $198.5 million, a decrease of $28.9 million, or 13%, from
the average balance for 2006. For 2007, the deposit cost of funds was 2.37% as
compared to 2.42% in 2006.




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.




16





The
average balances and weighted average rates paid on deposits for 2007, 2006 and
2005 are presented below.




TABLE10Years
      Ended December 31,2007
      Average
            
            
            2006
      Average
            
            
            2005
      Average(dollars
      in thousands)
            
            Balance/Rate
            
            
            Balance/Rate
            
            
            Balance/RateDemand
      deposits:Noninterest-bearing
            
            $
            269,353
            
            
            
            
            
            $
            253,671
            
            
            
            
            
            $
            220,566Interest-bearing
      (money market and checking)
            
            
            712,418
            
            
            
            3.47
            %
            
            
            605,043
            
            
            
            3.68
            %
            
            
            479,310
            
            
            
            2.49
            %Savings
            
            
            373,209
            
            
            
            2.41
            
            
            
            363,515
            
            
            
            2.35
            
            
            
            325,218
            
            
            
            1.55Time
            
            
            198,544
            
            
            
            4.26
            
            
            
            227,484
            
            
            
            3.93
            
            
            
            214,420
            
            
            
            3.00Total
      deposits
            
            $
            1,553,524
            
            
            
            
            
            
            $
            1,449,713
            
            
            
            
            
            
            $
            1,239,514




The
remaining maturity for certificates of deposit of $100,000 or more as of
December 31, 2007, 2006 and 2005 is presented in Table 11.




TABLE11Years
      Ended December 31,(in
      thousands)
            
            2007
            
            
            2006
            
            
            20053
      months or less
            
            $
            22,844
            
            
            $
            25,696
            
            
            $
            20,0023
      to 6 months
            
            
            19,452
            
            
            
            22,759
            
            
            
            6,4876
      to 12 months
            
            
            12,847
            
            
            
            38,901
            
            
            
            29,582Over
      12 months
            
            
            17,263
            
            
            
            20,034
            
            
            
            69,028Total
            
            $
            72,406
            
            
            $
            107,390
            
            
            $
            125,099




Short-Term
Borrowings and Repurchase Agreements




Short-term
borrowings used to meet temporary funding needs consist of overnight and
short-term advances from the Federal Home Loan Bank, securities sold under
agreements to repurchase and overnight federal funds lines of credit. For 2007,
short-term borrowings averaged $208.1 million. The weighted average rate paid
during 2007 was 5.12% for short-term borrowings. At December 31, 2007,
short-term borrowings totaled $217.3 million at an average rate of 3.59%. As of
December 31, 2006, short-term borrowings totaled $112.8 million at an average
rate of 5.40%. As of December 31, 2005, short-term borrowings totaled $157.9
million at an average rate of 4.24%. The maximum short-term borrowings
outstanding at any month-end were $249.4 million in 2007, $227.1 million in 2006
and $183.2 million in 2005. The maximum repurchase agree­ments outstanding
at any month-end were $55.0 million in 2006 and $70 million in 2005. There were
no repurchase agreements outstanding during any time in 2007.






Long-Term
Debt




Long-term
debt totaled $79.4 million at December 31, 2007 as compared to $29.4 million at
December 31, 2006. Our long-term debt consisted of Trust Capital Securities
through Commerce Harrisburg Capital Trust I, Commerce Harrisburg Capital Trust
II and Commerce Harrisburg Capital Trust III, our Delaware business trust
subsidiaries. At December 31, 2007, 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. As part of the
Company’s Asset/Liability management strategy, management utilized the Federal
Home Loan Bank convertible select borrowing product during the third quarter of
2007 with the purchase of a $25.0 million borrowing with a 5 year maturity and a
six month conversion term at an initial interest rate of 4.29% and a $25.0
million borrowing with a 2 year maturity and a three month conversion term at an
initial interest rate of 4.49%. The interest costs associated with the
convertible select borrowing agreements entered into in August 2007 averaged
approximately 42 basis points less than the average cost of the Bank’s
alternative source of borrowings over the last five months of 2007. As a result,
the Bank realized an approximate $78,000 reduction in borrowing expense over
this time period. 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, 2007, stockholders’ equity totaled $112.3 million, up $11.2
million, or 11%, over stockholders’ equity at December 31, 2006. This increase
was due to our net income for the year as well as proceeds for shares issued
under our stock purchase and stock option plans. Stockholders’ equity as a
percent of total assets was 5.68% at December 31, 2007, compared to 5.42% at
December 31, 2006. See Note 12 of Notes to Consolidated Financial
Statements for December 31, 2007, 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,




17




and the
allowance for loan losses.




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




TABLE12MinimumDecember
      31,
            
            
            Regulatory2007
            
            
            2006
            
            
            RequirementsTier
      1 Capital
            
            
            10.02
            %
            
            
            9.98
            %
            
            
            4.00
            %Total
      Capital
            
            
            10.77
            
            
            
            10.71
            
            
            
            8.00Leverage
      ratio
              (to
      total average assets)
            
            
            7.24
            
            
            
            7.30
            
            
            
            3.00-4.00




At
December 31, 2007, the consolidated capital levels of the Company and of the
Bank met the regulatory definition of a “well-capitalized” financial
institution, i.e., a leverage capital ratio exceeding 5%, a Tier 1 risk-based
capital ratio exceeding 6%, and a total risk-based capital ratio exceeding
10%.




Our
common stock trades on the NASDAQ Global Select Market under the symbol COBH.
The table below sets forth the prices on the NASDAQ Global Select Market known
to us for the period beginning January 1, 2006 through December 31, 2007. As of
December 31, 2007, there were approximately 2,500 holders of record of the
Company’s common stock.




Sales
      PriceQuarter
      Ended:
            
            High
            
            
            LowMarch
      31, 2007
            
            $
            29.26
            
            
            $
            26.09June
      30, 2007
            
            
            29.28
            
            
            
            25.20September
      30, 2007
            
            
            31.65
            
            
            
            22.35December
      31, 2007
            
            
            33.11
            
            
            
            27.46March
      31, 2006
            
            $
            33.50
            
            
            $
            30.01June
      30, 2006
            
            
            32.00
            
            
            
            26.54September
      30, 2006
            
            
            31.68
            
            
            
            25.58December
      31, 2006
            
            
            26.84
            
            
            
            24.77




The
following graph shows the yearly percentage change in the Company’s cumulative
total shareholder return on its common stock from December 31, 2002 to December
31, 2007 compared with the cumulative total return of a NASDAQ Bank Index and
the NASDAQ Composite Market Index.









18




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






Interest
Rate Sensitivity




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




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




An
interest rate sensitive asset or liability is one that, within a defined time
period, either matures or experiences an interest rate change in line with
general market interest rates. Historically, the most common method of
estimating interest rate risk was to measure the maturity and repricing
relationships between interest-earning assets and interest-bearing liabilities
at specific points in time, referred to as “GAP,” typically one year. Under this
method, a company is considered liability sensitive when the amount of its
interest-bearing liabilities exceeds the amount of its interest-earning assets
within the one-year horizon. However, assets and liabilities with similar
repricing characteristics may not reprice at the same time or to the same
degree. As a result, our GAP does not necessarily predict the impact of changes
in general levels of interest rates on net interest income. Table 13 shows our
GAP position as of December 31, 2007. The repricing assumptions used in the
table are as follows:




·
            Fixed
      rate loans receivable are scheduled according to their contractual
      amortization and payment schedules specific to each loan. A market
      consensus Constant Prepayment Rate is applied to Residential Mortgage
      Fixed rate loans.·
            Floating
      rate loans receivable are scheduled in the 1-90 day category as they are
      tied to a floating index such as New York Prime and available for
      immediate repricing.·
            Securities
      with pre-payment characteristics such as mortgage-backed securities and
      collateralized mortgage obligations are scheduled based upon their
      remaining weighted average lives as calculated utilizing a market
      consensus Constant Prepayment Rate. Securities with call options are
      analyzed in the context of the existing interest rate environment to
      estimate the likelihood of their call, and to project their resulting
      payment schedule. All other securities are assumed to reprice at their
      contractual maturity.·
            Fixed
      rate transaction accounts are scheduled to reprice in accordance with
      their estimated decay rates as determined in a core deposit study produced
      by an independent consultant. Floating rate transaction accounts are
      scheduled in the 1-90 day category as they are tied to a floating index
      such as the 91 Day Treasury Bill.·
            Time
      deposit accounts, short-term borrowings, and trust capital securities are
      scheduled based upon their contractual maturity
  dates.




TABLE13December
      31, 2007(dollars
      in thousands)
            
            1
      – 90
              Days
            
            
            91
      – 180
              Days
            
            
            181
      – 365
              Days
            
            
            1
      – 5
              Years
            
            
            Beyond
      5
              Years
            
            
            TotalInterest-earning
      assets:Loans
      receivable
            
            $
            457,322
            
            
            $
            33,196
            
            
            $
            66,141
            
            
            $
            459,387
            
            
            $
            155,468
            
            
            $
            1,171,514Securities
            
            
            140,362
            
            
            
            74,074
            
            
            
            88,047
            
            
            
            226,467
            
            
            
            139,751
            
            
            
            668,701Total
      interest-earning assets
            
            
            597,684
            
            
            
            107,270
            
            
            
            154,188
            
            
            
            685,854
            
            
            
            295,219
            
            
            
            1,840,215Interest-bearing
      liabilities:Transaction
      accounts, excluding DDA
            
            
            703,916
            
            
            
            11,684
            
            
            
            23,367
            
            
            
            94,682
            
            
            
            289,611
            
            
            
            1,123,260Time
      deposits
            
            
            59,470
            
            
            
            46,238
            
            
            
            27,848
            
            
            
            32,186
            
            
            
            0
            
            
            
            165,742Short-term
      borrowings
            
            
            217,335
            
            
            
            0
            
            
            
            0
            
            
            
            0
            
            
            
            0
            
            
            
            217,335Long-term
      debt
            
            
            0
            
            
            
            0
            
            
            
            0
            
            
            
            79,400
            
            
            
            0
            
            
            
            79,400Total
      interest-bearing liabilities
            
            
            980,721
            
            
            
            57,922
            
            
            
            51,215
            
            
            
            206,268
            
            
            
            289,611
            
            
            
            1,585,737Period
      GAP
            
            
            (383,037
            )
            
            
            49,348
            
            
            
            102,973
            
            
            
            479,586
            
            
            
            5,608
            
            
            $
            254,478Cumulative
      GAP
            
            $
            (383,037
            )
            
            $
            (333,689
            )
            
            $
            (230,716
            )
            
            $
            248,870
            
            
            $
            254,478Cumulative
      RSA / RSL
            
            
            60.94
            %
            
            
            67.87
            %
            
            
            78.83
            %
            
            
            119.20
            %
            
            
            116.05
            %




Notes:
Securities are reported at amortized cost for purposes of this table. RSA means
rate sensitive assets; RSL means rate sensitive liabilities.




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




19




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






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






The
following table compares the impact on forecasted net income at December 31,
2007 of a plus 200 and minus 200 basis point (bp) change in interest rates to
the impact at December 31, 2006 in the same scenarios.




Plus
      200
            
            
            Minus
      200December
      31, 2007:Twelve
      Months
            
            
            (1.9
            )%
            
            
            1.9
            %Twenty-Four
      Months
            
            
            (0.5
            )%
            
            
            0.5
            %December
      31, 2006:Twelve
      Months
            
            
            (4.1
            )%
            
            
            4.4
            %Twenty-Four
      Months
            
            
            (2.9
            )%
            
            
            2.8
            %




Management
continues to evaluate strategies in conjunction with the Company’s ALCO to
effectively manage the interest rate risk position. Such strategies could
include the sale of a portion of our available for sale investment portfolio,
the use of risk management tools such as interest rate swaps and caps, adjusting
the investment leverage position funded by short-term borrowings, or fixing the
cost of our short-term borrowings.




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




Management
also monitors interest rate risk by utilizing a market value of equity model.
The model assesses the impact of a change in interest rates on the market value
of all our assets and liabilities, as well as any off balance sheet items. The
model calculates the market value of our assets and liabilities in excess of
book value in the current rate scenario, and then compares the excess of market
value over book value given an immediate 200 basis point increase and a 200
basis point decrease in rates. Our ALCO policy indicates that the level of
interest rate risk is unacceptable if the immediate change would result in the
loss of 40% or more of the excess of market value over book value in the current
rate scenario. At December 31, 2007, the market value of equity indicates an
acceptable level of interest rate risk under this measurement.




The
market value of equity model reflects certain estimates and assumptions
regarding the impact on the market value of our assets and liabilities given an
immediate 200 basis point change in interest rates. One of the key assumptions
is the market value assigned to our core deposits, or the core deposit premium.
Using an independent consultant, we have completed and updated comprehensive
core deposit studies in order to assign our own core deposit premiums as
permitted by regulation. The studies have consistently confirmed management’s
assertion that our core deposits have stable balances over long periods of time,
are relatively insensitive to changes in interest rates and have significantly
longer average lives and durations than our loans and investment securities.
Thus, these core deposit balances provide an internal hedge to market
fluctuations in our fixed rate assets. Management believes the core deposit
premiums produced by its market value of equity model at December 31, 2007
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




20




business
opportunities. Our ALCO is responsible for implementing the policies and
guidelines of our board governing liquidity.




Liquidity
sources are found on both sides of the balance sheet. Liquidity is provided on a
continuous basis through scheduled and unscheduled principal reductions and
interest payments on outstanding loans and investments. Liquidity is also
provided through the availability and maintenance of a strong base of core
customer deposits; maturing short-term assets; the ability to sell marketable
securities; short-term borrowings and access to capital markets.




Liquidity
is measured and monitored daily, allowing management to better understand and
react to balance sheet trends. On a monthly basis, a comprehensive liquidity
analysis is reviewed by our Board of Directors. The analysis provides a summary
of the current liquidity measurements, projections and future liquidity
positions given various levels of liquidity stress. Management also maintains a
detailed liquidity contingency plan designed to respond to an overall decline in
the condition of the banking industry or a problem specific to the
Company.




The
Consolidated Statements of Cash Flows provide additional information on our
sources and uses of funds. From a funding standpoint, we have been able to rely
over the years on a stable base of strong “core” deposit growth. We generated
$23.2 million in cash from operating activities during 2007 versus $6.4 million
during 2006. This increase was primarily attributed to the change in balances of
other assets and other liabilities from one year to the next in addition to the
change in balances of proceeds from sales of loans and loans originated for
sale. Investing activities resulted in a net cash outflow of $126.3 million
during 2007 compared to $208.6 million in 2006. A reduction of investment
purchases of $47.4 million contributed to the decrease in investing activities
in 2007 from 2006. Financing activities resulted in a net inflow of $101.6
million in 2007 compared to $218.4 million in 2006. The cash inflow in 2007 was
mostly from an increase in short-term borrowings of $104.5 million and an
increase in long-term borrowings of $50.0 million offset by a decline in net
deposit balances of $55.9 million. For 2006, cash inflows resulted from $245.7
million in net deposit growth and were offset by a decrease in short-term
borrowings of $45.1 million.




At
December 31, 2007, 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 $444.9 million, or 23%, of total assets. This compares to $470.1
million, or 25%, of total assets, at December 31, 2006.




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, 2007, our total
potential liquidity through these secondary sources was $694.2 million of which
$426.8 million was currently available, as compared to $598.0 million at
December 31, 2006 of which $485.2 million was currently available.




Subject
to regulatory approvals, we are targeting to open approximately 15-20 new stores
over the next five years. The cost to construct and furnish a new store will be
approximately $3.1 million, excluding the cost to lease or purchase the land on
which the store is located.






Aggregate
Contractual Obligations




The
following table represents our on-and–off balance sheet aggregate contractual
obligations to make future payments as of December 31, 2007:







TABLE14December
      31, 2007(in
      thousands)
            
            Less
      than
              1
      Year
            
            
            1
      to 3
              Years
            
            
            3
      to 5
              Years
            
            
            Over
      5
              Years
            
            
            TotalTime
      Deposits
            
            $
            133,556
            
            
            $
            26,426
            
            
            $
            5,760
            
            
            $
            0
            
            
            $
            165,742Long-Term
      Debt
            
            
            0
            
            
            
            25,000
            
            
            
            25,000
            
            
            
            29,400
            
            
            
            79,400Operating
      Leases
            
            
            2,230
            
            
            
            4,135
            
            
            
            4,094
            
            
            
            28,488
            
            
            
            38,947Sponsorship
      Obligation
            
            
            318
            
            
            
            467
            
            
            
            467
            
            
            
            1,399
            
            
            
            2,651Total
            
            $
            136,104
            
            
            $
            56,028
            
            
            $
            35,321
            
            
            $
            59,287
            
            
            $
            286,740




For
further discussion regarding our commitments and contingencies, please see Note
18 in the Notes to
Consolidated Financial Statementsfor December 31, 2007, included
herein.




21




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 our customers. These financial
instruments include commitments to extend credit and standby letters of credit.
See Note 5 in the Notes to the
Consolidated Financial Statementsfor December 31, 2007, included herein,
for additional information.






Forward-Looking
Statements




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




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




●
            the
      strength of the United States economy in general and the strength of the
      local economies in which the Company conducts
  operations;●
            the
      effects of, and changes in, trade, monetary and fiscal policies, including
      interest rate policies of the Board of Governors of the Federal Reserve
      System;●
            inflation;●
            interest
      rate, market and monetary fluctuations;●
            the
      timely development of competitive new products and services by the Company
      and the acceptance of such products and services by
    customers;●
            the
      willingness of customers to substitute competitors’ products and services
      for the Company’s products and services and vice versa;●
            the
      impact of changes in financial services’ laws and regulations (including
      laws concerning taxes, banking, securities and
  insurance);●
            the
      impact of the rapid growth of the Company;●
            the
      Company’s dependence on Commerce Bancorp, Inc. to provide various services
      to the Company;●
            changes
      in the Company’s allowance for loan losses;●
            effect
      of terrorists attacks and threats of actual war;●
            unanticipated
      regulatory or judicial proceedings;●
            changes
      in consumer spending and saving habits;●
            and
      the success of the Company at managing the risks involved in the
      foregoing.







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






Impact
of Inflation and Changing Prices




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




22




Quantitative
and Qualitative Disclosures about Market Risk




Our
exposure to market risk principally includes interest rate risk, which was
previously discussed. Historically, our net interest margin has remained fairly
stable; our net interest margin for the year ended December 31, 2007 was 3.30%,
an increase of 12 basis points from 3.18% for the year ended December 31, 2006
effect throughout 2007. 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 99% 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.





23




Pennsylvania
Commerce Bancorp, Inc.


Report
on Management’s Assessment of Internal Control Over


Financial
Reporting







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









We, as
management of Pennsylvania Commerce Bancorp, Inc., are responsible for
establishing and maintaining effective internal control over financial reporting
that is designed to produce reliable financial statements in conformity with
United States generally accepted accounting principles. Internal control over
financial reporting includes those policies and procedures that pertain to the
maintenance of records that in reasonable detail accurately and fairly reflect
the transactions and dispositions of the assets of the Company; provide
reasonable assurance that the transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are
only being made in accordance with authorizations of management and directors of
the Company; and provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the Company’s
assets that could have a material effect on the financial statements. The system
of internal control over financial reporting as it relates to the financial
statements is evaluated for effectiveness by management and tested for
reliability 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, 2007, 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, 2007,
its system of internal control over financial reporting is effective and meets
the criteria of the Internal Control – Integrated Framework.









/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 7,
2008




24




Report
of Independent Registered Public Accounting Firm












To the
Board of Directors


And
Stockholders of Pennsylvania Commerce Bancorp, Inc.


Harrisburg,
Pennsylvania









We
have audited Pennsylvania Commerce Bancorp, Inc.’s internal control over
financial reporting as of December 31, 2007, based on criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Pennsylvania Commerce Bancorp,
Inc.’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 included in the accompanying Report on
Management’s Assessment of Internal Control over Financial Reporting. Our
responsibility is to express an opinion on the Pennsylvania Commerce Bancorp,
Inc.’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 of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included 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, Pennsylvania Commerce Bancorp, Inc. maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2007, 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 and
the related consolidated statements of income, stockholders’ equity and cash
flows of Pennsylvania Commerce Bancorp, Inc. and subsidiaries and our report
dated March 7, 2008 expressed an unqualified opinion.









/s/ Beard
Miller Company LLP












Beard
Miller Company LLP


Harrisburg,
Pennsylvania


March 7,
2008












25




Report
of Independent Registered Public Accounting Firm












To the
Board of Directors and


Stockholders
of Pennsylvania Commerce Bancorp, Inc.


Harrisburg,
Pennsylvania









We have
audited the accompanying consolidated balance sheets of Pennsylvania Commerce
Bancorp, Inc. and subsidiaries as of December 31, 2007 and 2006, 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, 2007. Pennsylvania
Commerce Bancorp, Inc.’s management is responsible for these consolidated
financial statements. 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 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 its subsidiaries as of December 31, 2007 and 2006, and the
results of their operations and their cash flows for the each of the years in
the three-year period ended December 31, 2007 in conformity with accounting
principles generally accepted in the United States of America.




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




We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Pennsylvania Commerce Bancorp, Inc.’s internal
control over the financial reporting as of December 31, 2007, 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 7,
2008 expressed an unqualified opinion.









/s/ Beard
Miller Company LLP












Beard
Miller Company LLP


Harrisburg,
Pennsylvania


March 7,
2008








26
    Consolidated Balance
      SheetsDecember
      31,(in
      thousands, except share and per share amounts)
              
              2007
              
              
              2006AssetsCash
      and due from banks
              
              $
              50,955
              
              
              $
              52,500Federal
      funds sold
              
              
              0
              
              
              
              0Cash
      and cash equivalents
              
              
              50,955
              
              
              
              52,500Securities,
      available for sale at fair value
              
              
              387,166
              
              
              
              392,058Securities,
      held to maturity at cost(fair
      value 2007: $256,248;  2006: $314,837)
              
              
              257,467
              
              
              
              319,628Loans,
      held for sale
              
              
              14,143
              
              
              
              15,346Loans
      receivable, net of allowance for loan losses(allowance
      2007: $10,742;  2006: $9,685)
              
              
              1,146,629
              
              
              
              973,033Restricted
      investments in bank stocks
              
              
              18,234
              
              
              
              11,728Premises
      and equipment, net
              
              
              89,307
              
              
              
              83,679Other
      assets
              
              
              15,110
              
              
              
              18,511Total
      assets
              
              $
              1,979,011
              
              
              $
              1,866,483Liabilities
      and Stockholders’ EquityDeposits:Noninterest-bearing
              
              $
              271,894
              
              
              $
              275,137Interest-bearing
              
              
              1,289,002
              
              
              
              1,341,640Total
      deposits
              
              
              1,560,896
              
              
              
              1,616,777Short-term
      borrowings and repurchase agreements
              
              
              217,335
              
              
              
              112,800Long-term
      debt
              
              
              79,400
              
              
              
              29,400Other
      liabilities
              
              
              9,045
              
              
              
              6,398Total
      liabilities
              
              
              1,866,676
              
              
              
              1,765,375Stockholders’
      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 2007: 6,313,663;  2006:
    6,149,155)
              
              
              6,314
              
              
              
              6,149Surplus
              
              
              70,610
              
              
              
              67,072Retained
      earnings
              
              
              38,862
              
              
              
              31,941Accumulated
      other comprehensive loss
              
              
              (3,851
              )
              
              
              (4,454
              )Total
      stockholders’ equity
              
              
              112,335
              
              
              
              101,108Total
      liabilities and stockholders’ equity
              
              $
              1,979,011
              
              
              $
              1,866,483
  
 See
accompanying notes.
  1
   
 Consolidated Statements of
      IncomeYears
      Ended December 31,(in
      thousands, except per share amounts)
              
              2007
              
              
              2006
              
              
              2005Interest
      IncomeLoans
      receivable, including fees:Taxable
              
              $
              76,753
              
              
              $
              64,592
              
              
              $
              47,949Tax-exempt
              
              
              2,109
              
              
              
              1,029
              
              
              
              421Securities:Taxable
              
              
              37,060
              
              
              
              38,845
              
              
              
              30,822Tax-exempt
              
              
              65
              
              
              
              85
              
              
              
              355Federal
      funds sold
              
              
              0
              
              
              
              0
              
              
              
              5Total
      interest income
              
              
              115,987
              
              
              
              104,551
              
              
              
              79,552Interest
      ExpenseDeposits
              
              
              42,197
              
              
              
              39,762
              
              
              
              23,408Short-term
      borrowings
              
              
              10,804
              
              
              
              10,267
              
              
              
              3,821Long-term
      debt
              
              
              3,494
              
              
              
              1,731
              
              
              
              1,418Total
      interest expense
              
              
              56,495
              
              
              
              51,760
              
              
              
              28,647Net
      interest income
              
              
              59,492
              
              
              
              52,791
              
              
              
              50,905Provision
      for loan losses
              
              
              1,762
              
              
              
              1,634
              
              
              
              1,560Net
      interest income after provision for loan losses
              
              
              57,730
              
              
              
              51,157
              
              
              
              49,345Noninterest
      IncomeService
      charges and other fees
              
              
              20,688
              
              
              
              16,816
              
              
              
              12,430Other
      operating income
              
              
              702
              
              
              
              640
              
              
              
              466Gains
      on sales of loans
              
              
              1,262
              
              
              
              1,136
              
              
              
              1,320Gains
      (losses) on sales/call of securities
              
              
              171
              
              
              
              160
              
              
              
              (60
              )Total
      noninterest income
              
              
              22,823
              
              
              
              18,752
              
              
              
              14,156Noninterest
      ExpensesSalaries
      and employee benefits
              
              
              34,495
              
              
              
              30,864
              
              
              
              26,267Occupancy
              
              
              7,560
              
              
              
              6,568
              
              
              
              5,380Furniture
      and equipment
              
              
              4,075
              
              
              
              3,587
              
              
              
              2,733Advertising
      and marketing
              
              
              3,334
              
              
              
              2,971
              
              
              
              3,461Data
      processing
              
              
              6,501
              
              
              
              5,420
              
              
              
              3,843Postage
      and supplies
              
              
              1,963
              
              
              
              1,621
              
              
              
              1,308Regulatory
      assessments
              
              
              3,062
              
              
              
              511
              
              
              
              432Telephone
              
              
              2,386
              
              
              
              1,152
              
              
              
              772Other
              
              
              7,431
              
              
              
              6,600
              
              
              
              6,207Total
      noninterest expenses
              
              
              70,807
              
              
              
              59,294
              
              
              
              50,403Income
      before taxes
              
              
              9,746
              
              
              
              10,615
              
              
              
              13,098Provision
      for federal income taxes
              
              
              2,745
              
              
              
              3,361
              
              
              
              4,281Net
      income
              
              $
              7,001
              
              
              $
              7,254
              
              
              $
              8,817Net
      Income per Common ShareBasic
              
              $
              1.11
              
              
              $
              1.18
              
              
              $
              1.47Diluted
              
              
              1.07
              
              
              
              1.12
              
              
              
              1.38Average
      Common and Common Equivalent Shares OutstandingBasic
              
              
              6,237
              
              
              
              6,099
              
              
              
              5,948Diluted
              
              
              6,462
              
              
              
              6,381
              
              
              
              6,318
  See
accompanying notes.
  2
   Consolidated Statements of
      Stockholders’ Equity(dollars
      in thousands)
                
                Preferred
      Stock
                
                
                Common
      Stock
                
                
                Surplus
                
                
                Retained
      Earnings
                
                
                Accumulated
      Other Comprehensive Income (Loss)
                
                
                TotalJanuary
      1, 2005
                
                $
                400
                
                
                $
                5,870
                
                
                $
                62,790
                
                
                $
                16,030
                
                
                $
                (51
                )
                
                $
                85,039Comprehensive
      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
                )
                
                
                91,643Comprehensive
      income:Net
      income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                7,254
                
                
                
                -
                
                
                
                7,254Change
      in unrealized gains (losses) on securities, net of taxes
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (57
                )
                
                
                (57
                )Total
      comprehensive income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                7,197Dividends
      declared on preferred stock
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (80
                )
                
                
                -
                
                
                
                (80
                )Common
      stock of 95,561 shares issued under stock option plans, including tax
      benefit of $513
                
                
                -
                
                
                
                96
                
                
                
                877
                
                
                
                -
                
                
                
                -
                
                
                
                973Common
      stock of 210 shares issued under employee stock purchase
    plan
                
                
                -
                
                
                
                -
                
                
                
                6
                
                
                
                -
                
                
                
                -
                
                
                
                6Proceeds
      from issuance of 39,525 shares of common stock in connection with dividend
      reinvestment and stock purchase plan
                
                
                -
                
                
                
                39
                
                
                
                1,001
                
                
                
                -
                
                
                
                -
                
                
                
                1,040Common
      stock share-based awards
                
                
                -
                
                
                
                -
                
                
                
                329
                
                
                
                -
                
                
                
                -
                
                
                
                329December
      31, 2006
                
                
                400
                
                
                
                6,149
                
                
                
                67,072
                
                
                
                31,941
                
                
                
                (4,454
                )
                
                
                101,108Comprehensive
      income:Net
      income
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                7,001
                
                
                
                -
                
                
                
                7,001Change
      in unrealized gains (losses) on securities, net of taxes
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                603
                
                
                
                603Total
      comprehensive income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                7,604Dividends
      declared on preferred stock
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (80
                )
                
                
                -
                
                
                
                (80
                )Common
      stock of 106,260 shares issued under stock option plans, including tax
      benefit of $368
                
                
                -
                
                
                
                106
                
                
                
                1,294
                
                
                
                -
                
                
                
                -
                
                
                
                1,400Common
      stock of 220 shares issued under employee stock purchase
    plan
                
                
                -
                
                
                
                -
                
                
                
                6
                
                
                
                -
                
                
                
                -
                
                
                
                6Proceeds
      from issuance of 58,028 shares of common stock in connection with dividend
      reinvestment and stock purchase plan
                
                
                -
                
                
                
                59
                
                
                
                1,519
                
                
                
                -
                
                
                
                -
                
                
                
                1,578Common
      stock share-based awards
                
                
                -
                
                
                
                -
                
                
                
                719
                
                
                
                -
                
                
                
                -
                
                
                
                719December
      31, 2007
                
                $
                400
                
                
                $
                6,314
                
                
                $
                70,610
                
                
                $
                38,862
                
                
                $
                (3,851
                )
                
                $
                112,335
  See
accompanying notes.
  
 3
    Consolidated
      Statements of Cash FlowsYears
      Ended December 31,(in thousands)
              
              2007
              
              
              2006
              
              
              2005Operating
      ActivitiesNet
      income
              
              $
              7,001
              
              
              $
              7,254
              
              
              $
              8,817Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      for loan losses
              
              
              1,762
              
              
              
              1,634
              
              
              
              1,560Provision
      for depreciation and amortization
              
              
              4,789
              
              
              
              4,004
              
              
              
              3,006Deferred
      income taxes
              
              
              73
              
              
              
              1,319
              
              
              
              (1,303
              )Amortization
      of securities premiums and accretion of discounts, net
              
              
              567
              
              
              
              776
              
              
              
              1,216Net
      (gains) losses on sales and calls of securities
              
              
              (171
              )
              
              
              (160
              )
              
              
              60Proceeds
      from sales of loans originated for sale
              
              
              86,604
              
              
              
              93,789
              
              
              
              104,627Loans
      originated for sale
              
              
              (84,301
              )
              
              
              (97,524
              )
              
              
              (100,032
              )Gains
      on sales of loans originated for sale
              
              
              (1,262
              )
              
              
              (1,136
              )
              
              
              (1,320
              )Loss
      on disposal of equipment
              
              
              0
              
              
              
              270
              
              
              
              99Tax
      benefit on exercise of stock options
              
              
              0
              
              
              
              0
              
              
              
              474Stock-based
      compensation
              
              
              719
              
              
              
              329
              
              
              
              68Amortization
      of deferred loan origination fees and costs
              
              
              1,858
              
              
              
              2,174
              
              
              
              2,088(Increase)
      decrease in other assets
              
              
              2,904
              
              
              
              (5,847
              )
              
              
              (1,500
              )Increase
      (decrease) in other liabilities
              
              
              2,647
              
              
              
              (518
              )
              
              
              (11,265
              )Net
      cash provided by operating activities
              
              
              23,190
              
              
              
              6,364
              
              
              
              6,595Investing
      ActivitiesSecurities
      held to maturity:Proceeds
      from principal repayments and maturities
              
              
              149,790
              
              
              
              44,923
              
              
              
              49,709Proceeds
      from sales
              
              
              0
              
              
              
              2,081
              
              
              
              5,456Purchases
              
              
              (87,590
              )
              
              
              (60,400
              )
              
              
              (151,046
              )Securities
      available for sale:Proceeds
      from principal repayments and maturities
              
              
              55,423
              
              
              
              112,533
              
              
              
              94,077Proceeds
      from sales
              
              
              0
              
              
              
              0
              
              
              
              55,263Purchases
              
              
              (49,949
              )
              
              
              (124,527
              )
              
              
              (224,441
              )Proceeds
      from sales of loans receivable
              
              
              2,683
              
              
              
              1,181
              
              
              
              10,005Net
      increase in loans receivable
              
              
              (179,720
              )
              
              
              (162,473
              )
              
              
              (190,170
              )Net
      (purchase) redemption of restricted investments in bank
    stock
              
              
              (6,507
              )
              
              
              (265
              )
              
              
              (5,747
              )Proceeds
      from sale of premises and equipment
              
              
              62
              
              
              
              827
              
              
              
              0Purchases
      of premises and equipment
              
              
              (10,479
              )
              
              
              (22,516
              )
              
              
              (24,181
              )Net
      cash used by investing activities
              
              
              (126,287
              )
              
              
              (208,636
              )
              
              
              (381,075
              )Financing
      ActivitiesNet
      increase in demand, interest checking, money market, and savings
      deposits
              
              
              3,270
              
              
              
              249,695
              
              
              
              193,634Net
      increase (decrease) in time deposits
              
              
              (59,151
              )
              
              
              (3,978
              )
              
              
              16,881Net
      increase (decrease) in short-term borrowings
              
              
              104,535
              
              
              
              (45,100
              )
              
              
              157,900Proceeds
      from long-term borrowings
              
              
              50,000
              
              
              
              0
              
              
              
              0Proceeds
      from issuance of long-term debt
              
              
              0
              
              
              
              15,800
              
              
              
              0Proceeds
      from common stock options exercised
              
              
              1,032
              
              
              
              460
              
              
              
              874Proceeds
      from dividend reinvestment and common stock purchase plan
              
              
              1,578
              
              
              
              1,040
              
              
              
              783Tax
      benefit on exercise of stock options
              
              
              368
              
              
              
              513
              
              
              
              0Cash
      dividends on preferred stock and cash in lieu of fractional
      shares
              
              
              (80
              )
              
              
              (80
              )
              
              
              (80
              )Net
      cash provided by financing activities
              
              
              101,552
              
              
              
              218,350
              
              
              
              369,992Increase
      (decrease) in cash and cash equivalents
              
              
              (1,545
              )
              
              
              16,078
              
              
              
              (4,488
              )Cash
      and cash equivalents at beginning of year
              
              
              52,500
              
              
              
              36,422
              
              
              
              40,910Cash
      and cash equivalents at year-end
              
              $
              50,955
              
              
              $
              52,500
              
              
              $
              36,422
 
 See
accompanying notes.
  4
   Notes to
Consolidated Financial Statements
  1. Significant
Accounting Policies
  Nature
of Operations and Basis of Presentation
  The
consolidated financial statements presented include the accounts of Pennsylvania
Commerce Bancorp, Inc. (the Company) and its wholly-owned subsidiary Commerce
Bank/Harrisburg, N.A. (Commerce or Bank). All material intercompany transactions
have been eliminated. The Company was formed July 1, 1999 and is subject to
regulation of the Federal Reserve Bank.
  The
Company is a one-bank holding company head­quartered in Harrisburg,
Pennsylvania and provides full banking services through its subsidiary Commerce
Bank. As a national bank, Commerce is subject to regulation of the Office of the
Comptroller of the Currency and the Federal Deposit Insurance Corporation. The
Bank serves primarily the Harrisburg, York, Reading and Lancaster markets of
South Central Pennsylvania.
  Estimates
  The
financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. These principles require
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and require disclosure of contingent assets and
liabilities. In the opinion of management, all adjustments considered necessary
for fair presentation have been included and are of a normal, recurring nature.
Actual results could differ from these estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses, the valuation of deferred tax
assets, and the valuation of securities available for sale.
  Significant
Group Concentrations of Credit Risk
  Most of
the Company’s activities are with customers located within the South Central
Pennsylvania Region. Note 3 discusses the types of securities that the Company
invests in. Notes 4 and 6 discuss the types of lending that the Company engages
in as well as loan concentrations. The Company does not have any significant
concentrations to any one 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) Adverse change
in the general market condition of the industry which the investment is related,
(2) the financial condition and near-term prospects of the issuer, and (3) the
intent and ability of the Company to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair
value.
  Management
determines the appropriate classification of debt securities at the time of
purchase and re-evaluates such designation as of each balance sheet
date.
  Loans
Receivable
  Loans
receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at their outstanding
unpaid principal balances, net of an allowance for loan losses and any deferred
fees and costs. Interest income is accrued on the unpaid principal balance. Loan
origination fees and costs are deferred and recognized as an adjustment of the
yield (interest income) of the related loans. The Bank is generally amortizing
these amounts over the contractual life of the loan or call date.
  The
accrual of interest is generally discontinued when the contractual payment of
principal or interest has become 90 days past due or management has serious
doubts about further collectibility of principal or interest, even though the
loan is currently performing. A loan may remain on accrual status if it is in
the process of collection and is either guaranteed or well secured. When a loan
is placed on nonaccrual status, unpaid interest credited to income in the
current year is reversed and unpaid interest accrued in prior years is charged
against the allowance for loan losses. Interest received on nonaccrual loans
generally is either applied against principal or reported as interest income,
according to management’s judgment as to the collectibility of principal.
Generally, loans are restored to accrual status when the obligation is brought
current, has performed in accordance with the contractual terms for a reasonable
period
  5
 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, commercial
mortgage 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, 2007, $11.8 million of the Company’s $15.7 million of FHLB stock
was purchased to cover the Company’s borrowing level on its credit line at the
FHLB. The stock is carried at cost.
  Advertising
Costs
  The
Company follows the policy of charging the costs of advertising to expense as
incurred.
  Income
Taxes
  Deferred
income taxes are provided on the liability method whereby deferred tax assets
are recognized for deductible temporary differences and deferred tax liabilities
are recognized for taxable temporary differences. Temporary differences are the
differences between the reported amounts of assets and liabilities and their tax
bases. Deferred tax assets and liabilities are adjusted through the provision
for income taxes for the effects of changes in tax laws and rates on the date of
enactment.
  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.
  6
 Foreclosed
Assets
  Assets
acquired through, or in lieu of, loan foreclosure are held for sale and are
initially recorded at fair value at the date of foreclosure, establishing a new
cost basis. Subsequent to foreclosure, valuations are periodically performed by
management and the assets are carried at the lower of carrying amount or fair
value less cost to sell. Revenue and expenses from operations and changes in the
valuation allowance are included in net expenses from foreclosed assets.
Foreclosed assets are included in other assets.
  Transfers
of Financial Assets
  Transfers
of financial assets, including sales of loans and loan participations, are
accounted for as sales, when control over the assets has been surrendered.
Control over transferred assets is deemed to be surrendered when (1) the assets
have been isolated from the Company, (2) the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge
or exchange the transferred assets, and (3) the Company does not maintain
effective control over the transferred assets through an agreement to repurchase
them before their maturity.
  Per
Share Data
  Basic
earnings per share represent income available to common stockholders divided by
the weighted-average number of common shares outstanding during the period.
Diluted earnings per share reflect additional common shares that would have been
outstanding if dilutive potential common shares had been issued as well as any
adjustments to income that would result from the assumed issuance. Potential
common shares that may be issued by the Company relate solely to outstanding
stock options, and are determined using the treasury stock method.
  Off
Balance Sheet Financial Instruments
  In the
ordinary course of business, the Company has entered into off balance sheet
financial instruments consisting of commitments to extend credit, commercial
letters of credit, and standby letters of credit. Such financial instruments are
recorded on the balance sheet when they become payable by the borrower to the
Company.
  Cash
Flow Information
  For
purposes of the statements of cash flows, the Company considers cash and due
from banks and federal funds sold as cash and cash equivalents. Generally,
federal funds are purchased and sold for one-day periods. Cash paid during the
years ended December 31, 2007, 2006, and 2005 for interest was $56.4 million,
$51.5 million, and $28.5 million respectively. Income taxes paid totaled
$1.7million, $2.7
million, and $3.9 million in 2007, 2006, and 2005, respectively.
  Stock-Based
Compensation
  Prior to
2006, the Company accounted for stock-based compensation issued to directors and
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”
(“APB 25”). This method required that compensation expense be recognized to the
extent that the fair value of the stock exceeded the exercise price of the stock
award at the grant date. The Company generally did not recognize compensation
expense related to stock option awards because the stock options generally had
fixed terms and exercise prices that were equal to or greater than the fair
value of the Company’s common stock at the grant date.
  Effective
January 1, 2006, the Company adopted Financial Accounting Standards Board (FASB)
Statement No. 123(R), “Share-Based Payment,” (“FAS 123(R)”) using the modified
prospective method. FAS 123(R) requires compensation costs related to
share-based payment transactions to be recognized in the income statement (with
limited exceptions) based on the grant-date fair value of the stock-based
compensation issued. Compensation costs are recognized over the period that an
employee provides service in exchange for the award. The adoption of Statement
of Financial Accounting Standards (“SFAS”) 123(R) had an unfavorable impact
on our net income and net income per share in 2006 and 2007 and will continue to
do so in future periods as we recognize compensation expense for stock option
awards.
  In
conjunction with FAS 123(R), the Company also adopted FASB Staff Position
(“FSP”) FAS 123(R)-2, “Practical Accommodation to the Application of Grant
Date as Defined in FAS 123(R)” effective January 1, 2006. FSP 123(R)-2
provides guidance on the application of grant date as defined in FAS 123(R). In
accordance with this standard, a grant date of an award exists if (a) the
award is a unilateral grant and (b) the key terms and conditions of the
award are expected to be communicated to an individual recipient within a
relatively short time period from the date of approval. The adoption of this
standard did not have a material impact on our consolidated financial position,
results of operations, or cash flows for the years ended December 31, 2007 or
December 31, 2006.
  On
December 16, 2005, the Company’s Board of Directors approved the accelerated
vesting of all outstanding unvested stock options awarded prior to July 1, 2005
to employees and directors. This acceleration was effective as of December 18,
2005. The Company recorded a one-time charge in the fourth quarter of 2005 of
approximately $70,000, or $.01 per share, as a result of the accelerated
vesting. The decision to accelerate the vesting of the options was to enable the
Company to reduce the amount of non-cash compensation expense that would have
been recorded in the Company’s income statement in future periods upon the
adoption of FAS
  7
 123(R) in
January 2006. The Company has placed a restriction on the members of senior
management and the Board of Directors that would prevent the sale, or any other
transfer, of any stock obtained through exercise of an accelerated option prior
to the earlier of the original vesting date or the individual’s termination of
employment. As a result of the acceleration, options to purchase approximately
176,000 shares of common stock became immediately exercisable in December
2005.
  The fair
value of each option grant was established at the date of grant using the
Black-Scholes option pricing model. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options, which have no
vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including
the stock price volatility. Because the Company's stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of the Company’s
stock options. The Black-Scholes model used the following weighted-average
assumptions for 2007, 2006, and 2005 respectively: risk-free interest rates
of 4.7%, 4.6% and 4.1%; volatility factors of the expected market price of the
Company's common stock of .19, .19 and .26; weighted average expected lives of
the options of 8.2 years, 8.2 years and 7.3 years and no cash dividends. Based
upon these assumptions, the weighted average fair value of options granted was
$10.21, $11.11, and $12.32, for the years ended December 31, 2007, 2006 and
2005, respectively.
  The
Company recorded compensation expense of approximately $719,000 for the year
ended December 31, 2007 compared to $329,000 for the year ended December 31,
2006. The tax benefit associated with compensation expense was $116,000 for 2007
and $51,000 for 2006.
  The
following table illustrates the impact on net income and earnings per share had
the Company applied FAS No. 123 (R) for the year ended December 31,
2005.
  (in
      thousands,
              Year
      Ended December 31,except
      per share amounts)
              2005Net
      income:As
      reported
              
              $
              8,817Total
      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
              )Pro-forma
              
              $
              6,275Reported
      earnings per share:Basic
              
              $
              1.47Diluted
              
              
              1.38Pro-forma
      earnings per share:Basic
              
              $
              1.04Diluted
              
              
              0.97
  Prior to
the adoption of FAS 123(R), the Company presented tax benefits of deductions
resulting from the exercise of stock options as operating cash flows in the
Consolidated Statement of Cash Flows. FAS 123(R) requires the cash flows
resulting from the tax benefits due to deductions in excess of the compensation
cost recognized for those options (excess tax benefits) to be classified as
financing cash flows. The $368,000 for 2007 and $513,000 for 2006 excess tax
benefit classified as a financing cash flow in 2007 and 2006 would have been
classified as an operating cash inflow if the Company had not adopted FAS
123(R).
  Recent
Accounting Standards
  In
September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements,
which defines fair value, establishes a framework for measuring fair value under
GAAP, and expands disclosures about fair value measurements. FASB Statement No.
157 applies to other accounting pronouncements that require or permit fair value
measurements. SFAS No. 157 is effective for our Company January 1,
2008.  We do not expect the implementation of FASB Statement No. 157
to have a material impact on our consolidated financial position or results of
operations.
  In
December 2007, the FASB issued proposed FASB Staff Position (FSP) 157-b,
“Effective Date of FASB Statement No. 157,” that would permit a one-year
deferral in applying the measurement provisions of Statement No. 157 to
non-financial assets and non-financial liabilities (non-financial items) that
are not recognized or disclosed at fair value in an entity’s financial
statements
  8
 on a
recurring basis (at least annually). Therefore, if the change in fair value of a
non-financial item is not required to be recognized or disclosed in the
financial statements on an annual basis or more frequently, the effective date
of application of Statement 157 to that item is deferred until fiscal years
beginning after November 15, 2008 and interim periods within those fiscal
years. This deferral does not apply, however, to an entity that applies
Statement 157 in interim or annual financial statements before proposed FSP
157-b is finalized. The Company is currently evaluating the impact, if any, that
the adoption of FSP 157-b will have on the Company’s operating income or net
earnings.
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115.” SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS No. 159 is
effective for our Company January 1, 2008. We do not expect the adoption
of  SFAS No. 159 to have a significant impact on our consolidated
financial statements.
  In March
2007, the FASB ratified EITF Issue No. 06-11, “Accounting for Income Tax
Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 requires
companies to recognize the income tax benefit realized from dividends or
dividend equivalents that are charged to retained earnings and paid to employees
for nonvested equity-classified employee share-based payment awards as an
increase to additional paid-in capital. EITF 06-11 became effective for fiscal
years beginning after September 15, 2007. We do not expect the adoption of EITF
Issue No. 06-11 to have a significant impact on our consolidated financial
statements.
  In June
2007, the Emerging Issues Task Force (EITF) reached a consensus on Issue
No. 06-11, “Accounting for Income Tax Benefits of Dividends on Share-Based
Payment Awards” (“EITF 06-11”). EITF 06-11 states that an entity should
recognize a realized tax benefit associated with dividends on nonvested equity
shares, nonvested equity share units and outstanding equity share options
charged to retained earnings as an increase in additional paid in
capital. The amount recognized in additional paid in capital should be
included in the pool of excess tax benefits available to absorb potential future
tax deficiencies on share-based payment awards. EITF 06-11 should be
applied prospectively to income tax benefits of dividends on equity-classified
share-based payment awards that are declared in fiscal years beginning after
December 15, 2007. The Company expects that EITF 06-11 will not have
an impact on its consolidated financial statements.
  In May
2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1 “Definition of
Settlement in FASB Interpretation No. 48” (FSP FIN 48-1). FSP FIN 48-1 provides
guidance on how to determine whether a tax position is effectively settled for
the purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is
effective retroactively to January 1, 2007. The implementation of FIN 48 and FIN
48-1 did not have a material impact on our consolidated financial position or
results of operations.
  FASB
statement No. 160 “Noncontrolling Interests in Consolidated Financial
Statements—an amendment of ARB No. 51” was issued in December of 2007. This
Statement establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary and for the deconsolidation of a subsidiary. The
guidance will become effective as of the beginning of a company’s fiscal year
beginning after December 15, 2008. The Company believes that this new
pronouncement will have an immaterial impact on the Company’s financial
statements in future periods.
  Staff
Accounting Bulletin No. 109 (SAB 109), "Written Loan Commitments Recorded at
Fair Value Through Earnings" expresses the views of the staff regarding written
loan commitments that are accounted for at fair value through earnings under
generally accepted accounting principles. To make the staff's views consistent
with current authoritative accounting guidance, the SAB revises and rescinds
portions of SAB No. 105, "Application of Accounting Principles to Loan
Commitments."  Specifically, the SAB revises the SEC staff's views on
incorporating expected net future cash flows related to loan servicing
activities in the fair value measurement of a written loan commitment. The SAB
retains the staff's views on incorporating expected net future cash flows
related to internally-developed intangible assets in the fair value measurement
of a written loan commitment. The staff expects registrants to apply the views
in Question 1 of SAB 109 on a prospective basis to derivative loan commitments
issued or modified in fiscal quarters beginning after December 15, 2007. The
Company does not expect SAB 109 to have a material impact on its financial
statements.
  Segment
Reporting
  Commerce
acts as an independent community financial services provider, and offers
traditional banking and related financial services to individual, business and
government customers. Through its stores, the Company offers a full array of
commercial and retail financial services.
  Management
does not separately allocate expenses, including the cost of funding loan
demand, between the commercial and retail operations of the Company. As such,
discrete financial information is not available and segment reporting would not
be meaningful.
  Reclassifications
  Certain
amounts in the 2006 and 2005 financial statements have been reclassified to
conform to the 2007 presentation format. Such reclassifications had no impact on
the Company’s net income.
  9
 2.   Restrictions
on Cash and Due from Bank Accounts
  The Bank
is required to maintain average reserves, in the form of cash and balances with
the Federal Reserve Bank, against its deposit liabilities. The average amount of
these reserve balances maintained for 2007 and 2006 was approximately $24.8
million and $22.6 million, respectively.
  3.   Securities
  The
amortized cost and fair value of securities are summarized in the following
tables.
  December
      31, 2007(in
      thousands)
              
              Amortized
      Cost
              
              
              Gross
      Unrealized Gains
              
              
              Gross
      Unrealized Losses
              
              
              Fair
      ValueAvailable
      for Sale:U.S.
      Government Agency securities
              
              $
              5,000
              
              
              $
              0
              
              
              $
              (42
              )
              
              $
              4,958Mortgage-backed
      securities
              
              
              388,000
              
              
              
              375
              
              
              
              (6,167
              )
              
              
              382,208Total
              
              $
              393,000
              
              
              $
              375
              
              
              $
              (6,209
              )
              
              $
              387,166Held
      to Maturity:U.S.
      Government Agency securities
              
              $
              133,303
              
              
              $
              606
              
              
              $
              (163
              )
              
              $
              133,746Municipal
      securities
              
              
              1,621
              
              
              
              16
              
              
              
              0
              
              
              
              1,637Mortgage-backed
      securities
              
              
              116,058
              
              
              
              213
              
              
              
              (1,545
              )
              
              
              114,726Corporate
      debt securities
              
              
              6,485
              
              
              
              70
              
              
              
              (416
              )
              
              
              6,139Total
              
              $
              257,467
              
              
              $
              905
              
              
              $
              (2,124
              )
              
              $
              256,248
 
 December
      31, 2006(in
      thousands)
              
              Amortized
      Cost
              
              
              Gross
      Unrealized Gains
              
              
              Gross
      Unrealized Losses
              
              
              Fair
      ValueAvailable
      for Sale:U.S.
      Government Agency securities
              
              $
              5,000
              
              
              $
              0
              
              
              $
              (193
              )
              
              $
              4,807Mortgage-backed
      securities
              
              
              393,909
              
              
              
              75
              
              
              
              (6,733
              )
              
              
              387,251Total
              
              $
              398,909
              
              
              $
              75
              
              
              $
              (6,926
              )
              
              $
              392,058Held
      to Maturity:U.S.
      Government Agency securities
              
              $
              175,043
              
              
              $
              15
              
              
              $
              (1,984
              )
              
              $
              173,074Municipal
      securities
              
              
              1,619
              
              
              
              13
              
              
              
              (2
              )
              
              
              1,630Mortgage-backed
      securities
              
              
              131,979
              
              
              
              66
              
              
              
              (3,240
              )
              
              
              128,805Corporate
      debt securities
              
              
              10,987
              
              
              
              341
              
              
              
              0
              
              
              
              11,328Total
              
              $
              319,628
              
              
              $
              435
              
              
              $
              (5,226
              )
              
              $
              314,837
  The
amortized cost and fair value of debt securities at December 31, 2007 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.
  Available
      for Sale
              
              
              Held
      to Maturity(in
      thousands)
              
              Amortized
                Cost
              
              
              Fair Value
              
              
              Amortized Cost
              
              
              Fair ValueDue
      in one year or less
              
              $
              0
              
              
              $
              0
              
              
              $
              3,804
              
              
              $
              3,809Due
      after one year through five years
              
              
              0
              
              
              
              0
              
              
              
              41,294
              
              
              
              40,953Due
      after five years through ten years
              
              
              0
              
              
              
              0
              
              
              
              40,344
              
              
              
              40,317Due
      after ten years
              
              
              5,000
              
              
              
              4,958
              
              
              
              55,967
              
              
              
              56,4435,000
              
              
              
              4,958
              
              
              
              141,409
              
              
              
              141,522Mortgage-backed
      securities
              
              
              388,000
              
              
              
              382,208
              
              
              
              116,058
              
              
              
              114,726Total
              
              $
              393,000
              
              
              $
              387,166
              
              
              $
              257,467
              
              
              $
              256,248
  There
were no sales of securities in the available for sale or held to maturity
portfolios in 2007. There was $171,000 in premiums on the call of two securities
realized in net income for 2007.
  10
 
  There
were no sales of securities in the available for sale portfolio in 2006.
Additionally, a gross gain of $80,000 was realized on the sale of one security
from the held to maturity portfolio. This sale consisted of a $2.1 million debt
security which was sold due to the expected and impending call of the security
by the issuer. The sale was near the call date and changes in market interest
rates had no effect on the security’s fair value. The amount of gain on sale was
essentially the same as the call premium that would have been recognized on the
call date. An $80,000 premium on the call of another debt security was also
realized in net income for 2006.
  Gross
gains of $186,000 and gross losses of $859,000 were realized on sales of
securities available for sale in 2005. Additionally, gross gains of $613,000 and
gross losses of $0 were realized on sales of securities held to maturity. The
sale of the held to maturity security consisted of a $5.5 million municipal bond
which was sold solely due to a continued deterioration in the issuer’s
creditworthiness.
  At
December 31, 2007 and 2006, securities with a fair value of $454.7 million and
$486.4 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, 2007Less
      than 12 months
              
              
              12
      months or more
              
              
              Total(in
      thousands)
              
              Fair
      Value
              
              
              Unrealized
      Losses
              
              
              Fair
      Value
              
              
              Unrealized
      Losses
              
              
              Fair
      Value
              
              
              Unrealized
      LossesAvailable
      for Sale:U.S.
      Government Agency securities
              
              $
              0
              
              
              $
              0
              
              
              $
              4,958
              
              
              $
              (42
              )
              
              $
              4,958
              
              
              $
              (42
              )Mortgage-backed
      securities
              
              
              80,732
              
              
              
              (1,110
              )
              
              
              226,261
              
              
              
              (5,057
              )
              
              
              306,993
              
              
              
              (6,167
              )Total
              
              $
              80,732
              
              
              $
              (1,110
              )
              
              $
              231,219
              
              
              $
              (5,099
              )
              
              $
              311,951
              
              
              $
              (6,209
              )Held
      to Maturity:U.S.
      Government Agency securities
              
              $
              9,990
              
              
              $
              (9
              )
              
              $
              59,846
              
              
              $
              (154
              )
              
              $
              69,836
              
              
              $
              (163
              )Mortgage-backed
      securities
              
              
              10
              
              
              
              0
              
              
              
              88,362
              
              
              
              (1,545
              )
              
              
              88,372
              
              
              
              (1,545
              )Corporate
      debt securities
              
              
              1,580
              
              
              
              (416
              )
              
              
              0
              
              
              
              0
              
              
              
              1,580
              
              
              
              (416
              )Total
              
              $
              11,580
              
              
              $
              (425
              )
              
              $
              148,208
              
              
              $
              (1,699
              )
              
              $
              159,788
              
              
              $
              (2,124
              )December
      31, 2006Less
      than 12 months
              
              
              12
      months or more
              
              
              Total(in
      thousands)
              
              Fair
      Value
              
              
              Unrealized
      Losses
              
              
              Fair
      Value
              
              
              Unrealized
      Losses
              
              
              Fair
      Value
              
              
              Unrealized
      LossesAvailable
      for Sale:U.S.
      Government Agency securities
              
              $
              0
              
              
              $
              0
              
              
              $
              4,807
              
              
              $
              (193
              )
              
              $
              4,807
              
              
              $
              (193
              )Mortgage-backed
      securities
              
              
              32,725
              
              
              
              (136
              )
              
              
              339,060
              
              
              
              (6,597
              )
              
              
              371,785
              
              
              
              (6,733
              )Total
              
              $
              32,725
              
              
              $
              (136
              )
              
              $
              343,867
              
              
              $
              (6,790
              )
              
              $
              376,592
              
              
              $
              (6,926
              )Held
      to Maturity:U.S.
      Government Agency securities
              
              $
              33,853
              
              
              $
              (54
              )
              
              $
              134,204
              
              
              $
              (1,930
              )
              
              $
              168,057
              
              
              $
              (1,984
              )Municipal
      securities
              
              
              344
              
              
              
              0
              
              
              
              308
              
              
              
              (2
              )
              
              
              652
              
              
              
              (2
              )Mortgage-backed
      securities
              
              
              2,561
              
              
              
              (4
              )
              
              
              116,898
              
              
              
              (3,236
              )
              
              
              119,459
              
              
              
              (3,240
              )Total
              
              $
              36,758
              
              
              $
              (58
              )
              
              $
              251,410
              
              
              $
              (5,168
              )
              
              $
              288,168
              
              
              $
              (5,226
              )
  At
December 31, 2007, ten mortgage-backed securities, one corporate debt security,
and one U.S. Government Agency security have been in a continuous unrealized
loss position for less than twelve months. For the same period, 76
mortgage-backed securities, and eight 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 changes in the level of interest
rates subsequent to the purchase of those securities. 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, 2007.
  The
unrealized losses on the Company’s investment in federal agency mortgage-backed
securities were caused by changes in the level of interest rates as well. The
Company purchased those investments at a discount relative to their face amount,
and the contractual cash flows of those investments are guaranteed by an agency
of the U.S. government. Accordingly, it is expected that the securities would
not be settled at a price less than the amortized cost of the Company’s
investment. Because the decline in market value is attributable to changes in
interest rates and not credit quality, and because the Company has the ability
and intent to hold those investments until a recovery of fair value, which may
be maturity, the Company does not consider those investments to be
other-than-
  11
 temporarily
impaired at December 31, 2007. The unrealized loss on the Company’s investment
in corporate debt securities is related to one security. The unrealized loss was
due to a combination of a change in the level of interest rates subsequent to
the purchase of the security as well as a credit rating downgrade of the
security in 2007 by the major bond rating agencies. As of December 31, 2007, the
security remained “investment grade” level and, subsequent to year-end, more
than half of the unrealized loss has been recovered. The security has a final
maturity of April 2009 and the Company has the ability and the intent to hold
the security until maturity. Therefore, the Company does not consider the
investment to be other-than-temporarily impaired at December 31,
2007.
  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)
              
              2007
              
              
              2006Real
      Estate:Commercial
      Mortgage
              
              $
              430,778
              
              
              $
              365,261Construction
      and land development
              
              
              54,475
              
              
              
              61,365Residential
      Mortgage
              
              
              80,575
              
              
              
              83,690Tax-Exempt
              
              
              53,690
              
              
              
              31,446Commercial
      Business
              
              
              192,390
              
              
              
              163,706Consumer
              
              
              211,536
              
              
              
              182,058Commercial
      Lines of Credit
              
              
              133,927
              
              
              
              95,1921,157,371
              
              
              
              982,718Less:
      Allowance for Loan Losses
              
              
              10,742
              
              
              
              9,685Net
      Loans Receivable
              
              $
              1,146,629
              
              
              $
              973,033
  The
following is a summary of the transactions in the allowance for loan
losses.
  Years
      Ended December 31,(in
      thousands)
              
              2007
              
              
              2006
              
              
              2005Balance
      at beginning of year
              
              $
              9,685
              
              
              $
              9,231
              
              
              $
              7,847Provision
      charged to expense
              
              
              1,762
              
              
              
              1,634
              
              
              
              1,560Recoveries
              
              
              72
              
              
              
              105
              
              
              
              596Loans
      charged off
              
              
              (777
              )
              
              
              (1,285
              )
              
              
              (772
              )Balance
      at end of year
              
              $
              10,742
              
              
              $
              9,685
              
              
              $
              9,231
  At
December 31, 2007 and 2006, the recorded investment in loans considered to be
impaired under FASB Statement No. 114 “Accounting by Creditors for Impairment of
a Loan” totaled $9.1 million and $13.9 million, respectively. At December 31,
2007, $1.3million
of impaired loans have a specific valuation allowance of $536,000 as compared to
$3.9 million of impaired loans having a specific valuation allowance of $1.0
million at December 31, 2006. Nonaccrual loans at December 31, 2007 and 2006
totaled $2.9 million and $3.4 million, respectively. Loans past due 90 days or
more and still accruing interest totaled $0 at December 31, 2007 and $2,000 at
December 31, 2006.
  Impaired
loans averaged approximately $11.7 million, $10.5 million and $7.3 million
during 2007, 2006 and 2005, respectively. Interest income recognized on these
loans amounted to $883,000, $1.1 million and $551,000 during 2007, 2006 and
2005, 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 $14.7
million and $13.4 million at December 31, 2007 and 2006, respectively. During
2007, $6.0 million of new advances were made and repayments totaled $4.7
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
  12
 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.
  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, 2007 for guarantees under standby letters of credit issued is
$0.
  The
Bank’s maximum exposure to credit loss for loan commitments (unfunded loans and
unused lines of credit, including home equity lines of credit) and standby
letters of credit outstanding were as follows:
  December
      31,(in
      thousands)
              
              2007
              
              
              2006Commitments
      to grant loans
              
              $
              5,537
              
              
              $
              7,350Unfunded
      commitments of existing loans
              
              
              369,104
              
              
              
              330,468Standby
      letters of credit
              
              
              37,004
              
              
              
              26,546Total
              
              $
              411,645
              
              
              $
              364,364
  6.    Concentrations
of Credit Risk
  The
Company’s loan portfolio is principally to borrowers throughout Cumberland,
Dauphin, York, Lebanon, Lancaster and Berks counties of Pennsylvania where it
has full-service stores. Commercial real estate loans and loan commitments for
commercial real estate projects aggregated $537.3 million at December 31,
2007.
  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 is computed on the straight-line method over the following
estimated useful lives of the related assets:
  YearsBuildings
      and leasehold improvements
              1 -
      40Furniture,
      fixtures and equipment
              1 –
      15Computer
      equipment and software
              3 -
      8
  A summary
of premises and equipment is as follows:
  December
      31,(in
      thousands)
              
              2007
              
              
              2006Land
              
              $
              15,386
              
              
              $
              14,720Buildings
              
              
              66,217
              
              
              
              58,386Construction
      in process
              
              
              1,010
              
              
              
              1,971Leasehold
      improvements
              
              
              2,346
              
              
              
              2,008Furniture,
      fixtures and equipment
              
              
              24,052
              
              
              
              21,522109,011
              
              
              
              98,607Less
      accumulated depreciation and amortization
              
              
              19,704
              
              
              
              14,928$
              89,307
              
              
              $
              83,679
  
 13
  Land,
buildings, and equipment are leased under non­cancelable operating lease
agreements that expire at various dates through 2033. Total rental expense for
operating leases in 2007, 2006, and 2005 was $2.6 million, $2.3 million, and
$2.3 million, respectively. At December 31, 2007, future minimum lease payments
for noncancelable operating leases are payable as follows:
  (in
      thousands)2008
              
              $
              2,2302009
              
              
              2,0822010
              
              
              2,0532011
              
              
              2,0932012
              
              
              2,001Thereafter
              
              
              28,488Total
      minimum lease payments
              
              $
              38,947
  8.   Deposits
  The
composition of deposits is as follows:
  December
      31,(in
      thousands)
              
              2007
              
              
              2006Non-interest
      bearing demand
              
              $
              271,894
              
              
              $
              275,137Interest
      checking and money market
              
              
              747,550
              
              
              
              720,180Savings
              
              
              375,710
              
              
              
              396,567Time
      certificates $100,000 or more
              
              
              72,406
              
              
              
              107,390Other
      time certificates
              
              
              93,336
              
              
              
              117,503$
              1,560,896
              
              
              $
              1,616,777
  At
December 31, 2007, the scheduled maturities of time deposits are as
follows:
  (in
      thousands)2008
              
              $
              133,5562009
              
              
              20,1282010
              
              
              6,2982011
              
              
              3,6242012
              
              
              2,136$
              165,742
  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 $594 million and certain qualifying assets of
the Bank collateralize the line. There was $191.8 million outstanding at
December 31, 2007 and $103.5 million outstanding at December 31, 2006 on this
line of credit. At December 31, 2007 the Bank has availability under one
repurchase agreement to borrow up to $50 million of which $0 was outstanding and
at December 31, 2006 the Bank had availability under two repurchase agreements
to borrow up to $75 million of which $0 was outstanding. The Company did not
have any securities pledged at December 31, 2007 or 2006 under these repurchase
agreements. In addition, the Bank has a line of credit of $50 million from
Commerce Bank, N.A. There was $25.5 million outstanding at December 31, 2007 and
$9.3 million outstanding at December 31, 2006 on this line of credit. The
weighted average interest rate of total short-term borrowings was 3.59% at
December 31, 2007 and 5.40% at December 31, 2006.
  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.
  On
September 28, 2001, the Company issued $8 million of 10% Trust Capital
Securities to Commerce Bancorp, Inc. through Trust II, a Delaware business trust
subsidiary. The issuance of the Trust Capital Securities has similar properties
as Trust I. The Trust Capital
  14
 Securities
evidence a preferred ownership interest in the Trust II of which the Company
owns 100% of the common equity. The proceeds from the issuance of the Trust
Capital Securities were invested in substantially similar Junior Subordinated
Debt of the Company. The Company unconditionally guarantees the Trust Capital
Securities. Interest on the debt is payable quarterly with similar terms as in
Trust I. The Trust Capital Securities are scheduled to mature on September 28,
2031. The Trust Capital Securities may be redeemed in whole or in part at the
option of the Company on or after September 28, 2011 at 105.00% of the
principal plus accrued interest, if any. The redemption price declines by 0.50%
on September 28 of each year from 2012 through 2021 at which time the securities
may be redeemed at 100% of the principal plus accrued interest, if any, to the
date fixed for redemption, subject to certain conditions. All $8 million of the
Trust Capital Securities qualified as Tier 1 capital for regulatory capital
purposes.
  On
September 29, 2006, the Company issued $15 million of 7.75% Trust Capital
Securities to Commerce Bank N.A. through Trust III, a Delaware business trust
subsidiary. The issuance of the Trust Capital Securities has similar properties
as Trust I and Trust II. The Trust Capital Securities evidence a preferred
ownership interest in Trust III of which the Company owns 100% of the common
equity. The proceeds from the issuance of the Trust Capital Securities were
invested in substantially similar Junior Subordinated Debt of the Company. The
Company unconditionally guarantees the Trust Capital Securities. Interest on the
debt is payable quarterly with similar terms as in Trust I and Trust II. The
Trust Capital Securities are scheduled to mature on September 29, 2036. The
Trust Capital Securities may be redeemed in whole or in part at the option of
the Company on or after September 29, 2011 at 100.00% of the principal plus
accrued interest, if any. All $15 million of the Trust Capital Securities
qualified as Tier 1 capital for regulatory capital purposes.
  The
remaining $1.4 million in long-term debt represents the Company’s ownership
interest in the non-bank subsidiary Trusts, which the Company was required to
deconsolidate in 2004 as a result of FASB Interpretation No. 46 “Consolidation
of a Variable Interest Entities, an Interpretation of ARB No. 51”.
  As part
of the Company’s Asset/Liability management strategy, management utilized the
Federal Home Loan Bank convertible select borrowing product during the third
quarter of 2007 with the purchase of a $25.0 million borrowing with a 5 year
maturity and a six month conversion term at an initial interest rate of 4.29%
and a $25.0 million borrowing with a 2 year maturity and a three month
conversion term at an initial interest rate of 4.49%. At December 31, 2007, all
$50.0 million of convertible select borrowings were outstanding at their
respective initial interest rates.
  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)
              
              2007
              
              
              2006
              
              
              2005Provision
      at statutory rate on pre-tax income
              
              $
              3,314
              
              
              $
              3,715
              
              
              $
              4,453Tax-exempt
      income on loans and investments
              
              
              (647
              )
              
              
              (339
              )
              
              
              (245
              )Other
              
              
              78
              
              
              
              (15
              )
              
              
              73$
              2,745
              
              
              $
              3,361
              
              
              $
              4,281
  The
statutory tax rate used to calculate the provision in 2007 and 2005 was 34% and
a 35% statutory tax rate was used in 2006 due to the projected pretax
consolidated earnings of the Company.
   The
components of income tax expense are as follows:
  Year
      Ended December 31,(in
      thousands)
              
              2007
              
              
              2006
              
              
              2005Current
              
              $
              2,672
              
              
              $
              2,042
              
              
              $
              5,584Deferred
              
              
              73
              
              
              
              1,319
              
              
              
              (1,303
              )$
              2,745
              
              
              $
              3,361
              
              
              $
              4,281
  
 15
  The
components of the net deferred tax assets were as follows:
  December
      31,(in
      thousands)
              
              2007
              
              
              2006Deferred
      tax assets:Allowance
      for loan losses
              
              $
              3,652
              
              
              $
              3,390Unrealized
      losses on securities
              
              
              1,984
              
              
              
              2,398Other
              
              
              271
              
              
              
              123Total
      deferred tax assets
              
              
              5,907
              
              
              
              5,911Deferred
      tax liabilities:Premises
      and equipment
              
              
              (2,428
              )
              
              
              (2,054
              )Prepaid
      expenses
              
              
              (414
              )
              
              
              (284
              )Deferred
      loan fees
              
              
              (1,039
              )
              
              
              (1,060
              )Total
      deferred tax liabilities
              
              
              (3,881
              )
              
              
              (3,398
              )Net
      deferred tax assets
              
              $
              2,026
              
              
              $
              2,513
  Net
income tax expense of $58,000 and $56,000 was recognized on net securities gains
during 2007 and 2006, respectively. A net income tax benefit of $21,000 on net
security losses was recognized in 2005. For 2007 the Company will receive a tax
benefit on its federal income tax return totaling $368,000, and for 2006 and
2005, the Company received a tax benefit on its federal income tax return
totaling $513,000 and $474,000, respectively for the exercise of non-qualified
stock options and disqualified dispositions of employee stock from options
exercised.
  12. 
Stockholders’ Equity
  At
December 31, 2007 and 2006, Commerce Bancorp, Inc., owned 40,000 shares of the
Company’s Series A $10 par value noncumulative nonvoting preferred stock and
warrants that entitle the holder to purchase 287,332 shares (adjusted for common
stock dividends and splits) of the Company’s common stock, exercisable at $3.48
per share (adjusted for common stock dividends and splits), in the event of a
“change in control” (as defined in the Warrant Agreement). Such warrants are
fully transferable and expire on October 7, 2008. None of these warrants were
exercised during 2007, 2006, or 2005. The preferred stock is redeemable at the
option of the Company at the price of $25 per share plus any unpaid dividends.
Dividends on the preferred stock are payable quarterly at a rate of $2 per share
per annum.
  The
Company has implemented a dividend reinvestment and stock purchase plan. Holders
of common stock may participate in the plan in which reinvested dividends and
voluntary cash payments of up to $10,000 per month (subject to change) may be
reinvested in additional common shares at a 3% discount (subject to change) from
the current market price. Employees who have been continuously employed for at
least one year are also eligible to participate in the plan under the same terms
as listed above for shareholders. A total of 58,248, 39,735 and 24,329 common
shares were issued pursuant to this plan in 2007, 2006, and 2005, respectively.
At December 31, 2007, the Company had reserved approximately 292,000 common
shares to be issued in connection with the plan.
  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 31,2007
              
              
              2006
              
              
              2005(in
      thousands, except
                per
      share amounts)
              
              Income
              
              
              Shares
              
              
              Per
      Share Amount
              
              
              Income
              
              
              Shares
              
              
              Per
      Share Amount
              
              
              Income
              
              
              Shares
              
              
              Per
      Share AmountBasic
      earnings per share:Net
      income
              
              $
              7,001
              
              
              
              
              
              
              
              
              $
              7,254
              
              
              
              
              
              
              
              
              $
              8,817Preferred
      stock dividends
              
              
              (80
              )
              
              
              
              
              
              
              
              
              (80
              )
              
              
              
              
              
              
              
              
              (80
              )Income
      available to common stockholders
              
              
              6,921
              
              
              
              6,237
              
              
              $
              1.11
              
              
              
              7,174
              
              
              
              6,099
              
              
              $
              1.18
              
              
              
              8,737
              
              
              
              5,948
              
              
              $
              1.47Effect
      of dilutive securities:Stock
      options
              
              
              
              
              
              
              225
              
              
              
              
              
              
              
              
              
              
              
              282
              
              
              
              
              
              
              
              
              
              
              
              370Diluted
      earnings per share:Income
      available to common stockholders plus assumed conversions
              
              $
              6,921
              
              
              
              6,462
              
              
              $
              1.07
              
              
              $
              7,174
              
              
              
              6,381
              
              
              $
              1.12
              
              
              $
              8,737
              
              
              
              6,318
              
              
              $
              1.38
  16
 Excluded
from the computation of diluted earnings per share for the year ended December
31, 2007 were 94,780 options outstanding at a price of $33.50 per option,
128,175 options outstanding at a price of $31.25 per option, 2,325 options
outstanding at a price of $30.57 per option, 2,181 options outstanding at a
price of $29.92 per option, and 850 options outstanding at a price of $30.65 per
option. Excluded from the computation of diluted earnings per share for the year
ended December 31, 2006 were 112,830 options outstanding at a price of $33.50
per option, 149,550 options outstanding at a price of $31.25 per option, 3,100
options outstanding at a price of $30.57 per option, and 3,050 options
outstanding at a price of $29.92 per option. Excluded from the computation of
diluted earnings per share for the year ended December 31, 2005 were 112,830
options outstanding at a price of $33.50 per option.
  14. 
Stock Option Plans
  In 2005,
the Board of Directors adopted and the Company’s shareholders approved the
adoption of the 2006 Employee Stock Option Plan for the officers and employees
of the Company. The Plan commenced January 1, 2006 and replaced the 1996
Employee Stock Option Plan, which expired December 31, 2005. The Plan covers
500,000 authorized shares of common stock reserved for issuance upon exercise of
options granted or available for grant to employees and will expire on December
31, 2015. The Plan provides that the option price of qualified incentive stock
options will be fixed by the Board of Directors, but will not be less than 100%
of the fair market value of the stock at the date of grant. In addition, the
Plan provides that the option price of nonqualified stock options (NQSO’s) also
will be fixed by the Board of Directors, however for NQSO’s the option price may
be less than 100% of the fair market value of the stock at the date of grant.
Options granted are exercisable one year after the grant date, will vest over a
four-year period, and expire ten years after the grant date.
  In 2000,
the Board of Directors adopted and the Company’s shareholders approved the
adoption of the 2001 Directors’ Stock Option Plan. The Plan commenced January 1,
2001 and replaced the 1990 Directors’ Stock Option Plan, which expired December
31, 2000. The Plan covers 243,100 authorized shares of common stock reserved for
issuance upon exercise of options granted or available for grant to non-employee
directors and will expire on December 31, 2010. Under the Company’s Directors’
Stock Option Plan, each non-employee director of the Company who is not
regularly employed on a salaried basis by the Company may be entitled to an
option to acquire shares, as determined by the Board of Directors, of the
Company’s common stock during each year in which the Director serves on the
Board. The Plan provides that the option price will be fixed by the Board of
Directors, but will not be less than 100% of the fair market value of the stock
on the date of the grant. Options granted through December 16, 2004 are
exercisable from the earlier of (1) one year after the date of the option grant,
or (2) the date of a change in control of the Bank. As a result of a plan
amendment adopted on December 17, 2004, all options granted subsequent to that
date will vest over a four-year period.
  On
December 16, 2005, the Company’s Board of Directors approved the accelerated
vesting of all outstanding unvested stock options awarded prior to July 1, 2005
to employees and directors. This acceleration was effective as of December 18,
2005. The decision to accelerate the vesting of the options was to enable the
Company to reduce the amount of non-cash compensation expense that would have
been recorded in the Company’s income statement in future periods upon the
adoption of Financial Accounting Standards Board Statement No. 123(R),
“Share-Based Payment”, in January 2006. The Company has placed a restriction on
senior management and the Board of Directors that would prevent the sale, or any
other transfer, of any stock obtained through exercise of an accelerated option
prior to the earlier of the original vesting date or the individual’s
termination of employment.
  As a
result of the acceleration, options to purchase approximately 176,000 shares of
common stock became immediately exercisable.
  The
Company recorded a one-time charge in the fourth quarter of 2005 of
approximately $70,000, or $.01 per share, as a result of the accelerated
vesting. As of December 31, 2007, there was $2.1 million of total unrecognized
compensation cost related to nonvested stock option awards. This cost is
expected to be recognized over an additional 3.2 year period. Cash received from
the exercise of options for 2007, 2006, and 2005 was $1.0 million, $460,000, and
$874,000, respectively.
  Stock
options transactions under the Plans were as follows:
 Years
      Ended December 31,2007
                
                
                2006
                
                
                2005Options
                
                
                Weighted
      Avg. Exercise Price
                
                
                Options
                
                
                Weighted
      Avg. Exercise Price
                
                
                Options
                
                
                Weighted
      Avg. Exercise PriceOutstanding
      at beginning of year
                
                
                933,726
                
                
                $
                20.18
                
                
                
                921,966
                
                
                $
                17.18
                
                
                
                944,967
                
                
                $
                14.12Granted
                
                
                164,250
                
                
                
                28.51
                
                
                
                153,650
                
                
                
                31.18
                
                
                
                120,505
                
                
                
                33.42Exercised
                
                
                (133,098
                )
                
                
                13.27
                
                
                
                (118,672
                )
                
                
                9.61
                
                
                
                (124,639
                )
                
                
                8.57Forfeited
                
                
                (40,663
                )
                
                
                30.64
                
                
                
                (23,218
                )
                
                
                28.08
                
                
                
                (18,867
                )
                
                
                24.83Outstanding
      at end of year
                
                
                924,215
                
                
                $
                22.19
                
                
                
                933,726
                
                
                $
                20.18
                
                
                
                921,966
                
                
                $
                17.18Exercisable
      at December 31
                
                
                673,063
                
                
                $
                19.43
                
                
                
                786,526
                
                
                $
                18.11
                
                
                
                921,966
                
                
                $
                17.18Options
      available for grant at December 31
                
                
                339,828Weighted-average
      fair value of options granted during the year
                
                
                
                
                
                $
                10.21
                
                
                
                
                
                
                $
                11.11
                
                
                
                
                
                
                $
                12.32
  17
  Options
exercisable and outstanding at December 31, 2007 had an intrinsic value of $6.3
million. The intrinsic value of options exercised was $1.9 million in 2007, $2.4
million in 2006 and $3.0 million in 2005.
   Exercise
prices for options outstanding as of December 31, 2007 are presented in the
following table.
  As
      of December 31, 2007Options
      Outstanding
              Weighted
      Avg. Exercise Price
              Weighted
      Avg. Contractual Life
              Options
      Exercisable
              Weighted
      Avg. Exercise PriceOptions
      with exercise prices ranging from $2.09 to $12.13
              218,807
              $
      10.60
              1.9
      Years
              218,807
              $
      10.60Options
      with exercise prices ranging from $12.14 to $25.38
              323,947
              20.02
              5.0
      Years
              323,765
              19.97Options
      with exercise prices ranging from $25.39 to $33.50
              381,461
              30.69
              8.2
      Years
              130,491
              32.86Total
      options outstanding with exercise prices ranging from $2.09 to
      $33.50
              924,215
              $
      22.19
              5.6
      Years
              673,063
              $
      19.43
  The
remaining weighted average contractual life for options exercisable at December
31, 2007 is 4.4 years.
  Number
      of Shares
              
              
              Weighted
      Avg. Grant Date Fair ValueNon-vested
      options, December 31, 2006
              
              
              147,200
              
              
              $
              11.11Granted
              
              
              164,250
              
              
              
              10.21Vested
              
              
              (34,154
              )
              
              
              9.67Forfeited/expired
              
              
              (26,144
              )
              
              
              10.81Non-vested
      options, December 31, 2007
              
              
              251,152
              
              
              $
              10.75
  15. Regulatory
Matters
  Regulatory
authorities restrict the amount of cash dividends the Bank can declare without
prior regulatory approval. Presently, the Bank cannot declare cash dividends in
one year in excess of its net profits for the current year plus its retained net
profits for the two preceding years, less any required transfers to surplus. In
addition, dividends paid by the Bank to the Corporation would be prohibited if
the effect thereof would cause the Bank’s capital to be reduced below applicable
minimum capital requirements.
  The
Company and the Bank are subject to various regulatory capital requirements
administered by federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possible additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
  Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios (set forth below) of
total and Tier 1 capital (as defined in the regulations) to risk-weighted
assets, and of Tier 1 capital to average assets. Management believes, as of
December 31, 2007, that the Company and the Bank meet all capital adequacy
requirements to which they are subject.
  As of
December 31, 2007, and December 31, 2006, 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.
  18
  The
following table presents the risk-based and leverage capital amounts and ratios
at December 31, 2007 and 2006 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
              
              RatioCompany
                As
      of December 31, 2007Risk
      based capital ratios:Total
      capital
              $
      154,928
              10.78
              %
              ≥
              $
      114,948
              ≥
              8.0
              %
              ≥
              N/A
              ≥
              N/ATier
      1 capital
              144,186
              10.03
              
              ≥
              57,474
              ≥
              4.0
              
              ≥
              N/A
              ≥
              N/ALeverage
      ratio
              144,186
              7.26
              
              ≥
              79,480
              ≥
              4.0
              
              ≥
              N/A
              ≥
              N/ABank
                As
      of December 31, 2007Risk
      based capital ratios:Total
      capital
              $
      154,556
              10.77
              %
              ≥
              $
      114,818
              ≥
              8.0
              %
              ≥
              $143,522
              ≥
              10.0
              %Tier
      1 capital
              143,814
              10.02
              
              ≥
              57,409
              ≥
              4.0
              
              ≥
              86,113
              ≥
              6.0Leverage
      ratio
              143,814
              7.24
              
              ≥
              79,415
              ≥
              4.0
              
              ≥
              99,269
              ≥
              5.0Company
                As
      of December 31, 2006Risk
      based capital ratios:Total
      capital
              $
      143,247
              10.72
              %
              ≥
              $
      106,866
              ≥
              8.0
              %
              ≥
              N/A
              ≥
              N/ATier
      1 capital
              133,562
              10.00
              
              ≥
              53,433
              ≥
              4.0
              
              ≥
              N/A
              ≥
              N/ALeverage
      ratio
              133,562
              7.31
              
              ≥
              73,071
              ≥
              4.0
              
              ≥
              N/A
              ≥
              N/ABank
                As
      of December 31, 2006Risk
      based capital ratios:Total
      capital
              $
      142,830
              10.71
              %
              ≥
              $
      106,737
              ≥
              8.0
              %
              ≥
              $133,421
              ≥
              10.0
              %Tier
      1 capital
              133,145
              9.98
              
              ≥
              53,369
              ≥
              4.0
              
              ≥
              80,053
              ≥
              6.0Leverage
      ratio
              133,145
              7.30
              
              ≥
              73,006
              ≥
              4.0
              
              ≥
              91,258
              ≥
              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 2007, 2006, and
2005, the Company’s matching contribution was established at 50% of the
employees’ salary deferral. The amount charged to expense was $347,000,
$407,000, and $269,000 in 2007, 2006, and 2005, respectively.
  17.
 Comprehensive Income
  Accounting
principles generally require that recognized revenue, expenses, gains, and
losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available for sale
securities, are reported as a separate component of the equity section of the
balance sheet, such items, along with net income are components of comprehensive
income. The only comprehensive income item that the Company presently has is
unrealized gains (losses) on securities available for sale. The federal income
taxes allocated to the unrealized gains (losses) are presented in the table
below. The reclassification adjustments included in comprehensive income are
also presented.
  Year
      Ended December 31,(in
      thousands)
              
              2007
              
              
              2006
              
              
              2005Unrealized
      holding gains (losses) arising during the year
              
              $
              1,017
              
              
              $
              (88
              )
              
              $
              (7,258
              )Less
      reclassification adjustment for losses on securities available for sale
      included in net income
              
              
              0
              
              
              
              0
              
              
              
              (673
              )Net
      unrealized gains (losses)
              
              
              1,017
              
              
              
              (88
              )
              
              
              (6,585
              )Income
      tax effect
              
              
              (414
              )
              
              
              31
              
              
              
              2,239Net
      of tax amount
              
              $
              603
              
              
              $
              (57
              )
              
              $
              (4,346
              )
  19
 18.
 Commitments and Contingencies
  In
January 2005, the Company entered into an agreement for naming rights to
Commerce Bank Park (formerly known as Riverside Stadium) located on Harrisburg
City Island, Harrisburg, Pennsylvania. Commerce Bank Park is home of the
Harrisburg Senators, an AA team affiliated with Major League Baseball. The term
of the naming rights agreement is 15 years with a total obligation of $3.5
million spread over the term.
  The
Company has purchased the land at the corner of Carlisle Road and Alta Vista
Road in Dover Township, York County, Pennsylvania. The Company plans to
construct a full-service store on this property to be opened in the
future.
  The
Company has entered into a land lease for the premises located at 2121 Lincoln
Highway East, East Lampeter Township, Lancaster County, Pennsylvania. The
Company plans to construct a full service store on this property to be opened in
the future.
  The
Company has purchased land at 105 N. George Street, York City, York County,
Pennsylvania. The Company plans to open a store on this property to be opened in
the future.
  In
addition, the Company is also subject to certain routine legal proceedings and
claims arising in the ordinary course of business. It is management’s opinion
that the ultimate resolution of these claims will not have a material adverse
effect on the Company’s financial position and results of
operations.
  19. 
Related Party Transactions
  Commerce
Bancorp, Inc. (a 10.6% shareholder of common stock and 100% shareholder of
Series A preferred stock of the Company), through a subsidiary (Commerce Bank,
N.A., a national bank located in Cherry Hill, New Jersey), provides various
services to the Company. These services include maintenance to the store LAN
network, proof and encoding services, deposit account statement rendering,
ATM/VISA card processing, data processing, advertising support, implementation
of new software for systems, and call center support. The Company paid
approximately $4.4 million, $3.1 million, and $2.1 million for services provided
by Commerce Bancorp, Inc. during 2007, 2006, and 2005, 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, 2007 there were no
participation balances outstanding. At December 31, 2006 approximately $1.9
million were outstanding.
  A federal
funds line of credit was established with Commerce Bank N.A. in the amount of
$50 million, which could be drawn upon if needed. The balance was $25.5 million
at December 31, 2007 and $9.3 at December 31, 2006.
  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 $355,000, $340,000 and $413,000, in
2007, 2006 and 2005, 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.
  20
 Securities
  Fair
values of securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments.
  Loans
Receivable
  For
variable-rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values. The fair values for other
loans receivable were estimated using discounted cash flow analysis, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality. Loans with significant collectibility concerns were
fair valued on a loan-by-loan basis utilizing a discounted cash flow method or
the fair market value of the underlying collateral.
  Accrued
Interest Receivable and Payable
  The
carrying amount of accrued interest receivable and accrued interest payable
approximate their fair values.
  Deposit
Liabilities
  The fair
values disclosed for demand deposits (e.g., interest-bearing and
noninterest-bearing checking, passbook savings, and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for fixed-rate
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on certificates of deposit
to a schedule of aggregated expected monthly maturities on time
deposits.
  Short-term
Borrowings
  The
carrying amounts reported approximate those liabilities’ fair
value.
  Long-term
Debt
  The fair
values for long-term debt were estimated using the interest rate currently
available from the related party that holds the existing debt.
  Off-balance
Sheet Instruments
  Fair
values for the Company’s off-balance sheet instruments are based on fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the counterparties’ credit
standing.
  The
carrying amounts and fair values of the Company’s financial instruments as of
December 31 are presented in the following table.
  2007
              
              
              2006(in
      thousands)
              
              Carrying
      Amount
              
              
              Fair Value
              
              
              Carrying
      Amount
              
              
              Fair ValueFinancial
      assets:Cash
      and cash equivalents
              
              $
              50,955
              
              
              $
              50,955
              
              
              $
              52,500
              
              
              $
              52,500Securities
              
              
              644,633
              
              
              
              643,414
              
              
              
              711,686
              
              
              
              706,895Loans,
      net (including loans held for sale)
              
              
              1,160,772
              
              
              
              1,165,793
              
              
              
              988,379
              
              
              
              986,975Restricted
      investments in bank stock
              
              
              18,234
              
              
              
              18,234
              
              
              
              11,728
              
              
              
              11,728Accrued
      interest receivable
              
              
              8,799
              
              
              
              8,799
              
              
              
              9,401
              
              
              
              9,401Financial
      liabilities:Deposits
              
              $
              1,560,896
              
              
              $
              1,560,303
              
              
              $
              1,616,777
              
              
              $
              1,616,192Long-term
      debt
              
              
              79,400
              
              
              
              79,428
              
              
              
              29,400
              
              
              
              33,282Short-term
      borrowings
              
              
              217,335
              
              
              
              217,335
              
              
              
              112,800
              
              
              
              112,800Accrued
      interest payable
              
              
              989
              
              
              
              989
              
              
              
              932
              
              
              
              932Off-balance
      sheet instruments:Standby
      letters of credit
              
              $
              0
              
              
              $
              0
              
              
              $
              0
              
              
              $
              0Commitments
      to extend credit
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              0
  
 21
 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 EndedDecember
      31
              
              
              September
      30
              
              
              June
      30
              
              
              March
      312007Interest
      income
              
              $
              29,885
              
              
              $
              29,450
              
              
              $
              28,865
              
              
              $
              27,787Interest
      expense
              
              
              13,065
              
              
              
              14,260
              
              
              
              14,611
              
              
              
              14,559Net
      interest income
              
              
              16,820
              
              
              
              15,190
              
              
              
              14,254
              
              
              
              13,228Provision
      for loan losses
              
              
              245
              
              
              
              537
              
              
              
              500
              
              
              
              480Gains
      on sales (call) of securities
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              171Provision
      for federal income taxes
              
              
              1,069
              
              
              
              780
              
              
              
              580
              
              
              
              316Net
      income
              
              
              2,467
              
              
              
              1,851
              
              
              
              1,571
              
              
              
              1,112Net
      income per share:Basic
              
              $
              0.39
              
              
              $
              0.29
              
              
              $
              0.25
              
              
              $
              0.18Diluted
              
              
              0.38
              
              
              
              0.28
              
              
              
              0.24
              
              
              
              0.172006Interest
      income
              
              $
              27,321
              
              
              $
              26,844
              
              
              $
              26,098
              
              
              $
              24,288Interest
      expense
              
              
              14,331
              
              
              
              13,688
              
              
              
              12,650
              
              
              
              11,091Net
      interest income
              
              
              12,990
              
              
              
              13,156
              
              
              
              13,448
              
              
              
              13,197Provision
      for loan losses
              
              
              225
              
              
              
              428
              
              
              
              506
              
              
              
              475Gains
      (losses) on sales of securities
              
              
              160
              
              
              
              0
              
              
              
              0
              
              
              
              0Provision
      for federal income taxes
              
              
              433
              
              
              
              902
              
              
              
              1,008
              
              
              
              1,018Net
      income
              
              
              1,522
              
              
              
              1,645
              
              
              
              2,050
              
              
              
              2,037Net
      income per share:Basic
              
              $
              0.24
              
              
              $
              0.27
              
              
              $
              0.33
              
              
              $
              0.33Diluted
              
              
              0.24
              
              
              
              0.26
              
              
              
              0.32
              
              
              
              0.32
  22. 
Condensed Financial Statements of Parent Company
 Balance
      SheetsDecember
      31,(in
      thousands)
              
              2007
              
              
              2006AssetsCash
              
              $
              883
              
              
              $
              605Investment
      in subsidiaries:Banking
      subsidiary
              
              
              139,963
              
              
              
              128,691Non-banking
      subsidiaries
              
              
              1,400
              
              
              
              1,400Other
      assets
              
              
              230
              
              
              
              215Total
      assets
              
              $
              142,476
              
              
              $
              130,911LiabilitiesLong-term
      debt
              
              $
              29,400
              
              
              $
              29,400Other
      liabilities
              
              
              741
              
              
              
              403Total
      liabilities
              
              
              30,141
              
              
              
              29,803Stockholders’
      EquityPreferred
      stock
              
              
              400
              
              
              
              400Common
      stock
              
              
              6,314
              
              
              
              6,149Surplus
              
              
              70,610
              
              
              
              67,072Retained
      earnings
              
              
              38,862
              
              
              
              31,941Accumulated
      other comprehensive loss
              
              
              (3,851
              )
              
              
              (4,454
              )Total
      stockholders’ equity
              
              
              112,335
              
              
              
              101,108Total
      liabilities and stockholders’ equity
              
              $
              142,476
              
              
              $
              130,911
  22
 Statements
of Income
  Years
      Ended December 31,(in
      thousands)
              
              2007
              
              
              2006
              
              
              2005Income:Dividends
      from bank subsidiary
              
              $
              2,018
              
              
              $
              1,725
              
              
              $
              1,512Interest
      income
              
              
              124
              
              
              
              78
              
              
              
              622,142
              
              
              
              1,803
              
              
              
              1,574Expenses:Interest
      expense
              
              
              2,645
              
              
              
              1,731
              
              
              
              1,418Other
              
              
              491
              
              
              
              677
              
              
              
              7173,136
              
              
              
              2,408
              
              
              
              2,135Income
      (loss) before income (taxes) benefit and equity in undistributed net
      income of subsidiaries
              
              
              (994
              )
              
              
              (605
              )
              
              
              (561
              )Income
      (taxes) benefit
              
              
              1,029
              
              
              
              812
              
              
              
              70335
              
              
              
              207
              
              
              
              142Equity
      in undistributed net income of bank subsidiary
              
              
              6,966
              
              
              
              7,047
              
              
              
              8,675Net
      income
              
              $
              7,001
              
              
              $
              7,254
              
              
              $
              8,817
 
  Statements
of Cash Flows
  Years
      Ended December 31,(in
      thousands)
              
              2007
              
              
              2006
              
              
              2005Operating
      Activities:Net
      Income
              
              $
              7,001
              
              
              $
              7,254
              
              
              $
              8,817Adjustments
      to reconcile net income to net cash provided by operating
      activities:Amortization
      of financing costs
              
              
              8
              
              
              
              6
              
              
              
              6Stock-based
      compensation
              
              
              719
              
              
              
              329
              
              
              
              68Increase
      (decrease) in other liabilities
              
              
              338
              
              
              
              20
              
              
              
              (419
              )(Increase)
      decrease in other assets
              
              
              (23
              )
              
              
              10
              
              
              
              512Equity
      in undistributed net income of bank subsidiary
              
              
              (6,966
              )
              
              
              (7,047
              )
              
              
              (8,675
              )Net
      cash provided by operating activities
              
              
              1,077
              
              
              
              572
              
              
              
              309Investing
      Activities:Investment
      in bank subsidiary
              
              
              (3,329
              )
              
              
              (16,829
              )
              
              
              (1,725
              )Investment
      in nonbank subsidiary
              
              
              -
              
              
              
              (800
              )
              
              
              0Net
      cash (used) by investing activities
              
              
              (3,329
              )
              
              
              (17,629
              )
              
              
              (1,725
              )Financing
      Activities:Proceeds
      from common stock options exercised
              
              
              1,032
              
              
              
              460
              
              
              
              874Proceeds
      from issuance of common stock under stock purchase plan
              
              
              1,578
              
              
              
              1,040
              
              
              
              783Proceeds
      from issuance of long-term debt
              
              
              0
              
              
              
              15,800
              
              
              
              0Cost
      of issuing long-term debt
              
              
              0
              
              
              
              (43
              )
              
              
              0Cash
      dividends on preferred stock and cash in lieu of fractional
      shares
              
              
              (80
              )
              
              
              (80
              )
              
              
              (80
              )Net
      cash provided by financing activities
              
              
              2,530
              
              
              
              17,177
              
              
              
              1,577Increase
      in cash and cash equivalents
              
              
              278
              
              
              
              120
              
              
              
              161Cash
      and cash equivalents at beginning of the year
              
              
              605
              
              
              
              485
              
              
              
              324Cash
      and cash equivalents at end of year
              
              $
              883
              
              
              $
              605
              
              
              $
              485
 
 
 23