UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For
the quarterly period ended March 31, 2010





OR





o TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For the
transition period from ______________to______________________





Commission
file number: 333-90273





FIDELITY
D & D BANCORP, INC.





STATE OF
INCORPORATION:  IRS EMPLOYER IDENTIFICATION NO:


PENNSYLVANIA                                     23-3017653





Address
of principal executive offices:


BLAKELY
& DRINKER ST.


DUNMORE,
PENNSYLVANIA 18512





TELEPHONE:


570-342-8281





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subjected to such filing requirements
for the past 90 days.  x YES o NO





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  o YES o NO





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.  (Check one):





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


o YES x NO





The
number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc.
on April 30, 2010, the latest practicable date, was 2,128,312
shares.








FIDELITY
D & D BANCORP, INC.





Form 10-Q March 31,
2010





Index


PagePart I.  Financial
      InformationItem 1.
                                                Financial Statements:Consolidated Balance Sheets as of March 31, 2010 and December
      31, 2009
                                                
                                                3Consolidated Statements of Income for the three months ended
      March 31, 2010 and 2009
                                                
                                                4Consolidated Statements of Changes in Shareholders’ Equity
      for the three months ended March 31, 2010 and 2009
                                                
                                                5Consolidated Statements of Cash Flows for the three months
      ended March 31, 2010 and 2009
                                                
                                                6Notes to Consolidated Financial
    Statements
                                                
                                                7Item 2.
                                                Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                                                
                                                18Item 3.
                                                Quantitative and Qualitative Disclosure about Market
      Risk
                                                
                                                31Item 4T.
                                                Controls and Procedures
                                                
                                                35Part II.  Other
      InformationItem 1.
                                                Legal Proceedings
                                                
                                                35Item 1A.
                                                Risk Factors
                                                
                                                35Item 2.
                                                Unregistered Sales of Equity Securities and Use of
      Proceeds
                                                
                                                35Item 3.
                                                Defaults upon Senior Securities
                                                
                                                35Item 4.
                                                (Removed and Reserved)
                                                
                                                35Item 5.
                                                Other Information
                                                
                                                35Item 6.
                                                Exhibits
                                                
                                                36Signatures
                                                
                                                38Exhibit index
                                                
                                                39


- 2
-


PART I – Financial Information


Item 1: Financial Statements





FIDELITY
D & D BANCORP, INC. AND SUBSIDIARY


Consolidated Balance Sheets


(Unaudited)





March 31, 2010
                              
                              
                              December 31, 2009Assets:Cash
      and due from banks
                              
                              $
                              10,929,676
                              
                              
                              $
                              8,173,199Federal
      funds sold
                              
                              
                              10,900,000
                              
                              
                              
                              -Interest-bearing
      deposits with financial institutions
                              
                              
                              18,352,978
                              
                              
                              
                              154,755Total
      cash and cash equivalents
                              
                              
                              40,182,654
                              
                              
                              
                              8,327,954Available-for-sale
      securities
                              
                              
                              80,761,669
                              
                              
                              
                              75,821,292Held-to-maturity
      securities
                              
                              
                              671,934
                              
                              
                              
                              708,706Federal
      Home Loan Bank Stock
                              
                              
                              4,781,100
                              
                              
                              
                              4,781,100Loans
      and leases, net (allowance for loan losses of$7,751,589
      in 2010; $7,573,603 in 2009)
                              
                              
                              426,157,278
                              
                              
                              
                              423,124,054Loans
      available-for-sale (fair value $349,289 in2010;
      $1,233,345 in 2009)
                              
                              
                              349,000
                              
                              
                              
                              1,221,365Bank
      premises and equipment, net
                              
                              
                              15,245,122
                              
                              
                              
                              15,361,810Cash
      surrender value of bank owned life insurance
                              
                              
                              9,192,627
                              
                              
                              
                              9,117,156Accrued
      interest receivable
                              
                              
                              2,189,529
                              
                              
                              
                              2,250,855Foreclosed
      assets held-for-sale
                              
                              
                              337,397
                              
                              
                              
                              887,397Other
      assets
                              
                              
                              15,420,265
                              
                              
                              
                              14,415,582Total
      assets
                              
                              $
                              595,288,575
                              
                              
                              $
                              556,017,271Liabilities:Deposits:Interest-bearing
                              
                              $
                              413,491,335
                              
                              
                              $
                              388,103,880Non-interest-bearing
                              
                              
                              73,065,849
                              
                              
                              
                              70,890,578Total
      deposits
                              
                              
                              486,557,184
                              
                              
                              
                              458,994,458Accrued
      interest payable and other liabilities
                              
                              
                              3,995,312
                              
                              
                              
                              2,815,159Short-term
      borrowings
                              
                              
                              26,370,222
                              
                              
                              
                              16,533,107Long-term
      debt
                              
                              
                              32,000,000
                              
                              
                              
                              32,000,000Total
      liabilities
                              
                              
                              548,922,718
                              
                              
                              
                              510,342,724Shareholders'
      equity:Preferred
      stock authorized 5,000,000 shares with no parvalue;
      none issued
                              
                              
                              -
                              
                              
                              
                              -Capital
      stock, no par value (10,000,000 shares authorized;shares
      issued and outstanding; 2,128,312 in 2010; and2,105,860
      in 2009)
                              
                              
                              20,311,982
                              
                              
                              
                              19,982,677Retained
      earnings
                              
                              
                              34,914,492
                              
                              
                              
                              34,886,265Accumulated
      other comprehensive loss
                              
                              
                              (8,860,617
                              )
                              
                              
                              (9,194,395
                              )Total
      shareholders' equity
                              
                              
                              46,365,857
                              
                              
                              
                              45,674,547Total
      liabilities and shareholders' equity
                              
                              $
                              595,288,575
                              
                              
                              $
                              556,017,271





See notes
to consolidated financial statements


- 3
-




FIDELITY
D & D BANCORP, INC. AND SUBSIDIARY


Consolidated Statements of Income


(Unaudited)





Three months endedMarch 31, 2010
                      
                      
                      March 31, 2009Interest
      income:Loans
      and leases:Taxable
                      
                      $
                      6,080,017
                      
                      
                      $
                      6,560,748Nontaxable
                      
                      
                      146,296
                      
                      
                      
                      114,774Interest-bearing
      deposits with financial institutions
                      
                      
                      8,428
                      
                      
                      
                      111Investment
      securities:U.S.
      government agency and corporations
                      
                      
                      480,319
                      
                      
                      
                      767,371States
      and political subdivisions (non-taxable)
                      
                      
                      253,327
                      
                      
                      
                      198,575Other
      securities
                      
                      
                      65,911
                      
                      
                      
                      185,050Federal
      funds sold
                      
                      
                      6,993
                      
                      
                      
                      784Total
      interest income
                      
                      
                      7,041,291
                      
                      
                      
                      7,827,413Interest
      expense:Deposits
                      
                      
                      1,414,061
                      
                      
                      
                      2,191,772Securities
      sold under repurchase agreements
                      
                      
                      44,892
                      
                      
                      
                      8,474Other
      short-term borrowings and other
                      
                      
                      631
                      
                      
                      
                      26,140Long-term
      debt
                      
                      
                      422,773
                      
                      
                      
                      776,207Total
      interest expense
                      
                      
                      1,882,357
                      
                      
                      
                      3,002,593Net
      interest income
                      
                      
                      5,158,934
                      
                      
                      
                      4,824,820Provision
      for loan losses
                      
                      
                      575,000
                      
                      
                      
                      425,000Net
      interest income after provision for loan losses
                      
                      
                      4,583,934
                      
                      
                      
                      4,399,820Other
      income:Service
      charges on deposit accounts
                      
                      
                      617,024
                      
                      
                      
                      632,420Fees
      and other service charges
                      
                      
                      503,459
                      
                      
                      
                      507,176Gain
      (loss) on sale or disposal of:Loans
                      
                      
                      99,330
                      
                      
                      
                      490,541Premises
      and equipment
                      
                      
                      (16,171
                      )
                      
                      
                      (2,246
                      )Foreclosed
      assets held-for-sale
                      
                      
                      21,010
                      
                      
                      
                      10,996Impairment
      losses on investment securities:Other-than-temporary
      impairment on investment securities
                      
                      
                      (1,436,636
                      )
                      
                      
                      (325,525
                      )Non-credit
      related losses on investment securities not expectedto
      be sold (recognized in other comprehensive income/(loss))
                      
                      
                      1,357,586
                      
                      
                      
                      -Net
      impairment losses on investment securities recognized in
      earnings
                      
                      
                      (79,050
                      )
                      
                      
                      (325,525
                      )Total
      other income
                      
                      
                      1,145,602
                      
                      
                      
                      1,313,362Other
      expenses:Salaries
      and employee benefits
                      
                      
                      2,769,090
                      
                      
                      
                      2,569,693Premises
      and equipment
                      
                      
                      894,819
                      
                      
                      
                      906,422Advertising
                      
                      
                      125,332
                      
                      
                      
                      142,401Other
                      
                      
                      1,315,208
                      
                      
                      
                      1,043,426Total
      other expenses
                      
                      
                      5,104,449
                      
                      
                      
                      4,661,942Income
      before income taxes
                      
                      
                      625,087
                      
                      
                      
                      1,051,240Provision
      for income taxes
                      
                      
                      69,207
                      
                      
                      
                      226,182Net
      income
                      
                      $
                      555,880
                      
                      
                      $
                      825,058Per
      share data:Net
      income - basic
                      
                      $
                      0.26
                      
                      
                      $
                      0.40Net
      income - diluted
                      
                      $
                      0.26
                      
                      
                      $
                      0.40Dividends
                      
                      $
                      0.25
                      
                      
                      $
                      0.25





See notes
to consolidated financial statements


- 4
-




FIDELITY
D & D BANCORP, INC. AND SUBSIDIARY


Consolidated Statements of Changes in Shareholders'
Equity


For the
three months ended March 31, 2010 and 2009


(Unaudited)





AccumulatedotherCapital
      stock
                                                            
                                                            
                                                            Treasury
      stock
                                                            
                                                            
                                                            Retained
                                                            
                                                            
                                                            comprehensiveShares
                                                            
                                                            
                                                            Amount
                                                            
                                                            
                                                            Shares
                                                            
                                                            
                                                            Amount
                                                            
                                                            
                                                            earnings
                                                            
                                                            
                                                            income
      (loss)
                                                            
                                                            
                                                            TotalBalance,
      December 31, 2008
                                                            
                                                            
                                                            2,075,182
                                                            
                                                            
                                                            $
                                                            19,410,306
                                                            
                                                            
                                                            
                                                            (12,255
                                                            )
                                                            
                                                            $
                                                            (351,665
                                                            )
                                                            
                                                            $
                                                            38,126,250
                                                            
                                                            
                                                            $
                                                            (8,224,240
                                                            )
                                                            
                                                            $
                                                            48,960,651Total
      comprehensive loss:Net
      income
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            825,058
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            825,058Change
      in net unrealized holding losseson
      available-for-sale securities, net ofreclassification
      adjustment and net of
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (3,841,964
                                                            )
                                                            
                                                            
                                                            (3,841,964
                                                            )tax
      adjustments of $1,979,194Change
      in cash flow hedge intrinsic value
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (156,787
                                                            )
                                                            
                                                            
                                                            (156,787
                                                            )Comprehensive
      loss
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (3,173,693
                                                            )Issuance
      of common stock through Employee StockPurchase
      Plan
                                                            
                                                            
                                                            1,701
                                                            
                                                            
                                                            
                                                            40,569
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            40,569Dividends
      reinvested through DividendReinvestment
      Plan
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            9,957
                                                            
                                                            
                                                            
                                                            275,442
                                                            
                                                            
                                                            
                                                            (73,067
                                                            )
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            202,375Stock-based
      compensation expense
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            4,508
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            4,508Purchase
      of treasury stock
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (2,500
                                                            )
                                                            
                                                            
                                                            (56,505
                                                            )
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (56,505
                                                            )Cash
      dividends declared
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (516,157
                                                            )
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (516,157
                                                            )Balance,
      March 31, 2009
                                                            
                                                            
                                                            2,076,883
                                                            
                                                            
                                                            $
                                                            19,455,383
                                                            
                                                            
                                                            
                                                            (4,798
                                                            )
                                                            
                                                            $
                                                            (132,728
                                                            )
                                                            
                                                            $
                                                            38,362,084
                                                            
                                                            
                                                            $
                                                            (12,222,991
                                                            )
                                                            
                                                            $
                                                            45,461,748Balance,
      December 31, 2009
                                                            
                                                            
                                                            2,105,860
                                                            
                                                            
                                                            $
                                                            19,982,677
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            34,886,265
                                                            
                                                            
                                                            $
                                                            (9,194,395
                                                            )
                                                            
                                                            $
                                                            45,674,547Total
      comprehensive income:Net
      income
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            555,880
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            555,880Change
      in net unrealized holding losseson
      available-for-sale securities, net ofreclassification
      adjustment and net of
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            1,229,785
                                                            
                                                            
                                                            
                                                            1,229,785tax
      adjustments of $633,526Non-credit
      related impairment losses oninvestment
      securities not expected to be sold,net
      of tax adjustments of $461,579
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (896,007
                                                            )
                                                            
                                                            
                                                            (896,007
                                                            )Comprehensive
      income
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            889,658Issuance
      of common stock through Employee StockPurchase
      Plan
                                                            
                                                            
                                                            4,754
                                                            
                                                            
                                                            
                                                            67,367
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            67,367Dividends
      reinvested through DividendReinvestment
      Plan
                                                            
                                                            
                                                            17,698
                                                            
                                                            
                                                            
                                                            254,453
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            254,453Stock-based
      compensation expense
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            7,485
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            7,485Cash
      dividends declared
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (527,653
                                                            )
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            
                                                            (527,653
                                                            )Balance,
      March 31, 2010
                                                            
                                                            
                                                            2,128,312
                                                            
                                                            
                                                            $
                                                            20,311,982
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            34,914,492
                                                            
                                                            
                                                            $
                                                            (8,860,617
                                                            )
                                                            
                                                            $
                                                            46,365,857





See notes
to consolidated financial statements


- 5
-





FIDELITY DEPOSIT & DISCOUNT BANCORP, INC. AND
SUBSIDIARY


Consolidated Statements of Cash Flows


(Unaudited)





Three months ended March 31,2010
                      
                      
                      2009Cash
      flows from operating activities:Net
      income
                      
                      $
                      555,880
                      
                      
                      $
                      825,058Adjustments
      to reconcile net income to net cash provided byoperating
      activities:Depreciation,
      amortization and accretion
                      
                      
                      448,246
                      
                      
                      
                      206,043Provision
      for loan losses
                      
                      
                      575,000
                      
                      
                      
                      425,000Deferred
      income tax benefit
                      
                      
                      (204,941
                      )
                      
                      
                      (38,076
                      )Stock-based
      compensation expense
                      
                      
                      7,485
                      
                      
                      
                      4,508Loss
      from investment in limited partnership
                      
                      
                      -
                      
                      
                      
                      20,100Proceeds
      from sale of loans available-for-sale
                      
                      
                      7,991,498
                      
                      
                      
                      38,786,069Originations
      of loans available-for-sale
                      
                      
                      (6,684,054
                      )
                      
                      
                      (27,746,937
                      )Increase
      in cash surrender value of life insurance
                      
                      
                      (75,471
                      )
                      
                      
                      (79,060
                      )Net
      gain on sale of loans
                      
                      
                      (99,330
                      )
                      
                      
                      (490,541
                      )Net
      gain on sale of foreclosed assets held-for-sale
                      
                      
                      (21,010
                      )
                      
                      
                      (10,996
                      )Loss
      on disposal of equipment
                      
                      
                      16,171
                      
                      
                      
                      2,246Other-than-temporary
      impairment on securities
                      
                      
                      79,050
                      
                      
                      
                      325,525Change
      in:Accrued
      interest receivable
                      
                      
                      33,544
                      
                      
                      
                      34,581Other
      assets
                      
                      
                      (89,807
                      )
                      
                      
                      (960,450
                      )Accrued
      interest payable and other liabilities
                      
                      
                      180,558
                      
                      
                      
                      41,925Net
      cash provided by operating activities
                      
                      
                      2,712,819
                      
                      
                      
                      11,344,995Cash
      flows from investing activities:Held-to-maturity
      securities:Proceeds
      from maturities, calls and principal pay-downs
                      
                      
                      36,771
                      
                      
                      
                      27,693Available-for-sale
      securities:Proceeds
      from maturities, calls and principal pay-downs
                      
                      
                      12,290,737
                      
                      
                      
                      6,283,129Purchases
                      
                      
                      (16,726,036
                      )
                      
                      
                      (6,908,445
                      )Net
      (increase) decrease in loans and leases
                      
                      
                      (4,014,606
                      )
                      
                      
                      4,013,373Acquisition
      of bank premises and equipment
                      
                      
                      (209,848
                      )
                      
                      
                      (212,285
                      )Proceeds
      from sale of bank premises and equipment
                      
                      
                      250
                      
                      
                      
                      -Proceeds
      from sale of foreclosed assets held-for-sale
                      
                      
                      570,605
                      
                      
                      
                      356,538Net
      cash (used in) provided by investing activities
                      
                      
                      (8,052,127
                      )
                      
                      
                      3,560,003Cash
      flows from financing activities:Net
      increase in deposits
                      
                      
                      27,562,726
                      
                      
                      
                      30,842,195Net
      increase (decrease) in short-term borrowings
                      
                      
                      9,837,115
                      
                      
                      
                      (27,387,890
                      )Repayments
      of long-term debt
                      
                      
                      -
                      
                      
                      
                      (10,000,000
                      )Purchase
      of treasury stock
                      
                      
                      -
                      
                      
                      
                      (56,505
                      )Proceeds
      from employee stock purchase plan
                      
                      
                      67,367
                      
                      
                      
                      40,569Dividends
      paid, net of dividends reinvested
                      
                      
                      (273,200
                      )
                      
                      
                      (313,782
                      )Net
      cash provided by (used in) financing  activities
                      
                      
                      37,194,008
                      
                      
                      
                      (6,875,413
                      )Net
      increase in cash and cash equivalents
                      
                      
                      31,854,700
                      
                      
                      
                      8,029,585Cash
      and cash equivalents, beginning
                      
                      
                      8,327,954
                      
                      
                      
                      12,771,147Cash
      and cash equivalents, ending
                      
                      $
                      40,182,654
                      
                      
                      $
                      20,800,732





See notes
to consolidated financial statements


- 6
-


FIDELITY
D & D BANCORP, INC.





Notes to Consolidated Financial Statements


(Unaudited)




1.   Nature
of operations and critical accounting policies





Nature of
operations




Fidelity
Deposit and Discount Bank (the Bank) is a commercial bank chartered in the
Commonwealth of Pennsylvania and a wholly-owned subsidiary of Fidelity D & D
Bancorp, Inc. (the Company or collectively, the Company).  Having
commenced operations in 1903, the Bank is committed to provide superior customer
service, while offering a full range of banking products and financial and trust
services to both our consumer and commercial customers from our main office
located in Dunmore and other branches located throughout Lackawanna and Luzerne
counties.




Principles of
consolidation




The
accompanying unaudited consolidated financial statements of the Company and the
Bank have been prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP) for interim financial
information and with the instructions to this Form 10-Q and Rule 10-01 of
Regulation S-X.  Accordingly, they do not include all of the
information and footnote disclosures required by GAAP for complete financial
statements.  In the opinion of management, all normal recurring
adjustments necessary for a fair presentation of the financial condition and
results of operations for the periods have been included.  All
significant inter-company balances and transactions have been eliminated in
consolidation.




The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reported periods.  Actual results could differ from those
estimates.  For additional information and disclosures required under
GAAP, refer to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2009.




Management
is responsible for the fairness, integrity and objectivity of the unaudited
financial statements included in this report.  Management prepared the
unaudited financial statements in accordance with GAAP.  In meeting
its responsibility for the financial statements, management depends on the
Company's accounting systems and related internal controls.  These
systems and controls are designed to provide reasonable but not absolute
assurance that the financial records accurately reflect the transactions of the
Company, the Company’s assets are safeguarded and that the financial statements
present fairly the financial condition and results of operations of the
Company.




In the
opinion of management, the consolidated balance sheets as of March 31, 2010 and
December 31, 2009 and the related consolidated statements of income for the
three-month periods ended March 31, 2010 and 2009 and changes in shareholders’
equity and cash flows for the three months ended March 31, 2010 and 2009 present
fairly the financial condition and results of operations of the
Company.  All material adjustments required for a fair presentation
have been made.  These adjustments are of a normal recurring
nature.




This
Quarterly Report on Form 10-Q should be read in conjunction with the Company’s
audited financial statements for the year ended December 31, 2009, and the notes
included therein, included within the Company’s Annual Report filed on Form
10-K.




Critical accounting
policies




The
presentation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect many of the reported amounts and
disclosures.  Actual results could differ from these
estimates.




A
material estimate that is particularly susceptible to significant change relates
to the determination of the allowance for loan losses.  Management
believes that the allowance for loan losses at March 31, 2010 is adequate and
reasonable.  Given the subjective nature of identifying and valuing
loan losses, it is likely that well-informed individuals could make different
assumptions, and could, therefore calculate a materially different allowance
value.  While management uses available information to recognize
losses on loans, changes in economic conditions may necessitate revisions in the
future.  In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Company’s allowance for
loan losses.  Such agencies may require the Company to recognize
adjustments to the allowance based on their judgment of information available to
them at the time of their examination.




Another
material estimate is the calculation of fair values of the Company’s investment
securities.  Except for the Company’s investment in corporate bonds,
consisting of pooled trust preferred securities, fair values of the other
investment securities are determined by prices provided by a third-party vendor,
who is a provider of financial market data, analytics and related services to
financial institutions.  For the pooled trust preferred securities,
management is unable to obtain readily attainable and realistic pricing from
market traders due to lack of active market participants and therefore
management has determined the market for these securities to be
inactive.  In order to determine the fair value of the pooled trust
preferred securities, management relied on the use of an income valuation
approach (present value technique) that maximizes the use of observable inputs
and minimizes the use of unobservable inputs, the results of which are more
representative of fair value than the market approach valuation technique used
for the other investment securities.


- 7
-


Based on
experience, management is aware that estimated fair values of investment
securities tend to vary among valuation services.  Accordingly, when
selling investment securities, price quotes from more than one source may be
obtained.  The majority of the Company’s investment securities are
classified as available-for-sale (AFS).  AFS securities are carried at
fair value on the consolidated balance sheet, with unrealized gains and losses,
net of income tax, reported separately within shareholders’ equity through
accumulated other comprehensive income (loss).




The fair
value of residential mortgage loans, classified as AFS, is obtained from the
Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank
(FHLB).  Generally, the market to which the Company sells mortgages it
originates for sale is restricted and price quotes from other sources are not
typically obtained.  On occasion, the Company may transfer loans from
the loan and lease portfolio to loans AFS.  Under these rare
circumstances, pricing may be obtained from other entities and the loans are
transferred at the lower of cost or market value and simultaneously
sold.  For a further discussion on the accounting treatment of AFS
loans, see the section entitled “Loans available-for-sale,” contained within
management’s discussion and analysis.




2.  New
Accounting Pronouncements




During
the first quarter of 2010, the Company adopted the new accounting guidance
related to the transfers and servicing of financial assets.  The
standard eliminates the concept of qualifying special purpose entities, provides
guidance as to when a portion of a transferred financial asset should be
evaluated for sale accounting, provides additional guidance with regard to
accounting for transfers of financial assets and requires additional
disclosures.  The adoption of the new accounting guidance did not have
a material impact on the Company’s consolidated financial
statements.




During
the first quarter of 2010, the Company adopted the amended accounting guidance
related to fair value measurements which entails new disclosures and clarifies
disclosure requirements about fair value measurement as set forth in previous
guidance.  The objective is to improve these disclosures and, thus,
increase the transparency in financial reporting.  Specifically, an
entity is required to disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers; and in the reconciliation for fair value measurements
using significant unobservable inputs, a reporting entity should present
separately information about purchases, sales, issuances, and
settlements.  The amended guidance also clarifies the requirements of
the following disclosures: for purposes of reporting fair value measurement for
each class of assets and liabilities, a reporting entity needs to use judgment
in determining the appropriate classes of assets and liabilities; and a
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and non-recurring fair
value measurements.  The new guidance became effective for interim and
annual reporting periods beginning after December 15, 2009, except for the
disclosures about purchases, sales, issuances, and settlements in the roll
forward of activity in Level 3 fair value measurements.  Those
disclosures will become effective for fiscal years beginning after December 15,
2010, and for interim periods within those fiscal years.


- 8
-


3.
Investment securities




The
amortized cost and fair value of investment securities at March 31, 2010 and
December 31, 2009 are summarized as follows (dollars in thousands):




March 31, 2010Amortized
                        
                        
                        Gross unrealized
                        
                        
                        Gross unrealized
                        
                        
                        Faircost
                        
                        
                        gains
                        
                        
                        losses
                        
                        
                        valueHeld-to-maturity
securities:MBS
      - GSE residential
                        
                        $
                        672
                        
                        
                        $
                        61
                        
                        
                        $
                        -
                        
                        
                        $
                        733Available-for-sale
    securities:Agency
      - GSE
                        
                        $
                        29,238
                        
                        
                        $
                        133
                        
                        
                        $
                        817
                        
                        
                        $
                        28,554Obligations
      of states andpolitical
      subdivisions
                        
                        
                        22,728
                        
                        
                        
                        367
                        
                        
                        
                        188
                        
                        
                        
                        22,907Corporate
      bonds:Pooled
      trust preferred securities
                        
                        
                        18,754
                        
                        
                        
                        -
                        
                        
                        
                        13,347
                        
                        
                        
                        5,407MBS
      - GSE residential
                        
                        
                        23,145
                        
                        
                        
                        397
                        
                        
                        
                        68
                        
                        
                        
                        23,474Total
      debt securities
                        
                        
                        93,865
                        
                        
                        
                        897
                        
                        
                        
                        14,420
                        
                        
                        
                        80,342Equity
      securities - financial services
                        
                        
                        322
                        
                        
                        
                        106
                        
                        
                        
                        8
                        
                        
                        
                        420Total
      available-for-sale securities
                        
                        $
                        94,187
                        
                        
                        $
                        1,003
                        
                        
                        $
                        14,428
                        
                        
                        $
                        80,762




December 31, 2009Amortized
                        
                        
                        Gross unrealized
                        
                        
                        Gross unrealized
                        
                        
                        Faircost
                        
                        
                        gains
                        
                        
                        losses
                        
                        
                        valueHeld-to-maturity
securities:MBS
      - GSE residential
                        
                        $
                        709
                        
                        
                        $
                        56
                        
                        
                        $
                        -
                        
                        
                        $
                        765Available-for-sale
    securities:Agency
      - GSE
                        
                        $
                        34,205
                        
                        
                        $
                        4
                        
                        
                        $
                        1,077
                        
                        
                        $
                        33,132Obligations
      of states andpolitical
      subdivisions
                        
                        
                        23,013
                        
                        
                        
                        394
                        
                        
                        
                        137
                        
                        
                        
                        23,270Corporate
      bonds:Pooled
      trust preferred securities
                        
                        
                        18,794
                        
                        
                        
                        -
                        
                        
                        
                        13,552
                        
                        
                        
                        5,242MBS
      - GSE residential
                        
                        
                        13,418
                        
                        
                        
                        401
                        
                        
                        
                        71
                        
                        
                        
                        13,748Total
      debt securities
                        
                        
                        89,430
                        
                        
                        
                        799
                        
                        
                        
                        14,837
                        
                        
                        
                        75,392Equity
      securities - financial services
                        
                        
                        322
                        
                        
                        
                        121
                        
                        
                        
                        14
                        
                        
                        
                        429Total
      available-for-sale securities
                        
                        $
                        89,752
                        
                        
                        $
                        920
                        
                        
                        $
                        14,851
                        
                        
                        $
                        75,821


- 9
-


The
amortized cost and fair value of debt securities at March 31, 2010 by
contractual maturity are summarized below (dollars in thousands):




Amortized
                      
                      
                      Marketcost
                      
                      
                      valueHeld-to-maturity
securities:MBS
      - GSE residential
                      
                      $
                      672
                      
                      
                      $
                      733Available-for-sale
    securities:Debt
      securities:Due
      in one year or less
                      
                      $
                      -
                      
                      
                      $
                      -Due
      after one year through five years
                      
                      
                      -
                      
                      
                      
                      -Due
      after five years through ten years
                      
                      
                      11,589
                      
                      
                      
                      11,574Due
      after ten years
                      
                      
                      59,131
                      
                      
                      
                      45,294Total
      debt securities
                      
                      
                      70,720
                      
                      
                      
                      56,868MBS
      - GSE residential
                      
                      
                      23,145
                      
                      
                      
                      23,474Total
      available-for-sale debt securities
                      
                      $
                      93,865
                      
                      
                      $
                      80,342







Expected
maturities will differ from contractual maturities because issuers and borrowers
may have the right to call or repay obligations with or without call or
prepayment penalty.  Federal agency and municipal securities are
included based on their original stated maturity.  Mortgage-backed
securities, which are based on weighted-average lives and subject to monthly
principal pay-downs, are listed in total.




The
following tables present the fair value and gross unrealized losses of
investment securities aggregated by investment type, the length of time and the
number of securities that have been in a continuous unrealized loss position as
of March 31, 2010 and December 31, 2009 (dollars in thousands):




March 31, 2010Less than 12 months
                        
                        
                        More than 12 months
                        
                        
                        TotalFair
                        
                        
                        Unrealized
                        
                        
                        Fair
                        
                        
                        Unrealized
                        
                        
                        Fair
                        
                        
                        Unrealizedvalue
                        
                        
                        losses
                        
                        
                        value
                        
                        
                        losses
                        
                        
                        value
                        
                        
                        lossesAgency
      - GSE
                        
                        $
                        9,018
                        
                        
                        $
                        55
                        
                        
                        $
                        5,147
                        
                        
                        $
                        762
                        
                        
                        $
                        14,165
                        
                        
                        $
                        817Obligations
      of states andpolitical
      subdivisions
                        
                        
                        4,137
                        
                        
                        
                        155
                        
                        
                        
                        2,586
                        
                        
                        
                        33
                        
                        
                        
                        6,723
                        
                        
                        
                        188Corporate
      bonds:Pooled
      trust preferred securities
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        5,407
                        
                        
                        
                        13,347
                        
                        
                        
                        5,407
                        
                        
                        
                        13,347MBS
      - GSE residential
                        
                        
                        15,517
                        
                        
                        
                        68
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        15,517
                        
                        
                        
                        68Total
      debt securities
                        
                        
                        28,672
                        
                        
                        
                        278
                        
                        
                        
                        13,140
                        
                        
                        
                        14,142
                        
                        
                        
                        41,812
                        
                        
                        
                        14,420Equity
      securities - financial services
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        166
                        
                        
                        
                        8
                        
                        
                        
                        166
                        
                        
                        
                        8Total
      temporarily impaired securities
                        
                        $
                        28,672
                        
                        
                        $
                        278
                        
                        
                        $
                        13,306
                        
                        
                        $
                        14,150
                        
                        
                        $
                        41,978
                        
                        
                        $
                        14,428Number
      of securities
                        
                        
                        21
                        
                        
                        
                        
                        
                        
                        
                        18
                        
                        
                        
                        
                        
                        
                        
                        39


- 10
-




December 31, 2009Less than 12 months
                        
                        
                        More than 12 months
                        
                        
                        TotalFair
                        
                        
                        Unrealized
                        
                        
                        Fair
                        
                        
                        Unrealized
                        
                        
                        Fair
                        
                        
                        Unrealizedvalue
                        
                        
                        losses
                        
                        
                        value
                        
                        
                        losses
                        
                        
                        value
                        
                        
                        lossesAgency
      - GSE
                        
                        $
                        21,090
                        
                        
                        $
                        291
                        
                        
                        $
                        5,038
                        
                        
                        $
                        786
                        
                        
                        $
                        26,128
                        
                        
                        $
                        1,077Obligations
      of states andpolitical
      subdivisions
                        
                        
                        3,534
                        
                        
                        
                        115
                        
                        
                        
                        2,600
                        
                        
                        
                        22
                        
                        
                        
                        6,134
                        
                        
                        
                        137Corporate
      bonds:Pooled
      trust preferred securities
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        5,242
                        
                        
                        
                        13,552
                        
                        
                        
                        5,242
                        
                        
                        
                        13,552MBS
      - GSE residential
                        
                        
                        5,055
                        
                        
                        
                        71
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        5,055
                        
                        
                        
                        71Total
      debt securities
                        
                        
                        29,679
                        
                        
                        
                        477
                        
                        
                        
                        12,880
                        
                        
                        
                        14,360
                        
                        
                        
                        42,559
                        
                        
                        
                        14,837Equity
      securities - financial services
                        
                        
                        114
                        
                        
                        
                        10
                        
                        
                        
                        46
                        
                        
                        
                        4
                        
                        
                        
                        160
                        
                        
                        
                        14Total
      temporarily impaired securities
                        
                        $
                        29,793
                        
                        
                        $
                        487
                        
                        
                        $
                        12,926
                        
                        
                        $
                        14,364
                        
                        
                        $
                        42,719
                        
                        
                        $
                        14,851Number
      of securities
                        
                        
                        23
                        
                        
                        
                        
                        
                        
                        
                        17
                        
                        
                        
                        
                        
                        
                        
                        40




Management
conducts a formal review of investment securities on a quarterly basis for the
presence of other-than-temporary impairment (OTTI).  The accounting
guidance related to OTTI requires the Company to assess whether OTTI is present
when the fair value of a debt security is less than its amortized cost as of the
balance sheet date.  Under these circumstances, OTTI is considered to
have occurred if: (1) the entity has intent to sell the security;
(2) more likely than not the entity will be required to sell the security
before recovery of its amortized cost basis; or (3) the present value of
expected cash flows is not sufficient to recover the entire amortized
cost.




The
accounting guidance requires that credit-related OTTI be recognized in earnings
while non-credit related OTTI on securities not expected to be sold be
recognized in other comprehensive income (OCI).  Non-credit related
OTTI is based on other factors effecting market conditions, including
illiquidity.  The presentation of OTTI is made in the consolidated
statements of income on a gross basis with an offset for the amount of
non-credit related OTTI recognized in OCI.




The
Company’s OTTI evaluation process also follows the guidance set forth in topics
related to debt and equity securities.  The guidance set forth in
these pronouncements require the Company to take into consideration current
market conditions, fair value in relationship to cost, extent and nature of
changes in fair value, issuer rating changes and trends, volatility of earnings,
current analysts’ evaluations, all available information relevant to the
collectability of debt securities, the ability and intent to hold investments
until a recovery of fair value, which may be maturity, and other factors when
evaluating for the existence of OTTI.  This guidance also eliminates
the requirement that a holder’s best estimate of cash flows is based upon those
that a market participant would use.  Instead, the guidance requires
that OTTI be recognized as a realized loss through earnings when there has been
an adverse change in the holder’s expected cash flows such that the full amount
(principal and interest) will probably not be received.  This
requirement is consistent with the impairment model in the guidance for
accounting for debt and equity securities.




For all
security types discussed below, at March 31, 2010 the Company applied the
criteria provided in the recognition and presentation of OTTI
guidance.  That is, management has no intent to sell the securities
and no conditions were identified by management that more likely than not would
require the Company to sell the securities before recovery of their amortized
cost basis.  The results indicated there was no presence of OTTI for
the Company’s portfolios of Agency – Government Sponsored Enterprise (GSE),
Mortgage-backed securities (MBS) – GSE residential and Obligations of states and
political subdivisions.




Agency - GSE and MBS - GSE
residential


Agency –
GSE and MBS – GSE residential securities consist of medium and long-term notes
issued by Federal Home Loan Mortgage Corporation (FHLMC), Federal National
Mortgage Association (FNMA), Federal Home Loan Bank (FHLB) and Government
National Mortgage Association (GNMA).  These securities have interest
rates that are largely fixed-rate issues, have varying mid- to long-term
maturity dates and have contractual cash flows guaranteed by the U.S. government
or agencies of the U.S. government.




Obligations of states and
political subdivisions


The
municipal securities are bank qualified, general obligation bonds rated as
investment grade by various credit rating agencies and have fixed rates of
interest with mid- to long-term maturities.  Fair values of these
securities are highly driven by interest rates.  Management performs
ongoing credit quality reviews on these issues.




In all of
the above security types, the decline in fair value is attributable to changes
in interest rates and not credit quality.  Consequently, no OTTI is
considered necessary for these securities at March 31, 2010.


- 11
-


Pooled trust preferred
securities


A Pooled
Trust Preferred Collateralized Debt Obligation (CDO) is a type of investment
security collateralized by trust preferred securities (TPS) issued by banks,
insurance companies and real estate investment trusts (REITs).  The primary
collateral type is a TPS issued by a bank.  A TPS is a hybrid security
with both debt and equity characteristics such as the ability to voluntarily
defer interest payments for up to 20 consecutive quarters.  A TPS is
considered a junior security in the capital structure of the
issuer.




There are
various tranches or investment classes issued by
the CDO with the most senior tranche having the lowest yield but
the most protection from credit losses compared to other tranches
that are subordinate.  Losses are generally allocated from the lowest
tranche with the equity component holding the most risk and then subordinate
tranches in reverse order up to the senior tranche.  The allocation of
losses is defined in the indenture when the CDO was formed.




Unrealized
losses in the pooled trust preferred securities (PreTSLs) are caused mainly by
the following factors: (1) collateral deterioration due to bank failures
and credit concerns across the banking sector; (2) widening of credit
spreads and (3) illiquidity in the market.  The Company’s review of
these securities, in accordance with the previous discussion, determined that in
2010, credit-related OTTI be recorded on two holdings of these securities both
of which are in the AFS securities portfolio.




The
following table summarizes the amount of credit-related OTTI recognized in
earnings for 2010 and the amount of credit- and non-credit related OTTI
recognized in earnings for 2009, by security during the periods indicated
(dollars in thousands):




Three months endedMarch 31,2010
                  
                  
                  2009Pooled
      trust preferred securities:PreTSL
      VII, Mezzanine
                  
                  $
                  19
                  
                  
                  $
                  326PreTSL
      XI, B3
                  
                  
                  60
                  
                  
                  
                  -Total
                  
                  $
                  79
                  
                  
                  $
                  326




The
following table is a tabular roll-forward of the cumulative amount of
credit-related OTTI recognized in earnings (dollars in thousands):




Inception toMarch 31, 2010HTM
                  
                  
                  AFS
                  
                  
                  TotalBeginning
      balance of credit-related OTTI
                  
                  $
                  -
                  
                  
                  $
                  (3,198
                  )
                  
                  $
                  (3,198
                  )Additions
      for credit-related OTTI not previously recognized
                  
                  
                  -
                  
                  
                  
                  (60
                  )
                  
                  
                  (60
                  )Additional
      credit-related OTTI previously recognized when there is no intent to sell
      before recovery of amortized cost basis
                  
                  
                  -
                  
                  
                  
                  (19
                  )
                  
                  
                  (19
                  )Ending
      balance of credit-related OTTI
                  
                  $
                  -
                  
                  
                  $
                  (3,277
                  )
                  
                  $
                  (3,277
                  )




To
determine the ending balance of credit-related OTTI, the Company uses discounted
present value cash flow analysis and compares the results with the bond’s face
value.  The analysis considered the following assumptions: the discount
rate which equated to the discount margin for each tranche (credit spread) at
the time of purchase which was then added to the appropriate three-month Libor
forward rate obtained from the forward Libor curve; historical average default
rates obtained from the FDIC for U.S. Banks and Thrifts for the period spanning
1988 to 1991 increased by a factor of three and rolled forward to project a rate
of default of approximately one-third; the default rate was reduced by the
actual deferrals / defaults experienced in all preferred term securities from
2008 through 2009; the remaining estimated default rate was then stratified with
higher default rates occurring in the beginning of 2010 regressing to normal in
2011, with an estimated 15% recovery by way of a two year lag; and no
prepayments of principal.




Two of
the Company’s initial mezzanine holdings (PreTSLs IV and V) are now senior
tranches and the remaining holdings are mezzanine tranches.  As of March
31, 2010, none of the pooled trust preferred securities were investment
grade.  At the time of initial issue, the subordination in the Company’s
tranches ranged in size from approximately 8.0% to 25.2% of the total principal
amount of the respective securities and no more than 5% of any pooled trust
preferred security consisted of a security issued by any one bank and 4% for
insurance companies.  As of March 31, 2010, management estimates the
subordination in the Company’s tranches ranging from 0% to 19.1% of the current
performing collateral.  During the first quarter of 2010, PreTSL IX with a
book value of $2.8 million and corresponding fair value of $1.2 million was
placed on non-accrual status.


- 12
-


The
following table is the composition of the Company’s non-accrual PreTSL
securities as of the period indicated (dollars in thousands):




March 31, 2010
                    
                    
                    December 31, 2009Book
                    
                    
                    Fair
                    
                    
                    Book
                    
                    
                    FairDeal
                    
                    Class
                    
                    
                    value
                    
                    
                    value
                    
                    
                    value
                    
                    
                    valuePre
      TSL VII
                    
                    Mezzanine
                    
                    
                    
                    410
                    
                    
                    
                    199
                    
                    
                    
                    432
                    
                    
                    
                    219Pre
      TSL  IX
                    
                    B-1,B-3
                    
                    
                    
                    2,810
                    
                    
                    
                    1,230
                    
                    
                    
                    -
                    
                    
                    
                    -Pre
      TSL  XV
                    
                    B-1
                    
                    
                    
                    1,359
                    
                    
                    
                    321
                    
                    
                    
                    1,359
                    
                    
                    
                    297Pre
      TSL XVI
                    
                    C
                    
                    
                    
                    1,290
                    
                    
                    
                    130
                    
                    
                    
                    1,290
                    
                    
                    
                    65Pre
      TSL XXV
                    
                    C-1
                    
                    
                    
                    507
                    
                    
                    
                    30
                    
                    
                    
                    507
                    
                    
                    
                    2$
                    6,376
                    
                    
                    $
                    1,910
                    
                    
                    $
                    3,588
                    
                    
                    $
                    583




The
securities included in the above table, have experienced impairment of principal
and interest was “paid-in-kind”.  On a quarterly basis, each of the other
issues will be evaluated for the presence of these two conditions and placed on
non-accrual status if necessary.




The
following table provides additional information with respect to the Company’s
pooled trust preferred securities as of March 31, 2010:




Current
                            
                            
                            
                            
                            
                            Actual
                            
                            
                            
                            
                            
                            Excess
                            
                            
                            Effectivenumber
                            
                            
                            
                            
                            
                            deferrals
                            
                            
                            
                            
                            
                            subordination *
                            
                            
                            subordination **of
                            
                            
                            Actual
                            
                            
                            and defaults
                            
                            
                            
                            
                            
                            as a % of
                            
                            
                            as a % ofMoody's /
                            
                            banks /
                            
                            
                            deferrals
                            
                            
                            as a % of
                            
                            
                            Excess
                            
                            
                            current
                            
                            
                            currentBook
                            
                            
                            Fair
                            
                            
                            Unrealized
                            
                            Fitch
                            
                            insurance
                            
                            
                            and defaults
                            
                            
                            current
                            
                            
                            subordination
                            
                            
                            performing
                            
                            
                            performingDeal
                            
                            Class
                            
                            
                            value
                            
                            
                            value
                            
                            
                            loss
                            
                            ratings
                            
                            companies
                            
                            
                            $(000)
                            
                            
                            collateral
                            
                            
                            $(000)
                            
                            
                            collateral
                            
                            
                            collateralPre
      TSL  IV
                            
                            Mezzanine
                            
                            
                            $
                            609,970
                            
                            
                            $
                            449,304
                            
                            
                            $
                            (160,666
                            )
                            Ca /
      CCC
                            
                            6 /
      -
                            
                            
                            
                            18,000
                            
                            
                            
                            27.1
                            
                            
                            
                            9,802
                            
                            
                            
                            19.1
                            
                            
                            
                            33.1Pre
      TSL  V
                            
                            Mezzanine
                            
                            
                            
                            275,153
                            
                            
                            
                            172,769
                            
                            
                            
                            (102,384
                            )
                            Ba3
      / C
                            
                            4 /
      -
                            
                            
                            
                            18,950
                            
                            
                            
                            43.1
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            N/APre
      TSL VII
                            
                            Mezzanine
                            
                            
                            
                            409,595
                            
                            
                            
                            198,649
                            
                            
                            
                            (210,946
                            )
                            Ca /
      C
                            
                            19 /
      -
                            
                            
                            
                            147,000
                            
                            
                            
                            64.8
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            N/APre
      TSL  IX
                            
                            B-1,B-3
                            
                            
                            
                            2,810,338
                            
                            
                            
                            1,230,250
                            
                            
                            
                            (1,580,088
                            )
                            Ca /
      C
                            
                            49 /
      -
                            
                            
                            
                            131,510
                            
                            
                            
                            29.2
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            N/APre
      TSL XI
                            
                            B-3
                            
                            
                            
                            2,337,836
                            
                            
                            
                            980,250
                            
                            
                            
                            (1,357,586
                            )
                            Ca /
      C
                            
                            65 /
      -
                            
                            
                            
                            147,750
                            
                            
                            
                            24.6
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            2.9Pre
      TSL  XV
                            
                            B-1
                            
                            
                            
                            1,359,562
                            
                            
                            
                            320,853
                            
                            
                            
                            (1,038,709
                            )
                            Ca /
      C
                            
                            63 /
      9
                            
                            
                            
                            156,050
                            
                            
                            
                            26.1
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            N/APre
      TSL XVI
                            
                            C
                            
                            
                            
                            1,289,742
                            
                            
                            
                            129,915
                            
                            
                            
                            (1,159,827
                            )
                            Ca /
      C
                            
                            49 /
      7
                            
                            
                            
                            182,270
                            
                            
                            
                            31.7
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            N/APre
      TSL XVII
                            
                            C
                            
                            
                            
                            1,005,528
                            
                            
                            
                            130,384
                            
                            
                            
                            (875,144
                            )
                            Ca /
      C
                            
                            51 /
      6
                            
                            
                            
                            116,240
                            
                            
                            
                            24.5
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            7.0Pre
      TSL XVIII
                            
                            C
                            
                            
                            
                            1,007,909
                            
                            
                            
                            139,092
                            
                            
                            
                            (868,817
                            )
                            Ca /
      C
                            
                            66 /
      14
                            
                            
                            
                            147,140
                            
                            
                            
                            21.7
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            5.5Pre
      TSL XIX
                            
                            C
                            
                            
                            
                            2,546,087
                            
                            
                            
                            309,665
                            
                            
                            
                            (2,236,422
                            )
                            Ca /
      C
                            
                            60 /
      14
                            
                            
                            
                            155,000
                            
                            
                            
                            22.1
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            4.7Pre
      TSL XXIV
                            
                            B-1
                            
                            
                            
                            2,213,392
                            
                            
                            
                            467,829
                            
                            
                            
                            (1,745,563
                            )
                            Caa3
      /  CC
                            
                            80 /
      13
                            
                            
                            
                            329,800
                            
                            
                            
                            31.4
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            13.5Pre
      TSL XXV
                            
                            C-1
                            
                            
                            
                            506,673
                            
                            
                            
                            30,576
                            
                            
                            
                            (476,097
                            )
                            Ca /
      C
                            
                            64 /
      9
                            
                            
                            
                            271,600
                            
                            
                            
                            31.0
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            N/APre
      TSL XXVII
                            
                            B
                            
                            
                            
                            2,382,621
                            
                            
                            
                            847,495
                            
                            
                            
                            (1,535,126
                            )
                            Caa3
      /  B
                            
                            42 /
      7
                            
                            
                            
                            81,800
                            
                            
                            
                            25.1
                            
                            
                            None
                            
                            
                            
                            N/A
                            
                            
                            
                            21.4$
                            18,754,406
                            
                            
                            $
                            5,407,031
                            
                            
                            $
                            (13,347,375
                            )




* Excess
subordination represents the excess (if any) of the amount of performing
collateral over the given class of bonds.




**Effective
subordination represents the estimated percentage of the performing collateral
that would need to defer or default at the next payment in order to trigger a
loss of principal or interest.  This differs from excess subordination in
that it considers the effect of excess interest earned on the performing
collateral.




For a
further discussion on the fair value determination of the Company’s investment
in pooled trust preferred securities, see “Investment securities” under the
caption “Comparison of financial condition at March 31, 2010 and December 31,
2009” of Part 1, Item 2, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”; below.




4. 
Earnings per share




Basic
earnings per share (EPS) is computed by dividing income available to common
shareholders by the weighted-average number of common stock outstanding for the
period.  Diluted EPS is computed in the same manner as basic EPS but
reflects the potential dilution that could occur if stock options to issue
additional common stock were exercised, which would then result in additional
stock outstanding to share in or dilute the earnings of the Company.  The
Company maintains two share-based compensation plans that may generate
additional potential dilutive common shares.  Generally, dilution would
occur if Company-issued stock options were exercised and converted into common
stock.


- 13
-


In the
computation of diluted EPS, the Company uses the treasury stock method to
determine the dilutive effect of its granted but unexercised stock
options.  Under the treasury stock method, the assumed proceeds received
from shares issued, in a hypothetical stock option exercise, are assumed to be
used to purchase treasury stock.  There were no potentially dilutive shares
outstanding in either period because the average share price of the Company’s
common stock during the three months ended March 31, 2010 and 2009 was below the
strike prices of all options granted.  For a further discussion on the
Company’s stock option plans, see note 5, “Stock plans,” below.




The
following table illustrates the data used in computing basic EPS and a
reconciliation to derive at the components of diluted EPS for the periods
indicated:




Three months ended March 31,
                        
                        2010
                        
                        
                        2009Net
      income available to common shareholders
                        
                        $
                        555,880
                        
                        
                        $
                        825,058Weighted-average
      common shares outstanding
                        
                        
                        2,113,672
                        
                        
                        
                        2,065,715Basic
      EPS
                        
                        $
                        0.26
                        
                        
                        $
                        0.40Diluted EPS:Net
      income available to common shareholders
                        
                        $
                        555,880
                        
                        
                        $
                        825,058Weighted-average
      common shares outstanding
                        
                        
                        2,113,672
                        
                        
                        
                        2,065,715Potentially
      dilutive common shares
                        
                        
                        -
                        
                        
                        
                        -Weighted-average
      common shares and dilutive potential shares
                        
                        
                        2,113,672
                        
                        
                        
                        2,065,715Diluted
      EPS
                        
                        $
                        0.26
                        
                        
                        $
                        0.40




5. 
Stock plans




The
Company has two stock-based compensation plans (the stock option plans) and
applies the fair value method of accounting for stock-based compensation
provided under the current accounting guidance.  The guidelines require the
cost of share-based payment transactions (including those with employees and
non-employees) be recognized in the financial statements.  The stock option
plans were shareholder-approved and permit the grant of share-based compensation
awards to its directors, key officers and certain other employees.  The
Company believes that the stock option plans better align the interest of its
directors, key officers and employees with the interest of its
shareholders.  The Company further believes that the granting of
share-based awards is necessary to retain the knowledge base, continuity and
expertise of its directors, key officers and employees.  In the stock
option plans, directors, key officers and certain other employees are eligible
to be awarded stock options to purchase the Company’s common stock at the fair
market value on the date of grant.




The
Company established the 2000 Independent Directors Stock Option Plan and has
reserved 55,000 shares of its un-issued capital stock for issuance under the
plan.  No stock options were awarded during the three months ended March
31, 2010 and 2009.  As of March 31, 2010, there were 24,650 unexercised
stock options outstanding under this plan.




The
Company also established the 2000 Stock Incentive Plan and has reserved 55,000
shares of its un-issued capital stock for issuance under the plan.  There
were no options awarded during the three months ended March 31, 2010 and
2009.  As of March 31, 2010, there were 9,310 unexercised stock options
outstanding under this plan.




Since no
awards were vested in either of the stock option plans during the three months
ended March 31, 2010 and 2009, there was no stock-based compensation expense
recognized related to either of the stock option plans.




In
addition to the two stock option plans, the Company established the 2002
Employee Stock Purchase Plan (the ESPP) and reserved 110,000 shares of its
un-issued capital stock for issuance.  The plan was designed to promote
broad-based employee ownership of the Company’s stock and to motivate employees
to improve job performance and enhance the financial results of the
Company.  Under the ESPP, employees use automatic payroll withholdings to
purchase the Company’s capital stock at a discounted price based on the fair
market value of the capital stock as measured on either the commencement date or
termination date.  As of March 31, 2010, 17,025 shares have been issued
under the ESPP.  The ESPP is considered a compensatory plan and as such, is
required to comply with the provisions of authoritative accounting
guidance.  The Company recognizes compensation expense on its ESPP on the
date the shares are purchased.  For the three months ended March 31, 2010
and 2009, compensation expense related to the ESPP approximated $7,000 and
$5,000, respectively, and is included as a component of salaries and employee
benefits in the consolidated statements of income.


- 14
-


6.  Fair value
measurements




The
accounting guidelines established a framework for measuring fair value and
enhancing disclosures about fair value measurements.  The guidelines of
fair value reporting instituted a valuation hierarchy for disclosure of the
inputs used to measure fair value.  This hierarchy prioritizes the inputs
into three broad levels as follows:




Level 1
inputs are quoted prices (unadjusted) in active markets for identical assets or
liabilities;




Level 2
inputs are quoted prices for similar assets and liabilities in active markets;
quoted prices for identical or similar assets or liabilities in markets that are
not active; or inputs that are observable for the asset or liability, either
directly or indirectly through market corroboration, for substantially the full
term of the financial instrument;




Level 3
inputs are unobservable inputs based on our own assumptions to measure assets
and liabilities at fair value.  Level 3 pricing for securities may also
include unobservable inputs based upon broker-traded transactions.  A
financial asset or liability’s classification within the hierarchy is determined
based on the lowest level input that is significant to the fair value
measurement.




The
Company uses fair value to measure certain assets and, if necessary, liabilities
on a recurring basis when fair value is the primary measure for
accounting.  Thus, the Company uses fair value for AFS securities and loans
AFS.  Fair value is used on a non-recurring basis to measure certain assets
when adjusting carrying values to market values, such as impaired
loans.




The
following table illustrates the financial instruments measured at fair value on
a recurring basis segregated by hierarchy fair value levels as of March 31, 2010
and December 31, 2009 (dollars in thousands):




Fair value measurements at March 31, 2010:Total carrying
                  
                  
                  Quoted prices
                  
                  
                  Significant other
                  
                  
                  Significantvalue at
                  
                  
                  in active markets
                  
                  
                  observable inputs
                  
                  
                  unobservable inputsAssets:
                  
                  March 31, 2010
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Available-for-sale
      securities:Agency
      - GSE
                  
                  $
                  28,554
                  
                  
                  $
                  -
                  
                  
                  $
                  28,554
                  
                  
                  $
                  -Obligations
      of states and political subdivisions
                  
                  
                  22,907
                  
                  
                  
                  -
                  
                  
                  
                  22,907
                  
                  
                  
                  -Corporate
      bonds:Pooled
      trust preferred securities
                  
                  
                  5,407
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,407MBS
      - GSE residential
                  
                  
                  23,474
                  
                  
                  
                  -
                  
                  
                  
                  23,474
                  
                  
                  
                  -Equity
      securities - financial services
                  
                  
                  420
                  
                  
                  
                  420
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      available-for-sale securities
                  
                  
                  80,762
                  
                  
                  
                  420
                  
                  
                  
                  74,935
                  
                  
                  
                  5,407Loans
      available-for-sale
                  
                  
                  349
                  
                  
                  
                  -
                  
                  
                  
                  349
                  
                  
                  
                  -Total
                  
                  $
                  81,111
                  
                  
                  $
                  420
                  
                  
                  $
                  75,284
                  
                  
                  $
                  5,407


- 15
-




Fair value measurements at December 31, 2009:Total carrying
                  
                  
                  Quoted prices
                  
                  
                  Significant other
                  
                  
                  Significantvalue at
                  
                  
                  in active markets
                  
                  
                  observable inputs
                  
                  
                  unobservable inputsAssets:
                  
                  December 31, 2009
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Available-for-sale
      securities:Agency
      - GSE
                  
                  $
                  33,132
                  
                  
                  $
                  -
                  
                  
                  $
                  33,132
                  
                  
                  $
                  -Obligations
      of states and political subdivisions
                  
                  
                  23,270
                  
                  
                  
                  -
                  
                  
                  
                  23,270
                  
                  
                  
                  -Corporate
      bonds:Pooled
      trust preferred securities
                  
                  
                  5,242
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,242MBS
      - GSE residential
                  
                  
                  13,748
                  
                  
                  
                  -
                  
                  
                  
                  13,748
                  
                  
                  
                  -Equity
      securities - financial services
                  
                  
                  429
                  
                  
                  
                  429
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      available-for-sale securities
                  
                  
                  75,821
                  
                  
                  
                  429
                  
                  
                  
                  70,150
                  
                  
                  
                  5,242Loans
      available-for-sale
                  
                  
                  1,221
                  
                  
                  
                  -
                  
                  
                  
                  1,221
                  
                  
                  
                  -Total
                  
                  $
                  77,042
                  
                  
                  $
                  429
                  
                  
                  $
                  71,371
                  
                  
                  $
                  5,242




Equity
securities in the AFS portfolio are measured at fair value using quoted market
prices for identical assets and are classified within Level 1 of the valuation
hierarchy.  Other than the Company’s investment in corporate bonds,
consisting of pooled trust preferred securities, all other debt securities in
the AFS portfolio are measured at fair value using prices provided by a
third-party vendor, who is a provider of financial market data, analytics and
related services to financial institutions.  Assets classified as Level 2
use valuation techniques that are common to bond valuations.  That is, in
active markets whereby bonds of similar characteristics frequently trade, quotes
for similar assets are obtained.  Loans AFS are measured for fair value
from quotes received through secondary market sources, i.e., FNMA or FHLB, who
provide pricing for similar assets with similar terms in actively traded
markets.  In the above table, loans AFS reflect the carrying value which is
the lower of cost or market value.  These loans are typically originated,
forward-committed and sold shortly thereafter. The spread between cost and
market value in loans AFS is normally minor.  For the three months ended
March 31, 2010, there were no significant transfers to and from Level 1 and
Level 2 fair value measurements for financial assets measured on a recurring
basis.




The
Company’s pooled trust preferred securities include both observable and
unobservable inputs to determine fair value and, therefore, are classified as
Level 3 inputs.  For a discussion on the fair value determination of the
Company’s investment in pooled trust preferred securities, see “Investment
securities” under the caption “Comparison of Financial Condition at March 31,
2010 and December 31, 2009” in “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” below.




The
following table illustrates the changes in Level 3 financial instruments,
consisting of the Company’s investment in pooled trust preferred securities,
measured at fair value on a recurring basis for the periods indicated (dollars
in thousands):




As of and for the
                      
                      
                      As of and for thethree months ended
                      
                      
                      three months endedMarch 31, 2010
                      
                      
                      March 31, 2009Assets:Balance
      at beginning of period
                      
                      $
                      5,242
                      
                      
                      $
                      10,260Realized
      / unrealized (losses) gains:in
      earnings
                      
                      
                      (79
                      )
                      
                      
                      (326
                      )in
      comprehensive income (loss)
                      
                      
                      205
                      
                      
                      
                      (6,040
                      )Purchases,
      sales, issuances and settlements, amortization and accretion,
      net
                      
                      
                      39
                      
                      
                      
                      18Balance
      at end of period
                      
                      $
                      5,407
                      
                      
                      $
                      3,912


- 16
-


The
following table illustrates the financial instruments measured at fair value on
a non-recurring basis segregated by hierarchy fair value levels as of March 31,
2010 and December 31, 2009 (dollars in thousands):




Fair value measurements at March 31, 2010 using:Total carrying
                
                
                Quoted prices
                
                
                Significant other
                
                
                Significantvalue at
                
                
                in active markets
                
                
                observable inputs
                
                
                unobservable inputsAssets:
                
                March 31, 2010
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Impaired
      loans
                
                $
                3,384
                
                
                $
                -
                
                
                $
                3,028
                
                
                $
                356





Fair value measurements at December 31, 2009 using:Total carrying
                
                
                Quoted prices
                
                
                Significant other
                
                
                Significantvalue at
                
                
                in active markets
                
                
                observable inputs
                
                
                unobservable inputsAssets:
                
                December 31, 2009
                
                
                (Level 1)
                
                
                (Level 2)
                
                
                (Level 3)Impaired
      loans
                
                $
                4,842
                
                
                $
                15
                
                
                $
                4,447
                
                
                $
                380





Impaired
loans that are collateral dependent are written down to fair value through the
establishment of specific reserves.  Techniques used to value the
collateral that secures the impaired loan include: quoted market prices for
identical assets classified as Level 1 inputs; observable inputs, employed by
certified appraisers for similar assets are utilized and then discounted by 25%
to 30% and classified as Level 2 inputs.  In cases where valuation
techniques included inputs that are unobservable, the valuations are based on
commonly used and generally accepted industry liquidation advance rates or
estimates and assumptions developed by management, with significant adjustments
applied to the best information available under each circumstance, the asset
valuation is classified as Level 3 inputs.  A net reduction or
transfer out of the impaired loans with Level 2 inputs occurred during the
quarter ended March 31, 2010 based upon updated valuations and payments
received.  As the resulting loan balance loan balance is now below the fair
value of the collateral, a specific reserve is not required and the loan was
removed from the table.  There were no significant transfers during the
quarter in the Level 1 and Level 3 impaired loans.




A summary
of the carrying amounts and estimated fair values of certain financial
instruments follows as of the periods indicated (dollars in
thousands):




March 31, 2010
                
                
                December 31, 2009Carrying
                
                
                Estimated
                
                
                Carrying
                
                
                Estimatedamount
                
                
                fair value
                
                
                amount
                
                
                fair valueFinancial
      assets:Cash
      and cash equivalents
                
                $
                40,183
                
                
                $
                40,183
                
                
                $
                8,328
                
                
                $
                8,328Held-to-maturity
      securities
                
                
                672
                
                
                
                733
                
                
                
                709
                
                
                
                765Available-for-sale
      securities
                
                
                80,762
                
                
                
                80,762
                
                
                
                75,821
                
                
                
                75,821FHLB
      stock
                
                
                4,781
                
                
                
                4,781
                
                
                
                4,781
                
                
                
                4,781Loans
      and leases
                
                
                426,157
                
                
                
                424,354
                
                
                
                423,124
                
                
                
                420,908Loans
      available-for-sale
                
                
                349
                
                
                
                349
                
                
                
                1,221
                
                
                
                1,233Accrued
      interest
                
                
                2,190
                
                
                
                2,190
                
                
                
                2,251
                
                
                
                2,251Financial
      liabilities:Deposit
      liabilities
                
                
                486,557
                
                
                
                481,789
                
                
                
                458,994
                
                
                
                453,264Short-term
      borrowings
                
                
                26,370
                
                
                
                26,370
                
                
                
                16,533
                
                
                
                16,533Long-term
      debt
                
                
                32,000
                
                
                
                34,953
                
                
                
                32,000
                
                
                
                35,017Accrued
      interest
                
                
                625
                
                
                
                625
                
                
                
                665
                
                
                
                665




The
following summarizes the methodology used to determine estimated fair values in
the above table:




The
carrying value of short-term financial instruments, as listed below,
approximates their fair value.  These instruments generally have limited
credit exposure, no stated or short-term maturities and carry interest rates
that approximate market.




·
            Cash
      and cash equivalents




·
            Non-interest
      bearing deposit accounts


- 17
-


·
            Savings,
      NOW and money market accounts




·
            Short-term
      borrowings




·
            Accrued
      interest




Securities: 
Except for corporate bonds consisting of preferred term securities, fair values
on the other investment securities are determined by prices provided by a
third-party vendor, who is a provider of financial market data, analytics and
related services to financial institutions.  The fair values of pooled
trust preferred securities is determined based on a present value technique
(income valuation) as described under the caption “Investment securities” of the
comparison of financial condition at March 31, 2010 and December 31, 2009,
below.




FHLB
stock, or restricted regulatory equity, is carried at cost, which approximates
fair value.




Loans and
leases:  The fair value of all loans is estimated by the net present value
of the future expected cash flows discounted at the current offering
rates.




Loans
available-for-sale:  For loans available-for-sale, the fair value is
estimated using rates currently offered for similar loans and are obtained from
the FNMA or the FHLB.




Certificates
of deposit:  The fair values of certificate of deposit accounts are based
on discounted cash flows using rates which approximate the offering rates of
deposits with similar maturities.




Long-term
debt:  The fair value is estimated using the rates currently offered for
similar borrowings.




Item 2:  Management’s Discussion and Analysis of Financial
Condition and Results of Operations




The
following is management's discussion and analysis of the significant changes in
the consolidated financial condition of the Company as of March 31, 2010
compared to December 31, 2009 and a comparison of the results of operations for
the three-months ended March 31, 2010 and 2009.  Current performance may
not be indicative of future results.  This discussion should be read in
conjunction with the Company’s 2009 Annual Report filed on Form
10-K.




Forward-looking
statements




Certain
of the matters discussed in this Interim Report on Form 10-Q may constitute
forward-looking statements for purposes of the Securities Act of 1933, as
amended, and the Securities Exchange Act of 1934, as amended, and as such may
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Company to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements.  The words “expect,” “anticipate,”
“intend,” “plan,” “believe,” “estimate,” and similar expressions are intended to
identify such forward-looking statements.




The
Company’s actual results may differ materially from the results anticipated in
these forward-looking statements due to a variety of factors, including, without
limitation:




§
            the
      effects of economic deterioration on current customers, specifically the
      effect of the economy on loan customers’ ability to repay
      loans;


§
            the
      costs and effects of litigation and of unexpected or adverse outcomes in
      such litigation;


§
            governmental
      monetary and fiscal policies, as well as legislative and regulatory
      changes;


§
            the
      effect of changes in accounting policies and practices, as may be adopted
      by the regulatory agencies, as well as the Financial Accounting Standards
      Board and other accounting standard
setters;


§
            the
      risks of changes in interest rates on the level and composition of
      deposits, loan demand, and the values of loan collateral, securities and
      interest rate protection agreements, as well as interest rate
      risks;


§
            the
      effects of competition from other commercial banks, thrifts, mortgage
      banking firms, consumer finance companies, credit unions, securities
      brokerage firms, insurance companies, money market and other mutual funds
      and other financial institutions operating in our market area and
      elsewhere, including institutions operating locally, regionally,
      nationally and internationally, together with such competitors offering
      banking products and services by mail, telephone, computer and the
      internet;


§
            technological
      changes;


§
            acquisitions
      and integration of acquired
businesses;


§
            the
      failure of assumptions underlying the establishment of reserves for loan
      and lease losses and estimations of values of collateral and various
      financial assets and liabilities;


§
            volatilities
      in the securities markets;


§
            deteriorating
      economic conditions;


§
            acts
      of war or terrorism; and


§
            disruption
      of credit and equity markets.


- 18
-


Management
of the Company cautions readers not to place undue reliance on forward-looking
statements, which reflect analyses only as of the date of this document. 
We have no obligation to update any forward-looking statements to reflect events
or circumstances after the date of this document.




Readers
should review the risk factors described in other documents that we file or
furnish, from time to time, with the Securities and Exchange Commission,
including Annual Reports to Shareholders, Annual Reports filed on Form 10-K and
other current reports filed or furnished on Form 8-K.




General




The
Company’s results of operations depend primarily on net interest income. 
Net interest income is the difference between interest income and interest
expense.  Interest income is generated from yields on interest-earning
assets, which consist principally of loans and investment securities. 
Interest expense is incurred from rates paid on interest-bearing liabilities,
which consist of deposits and borrowings.  Net interest income is
determined by the Company’s interest rate spread (the difference between the
yields earned on its interest-earning assets and the rates paid on its
interest-bearing liabilities) and the relative amounts of interest-earning
assets and interest-bearing liabilities.  Interest rate spread is
significantly impacted by: changes in interest rates and market yield curves and
their related impact on cash flows; the composition and characteristics of
interest-earning assets and interest-bearing liabilities; differences in the
maturity and re-pricing characteristics of assets compared to the maturity and
re-pricing characteristics of the liabilities that fund them and by the
competition in our marketplace.




The
Company’s profitability is also affected by the level of its non-interest income
and expenses, provision for loan losses and provision for income taxes. 
Non-interest income consists of service charges on the Bank’s loan and deposit
products, trust and asset management service fees, increases in the cash
surrender value of the bank owned life insurance (BOLI), net gains or losses
from sales of loans, securities and foreclosed properties held-for-sale and from
credit-related other-than-temporary impairment (OTTI) charges on investment
securities.  Non-interest expense consists of compensation and related
employee benefit expenses, occupancy, equipment, data processing, advertising,
marketing, professional fees, insurance and other operating
overhead.




The
Company’s profitability is significantly affected by general economic and
competitive conditions, changes in market interest rates, government policies
and actions of regulatory authorities.  The Company’s loan portfolio is
comprised principally of commercial and commercial real estate loans.  The
properties underlying the Company’s mortgages are concentrated in Northeastern
Pennsylvania.  Credit risk, which represents the possibility of the Company
not recovering amounts due from its borrowers, is significantly related to local
economic conditions in the areas the properties are located as well as the
Company’s underwriting standards.  Economic conditions affect the market
value of the underlying collateral as well as the levels of adequate cash flow
and revenue generation from income-producing commercial properties.




Comparison of the results of
operations


Three months ended March 31,
2010 and 2009




Overview




The
Company recorded net income of $556,000 for the first quarter of 2010 compared
to $825,000 recorded in the same quarter of 2009, or a 33% decline. 
Diluted earnings per share were $0.26 and $0.40 for each of the respective
quarters.  The factors contributing to the earnings decline consisted of
$398,000 in early retirement and severance costs from management’s
reorganization of the Company, an increase in the provision for loan losses of
$150,000, a decline in mortgage banking gains of $391,000, $121,000 of
additional FDIC insurance premiums and higher operating overhead of
$148,000.  Partially offsetting these negative variance factors included an
increase in net interest income of $334,000, or 7%, lower OTTI charges of
$246,000, salary and benefit savings of $198,000 and a decline in the provision
of income taxes of $157,000.




Return on
average assets (ROA) and return on average shareholders’ equity (ROE) were 0.38%
and 4.85%, respectively, for the three months ended March 31, 2010 compared to
0.58% and 7.02%, respectively, for the same period in 2009.  The decreases
in ROA and ROE are attributable to lower net income.


- 19
-


Net interest income and
interest sensitive assets / liabilities




Net
interest income improved by $334,000, or 7%, from $4,825,000, recorded in the
first quarter of 2009 to $5,159,000 recorded during the first quarter of
2010.  During the third quarter of 2009, the Company paid off $10,000,000
million of long-term Federal Home Loan Bank (FHLB) advances that were scheduled
to mature during the third quarter of 2010.  In addition, a $10,000,000
million FHLB advance matured in the first quarter of 2009 that was not
renewed.  These advances carried a combined weighted-average interest rate
of 5.72% and their elimination had the effect of reducing interest expense by
approximately $367,000 for the first three months of 2010.  The FHLB
advances were largely supplanted by growth in lower costing deposits and
repurchase agreements.  Though average balances of interest-bearing
deposits increased $23,000,000, mostly from a $50,000,000 increase in average
balances of savings deposits, interest expense from total deposits declined by
$778,000 due to a 92 basis point reduction in average rates paid thereon. 
Certificates of deposit accounts declined $27,000,000, on average, in the first
quarter of 2010 compared to the same quarter in 2009.  In a low rate
environment, depositor sentiment is to hold deposits in non-time sensitive
products such as savings, NOW and money market accounts until such time as rates
begin to rise.  Thus, reduction in rates paid on deposits and borrowings
was the principal cause of a $1,120,000, or 37%, decline in interest
expense.  The lower rates from the interest-sensitive liabilities helped
mitigate the impact of lower yields earned on interest-earning assets. 
Despite an increase in average balances, interest income declined $786,000, or
10%, due mostly to a 72 basis point drop in yield.  Average balances of
highly liquid, low yielding short-term cash investments of federal funds sold
and interest-bearing deposits have increased by approximately $24,800,000 so
that funds are available when normal seasonal, yet volatile deposits from the
Company’s public fund customers are withdrawn.




For the
three months ended March 31, 2010, the Company’s tax-equivalent margin and
spread were 3.91% and 3.63%, respectively, compared to 3.73% and 3.28% during
the three months ended March 31, 2009.  The improvements were due to higher
net interest income and the impact of rates on interest-bearing liabilities
declining more rapidly than the yields on interest-earning assets.




The low
interest rate environment continued into the current year’s first quarter. 
As we operate in this low rate environment, earning assets will continue to
price and re-price at lower levels thereby pressuring earning-yields
downward.  The Company’s Asset Liability Management (ALM) team meets
regularly to discuss among other things, interest rate risk and when deemed
necessary adjusts interest rates on deposits and repurchase agreements in order
to maintain acceptable interest rate margins.  The actions of the ALM team
have helped minimize the effect rate changes have had on interest income so that
net interest income is not materially impacted and the committee will continue
to address ALM issues in this difficult financial landscape.




The table
that follows sets forth a comparison of average balance sheet amounts and their
corresponding fully tax-equivalent (FTE) interest income and expense and
annualized tax-equivalent yield and cost for the periods indicated (dollars in
thousands):




Three months ended:March 31, 2010
                  
                  
                  March 31, 2009Average
                  
                  
                  
                  
                  
                  Yield /
                  
                  
                  Average
                  
                  
                  
                  
                  
                  Yield /Assets
                  
                  balance
                  
                  
                  Interest
                  
                  
                  rate
                  
                  
                  balance
                  
                  
                  Interest
                  
                  
                  rateInterest-earning
      assets:Loans
      and leases
                  
                  $
                  437,200
                  
                  
                  $
                  6,302
                  
                  
                  
                  5.85
                  %
                  
                  $
                  438,804
                  
                  
                  $
                  6,735
                  
                  
                  
                  6.22
                  %Investments
                  
                  
                  92,932
                  
                  
                  
                  924
                  
                  
                  
                  4.03
                  
                  
                  
                  102,485
                  
                  
                  
                  1,258
                  
                  
                  
                  4.98Federal
      funds sold
                  
                  
                  12,884
                  
                  
                  
                  7
                  
                  
                  
                  0.22
                  
                  
                  
                  1,446
                  
                  
                  
                  1
                  
                  
                  
                  0.22Interest-bearing
      deposits
                  
                  
                  13,458
                  
                  
                  
                  8
                  
                  
                  
                  0.25
                  
                  
                  
                  119
                  
                  
                  
                  -
                  
                  
                  
                  0.38Total
      interest-earning assets
                  
                  
                  556,474
                  
                  
                  
                  7,241
                  
                  
                  
                  5.28
                  
                  
                  
                  542,854
                  
                  
                  
                  7,994
                  
                  
                  
                  5.97Non-interest-earning
      assets
                  
                  
                  31,888
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  29,442Total
      assets
                  
                  $
                  588,362
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  572,296Liabilities and shareholders'
      equityInterest-bearing
      liabilities:Other
      interest-bearing deposits
                  
                  $
                  257,210
                  
                  
                  $
                  506
                  
                  
                  
                  0.78
                  %
                  
                  $
                  207,234
                  
                  
                  $
                  569
                  
                  
                  
                  1.11
                  %Certificates
      of deposit
                  
                  
                  146,384
                  
                  
                  
                  908
                  
                  
                  
                  2.46
                  
                  
                  
                  173,274
                  
                  
                  
                  1,623
                  
                  
                  
                  3.80Borrowed
      funds
                  
                  
                  42,042
                  
                  
                  
                  423
                  
                  
                  
                  4.08
                  
                  
                  
                  62,305
                  
                  
                  
                  803
                  
                  
                  
                  5.22Repurchase
      agreements
                  
                  
                  18,012
                  
                  
                  
                  45
                  
                  
                  
                  1.01
                  
                  
                  
                  10,362
                  
                  
                  
                  8
                  
                  
                  
                  0.33Total
      interest-bearing liabilities
                  
                  
                  463,648
                  
                  
                  
                  1,882
                  
                  
                  
                  1.65
                  
                  
                  
                  453,175
                  
                  
                  
                  3,003
                  
                  
                  
                  2.69Non-interest-bearing
      deposits
                  
                  
                  74,808
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  68,083Other
      non-interest-bearing liabilities
                  
                  
                  3,380
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,367Shareholders'
      equity
                  
                  
                  46,526
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  47,671Total
      liabilities and shareholders' equity
                  
                  $
                  588,362
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  572,296Net
      interest income / interest rate spread
                  
                  
                  
                  
                  
                  $
                  5,359
                  
                  
                  
                  3.63
                  %
                  
                  
                  
                  
                  
                  $
                  4,991
                  
                  
                  
                  3.28
                  %Net
      interest margin
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.91
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3.73
                  %





In the
preceding table, interest income was adjusted to a tax-equivalent basis, using
the corporate federal tax rate of 34%, to recognize the income from tax-exempt
interest-earning assets as if the interest was taxable.  This treatment
allows a uniform comparison between yields on interest-earning assets. 
Loans include loans AFS and non-accrual loans but exclude the allowance for loan
losses.  Securities include non-accrual securities.  Average balances
are based on amortized cost and do not reflect net unrealized gains or
losses.  Net interest margin is calculated by dividing net interest income
by total average interest-earning assets.


- 20
-


Provision for loan
losses




The
provision for loan losses represents the necessary amount to charge against
current earnings, the purpose of which is to increase the allowance for loan
losses to a level that represents management’s best estimate of known and
inherent losses in the Company’s loan portfolio.  Loans and leases
determined to be uncollectible are charged-off against the allowance for loan
losses.  The required amount of the provision for loan losses, based upon
the adequate level of the allowance for loan losses, is subject to ongoing
analysis of the loan portfolio.  The Company’s Special Assets Committee
meets periodically to review problem loans and leases.  The committee is
comprised of management, including the senior loan officer, the chief risk
officer, loan officers, loan workout officers and collection personnel. 
The committee reports quarterly to the Credit Administration Committee of the
Board of Directors.




Management
continuously reviews the risks inherent in the loan and lease portfolio. 
Specific factors used to evaluate the adequacy of the loan loss provision during
the formal process include:




•
            specific
      loans that could have loss
potential;


•
            levels
      of and trends in delinquencies and non-accrual
  loans;


•
            levels
      of and trends in charge-offs and
recoveries;


•
            trends
      in volume and terms of loans;


•
            changes
      in risk selection and underwriting
standards;


•
            changes
      in lending policies, procedures and
practices;


•
            experience,
      ability and depth of lending
management;


•
            national
      and local economic trends and conditions;
and


•
            changes
      in credit concentrations.




The
provision for loan losses was $575,000 for the first quarter ending March 31,
2010 and $425,000 for the three month period ending March 31, 2009. The
provision for the current quarter was recorded to provide for internally
classified downgrades resulting from local weakened economic conditions and to
reserve for a decline in real estate values.  For a further discussion on
non-performing loans, see “Non-performing assets” under the caption “Comparison
of financial condition at March 31, 2010 and December 31, 2009”,
below.




The
allowance for loan losses was $7,752,000 at March 31, 2010 compared to
$7,574,000 at December 31, 2009.  For a further discussion on the allowance
for loan losses, see “Allowance for loan losses” under the caption “Comparison
of financial condition at March 31, 2010 and December 31, 2009”
below.




Other
income




In the
first quarter of 2010, the Company recorded non-interest income of $1,146,000
compared to $1,313,000 recorded in the first quarter of 2009 or a decrease of
$168,000, or 13%.  The decline in non-interest earnings was from the
expected decline in gains from mortgage banking services.  During the 2009
quarter, the Company sold $38,296,000 of residential mortgage loans at gains of
$491,000.  Included in those sales were $10,838,000 of loans transferred
from the loan and lease portfolio to loans AFS.  In the current year
quarter, the Company sold $7,964,000 of mortgage loans and recognized gains of
$99,000.  The lower volume of sold loans can be attributed to a significant
slowing of residential mortgage re-financing which in 2009 predominantly
comprised fixed-rate loans that the Company typically sells into the secondary
market.  The Company considers the high volume of residential mortgage
origination and related sales activity that occurred in 2009 an aberration due
to the unprecedented low interest rate environment.  Partially offsetting
the decline in mortgage loan gains, the Company’s recorded a non-cash OTTI
charge of $79,000 compared to $326,000 recorded in the first quarter of
2009.  The charges are related to impairment from the Company’s investment
in pooled trust preferred securities.  See Note 3, “Investment securities”
for a further discussion on the Company’s portfolio of pooled trust preferred
securities.




Other operating
expenses




Other
(non-interest) expenses for the first three months of 2010 were $5,105,000, or
$443,000, higher than the $4,662,000 recorded during the first three months of
2009.  Salaries and employee benefits increased $199,000, or 8%, due to
nearly $400,000 of severance and voluntary termination payout caused by planned,
structured reorganization of the Company.  This was offset by lower
expenses related to employee group insurance, commission, bonus, overtime and
costs related to Company contributions to the employee retirement plan. 
The other category of non-interest expenses increased by $272,000, or 26% in the
current year’s first quarter, compared to the same quarter in 2009.  The
increase stems from anticipated, higher FDIC insurance premiums of $121,000 and
additional professional and legal costs of approximately $77,000. 
Operating expenses have also increased due to the effect of less deferral of
mortgage origination costs on a lower volume of mortgage originations during the
first quarter of 2010 compared to the first quarter of 2009.


- 21
-


Comparison of financial
condition at


March 31, 2010 and December
31, 2009




Overview




Consolidated
assets increased to $595,289,000 or 7%, as of March 31, 2010 from $556,017,000
at December 31, 2009.  The increase was primarily from $27,563,000 growth
in deposits, $9,500,000 in a low-cost, match-funded, short-term FHLB advance and
a $691,000 increase in shareholders’ equity.




Investment
securities




At the
time of purchase, management classifies investment securities into one of three
categories: trading, AFS or held-to- maturity (HTM).  To date, management
has not purchased any securities for trading purposes.  Most of the
securities purchased are classified as AFS even though there is no immediate
intent to sell them.  The AFS designation affords management the
flexibility to sell securities and position the balance sheet in response to
capital levels, liquidity needs or changes in market conditions. 
Securities AFS are carried at fair value in the consolidated balance sheet with
an adjustment to shareholders’ equity, net of tax, presented under the caption
“Accumulated other comprehensive income (loss).”  Securities designated as
HTM are carried at amortized cost and represent debt securities that the Company
has the ability and intent to hold until maturity.




As of
March 31, 2010, the carrying value of investment securities amounted to
$81,434,000, or 14% of total assets, compared to $76,530,000, or 14% of total
assets, at December 31, 2009.  At March 31, 2010, approximately 30% of the
carrying value of the investment portfolio was comprised of mortgage-backed
securities that amortize and provide monthly cash flow.




Investment
securities are comprised of HTM and AFS securities with carrying values of
$672,000 and $80,762,000, respectively.  As of March 31, 2010, the AFS debt
securities were recorded with a net unrealized loss in the amount of $13,523,000
and equity securities were recorded with an unrealized net gain of
$98,000.  During the three months ended March 31, 2010, total investments
increased $4,904,000, or 6%.




A
comparison of investment securities at March 31, 2010 and December 31, 2009 is
as follows (dollars in thousands):




March 31, 2010
                  
                  
                  December 31, 2009Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Agency
      - GSE
                  
                  $
                  28,554
                  
                  
                  
                  35.0
                  
                  
                  $
                  33,132
                  
                  
                  
                  43.3MBS
      - GSE residential
                  
                  
                  24,146
                  
                  
                  
                  29.7
                  
                  
                  
                  14,457
                  
                  
                  
                  18.9State
      & municipal subdivisions
                  
                  
                  22,907
                  
                  
                  
                  28.1
                  
                  
                  
                  23,270
                  
                  
                  
                  30.4Pooled
      trust preferred securities
                  
                  
                  5,407
                  
                  
                  
                  6.7
                  
                  
                  
                  5,242
                  
                  
                  
                  6.8Equity
      securities - financial services
                  
                  
                  420
                  
                  
                  
                  0.5
                  
                  
                  
                  429
                  
                  
                  
                  0.6Total
      investments
                  
                  $
                  81,434
                  
                  
                  
                  100.0
                  
                  
                  $
                  76,530
                  
                  
                  
                  100.0





Quarterly,
management performs a review of the investment portfolio to determine the cause
of declines in the fair value of each security.  The Company uses inputs
provided by independent third parties to determine the fair value of its
investment securities portfolio.  The inputs provided are reviewed and
corroborated by management.  Evaluations of the causes of the unrealized
losses are performed to determine whether impairment is temporary or
other-than-temporary.  Consideration such as the Company’s intent to sell
the security, more likely than not the Company will be required to sell the
security before recovery of its amortized cost basis, the present value of
expected cash flows is not sufficient to recover the entire amortized cost
basis, recoverability of the invested amounts over the intended holding period,
the length of time and the severity in pricing decline below cost, the interest
rate environment, receipts of amounts contractually due and whether or not there
is an active market for the security, for example, are applied, along with the
financial condition of the issuer for management to make a realistic judgment of
the probability that the Company will be unable to collect all amounts
(principal and interest) due in determining whether a security is
other-than-temporarily impaired.  If a decline in value is deemed to be
other-than-temporary, the amortized cost of the security is reduced by the
credit impairment amount and a corresponding charge to earnings is
recognized.  If at the time of sale, call or maturity the proceeds exceed
the security’s amortized cost, the impairment charge may be fully or partially
recovered.




Under
these circumstances, OTTI is considered to have occurred if: (1) the
entity has intent to sell the security; (2) more likely than not the
entity will be required to sell the security before recovery of its amortized
cost basis; or (3) the present value of expected cash flows is not
sufficient to recover the entire amortized cost.


- 22
-




The
uncertainty in the financial markets continues to foster volatility in fair
value estimates for the securities in the Company’s investment
portfolio.  Fair values of the Company’s investment securities have
improved since year-end 2009, but remain well below their amortized cost - $13.4
million, or 14% as of March 31, 2010 and $13.9 million, or 16% as of December
31, 2009.  Management believes fair values and their changes are due
mainly to a combination of the interest rate environment, instability in the
capital markets, limited trading activity and illiquid conditions in the
financial markets, not deterioration in the creditworthiness of the
issuers.  Nearly all of the securities in the portfolio have fixed
rates or have predetermined scheduled rate changes, and many have call features
that allow the issuer to call the security at par before its stated maturity
without penalty.  The most significant component of the $13.4 million
net unrealized loss in the AFS debt securities portfolio, as of March 31, 2010,
was $13.3 million from the Company’s investments in corporate bonds consisting
of collateralized debt obligation (CDO) securities that are backed by pooled
trust preferred securities issued by banks, thrifts and insurance
companies.




Management
is unable to obtain readily attainable and realistic pricing from market traders
for the pooled trust preferred securities portfolio because there continues to
be a lack of active market participants who deal in these
securities.




The
Company owns 13 tranches of pooled trust preferred securities
(PreTSLs).  Management has determined the market for these securities
and other issues of PreTSLs at March 31, 2010 remains inactive.  The
inactivity was evidenced first by a significant widening of the bid-ask spread
in the brokered markets in which PreTSLs trade, then by a significant decrease
in the volume of trades relative to historical levels and the lack of a
new-issue market since 2007.  There are currently very few market
participants who are willing and/or able to transact for these
securities.  Given the conditions in the debt markets today and the
absence of observable transactions in the secondary and new issue markets,
management has made the following observations and has determined:




·
            The
      few observable transactions and market quotations that were available were
      not reliable for purposes of determining fair value at March 31,
      2010,




·
            An
      income valuation approach (present value technique) that maximizes the use
      of relevant observable inputs and minimizes the use of unobservable inputs
      are equally or more representative of fair value than the market approach
      valuation technique, and




·
            The
      PreTSLs securities are classified within “Level 3” in the fair value
      hierarchy (as defined in current accounting guidance and explained in Note
      6, “Fair Value Measurements” of the consolidated financial statements)
      because significant adjustments are required to determine fair value at
      the measurement date.  The valuations of the Company’s PreTSLs
      were prepared by an independent third party and corroborated by
      management.  The approach to determine fair value involved the
      following:




o
            Data
      about the issue structure as defined in the indenture and the underlying
      collateral were collected,




o
            The
      credit quality of the collateral is estimated using issuer-specific
      probability of default values,




o
            The
      default probabilities also considered the potential for 50% correlation
      among issuers within the same industry (e.g. banks with other banks) and
      30% correlation between industries (e.g. banks vs.
    insurance),




o
            The
      loss given default, or amount of cash lost to the investor when a debt
      asset defaults, was assumed to be 100% (no recovery).  This
      replicates the historically high default loss levels on trust preferred
      instruments,




o
            The
      cash flows were forecast for the underlying collateral and applied to each
      tranche to determine the resulting distribution among the
      securities.  This ascertains which investors are paid and which
      investors incur losses.  Thus, these cash flow projections
      capture the credit risk,




o
            The
      expected cash flows utilize no prepayments and were discounted utilizing
      three-month LIBOR as the risk-free rate for the base case and then added a
      300bp liquidity premium as the discount rate to calculate the present
      value of the security,




o
            The
      effective discount rates on an overall basis range from 9.70% to 177.98%
      and are highly dependent upon the credit quality of the collateral, the
      relative position of the tranche within the capital structure of the
      security and the prepayment assumptions,
and




o
            The
      calculations were modeled in several thousand scenarios using a Monte
      Carlo engine to establish a distribution of intrinsic values and the
      average was used for valuation
purposes.




- 23
-


Based on
the technique described, the Company determined that as of March 31, 2010, the
fair value of two PreTSL securities: VII and XI had declined $1,648,000 in total
below their amortized cost basis and since the present value of the security’s
expected cash flows were insufficient to recover the entire amortized cost
basis, the securities are deemed to have experienced credit related
other-than-temporary impairment in the amount of $79,000 which was charged to
current earnings as a component of other income in the consolidated statement of
income for the three months ended March 31, 2010. This compares to $326,000 of
impairment charges recorded for the first quarter of 2009. The Company closely
monitors the pooled trust preferred securities market and performs collateral
sufficiency and cash flow analyses on a quarterly basis. Future analyses could
yield results that may indicate further impairment has occurred and would
therefore require additional write-downs and corresponding other-than-temporary
impairment charges to current earnings.




Federal Home Loan Bank
Stock




Investment
in FHLB stock is required for membership in the organization and is carried at
cost since there is no market value available. The amount the Company is
required to invest is dependent upon the relative size of outstanding borrowings
the Company has with the FHLB. Excess stock is typically repurchased from the
Company at par if the level of borrowings declines to a predetermined level. In
addition, the Company normally earns a return or dividend on the amount
invested. In order to preserve its capital level, in December 2008 the FHLB
announced that it had suspended the payment of dividends and excess capital
stock repurchasing and as of March 31, 2010, that position has not changed. That
decision was based on the FHLB’s analysis and consideration of certain negative
market trends and the impact those trends will have on their financial
condition. Based on the financial results of the FHLB for the three months ended
March 31, 2010 and for the year-ended December 31, 2009, management believes
that the suspension of both the dividend payments and excess capital stock
repurchase is temporary in nature. Management further believes that the FHLB
will continue to be a primary source of wholesale liquidity for both short- and
long-term funding and has concluded that its investment in FHLB stock is not
other-than-temporarily impaired. There can be no assurance, however, that future
negative changes to the financial condition of the FHLB may not require the
Company to recognize an impairment charge with respect to such holdings. The
Company will continue to monitor the financial condition of the FHLB and assess
its future ability to resume normal dividend payments and stock redemption
activities.




Loans available-for-sale
(AFS)




Generally,
upon origination, certain residential mortgages are classified as
AFS.  In the event of market rate increases, fixed-rate loans and
loans not immediately scheduled to re-price would no longer produce yields
consistent with the current market.  In a declining interest rate
environment, the Company would be exposed to prepayment risk and, as rates
decrease, interest income could be negatively affected.  Consideration
is given to the Company’s current liquidity position and projected future
liquidity needs.  To better manage prepayment and interest rate risk,
loans that meet these conditions may be classified as AFS.  The
carrying value of loans AFS is at the lower of cost or estimated fair
value.  If the fair values of these loans fall below their original
cost, the difference is written down and charged to current
earnings.  Subsequent appreciation in the portfolio is credited to
current earnings but only to the extent of previous write-downs.




Loans AFS
at March 31, 2010 amounted to $349,000 with a corresponding fair value of
approximately the same, compared to $1,221,000 and $1,233,000, respectively, at
December 31, 2009.  During the three months ended March 31, 2010,
residential mortgage loans with principal balances of $7,964,000 were sold into
the secondary market with net gains of approximately $99,000 recognized,
compared to $38,296,000 and $491,000, respectively, during the three months
ended March 31, 2009.  The Company expects loan originations and the
related sales to diminish in 2010 as the refinance activity in 2009, caused by
low interest rates, has ebbed with originations returning to normal
volumes.




Loans and
leases




The
Company originates commercial and industrial (commercial) and commercial real
estate (CRE) loans, residential mortgages, consumer, home equity and
construction loans.  The relative volume of originations is dependent
upon customer demand, current interest rates and the perception and duration of
future interest rate levels.  As part of the overall strategy to serve
the business community in which it operates, the Company is focused on
developing and implementing products and services to the broad spectrum of
businesses that operate in our marketplace.  The Company’s goals
center on building relationships by providing credit and non-credit products and
services, continuing to diversify its loan portfolio and utilizing
participations to reduce risk in larger credit transactions.  Especially in
today’s economy, the Company, in providing credit to existing and new customers,
has implemented policies and procedures to reduce the associated risk.  The
risks associated with interest rates are being managed by utilizing floating
versus long-term fixed rates and exploring programs where we can match our cost
of funds.




The
majority of the Company’s loan portfolio is collateralized, at least in part, by
real estate in Lackawanna and Luzerne Counties of Pennsylvania. Commercial
lending activities involve a greater degree of credit risk than consumer lending
because typically they have larger balances and are more affected by adverse
conditions in the economy. Because payments on commercial loans depend upon the
successful operation and management of the properties and the businesses which
operate from within them, repayment of such loans may be affected by factors
outside the borrower’s control. Such factors may include adverse conditions in
the real estate market, the economy, the industry or changes in government
regulations. As such, commercial loans require more ongoing evaluation and
monitoring which occurs with the Bank’s credit administration and outsourced
loan review functions.




- 24
-


The
composition of the loan portfolio at March 31, 2010 and December 31, 2009, is
summarized as follows (dollars in thousands):




March 31, 2010
                
                
                December 31, 2009Amount
                
                
                %
                
                
                Amount
                
                
                %
                
                
                Variance
                
                
                %Real
      estate:Commercial
                
                $
                180,708
                
                
                
                41.7
                
                
                $
                186,727
                
                
                
                43.3
                
                
                $
                (6,019
                )
                
                
                (3.3
                )Residential
                
                
                69,547
                
                
                
                16.0
                
                
                
                71,001
                
                
                
                16.5
                
                
                
                (1,454
                )
                
                
                (2.1
                )Construction
                
                
                10,956
                
                
                
                2.5
                
                
                
                10,125
                
                
                
                2.4
                
                
                
                831
                
                
                
                8.2Commercial
      and industrial
                
                
                88,049
                
                
                
                20.3
                
                
                
                76,788
                
                
                
                17.8
                
                
                
                11,261
                
                
                
                14.7Consumer
                
                
                84,300
                
                
                
                19.4
                
                
                
                85,690
                
                
                
                19.9
                
                
                
                (1,390
                )
                
                
                (1.6
                )Direct
      financing leases
                
                
                349
                
                
                
                0.1
                
                
                
                367
                
                
                
                0.1
                
                
                
                (18
                )
                
                
                (4.9
                )Gross
      loans
                
                
                433,909
                
                
                
                100.0
                
                
                
                430,698
                
                
                
                100.0
                
                
                $
                3,211
                
                
                
                0.8Allowance
      for loan losses
                
                
                (7,752
                )
                
                
                
                
                
                
                (7,574
                )Net
      loans
                
                $
                426,157
                
                
                
                
                
                
                $
                423,124




The
$3,211,000 increase in gross loans during the first quarter of 2010 is mostly
from growth in commercial and industrial (C&I).  During the
quarter, the Company originated a new short-term, match funded loan with a
municipal customer.  This loan matures during the fourth quarter of
2010.  The decline in commercial real estate (CRE) loans stems from
the pay off of some multi-million loans that the Company aggressively sought for
final settlement.




Allowance for loan
losses




Management
continually evaluates the credit quality of the Company’s loan portfolio and
performs a formal review of the adequacy of the allowance for loan losses (the
allowance) on a quarterly basis.  The allowance reflects management’s
best estimate of the amount of credit losses in the loan
portfolio.  Management’s judgment is based on the evaluation of
individual loans, past experience, the assessment of current economic conditions
and other relevant factors including the amounts and timing of cash flows
expected to be received on impaired loans.  Those estimates may be
susceptible to significant change.  The provision for loan losses
represents the amount necessary to maintain an appropriate
allowance.  Loan losses are charged directly against the allowance
when loans are deemed to be uncollectible.  Recoveries from previously
charged-off loans are added to the allowance when received.




Management
applies two primary components during the loan review process to determine
proper allowance levels.  The two components are a specific loan loss
allocation for loans that are deemed impaired and a general loan loss allocation
for those loans not specifically allocated.  The methodology to
analyze the adequacy of the allowance for loan losses is as
follows:




•
            identification
      of specific impaired loans by loan
category;


•
            calculation
      of specific allowances where required for the impaired loans based on
      collateral and other objective and quantifiable
  evidence;


•
            determination
      of homogenous pools by loan category and eliminating the impaired
      loans;


•
            application
      of historical loss percentages (three-year average) to pools to determine
      the allowance allocation; and


•
            application
      of qualitative factor adjustment percentages to historical losses for
      trends or changes in the loan portfolio, and /or current economic
      conditions.




Allocation
of the allowance for different categories of loans is based on the methodology
as explained above.  A key element of the methodology to determine the
allowance is the Company’s credit risk evaluation process, which includes credit
risk grading of individual commercial loans.  Commercial loans are
assigned credit risk grades based on the Company’s assessment of conditions that
affect the borrower’s ability to meet its contractual obligations under the loan
agreement.  That process includes reviewing borrowers’ current
financial information, historical payment experience, credit documentation,
public information and other information specific to each individual
borrower.  Upon review, the commercial loan credit risk grade is
revised or reaffirmed.  The credit risk grades may be changed at any
time management feels an upgrade or downgrade may be warranted.  The
credit risk grades for the commercial loan portfolio are taken into account in
the reserve methodology and loss factors are applied based upon the credit risk
grades.  The loss factors applied are based upon the company’s
historical experience as well as what management believes to be best practices
and within common industry standards.  Historical experience reveals
there is a direct correlation between the credit risk grades and loan
charge-offs.  The changes in allocations in the commercial loan
portfolio from period-to-period are based upon the credit risk grading system
and from periodic reviews of the loan and lease portfolios.


- 25
-


Each
quarter, management performs an assessment of the allowance and the provision
for loan losses.  The Company’s Special Assets Committee meets
quarterly and the applicable lenders discuss each relationship under review and
reach a consensus on the appropriate estimated loss amount based on current
accounting guidelines.  The Special Assets Committee’s focus is on
ensuring the pertinent facts are considered and the reserve amounts pursuant to
the accounting principles are reasonable.  The assessment process
includes the review of all loans on a non-accruing basis as well as a review of
certain loans to which the lenders or the Company’s Credit Administration
function have assigned a criticized or classified risk rating.




Total
charge-offs net of recoveries for the three months ending March 31, 2010, were
$397,000, compared to $73,000 in the first three months of 2009.  The
higher level of charge-offs recorded in the first quarter of the current year
primarily resulted from the write-down of an impaired commercial real estate
loan to its current fair value and the charge-off of five other commercial and
industrial loans to unrelated borrowers.  Commercial real estate loan
net charge-offs of $200,000 were recorded during the three months ending March
31, 2010 versus $11,000 at March 31, 2009.  Commercial and industrial
loan net charge-offs were $142,000 for the three months ending March 31, 2010
compared to net recoveries of $1,000 in the same period of
2009.  There were no residential real estate loan charge-offs or
recoveries in the three month period ending March 31, 2010.  Consumer
loan net charge-offs of $55,000 were recorded during the three months ending
March 31, 2010 versus $60,000 at the March 31, 2009 three months quarter
end.  For a discussion on the provision for loan losses, see the
“Provision for loan losses,” located in the results of operations section of
management’s discussion and analysis contained herein.




The
allowance for loan losses was $7,752,000 at March 31, 2010, an increase of
$178,000 from $7,574.000 at December 31, 2009.  The increase in the
allowance was primarily driven by a migration of commercial loan risk ratings
from pass to criticized or classified status.




Management
believes that the current balance in the allowance for loan losses of $7,752,000
is sufficient to withstand the identified potential credit quality issues that
may arise and others unidentified but inherent to the portfolio as of this time.
Potential problem loans are those where there is known information that leads
management to believe repayment of principal and/or interest is in jeopardy and
the loans are currently neither on non-accrual status or past due 90 days or
more. Given continuing pressure on property values and the generally uncertain
economic backdrop, there could be additional instances which become identified
in future periods that may require additional charge-offs and/or increases to
the allowance. The ratio of allowance for loan losses to total loans was 1.79%
at March 31, 2010 compared to 1.20% at March 31, 2009.




- 26
-




The
following tables set forth the activity in the allowance for loan losses and
certain key ratios for the period indicated:




As of and for the
                    
                    
                    As of and for the
                    
                    
                    As of and for thethree months ended
                    
                    
                    twelve months ended
                    
                    
                    three months endedMarch 31, 2010
                    
                    
                    December 31, 2009
                    
                    
                    March 31, 2009Balance
      at beginning of period
                    
                    $
                    7,573,603
                    
                    
                    $
                    4,745,234
                    
                    
                    $
                    4,745,234Provision
      charged to operations
                    
                    
                    575,000
                    
                    
                    
                    5,050,000
                    
                    
                    
                    425,000Charge-offs:Real
      estate:Commercial
                    
                    
                    200,000
                    
                    
                    
                    843,527
                    
                    
                    
                    11,361Residential
                    
                    
                    -
                    
                    
                    
                    9,158
                    
                    
                    
                    3,157Commercial
      and industrial
                    
                    
                    144,690
                    
                    
                    
                    983,490
                    
                    
                    
                    5,757Consumer
                    
                    
                    76,483
                    
                    
                    
                    432,951
                    
                    
                    
                    63,728Total
                    
                    
                    421,173
                    
                    
                    
                    2,269,126
                    
                    
                    
                    84,003Recoveries:Real
      estate:Commercial
                    
                    
                    -
                    
                    
                    
                    2,075
                    
                    
                    
                    769Residential
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Commercial
      and industrial
                    
                    
                    2,849
                    
                    
                    
                    34,735
                    
                    
                    
                    6,818Consumer
                    
                    
                    21,310
                    
                    
                    
                    10,685
                    
                    
                    
                    3,823Total
                    
                    
                    24,159
                    
                    
                    
                    47,495
                    
                    
                    
                    11,410Net
      charge-offs
                    
                    
                    397,014
                    
                    
                    
                    2,221,631
                    
                    
                    
                    72,593Balance
      at end of period
                    
                    $
                    7,751,589
                    
                    
                    $
                    7,573,603
                    
                    
                    $
                    5,097,641Total
      loans, end of period
                    
                    $
                    434,257,867
                    
                    
                    $
                    431,919,023
                    
                    
                    $
                    426,269,981




As of and for the
                                    
                                    
                                    As of and for the
                                    
                                    
                                    As of and for thethree months ended
                                    
                                    
                                    twelve months ended
                                    
                                    
                                    three months endedMarch 31, 2010
                                    
                                    
                                    December 31, 2009
                                    
                                    
                                    March 31, 2009Net charge-offs to:Average
      loans
                                    
                                    
                                    0.09
                                    %
                                    
                                    
                                    0.51
                                    %
                                    
                                    
                                    0.02
                                    %Allowance
      for loan losses
                                    
                                    
                                    5.12
                                    %
                                    
                                    
                                    29.33
                                    %
                                    
                                    
                                    1.42
                                    %Provision
      for loan losses
                                    
                                    
                                    0.69
                                    x
                                    
                                    
                                    0.44
                                    x
                                    
                                    
                                    0.17
                                    xAllowance for loan losses
    to:Total
      loans
                                    
                                    
                                    1.79
                                    %
                                    
                                    
                                    1.75
                                    %
                                    
                                    
                                    1.20
                                    %Non-accrual
      loans
                                    
                                    
                                    0.70
                                    x
                                    
                                    
                                    0.61
                                    x
                                    
                                    
                                    0.70
                                    xNon-performing
      loans
                                    
                                    
                                    0.68
                                    x
                                    
                                    
                                    0.59
                                    x
                                    
                                    
                                    0.67
                                    xNet
      charge-offs
                                    
                                    
                                    19.52
                                    x
                                    
                                    
                                    3.41
                                    x
                                    
                                    
                                    70.22
                                    xLoans
      30-89 days past due and still accruing
                                    
                                    $
                                    6,770,142
                                    
                                    
                                    $
                                    5,173,394
                                    
                                    
                                    $
                                    3,911,373Loans
      90 days past due and accruing
                                    
                                    $
                                    255,290
                                    
                                    
                                    $
                                    554,806
                                    
                                    
                                    $
                                    341,404Non-accrual
      loans
                                    
                                    $
                                    11,099,264
                                    
                                    
                                    $
                                    12,329,338
                                    
                                    
                                    $
                                    7,236,780Allowance
      for loan losses to loans 90 days or more past due and
      accruing
                                    
                                    
                                    30.36
                                    x
                                    
                                    
                                    13.65
                                    x
                                    
                                    
                                    14.93
                                    x




- 27
-


Non-performing
assets




The
Company defines non-performing assets as accruing loans past due 90 days or
more, non-accrual loans, restructured loans, other real estate owned (ORE),
non-accrual securities and repossessed assets.  As of March 31, 2010,
non-performing assets represented 2.28% of total assets compared to 1.56% at
March 31, 2009.  The increase was driven by the higher level of
non-accrual loans and investment securities at March 31, 2010.




In the
review of loans for both delinquency and collateral sufficiency, management
concluded that there were a number of loans that lacked the ability to repay in
accordance with contractual terms.  The decision to place loans or
leases on a non-accrual status is made on an individual basis after considering
factors pertaining to each specific loan.  The commercial loans are
placed on non-accrual status when management has determined that payment of all
contractual principal and interest is in doubt or the loan is past due 90 days
or more as to principal and interest, unless well-secured and in the process of
collection.  Consumer loans secured by real estate are placed on
non-accrual status at 120 days past due as to principal and interest, and,
unsecured consumer loans are charged-off when the loan is 90 days or more past
due as to principal and interest.  Uncollected interest income accrued
on all non-accrual loans is reversed and charged to interest
income.




The
majority of the non-performing assets for the period were comprised of
non-accruing commercial business loans, non-accruing real estate loans,
non-accrual securities and ORE.  Most of the loans are collateralized,
thereby mitigating the Company’s potential for loss.  During the first
three months of 2010, $1,327,000 of corporate bonds consisting of pooled trust
preferred securities were moved to non-accrual status.  There were no
non-accrual securities prior to 2009.  For a further discussion on the
Company’s securities portfolio, see Note 3, “Investments Securities”, within the
notes to the consolidated financial statements and the section entitled
“Investments”, contained within this management discussion and analysis
section.  At March 31, 2010 non-performing loans were $11,355,000
reduced from $12,884,000 at December 31, 2009.  The reduction was
primarily a result of one non-accrual commercial loan relationship which repaid
the loan in full during the quarter.  There were no restructured loans
or repossessed assets at March 31, 2010 or at December 31, 2009.  ORE
at March 31, 2010 was $337,000 and consisted of two properties.  At
March 31, 2010, the non-accrual loans aggregated $11,099,000 as compared to
$12,329,000 at December 31, 2009.  Additions to the non-accrual loan
component of the non-performing assets totaling $3,168,000 were made during the
first three months of the year.   These were partially offset by
reductions or payoffs of $3,844,000, charge-offs of $405,000, and $149,000 of
loans that returned to performing status.  On June 1, 2010 real
property which is collateral for loans aggregating approximately $2,595,000 is
scheduled for a foreclosure sale.  Should the foreclosure sale result
in the bank taking ownership of one or more of these properties, it will result
in a reduction of  the non-accrual loan balance
and  recording of the ownership of the property as ORE at fair
value.  Loans past due 90 days or more and accruing were $255,000 at
March 31, 2010 and $555,000, at December 31, 2009.  Non-accrual
securities were $1,910,000 at March 31, 2010 and $583,000 at December 31,
2009.




Non-performing
loans to total loans were 2.61% at March 31, 2010, down from 2.98% at December
31, 2009.  The percentage of non-performing assets to total assets was
2.28% at March 31, 2010, also down from 2.58% at December 31, 2009, primarily
driven by the aforementioned decline in the non-accrual loans
component.




The 30-89
day past due loans at March 31, 2010 were $6,770,000 and $5,173,000 at December
31, 2009.  The rise in these past due loans was driven by increased
commercial and commercial real estate loan delinquencies as current economic
conditions are impacting our borrowers who continue to have difficulty servicing
their debt.  Approximately, $1,000,000 of these past due loans were
paid to fully current status shortly after the quarter-end.




- 28
-


The
following table sets forth non-performing assets data as of the period
indicated:




March 31, 2010
                
                
                December 31, 2009
                
                
                March 31, 2009Loans
      past due 90 days or more and accruing
                
                $
                255,290
                
                
                $
                554,806
                
                
                $
                341,404Non-accrual
      loans
                
                
                11,099,264
                
                
                
                12,329,338
                
                
                
                7,236,780Total
      non-performing loans
                
                
                11,354,554
                
                
                
                12,884,144
                
                
                
                7,578,184Other
      real estate owned
                
                
                337,397
                
                
                
                887,397
                
                
                
                1,236,716Non-accrual
      securities
                
                
                1,910,243
                
                
                
                583,390
                
                
                
                -Total
      non-performing assets
                
                $
                13,602,194
                
                
                $
                14,354,931
                
                
                $
                8,814,900Total
      loans including AFS
                
                $
                434,257,867
                
                
                $
                431,919,023
                
                
                $
                426,269,981Total
      assets
                
                $
                595,288,575
                
                
                $
                556,270,727
                
                
                $
                566,785,573Non-accrual
      loans to total loans
                
                
                2.56
                %
                
                
                2.85
                %
                
                
                1.70
                %Non-performing
      loans to total loans
                
                
                2.61
                %
                
                
                2.98
                %
                
                
                1.78
                %Non-performing
      assets to total assets
                
                
                2.28
                %
                
                
                2.58
                %
                
                
                1.56
                %







The
composition of gross loans and non-performing loans as of March 31, 2010
(dollars in thousands):




Gross
                  
                  
                  Past due 90
                  
                  
                  Non-
                  
                  
                  Total non-
                  
                  
                  % ofloan
                  
                  
                  days or more
                  
                  
                  accrual
                  
                  
                  performing
                  
                  
                  grossbalances
                  
                  
                  and still accruing
                  
                  
                  loans
                  
                  
                  loans
                  
                  
                  loansReal
      estate:Commercial
                  
                  $
                  180,708
                  
                  
                  $
                  103
                  
                  
                  $
                  5,598
                  
                  
                  $
                  5,701
                  
                  
                  
                  3.15
                  %Residential
                  
                  
                  69,896
                  
                  
                  
                  32
                  
                  
                  
                  3,979
                  
                  
                  
                  4,011
                  
                  
                  
                  5.74
                  %Construction
                  
                  
                  10,956
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Commercial
      and industrial
                  
                  
                  88,049
                  
                  
                  
                  -
                  
                  
                  
                  828
                  
                  
                  
                  828
                  
                  
                  
                  0.94
                  %Consumer
                  
                  
                  84,300
                  
                  
                  
                  120
                  
                  
                  
                  695
                  
                  
                  
                  815
                  
                  
                  
                  0.97
                  %Direct
      financing leases
                  
                  
                  349
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  434,258
                  
                  
                  $
                  255
                  
                  
                  $
                  11,100
                  
                  
                  $
                  11,355
                  
                  
                  
                  2.61
                  %





Bank premises and equipment,
net




A leased
branch building with leasehold improvements with a net book value of
approximately $625,000, as of March 31, 2010 is in the process of foreclosure by
the Company, the lien holder.  The property is scheduled for sheriff’s
sale on June 1, 2010.  If the property in question is not sold and the
Company takes ownership of the property as ORE, the leasehold improvements may
have to be written down to the property’s fair market value with a corresponding
charge to current earnings.




Foreclosedassets
held-for-sale




Foreclosed
assets held-for-sale, consisting of ORE, was $337,000 at March 31, 2010
comprised of two properties which are listed for sale with local
realtors.  The $550,000 decline in ORE from December 31, 2009 was from
the sale of one property.




Other assets and accrued
interest payable and other liabilities




Pending
receivable and obligation to purchase an agency security of $1,000,000 was the
principal cause of other assets to increase by $1,005,000, or 7%, and accrued
interest payable and other liabilities to increase $1,180,000, or 42%, from
December 31, 2009 to March 31, 2010.  The purchase obligation settled
in April 2010.




Deposits




The Bank
is a community-based commercial financial institution, member FDIC, which offers
a variety of deposit products with varying ranges of interest rates and terms.
Deposit products include savings, clubs, interest-bearing checking (NOW), money
market, non-interest-bearing checking (DDAs) and certificates of deposit
accounts. Certificates of deposit accounts, or CDs, are deposits with stated
maturities which can range from seven days to ten years. The flow of deposits is
significantly influenced by general economic conditions, changes in prevailing
interest rates, pricing and competition. To determine deposit product interest
rates, the Company considers local competition, spreads to earning-asset yields,
liquidity position and rates charged for alternative sources of funding such as
borrowings which include repurchase agreements. Though the Company tends to
experience intense competition for deposits, the interest rate setting strategy
also includes consideration of the Company’s balance sheet structure and cost
effective strategies that are mindful of the current economic
landscape.


- 29
-


Compared
to December 31, 2009 total deposits grew $27,563,000, or 6%, during the first
three months of 2010.  The growth in total deposits was due to
increases in DDA, NOW and savings accounts of $2,176,000, or 3%, $21,978,000, or
35% and $11,582,000, or 13%, respectively, partially offset by lower CD
balances.  Generally, deposits are obtained from consumers and
businesses within the communities that surround the Company’s 11 branch offices
and all deposits are insured by the FDIC up to the full extent permitted by
law.  In an effort to grow and retain core deposits, the Company
introduces innovative options to its variety of deposit products.  The
multi-tiered interest rate savings account developed in 2009 continues to grow
while NOW account balances have prospered from the seasonal influx of local
municipal tax deposits.  The Company will continue to provide superb
customer service and bring innovative ideas to the market in order to continue
to grow and retain deposits.




The
following table represents the components of deposits as of the date
indicated:




March 31, 2010
                
                
                December 31, 2009Amount
                
                
                %
                
                
                Amount
                
                
                %Money
      market
                
                $
                88,611
                
                
                
                18.2
                
                
                $
                91,488
                
                
                
                19.9NOW
                
                
                84,009
                
                
                
                17.3
                
                
                
                62,031
                
                
                
                13.5Savings
      and club
                
                
                97,917
                
                
                
                20.1
                
                
                
                86,335
                
                
                
                18.8Certificates
      of deposit
                
                
                133,200
                
                
                
                27.4
                
                
                
                139,502
                
                
                
                30.5CDARS
                
                
                9,754
                
                
                
                2.0
                
                
                
                8,748
                
                
                
                1.9Total
      interest-bearing
                
                
                413,491
                
                
                
                85.0
                
                
                
                388,104
                
                
                
                84.6Non-interest-bearing
                
                
                73,066
                
                
                
                15.0
                
                
                
                70,890
                
                
                
                15.4Total
      deposits
                
                $
                486,557
                
                
                
                100.0
                
                
                $
                458,994
                
                
                
                100.0




The
Company uses the Certificate of Deposit Account Registry Service (CDARS)
reciprocal program to obtain FDIC insurance protection for customers who have
large deposits that at times may exceed the FDIC maximum amount of
$250,000.  In the CDARS program, deposits with varying terms and
interest rates, originated in the Company’s own markets, are exchanged for
deposits of other financial institutions that are members in the CDARS
network.  By placing these deposits in other participating
institutions, the deposits of our customers are fully insured by the
FDIC.  In return for deposits placed with network institutions, the
Company receives from network institutions deposits that are approximately equal
in amount and contain similar terms as those placed for our
customers.  Deposits the Company receives, or reciprocal deposits,
from other institutions are considered brokered deposits by regulatory
definitions.




Excluding
CDARS, certificates of deposit accounts of $100,000 or more amounted to
$51,744,000 and $54,941,000 at March 31, 2010 and December 31, 2009,
respectively.  Certificates of deposit of $250,000 or more amounted to
$18,811,000 and $20,641,000 as of March 31, 2010 and December 31,
2009.




Including
CDARS, approximately 34% of the CDs are scheduled to mature in
2010.  Renewing CDs may re-price to lower or higher market rates
depending on the direction of interest rate movements, the shape of the yield
curve, competition, the rate profile of the maturing accounts and depositor
preference for alternative products.  In this current low interest
rate environment, CDs continue to experience non-renewal as depositor’s
preference is to hold funds from maturing certificates in readily available
deposit products such as savings accounts. To help reduce the negative impact of
the unpredictable interest rate environment, management deploys strategies that
diversify the deposit mix across the entire gamut of deposit
products.




Borrowings




Borrowings
are used as a complement to deposit generation as an alternative funding source
whereby the Bank will borrow under customer repurchase agreements in the local
market, advances from the Federal Home Loan Bank of Pittsburgh (FHLB) and other
correspondent banks for asset growth and liquidity needs.




Repurchase
agreements are non-insured interest-bearing liabilities that have a perfected
security interest in qualified investments of the Company.  The FDIC
Depositor Protection Act of 2009 requires banks to provide a perfected security
interest to the purchasers of uninsured repurchase
agreements.  Repurchase agreements are offered through a sweep
product.  A sweep account is designed to ensure that on a daily basis,
an attached DDA is adequately funded and excess funds are transferred, or swept,
into an interest-bearing overnight repurchase agreement account.  Due
to the constant flow of funds in to and out of the sweep product, their balances
tend to be somewhat volatile, mimicking the likes of a DDA deposit account.
Customer liquidity is the typical cause for variances in repurchase agreements,
which for the first three months of 2010 increased $8,977,000, or more than
doubled from December 31, 2009, due to a single commercial
customer.


- 30
-


The
components of borrowings as of March 31, 2010 and December 31, 2009 are as
follows (dollars in thousands):




March 31, 2010
                  
                  
                  December 31, 2009Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Overnight
      borrowings
                  
                  $
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  8,573
                  
                  
                  
                  17.7Repurchase
      agreements
                  
                  
                  16,724
                  
                  
                  
                  28.7
                  
                  
                  
                  7,747
                  
                  
                  
                  16.0Demand
      note, U.S. Treasury
                  
                  
                  146
                  
                  
                  
                  0.2
                  
                  
                  
                  213
                  
                  
                  
                  0.4FHLB
      advances:Short-term
                  
                  
                  9,500
                  
                  
                  
                  16.3
                  
                  
                  
                  -
                  
                  
                  
                  -Long-term
                  
                  
                  32,000
                  
                  
                  
                  54.8
                  
                  
                  
                  32,000
                  
                  
                  
                  65.9Total
      borrowings
                  
                  $
                  58,370
                  
                  
                  
                  100.0
                  
                  
                  $
                  48,533
                  
                  
                  
                  100.0




Total
borrowings have increased $9,837,000 or 20%, during three months ended March 31,
2010.  Growth in both deposits and repurchase agreements has reduced
the Company’s reliance on overnight funding needs.  The short-term
FHLB advance was to accommodate a short-term, match funded commercial loan with
a municipal customer.




Item 3.  Quantitative and Qualitative Disclosure About
Market Risk




Management of interest rate
risk and market risk analysis




The
Company is subject to the interest rate risks inherent in its lending, investing
and financing activities.  Fluctuations of interest rates will impact
interest income and interest expense along with affecting market values of all
interest-earning assets and interest-bearing liabilities, except for those
assets or liabilities with a short term remaining to
maturity.  Interest rate risk management is an integral part of the
asset/liability management process.  The Company has instituted
certain procedures and policy guidelines to manage the interest rate risk
position.  Those internal policies enable the Company to react to
changes in market rates to protect net interest income from significant
fluctuations.  The primary objective in managing interest rate risk is
to minimize the adverse impact of changes in interest rates on net interest
income along with creating an asset/liability structure that maximizes
earnings.




Asset/Liability
Management.  One major objective of the Company when managing
the rate sensitivity of its assets and liabilities is to stabilize net interest
income.  The management of and authority to assume interest rate risk
is the responsibility of the Company’s Asset/Liability Committee (ALCO), which
is comprised of senior management and members of the board of
directors.  ALCO meets quarterly to monitor the relationship of
interest sensitive assets to interest sensitive liabilities.  The
process to review interest rate risk is a regular part of managing the
Company.  Consistent policies and practices of measuring and reporting
interest rate risk exposure, particularly regarding the treatment of
non-contractual assets and liabilities, are in effect.  In addition,
there is an annual process to review the interest rate risk policy with the
board of directors which includes limits on the impact to earnings from shifts
in interest rates.




Interest Rate Risk Measurement.Interest rate risk is monitored through the use of three complementary
measures: static gap analysis, earnings at risk simulation and economic value at
risk simulation.  While each of the interest rate risk measurements
has limitations, taken together they represent a reasonably comprehensive view
of the magnitude of interest rate risk in the Company and the distribution of
risk along the yield curve, the level of risk through time and the amount of
exposure to changes in certain interest rate relationships.




Static Gap.  The
ratio between assets and liabilities re-pricing in specific time intervals is
referred to as an interest rate sensitivity gap.  Interest rate
sensitivity gaps can be managed to take advantage of the slope of the yield
curve as well as forecasted changes in the level of interest rate
changes.




To manage
this interest rate sensitivity gap position, an asset/liability model commonly
known as cumulative gap analysis is used to monitor the difference in the volume
of the Company’s interest-sensitive assets and liabilities that mature or
re-price within given time intervals. A positive gap (asset sensitive) indicates
that more assets will mature or re-price during a given period compared to
liabilities, while a negative gap (liability sensitive) has the opposite effect.
The Company employs computerized net interest income simulation modeling to
assist in quantifying interest rate risk exposure. This process measures and
quantifies the impact on net interest income through varying interest rate
changes and balance sheet compositions. The use of this model assists the ALCO
to gauge the effects of the interest rate changes on interest-sensitive assets
and liabilities in order to determine what impact these rate changes will have
upon the net interest spread. At March 31, 2010, the Bank maintained a one-year
cumulative gap of positive $28.5 million, or 4.78%, of total assets. The effect
of this positive gap position provided a mismatch of assets and liabilities
which may expose the Bank to interest rate risk during periods of falling
interest rates. Conversely, in an increasing interest rate environment, net
interest income could be positively impacted because more assets than
liabilities would re-price upward during the one-year period.


- 31
-


Certain
shortcomings are inherent in the method of analysis discussed above and
presented in the next table.  Although certain assets and liabilities
may have similar maturities or periods of re-pricing, they may react in
different degrees to changes in market interest rates.  The interest
rates on certain types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other types of assets
and liabilities may lag behind changes in market interest
rates.  Certain assets, such as adjustable-rate mortgages, have
features which restrict changes in interest rates on a short-term basis and over
the life of the asset.  In the event of a change in interest rates,
prepayment and early withdrawal levels may deviate significantly from those
assumed in calculating the table.  The ability of many borrowers to
service their adjustable-rate debt may decrease in the event of an interest rate
increase.




The
following table illustrates the Company’s interest sensitivity gap position at
March 31, 2010 (dollars in thousands):




Interest sensitivity gap at March 31, 2010Three months
                  
                  
                  Three to
                  
                  
                  One to
                  
                  
                  Overor less
                  
                  
                  twelve months
                  
                  
                  three years
                  
                  
                  three years
                  
                  
                  TotalCash
      and cash equivalents
                  
                  $
                  10,990
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  29,193
                  
                  
                  $
                  40,183Investment
      securities(1)(2)
                  
                  
                  19,503
                  
                  
                  
                  3,689
                  
                  
                  
                  27,197
                  
                  
                  
                  31,045
                  
                  
                  
                  81,434Loans
      (2)
                  
                  
                  126,751
                  
                  
                  
                  66,838
                  
                  
                  
                  108,863
                  
                  
                  
                  124,054
                  
                  
                  
                  426,506Fixed
      and other assets
                  
                  
                  -
                  
                  
                  
                  9,193
                  
                  
                  
                  -
                  
                  
                  
                  37,973
                  
                  
                  
                  47,166Total
      assets
                  
                  $
                  157,244
                  
                  
                  $
                  79,720
                  
                  
                  $
                  136,060
                  
                  
                  $
                  222,265
                  
                  
                  $
                  595,289Total
      cumulative assets
                  
                  $
                  157,244
                  
                  
                  $
                  236,964
                  
                  
                  $
                  373,024
                  
                  
                  $
                  595,289Non-interest
      bearing transaction deposits (3)
                  
                  $
                  -
                  
                  
                  $
                  7,306
                  
                  
                  $
                  20,094
                  
                  
                  $
                  45,666
                  
                  
                  $
                  73,066Interest-bearing
      transaction deposits (3)
                  
                  
                  90,201
                  
                  
                  
                  -
                  
                  
                  
                  67,966
                  
                  
                  
                  112,369
                  
                  
                  
                  270,536Time
      deposits
                  
                  
                  14,801
                  
                  
                  
                  58,831
                  
                  
                  
                  56,256
                  
                  
                  
                  13,067
                  
                  
                  
                  142,955Repurchase
      agreements
                  
                  
                  16,724
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  16,724Short-term
      borrowings
                  
                  
                  146
                  
                  
                  
                  9,500
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,646Long-term
      debt
                  
                  
                  -
                  
                  
                  
                  11,000
                  
                  
                  
                  -
                  
                  
                  
                  21,000
                  
                  
                  
                  32,000Other
      liabilities
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,996
                  
                  
                  
                  3,996Total
      liabilities
                  
                  $
                  121,872
                  
                  
                  $
                  86,637
                  
                  
                  $
                  144,316
                  
                  
                  $
                  196,098
                  
                  
                  $
                  548,923Total
      cumulative liabilities
                  
                  $
                  121,872
                  
                  
                  $
                  208,509
                  
                  
                  $
                  352,825
                  
                  
                  $
                  548,923Interest
      sensitivity gap
                  
                  $
                  35,372
                  
                  
                  $
                  (6,917
                  )
                  
                  $
                  (8,256
                  )
                  
                  $
                  26,167Cumulative
      gap
                  
                  $
                  35,372
                  
                  
                  $
                  28,455
                  
                  
                  $
                  20,199
                  
                  
                  $
                  46,366Cumulative
      gap to total assets
                  
                  
                  5.94
                  %
                  
                  
                  4.78
                  %
                  
                  
                  3.39
                  %
                  
                  
                  7.79
                  %








(1)
                Includes
      FHLB stock and the net unrealized gains/losses on securities
      AFS.


(2)
                Investments
      and loans are included in the earlier of the period in which interest
      rates were next scheduled to adjust or the period in which they are
      due.  In addition, loans are included in the periods in which
      they are scheduled to be repaid based on scheduled
      amortization.  For amortizing loans and MBS – GSE residential,
      annual prepayment rates are assumed reflecting historical experience as
      well as management’s knowledge and experience of its loan
      products.


(3)
              The
      Bank’s demand and savings accounts are generally subject to immediate
      withdrawal.  However, management considers a certain amount of
      such accounts to be core accounts having significantly longer effective
      maturities based on the retention experiences of such deposits in changing
      interest rate environments.  The effective maturities presented
      are the recommended maturity distribution limits for non-maturing deposits
      based on historical deposit
studies.




Earnings at Risk and Economic Value
at Risk Simulations.  The Company recognizes that more
sophisticated tools exist for measuring the interest rate risk in the balance
sheet that extend beyond static re-pricing gap analysis.  Although it
will continue to measure its re-pricing gap position, the Company utilizes
additional modeling for identifying and measuring the interest rate risk in the
overall balance sheet.  The ALCO is responsible for focusing on
“earnings at risk” and “economic value at risk”, and how both relate to the
risk-based capital position when analyzing the interest rate
risk.


- 32
-




Earnings at
Risk.  Earnings at risk simulation measures the change in net
interest income and net income should interest rates rise and
fall.  The simulation recognizes that not all assets and liabilities
re-price one-for-one with market rates (e.g., savings rate).  The ALCO
looks at “earnings at risk” to determine income changes from a base case
scenario under an increase and decrease of 200 basis points in interest rate
simulation models.




Economic Value at Risk.Earnings at risk simulation measures the short-term risk in the balance
sheet.  Economic value (or portfolio equity) at risk measures the
long-term risk by finding the net present value of the future cash flows from
the Company’s existing assets and liabilities.  The ALCO examines this
ratio quarterly utilizing an increase and decrease of 200 basis points in
interest rate simulation models.  The ALCO recognizes that, in some
instances, this ratio may contradict the “earnings at risk” ratio.




The
following table illustrates the simulated impact of 200 basis points upward or
downward movement in interest rates on net interest income, net income and the
change in the economic value (portfolio equity).  This analysis
assumes that interest-earning asset and interest-bearing liability levels at
March 31, 2010 remain constant.  The impact of the rate movements was
developed by simulating the effect of rates changing over a twelve-month period
from the March 31, 2010 levels:




Earnings at risk:
                        
                        Rates +200
                        
                        
                        Rates -200Percent
      change in:Net
      interest income
                        
                        
                        4.7
                        %
                        
                        
                        0.4
                        %Net
      income
                        
                        
                        18.3
                        
                        
                        
                        0.8Economic
      value at risk:Percent
      change in:Economic
      value of equity
                        
                        
                        (39.0
                        )
                        
                        
                        1.1Economic
      value of equityas a percent of book assets
                        
                        
                        (3.0
                        )
                        
                        
                        0.1




Economic
value has the most meaning when viewed within the context of risk-based
capital.  Therefore, the economic value may normally change beyond the
Company's policy guideline for a short period of time as long as the risk-based
capital ratio (after adjusting for the excess equity exposure) is greater than
10%.  As of March 31, 2010, the Company’s risk-based capital ratio was
11.6%.




The table
below summarizes estimated changes in net interest income over a twelve-month
period beginning April 1, 2010, under alternate interest rate scenarios using
the income simulation model described above (dollars in thousands):




Net interest
                    
                    
                    $
                    
                    
                    %Change in interest rates
                    
                    income
                    
                    
                    variance
                    
                    
                    variance+200
      basis points
                    
                    $
                    21,502
                    
                    
                    $
                    970
                    
                    
                    
                    4.7
                    %+100
      basis points
                    
                    
                    20,849
                    
                    
                    
                    317
                    
                    
                    
                    1.5Flat
      rate
                    
                    
                    20,532
                    
                    
                    
                    -
                    
                    
                    
                    --100
      basis points
                    
                    
                    20,899
                    
                    
                    
                    367
                    
                    
                    
                    1.8-200
      basis points
                    
                    
                    20,617
                    
                    
                    
                    85
                    
                    
                    
                    0.4




Simulation
models require assumptions about certain categories of assets and
liabilities.  The models schedule existing assets and liabilities by
their contractual maturity, estimated likely call date or earliest re-pricing
opportunity.  MBS – GSE residential securities and amortizing loans
are scheduled based on their anticipated cash flow including estimated
prepayments.  For investment securities, the Bank uses a third-party
service to provide cash flow estimates in the various rate
environments.  Savings, money market and NOW accounts do not have a
stated maturity or re-pricing term and can be withdrawn or re-priced at any
time.  This may impact the margin if more expensive alternative
sources of deposits are required to fund loans or deposit
runoff.  Management projects the re-pricing characteristics of these
accounts based on historical performance and assumptions that it believes
reflect their rate sensitivity.  The model reinvests all maturities,
repayments and prepayments for each type of asset or liability into the same
product for a new like term at current product interest rates provided by
management.  As a result, the mix of interest-earning assets and
interest bearing-liabilities is held constant.


- 33
-


Liquidity




Liquidity
management ensures that adequate funds will be available to meet customers’
needs for borrowings, deposit withdrawals and maturities and normal operating
expenses of the Company. Current sources of liquidity are cash and cash
equivalents, asset maturities and pay-downs within one year, loans and
investments AFS, growth of core deposits, growth of repurchase agreements,
increases of other borrowed funds from correspondent banks and issuance of
capital stock. Although regularly scheduled investment and loan payments are a
dependable source of daily funds, the sales of both loans and investments AFS,
deposit activity and investment and loan prepayments are significantly
influenced by general economic conditions and the interest rate environment.
During a declining interest rate environment, prepayments from
interest-sensitive assets tend to accelerate and provide significant liquidity
which can be used to invest in other interest-earning assets but at lower market
rates. Conversely, in a period of rising interest rates, prepayments from
interest-sensitive assets tend to decelerate causing cash flow from mortgage
loans and the MBS–GSE residential securities portfolio to decrease. Rising
interest rates may also cause deposit inflow to accelerate and be invested at
higher market interest rates. The Company closely monitors activity in the
capital markets and takes appropriate action to ensure that the liquidity levels
are adequate for funding, investing and operating activities.




For the
three months ended March 31, 2010, the Company generated approximately $31.9
million of cash. During the quarter, the Company’s financing activities provided
$37.2 million, primarily from deposit growth of $27.8 million and a
match-funded, short-term borrowing of $9.5 million to finance a loan to one of
the Company’s municipal customers. Also, during this period, the Company’s
operations provided approximately $2.7 million primarily from the sales of
mortgages AFS net of originations and from increased net
income.  $20.7 million of the proceeds from financing, operations and
security pay offs were used to fund growth in the loan portfolio, purchase new
securities and facility improvements.




As of
March 31, 2010, the Company maintained $40.2 million in cash and cash
equivalents and $81.1 million of investments and loans AFS.  In
addition, as of March 31, 2010, the Company had approximately $124.6 million
available to borrow from the FHLB, $21.0 million available from other
correspondent banks, $24.6 million from the Discount Window of the Federal
Reserve Bank and $29.8 million with CDARS.  This combined total of
$321.3 million represented 54% of total assets at March 31,
2010.  Management believes this level of liquidity to be strong and
adequate to support current operations.




During
April 2010, the FHLB informed the Company of a 50% collateral maintenance
requirement on outstanding obligations and restrictions on utilization above 35%
of the amount available to borrow.  The Company is formulating
strategies to improve its position and have the requirements
lifted.  The requirements only impose more stringent collateral
delivery requirements and utilization subject to prior credit committee
decision-making and does not minimize or reduce the amount the Company may
borrow.  Management does not consider this action to significantly
effect the liquidity position of the Company.




Capital




During
the first quarter of 2010, total shareholders' equity increased $691,000, or
2%.  The increase was primarily caused by first quarter net income of
$556,000, $67,000 in proceeds from employees enrolled in the Company’s Employee
Stock Purchase Plan, a $334,000 net of tax, improvement in the market value of
the AFS securities portfolio, net of $896,000 in non-credit related OTTI,
partially offset by $273,000 of dividends paid to shareholders, net of dividends
reinvested and optional cash payments received from participants in the
Company’s Dividend Reinvestment Plan.




As of
March 31, 2010, the Company reported a net unrealized loss of $8,861,000, net of
tax, from the securities AFS compared to a net unrealized loss of $9,194,000 as
of December 31, 2009.  While the unrealized loss position has
improved, the prolonged economic downturn continues to assert uncertainty and in
certain circumstances illiquidity in the financial and capital markets and has
had a sizable negative impact on the fair value estimates on the securities in
banks’ investment portfolios.  Management maintains these changes are
due mainly to liquidity problems in the financial markets and to a lesser extent
the deterioration in the creditworthiness of the issuers.




The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements administered by the federal banking
agencies.  Failure to meet minimum capital requirements can initiate
certain mandatory and possible additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Company’s and
the Bank’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
their 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.  Prompt corrective
action provisions are not applicable to bank holding companies.




Under
these guidelines, assets and certain off-balance sheet items are assigned to
broad risk categories, each with appropriate weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and
certain off-balance sheet items. The appropriate risk-weighting, pursuant to
regulatory guidelines, required an increase in the risk-weighting of securities
that were recently rated below investment grade, thus significantly inflating
the total risk-weighted assets. The regulatory guidelines require all banks and
bank holding companies to maintain a minimum ratio of total risk-based capital
to total risk-weighted assets (Total Risk Adjusted Capital) of 8%, including
Tier I capital to total risk-weighted assets (Tier I Capital) of 4% and Tier I
capital to average total assets (Leverage Ratio) of at least 4%. As of March 31,
2010, the Company and the Bank met all capital adequacy requirements to which it
was subject.


- 34
-


The
Company continues to closely monitor and evaluate alternatives to enhance its
capital ratios as the regulatory and economic environments
change.  The following table depicts the capital amounts and ratios of
the Company and the Bank as of March 31, 2010:




To be well capitalizedFor capital
                                                                      
                                                                      
                                                                      
                                                                      under prompt correctiveActual
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      adequacy purposes
                                                                      
                                                                      
                                                                      
                                                                      action provisionsAmount
                                                                      
                                                                      
                                                                      Ratio
                                                                      
                                                                      
                                                                      
                                                                      Amount
                                                                      
                                                                      
                                                                      
                                                                      Ratio
                                                                      
                                                                      
                                                                      
                                                                      Amount
                                                                      
                                                                      
                                                                      
                                                                      RatioTotal
      capital(to
      risk-weighted assets)Consolidated
                                                                      
                                                                      $
                                                                      61,896,123
                                                                      
                                                                      
                                                                      
                                                                      11.6
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      42,872,207
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      8.0
                                                                      %
                                                                      
                                                                      
                                                                      
                                                                      N/A
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      N/ABank
                                                                      
                                                                      $
                                                                      61,497,188
                                                                      
                                                                      
                                                                      
                                                                      11.5
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      42,861,974
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      8.0
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      53,577,467
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      10.0
                                                                      %Tier
      I capital(to
      risk-weighted assets)Consolidated
                                                                      
                                                                      $
                                                                      55,140,364
                                                                      
                                                                      
                                                                      
                                                                      10.3
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      21,436,104
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      4.0
                                                                      %
                                                                      
                                                                      
                                                                      
                                                                      N/A
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      N/ABank
                                                                      
                                                                      $
                                                                      54,786,798
                                                                      
                                                                      
                                                                      
                                                                      10.2
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      21,430,987
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      4.0
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      32,146,480
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      6.0
                                                                      %Tier
      I capital(to
      average assets)Consolidated
                                                                      
                                                                      $
                                                                      55,140,364
                                                                      
                                                                      
                                                                      
                                                                      9.4
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      23,527,877
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      4.0
                                                                      %
                                                                      
                                                                      
                                                                      
                                                                      N/A
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      N/ABank
                                                                      
                                                                      $
                                                                      54,786,798
                                                                      
                                                                      
                                                                      
                                                                      9.3
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      23,511,174
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      4.0
                                                                      %
                                                                      ≥
                                                                      
                                                                      $
                                                                      29,388,967
                                                                      
                                                                      ≥
                                                                      
                                                                      
                                                                      5.0
                                                                      %




Item 4T.  Controls and Procedures




As of the
end of the period covered by this Quarterly Report on Form 10-Q, an evaluation
was carried out by the Company’s management, with the participation of its
Interim President and Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the Company’s disclosure controls and procedures, as
defined in Rule 13a-15(e) under the Securities Exchange Act of
1934.  Based on such evaluation, the Interim President and Chief
Executive Officer and Chief Financial Officer concluded that the Company’s
disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports the Company files or furnishes under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and regulations, and are
operating in an effective manner.  The Company made no significant
changes in its internal controls over financial reporting or in other factors
that materially affected, or are reasonably likely to materially affect, these
controls during the last fiscal quarter ended March 31, 2010.




PART II - Other Information




Item 1.  Legal Proceedings




The
nature of the Company’s business generates some litigation involving matters
arising in the ordinary course of business.  However, in the opinion
of the Company after consultation with legal counsel, no legal proceedings are
pending, which, if determined adversely to the Company or the Bank, would have a
material effect on the Company’s undivided profits or financial
condition.  No legal proceedings are pending other than ordinary
routine litigation incidental to the business of the Company and the
Bank.  In addition, to management’s knowledge, no governmental
authorities have initiated or contemplated any material legal actions against
the Company or the Bank.





Item 1A.  Risk Factors




Management
of the Company does not believe there have been any material changes in risk
factors that were disclosed in the 2009 Form 10-K filed with the Securities and
Exchange Commission on March 8, 2010.




Item 2.  Unregistered Sales of Equity Securities and Use
of Proceeds




None




Item 3.  Default Upon Senior Securities




None




Item 4.  (Removed and Reserved)




None




Item 5.  Other Information




None




- 35
-




Item 6.  Exhibits




The
following exhibits are filed herewith or incorporated by reference as a part of
this Form 10-Q:




3(i) Amended and
Restated Articles of Incorporation of Registrant.Incorporated by
reference to Annex B of the Proxy Statement/Prospectus included in Registrant’s
Amendment 4 to its Registration Statement No. 333-90273 on Form S-4, filed with
the SEC on April 6, 2000.




3(ii) Amended and
Restated Bylaws of Registrant.Incorporated by reference to Exhibit 3(ii)
to Registrant’s Form 8-K filed with the SEC on November 21, 2007.




*10.1 1998
Independent Directors Stock Option Plan of The Fidelity Deposit and Discount
Bank, as assumed by Registrant.Incorporated by reference to Exhibit 10.1
to Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the
SEC on November 3, 1999.




*10.2 1998 Stock
Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by
Registrant.Incorporated by reference to Exhibit 10.2 of Registrant’s
Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November
3, 1999.




*10.3
Registrant’s 2000 Dividend Reinvestment Plan.Incorporated by reference to Exhibit 4
to Registrant’s Registration Statement No. 333-45668 on Form S-1, filed with the
SEC on September 12, 2000 and as amended by Pre-Effective Amendment No. 1 on
October 11, 2000, by Post-Effective Amendment No. 1 on May 30, 2001, by
Post-Effective Amendment No. 2 on July 7, 2005, by Registration Statement No.
333-152806 on Form S-3 filed on August 6, 2008 and by Post-Effective
Amendment No. 1 on January 25, 2010.




*10.4 Registrant’s
2000 Independent Directors Stock Option Plan.Incorporated by
reference to Exhibit 4.3 to Registrant’s Registration Statement No. 333-64356 on
Form S-8 filed with the SEC on July 2, 2001.




*10.5 Amendment,
dated October 2, 2007, to the Registrant’s 2000 Independent Directors Stock
Option Plan.Incorporated by reference to Exhibit 10.2 to
Registrant’s Form 8-K filed with the SEC on October 4, 2007.




*10.6 Registrant’s
2000 Stock Incentive Plan.Incorporated by reference to
Exhibit 4.4 to Registrant’s Registration Statement No. 333-64356 on Form S-8
filed with the SEC on July 2, 2001.




*10.7 Amendment,
dated October 2, 2007, to the Registrant’s 2000 Stock Incentive
Plan.Incorporated by reference to Exhibit 10.1 to
Registrant’s Form 8-K filed with the SEC on October 4, 2007.




*10.8 Registrant’s
2002 Employee Stock Purchase Plan.Incorporated by reference
to Exhibit 4.4 to Registrant’s Registration Statement No. 333-113339 on Form S-8
filed with the SEC on March 5, 2004.




*10.9 Change of
Control Agreements with Salvatore R. DeFrancesco, Registrant and The Fidelity
Deposit and Discount Bank, dated March 21, 2006.Incorporated
by reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed
with the SEC on March 27, 2006.




*10.10 Amended and
Restated Executive Employment Agreement between Fidelity D & D Bancorp,
Inc., The Fidelity Deposit and Discount Bank and Steven C. Ackmann, dated July
11, 2007.Incorporated by
reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with
the SEC on July 13, 2007.




*10.11 Executive
Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity
Deposit and Discount Bank and Timothy P.
O’Brien, dated January 3, 2008.Incorporated by reference to
Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with the SEC on
January 10, 2008.




*10.12 Executive
Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity
Deposit and Discount Bank and Daniel J.
Santaniello, dated February 28, 2008.Incorporated by
reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with
the SEC on March 3, 2008.




*10.13 Release
Agreement between Steven C. Ackmann, Registrant and The Fidelity Deposit and
Discount Bank, dated August 31, 2009.  Incorporated by
reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with
the SEC on September 8, 2009.




*10.14 Consulting
Agreement between Steven C. Ackmann, former President and Chief Executive
Officer of the Registrant and The Fidelity Deposit and Discount Bank, and The
Fidelity Deposit and Discount Bank, dated September 1, 2009.  Incorporated by
reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with
the SEC on September 8, 2009.




- 36
-




11Statement
regarding computation of earnings per share.  Included herein
in Note No. 4, “Earnings per share,” contained within the Notes to Consolidated
Financial Statements, and incorporated herein by reference.




31.1
Rule 13a-14(a) Certification of Principal Executive Officer, filed
herewith.




31.2
Rule 13a-14(a) Certification of Principal Financial Officer, filed
herewith.




32.1
Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
herewith.




32.2
Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
herewith.







*Management
contract or compensatory plan or arrangement.


- 37
-





Signatures





FIDELITY
D & D BANCORP, INC.





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





FIDELITY
      D & D BANCORP, INC.Date:
      May 10, 2010
            /s/ Patrick J. DempseyPatrick
      J. Dempsey,Interim
      President and Chief Executive OfficerDate:
      May 10, 2010
            /s/ Salvatore R. DeFrancesco,
      Jr.Salvatore
      R. DeFrancesco, Jr.,Treasurer
      and Chief Financial Officer


- 38
-





EXHIBIT
INDEX


Page3(i)
      Amended and Restated Articles of Incorporation of Registrant.Incorporated by reference to Annex B of the Proxy
      Statement/Prospectus included in Registrant’s Amendment 4 to its
      Registration Statement No. 333-90273 on Form S-4, filed with the SEC on
      April 6, 2000.
                      
                      *3(ii)
      Amended and Restated Bylaws of Registrant.Incorporated by
      reference to Exhibit 3(ii) to Registrant’s Form 8-K filed with the SEC on
      November 21, 2007.
                      
                      *10.1 1998
      Independent Directors Stock Option Plan of The Fidelity Deposit and
      Discount Bank, as assumed by Registrant.Incorporated by reference
      to Exhibit 10.1 to Registrant’s Registration Statement No. 333-90273 on
      Form S-4, filed with the SEC on November 3, 1999.
                      
                      *10.2 1998
      Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed
      by Registrant.Incorporated by reference to Exhibit 10.2 of
      Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with
      the SEC on November 3, 1999.
                      
                      *10.3
      Registrant’s 2000 Dividend Reinvestment Plan.Incorporated
      by reference to Exhibit 4 to Registrant’s Registration Statement No.
      333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as
      amended by Pre-Effective Amendment No. 1 on October 11, 2000, by
      Post-Effective Amendment No. 1 on May 30, 2001, by Post-Effective
      Amendment No. 2 on July 7, 2005 and by Registration Statement No.
      333-152806 on Form S-3 filed on August 6, 2008 and by Post-Effective
      Amendment No. 1 on January 25, 2010.
                      
                      *10.4
      Registrant’s 2000 Independent Directors Stock Option
      Plan.Incorporated by reference to Exhibit 4.3 to
      Registrant’s Registration Statement No. 333-64356 on Form S-8 filed with
      the SEC on July 2, 2001.
                      
                      *10.5
      Amendment, dated October 2, 2007, to the Registrant’s 2000 Independent
      Directors Stock Option Plan.Incorporated by reference
      to Exhibit 10.2 to Registrant’s Form 8-K filed with the SEC on October 4,
      2007.
                      
                      *10.6
      Registrant’s 2000 Stock Incentive Plan.Incorporated by
      reference to Exhibit 4.4 to Registrant’s Registration Statement No.
      333-64356 on Form S-8 filed with the SEC on July 2, 2001.
                      
                      *10.7
      Amendment, dated October 2, 2007, to the Registrant’s 2000 Stock Incentive
      Plan.Incorporated by reference to Exhibit 10.1 to
      Registrant’s Form 8-K filed with the SEC on October 4,
    2007.
                      
                      *10.8
      Registrant’s 2002 Employee Stock Purchase
      Plan.Incorporated by reference to Exhibit 4.4 to
      Registrant’s Registration Statement No. 333-113339 on Form S-8 filed with
      the SEC on March 5, 2004.
                      
                      *10.9 Change
      of Control Agreements with Salvatore R. DeFrancesco, Registrant and The
      Fidelity Deposit and Discount Bank, dated March 21,
      2006.Incorporated by reference to Exhibit 99.2 to
      Registrant’s Current Report on Form 8-K filed with the SEC on March 27,
      2006.
                      
                      *10.10
      Amended and Restated Executive Employment Agreement between Fidelity D
      & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Steven
      C. Ackmann, dated July 11, 2007.Incorporated by
      reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed
      with the SEC on July 13, 2007.
                      
                      *10.11
      Executive Employment Agreement between Fidelity D & D Bancorp, Inc.,
      The Fidelity Deposit and Discount Bank and Timothy
      P. O’Brien, dated January 3, 2008.Incorporated by
      reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed
      with the SEC on January 10, 2008.
                      
                      *10.12
      Executive Employment Agreement between Fidelity D & D Bancorp, Inc.,
      The Fidelity Deposit and Discount Bank and Daniel J. Santaniello, dated
      February 28, 2008.Incorporated by reference to Exhibit
      10.1 to Registrant’s Current Report on Form 8-K filed with the SEC on
      March 3, 2008.
                      
                      *10.13
      Release Agreement between Steven C. Ackmann, Registrant and The Fidelity
      Deposit and Discount Bank, dated August 31,
      2009.Incorporated by reference to Exhibit 99.1 to
      Registrant’s Current Report on Form 8-K filed with the SEC on September 8,
      2009.
                      
                      *10.14
      Consulting Agreement between Steven C. Ackmann, former President and Chief
      Executive Officer of the Registrant and The Fidelity Deposit and Discount
      Bank, and The Fidelity Deposit and Discount Bank, dated September 1,
      2009.  Incorporated by reference to Exhibit 99.2 to
      Registrant’s Current Report on Form 8-K filed with the SEC on September 8,
      2009.
                      
                      *




- 39
-





11
      Statement
      regarding computation of earnings per share.
                
                1331.1
      Rule 13a-14(a) Certification of Principal Executive
    Officer.
                
                4131.2
      Rule 13a-14(a) Certification of Principal Financial
    Officer.
                
                4232.1
      Certification of Principal Executive Officer pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
                
                4332.2
      Certification of Principal Financial Officer pursuant to 18 U.S.C. Section
      1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
                
                44





*
Incorporated by Reference


- 40
-